Discussion 4

CFN80US
Time
Time Value
Value of
of
Money
Money
© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/e
Created by: Gregory A. Kuhlemeyer, Ph.D.
Carroll College, Waukesha, WI
1
 Discussion Objectives
1. Understand what is meant by “+time value of money."
2. Understand the relationship between present and future value.
3. Describe how the interest rate can be used to adjust the value of
cash flows – both forward and backward – to a single point in time.
4. Calculate both the future and present value of: (a) an amount
invested today; (b) a stream of equal cash flows (an annuity); and
(c) a stream of mixed cash flows.
5. Distinguish between an “ordinary annuity” and an “annuity due.”
6. Use interest factor tables and understand how they provide a
shortcut to calculating present and future values.
7. Use interest factor tables to find an unknown interest rate or
growth rate when the number of time periods and future and
present values are known.
2 8. Build an “amortization schedule” for an installment-style loan.
 The
The Interest
Interest Rate
Rate
Which would you prefer -- N$10,000
today or N$10,000 in 5 years?
years

Obviously, N$10,000 today.

today

You already recognize that there is

TIME VALUE TO MONEY!!
MONEY

3
 Time Value of Money

4 4
 Why
Why TIME?
TIME?

Why is TIME such an important

element in your decision?

TIME allows you the opportunity to

postpone consumption and earn
INTEREST.
INTEREST

5
 What is TVM?
• The concept that money you have now is worth more
than the identical sum in the future i.e. a $1 today is
better than a $1 tomorrow.
• Why? Because you can use money to make more
money! Money you have now has the potential to earn
more money between now and the future (by way of
interest if invested).
• How? You could run a business, or buy something now
and sell it later for more, or simply put the money in the
bank to earn interest.

6
 What is TVM?
• This core principle of finance holds that provided
money can earn interest, any amount of money is
worth more the sooner it is received.
• TVM is also sometimes referred to as present
discounted value.

7
 How
How Interest
Interest affect
affect TVM
TVM
1. The Interest Rate
2. Simple Interest
3. Compound Interest
4. Amortizing a Loan
5. Compounding More Than Once per
Year
8
 TVM Example
• Example: Let us say you can get 10% interest on
your money.
• So $1,000 now could earn $1,000 x 10%
= N$100 in a year. Your $1,000 now would
become $1,100 by next year. So $1,100 next
year is the same as $1,000 now.

9
 Types
Types of
of Interest
Interest
Simple Interest
Interest paid (earned) on only the original
amount, or principal, borrowed (lent).
Compound Interest
Interest paid (earned) on any previous
interest earned, as well as on the
principal borrowed (lent).

10
 The Time Value of Money
Compounding and
Discounting Single Sums

11 11
 Simple
Simple Interest
Interest Formula
Formula

Formula SI = P0(r)(n)
SI: Simple Interest
P0: Principal Deposited today (t=0)
r: Interest Rate per Period
n: Number of Time Periods
12
 Simple
Simple Interest
Interest Example
Example
 Assume that you deposit N$1,000 in an
account earning 7% simple interest for
2 years. What is the accumulated
interest at the end of the 2nd year?
 SI = P0(r)(n)
= N$1,000(.07)(2)
= N$140
13
 Simple
Simple Interest
Interest (FV)
(FV)
 What is the Future Value (FV)
FV of the
deposit?
FV = P0 + SI
= N$1,000 + N$140
= N$1,140
 Future Value is the value at some future
time of a present amount of money, or a
series of payments, evaluated at a given
14
interest rate.
 Simple
Simple Interest
Interest (PV)
(PV)
 What is the Present Value (PV)
PV of the
previous problem?
The Present Value is simply the
N$1,000 you originally deposited.
That is the value today!
 Present Value is the current value of a
future amount of money, or a series of
payments, evaluated at a given interest
15
rate.
 Why
Why Compound
Compound Interest?
Interest?
Future
Future Value of aa single
value of SingleN$1,000
$1,000 Deposit
Deposit
Future Value (U.S. Dollars)

