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Support
The Time Value
of Money
3b.1 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Remember? Future Value
Single Deposit (Graphic)
Assume that you deposit $1,000 at
a compound interest rate of 7% for
2 years.
0 1 2
7%
$1,000
FV2
3b.2 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Future Value Excel Formula
[Calculates a single value in the future based on current
expectations]
3b.3 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Future Value Example
Students may refer to the supporting Excel file for Chapter 3 (VW13E-
03.xlsx) to use in developing their own solutions to other present value
problems on the “Future Value” tab. Students may find this much easier!
3b.4 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Story Problem Revisited
Julie Miller wants to know how large her deposit
of $10,000 today will become at a compound
annual interest rate of 10% for 5 years.
0 1 2 3 4 5
10%
$10,000
FV5
3b.5 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Future Value Example
3b.6 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Another Future
Value Story Problem
• John and Mary are saving for retirement
and currently have $127,833.56 as a nest
egg.
• John indicates that they plan to retire 25
years from today while Mary expects that a
6% rate of return is appropriate for their risk
level given historical returns.
• Calculate how large the account is expected
to grow.
3b.7 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
“New” FV Story Problem
B C D E F
2 Inputs Explanations
3 rate: 6.00% Compound 6% per year
4 nper: 25 25 periods in the problem
5 pmt: $ - No payment as single flow
6 pv: $ (127,833.56) Invests $127,833.56 today
7 type: 0 Not relevant in single flow
8 Outputs
9 Future Value (FV): $548,645.11 =FV(D3,D4,D5,D6,D7)
3b.8 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
“New” FV Story Problem
• John and Mary will have their $ 127,833.56
investment grow to $ 548,645.11 in 25 years
if they earn exactly 6% each year.
• Note that the Excel answer is a ‘positive’
amount. This indicates that John and Mary
DEPOSITED $ 127,833.56 (the negative
amount as they have less cash) to receive
the positive $548,645.11 (when they receive
cash at retirement when they WITHDRAW the
funds).
3b.9 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Remember? Present Value
Single Deposit (Graphic)
Assume that you need $1,000 in 2 years.
Let’s examine the process to determine
how much you need to deposit today at a
discount rate of 7% compounded annually.
0 1 2
7%
$1,000
PV0 PV1
3b.10 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Present Value Excel Formula
[Calculates a single current value based on future
expectations]
Students may refer to the supporting Excel file for Chapter 3 (VW13E-
03.xlsx) to use in developing their own solutions to other present value
problems on the “Present Value” tab. Students may find this much easier!
3b.12 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Story Problem Revisited
Julie Miller wants to know how large of a
deposit to make so that the money will
grow to $10,000 in 5 years at a discount
rate of 10%.
0 1 2 3 4 5
10%
$10,000
PV0
3b.13 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Present Value Example
Students may refer to the supporting Excel file for Chapter 3 (VW13E-
03.xlsx) to use in developing their own solutions to other present value
problems on the “Present Value” tab. Students may find this much easier!
3b.14 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Another Present Value
Story Problem
• John and Mary are expecting to build a
$100,000 nest egg to use to travel the world
upon retirement. They would like to know
how much they need to set aside today to
reach this goal.
• John indicates that they will retire 20 years
from today while Mary thinks that a 6% rate
of return is appropriate for their risk level.
Calculate how much they need to set aside
today.
3b.15 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
“New” PV Story Problem
B C D E F
2 Inputs Explanations
3 rate: 6.00% Discount 6% per period
4 nper: 20 20 periods in the problem
5 pmt: $ - No payment as single flow
6 fv: $ 100,000 Want $100,000 in future
7 type: 0 Not relevant in single flow
8 Outputs
9 present value (pv) ($31,180.47) =PV(D3,D4,D5,D6,D7)
Students may refer to the supporting Excel file for Chapter 3 (VW13E-
03.xls) to use in developing their own solutions to other present value
problems on the “Present Value” tab.
3b.16 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
“New” PV Story Problem
• John and Mary need to set aside $31,180.47
today if they earn exactly 6% each year for
the next 20 years to reach their goal.
