Corporate Finance

Lecture: Time Value of Money

SHEN Tao （沈涛） Tsinghua University
Outline
1. Cost-Benefit Analysis
2. Market Prices and the Valuation Principle
3. The Time Value of Money and Interest Rates
4. Valuing Cash Flows at Different Points in Time
5. Valuing a Stream of Cash Flows
6. Perpetuities/Annuities/Growing Cash Flows
7. Solving for Variables Other Than Present Value or Future
Value
Cost-Benefit Analysis
 Most business decisions involve the evaluation of the benefits
generated compared the costs incurred creating the benefits.
 If the benefits exceed the costs value is created.
 May need help from other areas in identifying the relevant
costs and benefits
 Marketing
 Economics
 Organizational Behavior
 Strategy
 Operations
Cost-Benefit Analysis
 Suppose a jewelry manufacturer has the opportunity to trade
200 ounces of silver and receive 10 ounces of gold today.
 To compare the costs and benefits, we first need to convert
them to a common unit.
 If the current market price for silver is $20 per ounce, then the
200 ounces of silver we give up has a cash value of:
(200 ounces of silver) ×($20/ounce) = $4,000
 Assume gold can be bought and sold for a current market price
of $1,000 per ounce. Then the 10 ounces of gold we receive has
a cash value of:
(10 ounces of gold) ×($1,000/ounce) = $10,000
Cost-Benefit Analysis
 Therefore, the jeweler’s opportunity has a benefit of $10,000
today and a cost of $4,000 today. In this case, the net value of
the project today is:
$10,000 - $4,000=$6,000

 Because it is positive, the benefits exceed the costs and the

jeweler should accept the trade.
Cost-Benefit Analysis
 Competitive Market
 A market in which goods can be bought and sold at the same
price.
 In evaluating the jeweler’s decision, we used the current
market price to convert from ounces of silver or gold to
dollars.
 We did not concern ourselves with whether the jeweler thought
that the price was fair or whether the jeweler would use the
silver or gold.
 In a competitive market, the price determines the value of
the good. Personal opinion of the “fair” price is irrelevant
Problem:
 You have just won a contest and are disappointed to learn
that the prize is a gift certificate for dinner and drinks for
four at a local sushi restaurant. The face value of the gift
certificate is $200. Unfortunately, you are not a fan of
eating raw fish and would prefer a thick Angus steak. It
turns out that there is a second choice: a gift certificate
for dinner and drinks for two at your favorite steak
house. You see that on Moubao, a $200 gift certificate
from the sushi restaurant is selling for $175 while dinner
and drinks for two at your favorite steak house runs
$150. What should you do?
 Market prices, not your personal preference (nor
the face value of the tickets), are relevant here:
 Dinner for four at the sushi restaurant at $175
 Dinner at your favorite steak house at $150
 You need to compare the market value of each
option and choose the one with the highest
market value.
Market Prices and the Valuation
Principle
The Valuation Principle
 The value of a commodity or an asset to the firm or its investors
is determined by its competitive market price
 The benefits and costs of a decision should be evaluated using
those market prices
 When the value of the benefits exceeds the value of the costs,
the decision will increase the market value of the firm
Competitive market price does not always exist (retail stores)
 Maximum value
 Preference matters
Market Prices and the Valuation
Principle
Valuation Principle and finance in general rely on using a
competitive market price. Why there can be only one competitive
price for a good?
 Law of One Price
 In competitive markets, securities with the same cash flows must have the
same price
 Arbitrage
 The practice of buying and selling equivalent goods to take advantage of a
price difference
 Arbitrage Opportunity
 Any situation in which it is possible to make a profit without taking any
risk or making any investment
Applying the Valuation Principle
 If all decisions involved costs and benefits occurring at the
same time and resulting from competitive market prices,
establishing the value created would be simple.

 Most financial decisions involve costs and benefits occurring

at different points in time.

 Typically upfront costs create future benefits.