20000
10% Simple
15000 Interest
10000 7% Compound
Interest
5000 10% Compound
Interest
0
1st Year 10th 20th 30th
Year Year Year
16
 Future
Future Value
Value
Single
Single Deposit
Deposit (Graphic)
(Graphic)
Assume that you deposit N$1,000
at a compound interest rate of 7%
for 2 years.
years
0 1 2
7%
N$1,000
FV2
17
 Future
Future Value
Value
Single
Single Deposit
Deposit (Formula)
(Formula)
FV1 = P0 (1+r)1 = N$1,000 (1.07)
= N$1,070
Compound Interest
You earned N$70 interest on your
N$1,000 deposit over the first year.
This is the same amount of interest you
would earn under simple interest.
18
 Future
Future Value
Value
Single
Single Deposit
Deposit (Formula)
(Formula)
FV1 = P0 (1+r)1 = N$1,000 (1.07)
= N$1,070
FV2 = FV1 (1+r)1
= P0 (1+r)(1+r) = N$1,000(1.07)(1.07)
N$1,000
= P0 (1+r)2 = N$1,000(1.07)
N$1,000 2

= N$1,144.90
You earned an EXTRA N$4.90 in Year 2 with
19 compound over simple interest.
 General
General Future
Future
Value
Value Formula
Formula
FV1 = P0(1+r)1
FV2 = P0(1+r)2
etc.

General Future Value Formula:

FVn = P0 (1+r)n
or FVn = P0 (FVIFr,n) -- See Table I
20
 Valuation
Valuation Using
Using FV
FV Tables
Tables
FVIFr,n is found on Table I
at the end of the book.
Period 6% 7% 8%
1 1.060 1.070 1.080
2 1.124 1.145 1.166
3 1.191 1.225 1.260
4 1.262 1.311 1.360
21
5 1.338 1.403 1.469
 Using
Using Future
Future Value
Value Tables
Tables
FV2 = N$1,000 (FVIF7%,2) =
N$1,000 (1.145) =
N$1,145 [Due to Rounding]
Period 6% 7% 8%
1 1.060 1.070 1.080
2 1.124 1.145 1.166
3 1.191 1.225 1.260
4 1.262 1.311 1.360
5 1.338 1.403 1.469
22
 Using
Using Your
Your Calculator
Calculator to
to find
find FVIF
FVIF

Inputs using a Casio

( 1 . 0 7 ) ^ 1 =
Inputs using a Sharp

( 1 . 0 7 ) y* 1 =

 Focus on 3rd Row of keys (will be

displayed in slides as shown above)
23
 TVM on the Financial Calculator

 Use the highlighted row

of keys for solving any
of the FV, PV, FVA,
PVA, FVAD, and PVAD
problems
N: Number of periods
I/Y: Interest rate per period
PV: Present value
PMT: Payment per period
FV: Future value
CLR TVM: Clears all of the inputs
into the above TVM keys

24
 Entering the FV Problem
Press:
2nd CLR TVM
2 N
7 I/Y
-1000 PV
0 PMT
CPT FV

25
 Solving
Solving the
the FV
FV Problem
Problem
Inputs 2 7 -1,000 0
N I/Y PV PMT FV
Compute 1,144.90

N: 2 Periods (enter as 2)
I/Y: 7% interest rate per period (enter as 7 NOT .07)
PV: N$1,000 (enter as negative as you have “less”)
PMT: Not relevant in this situation (enter as 0)
FV: Compute (Resulting answer is positive)

26
 Story
Story Problem
Problem Example
Example
Julie Miller wants to know how large her deposit
of N$10,000 today will become at a compound
annual interest rate of 10% for 5 years.
years

0 1 2 3 4 5
10%
N$10,000
FV5
27
 Story
Story Problem
Problem Solution
Solution
 Calculation based on general formula:
FVn = P0 (1+r)n
FV5 = N$10,000 (1+ 0.10)5
= N$16,105.10
 Calculation based on Table I:
FV5 = N$10,000 (FVIF10%, 5)
= N$10,000 (1.611)
= N$16,110 [Due to Rounding]

28
 Entering the FV Problem
Press:
2nd CLR TVM
5 N
10 I/Y
-10000 PV
0 PMT
CPT FV

29
 Solving
Solving the
the FV
FV Problem
Problem
Inputs 5 10 -10,000 0
N I/Y PV PMT FV
Compute 16,105.10

The result indicates that a N$10,000

investment that earns 10% annually
for 5 years will result in a future value
of N$16,105.10.
30
 Double
Double Your
Your Money!!!
Money!!!

Quick! How long does it take to double

N$5,000 at a compound rate of 12%
per year (approx.)?

We will use the “Rule-of-72”.

