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Future value
Present value
Annuities
Rates of return
Amortization
6-1
Time lines
0
CF1
CF2
CF3
i%
CF0
i%
100
100
100
100
i%
6-3
100
75
50
i%
-50
6-4
10%
100
FV = ?
6-5
After 1 year:
FV1 = PV ( 1 + i ) = $100 (1.10)
= $110.00
After 2 years:
2
2
FV2 = PV ( 1 + i ) = $100 (1.10)
=$121.00
After 3 years:
3
3
FV3 = PV ( 1 + i ) = $100 (1.10)
=$133.10
After n years (general case):
n
FVn = PV ( 1 + i )
6-6
INPUTS
OUTPUT
10
-100
I/YR
PV
PMT
FV
133.10
6-7
Extra example
PV = 1000
R = 10%
n=1
FV = ? FV = 1000*(1.10) = 1,100
6-8
Example 2
Compound Interest
PV = 1000
R = 10%
n=3
FV = ?
FV = 1000*(1.1)*(1.1)*(1.1) = 1,331
FV = PV*(1+R)^n
6-9
Example 3:
PV = 1
R = 6%
n = 50
FV = ?
FV = PV*(1+R)^n = 18
n = 100, FV = 339
n = 200, FV = 115,000
6-10
Example 4:
Doubling times
6-11
Example 5
Retirement Saving
R = 0.07
FV = PV*(1+0.05)^45 = 8985
Doubling 14
FV=PV*(1+0.07)^45 = 21,002
Doubling = 10
Retirement Savings at 5%
interest
6-13
Goals
Annuities
Perpetuities
Mixed streams
Term structure again
Compounding
More applications
6-14
Example
6-15
Goals
Annuities
Perpetuities
Mixed streams
Term structure again
Compounding
More applications
6-16
10%
PV = ?
100
6-17
PV = FVn / ( 1 + i )n
PV = FV3 / ( 1 + i )3
= $100 / ( 1.10 )3
= $75.13
6-18
INPUTS
OUTPUT
10
I/YR
PV
100
PMT
FV
-75.13
6-19
Present Value
Annuity
Usually annual
6-21
(1 R)
772
6-22
6-23
Period
Period
Period
Period
10: 100
9: 100(1.05)
8: 100(1.05)(1.05)
1:
100(1.05)^9
Be careful!
6-24
Application: Lotteries
Choices
R = 7%
33
1
i
(1
0.07)
i1
PV
6-25
Annuity of $100
Interest = 5%
PV = 100/(1.05) + 100/(1.05)^2 +
100/(1.05)^3
= 272.32
6-26
100 = FV = PV*(1.05)^n (n = 1, 2, 3)
PV = 100/(1.05)^n (n = 1, 2, 3)
Solving for N:
If sales grow at 20% per year, how long
before sales double?
INPUTS
N
OUTPUT
20
-1
I/YR
PV
PMT
FV
3.8
6-28
i%
PMT
PMT
PMT
PMT
PMT
Annuity Due
0
i%
PMT
6-29
INPUTS
OUTPUT
10
-100
I/YR
PV
PMT
FV
331
6-30
INPUTS
OUTPUT
10
I/YR
PV
100
PMT
FV
-248.69
6-31
INPUTS
OUTPUT
10
-100
I/YR
PV
PMT
FV
364.10
6-32
INPUTS
OUTPUT
10
I/YR
PV
100
PMT
FV
-273.55
6-33
100
300
300
-50
10%
90.91
247.93
225.39
-34.15
530.08 = PV
6-34
CF0
CF1
CF2
CF3
CF4
=
=
=
=
=
0
100
300
300
-50
Perpetuity
6-36
Discounting to infinity
Math review:
6-37
Present Value of a
Constant Stream
a
1
1 R
PV
i1
PV y
y
(1 R)i
1
1 R
ai
i1
1
1
a
y
(1 R)
(1 R)
PV
y
(y)
1
1 R
1
1 a
R
1
(1 R)
1 R (1 R)
6-38
y=100
R = 0.05, PV = 2000
R = 0.03, PV = 3333
6-39
Goals
Annuities
Perpetuities
Mixed streams
Term structure again
Compounding
More applications
6-40
Mixed Stream
Apartment Building
87, 767
2
3
1.05 (1.05) (1.05)
6-41
Mixed Stream
Investment Project
100
PV 1000
38
i
(1.05)
i1
6-42
Solving for I:
What interest rate would cause $100 to
grow to $125.97 in 3 years?
