time value of money.ppt
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1、time value of money2Time Value Related Questions Why is a dollar today worth more than a dollar tomorrow? How do we compute the present value of a future sum of money? How do we compute the present value of a stream of future cash flows? Why is the concept of time value of money important?3Definitio
2、ns Time Value of Money-Money has a time value as long as interest can be earned by saving or investing it. Present Value (PV) -The value today of a given future amount of money, or a series of cash flows, when discounted at a given discount rate.4Definitions Future Value (FV) - The amount to which a
3、 lump sum, or series of cash flows, will grow when compounded at a given interest rate. Compounding is the process of accumulating interest in an investment over time to earn more interest.5Definitions Compound Interest-interest earned on both the initial investment (principal) and the interest rein
4、vested from prior periods. Simple Interest-interest earned only on the original principal amount invested6Definitions Discount Rate ( r ) - is the rate applied in order to discount future cash flows. Growth Rate ( r ) is the rate of interest or growth rate applied to find the future value of cash fl
5、ows. The number of Compounding periods (n). 7SINGLE AMOUNT Consider only two cash flows, one at the beginning and one at the end of the period. Application - place some money in your saving account today and withdraw the proceeds in the future. Questions - How much is there to withdraw?8Cash Flow Ti
6、ming Diagram$PV$FV01Year9A Simple Situation Assume your bank pays you 6% per year in interest on your saving account. You deposited $1,000 in your account today. How much do you have at the end of one year?10Interest Compounding We have assumed interest is paid once at the end of the year. Now assum
7、e that interest is paid every six months. That is interest is compounded semi-annually. How much money do you have at the end of the year?11Compounding Interest rate is normally stated in an annual basis. Thus 6 % annually is 3 % semi-annually. The 3 % rate is called the periodic rate. Periodic Rate
8、 = Annual Rate / number of compounding periods per year. Total number of Compounding Periods ( n) is the number of years times the number of compounding periods per year.12Interest Compounding How much more do you have if interest is compounded semiannually rather than annually? Why?13Interest Compo
9、unding If interest is compounded semi-annually, you receive $30 of interest at the end of the six months; therefore, your principal will increase to $1,030. During the last 6 months of the year you receive interest on original principal of $1,000 and the interest of $30. Thus, the total interest ear
10、ned is: $60.91 rather than just $60 without compounding.14General Formula FV = PV (1 + r )nWhere, r is the periodic interest rate or growth rate (may not be the same as annual rate of interest or growth rate). The number of compounding period (n) may not be the same as the number of years.15Periodic
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