31
 The
The “Rule-of-72”
“Rule-of-72”

Quick! How long does it take to double

N$5,000 at a compound rate of 12%
per year (approx.)?

Approx. Years to Double = 72 / r%

72 / 12% = 6 Years
[Actual Time is 6.12 Years]
32
 Solving
Solving the
the Period
Period Problem
Problem
Inputs 12 -1,000 0 +2,000
N I/Y PV PMT FV
Compute 6.12 years

The result indicates that a N$1,000

investment that earns 12% annually
will double to N$2,000 in 6.12 years.
Note: 72/12% = approx. 6 years
33
 Present
Present Value
Value
Single
Single Deposit
Deposit (Graphic)
(Graphic)
Assume that you need N$1,000 in 2 years.
Let’s examine the process to determine how
much you need to deposit today at a discount
rate of 7% compounded annually.

0 1 2
7%
N$1,000
PV0 PV1
34
 Present
Present Value
Value
Single
Single Deposit
Deposit (Formula)
(Formula)
PV0 = FV2 / (1+r)2 = N$1,000 /
(1.07)2 = FV2 / (1+r)2 = N$873.44

0 1 2
7%
N$1,000
PV0
35
 General
General Present
Present
Value
Value Formula
Formula
PV0 = FV1 / (1+r)1

PV0 = FV2 / (1+r)2

etc.

General Present Value Formula:

PV0 = FVn / (1+r)n
or PV0 = FVn (PVIFr,n) -- See PV Tables
36
 Valuation
Valuation Using
Using PV
PV Tables
Tables

PVIFr,n is found on PV Tables

at the end of most CF books
Period 6% 7% 8%
1 .943 .935 .926
2 .890 .873 .857
3 .840 .816 .794
4 .792 .763 .735
5 .747 .713 .681
37
 Using
Using Present
Present Value
Value Tables
Tables
PV2 = N$1,000 (PVIF7%,2)
= N$1,000 (.873)
= N$873 [Due to Rounding]
Period 6% 7% 8%
1 .943 .935 .926
2 .890 .873 .857
3 .840 .816 .794
4 .792 .763 .735
38
5 .747 .713 .681
 Using
Using Your
Your Calculator
Calculator to
to find
find PVIF
PVIF

Inputs using a Casio

( 1 . 0 7 ) ^ - 1 =
Inputs using a Sharp

( 1 . 0 7 ) y* 1 +/- =

 Focus on 3rd Row of keys (will be

displayed in slides as shown above)
39
 Solving
Solving the
the PV
PV Problem
Problem
Inputs 2 7 0 +1,000
N I/Y PV PMT FV
Compute -873.44

N: 2 Periods (enter as 2)
I/Y: 7% interest rate per period (enter as 7 NOT .07)
PV: Compute (Resulting answer is negative “deposit”)
PMT: Not relevant in this situation (enter as 0)
FV: $1,000 (enter as positive as you “receive $”)

40
 Story
Story Problem
Problem Example
Example
Julie Miller wants to know how large of a
deposit to make so that the money will grow
to $10,000 in 5 years at a discount rate of
10%.
0 1 2 3 4 5
10%
$10,000
PV0
41
 Story
Story Problem
Problem Solution
Solution
 Calculation based on general formula:
PV0 = FVn / (1+i)n
PV0 = $10,000 / (1+ 0.10)5
= $6,209.21
 Calculation based on Table I:
PV0 = $10,000 (PVIF10%, 5)
= $10,000 (.621)
= $6,210.00 [Due to Rounding]
42
 Solving
Solving the
the PV
PV Problem
Problem
Inputs 5 10 0 +10,000
N I/Y PV PMT FV
Compute -6,209.21

The result indicates that a $10,000

future value that will earn 10% annually
for 5 years requires a $6,209.21 deposit
today (present value).
43
 Types
Types of
of Annuities
Annuities
 An Annuity represents a series of equal
payments (or receipts) occurring over a
specified number of equidistant periods.
 Ordinary Annuity:
Annuity Payments or receipts
occur at the end of each period.
 Annuity Due:
Due Payments or receipts
occur at the beginning of each period.

