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Chapter 5

FIN 300 - Chapter 5 Notes

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FIN 300
Mike Inglis

FIN 300 – Chapter 5: Introduction to Valuation: The Time Value of Money Introduction  The time value of money refers to the fact that a dollar in hand today is worth more than a dollar promised at some time in the future. o One reason is that you can earn interest while you wait. 5.1 Future Value and Compounding  Future Value – The amount an investment is worth after one or more periods. Also compound value. o The amount of money an investment would grow over some length of time at some given interest rate. Investing in a Single Period  If you invest for one period at an interest rate, r, your investment grows to (1 + r) per dollar invested. Investing for More than One Period  Compounding – The process of accumulating interest in an investment over time to earn more interest. o Leaving your money and any accumulated interest in an investment for more than one period, thereby reinvesting the interest is compounding.  Interest on Interest – Interest earned on the reinvestment of previous interest payments.  Compound Interest – Interest earned on both the initial principal and the interest reinvested from prior periods.  Simple Interest – Interest earned only on the original principal amount invested.  The future value of $1 invested for t periods at a rate or r per period is: o Future Value = $1 + (1 + r) t  (1+r) is called the future value of interest factor (or future value factor) 5.2 Present Value and Discounting  Future value determines how much money you will make on an investment in the future, but present value finds out how much money you need to invest to make a specific amount of money in the future. The Sing
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