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Lecture 2

MGT 181 Lecture Notes - Lecture 2: Cash Flow, Interest, Compound Interest

Rady School of Management
Course Code
MGT 181
L Jean Dunn

of 2
October 6th, 2015
Present Value: The value of a given stream of future cash flows.
Future Value: The value in the future of cash flow invested today.
Interest Rate: The rate of return required by an investor for a given time period and level of risk.
If there is a higher risk, the investors will require a higher rate. Similarly, if the investment is
longer term, the investors will require a higher rate of return.
Future value: Suppose you invest $1000 for 1 year at 5%. What is the amount of your return?
N=1, I/Y=5, PV=-1000 cpt FV
Simple interest: Periodical interest on the principal amount. The interest earned from previous
year is not included in the principal amount.
Compound interest: Includes interest earned on interest earned prior years.
Calculating present value is the same as discounting. The discount rate, interest rate and
required rate of return are the same thing.
Annuity: A finite series of equal payments that occur at regular intervals.
If the first payment occurs at the end of the period, it is called an ordinary annuity.
If the first payment occurs at the beginning of the period, it is called an annuity due.
Perpetual annuity: an infinite series of equal payments that occur at regular intervals.
The PMT key on the calculator is used for equal payments.
Effective Annual Rate: The actual rate paid or received after accounting for compounding during
the year.
If you want to compare rates with different compounding periods you need to compute the
effective annual rate and use that for comparison.
Annual percentage rate: The annual rate quoted by law and is equal to the period rate times the
number of periods per year.
If the monthly rate is .5% then 6% is the annual rate (APR).
Suppose you can earn 1% per month on $1 invested today.
What is the effective rate?
rate=(1.1268-1)*100 = 12.68%
Discount Loans are loans that pay no interest and are sold at a discount (including Treasury bills
and islamic finance).
Interest Only Loan: A loan that requires the payment of interest only and does not require any
payment of the principal over its term.
Fixed Payment loan: A loan where the payment is fixed over the term of the loan. Usually has
both interest and principal components.