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Chapter 5 Time Value of Money

Chapter 5 Time Value of Money. Time value. What is the difference between simple interest and compound interest? https://www.youtube.com/watch?feature=player_embedded&v=-qgdMTbTJlA. Let’s Look at the worksheet.

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Chapter 5 Time Value of Money

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  1. Chapter 5 Time Value of Money

  2. Time value • What is the difference between simple interest and compound interest? https://www.youtube.com/watch?feature=player_embedded&v=-qgdMTbTJlA

  3. Let’s Look at the worksheet • In the worksheet, is there something special that needs to be done for a present value amount?

  4. FV Example • If you were to invest $3,000 today, what would it be worth in 1 year if you can earn 10% on your investments on average? 2 Years? 5 years?

  5. What does the word value or worth mean to you?

  6. PV Example • When you were 10 years old your grandfather tells you that upon college graduation (age 22) he will give you $30,000. Inflation is expected to be 3.5%. What is this amount worth as a 10 year old?

  7. PV example • When you retire at age 65, your retirement fund promises to pay you $150,000 the first year of your retirement. You are now 25. If inflation is 4%, what is this worth to you in today’s money? • If the company can earn 12% on its retirement investments, how much must they put away today to get the above payment?

  8. Complete this for your age.

  9. Annuities • What are some examples of cash flows that are annuity cash flow streams? • What is the difference between an annuity due and an ordinary annuity?

  10. Annuity Example • If you started at age 19 to save 2,000 per year at the end of the year and could average 11% per year in earnings, how much would you have at retirement at age 65?

  11. Would it make a difference if you started at the beginning of the year instead of the end? How much?

  12. Building Wealth http://www.youtube.com/watch?feature=player_detailpage&v=23zghpS9034

  13.  Annuity Example • If you started saving $1,500 per year on a monthly basis for 18 years toward your child’s college education, how much would you have if you invested and earned 8%? 12%?

  14. Annuity Example • You have analyzed your retirement plan and have concluded that you need 3,850,000 at age 62. You are currently 25. If you can invest at 12% on average, how much must you invest monthly to achieve the financial goal?

  15. Use your age.

  16.  Annuity example • Let’s assume that at age 62 you have saved the amount in the above slide. You think you will live to be 88 years old. During retirement, you plan to earn 8% on your investments. How much can you withdraw every month for the remainder of your life?

  17. With respect to money what do the following people worry about? • College student 19 years old. • Young married person 31 years old with a child age 5. • A stable working married adult age 50, children are out of the house and college. • A senior citizen age 64 recently retired.

  18. Annuity Example • You win a prestigious sweepstake award. The company offers you $50,000 per year for the next 30 years or a lump sum. Answer the following questions. • If the company can invest at 7%, how much would they need to invest to pay the promised cash flow stream? This is the amount of the lump sum offer? • If you could invest at 9%, how much could you withdraw for the 30 years, if you invest the lump sum?

  19. Annuity Example • At retirement you want to receive $60,000 per year for 25 years and can earn 13%. How much must you invest to achieve this goal? • If you are concerned about the 3.75% inflation rate, how much must you invest?

  20. Annuity • If you wanted to receive $10,000 per year for ever, how much would you need to invest at 12%? • What kind of cash flow stream is this?

  21. Change the interest rate to 10%. How much must you invest? How does the perpetuity work?

  22.  Mixed Cash Flows • A company is planning a project that will provide the following cash flow stream. If they can earn 14% on average, what is the value of this project? • If the company could reinvest the above cash flow stream at 12%, what would they have at the end of the 7th year?

  23. Compounding frequency • How do you change the compounding frequency in a time value problem? • What is the Effective interest rate for a 12%, monthly compounded investment? Quarterly?

  24.  Example • A newly married couple is considering buying a new home. The house of their dreams costs $325,000. They have 10% to put down on the home and can borrow at 3.95%. • How much must they borrow? • What are the monthly payments on a 30 year mortgage? • What is the total cost of the loan for the 360 months? • Loan Analysis worksheet

  25. What is a loan amortization table? • How much interest is paid out of the first month’s payment? • When the couple pays their 180th payment, what is the balance? • If they paid an extra 50 payment per month, how much interest would they save? • If they paid biweekly payments, how much would they save? (divide monthly payments by 12)

  26.  Example of returns • When I was born my Grandfather purchased a stock for $25. When I was 25 the stock was worth $75. What did I earn on the investment? • What would I earn at age 65 if the stock was then worth $250?

