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02 - The Time Value of Money
02 - The Time Value of Money
Money
Future Value
and Compounding
The future value (FV) is the amount to
which an investment will grow after
earning interest.
Future Value
and Compounding
If you invest $ today at an interest rate of r,
you will have $ + $(r) = $(1 + r) in one
year.
Example 1: $100 at 10% interest per year
gives $100(1.1) = $110.
Future Value
and Compounding
Reinvesting the interest, we earn interest
on interest, i.e., compounding FV = $(1 +
r)(1 + r) = $(1 + r)2
Example 2: $100 at 10% interest per year
for 2 years gives $100(1.1)(1.1) =
$100(1.1)2 = $121.
Future Value
and Compounding
In general, for t periods, FV = $(1 + r)t
where (1 + r)t is the compound interest
or interest earned on interest at the rate, r,
for t periods.
It is also called future value interest
factor, FVIF(r,t).
Future Value
and Compounding
Example 3: $100 at 10% interest per year
for 10 years gives $100(1.1)10 = $259.37.
Future Value
and Compounding
Interest can be compounded more than
once a year.
In such cases, the formula for FV
becomes: FV = $ (1 + (r / m))t x m, where m
is the number of total compounding
periods in a year.
Future Value
and Compounding
Example 4: $100 at 10% interest per year
compounded semi-annually for 3 years
gives $100(1+(0.10 / 2))3 x 2 = $100(1 +
0.5)6 = $134.
Present Value
and Discounting
The value today of a future cash flow is
called the present value (PV).
Remember that FV = $(1 + r).
Rearrange and solve for $, which is the
present value.
Therefore, PV = FV / (1 + r).
Present Value
and Discounting
Example 5: $110 in 1 period with an
interest rate of 10% has a PV = $110 /
(1.1) = $100.
Present Value
and Discounting
PV of future amount in t periods at r is: PV
= FV [1 / (1 + r)t] where [1 / (1 + r)t] is the
discount factor, or the present value
interest factor, PVIF(r,t).
Present Value
and Discounting
Example 6: If you have $259.37 in 10
periods and the interest rate was 10%,
how much did you deposit initially?
PV = $259.37 [1/(1.1)10] = $259.37(.3855)
= $100
Present Value
and Discounting
Present values are directly related to the
future cash flows and inversely related to
the discount rate, r, and time, t.
The higher the future cash flows, the
higher the PV; the higher the discount
rate and longer the term, the lower the
PV.
More on Present
and Future Values
• Present
Value versus Future Value.
Present value interest factors are
reciprocals of future value interest factors:
More on Present
and Future Values
• Example
7: FVIF(10%,4) = 1.14 = 1.464;
PVIF(10%,4) = 1 / 1.14 = 0.683
Basic present value equation:
(SciCal)
(SciCal)
More on Present
and Future Values
Present value. To compute the present
value using an electronic spreadsheet, the
syntax of the function is:
=PV(rate, nper, pmt, fv, type)
More on Present
and Future Values
Present value. To compute the present
value using an electronic spreadsheet, the
syntax of the function is:
=PV(rate, nper, pmt, fv, type)
where: =PV() is the present value function
More on Present
and Future Values
Present value. To compute the present
value using an electronic spreadsheet, the
syntax of the function is:
=PV(rate, nper, pmt, fv, type)
where: rate is the periodic interest rate
More on Present
and Future Values
Present value. To compute the present
value using an electronic spreadsheet, the
syntax of the function is:
=PV(rate, nper, pmt, fv, type)
where: nper is the total number of
payment periods
More on Present
and Future Values
Present value. To compute the present
value using an electronic spreadsheet, the
syntax of the function is:
=PV(rate, nper, pmt, fv, type)
where: pmt is the payment made each
period
More on Present
and Future Values
Present value. To compute the present
value using an electronic spreadsheet, the
syntax of the function is:
=PV(rate, nper, pmt, fv, type)
where: fv [optional] is the future value
More on Present
and Future Values
Present value. To compute the present
value using an electronic spreadsheet, the
syntax of the function is:
=PV(rate, nper, pmt, fv, type)
where: type [optional] refers to when
payments are due (0 = end of period, 1 =
beginning of period)
Present Value
and Discounting
Example 6: If you have $259.37 in 10
periods and the interest rate was 10%,
how much did you deposit initially?
