Tài chính doanh nghiệp - Chapter 4: Time value of money

Chapter 4Time Value of MoneyLearning GoalsDiscuss the role of time value in finance, the use of computational aids, and the basic patterns of cash flow.Understand the concept of future value and present value, their calculation for single amounts, and the relationship between them.Find the future value and the present value of both an ordinary annuity and an annuity due, and the present value of a perpetuity.2Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Learning Goals (cont.)Calculate both the future value and the present value of a mixed stream of cash flows.Understand the effect that compounding interest more frequently than annually has on future value and the effective annual rate of interest.Describe the procedures involved in (1) determining deposits needed to accumulate to a future sum, (2) loan amortization, (3) finding interest or growth rates, and (4) finding an unknown number of periods. 3Copyright © 2006 Pearson Addison-Wesley. All rights reserved.QuestionWould it be better for a company to invest $100,000 in a product that would return a total of $200,000 after one year, or one that would return $220,000 after two years?The Role of Time Value in FinanceMost financial decisions involve costs & benefits that are spread out over time.Time value of money allows comparison of cash flows from different periods.4Copyright © 2006 Pearson Addison-Wesley. All rights reserved.AnswerIt depends on the interest rate! The Role of Time Value in Finance (cont.)Most financial decisions involve costs & benefits that are spread out over time.Time value of money allows comparison of cash flows from different periods.5Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Basic ConceptsFuture Value: compounding or growth over timePresent Value: discounting to today’s valueSingle cash flows & series of cash flows can be consideredTime lines are used to illustrate these relationships6Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Computational AidsUse the EquationsUse the Financial TablesUse Financial CalculatorsUse Electronic Spreadsheets7Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Computational Aids (cont.)8Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Computational Aids (cont.)9Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Computational Aids (cont.)10Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Computational Aids (cont.)11Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Advantages Electronic SpreadsheetsSpreadsheets go far beyond the computational abilities of calculators.Spreadsheets have the ability to program logical decisions.Spreadsheets display not only the calculated values of solutions but also the input conditions on which solutions are based.Spreadsheets encourage teamwork.Spreadsheets enhance learning.Spreadsheets communicate as well as calculate.12Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Basic Patterns of Cash FlowThe cash inflows and outflows of a firm can be described by its general pattern.The three basic patterns include a single amount, an annuity, or a mixed stream:13Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Simple InterestWith simple interest, you don’t earn interest on interest.Year 1: 5% of $100 = $5 + $100 = $105Year 2: 5% of $100 = $5 + $105 = $110Year 3: 5% of $100 = $5 + $110 = $115Year 4: 5% of $100 = $5 + $115 = $120Year 5: 5% of $100 = $5 + $120 = $12514Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Compound InterestWith compound interest, a depositor earns interest on interest!Year 1: 5% of $100.00 = $5.00 + $100.00 = $105.00Year 2: 5% of $105.00 = $5.25 + $105.00 = $110.25Year 3: 5% of $110.25 = $5 .51+ $110.25 = $115.76Year 4: 5% of $115.76 = $5.79 + $115.76 = $121.55Year 5: 5% of $121.55 = $6.08 + $121.55 = $127.6315Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Time Value TermsPV0 = present value or beginning amounti = interest rateFVn = future value at end of “n” periodsn = number of compounding periodsA = an annuity (series of equal payments or receipts)16Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Four Basic ModelsFVn = PV0(1+i)n = PV x (FVIFi,n)PV0 = FVn[1/(1+i)n] = FV x (PVIFi,n)FVAn = A (1+i)n - 1 = A x (FVIFAi,n) iPVA0 = A 1 - [1/(1+i)n] = A x (PVIFAi,n) i17Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Future Value of a Single AmountFuture Value techniques typically measure cash flows at the end of a project’s life.Future value is cash you will receive at a given future date.The future value technique uses compounding to find the future value of each cash flow at the end of an investment’s life and then sums these values to find the investment’s future value.We speak of compound interest to indicate that the amount of interest earned on a given deposit has become part of the principal at the end of the period.18Copyright © 2006 Pearson Addison-Wesley. All rights reserved. $100 x (1.08)1 = $100 x FVIF8%,1 $100 x 1.08 = $108Future Value of a Single Amount: Using FVIF TablesIf Fred Moreno places $100 in a savings account paying 8% interest compounded annually, how much will he have in the account at the end of one year?19Copyright © 2006 Pearson Addison-Wesley. All rights reserved. FV5 = $800 X (1 + 0.06)5 = $800 X (1.338) = $1,070.40Future Value of a Single Amount: The Equation for Future ValueJane Farber places $800 in a savings account paying 6% interest compounded annually. She wants to know how much money will be in the account at the end of five years.20Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Future Value of a Single Amount:Using a Financial Calculator21Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Future Value of a Single Amount:Using Spreadsheets22Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Future Value of a Single Amount:A Graphical View of Future