  27. The Rule of 72. What is this rule? 12% 2000 4000 8000 16000 32000 64000 128000 256000 512000 6% 2000 4000 8000 16000 32000 3% 2000 4000 8000

  28. Time • http://www.youtube.com/watch?feature=player_detailpage&v=_zpGZfFbW4M

  29. Retirement example • You currently earn 50,000 per year and have been able to save $15,000 in a retirement account. You will retire in 35 years at age 60 and inflation is 4%. What will your income need to be in year 1 of retirement to maintain your current lifestyle? PV = 50K FV = ? N=35 I/Y=4% m=1 PMT = 0 • If you live to 90, how much do you need in your pension fund at age 60 with 8% return. PVA = ? FV = 0 N=30 I/Y=8% m=1 PMT = 197304 • If you wanted your retirement income to keep up with an expected inflation rate of 4.5%, how much would you need? PVA = ? FV = 0 N=30 I/Y=8% m=1 PMT = 197304 Growth of annuity = 4.5% • How much must you invest each month in your retirement plans to get your desired growing retirement income if you can earn a 12% return? PV = -15000 FV = 3539071 N=35 I/Y=12% m=12 PMT for FVA = ?

  30. Retirement example • You currently earn 50,000 per year and have been able to save $15,000 in a retirement account. You will retire in 35 years at age 60 and inflation is 4%. What will your income need to be in year 1 of retirement to maintain your current lifestyle? PV = 50K FV = ? N=35 I/Y=4% m=1 PMT = 0 • If you live to 90, how much do you need in your pension fund at age 60 with 8% return. PVA = ? FV = 0 N=30 I/Y=8% m=1 PMT = 197304 • If you wanted your retirement income to keep up with an expected inflation rate of 4.5%, how much would you need? PVA = ? FV = 0 N=30 I/Y=8% m=1 PMT = 197304 Growth of annuity = 4.5% • How much must you invest each month in your retirement plans to get your desired growing retirement income if you can earn a 12% return? PV = -15000 FV = 3539071 N=35 I/Y=12% m=12 PMT for FVA = ?

  31. Retirement example • You currently earn 50,000 per year and have been able to save $15,000 in a retirement account. You will retire in 35 years at age 60 and inflation is 4%. What will your income need to be in year 1 of retirement to maintain your current lifestyle? PV = 50K FV = ? N=35 I/Y=4% m=1 PMT = 0 • If you live to 90, how much do you need in your pension fund at age 60 with 8% return. PVA = ? FV = 0 N=30 I/Y=8% m=1 PMT = 197304 • If you wanted your retirement income to keep up with an expected inflation rate of 4.5%, how much would you need? PVA = ? FV = 0 N=30 I/Y=8% m=1 PMT = 197304 Growth of annuity = 4.5% • How much must you invest each month in your retirement plans to get your desired growing retirement income if you can earn a 12% return? PV = -15000 FV = 3539071 N=35 I/Y=12% m=12 PMT for FVA = ?

  32. Retirement example • You currently earn 50,000 per year and have been able to save $15,000 in a retirement account. You will retire in 35 years at age 60 and inflation is 4%. What will your income need to be in year 1 of retirement to maintain your current lifestyle? PV = 50K FV = ? N=35 I/Y=4% m=1 PMT = 0 • If you live to 90, how much do you need in your pension fund at age 60 with 8% return. PVA = ? FV = 0 N=30 I/Y=8% m=1 PMT = 197304 • If you wanted your retirement income to keep up with an expected inflation rate of 4.5%, how much would you need? PVA = ? FV = 0 N=30 I/Y=8% m=1 PMT = 197304 Growth of annuity = 4.5% • How much must you invest each month in your retirement plans to get your desired growing retirement income if you can earn a 12% return? PV = -15000 FV = 3539071 N=35 I/Y=12% m=12 PMT for FVA = ?

  33. Retirement example • You currently earn $XXXX per year and have been able to save $XXX in a retirement account. You will retire in X years at age 65 and inflation is 3.1%. What will your income need to be in year 1 of retirement to maintain your current lifestyle? • If you live to 90, how much do you need in your pension fund at age 60 with 8% return? • If you wanted your retirement income to keep up with an expected inflation rate of 3.1%, how much would you need? • How much must you invest each month in your retirement plans to get your desired growing retirement income, if you can earn a 12% return?

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