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Class 3 - Tagged

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45 views40 pages

Class 3 - Tagged

Uploaded by

tylerlemieuxbusiness
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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2406 Principles of

Finance With Excel


Class 3
Learning Outcomes:
Time value of money.
Future value (FV): The amount you will accumulate
at some future date from deposits made in the
present.
Present value (PV): The value today of future
anticipated cash flows.
The number of periods to pay off the investment.
Excel functions FV, PV, NPV.
The Present Value of Non-Annuity (Meaning: Non-Constant)
Cash Flows
• The present value concept can also be applied to non-annuity
cash flow streams - cash flows that are not the same every period.
• For example, that your Aunt Terry has promised to pay you
$100 at the end of year 1,
$200 at the end of year 2,
$300 at the end of year 3,
$400 at the end of year 4,
$500 at the end of year 5.
Suppose that the bank pays 6% interest on savings accounts.
This is not an annuity, and so it cannot be accommodated by the
PV function. But we can find the present value of this promise by
using the NPV function:
Saving for the Future
• Mario wants a car that costs $20,000.
• He wants to buy a car in 2 years.
• He plans to open a bank account and to deposit $X today and $X in 1 year.
• Balances in the account will earn 8%.
• How much does Mario need to deposit so that he has $20,000 in 2
years?

In order to finance future consumption with a savings plan, the future value
of all the cash flows (positive and negative) has to be zero. In the jargon of
finance—the future consumption plan is fully funded if the future value of all
the cash flows is zero.
Three methods for solving Mario’s
saving problem:
• Method 1: Trial and Error
• Method 2: Using Excel’s Goal Seek
• Method 3: Using the Excel PMT
Function
$C$9
0
$B$2
The Excel PMT function is a financial function that returns the periodic payment
for a loan. You can use the PMT function to figure out payments for a loan, given
the loan amount, number of periods, and interest rate.
Saving for University
We start by trying to determine whether a young girl’s parents
are putting enough money aside to save for her college
education. Here’s the problem:
On her 10th birthday Linda Jones’s parents decide to deposit
$4,000 in a savings account for their daughter. They intend to
put an additional $4,000 in the account each year on her 11th,
12th, ..., 17th birthdays.
All account balances will earn 8% per year.
On Linda’s 18th, 19th, 20th, and 21st birthdays, her parents will
withdraw $20,000 to pay for Linda’s college education.
Is the $4,000 per year sufficient to cover the anticipated college
expenses?
By looking at the end-year balances in column E, the $4,000 is not
enough—Linda and her parents will run out of money somewhere
between her 19th and 20th birthdays.

By the end of her college career, they will be $34,817 “in the hole”
(cell E18). Another way to see this is to look at the present value
calculation in cell C20: As we saw in the previous section, a
combination savings/withdrawal plan is fully funded when the PV
of all the payments/withdrawals is zero.

In cell C20, we see that the PV is negative—Linda’s plan is


underfunded. How much should Linda’s parents put aside each
year?

There are several ways to answer this question, which we explore


below. These methods are basically the same as the three
methods for solving Mario’s problem presented in the previous
Pension Plan (saving for retirement)
Suppose that Joe is 20 today and wishes to start saving
so that when he’s 65 he can have 20 years of $100,000
annual withdrawals.
Quiz
time
Algebraic Present Value Formulas
This formula will be used in the “Gordon dividend model”
Annuity Formulas in Excel
Keeping this in mind enables us to understand the
following:

• 1. The reason we get a negative PV value when we


solve for PV and PMT is entered in positive number.
• 2. We can solve for the present value using the last four
arguments (or omit FV and Excel will plug “0” for FV).
• 3. We can solve for the future value using the other four
arguments (or omit PV and Excel will plug “0” for PV).
• 4. We can solve for the periodic payment using the PMT
function. 5. We can solve for the interest rate of the
annuity using the RATE function. 6. We can solve for the
number of periods using the NPER function.

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