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Compounding Interest

Compounding Interest. How it works…. Concepts. Future Value : determine what your money will be worth in a given number of years. Present Value : present day value of an amount that is received at a future. Payments : The amount of money you must pay each period on a loan

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Compounding Interest

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  1. Compounding Interest

  2. How it works…

  3. Concepts • Future Value: determine what your money will be worth in a given number of years. • Present Value: present day value of an amount that is received at a future. • Payments: The amount of money you must pay each period on a loan • Net Present Value: the present value of net cash inflows generated by a project

  4. Future Value on an Investment BASED ON THE COMPOUND INTEREST FORMULA annual interest rate(as a decimal) Principal(amount at start) time(in years) amount at the end number of times per year that interest in compounded

  5. Present ValuePV • i:interest rate per compounding period; andn: the number of compounding periods. Example: An investment consultant tells you that if you invest in a certain contract, you will receive exactly $10,000in one year. How much should you invest in this contract, assuming you demand a 4% return (yield) on your money?

  6. Loan Payments

  7. Net Present ValueNPV Decision Rule: Accept the project only if its NPV is positive or zero. Reject the project having negative NPV.

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