Value23Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Present Value of a Single AmountPresent value is the current dollar value of a future amount of money.It is based on the idea that a dollar today is worth more than a dollar tomorrow.It is the amount today that must be invested at a given rate to reach a future amount.Calculating present value is also known as discounting.The discount rate is often also referred to as the opportunity cost, the discount rate, the required return, or the cost of capital.24Copyright © 2006 Pearson Addison-Wesley. All rights reserved. $300 x [1/(1.06)1] = $300 x PVIF6%,1 $300 x 0.9434 = $283.02Present Value of a Single Amount: Using PVIF TablesPaul Shorter has an opportunity to receive $300 one year from now. If he can earn 6% on his investments, what is the most he should pay now for this opportunity?25Copyright © 2006 Pearson Addison-Wesley. All rights reserved. PV = $1,700/(1 + 0.08)8 = $1,700/1.851 = $918.42Present Value of a Single Amount: The Equation for Future ValuePam Valenti wishes to find the present value of $1,700 that will be received 8 years from now. Pam’s opportunity cost is 8%.26Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Present Value of a Single Amount: Using a Financial Calculator27Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Present Value of a Single Amount: Using Spreadsheets28Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Present Value of a Single Amount: A Graphical View of Present Value29Copyright © 2006 Pearson Addison-Wesley. All rights reserved.AnnuitiesAnnuities are equally-spaced cash flows of equal size.Annuities can be either inflows or outflows.An ordinary (deferred) annuity has cash flows that occur at the end of each period.An annuity due has cash flows that occur at the beginning of each period.An annuity due will always be greater than an otherwise equivalent ordinary annuity because interest will compound for an additional period.30Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Types of AnnuitiesNote that the amount of both annuities total $5,000.Fran Abrams is choosing which of two annuities to receive. Both are 5-year $1,000 annuities; annuity A is an ordinary annuity, and annuity B is an annuity due. Fran has listed the cash flows for both annuities as shown in Table 4.1 on the following slide.31Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Future Value of an Ordinary Annuity32Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Future Valueof an Ordinary Annuity (cont.)Fran Abrams wishes to determine how much money she will have at the end of 5 years if he chooses annuity A, the ordinary annuity and it earns 7% annually. Annuity a is depicted graphically below:33Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Future Value of an Ordinary Annuity: Using the FVIFA TablesFVA = $1,000 (FVIFA,7%,5) = $1,000 (5.751) = $5,751 34Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Future Value of an Ordinary Annuity: Using a Financial Calculator35Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Future Value of an Ordinary Annuity: Using Spreadsheets36Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Present Value of an Ordinary AnnuityBraden Company, a small producer of plastic toys, wants to determine the most it should pay to purchase a particular annuity. The annuity consists of cash flows of $700 at the end of each year for 5 years. The required return is 8%.37Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Present Value of an Ordinary Annuity: The Long Method38Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Present Value of an Ordinary Annuity: Using PVIFA TablesPVA = $700 (PVIFA,8%,5) = $700 (3.993) = $2,795.1039Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Present Value of an Ordinary Annuity: Using a Financial Calculator40Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Present Value of an Ordinary Annuity: Using Spreadsheets41Copyright © 2006 Pearson Addison-Wesley. All rights reserved.PV = Annuity/Interest RatePV = $1,000/.08 = $12,500Present Value of a PerpetuityA perpetuity is a special kind of annuity.With a perpetuity, the periodic annuity or cash flow stream continues forever.For example, how much would I have to deposit today in order to withdraw $1,000 each year forever if I can earn 8% on my deposit?42Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Future Value of a Mixed Stream43Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Future Value of a Mixed Stream (cont.)44Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Future Value of a Mixed Stream: Using Excel45Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Present Value of a Mixed StreamFrey Company, a shoe manufacturer, has been offered an opportunity to receive the following mixed stream of cash flows over the next 5 years.46Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Present Value of a Mixed StreamIf the firm must earn at least 9% on its investments, what is the most it should pay for this opportunity?This situation is depicted on the following time line.47Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Present Value of a Mixed Stream48Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Present Value of a Mixed Stream: Using Excel49Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Compounding Interest More Frequently Than AnnuallyCompounding more frequently than once a year results in a higher effective interest rate because you are earning on interest on interest more frequently.As a result, the effective interest rate is greater than the nominal (annual) interest rate.Furthermore, the effective rate of interest will increase the more frequently interest is compounded.50Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Compounding Interest More Frequently Than Annually (cont.)Fred Moreno has found an institution that will pay him 8% annual