Corporate Finance Lecture Notes 4.pdf

Time Value of Money Lecture 4 Future Values ? Suppose you invest RM1000 for one year at 5% per year. What is the future value in one year? Future Values ? Suppose you leave the money in for another year. How much will you have two years from now? Future Values: General Formula ? FV = PV(1 + r)t – FV = future value – PV = present value – r = period interest rate, expressed as a decimal – T = number of periods ? Future value interest factor = (1 + r)t Effects of Compounding ? Simple interest ? Compound interest ? Consider the previous example – FV with simple interest = 1000 + 50 + 50 = 1100 – FV with compound interest = 1102.50 – The extra 2.50 comes from the interest of .05(50) = 2.50 earned on the first interest payment Future Values – Example 2 ? Suppose you invest the RM1000 from the previous example for 5 years. How much would you have? – 5 N – 5 I/Y – 1000 PV – CPT FV = – The effect of compounding is small for a small number of periods, but increases as the number of periods increases. (Simple interest would have a future value of RM1250, for a difference of RM26.28.) Future Values – Example 3 ? Suppose you had a relative who deposited RM10 at 5.5% interest 200 years ago. How much would the investment be worth today? – 200 N – 5.5 I/Y – 10 PV – CPT FV = ? What is the effect of compounding? – Simple interest = – Compounding added RM446,979.29 to the value of the investment Future Value as a General Growth Formula ? Suppose your company expects to increase unit sales of widgets by 15% per year for the next 5 years. If you currently sell 3 million widgets in one year, how many widgets do you expect to sell in 5 years? – 5 N – 15 I/Y – 3,000,000 PV – CPT FV = Quick Quiz – Part I ? What is the difference between simple interest and compound interest? ? Suppose you have RM500 to invest and you believe that you can earn 8% per year over the next 15 years. – How much would you have at the end of 15 years using compound interest? – How much