 We must develop a method to account for these timing

differences.
 Introduction to the Timeline
 Assume a firm can invest $100,000 in a project today and
generate $104,000 in one year.
Today One Year
0 1

-$100,000 $104,000
Cashflows
 Is $4,000 the correct measure of value created?

 What if the firm could earn 6% interest rate investing in

Government Bonds?

 The measure of value created needs to take this alternative

investment opportunity into account.
 Interest Rates as Prices
Today One Year
0 1

Investment -$100,000 $104,000

Govt. Bond -$100,000 $106,000

 The interest rate earned on the Government Bond is the

“price” in the market for money in one year.

 The benefits of buying the Government Bond ($6,000)

exceed the benefits of the Investment ($4,000) so you should
reject the project.

 We can use the 6% interest rate to establish the market

values to compare the cash flows over time.
 Time Value of Money
 Government bond are available to all investors.
 Money today and money in the future are different!!

Today One Year

0 1

Govt. Bond -$100,000 $100,000 x 1.06 $106,000

 In this case $1.00 today is equivalent to $1.06 in one year.

Money today is more valuable than money in one year.
 Therefore (1+interest rate) or (1.06) is the interest rate
factor. 1/(1+interest rate) or 1/1.06 is called discount
factor.
 Time Value of Money
 We can use the interest rate factor or discount factor to
establish equivalent value over time using the Time Value of
Money. Today One Year
0 1

Investment -$100,000 $104,000

Govt. Bond $ 98,113.21 $104,000
1.06

 You should reject this investment because the benefits are less
than the costs when compared using market prices.
 The value today of a future cash flow is called the “Present
Value.”
 Time Value of Money
Question: How is this problem related to Market Price?
 Future money is just like any goods traded in the market
today.
 The discount factor represents the today’s “market price” of
the future money.
 The today’s “price” of next year’s $1 is 1/1.06=$0.94
 Giving you the interest rate is equivalent to giving you the
market price of future money.
 Using interest rates this way allows to compute “Equivalent
Values” to compare cash flows across time.
Problem:
The launch of Sony’s PlayStation 3 was delayed until November
2006, giving Microsoft’s Xbox 360 a full year on the market
without competition. Sony did not repeat this mistake in 2013
when the PS4 launched at the same time as the Xbox One.
Imagine that it is November 2005 and you are the marketing
manager for the PlayStation.You estimate that if the PlayStation
3 were ready to be launched immediately, you could sell $2
billion worth of the console in its first year. However, if your
launch is delayed a year, you believe that Microsoft’s head start
will reduce your first-year sales by 20% to $1.6 billion. If the
interest rate is 8%, what is the cost of a delay in terms of
dollars in 2005?
 If the launch is delayed to 2006, revenues will drop by 20% of $2
billion, or $400 million, to $1.6 billion.
 To compare this amount to revenues of $2 billion if launched in 2005,
we must convert it using the interest rate of 8%:
$1.6 billion/1.08 = $1.481 billion in 2005
 Therefore, the cost of a delay of one year is
$2 billion - $1.481 billion = $0.519 billion ($519 million).
 In this example, we focused only on the effect on the first year’s
revenues. However, delaying the launch delays the entire revenue stream
by one year, so the total cost would be calculated in the same way by
summing the cost of delay for each year of revenues.
Net Present Value
Net Present Value (NPV)
 The difference between the present value of a projects benefits
and the present value of it’s costs.
NPV = PV of Benefits - PV of Costs

The NPV Rules

1. Accept positive-NPV projects, and reject negative-NPV
projects.
2. Choosing among alternative projects, always choose the one
with highest NPV, given it is positive. It is equivalent to
receiving NPV in cash today.
 Example
 Suppose you own a coffee stand across from campus and you hire
someone to operate it for you. You will be graduating next year and
have started to consider selling it. An investor has offered to buy the
business from you for $20,000 whenever you are ready. Your interest
rate is 10% and you are considering three alternatives:
 Sell the business now.
 Operate normally for one more year and then sell the business
(requiring you to spend $5,000 on supplies and labor now, but
earn $10,000 at the end of the year).
 Be open only in the mornings for one more year and then sell
the business (requiring you to spend $3,000 on supplies and
labor now, but earn $6,000 at the end of the year).
Solution

Question:
What if you need(or prefer) the cash $20,000 today?