• Note that the Excel answer is a ‘negative’
amount. This indicates that John and Mary
will need to DEPOSIT this amount of money
(they have less cash) to receive the positive
$100,000 (when they receive cash) they would
WITHDRAW monies.
3b.17 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Remember? Double
Your Money!!!
3b.18 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Output: The Periods!
Students may refer to the supporting Excel file for Chapter 3 (VW13E-
03.xlsx) to use in developing their own solutions to other interest rate
problems on the “Periods” tab. Students may find this much easier!
NOTE: The same answer! Solved in only one cell in Excel!!
3b.19 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Remember? Double
Your Money!!!
3b.20 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Output: The Interest Rate!
Students may refer to the supporting Excel file for Chapter 3 (VW13E-
03.xlsx) to use in developing their own solutions to other interest rate
problems on the “Rate” tab.
Note that we “guessed 12% as 12 x 6 = 72. The answer was very close!
3b.21 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Remember? Example of an
Ordinary Annuity -- PVA
Cash flows occur at the end of the period
0 1 2 3 4
7%
3b.23 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
PV Annuity Example
(Ordinary Annuity)
Students may refer to the supporting Excel file for Chapter 3 (VW13E-
03.xlsx) to use in developing their own solutions to other present value
problems on the “PV Annuity” tab. Students will find this much easier!
3b.24 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
“New” PV Annuity Example
(Ordinary Annuity)
• John and Mary are trying to build a nest egg to use
in the future. They would like to know how much
they need to set aside in a single lump sum today to
be equivalent to investing $10,000 each year starting
one year from today to reach this goal.
• John indicates that they will use the money 20 years
from today while Mary thinks that a 6% rate of return
is appropriate for their risk level.
• Calculate the equivalent present value of this
ordinary annuity stream.
3b.25 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
“New” PV Annuity Example
(Ordinary Annuity)
B C D E F
2 Inputs Explanations
3 rate: 6.00% Discount 6% per period
4 nper: 25 25 periods in the problem
5 pmt: $ (10,000) $10,000 invested per yr
6 fv: $ - No future amount in additon
7 type: 0 Ordinary Annuity
8 Outputs
9 present value (pv) $127,833.56 =PV(D3,D4,D5,D6,D7)
Students may refer to the supporting Excel file for Chapter 3 (VW13E-
03.xlsx) to use in developing their own solutions to other present value
problems on the “PV Annuity” tab. Students will find this much easier!
3b.26 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
“New” PV Annuity Example
(Ordinary Annuity)
• John and Mary need to set aside $127,833.56
today to be equivalent to setting aside
$10,000 per year at exactly 6% each year for
the next 25 years.
• In this case, John and Mary need to decide
which is their preference. This sum will grow
to exactly the same as the future value of an
ordinary annuity (see slides 7 to 9).
3b.27 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Remember? Example of an
Ordinary Annuity -- FVA
Cash flows occur at the end of the period
0 1 2 3 4
7%
Students may refer to the supporting Excel file for Chapter 3 (VW13E-
03.xlsx) to use in developing their own solutions to other present value
problems on the “FV Annuity” tab. The same answer as before is arrived at
in a single step in Excel - one formula ‘=FV(.07,3,-1000,0,0)’!
3b.30 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
“New” Future Value Annuity
Example (Ordinary Annuity)
• John and Mary are trying to build a nest egg to use
in the future. They would like to know how much
they need to set aside in a single lump sum today to
be equivalent to investing $10,000 each year
starting one year from today to reach this goal. (See
slides 21 to 23 and also 7 to 9)
• John indicates that they will use the money 20 years
from today while Mary thinks that a 6% rate of
return is appropriate for their risk level.
• Calculate the equivalent present value of this
ordinary annuity stream.
