Principles of Managerial Finance

Sixteenth Edition, Global Edition

Chapter 5
Time Value of Money

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Learning Goals (1 of 2)
LG 1 Discuss the role of time value in finance, the use of
computational tools, and the basic patterns of cash
flow.
LG 2 Understand the concepts of future value and present
value, their calculation for single cash flow amounts,
and the relationship between them.
LG 3 Find the future value and the present value of both an
ordinary annuity and an annuity due, and find the
present value of a perpetuity.

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Learning Goals (2 of 2)
LG 4 Calculate both the future value and the present value
of a mixed stream of cash flows.
LG 5 Understand the effect that compounding interest more
frequently than annually has on future value and on the
effective annual rate of interest.
LG 6 Describe the procedures involved in (1) determining
deposits needed to accumulate a future sum, (2) loan
amortization, (3) finding interest or growth rates, and
(4) finding an unknown number of periods.

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5.1 The Role of Time Value in
Finance (1 of 6)
• Time Value of Money
– Refers to the observation that it is better to receive
money sooner than later
• Future Value Versus Present Value
– Suppose that a firm has an opportunity to spend
$15,000 today on some investment that will produce
$17,000 spread out over the next five years as follows:
Year Cash flow
1 $ 3,000
2 $ 5,000
3 $ 4,000
4 $ 3,000
5 $ 2,000

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5.1 The Role of Time Value in
Finance (2 of 6)
• Future Value Versus Present Value
– Is this investment a wise one?
– Timeline
 A horizontal line on which time zero appears at the
leftmost end and future periods are marked from left
to right; can be used to depict the timing of cash
flows

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5.1 The Role of Time Value in Finance
(3 of 6)
• Future Value Versus Present Value
– Suppose that a firm has an opportunity to spend $15,000
today on some investment that will produce $17,000 spread
out over the next five years as follows:

– Is this investment a wise one?

– A timeline illustrating our hypothetical investment
problem appears in Figure 5.1 on the next slide.

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Figure 5.1 Timeline

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5.1 The Role of Time Value in
Finance (4 of 6)
• Future Value Versus Present Value
– To make the correct investment decision, managers
must compare the cash flows depicted in Figure 5.1 at
a single point in time
 Typically that point is either at the end or the
beginning of the investment’s life.
– Compounding 复合
 Used to find the future value of each cash flow at
the end of an investment’s life
– Discounting 折现
 Used to find the present value of each cash flow at
time zero
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Figure 5.2 Compounding and
Discounting

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5.1 The Role of Time Value in
Finance (5 of 6)
• Computational Tools
– Financial Calculators
– Electronic Spreadsheets
– Cash Flow Signs
 To provide a correct answer, financial calculators
and electronic spreadsheets require that users
designate whether a cash flow represents an inflow
or an outflow.
 Cash inflows are indicated by entering positive
values
 Cash outflows are indicated by entering negative
values
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Figure 5.3 Financial Calculator Keys

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5.1 The Role of Time Value in Finance
(6 of 6)

• Basic Patterns of Cash Flow

– Single Amount
 A lump-sum amount either
currently held or expected at
some future date
– Annuity
 A level periodic stream of
cash flows
– Mixed Stream
 A stream of cash flows that is
not an annuity
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5.2 Single Amounts (1 of 7)
• Future Value of a Single Amount
– Future Value
 The value on some future date of money that you
invest today
– The Concept of Future Value
 Compound Interest
– Interest that is earned on a given deposit and
has become part of the principal at the end of a
specified period
 Principal
– The amount of money on which interest is paid

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Personal Finance Example 5.1 (1 of 2)
If Fred Moreno places $100 in an account paying 8% interest
compounded annually (i.e., interest is added to the $100
principal one time per year), after one year he will have $108
in the account. That’s just the initial principal of $100 plus 8%
($8) in interest. The future value at the end of the first year is
Future value at end of year 1 = $100 × (1 + 0.08) = $108

If Fred were to leave this money in the account for another

year, he would be paid interest at the rate of 8% on the new
principal of $108. After two years there would be $116.64 in
the account. This amount would represent the principal after
the first year ($108) plus 8% of the $108 ($8.64) in interest.

