Lecture 11 02052020 105219pm 28122020 051832pm
Lecture 11 02052020 105219pm 28122020 051832pm
Lecture 11 02052020 105219pm 28122020 051832pm
Lecture: 11
Future Value Interest Factor at ‘r’ rate of interest for ‘n’ time periods
Examples on computation of future value of a single cash flow
Future Value (Graphic)
0 1 2
6%
$2,000
FV
Future Value (Formula)
FV1 = PV (1+r)n
= $2,000 (1.06)2
= $2,247.20
FV = future value, a value at some future point in time
PV = present value, a value today which is usually designated as time 0
r = rate of interest per compounding period
n = number of compounding periods
Future Value (Example)
0 1 2 3 4 5
8%
$5,000
FV5
Future Value Solution
Period 6% 7% 8%
1 1.060 1.070 1.080
2 1.124 1.145 1.166
3 1.191 1.225 1.260
4 1.262 1.311 1.360
5 1.338 1.403 1.469
Using Future Value
Tables
Period 6% 7% 8%
1 1.060 1.070 1.080
2 1.124 1.145 1.166
3 1.191 1.225 1.260
4 1.262 1.311 1.360
Present Value and Discounting
The current value of future cash flows discounted at the appropriate
discount rate over some length of time period
Discounting is the process of translating a future value or a set of future
cash flows into a present value.
To compute present value of a single cash flow, we need:
Future value of the cash flow (FV)
Interest rate (r) and
Time Period (n)
PV0 = FVn / (1 + r) n
Present Value (Graphic)
0 5 10
6%
$4,000
PV0
Present Value (Formula)
PV0 = FV / (1+r)10
= $4,000 / (1.06)10
= $2,233.58
0 5 10
6%
$4,000
PV0
Present Value Example
FV= PV (1 + r)n
=
1,000(1.03)32
=
2,575.10
Present Value Single Deposit (Graphic)
annually.
0 1 2
7%
$1,000
PV0 PV1
Present Value Single Deposit (Formula)
0 1 2
7%
$1,000
PV0
General Present Value Formula
Period 6% 7% 8%
1 .943 .935 .926
Period 6% 7% 8%
1 .943 .935 .926
2 .890 .873 .857
3 .840 .816 .794
4 .792 .763 .735
5 .747 .713 .681
Annuities
(Ordinary Annuity)
End of End of End of
Period 1 Period 2 Period 3
0 1 2 3
(Annuity Due)
Beginning of Beginning of Beginning of
Period 1 Period 2 Period 3
0 1 2 3
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Example of an
Ordinary Annuity -- FVA
Cash flows occur at the end of the period
0 1 2 3 4
7%
$1,000 $1,000 $1,000
$1,070
$1,145
FVA3 = $1,000(1.07)2 + $1,000(1.07)1
+ $1,000(1.07)0 $3,215 = FVA3
= $1,145 + $1,070 + $1,000
= $3,215
26
FV of Ordinary Annuity-
Simple Formula
27
Hint on Annuity Valuation
The future value of an ordinary
annuity can be viewed as
occurring at the end of the last
cash flow period, whereas the
future value of an annuity due
can be viewed as occurring at
the beginning of the last cash
flow period.
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Overview View of an
Annuity Due -- FVAD
Cash flows occur at the beginning of the period
0 1 2 3 n-1 n
i% . . .
R R R R R
31
Overview of an
Ordinary Annuity -- PVA
Cash flows occur at the end of the period
0 1 2 n n+1
i% . . .
R R R
R = Periodic
Cash Flow
PVAn
PVAn = R/(1+i)1 + R/(1+i)2
+ ... + R/(1+i)n
32
Example of an
Ordinary Annuity -- PVA
Cash flows occur at the end of the period
0 1 2 3 4
7%
$1,000 $1,000 $1,000
$934.58
$873.44
$816.30
$2,624.32 = PVA3 PVA3 = $1,000/(1.07)1 +
$1,000/(1.07)2 + $1,000/(1.07)3
= $934.58 + $873.44 + $816.30
= $2,624.32
33
Cash flow after 10 years= $7000
I = 8%
n=10
Annuity Ordinary?
34
Cash flow after 5 years= $6000
I = 12%
n=5
Annuity Ordinary?
35
Hint on Annuity Valuation
The present value of an ordinary
annuity can be viewed as
occurring at the End of the first
cash flow period, whereas the
Present value of an annuity due
can be viewed as occurring at
the Beginning of the first cash
flow period.
36
PV of Ordinary Annuity -
Simple Formula
37
Overview of an
Annuity Due -- PVAD
Cash flows occur at the beginning of the period
0 1 2 n-1 n
i% . . .
R R R R
R: Periodic
PVADn Cash Flow
40
Perpetuities