Professional Documents
Culture Documents
Chapter 5
Time Value of Money
• Computational Tools
– Financial Calculators
– Electronic Spreadsheets
– Cash Flow Signs
To provide a correct answer, financial calculators and
electronic spreadsheets require that a calculation’s relevant
cash flows be entered accurately as cash inflows or cash
outflows
Cash inflows are indicated by entering positive values
Cash outflows are indicated by entering negative values
FVn
PV0 (5.2)
(1 r ) n
1 r n 1
FVn CF1 (5.3)
r
[(1 0.07)5 1]
FV5 $1, 000 $5, 750.74
0.07
CF1 1
PV0 1 n
(5.4)
r 1 r
1 r n 1
FVn CF0 (1 r ) (5.5)
r
CF0 1
PV0 1 n
(1 r ) (5.6)
r 1 r
– Growing Perpetuity
An annuity with an infinite life, providing continual annual cash
flow, with the cash flow growing at a constant annual rate
CF1
PV0 (5.8)
rg
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Personal Finance Example 5.11 (1 of 2)
Ross Clark wishes to endow a chair in finance at his alma
mater. In other words, Ross wants to make a lump sum
donation today that will provide an annual stream of cash
flows to the university forever. The university indicated that
the annual cash flow required to support an endowed chair is
$400,000 and that it will invest money Ross donates today in
assets earning a 5% return. If Ross wants to give money
today so that the university will begin receiving annual cash
flows next year, how large must his contribution be? To
determine the amount Ross must give the university to fund
the chair, we must calculate the present value of a $400,000
perpetuity discounted at 5%.
$400, 000
PV0 $13,333,333
0.05 0.02
22
0.08
FV2 $100 1 $100 (1 0.04) 4 $116.99
2
42
0.08
FV2 $100 1 $100 (1 0.02)8 $117.17
4
These results agree with the values for FV2 in Tables 5.4 and
5.5.
m
r
EAR 1 1 (5.11)
m
1
0.08 1
EAR 1 1 (1 0.08) 1 1 0.08 1 0.08 8%
1
4
0.08 4
EAR 1 1 (1 0.02) 1 1.0824 1 0.0824 8.24%
4
1 r n 1
(5.12)
CF1 FVn
r
• Loan Amortization
– The determination of the equal periodic loan payments
necessary to provide a lender with a specified interest return
and to repay the loan principal over a specified period
– Loan Amortization Schedule
A schedule of equal payments to repay a loan
It shows the allocation of each loan payment to interest and
principal
1
CF1 PV0 r 1 n
(5.13)
1 r
FVn
log
PV0
n (5.15)
log 1 r
$2,500
log 0.39794
$1, 000
n 11.9
log(1.08) 0.03342