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Personal Finance Example 5.1 (2 of 2)
The future value after two years is
Future value after two years = $108 × (1 + 0.08)
= $116.64
Substituting the expression $100 × (1 + 0.08) from the first-
year calculation for the $108 value in the second-year
calculation gives us
Future value after two years = $100 × (1 + 0.08) × (1 + 0.08)
= $100 × (1 + 0.08)2
= $116.64

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5.2 Single Amounts (2 of 7)
• Future Value of a Single Amount
– The Equation for Future Value
 FVn = future value after n periods
 PV0 = initial principal, or present value when time =
0
 r = interest rate per period
 n = number of periods (typically years) that the
money remains invested

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Personal Finance Example 5.2
Jane Farber places $800 in a savings account paying 3%
interest compounded annually. She wants to know how
much money will be in the account after five years.
Substituting P V0 = $800, r = 0.03, and n = 5 into Equation
5.1 gives the future value after five years:
F V5 = $800 × (1 + 0.03)5 = $800 × (1.15927) = $927.42
We can depict this situation on a timeline as follows:
Timeline for future value of $800 initial principal, earning 3%,
for five years

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5.2 Single Amounts (3 of 7)
• Future Value of a Single Amount
– A Graphical View of Future Value
 Figure 5.4 illustrates how the future value of $1
depends on the interest rate and the number of
periods that money is invested
 It shows that (1) the higher the interest rate per
period, the higher the future value, and (2) the
longer the money remains invested, the higher the
future value

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5.2 Single Amounts (4 of 7)
• Future Value of a Single Amount
– Compound Interest versus Simple Interest
 Simple Interest
– Interest that is earned only on an investment’s
original principal and not on interest that
accumulates over time
 Figure 5.5, on the next slide, shows how the future
value of a $1,000 investment paying 10% interest
grows more rapidly with compound interest
compared with simple interest.

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Figure 5.5 Simple Interest vs.
Compound Interest

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5.2 Single Amounts (5 of 7)
• Present Value of a Single Amount
– The Concept of Present Value
 Present Value
– The value in today’s dollars of some future cash
flow
 Discounting Cash Flows
– The process of finding present values; the
inverse of compounding interest

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Personal Finance Example 5.4 (1 of 2)
Paul Shorter has an opportunity to receive $300 in a year.
What is the most that Paul should pay now for this
opportunity? The answer depends in part on what Paul’s
current investment opportunities are (i.e., what his
opportunity cost is). Suppose Paul can earn a 2% return on
money that he has on hand today. To determine how much
he’d be willing to pay for the right to receive $300 one year
from now, Paul can think about how much of his own money
he’d have to set aside right now to earn $300 by next year.
Letting PV0 equal this unknown amount and using the same
notation as in the future value discussion, we have
PV0 × (1 + 0.02) = $300

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Personal Finance Example 5.4 (2 of 2)
Solving for P V0 gives us

The value today (“present value”) of $300 received one year

from today, given an interest rate of 2%, is $294.12. That is,
$294.12 invested today at 2% would grow to $300 in one
year. Given his opportunity cost (or his required return) of
2%, Paul should not pay more than $294.12 for this
investment. Doing so would mean that he would earn a
return of less than 2% on this investment. That’s unwise if he
has other similar investment opportunities that pay 2%.
However, if Paul could buy this investment for less than
$294.12, he would earn a return greater than his 2%
opportunity cost.
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5.2 Single Amounts (6 of 7)
• Present Value of a Single Amount
– The Equation for Present Value
 F Vn = future value after n periods
 P V0 = initial principal, or present value when time =
0
 r = annual rate of interest
 n = number of periods (typically years) that the
money remains invested

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Personal Finance Example 5.5 (1 of 4)
Pam Valenti has an investment opportunity that will pay
$1,700 in eight years. Pam has other investment
opportunities available to her that pay 4%, so she will require
a 4% return on this opportunity. What is the investment worth
to Pam? That is, what is the present value of $1,700 that
comes in eight years if the opportunity cost is 4%?
Substituting F V8 = $1,700, n = 8, and r = 0.04 into Equation
5.2 yields

The following timeline shows this analysis.

