Personal Finance Time Value of Money Bill Klinger

Personal Finance Review Opportunity cost Cash flow statement Changes over time Factors affecting Balance sheet Assets Liabilities Net worth Analysis Ratios

Interest Interest is the cost of money When you borrow You pay interest to get the money When you invest or loan Others pay you interest to get the money

Time Value of Money A dollar today is worth less than a dollar in the future Why? If you give up money today, you expect to receive more in the future You have opportunity costs What is opportunity cost?

Future Value Simple future value (FV) Example FV = amount x (1 + interest rate) Example Assume interest rate of 3% If invest $1000 today, how much will you have next year? FV = 1000 x (1 + .04) FV = $1040

Future Value Compound interest FV formula too complex for this class Earn interest on the interest on the interest … Einstein said was the most powerful force in the universe FV formula too complex for this class Will use tables in text Can also use Excel function, FV FV = PV x FVIF FV = Future value, amount you will have in the future PV = Present value, amount you have today FVIF = Future value interest factor, found in text Appendix C.1

Future Value Problems You invest $100 today at 4% interest. How much will you have in 4 years? You invest $100 today at 4% interest. How much will you have in 10 years? You invest $100 today at 9% interest. How much will you have in 4 years? You invest $100 today at 9% interest. How much will you have in 10 years? What can you say about the length of time you invest? What does that say about your investment plans? What can you say about the difference the interest rate makes?

Future Value Years to double = 72 / (interest rate) Compounding rule of thumb Rule of 72 Calculate how long it will take money to double Years to double = 72 / (interest rate)

Present Value Present value represents the value of future payments to you now For example What is $1000 next year worth to you now? Can also think of it as willingness to pay What would you pay today for $10,000 in 5 years? To calculate PV, need to know Future amount Interest rate Number of years

Present Value PV formula too complex for this class PV = FV x PVIF Will use tables in text Can also use Excel function, PV PV = FV x PVIF PV = Present value, amount you have today FV = Future value, amount you will have in the future PVIF = Present value interest factor, found in text Appendix C.2

PV = FV x PVIFi,n Text Error Table C.2 has an error Heading is incorrect Should read PV = FV x PVIFi,n

Present Value Problems What is $10,000 five years from now worth today if interest rates are 4%? What is $10,000 ten years from now worth today if interest rates are 4%? What is $10,000 five years from now worth today if interest rates are 10%? What is $10,000 ten years from now worth today if interest rates are 10%? What can you say about the effect of the length of time? What can you say about the difference the interest rate makes?

Present Value Problems How much are you willing to pay for $5,000 next year if interest rates are 6%? How much are you willing to pay for $50,000 in 20 years if interest rates are 6%?

In Class In groups of two Chapter 3 Financial Planning Problems Create a simple budget with one or two problems Exchange with another group and find problems