3b.31 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
“New” Future Value Annuity
Example (Ordinary Annuity)
B C D E F
2 Inputs Explanations
3 rate: 6.00% Compound 6% per year
4 nper: 25 25 periods in the problem
5 pmt: $ (10,000) $10,000 per year invested
6 pv: $ - No additional monies today
7 type: 0 Not relevant in single flow
8 Outputs
9 Future Value (FV): $548,645.12 =FV(D3,D4,D5,D6,D7)
Students may refer to the supporting Excel file for Chapter 3 (VW13E-03.xlsx) to use
in developing their own solutions to other present value problems on the “FV
Annuity” tab. Students will find this is the exact same answer as those derived using
PV of an annuity and then Future Value!
3b.32 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
“New” Future Value Annuity
Example (Ordinary Annuity)
• John and Mary will accumulate nearly
$550,000 by investing $10,000 per year
at exactly 6% each year for the next 25
years.
• In this case, note that this result is
equivalent to the future value of a single
sum where John and Mary needed to
set aside over $127,000 to generate this
sum.
3b.33 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Remember? Example of
an Annuity Due – PVAD
Cash flows occur at the beginning of the period
0 1 2 3 4
7%
$2,808.02 = PVADn
3b.36 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
“New” PV Annuity
Example (Annuity Due)
B C D E F
2 Inputs Explanations
3 rate: 6.00% Discount 6% per period
4 nper: 25 25 periods in the problem
5 pmt: $ (10,000) $10,000 invested per yr
6 fv: $ - No future amount in additon
7 type: 1 Ordinary Annuity
8 Outputs
9 present value (pv) $135,503.58 =PV(D3,D4,D5,D6,D7)
0 1 2 3 4 5
10%
$600 $600 $400 $400 $100
PV0
3b.40 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Solve a “mixed flows” problem
using the NPV function
Period Cash Flows
Students may refer to 1 $ 600.00
2 $ 600.00 Interest Rate:
the supporting Excel file 10%
3 $ 400.00 (discount rate)
for Chapter 3 (VW13E- 4 $ 400.00
03.xlsx) to use in 5 $ 100.00 Present Value*: $1,677.15
6 =NPV(F3,C3:C22)
developing their own
7
solutions to other
8
present value problems * Do NOT include cash
9
on the “Mixed Flows” 10 flows in period 0. Please
tab. 11
add or subtract these flows
12 from the final answer above.
Simply type in the cash
13 (Cell F6)
flows in the green
14
column and the correct 15
interest rate in yellow 16
and you get your 17
answer! 18
19
20
3b.41 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Solve a “mixed flows” problem
using the NPV function
Period Cash Flows
Students can also solve 1 $ 600.00
this in one formula step 2 $ 600.00 Interest Rate:
10%
(discount rate)
again! 3 $ 400.00
4 $ 400.00
=npv(.10, 600, 600, 400, 5 $ 100.00 Present Value*: $1,677.15
=NPV(F3,C3:C22)
400, 100) 6
7
This will generate the 8
same and correct output. 9 * Do NOT include cash
The model on the right is 10 flows in period 0. Please
add or subtract these flows
designed to be slightly 11
from the final answer above.
more flexible in solving 12
13 (Cell F6)
these types of problems.
14
Remember the NPV 15
function, because we will 16
17
use it later! 18
19
20
3b.42 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Remember? BWs Effective
Annual Interest Rate
Basket Wonders (BW) has a $1,000
CD at the bank. The interest rate is
6% compounded quarterly for 1
year. What is the Effective Annual
Interest Rate (EAR)?
EAR = ( 1 + 6% / 4 )4 - 1
= 1.0614 - 1 = .0614 or 6.14%!
3b.43 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
BWs Effective
Annual Interest Rate
We can use a single function in Excel again to
solve for the Effective Annual Interest Rate (EAR)
Nominal Periods Effective Formula Used
6% 1 6.0000% =EFFECT(B3,C3)
6% 2 6.0900% =EFFECT(B4,C4)
6% 4 6.1364% =EFFECT(B5,C5)
6% 6 6.1520% =EFFECT(B6,C6)
6% 12 6.1678% =EFFECT(B7,C7)
6% 365 6.1831% =EFFECT(B8,C8)
6% 1,000,000 6.1837% =EFFECT(B9,C9)
3b.46 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.