Video 8 (Topic 2.2.5): Non-Annual Cash Flows

1. Video 8 (Topic 2.2.5):Non-Annual Cash Flows FIN 614: Financial Management Larry Schrenk, Instructor

2. Topics • What are Non-Annual Cash Flows? • Valuing Non-Annual Cash Flows • Using P/Y • Adjusting the Interest Rate

3. What are Non-Annual Cash Flows? • Few Things are Paid Annually: • Cell Phone Bill • Car Insurance • Retirement Contribution Monthly Quarterly Weekly, Every Two Weeks, Monthly (depending on your pay period)

4. Importance ▪ • You save a total of $1,200 every year at 7%. How much do you have in 25 years? • Pattern A: Save 1,200 at the end of each year. Answer: • Pattern B: Save 100 at the end of each month. Answer: • Difference:

5. Importance ▪ • You save a total of $1,200 every year at 7%. How much do you have in 25 years? • Pattern A: Save 1,200 at the end of each year. Answer: $75,898.85 • Pattern B: Save 100 at the end of each month. Answer: • Difference:

6. Importance ▪ • You save a total of $1,200 every year at 7%. How much do you have in 25 years? • Pattern A: Save 1,200 at the end of each year. Answer: $75,898.85 • Pattern B: Save 100 at the end of each month. Answer: $81,007.17 • Difference:

7. Importance ▪ • You save a total of $1,200 every year at 7%. How much do you have in 25 years? • Pattern A: Save 1,200 at the end of each year. Answer: $75,898.85 • Pattern B: Save 100 at the end of each month. Answer: $81,007.17 • Difference: $5,108.32 or 6.73%

8. A New Variable, ‘m’ • Introducing ‘m’ • Number of Periods in a Year Annual Semiannual Quarterly Monthly Weekly Daily 1 2 4 12 52 365 or 360 Period m

9. First Adjustment: N • Recall, N = Number of Periods (Not Years)

10. Second Adjustment: Interest Rate • Compound or Discount at the Period (Not the Annual) Interest Rate • Method 1: Change P/Y • Method 2: Adjust the Interest Rate • NOTE: These are doing exactly the same thing, so it does not matter which you use.

11. Change P/Y • In the TVM section, change P/Y to m: N=0 I%=0 PV=0 PMT=0 FV=0 P/Y=1◄ Change to m C/Y=1 PMT: ENDBEGIN

12. Adjust the Interest Rate • Adjustment • Find the Annual Interest Rate • Divide It by m. • Use the result for I%.

13. EXAMPLE 1: Change P/Y You save $100 every month at 7%. How much do you have in 25 years? N=300 (= 25 x 12) I%=7 PV=0 PMT=-100 FV=0 ◄ Select FV, then [ALPHA] [ENTER] P/Y=12 (= m) C/Y=12 (C/Y will automatically change to the value of P/Y.) PMT: END BEGIN FV = 81,007.17

14. EXAMPLE 1: Adjust Interest Rate You save $100 every month at 7%. How much do you have in 25 years? N=300 (= 25 x 12) I%=7/12 (= 7/12) PV=0 PMT=-100 FV=0 ◄ Select FV, then [ALPHA] [ENTER] P/Y=1 (Do not change P/Y) C/Y=1 PMT: END BEGIN FV = 81,007.17

15. A Warning▪ When you solve non-annual time or interest rate problems, the answer is in ‘periods’. I saved $100 monthly and have $1300 in my account. If my rate of return was 10%, how long did I hold the investment? Answer: 12.39

16. A Warning▪ When you solve non-annual time or interest rate problems, the answer is in ‘periods’. I saved $100 monthly and have $1300 in my account. If my rate of return was 10%, how long did I hold the investment? Answer: 12.30 Months, NOT years

17. A Warning▪ When you solve non-annual time or interest rate problems, the answer is in ‘periods’. I saved $100 monthly and have $1300 in my account. If my rate of return was 10%, how long did I hold the investment? Answer: 12.30 Months, NOT years

18. Video 8 (Topic 2.2.5):Non-Annual Cash Flows FIN 614: Financial Management Larry Schrenk, Instructor