TAILIEUCHUNG - Lecture Fundamentals of finance – Chapter 4: Introduction to valuation: the time value of money

After completing this unit, you should be able to compute the future value of an investment made today, be able to compute the present value of cash to be received at some future date, be able to compute the return on an investment. | Chapter 4 Lecture - Introduction to Valuation: The Time Value of Money Chapter 4 Lecture Introduction to Valuation: The Time Value of Money Learning Objectives After studying this chapter, you should be able to: LO1 Determine the future value of an investment made today. LO2 Determine the present value of cash to be received at a future date. LO3 Calculate the return on an investment. LO4 Predict how long it takes for an investment to reach a desired value. 4-1 4-2 Basic Definitions Time Line of Cash Flows • Present Value (PV) – The current value of future cash flows discounted at the appropriate discount rate – Value at t=0 on a time line • Future Value (FV) – The amount an investment is worth after one or more periods. – “Later” money on a time line • Interest rate (r) – Discount rate – Cost of capital – Opportunity cost of capital – Required return – Terminology depends on usage •Tick marks at ends of periods • Time 0 is today; • Time 1 is the end of Period 1 0 1 2 3 CF1 CF2 CF3 r% CF0 +CF = Cash INFLOW -CF = Cash OUTFLOW 4-3 PMT (payment) = Constant CF 4-4 1 Chapter 4 Lecture - Introduction to Valuation: The Time Value of Money Time Line for a $100 Lump Sum due at the End of Year 2. 0 1 r% The Timeline Example (cont’d) • Assume that you lend $20,000 to a friend. You will be repaid in two payments, one at the end of each year over the next two years. 2 Year 100 4-5 4-6 Simple Interest and Compound Interest The Timeline Example (cont’d) • What is the difference between simple interest and compound interest? – Simple interest: Interest is earned only on the principal amount. – Compound interest: Interest is earned on both the principal and accumulated interest of prior periods. • Assume that you are lending $10,000 today and that the loan will be repaid in two annual $6,000 payments. This assumes some interest) The first cash flow at date 0 (today) is represented as a negative sum because it is an outflow. • Example: Suppose that

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