Future Value: The process of going from todays value or present value to Future value is called compounding.

FV = PV + INT FV = PV + PV (i) FV = PV (1+i) FV = PV (1+i)n Example: 0 5% 1 -100 FV = PV (1+i)n FV = 100 (1+ 0.05)5 FV = 100 (1.05)5 FV = 100 (1.2762) FV = 127.62 Present Value: The reserve of compounding is discounting. The process of going from FV to PV is called discounting. FV = PV (1+i)n Or PV (1+i)n = FV PV = FV (1+i)-n 2 3 4 5 FV=?

0 5% PV= ?

5 127.63

PV = FV (1+i)-n PV = 127.63 (1.05)-5 PV= 100 Solving for i: PV = 100, FV= 127.63, n = 5, i=? Ans = 5%

Solving for n: PV = 100, FV= 127.63, n = ?, i=5% Ans = 5 years

Uneven Cash Flow Streams PV of Uneven Cash Flow:

0 6% ?

1 100

2 200

3 200

4 200

5 200

6 0

7 1000

PV = CF1/(1+r)1 + CF2/ (1 + r)2 + CF3/ (1 + r)3 CFn/ (1 + r)n PV = 100/ 1.06 + 200/ 1.06 + 200/ 1.06 + 200/ 1.06 + 200/ 1.06 + 0/ 1.06 + 1000/ 1.06 PV = 94.33 + 177.999 + 167.92 + 158. 428 + 149.45 + 0 + 665.070 PV = 1413

FV of uneven Cash Flow: 0 6% 1 100 200 2 3 200 4 200 5 200 0 6 7 1000

FV = ? PV = CF1/(1+r)6 + CF2/ (1 + r)5 + CF3/ (1 + r)4 CFn/ (1 + r)n

Annuity: An annuity is a series of equal payments made at fixed intervals for a specified number of periods. For example Rs. 100 at the end of each of the next three years is a three year annuity. Ordinary Annuity: Future Value If the payments occur at the end of each period the annuity is called an ordinary annuity. i.e. Payments on mortgages, car loans and student loans. FVAn = PMT {(1+i)n -1/i} 0 5% 1 100 2 100 3 100

FVAn =100 {(1+0.05)3 -1/0.05} FVAn = 100 ( 0.1576/ 0.05) FVAn = 100 ( 3.1525) FVAn = 315.25 FVAn = PMT (FVIFA, i, n)

Annuity Due: Future Value If payments are made at the beginning of each year, the annuity is an annuity due. Rental payments of an apartment, life insurance premiums.

FVAn = PMT {(1+i)n -1/i} (1 + i) 0 5% 1 100 2 100 3 100

FVAn =100 {(1+0.05)3 -1/0.05} (1+ 0.05) FVAn =100 {(1+0.05)3 -1/0.05} (1+ 0.05) FVAn = 331.01

Ordinary Annuity: Present Value PVAn = PMT {1PVAn = 100 {1PVAn = 272.32 1/ (1 + i)n/ i} 1/ (0.05)3/ 0.05}

Annuity Due: Present Value PVAn = PMT {1PVAn = 285.94 PVAn = PMT (PVIFA, i, n) 1/ (1 + i)n/ i} (1 + 0.05)

Perpetuities Annuities go for finite period of time are called perpetuities. The present value of an perpetuity can be found as follows: PV (perpetuity) = Payment / Interest rate PV (perpetuity) = PMT / i PMT = 100, i= 5 % PV (perpetuity) = 100 / 0.05 PV (perpetuity) = 2000