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Chapter - Time value of money - single cash flow

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ENGINEERING ECONOMY
Seventeenth Edition, Global Edition
Chapter 4
The Time Value
of Money
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2
Topic
Time value of Single CF
Modified for Lecture of Engineering Economics
By Dr. Nguyen Thu Hien
Modified from slides by Ross, Westerfield, Jordan,
“Fundamentals of Corporate Finance”, 7th ed., McGraw-Hill Irwin
Time value of money
OR Money value over a timeline
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4
Future Values
• Suppose you invest $1000 for one year at 10% per
year. What is the future value in one year?
– Interest = 1000(.10) = 100
– Value in one year = principal + interest = 1000 + 100 = 1100
– Future Value (FV) = 1000(1 + .10) = 1100
• Suppose you leave the money in for another year.
How much will you have two years from now?
– FV = 1000(1.10)(1.10) = 1000(1.10)2 = 1210
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Figure 4-1: Illustration of Simple versus
Compound Interest
i = 10% p.a.
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Effects of Compounding
• Simple interest method
• Compound interest method
• Consider the previous example
– FV with simple interest = 1000 + 100 + 100 = 1200
– FV with compound interest = 1000 + 100 + 110 = 1210
– The extra $10 comes from the interest of .10(100) = 10 earned on the first
interest payment
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Present Values – Example 2
• You want to begin saving for your daughter’s college education and you estimate that
she will need $150,000 in 17 years. If you feel confident that you can earn 8% per
year, how much do you need to invest today?
– PV = 150,000 / (1.08)17 = 40,540.34
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Present Value –
No. of periods and PV Relationship
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•For a given interest rate – the longer the time
period, the lower the present value
–What is the present value of $500 to be
received in 5 years? 10 years? The discount
rate is 10%
–5 years: PV = 500 / (1.1)5 = 310.46
–10 years: PV = 500 / (1.1)10 = 192.77
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Present Value –
Interest and PV Relationship
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•For a given time period – the higher the interest
rate, the smaller the present value
–What is the present value of $500 received in
5 years if the interest rate is 10%? 15%?
▪Rate = 10%: PV = 500 / (1.1)5 = 310.46
▪Rate = 15%; PV = 500 / (1.15)5 = 248.59
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The Basic PV Equation - Refresher
• PV = FV / (1 + r)t
▪The formula can also be written as: P = F(P/F,r%,t)
• There are four parts to this equation
–PV, FV, r and t
–If we know any three, we can solve for the fourth
• If you are using a financial calculator, be sure and
remember the sign convention or you will receive an error
(or a nonsense answer) when solving for r or t
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Table 4-2: Discrete Cash-Flow Examples
Illustrating Equivalence (1 of 2)
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Quick Quiz – Part III
• What are some situations in which you might want to
know the implied interest rate?
• You are offered the following investments:
–You can invest $500 today and receive $600 in 5
years. The investment is high risk.
–You can invest the $500 in a bank account paying
4%.
–What is the implied interest rate for the first choice
and which investment should you choose?
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