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5.2 Single Amounts (7 of 7)
• Present Value of a Single Amount
– A Graphical View of Present Value
 Figure 5.6 illustrates how the present value of $1
depends on the discount rate per period and the
number of periods an investor must wait to receive
$1
 The figure shows that, everything else being equal,
(1) the higher the discount rate, the lower the
present value; and (2) the longer the waiting period,
the lower the present value

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Figure 5.6 Present Value Relationship

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5.3 Annuities (1 of 9)
• Types of Annuities
– Annuity
 A stream of equal periodic cash flows over a
specified time period
 These cash flows can be inflows or outflows of
funds
– Ordinary Annuity
 An annuity for which the cash flow occurs at the end
of each period
– Annuity Due
 An annuity for which the cash flow occurs at the
beginning of each period

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Personal Finance Example 5.6 (1 of 2)
Fran Abrams is evaluating two annuities. Both annuities pay
$1,000 per year, but annuity A is an ordinary annuity, while
annuity B is an annuity due. Table 5.1 shows that the two
annuities are identical except for the timing of cash flows:
The cash flows occur sooner with the annuity due than with
the ordinary annuity.

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Table 5.1 Comparison of Ordinary
Annuity and Annuity Due Cash Flows
($1,000, 5 Years)

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Personal Finance Example 5.6 (2 of 2)
Although both annuities pay $5,000, the annuity due would
have a higher future value because each of its five annual
cash flows can earn interest for one year more than each of
the ordinary annuity’s cash flows. In general, the value
(present or future) of an annuity due is always greater than
the value of an otherwise identical ordinary annuity.

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5.3 Annuities (2 of 9)

• Finding the Future Value of an Ordinary Annuity

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Personal Finance Example 5.7 (1 of 5)
Fran Abrams wishes to determine how much money she will
have after five years if she chooses annuity A, the ordinary
annuity. She will deposit the $1,000 annual payments that
the annuity provides each year into a savings account
paying 7% annual interest. This following timeline depicts the
situation.
Timeline for future value of an ordinary annuity with $1,000
end-of-year deposits, earning 7%, for five years

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Personal Finance Example 5.7 (2 of 5)
The timeline shows after five years, Fran will have $5,750.74
in her account. Note that because she makes deposits at the
end of the year, the first deposit will earn interest for four
years, the second for three years, and so on. Plugging the
relevant values into Equation 5.3, we have

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5.3 Annuities (3 of 9)

• Finding the Present Value of an Ordinary Annuity

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Example 5.8 (1 of 3)
Braden Company wants to calculate the value of a particular
ordinary annuity. The annuity consists of cash inflows of
$700 at the end of each year for five years. Braden has
access to similar investments that pay a 4% return. The
timeline below depicts this situation.
Timeline for present value of an ordinary annuity with $700
end-of-year cash flows, discounted at 4%, for five years

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Table 5.2 Long Method for Finding
the Present Value of an Ordinary
Annuity

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5.3 Annuities (4 of 9)

• Finding the Future Value of an Annuity Due

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Personal Finance Example 5.9 (1 of 4)
Recall from an earlier example, illustrated in Table 5.1, that
Fran Abrams wanted to choose between an ordinary annuity
and an annuity due, both offering similar terms except for the
timing of cash flows. We calculated the future value of the
ordinary annuity in Example 5.7, but we now want to
calculate the future value of the annuity due. The timeline on
the next slide depicts this situation. Take care to notice on
the timeline that when we use Equation 5.5 (or any of the
shortcuts that follow) we are calculating the future value of
Fran’s annuity due after five years even though the fifth and
final payment in the annuity due comes after four years
(which is equivalent to the beginning of year five).

