Future Value problem

Example
Suppose you had a relative deposit
$10 at 5.5% interest 200 years ago.
How much would the investment
be worth today?
Solutions:

3.1 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Future Value problem
Solutions:

FV = PV (1 + r )n
FV = $10 (1 + 0.055 )200
= 447,189.83

3.2 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Future Value of Multiple
Amounts
 The concept of FV can be extended
beyond compounding a single
payment to compounding a series of
payments.
 Formula for calculating stream of
unequal payments &receipts:

3.3 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Future Value of Multiple
Amounts
 FVn = PV(1 + r )n + PV(1 + r )n-1 +

PV(1 + r )n-2 +PV(1+r)n-n

Example:
Mr. Ahmad deposit $2,000 today &1,500
one year from now. Interest rate is
10%. Calculate the FV4 of an unequal
series.
3.4 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Future Value of Multiple
Amounts
Solutions:
FVn =PV0(1 + r )n + PV1(1 + r )n-1
FV4 =2,000(1 + .10 )4 + 1,500(1 + .10)4-1
FV4 = 2,928.2 +1,996.5
FV4 = 4,924.7

3.5 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 PV of an Uneven
Amounts:
 To find the Present value of an
unequal stream of payments,
simply calculate the Present
value of each future mount
separately and then add these
present values together.

3.6 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 PV of an Uneven
Amounts:

Example:
Ahmad & Co. want to receive the
following payments i.e. $500 one year
from today, $800 two years from today,
and $950 three years from today. The
discount rate is 8 percent. Calculate
the PV of multiple future cash flows?

3.7 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 PV of an Uneven
Amounts:
Pvo = FV1[1/(1+i)1] + FV2[1/(1+i)2]+FV3[1/(1+i)3]
Pvo = 500[1/(1+.08)1]+$800 [1/(1+.08)2]+
950[1/(1+.08)3]
PV0 = 500[1/(1.08)1]+800 [1/(1.08)2]+
950[1/(1.08)3]
PV0 = 500/1.08+800/(1.08)2+950/(1.08)3
PV0 = 462.95+ 685.86+754.11 = $1,902.92

3.8 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 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)
5.
3.9
Start again at Step 2 and repeat.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 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)
3.10
R = $10,000 / 3.605 = $2,774
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 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]

3.11 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Usefulness of
Amortization
1. Determine Interest Expense
– Interest expenses may
reduce taxable income of the
2.firm.
Calculate Debt Outstanding –
The quantity of outstanding
debt may be used in financing
the day-to-day activities of the
firm.
3.12 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Sinking Fund
 It is used when we want to calculate
how much we have to deposit every
year for ‘X’ years at the interest rate
of i% pa to receive amount ‘Y’ at the
end of ‘X’ years.
 Example: Suppose we want to
accumulate $500,000 at the end of 10
years. How much we should deposit
each year at an interest rate 10% pa?
3.13 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Sinking Fund
Solutions:
FVOAn = A* PVIFAi%,n
A = FVOAn/PVIFAi%,n
A = 500,000/PVIFA10%,10
A = 500,000/15.937
A = 31,373.53

3.14 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Perpetuities
 An annuity in which the cash flows
continue forever. Consol is a type of
perpetuity.
 PV of perpetuity = CF/r
 For example, an investment offers a
personnel cash flows of $500 every
year. The return you require on such an
investment is 8%. What is the value of
this investment?
3.15 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Perpetuities
 Solutions:
 PV of perpetuity = CF/r
= $500/.08
= $6,250

3.16 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Finding ‘r’ for a Single
Investment
Example:
You are considering a one-year
investment. If you put up $1,250,
you will get back $1,350. What
rate in this investment paying?

3.17 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Finding ‘r’ for a Single
Investment
Solutions:
We know that
PV0 = FVn / (1 + i)n
1,250 = 1,350 / (1 + i)1
(1 + i) 1,250 = 1,350
(1 + i) = 1,350/ 1,250, 1 + I = 1.08
i = 1.08- 1 = .08 0r 8%

3.18 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Assignment #1
Question #1:
You have been offered an investment
that promise to double your money
every 10 years. What is the
approximate rate of return on the
investment?

3.19 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Assignment # 1
Question #2:
You would to retire in 50 years. If you
have 10,000 today. What rate of return
you need to earn to achieve your goal?
Question #3:
You have been saving up the Godot
Company. The total cost will be $10 M.
3.20 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Assignment # 1

You currently have about $2.3 M. If

you can earn 5 person on your
money, how long will you have to
wait? At 16%, how long must you
want?

3.21 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Assignment # 1

Question #: 4
A typical credit card agreement
quotes an interest rate of 18%
APR. Monthly payments are
required. What is the actual
interest rate you pay on such a
credit card?
3.22 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Assignment # 1

Question # 5:
Mr. Ahmad takes loan from bank
$50,000 today to buy a car for his
son. Interest rate is 10%. How
much he has to pay per year to
repay the loan in 3 equal end of
year payments.
3.23 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.