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NPV and Cash Needs

 NPV General Principle

 Regardless of our preferences for cash today versus cash in the
future, we should always maximize NPV first. We can then
borrow or lend to shift cash flows through time and find our
most preferred pattern of cash flows.

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Pricing of a Security
 Security: A claim to future cash flows.
 ($$) Pricing of a security: The price of a security should
equal to the present value of the future cash flows.

Problem:
 You are considering purchasing a security, a “bond,” that pays
$1,000 without risk in one year, and has no other cash flows.
If the interest rate is 5%, what should its price be?

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Solution
 The present value of the $1,000 cash flow is

1.05 $ in one year

$1000 in one year   $952.38 today
$ today

 So the price must be $952.38

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 Timeline
 Time Value of Money (TVM) problems involve identifying
the payment or receipt of cash over time.
 A useful tool in the analysis of these problems is the timeline
illustrated below.
Years or Periods
0 1 2 3 4 5

CF CF CF CF CF CF
0 1 2 3 4 5
Cashflows

Rule One: It is only possible to compare or combine values

at the same point in time. 25
 Interest Rates
 If a bank pays 5% interest on deposits how much will a deposit
of $100 earn, in interest, in one year?
 $100 x .05 = $5

 How much money will you have accumulated in your account

after one year?
 Deposit + Interest = $100 + $5 = $105

 How much money will you have accumulated in your account

after two years?
 Yr 1 Deposit + Interest = $100 + $5 = $105
 Yr 2 Balance + Interest = $105 + $5.25 = $110.25
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 Compounding of Interest
 The future value relationship assumes that interest is
compounded. (Interest is earned on interest)
0 1 2 3 4 5

CF CF CF CF CF CF
0 1 2 3 4 5
$100 x 1.05 = $105
$105 x 1.05 = $110.25 Equivalent Values
$110.25 x 1.05 = $115.76
$115.76 x 1.05 = $121.55

$121.55 x 1.05 = $127.63

This compounding is expressed exponentially

Future Value $100 x (1.05)5 = $127.63
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 Future Value - Compounding
 FutureValue - The compounded value of an investment for n
periods.
(1+r) is the one year
equivalent money
FV  PV(1 r )n factor
 Where:
 PV = value of original investment
 FV = future value of investment
n = number of periods
r = interest rate per period

Rule Two: To calculate a cash flow’s future value you must

compound it.
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Compounding of Interest
 How long it will take your money to double given different
interest rates?

 if the interest rate is 9%, the doubling time should be about

72/9 = 8 years
 Compound Interest
 The longer the investment period the greater the impact of
compound interest.

 $1,000 invested at 5% for 30 years compounded annually is ?

 $1,000x(1.05)30 = $4,321.94

 The larger the interest rate the greater the impact of

compound interest.

 $1,000 invested at 15% for 30 years compounded annually is ?

 $1,000x(1.15)30 = $66,211.77

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 The Impact of Compound Interest
Future Value of $1

$18

$16

$14

$12
Dollars

$10 r = 5%
r = 10%
$8 r = 15%
$6

$4

$2

$0
0 2 4 6 8 10 12 14 16 18 20

Years
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 Present Value - Discounting
Years
0 1 2 3 4 5

Present Future
Value Value

Since receiving money in the future is less valuable

than having cash today, we call the application of this
discounting.

PV < FV FV – PV = Discount

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Present Value - Discounting
 If we know the value in the future, and want to calculate the
value today we simply reverse the compounding process:

Future Value
Present Value 
Alternatively: (1  r) t

1
PV FV  Discount Factor
Where: (1  r )t
PV= present value of original investment
FV = future value of investment
n = number of periods
r = interest rate per period

Rule Three: To calculate the value of a future cash flow at an

earlier point in time you must discount it.
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Calculating Present Value
 Calculate the present value of $127.63 received in 5 years at a
5% interest rate.