44
 Examples of Annuities

 Student Loan Payments

 Car Loan Payments
 Insurance Premiums
 Mortgage Payments
 Retirement Savings
45
 Parts
Parts of
of an
an Annuity
Annuity
(Ordinary Annuity)
End of End of End of
Period 1 Period 2 Period 3

0 1 2 3

$100 $100 $100

Today Equal Cash Flows

46
Each 1 Period Apart
 Parts
Parts of
of an
an Annuity
Annuity
(Annuity Due)
Beginning of Beginning of Beginning of
Period 1 Period 2 Period 3

0 1 2 3

$100 $100 $100

Today Equal Cash Flows

Each 1 Period Apart
47
 Overview
Overview of
of an
an
Ordinary
Ordinary Annuity
Annuity --
-- FVA
FVA
Cash flows occur at the end of the period
0 1 2 n n+1
i% . . .
R R R
R = Periodic
Cash Flow

FVAn = R(1+i)n-1 + R(1+i)n-2 + FVAn

... + R(1+i)1 + R(1+i)0
48
 Example
Example of
of an
an
Ordinary
Ordinary Annuity
Annuity --
-- FVA
FVA
Cash flows occur at the end of the period
0 1 2 3 4
7%
$1,000 $1,000 $1,000
$1,070
$1,145
FVA3 = $1,000(1.07)2 +
$1,000(1.07)1 + $1,000(1.07)0
$3,215 = FVA3
= $1,145 + $1,070 + $1,000
= $3,215
49
 Hint on Annuity Valuation
The future value of an ordinary
annuity can be viewed as
occurring at the end of the last
cash flow period, whereas the
future value of an annuity due
can be viewed as occurring at
the beginning of the last cash
flow period.
50
 Valuation
Valuation Using
Using Table
Table III
III
FVAn = R (FVIFAi%,n) FVA3 =
$1,000 (FVIFA7%,3) = $1,000
(3.215) = $3,215
Period 6% 7% 8%
1 1.000 1.000 1.000
2 2.060 2.070 2.080
3 3.184 3.215 3.246
4 4.375 4.440 4.506
5 5.637 5.751 5.867
51
 Solving
Solving the
the FVA
FVA Problem
Problem
Inputs 3 7 0 -1,000
N I/Y PV PMT FV
Compute 3,214.90

N: 3 Periods (enter as 3 year-end deposits)

I/Y: 7% interest rate per period (enter as 7 NOT .07)
PV: Not relevant in this situation (no beg value)
PMT: $1,000 (negative as you deposit annually)
FV: Compute (Resulting answer is positive)

52
 Overview
Overview View
View ofof an
an
Annuity
Annuity Due
Due --
-- FVAD
FVAD
Cash flows occur at the beginning of the period
0 1 2 3 n-1 n
i% . . .
R R R R R

FVADn = R(1+i)n + R(1+i)n-1 + FVADn

... + R(1+i)2 +
R(1+i)1 = FVAn (1+i)
53
 Example
Example of
of an
an
Annuity
Annuity Due
Due --
-- FVAD
FVAD
Cash flows occur at the beginning of the period
0 1 2 3 4
7%
$1,000 $1,000 $1,000 $1,070
$1,145
$1,225
FVAD3 = $1,000(1.07)3 +
$3,440 = FVAD3
$1,000(1.07)2 + $1,000(1.07)1
= $1,225 + $1,145 + $1,070
= $3,440
54
 Valuation
Valuation Using
Using Table
Table III
III
FVADn = R (FVIFAi%,n)(1+i)
FVAD3 = $1,000 (FVIFA7%,3)(1.07)
= $1,000 (3.215)(1.07) = $3,440
Period 6% 7% 8%
1 1.000 1.000 1.000
2 2.060 2.070 2.080
3 3.184 3.215 3.246
4 4.375 4.440 4.506
5 5.637 5.751 5.867
55
 Solving
Solving the
the FVAD
FVAD Problem
Problem
Inputs 3 7 0 -1,000
N I/Y PV PMT FV
Compute 3,439.94
Complete the problem the same as an “ordinary annuity”
problem, except you must change the calculator setting
to “BGN” first. Don’t forget to change back!
Step 1: Press 2nd BGN keys
Step 2: Press 2nd SET keys
Step 3: Press 2nd QUIT keys
56
 Overview
Overview of
of an
an
Ordinary
Ordinary Annuity
Annuity --
-- PVA
PVA
Cash flows occur at the end of the period
0 1 2 n n+1
i% . . .
R R R