interest, compounded quarterly. If he leaves the money in the account for 24 months (2 years), he will be paid 2% interest compounded over eight periods.51Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Compounding Interest More Frequently Than Annually (cont.)52Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Compounding Interest More Frequently Than Annually (cont.)53Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Compounding Interest More Frequently Than Annually (cont.)A General Equation for Compounding More Frequently than Annually54Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Compounding Interest More Frequently Than Annually (cont.)A General Equation for Compounding More Frequently than AnnuallyRecalculate the example for the Fred Moreno example assuming (1) semiannual compounding and (2) quarterly compounding.55Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Compounding Interest More Frequently Than Annually: Using a Financial Calculator56Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Compounding Interest More Frequently Than Annually: Using a Spreadsheet57Copyright © 2006 Pearson Addison-Wesley. All rights reserved.FVn (continuous compounding) = PV x (ekxn) where “e” has a value of 2.7183.Continuous CompoundingWith continuous compounding the number of compounding periods per year approaches infinity.Through the use of calculus, the equation thus becomes:Continuing with the previous example, find the Future value of the $100 deposit after 5 years if interest is compounded continuously.58Copyright © 2006 Pearson Addison-Wesley. All rights reserved.FVn (continuous compounding) = PV x (ekxn) where “e” has a value of 2.7183.FVn = 100 x (2.7183).08x2 = $117.35Continuous Compounding (cont.)With continuous compounding the number of compounding periods per year approaches infinity.Through the use of calculus, the equation thus becomes:59Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Continuous Compounding: Using a Financial Calculator60Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Continuous Compounding: Using a Spreadsheet61Copyright © 2006 Pearson Addison-Wesley. All rights reserved.EAR = (1 + i/m) m - 1Nominal & Effective Annual Rates of InterestThe nominal interest rate is the stated or contractual rate of interest charged by a lender or promised by a borrower.The effective interest rate is the rate actually paid or earned.In general, the effective rate > nominal rate whenever compounding occurs more than once per year62Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Nominal & Effective Annual Rates of Interest (cont.)Fred Moreno wishes to find the effective annual rate associated with an 8% nominal annual rate (I = .08) when interest is compounded (1) annually (m=1); (2) semiannually (m=2); and (3) quarterly (m=4).63Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Special Applications of Time Value: Deposits Needed to Accumulate to a Future Sum64Copyright © 2006 Pearson Addison-Wesley. All rights reserved.PMT = $30,000/5.637 = $5,321.98Special Applications of Time Value: Deposits Needed to Accumulate to a Future Sum (cont.)Suppose you want to buy a house 5 years from now and you estimate that the down payment needed will be $30,000. How much would you need to deposit at the end of each year for the next 5 years to accumulate $30,000 if you can earn 6% on your deposits?65Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Special Applications of Time Value: Deposits Needed to Accumulate to a Future Sum (cont.)66Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Special Applications of Time Value: Deposits Needed to Accumulate to a Future Sum (cont.)67Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Special Applications of Time Value:Loan Amortization68Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Special Applications of Time Value:Loan Amortization (cont.)69Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Ray Noble wishes to find the rate of interest or growth reflected in the stream of cash flows he received from a real estate investment over the period from 2002 through 2006 as shown in the table on the following slide.Special Applications of Time Value: Interest or Growth RatesAt times, it may be desirable to determine the compound interest rate or growth rate implied by a series of cash flows.70Copyright © 2006 Pearson Addison-Wesley. All rights reserved.PVIFi,5yrs = PV/FV = ($1,250/$1,520) = 0.822PVIFi,5yrs = approximately 5%Special Applications of Time Value: Interest or Growth Rates (cont.)71Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Special Applications of Time Value: Interest or Growth Rates (cont.)72Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Special Applications of Time Value: Interest or Growth Rates (cont.)73Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Ann Bates wishes to determine the number of years it will take for her initial $1,000 deposit, earning 8% annual interest, to grow to equal $2,500. Simply stated, at an 8% annual rate of interest, how many years, n, will it take for Ann’s $1,000 (PVn) to grow to $2,500 (FVn)?Special Applications of Time Value: Finding an Unknown Number of PeriodsAt times, it may be desirable to determine the number of time periods needed to generate a given amount of cash flow from an initial amount.74Copyright © 2006 Pearson Addison-Wesley. All rights reserved.PVIF8%,n = PV/FV = ($1,000/$2,500) = .400PVIF8%,n = approximately 12 yearsSpecial Applications of Time Value: Finding an Unknown Number of Periods (cont.)75Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Special Applications of Time Value: Finding an Unknown Number of Periods (cont.)76Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Special Applications of Time Value: Finding an Unknown Number of Periods (cont.)77Copyright © 2006 Pearson Addison-Wesley. All rights reserved.