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Lawrence Gitman

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Which is more Valuable?

 1000 $ now
 1000 $ after 2 years

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Money NOW
is worth more than
money LATER!

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Future Value Versus Present Value

Financial decisions are based on either


future value or present value

• Future value- cash • Present value- cash


you will receive in hand today
at a future date

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Time Line

 Horizontal line on which time


zero appears at the left most
end and future periods are
marked from left to right
 Used to depict investment cash
flows

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Time Line

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• Future value- value at future date of a
present amount deposited and earning
specified interest rate. (Compounding)

• Present value-The current value of a


future amount. The amount that have to be
invested today at a given interest rate over
a specified period for a future amount.
(Discounting)

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Types of
Cash Flows

Mixed Stream
Annuities
(a stream of
Single Amounts (a stream of equal
unequal cash
periodic cash flows)
flows )

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Future value of Single Amount
The General equation for the future value at
end of period n is

FVn= PV X (1+i)n

Where,
FVn= Future value at the end of
period n
PV= Present Value
i= annual rate of interest paid
n= number of periods that money is left
for deposits

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Example
 Jane places $800 in a saving account
paying 6% interest compounded
annually. She wants to know how
much money will be in account at the
end of 5 years.

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Now in this example
PV = $800, i = 0.06, n = 5
So,

FVn= PV X (1+i)n
FV5= $800 X (1+0.06)5=$1070.40

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Future value Relationship
(Interest rates, time periods, and future value
of one dollar)

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Present Value of a Single
Amount

 The process of finding present


value is often referred as
discounting cash flow
 Inverse of compounding

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Example
Pam wishes to find the present value of
$1700 that will be received 8 years from
now. Opportunity cost is 8%

We know,
FVn= PV X (1+i)n
so,
PV= FVn = $1700 = $918.42
(1+i)n (1+8)8

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Comparing Present Value and
Future Value

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Types of Annuities
• Ordinary Annuity - • Annuity Due- cash
cash flows occur at flows occur at the
the end of each beginning of each
period period.

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Future Value of an Ordinary
Annuity

 FVAn=PMT X (FVIAi,n)

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 Frank wishes to determine how much
money he will have at the end of 5
years if he chooses annuity A. i=7%

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Present Value of an ordinary
annuity
 PVAn= PMT X (PVIFAi,n)

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Braden wants to know what
should it most pay to receive $700
at the end of each year

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Annuity Due

 Future value  Present


of an value of an
annuity due annuity due

 FVIAi,n(Annuity due)=
 PVIFAi,n(annuity
FVIAi,n X (1+i)
due)= PVIFAi,n X
(1+i)

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Future value of a Mixed Stream
 Shrell expects a stream of mixed cash
flows over the next five years and
expects to earn 8%. What will be
earned after five years if cash flows
are immediately invested.

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Present value of a mixed stream
 Frey has an opportunity of receving
mixed stream cash flows over 5
years. If he must earn 9%, what is
the most he should pay.

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Application of time Value

 Determining deposits needed to


accumlate a future amount
 Determination of equal periodic
loan payments
 EMI’s
 Finding interest rates
 Finding an unknown number of
periods
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Have a nice Day…………….

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