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Time Line
Refer to period of one investment. Time 0 (t0) refer to the present time, time 1 (t1) refer to the end of the first period and so forth.
Compounding Interest
Types of interest
Simple Interest : Interest that will be received based on the principal amount Compounding Interest : Interest that will be paid not only on the principal amount but also on any interest payable not withdrawn throughout the period
Graphical Illustration of FV
There are 3 basic elements which sill influenced the future value, these are
Principal (amount that was borrowed or invested) Time period (the number of frequency of interest payment) Interest rate payable or interest received
Calculation of PV
There are formula to calculate PV PV0 = FV (1 + i)n Exmaple 3.4 : Assume you expect to received returns of RM2,500 a year from now. How much the present value if the discount rate is 8% per year PV0 = FV (1 + i)n = RM2,500 (1 + 0.08)1 = RM2,314.81
Calculation of PV (Cont)
What is the present value that you must invest if your expect to received RM2,500 in the period 2 years and 3 years at a discount rate 8% per year? PV0 = FV (1 + i)n = RM2,500 (1 + 0.08)2 = RM2,143.35 PV0 = FV (1 + i)n = RM2,500 (1 + 0.08)3 = RM1,984.58
Graphical Illustration of PV
Change of interest rate, time of period or the return will changed of the present value. Example 3.7 : You intend to obtain return of RM1,000 in 3 years from Bank A, B and C that offer interest 8%, 10% and 12%. What id the principal value that should make?
PVB
PVC
Annuity
Series of payments @ receiving of the same amount at the same intervals through the period For example, Cash flow of RM5 that receive for every month is an example of Annuity Types of Annuity
Ordinary Annuity : Annuity occurs at the end of each period Annuity Due : Annuity at the beginning of the period
Perpetuity
Is the annuity that have infinity period Cannot be used in decision making because every investment have valuation period. The formula is PVp = P i
Perpetuity (Cont)
Sukehati Company issued securities that promised a payment of RM100 per year at the yearly interest rate of 8% to the holders of that security. How much the present value for that cash flow? PVp =Pi = RM100 0.08 = RM1,250