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22 views40 pages

Class 2 - Tagged

Uploaded by

tylerlemieuxbusiness
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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2406 Principles of

Finance With Excel


Class 2
Learning Outcomes:
• Time value of money.
• Algebraic Present Value Formulas.
• Effective Interest Rates.
• Functions IRR, NPV.
• Financial Functions in Excel
Microsoft Excel on Mac versus Excel on Windows

• Microsoft Excel on Mac versus Excel on Windows (parall


els.com)
Modeling Rules
Modeling rule 1: Put all the variables which are
important (the fashion-able jargon is “value drivers”)
at the top of your spreadsheet.
Modeling rule 2: Never use a number where a
formula will also work.
Modeling rule 3: Avoid the use of blank columns to
accommodate cell “spillovers.”

Modeling rule 4: Make your Excel default one


sheet. File ➔ Options ➔ General ➔
Popular:
Modeling Rules
Modeling Rule 5: Turn off the “auto jump down”
feature.
The Excel default is that when you click Enter, the cursor jumps down
to the next cell. But in financial modeling, we need to look at the
formulas we’ve written to make sure that they make sense! So turn off
this feature!
Go to the File ➔ Options ➔ Advanced:
Future value is the value at some future date of a payment (or payments)
made before this future date. The future value includes the interest earned
on the payments.
Future value (FV) is a concept that relates the value in the future of
money deposited in a bank account today and over time and left in the
account to draw interest.

For example, that you put $100 in a savings account in your bank today and that the
bank pays you 6% interest at the end of every year.
If you leave the money in the bank for 1 year, you will have $106 after 1 year: $100
of the original savings balance + $6 in interest.
The $106 is the future value after 1 year of the initial deposit of $100 at 6% annual
interest. Now suppose you leave the money in the account for a second year. At the
end of this year, you will have:

$106 The saving account balance at the end of the year


Plus
6%*$106=$6.36 The interest of this balance for the second year
=$112.36 Total in account after 2 years
The future value uses the concept of compound interest: The interest earned in the first year
($6) itself earns interest in the second year. To sum up: The future value of $X deposited today in
an account paying r% interest annually and left in the account for n years is
In the spreadsheet below, we present a table and graph that show the future
value of $100 for three different interest rates: 0%, 6%, and 12%. As the spread-sheet
shows, future value is very sensitive to the interest rate! Note that when the interest rate
is 0%, the future value doesn’t grow.
Accumulation—Savings Plans and Future
Value
Suppose you intend to make 10 annual deposits of $100, with the first deposit made in
year 0 (today) and each succeeding deposit made at the end of years 1, 2, . . . , 9.

The future value of all these deposits at the end of year 10 tells you how much
you will have accumulated in the account. If you are saving for the future (whether to
buy a car at the end of your college years or to finance a pension at the end of your
working life), this is obviously an important and interesting calculation. So how much
will you have accumulated at the end of year 10?

There’s an Excel function for calculating this answer which we will discuss later; for the
moment, we will set this problem up in Excel and do our calculation the long way, by
showing how much we will have at the end of each year.
The FV function requires as inputs:
the Rate of interest,
the number of periods Nper,
the annual payment Pmt.

You can also indicate the Type, which tells Excel whether payments are made at
the beginning of the period (type 1 as in our example) or at the end of the period
(type 0).
Beginning Versus End of
Period
In the example above, you make deposits of $100 at the beginning of each year.
In terms of timing, your deposits are made at dates 0, 1, 2, 3, ..., 9. Here’s a schematic
way of looking at this, showing the future value of each deposit at the end of year 10:
If you made 10 deposits of $100 at the end of each year. How would
this affect the accumulation in the account at the end of 10 years? The
schematic diagram below illustrates the timing and accumulation of the
payments:
Some Finance Definitions and the Excel FV Function

An annuity is a series of equal, periodic payments made over a specified amount of time.
Examples of annuities are widespread:

• The allowance your parents give you ($1,000 per month, for your next 4 years of college) is a
monthly annuity with 48 payments.
• Pension plans often give the retiree a fixed annual payment for as long as he lives. This is a
bit more complicated annuity, since the number of payments is uncertain.
• Certain kinds of loans are paid off in fixed periodic (usually monthly, some-times annual)
installments. Mortgages and student loans are two examples.

An annuity with payments at the end of each period is often called a regular
annuity.
The future value of a regular annuity is calculated with =FV(B2,A14,-100).
An annuity with payments at the beginning of each period is often called an annuity due
and its value is calculated with the Excel function =FV(B2,A14,-100,,1).
Clicking on the fx icon
brings up the dialog box
below. We’ve chosen the
category
to be the Financial
functions, and we’ve
scrolled down in the next
section of the dialog box to
put the cursor on the FV
function.
Present Value
The present value is the value today of a payment (or payments) that will be
made in the future. Here’s a simple example: Suppose that you anticipate getting $100 in
3 years from your Uncle Simon, whose word is as good as a bank’s. Suppose that the bank
pays 6% interest on savings accounts. How much is the anticipated future payment worth
today?
The answer is $83.96= 100 /(1.06)^3 ;
If you put $83.96 in the bank today at 6% annual interest, then in 3 years you would have
$100.

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