R = Periodic
Cash Flow
PVAn
PVAn = R/(1+i)1 + R/(1+i)2
+ ... + R/(1+i)n
57
 Example
Example of
of an
an
Ordinary
Ordinary Annuity
Annuity --
-- PVA
PVA
Cash flows occur at the end of the period
0 1 2 3 4
7%
$1,000 $1,000 $1,000
$934.58
$873.44
$816.30
$2,624.32 = PVA3 PVA3 = $1,000/(1.07)1 +
$1,000/(1.07)2 +
$1,000/(1.07)3
= $934.58 + $873.44 + $816.30
58
= $2,624.32
 Hint on Annuity Valuation
The present value of an ordinary
annuity can be viewed as
occurring at the beginning of the
first cash flow period, whereas
the future value of an annuity
due can be viewed as occurring
at the end of the first cash flow
period.
59
 Valuation
Valuation Using
Using Table
Table IV
IV
PVAn = R (PVIFAi%,n) PVA3 =
$1,000 (PVIFA7%,3) = $1,000
(2.624) = $2,624
Period 6% 7% 8%
1 0.943 0.935 0.926
2 1.833 1.808 1.783
3 2.673 2.624 2.577
4 3.465 3.387 3.312
5 4.212 4.100 3.993
60
 Solving
Solving the
the PVA
PVA Problem
Problem
Inputs 3 7 -1,000 0
N I/Y PV PMT FV
Compute 2,624.32

N: 3 Periods (enter as 3 year-end deposits)

I/Y: 7% interest rate per period (enter as 7 NOT .07)
PV: Compute (Resulting answer is positive)
PMT: $1,000 (negative as you deposit annually)
FV: Not relevant in this situation (no ending value)

61
 Overview
Overview of
of an
an
Annuity
Annuity Due
Due --
-- PVAD
PVAD
Cash flows occur at the beginning of the period
0 1 2 n-1 n
i% . . .
R R R R

R: Periodic
PVADn Cash Flow

PVADn = R/(1+i)0 + R/(1+i)1 + ... + R/(1+i)n-1

= PVAn (1+i)
62
 Example
Example of
of an
an
Annuity
Annuity Due
Due --
-- PVAD
PVAD
Cash flows occur at the beginning of the period
0 1 2 3 4
7%

$1,000.00 $1,000 $1,000

$ 934.58
$ 873.44
$2,808.02 = PVADn

PVADn = $1,000/(1.07)0 + $1,000/(1.07)1 +

$1,000/(1.07)2 = $2,808.02
63
 Valuation
Valuation Using
Using Table
Table IV
IV
PVADn = R (PVIFAi%,n)(1+i)
PVAD3 = $1,000 (PVIFA7%,3)(1.07)
= $1,000 (2.624)(1.07) = $2,808
Period 6% 7% 8%
1 0.943 0.935 0.926
2 1.833 1.808 1.783
3 2.673 2.624 2.577
4 3.465 3.387 3.312
5 4.212 4.100 3.993
64
 Solving
Solving the
the PVAD
PVAD Problem
Problem
Inputs 3 7 -1,000 0
N I/Y PV PMT FV
Compute 2,808.02
Complete the problem the same as an “ordinary annuity”
problem, except you must change the calculator setting
to “BGN” first. Don’t forget to change back!
Step 1: Press 2nd BGN keys
Step 2: Press 2nd SET keys
Step 3: Press 2nd QUIT keys
65
 Steps
Steps to
to Solve
Solve Time
Time Value
Value
of
of Money
Money Problems
Problems
1. Read problem thoroughly
2. Create a time line
3. Put cash flows and arrows on time line
4. Determine if it is a PV or FV problem
5. Determine if solution involves a single CF,
annuity stream(s), or mixed flow
6. Solve the problem
7. Check with financial calculator (optional)
66
 Mixed
Mixed Flows
Flows Example
Example
Julie Miller will receive the set of cash
flows below. What is the Present Value
at a discount rate of 10%.
10%

0 1 2 3 4 5
10%
$600 $600 $400 $400 $100
PV0
67
 How
How to
to Solve?
Solve?