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Personal Finance Example 5.9 (2 of 4)
Timeline for future value of Year an annuity due with $1,000
beginning-of-year deposits, earning 7%, for five years

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5.3 Annuities (5 of 9)
• Finding the Future Value of an Annuity Due
– Comparison of an Annuity Due with an Ordinary Annuity
Future Value
 The future value of an annuity due is always greater than
the future value of an otherwise identical ordinary annuity
 We can see that by comparing the future values after five
years of Fran Abram’s two annuities:
Ordinary annuity = $5,750.74 vs. Annuity due =
$6,153.29
($6,153.29 - $5,750.74) ÷ $5,750.74 = 0.07 = 7%
 Recall the interest rate in this example is 7%
– An extra year of interest on each of the annuity due’s
payments makes the annuity due 7% more valuable.
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5.3 Annuities (6 of 9)

• Finding the Present Value of an Annuity Due

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Example 5.10 (1 of 3)
In Example 5.8 involving Braden Company, we calculated a
$3,116.28 present value for Braden’s $700, five-year
ordinary annuity discounted at 4%. We now assume that
Braden’s $700 annual cash inflow occurs at the start of each
year and is thereby an annuity due. The following timeline
illustrates the new situation.
Timeline for present value of an ordinary annuity with $700
end-of-year cash flows, discounted at 4%, over five years

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5.3 Annuities (7 of 9)
• Finding the Present Value of an Annuity Due
– Comparison of an Annuity Due with an Ordinary Annuity
Present Value
 The present value of an annuity due is always greater
than the present value of an otherwise identical ordinary
annuity
 We can verify this statement by comparing the present
values of Braden Company’s two annuities:
Ordinary annuity = $3,116.28 vs. Annuity due =
$3,240.93
($3,240.93 - $3,116.28) ÷ $3,116.28 = 0.04 = 4%
– Remember that 4% is the discount rate that Braden
uses
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5.3 Annuities (8 of 9)
• Finding the Present Value of a Perpetuity
– Perpetuity
 An annuity with an infinite life, providing continual
periodic cash flow

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Personal Finance Example 5.11 (1 of 2)
Ross Clark wishes to endow a chair in finance at his alma
mater. He will make a lump sum donation today that will
provide an annual cash flow stream to the university forever.
The university indicated that the annual cash flow required to
support an endowed chair is $400,000 and that it will invest
money Ross donates in assets earning a 5% return. If Ross
wants to give money today so that cash flow to the university
starts in a year, how large must his contribution be? The
answer is just the present value of a $400,000 perpetuity
discounted at 5%.

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Personal Finance Example 5.11 (2 of 2)
Using Equation 5.7, we can determine that this present value
is $8 million.
PV0 = $400,000 ÷ 0.05 = $8,000,000
To generate $400,000 every year forever requires
$8,000,000 today if Ross Clark’s alma mater can earn 5% on
its investments. If the university earns 5% interest annually
on the $8,000,000, it can withdraw $400,000 per year
without ever touching the original $8,000,000.

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5.3 Annuities (9 of 9)
• Finding the Present Value of a Perpetuity
– Growing Perpetuity
 An annuity with an infinite life, providing continual
annual cash flow, with the cash flow growing at a
constant annual rate

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Personal Finance Example 5.12
Suppose Ross Clark learns that the university requires the
endowment to provide a $400,000 cash flow next year, but
subsequent annual cash flows must grow by 2% per year to
keep up with inflation. How much does Ross need to donate
today to cover this requirement? Plugging the relevant
values into Equation 5.8, we have:

Compared to the level perpetuity providing $400,000 per

year, the growing perpetuity requires Ross to make a much
larger initial donation, $13.3 million versus $8 million.

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5.4 Mixed Streams (1 of 2)
• Mixed Stream
– A stream of unequal periodic cash flows that reflect no
particular pattern
• Future Value of a Mixed Stream
– To determine the future value of a mixed stream of
cash flows, compute the future value of each cash flow
at the specified future date and then add all the
individual future values to find the total future value

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5.4 Mixed Streams (2 of 2)
• Present Value of a Mixed Stream
– To determine the present value of a mixed stream of
cash flows, compute the present value of each cash
flow and then add all the individual present values
together to find the total present value

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Example 5.14 (1 of 4)
Frey Company, a shoe manufacturer, has the opportunity to
receive the following mixed stream of cash flows over the next five
years.

Time Cash flow

0 $ 0
1 400
2 800
3 500
4 400
5 300

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Example 5.14 (2 of 4)
If the firm discounts cash flows at 9%, the following timeline
shows that the cash flow stream is worth $1,904.76 today.