Using Example 6 for the simple present
value, the syntax to get $100 is
=PV(10%,10,0,259.37,0).
Present Value
and Discounting
Example 6: If you have $259.37 in 10
periods and the interest rate was 10%,
how much did you deposit initially?
Using Example 6 for the simple present
value, the syntax to get $100 is
=PV(10%,10,0,259.37,0).
PV is negative, since it’s a cash outflow.
More on Present
and Future Values
Future value. To compute the future value
using an electronic spreadsheet, the
syntax of the function is:
=FV(rate, nper, pmt, pv, type)
More on Present
and Future Values
Future value. To compute the future value
using an electronic spreadsheet, the
syntax of the function is:
=FV(rate, nper, pmt, pv, type)
where: =FV() is the future value function,
rate is the periodic interest rate
More on Present
and Future Values
Future value. To compute the future value
using an electronic spreadsheet, the
syntax of the function is:
=FV(rate, nper, pmt, pv, type)
where: rate is the periodic interest rate
More on Present
and Future Values
Future value. To compute the future value
using an electronic spreadsheet, the
syntax of the function is:
=FV(rate, nper, pmt, pv, type)
where: nper is the total number of
payment periods
More on Present
and Future Values
Future value. To compute the future value
using an electronic spreadsheet, the
syntax of the function is:
=FV(rate, nper, pmt, pv, type)
where: pmt is the payment made each
period
More on Present
and Future Values
Future value. To compute the future value
using an electronic spreadsheet, the
syntax of the function is:
=FV(rate, nper, pmt, pv, type)
where: pv [optional] is the present value
More on Present
and Future Values
Future value. To compute the future value
using an electronic spreadsheet, the
syntax of the function is:
=FV(rate, nper, pmt, pv, type)
where: type [optional] refers to when
payments are due (0 = end of period, 1 =
beginning of period)
More on Present
and Future Values
Example 3: $100 at 10% interest per year
for 10 years gives $100(1.1)10 = $259.37.
Using Example 3 for the simple future
value, the syntax to get $259.37 is
=FV(10%,10,0,-100,0).
More on Present
and Future Values
Example 3: $100 at 10% interest per year
for 10 years gives $100(1.1)10 = $259.37.
Using Example 3 for the simple future
value, the syntax to get $259.37 is
=FV(10%,10,0,-100,0).
PV is negative, since it’s a cash outflow.
Exercise 1
Compute the future value of $1,000
compounded annually for:
a. 10 years at 5 percent.
b. 10 years at 10 percent.
c. 20 years at 5 percent.
Exercise 1
Compute the future value of $1,000
compounded annually for:
a. 10 years at 5 percent. $1,628.89 or
=FV(5%,10,0,-1000,0)
b. 10 years at 10 percent. $2,593.74 or
=FV(10%,10,0,-1000,0)
c. 20 years at 5 percent. $2,653.30 or
=FV(5%,20,0,-1000,0)
Exercise 2
Present Value Years Interest Rate Future Value
6 7% $13,827
9 15% $43,852
18 11% $725,380
23 18% $590,710
=PV(7%,6,0,13827,0)
=PV(15%,9,0,43852,0)
=PV(11%,18,0,725380,0)
=PV(18%,23,0,590710,0)
More on Present
and Future Values
• Determining
the Discount Rate.
Rearrange the PV equation to solve for r:
(SciCal)
More on Present
and Future Values
• Derivation:
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and Future Values
• Derivation:
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and Future Values
• Derivation:
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and Future Values
• Derivation:
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and Future Values
• Derivation:
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More on Present
and Future Values
Example 8: What interest rate makes a PV
of $100 become a FV of $150 in 6
periods?
