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    Week 4

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    kayvidalc

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    Week 4

    Uploaded by

    kayvidalc
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    2. Week 4

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    Week 4

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    WEEK 4 Chapter 05

    Present value, Future value,


    Ordinary Annuity, Annuity Due
    Notation

    ● PMT = Cash Payment

    ● PV = Present Value

    ● FV = Future Value

    ● t = Time

    ● n = Number of Periods

    ● i =Interest Rate
    ● FVIF: ( 1 + r) n

    ● FVIFA: ((1 + r) n - 1) /r

    ● PVIF: 1/(1+r) n

    ● PVIFA: (1 - (1 + r) n)/r
    Annuities

    - Ordinary Annuity :
    Payment occur at the end of each
    period

    - Annuity Due:
    Payment occur at the beginning of
    each period
    Annuities

    - Future Value of Annuity:


    The total value of payments at a specific
    point in time.

    - Present Value of Annuity :


    How much money would be required
    now to produce those future payments.
    Ordinary Annuity

    Future Value of Ordinary Annuity


    Formula :
    [(1 + i)n- 1]
    - FVAN0 = PMTn
    i
    Ordinary Annuity
    Example :
    An annuity makes 5 annual payments of $ 1000 at the
    end of each year. What is the future value of this as of 5 years
    from now if the interest rate is 7%?
    Ordinary Annuity

    Answer:
    - FVAN5 = 1000 [(1 + 0.07)5- 1]
    0.07
    = $ 5750.739
    Ordinary Annuity
    Example :
    An investment promises to pay $6,000 at the end of each year
    for the next five years and $4,000 at the end of each year for years 6
    through 10.
    If you require a 12 percent rate of return on an investment of
    the sort, what is the future value of the investment?
    Ordinary Annuity

    Answer:
    - FVAN10 = 6,000 FVIFA5,12%FVIF5,12%+
    - 4,000 FVIFA5,12%
    = $67,087.68+$25,412
    = $92,499.68
    Ordinary Annuity

    Present Value of Ordinary Annuity


    Formula :
    Ordinary Annuity
    Present Value of Ordinary Annuity
    Example :
    Suppose you receive a 5-year ordinary annuity of $1,000
    per year and deposit the money in a savings account at the end of
    each year. The account earns interest at a rate of 5 percent
    compounded annually. How much is this annuity worth to you
    today?
    Ordinary Annuity

    Answer:

    PVAN5 = 1000 [1-(1/(1 + 0.05)5)]

    0.05
    = $ 4329.476
    Ordinary Annuity
    Practice:
    Suppose you deposit $3000 in the end of each year, and you
    can earn 5% of interest rate compounded annually. What is the future
    value of this investment at the end of 8th year?
    Ordinary Annuity
    Present Value of Ordinary Annuity
    Example :
    Suppose you inherited $200,000 and invested it at 6% per
    year. How much could you withdraw at the end of each of the next 15
    years?
    Ordinary Annuity

    Answer:

    1. 200,000 = PMT [1-(1/(1 + 0.06)15)]


    0.06

    = $ 20,592.55
    Annuity Due

    Future Value of Annuity Due


    Formula :
    -
    n
    FVAND0 = PMTn [(1 + i) - 1] (1+ i)
    i
    Annuity Due
    Example :
    Suppose you receive a 5-year annuity due of $1,000
    per year and deposit the money in a savings account at the
    beginning of each year. The account earns interest at a rate of
    5 percent compounded annually. How much will your account
    be worth at the end of the 5-year period?
    Annuity Due

    Future Value of Annuity Due


    Answer :
    - FVAND5 = 1000 [(1 + 0.05)5- 1] (1+ 0.05)
    0.05
    = 5801.912
    Annuity Due

    Example :
    An investment promises to pay $6,000 at the
    beginning of each year for the next five years and $4,000
    at the beginning of each year for years 6 through 10.
    If you require a 12 percent rate of return on an
    investment of the sort, how much will your account be
    worth at the end of the 10-year period?
    Annuity Due

