ACCOUNTG 221 Lecture Notes - Lecture 13: Interest, Interest Rate, Cash Flow

39 views4 pages

goldprairie-dog879

13 Jan 2017

School

Department

Course

Professor

For unlimited access to Class Notes, a Class+ subscription is required.

Document Summary

Future value and present value application are based on the simple truth: is worth more now than in the future. ?- you can invest now and earn interest as time passes. I=p*r*t (interest=principle*rate*time: example: given the following data. Option a: you can have ,000,000 paid out to you at k for 20 years. Option b: you can ,000 today: which option (use 6% as your interest, or discount rate, future annuity table and you get 11. 54, take 11. 54*50,000=,500. Larger because adding interest: use future value of table, 2. 16*30,000=64,800. Future or present value (given at least one) If it should be more factor is greater than one. If it should be less factor is less than one. If trying to find deposit or withdrawal you have to divide by the table that relates to it. Examples: sarah want to deposit her high school graduation money of ,000.

Related Questions

Just yesterday I posted a key question as to why the statelottery might hypothetically offer you an upfront lump-sum paymentof $50 million or an ongoing annuity of a $5 million check eachyear for 20 years (totaling $100 million in checks). Remember thatthis was just my simplified hypothetical example. A few peopleattempted the answer to this further above, but here's what'sreally going on...it has to do with Net Present Value (NPV). It'sbecause future-year dollars are worth less, and the further you gointo the future, the less those dollars are worth in terms oftoday's dollars. And that is why, when financial analysts look at adecision involving multi-year cash flows, they will use discountfactors to convert all of the future-year dollars to present value(i.e., this year's dollars) and add them up to yield the NPV of allof the amounts to put a final answer in terms of today's value.Where do these discount factors come from? They're derived from thereciprocal of the famous compound interest formula, but you justneed to go and look at two tables in your textbook in Chapter 12,Appendix 12A, Table A (present value of $1 due in n periods) andTable B (present value of an annuity of $1 per period). Class, Icannot stress to you enough how widely-used this concept is, andthe importance of understanding how these discount factors areapplied to solve for net present value (NPV) and a related metric,internal rate of return (IRR). You will likely need to read, andreread, Chapter 12 and closely walk through some textbook exampleswhere each year's cash flows are multiplied by the appropriatediscount factor to convert all of that money into this year'sdollars (present value). We are surrounded by this financialanalysis methodology when faced with a decision on a lotterypayout, a retirement payout (lump sum versus annuity), and many ofour states and cities right now are dealing with issues relating tothe calculation of NPV in assessing whether they currently haveenough money in the appropriate accounts to meet the futureretirement payment obligations they've made to their publicemployees. This is an economic issue that has been on the brink ofexploding for a long time (don't take my word for it, it's beendiscussed in multiple articles in the NY Times, Wall StreetJournal, The Economist), but I'm not going to add all of that intothis discussion here. Let's learn to walk before we try to run.Would you like to see how the lottery payouts I described would bemultiplied by each year's financial discount factor? Just take alook at my attached Excel workbook, and note that there are threetabs: the first assumed a 0% cost of capital (no financialdiscounting done), the second assumed a 5% cost of capital, and thethird sheet inserted a 10% cost of capital. You'll see how thesedifferent interest rates changed the discount factor multipliersand ultimately changed the NPV of each alternative (the value ofthe lump sum or the annuity, all shown in present value). Also,this example just shows money moving one way (i.e., to the state,it's cash out of their pocket...to the lottery winner, it's cashinto their pocket). In many NPV and IRR examples, money will moveboth ways over multiple years...cash flows that are expenses orinvestments are outflows and are shown as negative, while revenuesor other incoming money are inflows and are shown as positive.Please look closely at my attached Excel workbook (all three tabs)and also walk through all of the examples in the chapter showinghow to do NPV and IRR problems. There are also examples in the textof simpler metrics including payback period and accounting rate ofreturn. It's typically very hard stuff for students to master. Now,for those of you who've looked at the chapter examples, maybeyou've figured this out already:

1. What is the key difference between Tables A and B in Chapter12, Appendix 12A, and how and when are each of them used in ananalysis?

2. What do we mean by âYear 0â in a financial analysis? Whatvalue do we use for the discount factor or multiplier for the cashflow in Year 0 of a financial analysis?

1. An increase in the discount rate:

A) will increase the present value of future cash flows.

B) will have no effect on net present value.

C) will reduce the present value of future cash flows.

D) is one method of compensating for reduced risk.