r = (150 / 100)1/6 – 1 = 7%
More on Present
and Future Values
Interest rate. To compute the interest rate
per period using an electronic
spreadsheet, the syntax of the function is:
=RATE(nper, pmt, pv, fv, type)
More on Present
and Future Values
Interest rate. To compute the interest rate
per period using an electronic
spreadsheet, the syntax of the function is:
=RATE(nper, pmt, pv, fv, type)
where: =RATE() is the periodic interest
rate
More on Present
and Future Values
Interest rate. To compute the interest rate
per period using an electronic
spreadsheet, the syntax of the function is:
=RATE(nper, pmt, pv, fv, type)
where: nper is the total number of
payment periods
More on Present
and Future Values
Interest rate. To compute the interest rate
per period using an electronic
spreadsheet, the syntax of the function is:
=RATE(nper, pmt, pv, fv, type)
where: pmt is the payment made each
period
More on Present
and Future Values
Interest rate. To compute the interest rate
per period using an electronic
spreadsheet, the syntax of the function is:
=RATE(nper, pmt, pv, fv, type)
where: pv is the present value
More on Present
and Future Values
Interest rate. To compute the interest rate
per period using an electronic
spreadsheet, the syntax of the function is:
=RATE(nper, pmt, pv, fv, type)
where: fv [optional] is the future value
More on Present
and Future Values
Interest rate. To compute the interest rate
per period using an electronic
spreadsheet, the syntax of the function is:
=RATE(nper, pmt, pv, fv, type)
where: type [optional] refers to when
payments are due (0 = end of period, 1 =
beginning of period)
More on Present
and Future Values
Example 8: What interest rate makes a PV
of $100 become a FV of $150 in 6
periods?
Using Example 8, the syntax to get 7% is
=RATE(6,0,-100,150,0).
Exercise 3
Present Value Years Interest Rate Future Value
$242 4 $307
$410 8 $896
$51,700 16 $162,181
$18,750 27 $483,500
=RATE(4,0,-242,307,0)
=RATE(8,0,-410,896,0)
=RATE(16,0,-51700,162181,0)
=RATE(27,0,-18750,483500,0)
More on Present
and Future Values
• Finding
the Number of Periods.
Rearrange the PV formula and solve for t:
More on Present
and Future Values
• Derivation:
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and Future Values
• Derivation:
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and Future Values
• Derivation:
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and Future Values
• Derivation:
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and Future Values
• Derivation:
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More on Present
and Future Values
Example 9: How many periods before
$100 today grows to $150 at 7%?
t = ln(150 / 100) / ln(1.07) = 6 periods
More on Present
and Future Values
Number of periods. To compute the
number of payment periods using an
electronic spreadsheet, the syntax:
=NPER (rate, pmt, pv, fv, type)
More on Present
and Future Values
Number of periods. To compute the
number of payment periods using an
electronic spreadsheet, the syntax:
=NPER (rate, pmt, pv, fv, type)
where: =NPER() is the total number of
payment periods
More on Present
and Future Values
Number of periods. To compute the
number of payment periods using an
electronic spreadsheet, the syntax:
=NPER (rate, pmt, pv, fv, type)
where: rate is the periodic interest rate
More on Present
and Future Values
Number of periods. To compute the
number of payment periods using an
electronic spreadsheet, the syntax:
=NPER (rate, pmt, pv, fv, type)
where: pmt is the payment made each
period
More on Present
and Future Values
Number of periods. To compute the
number of payment periods using an
electronic spreadsheet, the syntax:
=NPER (rate, pmt, pv, fv, type)
where: pv is the present value
More on Present
and Future Values
Number of periods. To compute the
number of payment periods using an
electronic spreadsheet, the syntax:
=NPER (rate, pmt, pv, fv, type)
where: fv [optional] is the future value
More on Present
and Future Values
Number of periods. To compute the
number of payment periods using an
electronic spreadsheet, the syntax:
=NPER (rate, pmt, pv, fv, type)
where: type [optional] refers to when
payments are due (0 = end of period, 1 =
beginning of period)
More on Present
and Future Values
Example 9: How many periods before
$100 today grows to $150 at 7%?
Using Example 9, the syntax to get 6
periods is =NPER(7%,0,-100,150,0).