INPUTS
3
N
OUTPUT
I/YR
-100
125.97
PV
PMT
FV
8
6-43
INPUTS
OUTPUT
45
12
-1095
I/YR
PV
PMT
FV
1,487,262
6-45
INPUTS
OUTPUT
25
12
-1095
I/YR
PV
PMT
FV
146,001
6-46
INPUTS
OUTPUT
25
12
I/YR
PV
1,487,262
PMT
FV
-11,154.42
6-47
100
133.10
Annually: FV3 = $100(1.10)3 = $133.10
0
0
100
5%
1
2
2
4
3
6
134.01
6-48
6-49
10.00%
10.38%
10.47%
10.52%
6-51
6-52
6-53
iNOM mn
FVn PV ( 1
)
m
0.10 23
FV3S $100 ( 1
)
2
6
FV3S $100 (1.05) $134.01
12
1
2
2
4
3
6
5%
100
100
100
Method 1:
Compound each cash flow
0
1
2
2
4
3
6
5%
100
100
100
110.25
121.55
331.80
6-56
Method 2:
Financial calculator
INPUTS
OUTPUT
10.25
-100
I/YR
PV
PMT
FV
331.80
6-57
INPUTS
OUTPUT
10.25
I/YR
PV
100
PMT
FV
-247.59
6-58
Loan amortization
Step 1:
Find the required annual payment
INPUTS
OUTPUT
10
-1000
I/YR
PV
PMT
FV
402.11
6-60
Step 2:
Find the interest paid in Year 1
Step 3:
Find the principal repaid in Year 1
Step 4:
Find the ending balance after Year 1
INT
PRIN
END
BAL
$302
$698
$1,000
$402
$100
698
402
70
332
366
366
402
37
366
1,206.34
206.34
1,000
TOTAL
402.11
Interest
302.11
Principal Payments
Constant payments.
Declining interest payments.
Declining balance.
6-65
Partial amortization
INPUTS
OUTPUT
20
7.5
-22500
I/YR
PV
PMT
FV
2207.07
6-67
Term Structure
Term Structure
y1
y2
y3
PV
2
(1 R1 ) (1 R2 ) (1 R3 )3
6-70
(1+.06/12)^12-1
6.17%
General Formulas
EFF e
APR
Goals
Annuities
Perpetuities
Mixed streams
Term structure again
Compounding
More examples
6-73
More Examples
Home mortgage
Car loans
College
Calculating present values
6-74
Home Mortgage
Amortization
Specifications:
$100,000 mortgage
9% interest
3 years (equal payments) pmt
Find pmt
PV(pmt) = $100,000
6-75
Mortgage PV
PMT
PV
100000
i
(1.09)
i1
3
1
100000
i
(1.09)
i1
PMT
PMT = 39,504
6-76
Car Loan
Amount = $1,000
1 Year
Car Loan
PMT
PV
1000
i
(1.01)
i1
12
1
1000
i
(1.01)
i1
PMT
= 88.85
PMT
6-78
Total Payment
12*88.85 = 1,066.20
Looks like 6.6% interest
Why?
6-79
(1+0.01)*921.15 = 930.36
Remaining = 930.36 88.85 = 841.51
6-80
College
1. Compare
Sometimes difficult
Methods
Powerful tool
Useful for day to day problems
Loans/mortgages
Retirement
Stock pricing
Bond pricing
6-83
Trick
6-8484
Example
Annuity
PV
n1
1 r
n
86
6-8686
Example
87
6-87
Trick
C 1 C
PV
N
r 1 r r
N
C
1
1
r
1 r
88
6-8888
Example
89
6-89
Next Lecture
Topics
Reading
Chapter 5
6-9090