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Principles of Managerial Finance: Time Value of Money
Principles of Managerial Finance: Time Value of Money
Managerial Finance
9th Edition
Chapter 5
Question?
Would it be better for a company to invest
$100,000 in a product that would return a total of
$200,000 in one year, or one that would return
$500,000 after two years?
The Role of Time Value in Finance
• Most financial decisions involve costs & benefits that
are spread out over time.
• Time value of money allows comparison of cash flows
from different periods.
Answer!
It depends on the interest rate!
Basic Concepts
• Future Value: compounding or growth over time
considered
• Use Spreadsheets
Computational Aids
Computational Aids
Computational Aids
Computational Aids
Simple Interest
With simple interest, you don’t earn interest on
interest.
• k = interest rate
On Excel
Annually Sem iAnnually Quarterly Monthly
PV $ 100.00 $ 100.00 $ 100.00 $ 100.00
k 12.0% 0.06 0.03 0.01
n 5 10 20 60
FV $176.23 $179.08 $180.61 $181.67
Continuous Compounding
• With continuous compounding the number of
compounding periods per year approaches infinity.
• Through the use of calculus, the equation thus
becomes:
EAR = (1 + k/m) m -1
Nominal & Effective Rates
• For example, what is the effective rate of interest on
your credit card if the nominal rate is 18% per year,
compounded monthly?
EAR = (1 + .18/12) 12 -1
EAR = 19.56%
Present Value
• Present value is the current dollar value of a future
amount of money.
• It is based on the idea that a dollar today is worth
more than a dollar tomorrow.
• It is the amount today that must be invested at a given
rate to reach a future amount.
• It is also known as discounting, the reverse of
compounding.
• The discount rate is often also referred to as the
opportunity cost, the discount rate, the required return,
and the cost of capital.
Present Value Example
Algebraically and Using PVIF Tables
PV = $1,000/.08 = $12,500
Loan Amortization
Determining Interest or Growth Rates
• At times, it may be desirable to determine the
compound interest rate or growth rate implied by a
series of cash flows.
• For example, you invested $1,000 in a mutual fund in
1994 which grew as shown in the table below?
1994 $ 1,000 It is first important to note
1995 1,127
that although there are 7
1996 1,158
years show, there are only 6
1997 2,345
time periods between the
1998 3,985
initial deposit and the final
1999 4,677
value.
2000 5,525
Determining Interest or Growth Rates
• At times, it may be desirable to determine the
compound interest rate or growth rate implied by a
series of cash flows.
• For example, you invested $1,000 in a mutual fund in
1994 which grew as shown in the table below?
1994 $ 1,000
1995 1,127 Thus, $1,000 is the present
1996 1,158 value, $5,525 is the future
1997 2,345 value, and 6 is the number
1998 3,985 of periods. Using Excel,
1999 4,677 we get:
2000 5,525
Determining Interest or Growth Rates
• At times, it may be desirable to determine the
compound interest rate or growth rate implied by a
series of cash flows.
• For example, you invested $1,000 in a mutual fund in
1994 which grew as shown in the table below?
1994 $ 1,000
1995 1,127 PV $ 1,000
1996 1,158
1997 2,345
FV $ 5,525
1998 3,985 n 6
1999 4,677 k? 33.0%
2000 5,525
Determining Interest or Growth Rates
• At times, it may be desirable to determine the
compound interest rate or growth rate implied by a
series of cash flows.
• For example, you invested $1,000 in a mutual fund in
1994 which grew as shown in the table below?
1994 $ 1,000
1995 1,127 Excel Function
1996 1,158
1997 2,345 =Rate(periods, pmt, PV, FV)
1998 3,985
1999 4,677 =Rate(6, ,1000, 5525)
2000 5,525