Exercise 4
Present Value Years Interest Rate Future Value
625 9% $1,284
810 11% $4,341
18,400 17% $402,662
21,500 8% $173,439
=NPER(9%,0,-625,1284,0)
=NPER(11%,0,-810,4341,0)
=NPER(17%,0,-18400,402662,0)
=NPER(8%,0,- 21500,173439,0)
Exercise 5
At 8 percent interest, how long does it take
to double your money? To quadruple it?
Exercise 5
At 8 percent interest, how long does it take
to double your money? To quadruple it?
Double: 9.01 years or =NPER(8%,0,-
1,2,0)
Quadruple: 18.01 years or =NPER(8%,0,-
1,4,0).
Exercise 6
First City Bank pays 8 percent simple interest on its
savings account balances, whereas Second City Bank
pays 8 percent interest compounded annually. If you
made a $5,000 deposit in each bank, how much more
money would you earn from your Second City Bank
account at the end of 10 years?
Exercise 6
First City Bank pays 8 percent simple interest on its
savings account balances, whereas Second City Bank
pays 8 percent interest compounded annually. If you
made a $5,000 deposit in each bank, how much more
money would you earn from your Second City Bank
account at the end of 10 years?
First City Bank $9,000 or =5000+5000*8%*10
Second City Bank, $10,794.62 or =FV(8%,10,0,5000,0).
Difference: $1,794.62
Multiple Cash Flows
Many finance situations involve more than
one cash flow.
Whether they are equal, consecutive
payments or irregular, unequal cash flows
over time, they are referred to as a stream
of cash flows.
Multiple Cash Flows
Present Value of Multiple Cash Flows.
Calculating the present value of an
unequal series of future cash flows is
determined by summing the present
values of each discounted single future
cash flow.
Multiple Cash Flows
Example 10: An investor has determined that the
expected future cash flows of an asset will follow
the following schedule: $5,000 at the beginning
of year 1, $2,000 at the beginning of year 2,
$500 at the beginning of year 3, and $10,000 at
the beginning of year 4. Suppose that the
discount rate from the cash flows above is 8%.
What is the present value of the cash flows at
8%?
Multiple Cash Flows
Year Cash Flows PVIF(r,t) PV
1 $5,000 -- $ 5,000.00
2 $2,000 1/(1 + 0.8) 1,851.85
3 $500 1/(1 + 0.8)2 428.67
4 $10,000 1/(1 + 0.8)3 7,938.32
$15,218.84
Multiple Cash Flows
Year Cash Flows PVIF(r,t) PV
1 $5,000 -- $ 5,000.00
2 $2,000 1/(1 + 0.8) 1,851.85
3 $500 1/(1 + 0.8)2 428.67
4 $10,000 1/(1 + 0.8)3 7,938.32
$15,218.84
(SciCal)
Constant Annuities
Derivation:
•
Constant Annuities
Derivation:
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Constant Annuities
Derivation:
•
,,
Constant Annuities
Derivation:
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,,
Constant Annuities
Derivation:
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,,
(SciCal)
Constant Annuities
• Derivation:
Constant Annuities
• Derivation:
⇒
Constant Annuities
Example 12: If you borrow $400,
promising to repay in 4 monthly
installments at 1% per month, how much
are your payments?
C = $400 {.01 / [1 – 1/(1.01)4]} =
$400(0.2563) = $102.51
Constant Annuities
Payment. To compute the periodic
payment using an electronic spreadsheet,
the syntax of the function is:
=PMT(rate, nper, pv, fv, type)
Constant Annuities
Payment. To compute the periodic
payment using an electronic spreadsheet,
the syntax of the function is:
=PMT(rate, nper, pv, fv, type)
where: =PMT() is the payment made each
period
Constant Annuities
Payment. To compute the periodic
payment using an electronic spreadsheet,
the syntax of the function is:
=PMT(rate, nper, pv, fv, type)
where: rate is the periodic interest rate
Constant Annuities
Payment. To compute the periodic
payment using an electronic spreadsheet,
the syntax of the function is:
=PMT(rate, nper, pv, fv, type)
where: nper is the total number of
payment periods
Constant Annuities
Payment. To compute the periodic
payment using an electronic spreadsheet,
the syntax of the function is:
=PMT(rate, nper, pv, fv, type)
where: pv is the present value
Constant Annuities
Payment. To compute the periodic
payment using an electronic spreadsheet,
the syntax of the function is:
=PMT(rate, nper, pv, fv, type)
where: fv [optional] is the future value
Constant Annuities
Payment. To compute the periodic
payment using an electronic spreadsheet,
the syntax of the function is:
=PMT(rate, nper, pv, fv, type)
where: type [optional] refers to when
payments are due (0 = end of period, 1 =
beginning of period)
Constant Annuities
Example 12: If you borrow $400,
promising to repay in 4 monthly
installments at 1% per month, how much
are your payments?