1. Solve a “piece-at-a-time”
piece-at-a-time by
discounting each piece back to
t=0.
2. Solve a “group-at-a-time”
group-at-a-time by first
breaking problem into groups of
annuity streams and any single cash
flow groups. Then discount each
group back to t=0.
68
 ““Piece-At-A-Time”
Piece-At-A-Time”

0 1 2 3 4 5
10%
$600 $600 $400 $400 $100
$545.45
$495.87
$300.53
$273.21
$ 62.09
$1677.15 = PV0 of the Mixed Flow
69
 ““Group-At-A-Time”
Group-At-A-Time” (#1)
(#1)
0 1 2 3 4 5
10%
$600 $600 $400 $400 $100
$1,041.60
$ 573.57
$ 62.10
$1,677.27 = PV0 of Mixed Flow [Using Tables]
$600(PVIFA10%,2) = $600(1.736) = $1,041.60
$400(PVIFA10%,2)(PVIF10%,2) = $400(1.736)(0.826) = $573.57
$100 (PVIF10%,5) = $100 (0.621) = $62.10
70
 ““Group-At-A-Time”
Group-At-A-Time” (#2)
(#2)
0 1 2 3 4

$400 $400 $400 $400

$1,268.00
0 1 2 PV0 equals
Plus
$200 $200 $1677.30.
$347.20
0 1 2 3 4 5
Plus
$100
$62.10
71
 Solving
Solving the
the Mixed
Mixed Flows
Flows
Problem
Problem using
using CF
CF Registry
Registry
 Use the highlighted
key for starting the
process of solving a
mixed cash flow
problem
 Press the CF key
and down arrow key
through a few of the
keys as you look at
the definitions on
72 the next slide
 Solving
Solving the
the Mixed
Mixed Flows
Flows
Problem
Problem using
using CF
CF Registry
Registry
Defining the calculator variables:
For CF0:This is ALWAYS the cash flow occurring at
time t=0 (usually 0 for these problems)
For Cnn:* This is the cash flow SIZE of the nth
group of cash flows. Note that a “group” may only
contain a single cash flow (e.g., $351.76).
For Fnn:* This is the cash flow FREQUENCY of
the nth group of cash flows. Note that this is
always a positive whole number (e.g., 1, 2, 20, etc.).
* nn represents the nth cash flow or frequency. Thus, the
first cash flow is C01, while the tenth cash flow is C10.
73
 Solving
Solving the
the Mixed
Mixed Flows
Flows
Problem
Problem using
using CF
CF Registry
Registry
Steps in the Process
Step 1: Press CF key
Step 2: Press 2nd CLR Work keys
Step 3: For CF0 Press 0 Enter ↓ keys
Step 4: For C01 Press 600 Enter ↓ keys
Step 5: For F01 Press 2 Enter ↓ keys
Step 6: For C02 Press 400 Enter ↓ keys
Step 7: For F02 Press 2 Enter ↓ keys

74
 Solving
Solving the
the Mixed
Mixed Flows
Flows
Problem
Problem using
using CF
CF Registry
Registry
Steps in the Process
Step 8: For C03 Press 100 Enter ↓ keys
Step 9: For F03 Press 1 Enter ↓ keys
Step 10: Press ↓ ↓ keys
Step 11: Press NPV key
Step 12: For I=, Enter 10 Enter ↓ keys
Step 13: Press CPT key

Result: Present Value = $1,677.15

75
 Frequency
Frequency of
of
Compounding
Compounding
General Formula:
FVn = PV0(1 + [i/m])mn
n: Number of Years
m: Compounding Periods per
Yeari: Annual Interest Rate
FVn,m: FV at the end of Year n
PV0: PV of the Cash Flow today
76
 Impact
Impact of
of Frequency
Frequency
Julie Miller has $1,000 to invest for 2
Years at an annual interest rate of
12%.
Annual FV2 = 1,000(1+
1,000 [.12/1])(1)(2)
= 1,254.40
Semi FV2 = 1,000(1+
1,000 [.12/2])(2)(2)
= 1,262.48
77
 Impact
Impact of
of Frequency
Frequency
Qrtly FV2 = 1,000(1+
1,000 [.12/4])(4)(2)
= 1,266.77
Monthly FV2 = 1,000(1+
1,000 [.12/12])(12)(2)
= 1,269.73
Daily FV2 = 1,000(1+
1,000 [.12/365])(365)
(2)
= 1,271.20
78
 Solving
Solving the
the Frequency
Frequency
Problem
Problem (Quarterly)
(Quarterly)
Inputs 2(4) 12/4 -1,000 0
N I/Y PV PMT FV
Compute 1266.77

