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3 - The Time Value of Money

The document discusses methods for calculating present value, future value, payment amounts, and interest rates for annuities. It provides examples of using formulas to find: 1) The present value of a future cash flow given the interest rate and number of periods. 2) The future value of a present amount given the interest rate and number of periods. 3) The payment amount required to pay off a loan given the principal, interest rate, and number of periods. 4) The number of payment periods required to pay off a loan given the payment amount, interest rate, and loan principal. 5) The interest rate required to achieve a future value goal given the payment amount, number of

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dewatharschinia19
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33 views

3 - The Time Value of Money

The document discusses methods for calculating present value, future value, payment amounts, and interest rates for annuities. It provides examples of using formulas to find: 1) The present value of a future cash flow given the interest rate and number of periods. 2) The future value of a present amount given the interest rate and number of periods. 3) The payment amount required to pay off a loan given the principal, interest rate, and number of periods. 4) The number of payment periods required to pay off a loan given the payment amount, interest rate, and loan principal. 5) The interest rate required to achieve a future value goal given the payment amount, number of

Uploaded by

dewatharschinia19
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Week 03

Finding P when Given A


• From Equation (4-2), F = P(1 + i)N. Substituting for F in Equation (4-8) we
determine that

• Dividing both sides by (1 + i)N, we get

• The quantity in brackets is called the uniform series present worth factor. We
shall use the functional symbol (P/A, i%, N) for this factor.
Example 4-9: Present Equivalent of an Annuity (Uniform
Series)
A micro-brewery is considering the installation of a newly designed
boiler system that burns the dried, spent malt and barley grains from
the brewing process. The boiler will produce process steam that powers
the majority of the brewery’s energy operations, saving $450,000 per
year over the boiler’s expected life of 10 years. If the interest rate is 12%
per year, how much money can the brewery afford to invest in the new
boiler system?
Example 4-9: Solution
Example 4-9: Solution… p/2
Example 4-10: How Much Is a Lifetime Oil Change Offer
Worth?
“Make your best deal with us on a new automobile and we’ll change
your oil for free for as long as you own the car!” If you purchase a car
from this dealership, you expect to have four free oil changes per year
during the five years you keep the car. Each oil change would normally
cost you $30. If you save your money in a mutual fund earning 2% per
quarter, how much are the oil changes worth to you at the time you buy
the car?
Example 4-10: Solution
Example 4-10: Solution… p/2
Finding A when Given F
• Taking Equation (4-8) and solving for A, we find that

• Thus, Equation (4-12) is the relation for finding the amount, A, of a


uniform series of cash flows occurring at the end of N interest periods
that would be equivalent to (have the same value as) its future value
occurring at the end of the last period. The quantity in brackets is
called the sinking fund factor.
• We shall use the functional symbol (A/F, i%,N), hence
Finding A when Given P
• Taking Equation (4-10) and solving for A, we find that

• Thus, Equation (4-14) is the relation for finding the amount, A, of a uniform series
of cash flows occurring at the end of each of N interest periods that would be
equivalent to, or could be traded for, the present equivalent P, occurring at the
beginning of the first period. The quantity in brackets is called the capital
recovery factor.
• We shall use the functional symbol (A/P, i%, N) for this factor. Hence,
Example 4-11: Computing Your Monthly Car
Payment
You borrow $15,000 from your credit union to purchase a used car. The
interest rate on your loan is 0.25% per month∗ and you will make a
total of 36 monthly payments. What is your monthly payment?
Example 4-11: Solution
Example 4-11: Solution… p/2
Finding the Number of Cash Flows in an Annuity
Given A, P, and i
• Sometimes we may have information about a present amount of
money (P), the magnitude of an annuity (A), and the interest rate (i).
• The unknown factor in this case is the number of cash flows in the
annuity (N).
Example 4-12: Prepaying a Loan−
−Finding N
Your company has a $100,000 loan for a new security system it just
bought. The annual payment is $8,880 and the interest rate is 8% per
year for 30 years. Your company decides that it can afford to pay
$10,000 per year. After how many payments (years) will the loan be
paid off?
Example 4-12: Solution
Example 4-12: Solution… p/2
Example 4-12: Solution… p/3
Finding the Interest Rate, i, Given A, F,
and N
• Now let’s look at the situation in which you know the amount (A) and
duration (N) of a uniform payment series. You also know the desired
future value of the series (F). What you don’t know is the interest rate
that makes them equivalent.
• As was the case for an unknown N, there is no single equation to
determine i. However, we can use the known relationships between i,
A, F, and N and the method of linear interpolation to approximate the
interest rate.
Example 4-13: Finding the Interest Rate to
Meet an Investment Goal
After years of being a poor, debt-encumbered college student, you
decide that you want to pay for your dream car in cash. Not having
enough money now, you decide to specifically put money away each
year in a “dream car” fund. The car you want to buy will cost $60,000 in
eight years. You are going to put aside $6,000 each year (for eight
years) to save for this. At what interest rate must you invest your money
to achieve your goal of having enough to purchase the car after eight
years?
Example 4-13: Solution
Summary of Interest Formulas and Relationships
for Discrete Compounding

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