$127.63 x (1/(1.05)5) = $100.00

The present value of one dollar received five years from now at a
5% interest rate is $0.78353.

The interest rate used in a present value calculation is called the

Discount Rate.

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Present Value of an Investment
 What is the present value of $1,000 discounted for 10 years
at 5%?
 PV = $1,000 x 1/(1.05)10 = $613.91

 What is the present value or $1,000 discounted for 30 years

at 10%?
 PV = $1,000 x 1/(1.10)30 = $57.31

 Calculate the Discount Factors 1/(1+rate)# of periods from

above.
 DF 10 yrs = .61391
 DF 30 yrs = .05731
 Present Value gives us the equivalent value today of some
value in the future.
 Present Value should be thought of as a “price.”
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 Effect of Interest Rates and Time on
Present Value
 The longer the investment period the smaller the discounted
value.

$1,000 discounted for 10 years at 5% is

Discount Factor = 1/1.0510 = .61391

$1,000x(1/1.0510) = $613.91

 $1,000 discounted for 30 years at 5% is

Discount Factor = 1/1.0530= .23138

$1,000x(1/1.0530) = $231.38 37
 Effect of Interest Rates and Time on
Present Value
 The higher the interest rate the greater the impact of
compound interest.

 $1,000 discounted for 10 years at 10% is

Discount Factor = 1/1.1010= .38554

$1,000x(1/1.1010) = $385.54

 $1,000 discounted for 30 years at 10% is

Discount Factor = 1/1.1030= .05731

$1,000x(1/1.1030) = $57.31
38
 Present Value of $1
PRESENT VALUE (Price) of $1
Discount Factors
$1.00 Year 5% 10% 15%
1 .9524 .9091 .8696
2 .9070 .8265 .7561
$0.80
5 .7835 .6209 .4972
10 .6139 .3855 .2472
PV or Price

$0.60 20 .3769 .1486 .0611

$0.40

$0.20

$0.00
0 2 4 6 8 10 12 14 16 18 20
Years

r = 5% r = 10% r = 15%
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A Stream of Cash Flows
 Suppose we plan to save $1,000 today, and $1,000 at the end
of each of the next two years. If we earn a fixed 10% interest
rate on our savings, how much will we have three years from
today?
 Method #1:

44
A Stream of Cash Flows
 Method #2: compute the future value in year 3 of each cash
flow separately. Once all three amounts are in year 3 dollars,
we can then combine them.

45
A Stream of Cash Flows
 Method #3:
1. Calculate the year-0 present value of all cash flows.

2. Calculate the future value in year 3 of the present value

obtained from step 1.

46
A Stream of Cash Flows
 Question: Why these three methods are equivalent?

 Answer:
The problem is equivalent to: Suppose you have 10 Dollars, 5
British Pounds, 1000 Yens, and 8 Euros. You can convert all
the money into Dollars directly. Or you can convert all into
Euros, and then convert into Dollars. No matter how you
convert the money, in the end you would end up with the
same amount of Dollars. The exchange rates in this situation
is equivalent to the time value of money.

47
 The Net Present Value of a Stream of
Cash Flows
NPV = PV(benefits)  PV(costs)  PV (benefits  costs)

Example:
You have been offered the following investment opportunity:
If you invest $1,000 today, you will receive $500 at the end
of the next two years, followed by $550 at the end of the
third year. If you could otherwise earn 10% per year on your
money, should you undertake the investment opportunity?

48
The Net Present Value of a Stream of
Cash Flows
 Solution:

500 500 550

NPV  1000   2
 3
 $280.99
1.10 1.10 1.10
Because the NPV is positive, the benefits exceed the costs
and we should make the investment.

