CHAPTER OUTLINE

• Future and Present Values of Multiple Cash Flows

• Valuing Level Cash Flows: Annuities and Perpetuities

• Comparing Rates: The Effect of Compounding

• Loan Types and Loan Amortization

6C-1
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 MULTIPLE CASH FLOWS – FV
EXAMPLE 6.1
• You think you will be able to deposit $4,000 at the end of each
of the next three years in a bank account paying 8 percent
interest.
• You currently have $7,000 in the account.
• How much will you have in three years?
• How much will you have in four years?

Copyright © 2016 by McGraw-Hill Global Education LLC. All rights reserved.

 MULTIPLE CASH FLOWS – FV
EXAMPLE 1
• Find the value at year 3 of each cash flow and add
them together
 Today’s (year 0) CF: 3 N; 8 I/Y; -7,000 PV; CPT FV =
8817.98
 Year 1 CF: 2 N; 8 I/Y; -4,000 PV; CPT FV = 4,665.60
 Year 2 CF: 1 N; 8 I/Y; -4,000 PV; CPT FV = 4,320
 Year 3 CF: value = 4,000
 Total value in 3 years = 8,817.98 + 4,665.60 + 4,320 + 4,000 =
21,803.58

• Value at year 4: 1 N; 8 I/Y; -21,803.58 PV; CPT FV =

23,547.87
6C-3
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MULTIPLE CASH FLOWS – FV
EXAMPLE 2
• Suppose you invest $500 in a mutual fund
today and $600 in one year.
• If the fund pays 9% annually, how much will you
have in two years?

 Year 0 CF: 2 N; -500 PV; 9 I/Y; CPT FV = 594.05

 Year 1 CF: 1 N; -600 PV; 9 I/Y; CPT FV = 654.00

 Total FV = 594.05 + 654.00 = 1,248.05

6C-4
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MULTIPLE CASH FLOWS – FV
EXAMPLE 2 CONTINUED
• How much will you have in 5 years if you make no
further deposits?

• First way:
 Year 0 CF: 5 N; -500 PV; 9 I/Y; CPT FV = 769.31
 Year 1 CF: 4 N; -600 PV; 9 I/Y; CPT FV = 846.95
 Total FV = 769.31 + 846.95 = 1,616.26

• Second way – use value at year 2:

 3 N; -1,248.05 PV; 9 I/Y; CPT FV = 1,616.26

6C-5
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MULTIPLE CASH FLOWS – FV
EXAMPLE 3
• Suppose you plan to deposit $100 into an
account in one year and $300 into the account in
three years.
• How much will be in the account in five years if the
interest rate is 8%?

 Year 1 CF: 4 N; -100 PV; 8 I/Y; CPT FV = 136.05

 Year 3 CF: 2 N; -300 PV; 8 I/Y; CPT FV = 349.92

 Total FV = 136.05 + 349.92 = 485.97

6C-6
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 EXAMPLE 6.3 TIMELINE
0 1 2 3 4

200 400 600 800

178.57

318.88

427.07

508.41
1,432.93

6C-7
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MULTIPLE CASH FLOWS USING A
SPREADSHEET
• You can use the PV or FV functions in Excel to
find the present value or future value of a set of
cash flows

• Setting the data up is half the battle – if it is set

up properly, then you can just copy the formulas

• Click on the Excel icon for an example

6C-8
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MULTIPLE CASH FLOWS – PV
ANOTHER EXAMPLE
• You are considering an investment that will
pay you $1,000 in one year, $2,000 in two
years and $3,000 in three years.
• If you want to earn 10% on your money, how much
would you be willing to pay?

 N = 1; I/Y = 10; FV = 1,000; CPT PV = -909.09

 N = 2; I/Y = 10; FV = 2,000; CPT PV = -1,652.89
 N = 3; I/Y = 10; FV = 3,000; CPT PV = -2,253.94
 PV = 909.09 + 1,652.89 + 2,253.94 = 4,815.93

6C-9
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MULTIPLE UNEVEN CASH FLOWS –
USING THE CALCULATOR
• Another way to use the financial calculator for uneven cash flows is
to use the cash flow keys

 Press CF and enter the cash flows beginning with year 0.