2. Suddeth Corporation has entered into a 6 year lease for a building it will use as a warehouse. The annual payment under the lease will be $2,468. The first payment will be at the end of the current year and all subsequent payments will be made at year-ends. If the discount rate is 5%, the present value of the lease payments is closest to (Ignore income taxes.):

See separate handout to determine the appropriate discount factor(s) using table.

A) $12,528

B) $14,103

C) $14,808

D) $11,050

3. At an interest rate of 14%, approximately how much would you need to invest today if you wanted to have $2,000,000 in 10 years? (Ignore income taxes.)

See separate handout to determine the appropriate discount factor(s) using table.

A) $383,436

B) $540,000

C) $740,741

D) $1,043,200

4. A company wants to have $20,000 at the end of a ten-year period by investing a single sum now. How much needs to be invested in order to have the desired sum in ten years, if the money can be invested at 12%? (Ignore income taxes.)

See separate handout to determine the appropriate discount factor(s) using table.5

A) $3,254.68

B) $3,539.82

C) $6,440

D) $7,720

5. Amster Corporation has not yet decided on the required rate of return to use in its capital budgeting. This lack of information will prevent Amster from calculating a project's:

Payback

Net Present Value

Internal Rate of Return

Yes

THIS IS THE handout to determine the appropriate discount factor(s) using table.5

Time Value of Money Factor for the Present Value of a Sum
PV =FV * TVM Factor					Present Value of a Sum = FV * 1/ (1 + i) ⁿ
	2%	3%	4%	5%	6%	8%	10%	12%
1	0.9804	0.9709	0.9615	0.9524	0.9434	0.9259	0.9091	0.8929
2	0.9612	0.9426	0.9246	0.9070	0.8900	0.8573	0.8264	0.7972
3	0.9423	0.9151	0.8890	0.8638	0.8396	0.7938	0.7513	0.7118
4	0.9238	0.8885	0.8548	0.8227	0.7921	0.7350	0.6830	0.6355
5	0.9057	0.8626	0.8219	0.7835	0.7473	0.6806	0.6209	0.5674
6	0.8880	0.8375	0.7903	0.7462	0.7050	0.6302	0.5645	0.5066
7	0.8706	0.8131	0.7599	0.7107	0.6651	0.5835	0.5132	0.4523
8	0.8535	0.7894	0.7307	0.6768	0.6274	0.5403	0.4665	0.4039
9	0.8368	0.7664	0.7026	0.6446	0.5919	0.5002	0.4241	0.3606
10	0.8203	0.7441	0.6756	0.6139	0.5584	0.4632	0.3855	0.3220
20	0.6730	0.5537	0.4564	0.3769	0.3118	0.2145	0.1486	0.1037
25	0.6095	0.4776	0.3751	0.2953	0.2330	0.1460	0.0923	0.0588
Time Value of Money Factor for the Present Value of an Annuity
PV = Annuity * TVM Factor						Present Value of an Annuity = X*((1-(1/(1+i)^n))/i)
	2%	3%	4%	5%	6%	8%	10%	12%
1	0.9804	0.9709	0.9615	0.9524	0.9434	0.9259	0.9091	0.8929
2	1.9416	1.9135	1.8861	1.8594	1.8334	1.7833	1.7355	1.6901
3	2.8839	2.8286	2.7751	2.7232	2.6730	2.5771	2.4869	2.4018
4	3.8077	3.7171	3.6299	3.5460	3.4651	3.3121	3.1699	3.0373
5	4.7135	4.5797	4.4518	4.3295	4.2124	3.9927	3.7908	3.6048
6	5.6014	5.4172	5.2421	5.0757	4.9173	4.6229	4.3553	4.1114
7	6.4720	6.2303	6.0021	5.7864	5.5824	5.2064	4.8684	4.5638
8	7.3255	7.0197	6.7327	6.4632	6.2098	5.7466	5.3349	4.9676
9	8.1622	7.7861	7.4353	7.1078	6.8017	6.2469	5.7590	5.3282
10	8.9826	8.5302	8.1109	7.7217	7.3601	6.7101	6.1446	5.6502
20	16.3514	14.8775	13.5903	12.4622	11.4699	9.8181	8.5136	7.4694
25	19.5235	17.4131	15.6221	14.0939	12.7834	10.6748	9.0770	7.8431

ACCOUNTG 221 Lecture Notes - Lecture 13: Interest, Interest Rate, Cash Flow

Document Summary

Get access

Related Documents

ECON 2560 Study Guide - Midterm Guide: Dividend Tax, The Globe And Mail, Dividend Discount Model

ECON 2560 Study Guide - Final Guide: Dbrs, Dividend Discount Model, Interest Rate Risk

ECON 2560 Lecture Notes - Lecture 1: Cash Flow, Preferred Stock, Credit Risk

Related Questions