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 Present Value of Multiple Payments
 Perpetuity - a stream of equal payments received at regular
intervals forever.
Years
0 1 2 3 4….

$10 $10 $10 $10…

Cashflows

 If interest rates are 10% what is the value of this infinite

stream of cash flows?
 If I invest $100 in a perpetuity that pays 10%, how much will
I receive each year forever?
Example: $100 x .10 = $10 50
 Present Value of Multiple Payments
 It follows that the value of a perpetuity is the amount you
would be willing to pay for the right to receive a constant
payment forever.
 Therefore the formula for the present value of a perpetuity is:

Cash Payment
Present Value of Perpetuity 
Required Discount Rate

PMT $10
PV Perpetuity  $100 
r .10

51
Perpetuities
 Suppose we invest an amount P at an interest rate r
 Every year we can withdraw the interest we earned, C=r ×
P, leaving P in the bank
 Because the cost to create the perpetuity is the investment of
principal, P, the value of receiving C in perpetuity is the
upfront cost, P
 Valuing Perpetuities
PV = CF
r
EXAMPLE:

n Suppose you wish to endow a chair at your old

university. The aim is to provide $100,000
forever and the interest rate is 10%.

PV = $100,000/0.10 = $1,000,000

A donation of $1,000,000 will provide an annual

income of .10 x $1,000,000 = $100,000 forever.

53
.
Extensions
 What is the time-0 PV of the following cash flows?

0 1 2 3 4….

$10 $10 $10 $10 $10…

0 1 2 3 4….

$10 $20 $10 $10…

54
Annuity
 Annuity - - a stream of equal payments received at regular
intervals for a specified number of periods.

 Example of an annuity - 48 equal monthly payments on a car

loan.

 Example of an annuity - 20 equal annual payments from

winning the Lottery.

55
 Present Value of an Annuity
 An Annuity is illustrated below on the timeline.
 Annuities must have identical payment received at identical
intervals.

Years or Periods
0 1 2 3 4 5

PV $1,000 $1,000 $1,000 $1,000 $1,000

Cashflows

56
 Intuitive Development of the Valuation
of an Annuity
 Delayed Perpetuity - A perpetuity that starts at a future date.
 Valuation of Delayed Perpetuity is a combination of the
perpetuity and present value formulas:

Cash Payment
Valueof Delayed PerpetuityToday  r
(1  r )Time to First Payment - 1Period

57
 Intuitive Development of the Valuation
of an Annuity
 An annuity can be thought of as a combination of a perpetuity
less a delayed perpetuity.
 Value of Annuity=Perpetuity - Delayed Perpetuity

CF
CF r 1 1 
Value of Annuity =   CF 
 r r (1  r ) n 
r (1  r ) n  

58
 Present Value of an Annuity
 What is the present value of a 5 year annuity of $1,000 a year
at a discount rate of 9%?

 1 1 
PV Annuity = 1000   5 
 $3,889.65
.09 .09(1.09) 

 Using your financial calculator:

PMT =$1,000, n = 5, r = 9%, FV =$0
=> PV =$3,889.65

59
Example
Problem:
 You are the lucky winner of the $30 million state lottery.You
can take your prize money either as (a) 30 payments of $1
million per year (starting today), or (b) $15 million paid
today. If the interest rate is 8%, which option should you
take?

60
 Example
 Solution:

1  1 
PV( 29-year annuity of $1million)  $1 million   1
0.08  29 
1.08 
 $1 million  11.16
 $11.16 million today

Thus, the total present value of the cash flows is $1 million +

$11.16 million = $12.16 million. So you should choose option
(b)

61
 Future Value of an Annuity
 We may be interested in calculating the accumulated value of
a stream of annuity payments invested at a constant rate of
interest.
0 1 2 3 4 5

Cashflows $1,000 $1,000 $1,000 $1,000 $1,000

FV

 Example – Retirement Plan

62
 Intuitive Development of the
Future Value of an Annuity
 The future value of an annuity can be calculated by computing
the Present Value annuity factor and multiplying it by the
Future Value Factor for the same term as the annuity.