Timeline for present value of a mixed stream of end-of-year

cash flows, discounted at 9% to time 0

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5.5 Compounding Interest More
Frequently Than Annually (1 of 7)
• Semiannual Compounding
– Compounding of interest over two periods within the
year
– The investment pays half its annual stated interest rate
every six months, rather than making one payment at
the end of the year.

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Personal Finance Example 5.15
Fred Moreno has decided to invest $100 in a savings
account paying 8% annual interest compounded
semiannually. If he leaves his money in the account for 24
months, he will receive 4% interest compounded over four
periods, each of which is six months long. Table 5.3 shows
that after 12 months with 8% semiannual compounding, Fred
will have $108.16; after 24 months, he will have $116.99.

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Table 5.3 Future Value from Investing
$100 at 8% Interest Compounded
Semiannually over 24 Months (2
Years)
Beginning Future value Future value at end
Period principal calculation of period
6 months $100.00 $100.00 × (1 + 0.04) = $104.00

12 months 104.00 $104.00 × (1 + 0.04) = $108.16

18 months 108.16 $108.16 × (1 + 0.04) = $112.49

24 months 112.49 $112.49 × (1 + 0.04) = $116.99

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5.5 Compounding Interest More
Frequently Than Annually (2 of 7)
• Quarterly Compounding
– Compounding of interest over four periods within the
year
– One-fourth of the stated interest rate is paid four times
a year

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Personal Finance Example 5.16 (1 of 2)
Fred Moreno has found an institution that will pay him 8%
annual interest compounded quarterly. If he leaves his
money in this account for 24 months, he will receive 2%
interest compounded over eight periods, each of which is
three months long. Table 5.4 shows the amount Fred will
have at the end of each period. After 12 months, with 8%
quarterly compounding, Fred will have $108.24; after 24
months, he will have $117.17.

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Table 5.4 Future Value from Investing
$100 at 8% Interest Compounded
Quarterly over 24 Months (2 Years)

Period Beginning principal Future value calculation Future value at end of period
3 months $100.00 $100.00 × (1 + 0.02) = $102.00
6 months 102.00 $102.00 × (1 + 0.02) = $104.04
9 months 104.04 $104.04 × (1 + 0.02) = $106.12
12 months 106.12 $106.12 × (1 + 0.02) = $108.24
15 months 108.24 $108.24 × (1 + 0.02) = $110.41
18 months 110.41 $110.41 × (1 + 0.02) = $112.62
21 months 112.62 $112.62 × (1 + 0.02) = $114.87
24 months 114.87 $114.87 × (1 + 0.02) = $117.17

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Personal Finance Example 5.16 (2 of 2)
Table 5.5 compares values for Fred Moreno’s $100 at the
end of years 1 and 2, given annual, semiannual, and
quarterly compounding frequency at the 8% annual rate. The
table shows that the more frequently interest compounds,
the greater the amount of money that accumulates. This
statement is true for any interest rate above zero for any
time horizon.

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Table 5.5 Future Value at the End of
Years 1 and 2 from Investing $100 at
8% Interest, Given Various
Compounding Periods

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5.5 Compounding Interest More
Frequently Than Annually (3 of 7)
• A General Equation for Compounding

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Personal Finance Example 5.17 (1 of 2)
The preceding examples calculated the amount that Fred
Moreno would have after two years if he deposited $100 at
8% interest compounded semiannually or quarterly. For
semiannual compounding, m would equal 2 in Equation 5.9;
for quarterly compounding, m would equal 4. Substituting the
appropriate values for semiannual and quarterly
compounding into Equation 5.9, we find that
1. For semiannual compounding:

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Personal Finance Example 5.17 (2 of 2)
2. For quarterly compounding:

These results agree with the values after two years in Table
5.5. If the interest were compounded monthly, weekly, or
daily, m would equal 12, 52, or 365, respectively.

