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PMT
PMT
PMT
PMT
n-1
PMT
PMT
PMT
PMT
n-1
Compounding
(Future value)
CH 28 - 2
II. Future Value : FVIFi ,n= ( 1 + i)
1,000
{C0s value at t=1} = 1,000(1+0.03)1 = 1,030
{C0s value at t=2} = 1,000(1+0.03)(1+0.03) = 1,000(1+0.03)2 = 1,060.90
{C0s value at t=3} = 1,000(1+0.03)(1+0.03)(1+0.03) = 1,000(1+0.03)3 = 1,092.727
{Value at t=3} = 1,000 FVIF(0.03,3) = 1,000(1+0.03)3 = 1,092.727
[2] Different streams: C1=1,000; C2=1,300; C3=900; i=0.03; {Value at t=3}?
0
1
2
3
1,000
1,300
900
i
i,n
t =1
PMT=1,000; n=3; i=0.03; {FV of the annuity (value at the end of the annuity)}?
0
1
2
3
1,000
1,000
1,000
t =1
(1 + 0.03)3 1
= 1,000 FVIFA(0.03,3) = 1,000
= 3,090.90
0.03
[4] Annuity due:
PMT=1,000; n=3; i=0.03; {FV of the annuity due (value at the end of the annuity due)}?
0
1
2
3
2
1,000
1,000
1,000
CH 28 - 3
1
( 1 + i)n
[1] Single cash flow: C3=1,000; i=0.03; {Value at t=0}?
0
1
2
III. Present Value : PVIFi ,n=
3
1,000
1
970.8737864
(1 + 0.03)
1
1
{C3s value at t=1} = 1,000
942.5959091
(1 + 0.03) (1 + 0.03)
1
1
1
.
{C3s value at t=0} = 1,000
9151416594
(1 + 0.03) (1 + 0.03) (1 + 0.03)
1
{Value at t=0} = 1,000 PVIF(0.03,3) = 1,000
915.1416594
(1 + 0.03)3
{C3s value at t=2} = 1,000
1,300
900
i ,n
t
i
t =1 ( 1 + i)
PMT=1,000; n=3; i=0.03; {PV of the annuity (value at the beginning of the annuity)}?
0
1
2
3
1,000
1,000
1,000
1
1
1
+ 1,000
+ 1,000
1
2
(1+ 0.03)
(1+ 0.03)
(1+ 0.03) 3
1
1
1
1
1
000
= 1,000
+
+
=
1
2
3
t
(1+ 0.03)
(1+ 0.03) (1+ 0.03)
t =1 (1+ 0.03)
1
1(1 + 0.03) 3
= 1,000 PVIFA(0.03,3) = 1,000
2,828.611355
0.03
CH 28 - 4
[4] Annuity due:
PMT=1,000; n=3; i=0.03; {PV of the annuity due (value at the beginning of the annuity due)}?
0
1
2
3
1,000
1,000
1,000
1
1
= 1,000 1 +
+
1
2
(1+ 0.03) (1+ 0.03)
1
1
1
= 1,000
+
+
(1 + 0.03)
1
2
3
(1+ 0.03)
(1+ 0.03) (1+ 0.03)
3
1
= 1,000
(1 + 0.03)
t
t =1 (1+ 0.03)
1
(1 + 0.03)3
= 1,000 PVIFA(0.03,3) FVIF(0.03,1) = 1,000
(1 + 0.03) 2,913.469696
0.03
Note that 1,000PVIFA(0.03,3) is the value at t=-1
1
11
(1 + i)
IV. Present value of perpetuity = PMT PVIFA(i, ) = PMT
PMT
i
i
Exercise: i=0.05 {Value of the following cash flows at time=4}?
0
1
2
3
4
29
30
1-
(1 + 0.05) 4 38,44550647
2
000
,
.
(1 + 0.05) 26
0.05
Exercise: 30-year mortgage loan; interest 7.75%; Loan =$200,000; Monthly payment?