1 
 1  r 
1
Future Value of Annuity = PMT   
n
n 
 r r (1  r ) 

(1  r ) n  1
Future Value of Annuity = PMT 
r

63
 Future Value of an Annuity
 What is the future value of a 10 year annuity of $1,000 a year
at an interest rate of 9%?

(1  .09)10  1
FV = 1,000   $15,192.93
.09

 Using the financial Calculator

PMT =1,000, n = 10, i = 9% : FV = $15,195.29

64
Retirement Savings Plan Annuity
Problem:
 Ellen is 35 years old, and she has decided it is time to plan seriously for her
retirement.
 At the end of each year until she is 65, she will save $10,000 in a retirement
account.
 If the account earns 10% per year, how much will Ellen have saved at age 65?
Retirement Savings Plan Annuity
Solution:
Plan:
 As always, we begin with a timeline. In this case, it is helpful to keep track of
both the dates and Ellen’s age:
Retirement Savings Plan Annuity
Plan (cont’d):
 Ellen’s savings plan looks like an annuity of $10,000 per year for 30 years.
 (Hint: It is easy to become confused when you just look at age, rather than at
both dates and age. A common error is to think there are only 65-36= 29
payments. Writing down both dates and age avoids this problem.)
 To determine the amount Ellen will have in the bank at age 65, we’ll need to
compute the future value of this annuity.
 Retirement Savings Plan Annuity
Execute: 1
FV  $10,000  (1.1030  1)
0.10
 $10,000  164.49
 $1.645 million at age 65

Using Financial calculators or Excel:

Given: 30 10.0 0 -10,000

Solve for: -1,644,940
Excel Formula: =FV(RATE,NPER, PMT, PV) = FV(0.10,30,10000,0)
 Present Value of Constant Growth
Perpetuity
 Constant Growth Perpetuity - a stream of growing payments
received at regular intervals forever.
 If I invest in a perpetuity that pays $10 the first year and
grows at a rate of 5% per year I will receive increasing
payments forever.

Example:
Years
0 1 2 3 4

PV $10 $10.50 $11.03 $11.58 …

Cashflows
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 Constant Growth Perpetuities
 If the cash flows continue forever, but grow over time at a
constant rate, the following formula is used.
CF
Present Value of Constant Growth Perpetuity 
rg
where :
CF  the cashflow in the next period
r  the required discount rate
g  the constant growth rate
Note : r has to be bigger than g , otherwise, PV will not be finite

70
 Example of a Growing Perpetuity
 A college scholarship endowment must grow annually if it is
to keep up with increases in tuition.
 Assumptions:
 Annual Tuition = $12,000
 Assumed Growth Rate = 5%
 Required Return on Investments = 10%

CF $12,000
Present Value    $240,000
r  g .10  .05

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Growing Cash Flows
Present Value of a Growing Annuity
 A growing annuity is a stream of N growing cash flows, paid
at regular intervals
 It is a growing perpetuity that eventually comes to an end
 The following timeline shows a growing annuity with initial
cash flow C, growing at a rate of g every period until period
N:
Growing Cash Flows
 Present Value of a Growing Annuity:

1  1 g  
N

PV= C  1    
r - g   1 r  
 r=g (l'Hô
pital's Rule)
 r<g (geometric sequence and sums)
Solving for other Variables
 Solving for the Discount Rate

 Solving for the Payment Amount

 Solving for the Number of Periods

 Solving for the Discount Rate
 If you know the required current investment (present value)
and the future investment payoff (future value) you can solve
for the implied discount rate.
Years
0 1 2 3 4 5

Present Future
Value Value
Rate of Growth???