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5.5 Compounding Interest More
Frequently Than Annually (4 of 7)
• Using Computational Tools for Compounding
– We can simplify the computation process by using a
calculator or spreadsheet program

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5.5 Compounding Interest More
Frequently Than Annually (5 of 7)
• Continuous Compounding
– Compounding of interest, literally, all the time
– Equivalent to compounding interest an infinite number
of times per year

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Personal Finance Example 5.19 (1 of 4)
To find the value after two years (n = 2) of Fred Moreno’s
$100 deposit (P V0 = $100) in an account paying 8% annual
interest (r = 0.08) compounded continuously, we can
substitute into Equation 5.10:

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Personal Finance Example 5.19 (4 of 4)
As expected, Fred’s deposit grows more with continuous
compounding than it does with semiannual ($116.99) or
quarterly ($117.17) compounding. In fact, continuous
compounding produces a greater future value than any other
compounding frequency.

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5.5 Compounding Interest More
Frequently Than Annually (6 of 7)
• Nominal and Effective Annual Rates of Interest
– Nominal (Stated) Annual Rate
 Contractual annual rate of interest charged by a
lender or promised by a borrower
– Effective (True) Annual Rate (EAR)
 The annual rate of interest actually paid or earned

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Personal Finance Example 5.20 (1 of 7)
Fred Moreno wishes to find the effective annual rate
associated with an 8% nominal annual rate (r = 0.08) when
interest is compounded (1) annually (m = 1), (2) semiannually
(m = 2), and (3) quarterly (m = 4). Substituting these values
into Equation 5.11, we get
1. For annual compounding:

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Personal Finance Example 5.20 (2 of 7)
2. For semiannual compounding:

3. For quarterly compounding:

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Personal Finance Example 5.20 (7 of 7)
These examples demonstrate two important points. First, the
nominal rate equals the effective rate if compounding occurs
annually. Second, the effective annual rate increases with
increasing compounding frequency, up to a limit that occurs
with continuous compounding.

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5.5 Compounding Interest More
Frequently Than Annually (7 of 7)
• Nominal and Effective Annual Rates of Interest
– Annual Percentage Rate (AP R)
 The nominal annual rate of interest, found by
multiplying the periodic rate by the number of
periods in one year, that must be disclosed to
consumers on credit cards and loans as a result of
“truth-in-lending laws.”
– Annual Percentage Yield (AP Y)
 The effective annual rate of interest that must be
disclosed to consumers by banks on their savings
products as a result of “truth-in-savings laws.”

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5.6 Special Applications of Time
Value (1 of 4)
• Determining Deposits Needed to Accumulate a Future
Sum

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5.6 Special Applications of Time
Value (2 of 4)
• Loan Amortization
– The determination of the equal periodic loan payments
necessary to provide a lender with a specified interest
return and to repay the loan principal over a specified
period
– Loan Amortization Schedule
 A schedule of equal payments to repay a loan
 It shows the allocation of each loan payment to
interest and principal

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Personal Finance Example 5.22 (1 of 6)
Alex May borrows $6,000 from a bank. The bank requires Alex
to repay the loan fully in four years by making four equal end-
of-year payments. The interest rate on the loan is 10%. What
is Alex’s loan payment? Plugging the appropriate values into
Equation 5.13, we have

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5.6 Special Applications of Time
Value (3 of 4)
• Finding Interest or Growth Rates

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Personal Finance Example 5.23 (1 of 5)
Consumers across the United States are familiar with Ulta
Beauty stores, which offer salon services and a variety of
beauty products. Most shoppers at Ulta Beauty probably do
not know that the company’s stock was one of the best-
performing stocks of the last decade. An investor who
purchased a $19 share of Ulta Beauty stock in January 2010
saw the firm’s stock price grow to $254 by January 2020.
What compound annual growth rate does that increase
represent? Or, equivalently, what average annual rate of
interest did shareholders earn over that period?

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Personal Finance Example 5.23 (2 of 5)
Let the initial $19 price represent the stock’s present value in
2010, and let $254 represent the stock’s future value 10
years later. Plugging the appropriate values into Equation
5.13, we find that Ulta Beauty stock increased almost 29.6%
per year over this decade.

r = ($254 ÷ $19)1/10 – 1 = 0.296 = 29.6%

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5.6 Special Applications of Time
Value (4 of 4)
• Finding an Unknown Number of Periods

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Personal Finance Example 5.25 (1 of 3)
Ann Bates wishes to determine how long it will take for her
initial $1,000 deposit, earning 8% annual interest, to grow to
$2,500. Applying Equation 5.15, at an 8% annual rate of
interest, how many years, n, will it take for Ann’s $1,000, P
V0, to grow to $2,500, F Vn?

