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Time Value of Money – Part One (Ch. 2)

Time Value of Money – Part One (Ch. 2). 04/10/06. Basic intuition. Because of the ability of investors to earn interest on funds available today, the time value of money posits that a dollar today is worth more than a dollar tomorrow. Future value.

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Time Value of Money – Part One (Ch. 2)

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  1. Time Value of Money – Part One (Ch. 2) 04/10/06

  2. Basic intuition • Because of the ability of investors to earn interest on funds available today, the time value of money posits that a dollar today is worth more than a dollar tomorrow.

  3. Future value • Future value – the value of a present or future, single cash flow or stream of cash flows at a specific future date. • Principal – amount deposited today • Interest rate – the rate at which your money is growing. This can also be considered to be a growth rate and can also represent an opportunity cost. • Compounding of interest (interest on interest) – interest earned on accumulated interest

  4. Future value • The future value at time n of a single cash flow today compounded (or growing) at an interest rate r can be calculated as: • The term (1+r)n is also referred to as the Future Value Interest Factor (FVIF)

  5. Methods of calculation • Equation • Financial calculator • Spreadsheet

  6. Present value • Present value – the value of a future, single cash flow or stream of future cash flows today. • Discount rate – the interest rate that allows us to convertfuture cash flows into cash flows in present dollars.

  7. Present value • The present value of a single cash flow at time n today discounted at an interest rate r can be calculated as: • The term 1/(1+r)n is also referred to as the Present Value Interest Factor (PVIF)

  8. Four variables -- one equation • With a single future cash flow and a cash flow today, we can also solve for • n: • r:

  9. Doubling your money: The rule of 72s • Before calculators and spreadsheets a quick estimate of the time needed to double your money was found by using the rule of 72s: • Time estimate = 72 / interest rate • The rule is also good to find the interest rate needed to double your money in a given period • Interest rate estimate = 72 / n

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