Present value and yields

Present value and yields

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PRESENT VALUE

So far we have only gone forward in time. There are

many situations when we want to calculate how much
a future cash flow is worth today.

We need to rearrange the formula:

FV = PV * (1 + i)n
PV = FV (1 + i)n
Or
PV = FV * 1/(1 + i)n
Now that was easy!

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 Present value and yields

PRESENT VALUE

You want to buy a Ferrari car in five years.

You estimate the car will cost you $200,000.
How much do you have to invest today at 7%
to be able to afford the car?

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PRESENT VALUE - IN WORDS

If I invest $142,597 today at 7% compounding

each year. I will have $200,000 in five years

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 Present value and yields

PRESENT VALUE - GRAPHICALLY

Asset value Cash flows

250.0 $200k
200.0 FV
200.0
142.6
000s

150.0

100.0
Five years
50.0
$142.6k
0.0 PV
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

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ALGEBRA

FV = PV * (1 + i)n
So:
PV = FV (1 + i)n

142,597.2 = 200,000 (1 + 7%)5

Or
142,597.2 = 200,000 * 1/ (1 + 7%)5

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 Present value and yields

YIELDS

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YIELDS

There is one part of the time value of money

we have not solved for the interest rate

We need a bit of algebra to solve for the

interest rate in the time value of money
equation:

FV = PV * (1 + i)n

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 Present value and yields

SOLVING FOR THE INTEREST RATE

FV = PV * (1 + i)n

FV PV = (1 + i)n

(FV PV)(1/n) = (1 + i)

(FV PV)(1/n) -1 = i

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THE LAST EXAMPLE

Were nearly done. Finally lets do an example

of a yield question:

You invested $100,000 in GE stock. Three

years later your investment was worth
$150,000. What was your compound annual
growth rate over the three years. Assume
you received no dividends.

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 Present value and yields

YIELD EXAMPLE

Present value = 100,000

Future value = 150,000
n= 3

(FV PV)(1/n) -1 = i

(150,000 100,000)(1/3) -1 = 14.5%

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THATS IT!

We have covered the four main topics:

Future value
Compounding
Present value
Yields

Note we have not covered investments with

multiple cash flows which is outside the
scope of this lesson.
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 Present value and yields

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