| | In the field of finance, the change of value in cash flows is key to understand. This change in value is the product of 5 major factors. (Sorry, it is not a reference to Porter's Five Forces.) |
| | | -- | The value something is worth/valued today. | | | | | | | Present Value |
| | | -- | The expected or guaranteed value at a future point. | | | | | | | Future Value |
| | | -- | The explicit or implicit interest rate that affects the change in value. | | | | | | | Interest Rate |
| | | -- | The "consistent" inflow or outflow of cash from or to an investment. | | | | | | | Payment |
| | | -- | The length of time an investment is made. | | | | | | | Time |
| | In general, there are two categories in which an investment scenario exists: |
| | | 1) Lump Sum - an investment in which no installment plan or consistent payment exists. |
| | | 2) Annuity - an investment in which a consistent cash flow helps or hinders its value. |
| | Let's begin with Lump Sum. |
| | | Commonly used today in Certificate of Deposits (CDs), an investment is made today in which nothing is required on your part. Time and rates create the ripple effect to value. |
| | | | Determining value moving forward ---> | | | | Compounding |
| | | | Determining value moving backward ---> | | | | Discounting |
| | EXAMPLE |
| | | If a bank advertised a guarantee of $1,762.34 in a 5-yr CD yielding 12% interest annually, what is your required deposit today? |
| | | INPUTS |
| | | | | | | | | | <----- | Enter a non-numeric symbol (e.g. ?, !, #) on the value needing to determine. |
| | | | | | | | | | <----- | 5 denotes as the number of periods of time. (In this example, periods are denoted as years.) |
| | | | | | | | | | <----- | 12% represents the rate provided in each period of time. (In this example, periods are denoted as years.) |
| | | | | | | | | | <----- | $0 represents a lump sum scenario in which the user is not making/receiving payments. |
| | | | | | | | | | <----- | $1,762.34 represents the value at a future point in time. |
| | | ANSWER |
| | | | | | | | | | IMPORTANT TO NOTICE: |
| | | | | | | | | | * | The negative value correctly corresponds to the requirement of cash flow required for you to "pay". |
| | What if the terms of an investment is compounded more often? Such as semiannually, quarterly, monthly, weekly, or even daily? |
| | Naturally, since we know we could potentially earn more if interest is accrued more often, this is how credit cards are notorious in charging you money. |
| | | (FYI - Credit cards charge unpaid balances based on a daily interest rate!) |
| | EXAMPLE |
| | | You find a new or used car you want to purchase. If your bank is able to service your $22,000 auto loan without a down payment, |
| | | what is your expected monthly payment if 4.8% and 5 years are the terms? |
| | | Whoa… there are multiple "time languages" mentioned. (Monthly, years) What do I do? |
| | | To accurately account for the monthly compounding of the loan (and your payments), you must adjust your inner variables for the smallest language. |
| | | INPUTS |
| | | | | | | | | | <---- | Beginning balance of the auto loan "given" to you by the bank. (Hence why this is positive.) |
| | | | | | | | | | | All converted to monthly figures. 5 years = 60 months. 4.8% a year = 0.40% per month. |
| | | | | | | | | | | | When done correctly, your answer will be stated in the correct "monthly" figure. |
| | | | | | | | | | <---- | Though an ending balance is not mentioned, the assumption is to pay your loans off. |
| | | ANSWER |
nirmak
TimeValueofMoneyLectureCalc-6.xlsx