1
1
360
0.0775
1
+
0.0775
12
200,000 = PMT PVIFA(
,360) = PMT
12
0.0775
12
200,000
PMT =
= 1,432.824493 1,432.82
1
360
1
1 + 0.0775
12
0.0775
12
CH 28 - 5
V. Summary
[1] Interest factors
(1) FVIFi,n = (1 + i) n 1
0
C
(1 + i ) n 1
n.
i
(2) FVIFAi,n = (1 + i ) nt =
t =1
(3) PVIFi,n =
PMT
1
1
(1 + i ) n
PMT
PMT
PMT
(4) PVIFAi,n =
( 1 + i)
t =1
1
=
1
PMT
1
(1 + i) n
n
i
2
PMT
PMT
PMT
PMT
1
=
i
i
CH 28 - 6
[Exercise problem]
A project costs $6M per year for 5 years, starting immediately. You reckon that it will produce an cash inflow after
operating costs of $4M a year for 15 years, starting 5 years from now. The opportunity cost of capital is 10 percent.
0
17
18
19
-6
-6
-6
-6
-6
+4
+4
+4
+4
+4
+4
+4
1
(1 + 0.10)
5
1
(1 + 0.10) = $25,019,192.68
0.10
1
15
(1 + 0.10)
0.10
1
= $20,780,218.58
(1 + 0.10) 4
c. Based on these cost and cash inflow estimates, what is your recommendation?
Because the present value of the costs is greater than the present value of cash inflows, the project should be
rejected.
28-4
Your grandmother has asked you to evaluate two alternative investments for her. The first is a security that pays
$50 at the end of each of the next 3 years, with a final payment of $1,050 at the end of Year 4. This security
costs $900. The second investment involves simply putting the same amount of money in a bank savings account
that pays an 8 percent nominal (quoted) interest rate, but with quarterly compounding. Your grandmother regards
the two investments as being equally safe and liquid, so the required effective annual rate of return on the security
is the same as that on the bank deposit. She has asked you to calculate the value of the security to help her decide
whether it is a good investment. What is its value relative to the bank deposit?
One period = 1 quarter; i = 0.08/4 = 0.02; C4 = 50, C8 = 50, C12 = 50, C16 = 1050
PV = 50 PVIF(0.02,4) + 50 PVIF(0.02,8) + 50 PVIF(0.02,12) + 1,050 PVIF(0.02,16)
= 50
28-5
+ 50
+ 50
12
+ 1,050
Assume that your father is now 55 years old, that he plans to retire in 12 years, and that he expects to live for 20
years after he retires, that is, until he is 87. He wants a fixed retirement income that has the same purchasing
power at the time he retires as $60,000 has today (he realizes that the real value of his retirement income will
decline year by year after he retires, but he wants level payments during retirement anyway). His retirement
income will begin the day he retires, 12 years from today, and he will receive 20 annual payments. Inflation is
expected to be 5 percent per year from today forward. He currently has $100,000 in savings, and he expects to
earn a return on his savings of 8 percent per year, annual compounding. To the nearest dollar, how much must
he save during each of the next 12 years (with deposits being made at the end of each year) to meet his retirement
goal?
55
56
57
66
67
+D
+D
+D
+D
68
86
+100,000
-60,000(1+0.05)12
-60,000(1+0.05)12
-60,000(1+0.05)12
87
CH 28 - 7
a.
c.
(Value of 12 deposits at 67) + (Value of 100,000 at 67) = (Value of 20 retirement incomes at 67)
(Value of 12 deposits at 67) = (Value of 20 retirement incomes at 67) - (Value of 100,000 at 67)
(Value of 12 deposits at 67) = 1,142,552.44 251,817.0117 = 890,735.428
Deposit FVIFA(0.08,12) = 890,735.428
890,735.428
890,735.428
=
Deposit =
= 46,937.31846
FVIFA(0.08,12) (1 + 0.08)12 1
0.08