 You have to press the “Enter” key for each cash flow
 Use the down arrow key to move to the next cash flow
 The “F” is the number of times a given cash flow occurs in
consecutive periods
 Use the NPV key to compute the present value by entering the
interest rate for I, pressing the down arrow, and then computing
the answer
 Clear the cash flow worksheet by pressing CF and then 2 nd CLR
Work

6C-10
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 DECISIONS, DECISIONS
• Your broker calls you and tells you that he has this great
investment opportunity.
• If you invest $100 today, you will receive $40 in one
year and $75 in two years.
• If you require a 15% return on investments of this
risk, should you take the investment?

 Use the CF keys to compute the value of the investment

 CF; CF0 = 0; C01 = 40; F01 = 1; C02 = 75; F02 = 1
 NPV; I = 15; CPT NPV = 91.49
 No – the broker is charging more than you would be
willing to pay.
6C-11
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 SAVING FOR RETIREMENT

• You are offered the opportunity to put some money

away for retirement.
• You will receive five annual payments of $25,000 each
beginning in 40 years.
• How much would you be willing to invest today if you
desire an interest rate of 12%?

 Use cash flow keys:

• CF; CF0 = 0; C01 = 0; F01 = 39; C02 = 25,000; F02 = 5; NPV; I =
12; CPT NPV = 1,084.71

6C-12
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SAVING FOR RETIREMENT TIMELINE

0 1 2 … 39 40 41 42 43 44

0 0 0 … 0 25K 25K 25K 25K 25K

Notice that the year 0 cash flow = 0 (CF0 = 0)

The cash flows in years 1 – 39 are 0 (C01 = 0; F01 =
39)
The cash flows in years 40 – 44 are 25,000 (C02 =
25,000; F02 = 5)
6C-13
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ANNUITIES AND PERPETUITIES
DEFINED
• Annuity – finite series of equal payments that
occur at regular intervals
 If the first payment occurs at the end of the period, it
is called an ordinary annuity
 If the first payment occurs at the beginning of the
period, it is called an annuity due

• Perpetuity – infinite series of equal payments

6C-14
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ANNUITIES AND PERPETUITIES –
BASIC FORMULAS
• Perpetuity: PV = C / r

• Annuities:

 1 
1  (1  r ) t 
PV  C  
 r 

 

 (1  r ) t  1 
FV  C  
 r 
6C-15
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 ANNUITIES AND THE
CALCULATOR
• You can use the PMT key on the calculator for
the equal payment
• The sign convention still holds
• Ordinary annuity versus annuity due
 You can switch your calculator between the two
types by using the 2nd BGN 2nd Set on the TI BA-II
Plus
 If you see “BGN” or “Begin” in the display of your
calculator, you have it set for an annuity due
 Most problems are ordinary annuities

6C-16
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 ANNUITY – EXAMPLE 6.5

• After carefully going over your budget, you have determined

you can afford to pay $632 per month toward a new sports car.
• You call up your local bank and find out that the going rate
is 1 percent per month for 48 months.
• How much can you borrow?

• To determine how much you can borrow, we need to calculate

the present value of $632 per month for 48 months at 1 percent
per month.

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 ANNUITY – EXAMPLE 6.5

• You borrow money TODAY so you need to compute the

present value.
 48 N; 1 I/Y; -632 PMT; CPT PV = 23,999.54 ($24,000)

• Formula:
 1 
1  (1.01) 48 
PV  632    23,999.54
 .01 
 

6C-18
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 ANNUITY –
SWEEPSTAKES EXAMPLE
• Suppose you win the Publishers Clearinghouse
$10 million sweepstakes.
• The money is paid in equal annual end-of-year
installments of $333,333.33 over 30 years.
• If the appropriate discount rate is 5%, how much is
the sweepstakes actually worth today?

 30 N; 5 I/Y; 333,333.33 PMT;

CPT PV = 5,124,150.29

6C-19
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 BUYING A HOUSE
• You are ready to buy a house, and you have $20,000 for
a down payment and closing costs.
• Closing costs are estimated to be 4% of the loan value.
• You have an annual salary of $36,000, and the bank is
willing to allow your monthly mortgage payment to be
equal to 28% of your monthly income.
• The interest rate on the loan is 6% per year with
monthly compounding (.5% per month) for a 30-year
fixed rate loan.
• How much money will the bank loan you?
• How much can you offer for the house?

6C-20
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 BUYING A HOUSE - CONTINUED

• Bank loan
 Monthly income = 36,000 / 12 = 3,000
 Maximum payment = .28(3,000) = 840
• 30*12 = 360 N
• .5 I/Y
• -840 PMT
• CPT PV = 140,105

• Total Price
 Closing costs = .04(140,105) = 5,604
 Down payment = 20,000 – 5,604 = 14,396
 Total Price = 140,105 + 14,396 = 154,501

6C-21
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 FINDING THE PAYMENT

• Suppose you want to borrow $20,000 for a new car.