(1 / n )
 Future Value 
Discount Rate   1
 Present Value 
75
Solving for the Discount Rate
 Example: the implied return based on receiving $127.63
after five years on an initial investment of $100 is as follows:

(1 / 5 )
127.63 
5% or .05  1
 100 
 Example: the implied return based on receiving $2000 after
ten years on an initial investment of $1000 is as follows:

(1/ 10 )
 2000 
7.18% or .0718  1
 1000 
76
Solving for the Rate with Multiple Cash
flows
 If you know the Present Value and the Payment Amount you
can solve for the discount rate by setting the annuity
relationship equal to zero.
 You need to use trial and error.
 This Rate is called the Internal Rate of Return (IRR)
 Your Financial Calculator simplifies this calculation.
Years or Periods
0 1 2 3 4 5

PV CF CF CF CF CF

1 1 
0  PV  PMT   n
 r r (1  r ) 
Solve for discount rate by trial & error
Solving for the Rate with Multiple Cash
flows
 Suppose your firm needs to purchase a new forklift
 The dealer gives you two options:
 A price for the forklift if you pay cash ($40,000)
 The annual payments if you take out a loan from the dealer (no
money down and four annual payments of $15,000)
Solving for the Rate with Multiple Cash
flows
 Setting the present value of the cash flows equal to zero
requires that the present value of the payments equals the
purchase price:

1 1 
40,000  15,000  1 
r  (1  r) 4 
 The solution for r is the interest rate charged by the dealer,
which you can compare to the rate charged by your bank
Solving for the Rate with Multiple Cash
flows

Given: 4 40,000 -15,000 0

Solve for: 18.45
Excel Formula: =RATE(NPER,PMT,PV,FV)=Rate(4,-25000,40000,0)
 Solving for the Payment
 If you know the required current investment (present value),
the interest rate and the number of periods, you can solve for
the payment.
Years or Periods
0 1 2 3 4 5

PV CF CF CF CF CF

1 1 
CF or Payment =PV   n
 r r (1  r ) 
Computing a Loan Payment
Problem:
 Your firm plans to buy a warehouse for $100,000.
 The bank offers you a 30-year loan with equal annual payments and an interest
rate of 8% per year.
 The bank requires that your firm pay 20% of the purchase price as a down
payment, so you can borrow only $80,000.
 What is the annual loan payment?
Computing a Loan Payment
Solution:
 We start with the timeline (from the bank’s perspective):

 Solve for the loan payment, C, given N=30, r = 8% (0.08) and P=$80,000
Computing a Loan Payment (cont’d)
Execute:

P 80, 000
C 
1 1  1  1 
 1 N   1 30 
r (1 r)  0.08  (1.08) 
 $7106.19
 Solving for the Number of Periods
 If you know the Present Value, Discount Rate and Future Value
solving for the Number of Periods also requires trial & error.
 This calculation could be done mathematically using
Logarithms.
 Your Financial Calculator simplifies this problem.

Years or Periods
0 1 2 3 4 5

PV FV

0  Pr esent Value(1  r )  Future Value

n
Solving for the Number of Periods in a Savings
Plan
Problem:
 Imagine you have $10,050 saved already, and you can now afford to save $5,000
per year at the end of each year.
 You earn 7.25% per year on your savings.
 How long will it take you to get to your goal of $60,000?
Solving for the Number of Periods in a Savings
Plan
Solution:
Plan:
 The timeline for this problem is
Solving for the Number of Periods in a Savings
Plan
Plan (cont’d):
 We need to find N so that the future value of our current savings plus the future
value of our planned additional savings (which is an annuity) equals our desired
amount.
 There are two contributors to the future value: the initial lump sum $10,050
that will continue to earn interest, and the annuity contributions of $5,000 per
year that will earn interest as they are contributed.
 Thus, we need to find the future value of the lump sum plus the future value of
the annuity
 Solving for the Number of Periods in a Savings
Plan
Execute:

Given: 7.25 -10,050 -5,000 60,000

Solve for: 7
Excel Formula: =NPER(RATE,PMT, PV, FV) =
NPER(0.0725,-5000,-10050,60000)

It will take seven years to save the down payment