Business Finance (MGT 232) Lecture 7

Time Value of Money

Overview of the Last Lecture Uneven Cash flow Streams Impact of frequency compounding PV and FV Compounding Nominal Interest rate Periodic Interest rate Effective Annual Interest rate

Impact of Frequency Suppose Ali will have Rs. 1000 after 2 years at an annual interest rate of 12%. What is its PV? Annual PV = Semi PV =

Impact of Frequency Qrtly PV Monthly PV = Daily PV =

Impact of Frequency Ali has to make equal payments of Rs.1,000 for 2 years at an annual interest rate of 12%. What lump sum amount he should deposit today? Annual PVA = Semi PVA =

Impact of Frequency Qrtly PVA Monthly PVA = Daily PVA =

Finding ‘i’ in Time Value of Money Problems Suppose you deposit Rs. 1000 today that will become Rs. 1469 after 5 years. What interest rate you would earn on your deposit?

Finding ‘n’ in Time Value of Money Suppose you deposit Rs. 100 and you will have Rs. 115 at an interest rate of 5%. Hw much time it will take to earn Rs. 115?

Loan Amortization If a loan is to be repaid in equal periodic payments, it is said to be amortized loan. It is an application of compounding interest and annuity. Example: Car Loan, Mortgage Loan, Student Loan

Steps to Amortizing a Loan 1. Calculate the payment per period. Determine the interest in Period t. (interest x Beg. Amt) 3. Compute principal payment in Period t. (Payment - interest from Step 2) 4. Determine ending balance in Period t. (Balance - principal payment from Step 3) 5. Start again at Step 2 and repeat.

Amortizing a Loan Example Ali is borrowing Rs.10,000 at a compound annual interest rate of 12%. Amortize the loan if annual payments are made for 5 years. Step 1: Payment PV =

Loan Amortization Schedule

Amortizing a Loan Example [Last Payment Slightly Higher Due to Rounding]

Summary Impact of Frequency in PV and PVA Finding i and n in TMV problems Amortizing a Loan Loan Amortization Schedule