• You can borrow at 8% per year, compounded monthly (8/12 = .66667%
per month).
• If you take a 4-year loan, what is your monthly payment?

 4(12) = 48 N; 20,000 PV; .66667 I/Y; CPT PMT = 488.26

6C-22
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 FINDING THE NUMBER OF
PAYMENTS – EXAMPLE 6.6
• You ran a little short on your spring break vacation, so you put
$1,000 on your credit card.
• You can afford only the minimum payment of $20 per month.
• The interest rate on the credit card is 1.5 percent per month.
• How long will you need to pay off the $1,000?

Copyright © 2016 by McGraw-Hill Global Education LLC. All rights reserved.

FINDING THE NUMBER OF
PAYMENTS – EXAMPLE 6.6
• The sign convention matters!
 1.5 I/Y
 1,000 PV
 -20 PMT
 CPT N = 93.111 months = 7.75 years

• And this is only if you don’t charge anything more

on the card!

6C-24
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 FINDING THE NUMBER OF
PAYMENTS – ANOTHER EXAMPLE
• Suppose you borrow $2,000 at 5%, and you
are going to make annual payments of
$734.42.
• How long before you pay off the loan?

 Sign convention matters!!!

 5 I/Y
 2,000 PV
 -734.42 PMT
 CPT N = 3 years

6C-25
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 FINDING THE RATE

• Suppose you borrow $10,000 from your parents to

buy a car.
• You agree to pay $207.58 per month for 60 months.
• What is the monthly interest rate?

 Sign convention matters!!!

 60 N
 10,000 PV
 -207.58 PMT
 CPT I/Y = .75%

6C-26
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FUTURE VALUES FOR ANNUITIES
• Suppose you begin saving for your retirement by
depositing $2,000 per year in an IRA.
• If the interest rate is 7.5%, how much will you have in 40
years?

 Remember the sign convention!

 40 N
 7.5 I/Y
 -2,000 PMT
 CPT FV = 454,513.04

6C-27
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 ANNUITY DUE
• You are saving for a new house and you put $10,000 per
year in an account paying 8%. The first payment is
made today.
• How much will you have at the end of 3 years?

 2nd BGN 2nd Set (you should see BGN in the display)
 3N
 -10,000 PMT
 8 I/Y
 CPT FV = 35,061.12
 2nd BGN 2nd Set (be sure to change it back to an ordinary
annuity)

6C-28
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ANNUITY DUE TIMELINE

0 1 2 3

10000 10000 10000

32,464

35,016.12

6C-29
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 EFFECTIVE ANNUAL RATE
(EAR)
• This is the actual rate paid (or received) after
accounting for compounding that occurs during the
year

• If you want to compare two alternative investments

with different compounding periods, you need to
compute the EAR and use that for comparison.

6C-30
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 ANNUAL PERCENTAGE RATE
• This is the annual rate that is quoted by law

• By definition APR = period rate times the number of

periods per year

• Consequently, to get the period rate we rearrange the

APR equation:
 Period rate = APR / number of periods per year

• You should NEVER divide the effective rate by the

number of periods per year – it will NOT give you the
period rate

6C-31
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COMPUTING EARS - EXAMPLE
• Suppose you can earn 1% per month on $1 invested
today.
 What is the APR? 1(12) = 12%
 How much are you effectively earning?
• FV = 1(1.01)12 = 1.1268
• Rate = (1.1268 – 1) / 1 = .1268 = 12.68%

• Suppose you put it in another account and earn 3% per

quarter.
 What is the APR? 3(4) = 12%
 How much are you effectively earning?
• FV = 1(1.03)4 = 1.1255
• Rate = (1.1255 – 1) / 1 = .1255 = 12.55%
6C-32
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 EAR - FORMULA

m
 APR 
EAR  1    1
 m 
Remember that the APR is the quoted rate, and
m is the number of compounding periods per year

6C-33
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 DECISIONS, DECISIONS II

• You are looking at two savings accounts. One pays 5.25%,

with daily compounding. The other pays 5.3% with
semiannual compounding. Which account should you use?

 First account:
• EAR = (1 + .0525/365)365 – 1 = 5.39%
 Second account:
• EAR = (1 + .053/2)2 – 1 = 5.37%

• Which account should you choose and why?

6C-34
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AMORTIZATION EXAMPLE