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Topics Covered Future Values and Compound Interest Present Values Multiple Cash Flows Level Cash Flows Perpetuities and Annuities Inflation Time Value Effective Annual Interest Rate Future Values Future Value - Amount to which an investment will grow after earning interest. (at some future point in time) Simple Interest - Interest earned only on the original investment (only on the principal). Compound Interest - Interest earned on interest. (not only on the principal) Future Values Example - Simple Interest Interest earned at a rate of 6% for five years on a principal balance of $100. Future Values Example - Simple Interest Interest earned at a rate of 6% for five years on a principal balance of $100. Today Future Years 1 2 3 4 5 Interest Earned Value 100 Future Values Example - Compound Interest Interest earned at a rate of 6% for five years on the previous year’s balance. Interest Earned Per Year =Prior Year Balance x .06 Future Values Example - Compound Interest Interest earned at a rate of 6% for five years on the previous year’s balance. Today Future Years 1 2 3 4 5 Interest Earned Value 100 Future Values Future Value of $100 = FV Future Values Future Values with Compounding Manhattan Island Sale Present Values Present Values Present Values Example You just bought a new computer for $3,000. The payment terms are 2 years same as cash. If you can earn 8% on your money, how much money should you set aside today in order to make the payment when due in two years? Present Values Discount Factor = DF = PV of $1 Discount Factors can be used to compute the present value of any cash flow. Time Value of Money(applications) The PV formula has many applications. Given any variables in the equation, you can solve for the remaining variable. Present Values with Compounding Time Value of Money(applications) Value of Free Credit Implied Interest Rates Internal Rate of