Using Example 12, the syntax to get
$102.51 is =PMT(1%,4,-400,0,0).
Exercise 9
Consider a 4-year amortizing loan. You
borrow $1,000 initially and repay it in four
equal annual year-end payments. If the
interest rate is 8%, what is the annual
payment?
Exercise 9
Consider a 4-year amortizing loan. You
borrow $1,000 initially and repay it in four
equal annual year-end payments. If the
interest rate is 8%, what is the annual
payment?
$301.92 or =PMT(8%,4,-1000,0,0)
Constant Annuities
• To
find the number of payments, t, given
PV, C, and r, use
(SciCal)
Constant Annuities
• Derivation:
Constant Annuities
• Derivation:
⇒
Constant Annuities
• Derivation:
⇒ ⇒
Constant Annuities
• Derivation:
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⇒
Constant Annuities
• Derivation:
⇒ ⇒
⇒ ⇒
⇒
Constant Annuities
• Derivation:
Constant Annuities
• Derivation:
⇒
Constant Annuities
Example 13: How many P100 payments
will pay off a P5,000 loan at 1% per
period?
t = ln[(1 / 1 - .01(5,000)/100)] / ln(1.01) =
69.66 periods
Constant Annuities
Example 13: How many P100 payments
will pay off a P5,000 loan at 1% per
period?
Using Example 13, the syntax to get 69.66
periods is =NPER(1%,-100,5000,0,0).
Exercise 10
You have $42,180.53 in a brokerage account,
and you plan to deposit an additional $5,000 at
the end of every future year until your account
totals $250,000. You expect to earn 12%
annually on the account. How many years will it
take to reach your goal?
Exercise 10
You have $42,180.53 in a brokerage account,
and you plan to deposit an additional $5,000 at
the end of every future year until your account
totals $250,000. You expect to earn 12%
annually on the account. How many years will it
take to reach your goal?
11 years or =NPER(12%,-5000,-
42180.53,250000,0)
Exercise 11
You now have $20,000 in the bank earning
interest of 0.5% per month. You need
$30,000 to make a down payment on a
house. You can save an additional $100
per month. How long will it take you to
accumulate the $30,000?
Exercise 11
You now have $20,000 in the bank earning
interest of 0.5% per month. You need
$30,000 to make a down payment on a
house. You can save an additional $100
per month. How long will it take you to
accumulate the $30,000?
44.74 months or =NPER(0.5%,-100,-
20000,30000,0)
Constant Annuities
There is no analytical solution, however, to
find the rate given PV, C, and t.
However, the rate can be computed using
a financial calculator or an electronic
spreadsheet.
Constant Annuities
Example 11: If a person is willing to make
36 monthly payments of $100 at 1.5% per
month starting next month, what size loan
can you obtain? $2,766.07
Using Example 11, the syntax to get 1.5%
is =RATE(36,-100,2766.07,0,0).
Exercise 12
Professor’s Annuity Corp. offers a lifetime
annuity to retiring professors. For a payment of
$80,000 at age 65, the firm will pay the retiring
professor $600 a month until death. If the
professor’s remaining life expectancy is 20
years, what is the monthly interest rate on this
annuity?
Exercise 12
Professor’s Annuity Corp. offers a lifetime
annuity to retiring professors. For a payment of
$80,000 at age 65, the firm will pay the retiring
professor $600 a month until death. If the
professor’s remaining life expectancy is 20
years, what is the monthly interest rate on this
annuity?