The result indicates that a $1,000

investment that earns a 12% annual
rate compounded quarterly for 2 years
will earn a future value of $1,266.77.
79
 Solving
Solving the
the Frequency
Frequency
Problem
Problem (Quarterly
(Quarterly Altern.)
Altern.)
Press:
2nd P/Y 4 ENTER
2nd QUIT
12 I/Y
-1000 PV
0 PMT
2 2nd xP/Y N
80
CPT FV
 Solving
Solving the
the Frequency
Frequency
Problem
Problem (Daily)
(Daily)
Inputs 2(365) 12/365 -1,000 0
N I/Y PV PMT FV
Compute 1271.20

The result indicates that a $1,000

investment that earns a 12% annual
rate compounded daily for 2 years will
earn a future value of $1,271.20.
81
 Solving
Solving the
the Frequency
Frequency
Problem
Problem (Daily
(Daily Alternative)
Alternative)
Press:
2nd P/Y 365 ENTER
2nd QUIT
12 I/Y
-1000 PV
0 PMT
2 2nd xP/Y N
82
CPT FV
 Effective
Effective Annual
Annual
Interest
Interest Rate
Rate
Effective Annual Interest Rate
The actual rate of interest earned
(paid) after adjusting the nominal
rate for factors such as the number
of compounding periods per year.

(1 + [ i / m ] )m - 1

83
 BWs
BWs Effective
Effective
Annual
Annual Interest
Interest Rate
Rate
Basket Wonders (BW) has a $1,000
CD at the bank. The interest rate is
6% compounded quarterly for 1
year. What is the Effective Annual
Interest Rate (EAR)?
EAR
EAR = ( 1 + 6% / 4 )4 - 1
= 1.0614 - 1 = .0614 or 6.14%!
84
 Converting to an EAR
Press:
2nd I Conv
6 ENTER
↓ ↓
4 ENTER
↑ CPT
2nd QUIT

85
 Steps
Steps to
to Amortizing
Amortizing aa Loan
Loan
1. Calculate the payment per period.
2. Determine the interest in Period t.
(Loan Balance at t-1) x (i% / m)
3. Compute principal payment in Period t.
(Payment - Interest from Step 2)
4. Determine ending balance in Period t.
(Balance - principal payment from Step
3)
86 5. Start again at Step 2 and repeat.
 Amortizing
Amortizing aa Loan
Loan Example
Example
Julie Miller is borrowing $10,000 at a
compound annual interest rate of 12%.
Amortize the loan if annual payments are
made for 5 years.
Step 1: Payment
PV0 = R (PVIFA i%,n)
$10,000 = R (PVIFA 12%,5)
$10,000 = R (3.605)
87
R = $10,000 / 3.605 = $2,774
 Amortizing
Amortizing aa Loan
Loan Example
Example
End of Payment Interest Principal Ending
Year Balance
0 --- --- --- $10,000
1 $2,774 $1,200 $1,574 8,426
2 2,774 1,011 1,763 6,663
3 2,774 800 1,974 4,689
4 2,774 563 2,211 2,478
5 2,775 297 2,478 0
$13,871 $3,871 $10,000

[Last Payment Slightly Higher Due to Rounding]

88
 Solving
Solving for
for the
the Payment
Payment
Inputs 5 12 10,000 0
N I/Y PV PMT FV
Compute -2774.10

The result indicates that a $10,000 loan

that costs 12% annually for 5 years and
will be completely paid off at that time
will require $2,774.10 annual payments.
89
 Using the Amortization
Functions of the Calculator
Press:
2nd Amort
1 ENTER
1 ENTER
Results:
BAL = 8,425.90* ↓
PRN = -1,574.10* ↓
INT = -1,200.00* ↓
Year 1 information only
90 *Note: Compare to 3-82
 Using the Amortization
Functions of the Calculator
Press:
2nd Amort
2 ENTER
2 ENTER
Results:
BAL = 6,662.91* ↓
PRN = -1,763.99* ↓
INT = -1,011.11* ↓
Year 2 information only
91 *Note: Compare to 3-82
 Using the Amortization
Functions of the Calculator
Press:
2nd Amort
1 ENTER
5 ENTER
Results:
BAL = 0.00 ↓
PRN =-10,000.00 ↓
INT = -3,870.49 ↓
Entire 5 Years of loan information
92 (see the total line of 3-82)
 Usefulness of Amortization

1. Determine Interest Expense --

Interest expenses may reduce
taxable income of the firm.
2. Calculate Debt Outstanding --
The quantity of outstanding
debt may be used in financing
the day-to-day activities of the
93
firm.