    Future Value of Annuity Due


    Answer :
    - FVAN10 = 6,000 FVIFA5,12% FVIF5,12%(1+12%)+
    - 4,000 (FVIFA5,12% )(1+12%)
    = $75,138.20+16,378.88
    = $ 91,517.08
    Annuity Due

    Present Value of Annuity Due


    Formula :
    PVAND0 (1+ i)
    Annuity Due
    Example :
    Suppose you receive a 5-year annuity due of $1,000 per year
    and deposit the money in a savings account at the beginning of each
    year. The account earns interest at a rate of 5 percent compounded
    annually. How much is this annuity worth to you today?
    Annuity Due

    Present Value of Annuity Due


    Answer :
    -
    5
    PVAND5 = 1000 [1-(1/(1 + 0.05) )] (1+ 0.05)
    0.05
    - = $4545.95
    Annuity Due
    Practice :
    Steven White is considering taking early retirement. He wants
    to withdrawn $40,000 at the beginning of each year for 10
    years. White feels the savings can earn 10 percent per year.
    How much does he need to deposit now?
    Present Value: Some Additional Cash
    Flow Patterns

    ● Perpetuities : Annuity that last forever

    ● Present Value of an Uneven Payment Stream

    ● PV0 = PMTn / FVIFn + ….


    Present Value: Some Additional Cash
    Flow Patterns
    Example

    What is the present value from the following cash flows if


    your required rate of return is 12 percent?

    Year 1 $5,000
    Year 2 $8,000
    Year 3 $12,000
    Years 4-10 $15,000
    Present Value: Some Additional Cash
    Flow Patterns
    ANSWER:

    PV = 5000(0.893) + 8000 (0.797) + 12000 (0.712) + 15000(


    5.650 - 2.402)

    = $ 68,105
    Compounding Periods and Effective
    Interest Rate
    - Nominal Interest Rate

    - Effective Interest Rate


    Compounding Periods and Effective
    Interest Rate
    - Effective Interest Rate
    - ieff = [1 + (inom/m)]m – 1
    Compounding Periods and Effective
    Interest Rate

    Example:
    Calculate the effective annual rate if the nominal annual
    rate is 10 percent compounded semi-annually.
    Compounding Periods and Effective
    Interest Rate
    Answer:
    ieff = [1 + (inom/m)]m – 1
    = [1 + (0.1/2)]2 – 1
    = 10.25%
    Compounding Periods and Effective
    Interest Rate

    Example:
    Calculate the effective annual rate if the nominal annual
    rate is 10 percent compounded continuously.
    Compounding Periods and Effective
    Interest Rate
    Answer:
    ei- 1
    = 2.171828(0.1)- 1
    = 0.080644 or 8.06%
    Practice

    City Bank offers a 7-year CD with a nominal rate of interest


    of 7.0%. If compounding occurs continuously, what is the
    effective annual rate?
    Practice

    Answer:
    ei- 1
    = 2.171828(0.7)- 1
    =1.0137or 101.37%
    Net Present Value

    Net Present Value


    Difference between the value of cash inflows and outflows
    over periods of time

    NPV = Present Value of Future Cash


    Flows – Initial Outlay
    Practice

    Calculate the present value of the following net cash flows


    if the discount rate is 12%.
    Year Cash Flow
    1-5 $10,000 each year
    6-10 $15,000 each year
    11-15 $17,000 each year
    Practice

    Answer:
    PV=1,000(PVIFA12%,5) + 15,000(PVIFA12%,5)(PVIF12%,5) +
    17,000(PVIFA12%,5)(PVIF12%,10)
    =3,604.8 + 30,986.85 + 19,732.68
    =54,324.33
    Practice

    Following by the last question. The initial cost is $30,000 ,


    what is the NPV?
    Year Cash Flow
    1-5 $10,000 each year
    6-10 $15,000 each year
    11-15 $17,000 each year
    Practice

    Answer:
    NPV=54,324.33 – 30,000
    =24,324.33

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