0.55% or =RATE(20*12,600,-80000,0,0)
Constant Annuities
• Present
Value of an Annuity Due. The
present value of an annuity due of cash
flow C per period for t periods at r percent
interest:
(SciCal)
Constant Annuities
• Present
Value of an Annuity Due. The
present value of an annuity due of cash
flow C per period for t periods at r percent
interest: (alternative solution)
(SciCal)
Constant Annuities
Example 14: If a person is willing to make
36 monthly payments of $100 at 1.5% per
month starting today, what size loan can
you obtain?
PV = 100 {[1 – 1/(1.015)36 - 1] / .015 + 1) =
100(28.0756) = $2,807.56
Constant Annuities
Example 14: If a person is willing to make
36 monthly payments of $100 at 1.5% per
month starting today, what size loan can
you obtain?
Alternative solution: PV = 100 {[1 –
1/(1.015)36] / .015} (1.015) = 100(28.0756)
= $2,807.56
Constant Annuities
Example 14: If a person is willing to make
36 monthly payments of $100 at 1.5% per
month starting today, what size loan can
you obtain?
Using Example 14 for the present value for
an annuity due, the syntax to get
$2,807.56 is =PV(1.5%,36,-100,0,1).
Exercise 14
Your landscaping company can lease a
truck for $8,000 a year for 6 years. The
interest rate your company can earn on its
funds is 7%. If the first lease payment is
made immediately instead of at the end of
the first period, what is the cost of leasing?
Exercise 14
Your landscaping company can lease a
truck for $8,000 a year for 6 years. The
interest rate your company can earn on its
funds is 7%. If the first lease payment is
made immediately instead of at the end of
the first period, what is the cost of leasing?
$40,801.58 or =PV(7%,6,8000,0,1)
Constant Annuities
• Future
Value of an Ordinary Annuity.
The future value of an ordinary annuity of
cash flow C per period for t periods at r
percent interest:
(SciCal)
Constant Annuities
• Derivation:
Constant Annuities
• Derivation:
Constant Annuities
• Derivation:
,
Constant Annuities
• Derivation:
,
Constant Annuities
• Derivation:
,
,
,
,
(SciCal)
Constant Annuities
• Future
Value for an Annuity Due. The
future value of an annuity due of cash flow
C per period for t periods at r percent
interest:
(SciCal)
Constant Annuities
Example 16: If you make 20 payments of
$1,000 beginning today at 10% per period,
how much will your account grow to be?
Corrected solution: FV = $1,000 {[(1.1)20 + 1
– 1] / .1 – 1} = $1,000(0.630025) =
$63,002.50
Constant Annuities
Example 16: If you make 20 payments of
$1,000 beginning today at 10% per period,
how much will your account grow to be?
Alternative solution: $1,000 {[(1.1)20 –
1] / .1} (1.1) = $1,000(0.630025) =
$63,002.50
Constant Annuities
Example 16: If you make 20 payments of
$1,000 beginning today at 10% per period,
how much will your account grow to be?
Using Example 16 for the present value for
an annuity due, the syntax to get
$63,002.50 is =FV(10%,20,-1000,0,1).
Exercise 15
The Lancer Leasing Company has agreed to lease a
hydraulic trencher to the Chavez Excavation Company
for $20,000 a year over the next eight years. Lease
payments are to be made at the end of each year.
a. Assuming that Lancer invests these payments at an
annual rate of 9 percent, how much will it have
accumulated by the end of the eighth year?
b. What if the first payment is made immediately instead of
at the end of the first period?
Exercise 15
The Lancer Leasing Company has agreed to lease a
hydraulic trencher to the Chavez Excavation Company
for $20,000 a year over the next eight years. Lease
payments are to be made at the end of each year.
a. Assuming that Lancer invests these payments at an
annual rate of 9 percent, how much will it have
accumulated by the end of the eighth year?
$220,569.48 or =FV(9%,8,-20000,0,0)
b. What if the first payment is made immediately instead of
at the end of the first period? $240,420.73 or
=FV(9%,8,-20000,0,1)
Exercise 16
Clarence Weatherspoon, a super salesman contemplating
retirement on his fifty-fifth birthday, decides to create a fund on an
8% basis that will enable him to withdraw $20,000 per year on June
30, beginning in 2021 and continuing through 2024. To develop this
fund, Clarence intends to make equal contributions on June 30 of
each of the years 2017–2020.
a. How much must the balance of the fund equal on June 30, 2020, in
order for Clarence to satisfy his objective?
b. What are each of Clarence’s contributions to the fund?
