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Unit 2, Time value money, Time value of money, Present value (discounting)…
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Time value money
- Money loses value as time
passes by
2 reasons money loses value over time:
- Inflation(not TVM)
- Opportunity cost (Interest)
interest compensates the owner for not having the money available for other productive use > a TVM concept
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- Present value (discounting)
- Future value (compounding)
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- Money has an opportunity cost in the form of interest
- difference between receiving money today or in the future is interest
- cash flows can only be compared at the same point in time
- express them at the same time, choice between the two.
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Simple Interest - Interest earned is calculated each year simply on the ORIGINAL CAITAL AMOUNT.Compound interest - (Interest on interest)
- Original capital + interest of current year
- become principle for following year
- Compound interest results in a higher future value
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Multiple cash flows
- Even cash flows
-Ordinary annuities
- PV/FVPMT/N/I
-Annuities due
- PV/FV/PMT/N/I
-Perpetuities
- Formula
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Single cash flow or lump sum calculations
- A single amount is referred to as a lump sum of money
-whenever a single amount is involved, only one cash flow occurs
FVn = PV0 x (1 + i)^n
12% = 0.012
FVn = PV0 x FVIFi,n
PV0 = FVn x (1 + i)^-nPVo = FVn x PVIFi,n