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Interest, Present & Future Value, NPV Explained

The slides explain the two types of interests, their formula derivation, present & future value, net present value.

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Alfi Shahrier Niloy
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67 views8 pages

Interest, Present & Future Value, NPV Explained

The slides explain the two types of interests, their formula derivation, present & future value, net present value.

Uploaded by

Alfi Shahrier Niloy
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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INTEREST: RENT ON MONEY

I borrowed $100
I returned $100 one year later. So, no rent paid.

I borrowed $100
I returned 110$ one year later. So I paid an extra rent of $10 for using
that $100 in one year. This $10 rent is interest.
Types of
Interest

Simple Compound
Interest Interest

Simple Interest: The interest is calculated on a constant principal.

Compound Interest: After a payment, the interest is added to the principal.


The interest of the next payment is calculated on this new principal.
p = principal; rate of risk free interest= r; time period= n

Time Interest Total Payment


0 0 p
1 rp P + rp = P (1+r) SIMPLE
2 rp + rp= 2rp p + 2rp = P (1+2r) INTEREST
……. ……. …….
n nrp P + nrp = p (1+ nr)

If “p” amount of money is deposited for n years of time & risk free rate of
interest is r,

Therefore, total interest i = pnr


Total payable amount c = p (1+nr)
p = principal; rate of risk free interest= r; time period= n

Time Total Payment


0 p
1 p + rp = p (1+r) = New Principal (NP)
COMPOUND
NP + NP.r = p(1+r) + p(1+r).r
2
= p(1+r) (1+r)= p(1+r)2
INTEREST
……. …….
n P (1+r)n

If “p” amount of money is deposited for n years of time & risk free rate of
interest is r,

Therefore, Total payable amount c = p (1+r)n


Bank Discount Rate: Simple Interest

 Formula:

Where n= number of payments;


discount rate= rate of interest

 Effective Interest Rate, I =


effective
1. Present Value & Future Value:

0 1 2 3 ………. n

0 is the Present Time. In other words, 0 means Today.


 
Formula:
If Future Value = FV & Present Value = PV; period = n; rate of interest = r
Then, &
Scenario 1.01: I shall either pay you $100 today or $110 one year later. Considering that current rate
of risk free interest is 5%, which one will be more profitable for you?

After
Today  Here, FV= $110; Time period, n= 1 year; rate of
Year 1
interest r = 5%;
Choice 1 $100
Therefore,
Choice 2 $104.76 $110

Present Value of $110

Scenario 1.02: I shall either pay you $105 today or $110 one year later. Considering that current rate
of risk free interest is 5%, which one will be more profitable for you?

After  Here, FV= $110; Time period, n= 1 year; rate of


Today
Year 1 interest r = 5%;
Choice 1 $105
Therefore,
Choice 2 $104.76 $110

Present Value of $110


2. Net Present Value (NPV): Summation of Present Value of All Payments.
$200 $100 $500 $300 $200 $100 Rate of risk free
Scenario
2.01: interest, r = 6%
0 1 2 3 4 5

  $ 100 $ 500 $ 3 00 $ 2 00 $ 100


𝑁𝑃𝑉 =$ 200+ + 2
+ 3
+ 4
+ 5
=$ 1224.368
(1+6 % ) (1+6 %) (1+6 %) (1+6 % ) (1+6 %)

Scenario 2.02: A bank will provide interest at 1% if deposited for 1 year & 5% if deposited for 2 years.
Find out which of the following choices is best for investment.
 𝑷𝑽 = $ 𝟏𝟏𝟎 $ 𝟏𝟏𝟎
After After = = $ 𝟗𝟗. 𝟕𝟕
Today (𝟏+𝟓 %)
𝟐
𝟏 .𝟎𝟓
𝟐
Year 1 Year 2
Choice 1 $100  

Choice 2 $99.77 x $110


Choice 3 $20 $50 $35 PV = $101.25

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