Exercise 16
Clarence Weatherspoon, a super salesman contemplating
retirement on his fifty-fifth birthday, decides to create a fund on an
8% basis that will enable him to withdraw $20,000 per year on June
30, beginning in 2021 and continuing through 2024. To develop this
fund, Clarence intends to make equal contributions on June 30 of
each of the years 2017–2020.
a. How much must the balance of the fund equal on June 30, 2020, in
order for Clarence to satisfy his objective? $66,242.54 or
=PV(8%,4,-20000,0,0)
b. What are each of Clarence’s contributions to the fund? $14,700.60
or =PMT(8%,4,0,-PV(8%,4,-20000,0,0),0)
Exercise 17
IRA Investments develops retirement programs for individuals. You are 30
years old and plan to retire on your 60th birthday. You want to establish a
plan with IRA that will require a series of equal, annual, end-of-year deposits
into the retirement account. The first deposit will be made one year from
today on your 31st birthday. The final payment on the account will be made
on your 60th birthday. The retirement plan will allow you to withdraw
$120,000 per year for 15 years, with the first withdrawal on your 61st
birthday. Also, at the end of the 15th year, you wish to withdraw an
additional $250,000. The retirement account promises to earn 12 percent
annually. What periodic payment must be made into the account to achieve
your retirement objective?
Exercise 17
IRA Investments develops retirement programs for individuals. You are 30
years old and plan to retire on your 60th birthday. You want to establish a
plan with IRA that will require a series of equal, annual, end-of-year deposits
into the retirement account. The first deposit will be made one year from
today on your 31st birthday. The final payment on the account will be made
on your 60th birthday. The retirement plan will allow you to withdraw
$120,000 per year for 15 years, with the first withdrawal on your 61st
birthday. Also, at the end of the 15th year, you wish to withdraw an
additional $250,000. The retirement account promises to earn 12 percent
annually. What periodic payment must be made into the account to achieve
your retirement objective?
PV at age 60: $862,977.80 or =PV(12%,15,120000,0,0) +
PV(12%,15,0,250000,0)
PMT: $3,576 or =PMT(12%,30,0,-862977.80,0)
Exercise 18
Suppose that you will receive annual payments of
$10,000 for a period of 10 years. The first payment will
be made 4 years from now. If the interest rate is 5%,
what is the present value of this stream of payments?
Exercise 18
Suppose that you will receive annual payments of
$10,000 for a period of 10 years. The first payment will
be made 4 years from now. If the interest rate is 5%,
what is the present value of this stream of payments?
Option 1: Calculate the PV of an ordinary annuity.
$77,217.35 or PV(5%,10,10000,0,0). Then calculate the
PV. $66,703.25 or =PV(5%,3,0,PV(5%,10,10000,0,0),0).
Option 2: Calculate the PV of an annuity due.
$81,078.22 or =PV(5%,10,10000,0,1). Then calculate
the PV. $66,703.25 or
=PV(5%,4,0,PV(5%,10,10000,0,1),0).
Constant Perpetuities
• A
perpetuity is a perpetual annuity; that
means, cash flows go on forever.
The PV of a perpetuity is equal to the
periodic cash flow divided by the
appropriate discount rate, or .
Growing Annuities
and Perpetuities
Derivation:
•
Growing Annuities
and Perpetuities
Derivation:
•
Growing Annuities
and Perpetuities
Derivation:
•
,,
Growing Annuities
and Perpetuities
Derivation:
•
,,
Growing Annuities
and Perpetuities
Derivation:
•
,,
(SciCal)
Growing Annuities
and Perpetuities
Derivation:
•
Growing Annuities
and Perpetuities
Derivation:
•
Growing Annuities
and Perpetuities
Derivation:
•
,,
Growing Annuities
and Perpetuities
Derivation:
•
,,
Growing Annuities
and Perpetuities
Derivation:
•
,,
=EFFECT(7%,4)
=EFFECT(16%,12)
=EFFECT(11%,365)
EAR and APR
To compute the APR given the EAR, APR
= m[(1 + EAR)1/m – 1].