Ann will have to wait almost 12 years to reach her savings

goal of $2,500.

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Review of Learning Goals (1 of 8)
• LG 1
– Discuss the role of time value in finance, the use of
computational tools, and the basic patterns of cash flow.
 Financial managers and investors use time-value-of-
money techniques when assessing the value of expected
cash flow streams
 Alternatives can be assessed by either compounding to
find future value or discounting to find present value
 Financial managers rely primarily on present-value
techniques
 Financial calculators and electronic spreadsheets
streamline the time-value calculations
 Cash flow patterns are of three types: a single amount or
lump sum, an annuity, or a mixed stream
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Review of Learning Goals (2 of 8)
• LG 2
– Understand the concepts of future value and present value,
their calculation for single amounts, and the relationship
between them.
 Future value (F V) relies on compound interest to
translate current dollars into future dollars
 The initial principal or deposit in one period, along with
the interest earned on it, becomes the beginning
principal of the following period
 The present value (P V) of a future amount is the amount
of money today that is equivalent to the given future
amount, considering the return that can be earned
 Present value is the inverse of future value

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Review of Learning Goals (3 of 8)
• LG 3
– Find the future value and the present value of both an
ordinary annuity and an annuity due, and find the
present value of a perpetuity.
 An annuity is a pattern of equal periodic cash flows
 For an ordinary annuity, the cash flows occur at the
end of the period
 For an annuity due, cash flows occur at the
beginning of the period
 The future or present value of an ordinary annuity
can be found by using algebraic equations, a
financial calculator, or a spreadsheet program

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Review of Learning Goals (4 of 8)
• LG 3 (Cont.)
– Find the future value and the present value of both an
ordinary annuity and an annuity due, and find the
present value of a perpetuity.
 The value of an annuity due is always r% greater
than the value of an identical annuity
 The present value of a perpetuity—an infinite-lived
annuity—equals the annual cash payment divided
by the discount rate
 The present value of a growing perpetuity equals
the initial cash payment divided by the difference
between the discount rate and the growth rate

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Review of Learning Goals (5 of 8)
• LG 4
– Calculate both the future value and the present value
of a mixed stream of cash flows.
 A mixed stream consists of unequal periodic cash
flows that reflect no particular pattern
 The future value of a mixed stream is the sum of the
future values of the individual cash flows
 Similarly, the present value of a mixed stream is the
sum of the present values of the individual cash
flows

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Review of Learning Goals (6 of 8)
• LG 5
– Understand the effect that compounding interest more
frequently than annually has on future value and on the
effective annual rate of interest.
 Interest can compound at intervals ranging from
annually to daily and even continuously
 The more often interest compounds, the larger the
future amount that will be accumulated, and the
higher the effective, or true, annual rate (EA R)
 The annual percentage rate (A P R)—a nominal
annual rate—is quoted on credit cards and loans
 The annual percentage yield (AP Y)—an effective
annual rate—is quoted on savings products
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Review of Learning Goals (7 of 8)
• LG 6
– Describe the procedures involved in (1) determining
deposits needed to accumulate a future sum, (2) loan
amortization, (3) finding interest or growth rates, and
(4) finding an unknown number of periods.
 (1) The periodic deposit to accumulate a given
future sum can be found by solving the equation for
the future value of an annuity for the annual
payment
 (2) A loan can be amortized into equal periodic
payments by solving the equation for the present
value of an annuity for the periodic payment

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Review of Learning Goals (8 of 8)
• LG 6 (Cont.)
– Describe the procedures involved in (1) determining
deposits needed to accumulate a future sum, (2) loan
amortization, (3) finding interest or growth rates, and
(4) finding an unknown number of periods.
 (3) Interest or growth rates can be estimated by
finding the unknown interest rate in the equation for
the present value of a single amount or an annuity
 (4) The number of periods can be estimated by
finding the unknown number of periods in the
equation for the present value of a single amount or
an annuity

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