Example 21: 13.54% EAR is (4)[(1 +
01354)1/4 – 1] = 12.9% APR compounded
quarterly.
EAR and APR
Annual percentage rate. To compute the
annual percentage rate using an electronic
spreadsheet, the syntax of the function is:
=NOMINAL(effect_rate, npery)
EAR and APR
Annual percentage rate. To compute the
annual percentage rate using an electronic
spreadsheet, the syntax of the function is:
=NOMINAL(effect_rate, npery)
where: =NOMINAL is the nominal interest
rate
EAR and APR
Annual percentage rate. To compute the
annual percentage rate using an electronic
spreadsheet, the syntax of the function is:
=NOMINAL(effect_rate, npery)
where: effect_rate is the effective interest
rate
EAR and APR
Annual percentage rate. To compute the
annual percentage rate using an electronic
spreadsheet, the syntax of the function is:
=NOMINAL(effect_rate, npery)
where: npery is the number of
compounding periods per year.
EAR and APR
Example 21: 13.54% EAR is (4)[(1 +
01354)1/4 – 1] = 12.9% APR compounded
quarterly.
Using Example 21, the syntax to get
12.9% is =NOMINAL(13.54%,4).
Exercise 23
Number of Times
Stated Rate (APR) Effective Rate (EAR)
Compounded
Semiannually 9.8%
Monthly 19.6%
Weekly 8.3%
=NOMINAL(9.8%,2)
=NOMINAL(19.6%,12)
=NOMINAL(8.3%,54)
Exercise 24
First National Bank charges 11.2 percent
compounded monthly on its business
loans. First United Bank charges 11.4
percent compounded semiannually. As a
potential borrower, to which bank would
you go for a new loan?
Exercise 24
First National Bank charges 11.2 percent
compounded monthly on its business
loans. First United Bank charges 11.4
percent compounded semiannually. As a
potential borrower, to which bank would
you go for a new loan?
FNB: 11.79% or =EFFECT(11.2%,12)
FUB: 11.72% or =EFFECT(11.4%,2)
Exercise 24
As a jewelry store manager, you want to offer credit, with
interest on outstanding balances paid monthly. To carry
receivables, you must borrow funds from your bank at a
nominal 6%, monthly compounding. To offset your
overhead, you want to charge your customers an
effective annual rate that is 2% more than the bank is
charging you. What annual percentage rate should you
charge your customers?
Exercise 24
As a jewelry store manager, you want to offer credit, with
interest on outstanding balances paid monthly. To carry
receivables, you must borrow funds from your bank at a
nominal 6%, monthly compounding. To offset your
overhead, you want to charge your customers an
effective annual rate that is 2% more than the bank is
charging you. What annual percentage rate should you
charge your customers?
7.88% or =NOMINAL(EFFECT(6%,12)+2%,12)
More Spreadsheet
Functions
ROUND Function. The ROUND function
returns a number rounded to a given
number of digits. The syntax of the
function is:
=ROUND (number, num_digits)
More Spreadsheet
Functions
ROUND Function. The ROUND function
returns a number rounded to a given
number of digits. The syntax of the
function is:
=ROUND (number, num_digits)
where: =ROUND is the round function
More Spreadsheet
Functions
ROUND Function. The ROUND function
returns a number rounded to a given
number of digits. The syntax of the
function is:
=ROUND (number, num_digits)
where: number is the number to be
rounded
More Spreadsheet
Functions
ROUND Function. The ROUND function
returns a number rounded to a given
number of digits. The syntax of the
function is:
=ROUND (number, num_digits)
where: num_digits is the number of digits
to which number should be rounded.
More Spreadsheet
Functions
For example, the syntax to round
$1,316.4952 to the nearest dollar is
=ROUND(1316.4952,0).
The syntax to round $1,316.4952 to two
decimal places is =ROUND(1316.4952,2).
End of Module 2