6.1 Time Value of Money
6.1 Time Value of Money
6.1 Time Value of Money
Week 6
Solve problem
• 4-16
• 4-17
• 4-18
Perpetuities
• Annuities whose payments continue for a specific number of periods
—for example, $100 per year for 10 years.
• Some securities promise to make payments forever like British govt
bonds named “consols”.
• Any bond that promises to pay interest perpetually is called a consol,
or a perpetuity.
• E.g. The interest rate on the consols was 3.5%, so a consol with a face
value of $1,000 would pay $35 per year in perpetuity.
UNEVEN, OR IRREGULAR, CASH
FLOWS
• E.g. the dividends on common stocks are typically expected to
increase over time, and investments in capital equipment almost
always generate cash flows that vary from year to year
• There are two important classes of uneven cash flows:
(1) those in which the cashflow stream consists of a series of annuity
payments plus an additional final lump sum in Year N, and
(2) All other uneven streams.
Annuity Plus Additional Final Payment
• Stream 1 that it is a 5-year, 12%, ordinary annuity plus a final payment
of $1,000. We can find the PV of the annuity,
Stream 1:
• PV= CF / (1+i)n
• Pv1 = 100 / (1+0.12)1 = 89.29
• PV2 = 300/ (1+0.12)2 =239.1629
• Pv3= 300/(1+0.12)3 =213.53
• PV4 = 300/ (1+0.12)4 = 190.66
• PV5= 500 /(1+0.12)5 =283.71
Now , sum-up each of the PVs of CF stream (1016.35)
Practice question uneven stream
• What is the present value of the following uneven cash flow stream:
$0 at Time 0, $100 at the end of Year 1 (or at Time 1), $200 at the end
of Year 2, $0 at the end of Year 3, and $400 at the end of Year 4—
assuming the interest rate is 8%?
Irregular Cash Flow Stream: Financial
calculator
= PMT(0.06,5,100000,0) = −$23,739.64
• Each payment of PMT will consist of two parts—part interest and part
repayment of principal. This breakdown is shown in the amortization
schedule
Practice question
• A company borrows $100,000, with the loan to be repaid. The lender
charges 6% on the balance at the beginning of each year. If the loan
were amortized over 5 years with 60 equal monthly payments, how
much would each payment be, and how would the first payment be
divided between interest and principal?
Problem 4-20: part a & b
a. Set up an amortization schedule for a $25,000 loan to be repaid in
equal installments at the end of each of the next 5 years. The interest
rate is 10%.
b. How large must each annual payment be if the loan is for $50,000?
Assume that the interest rate remains at 10% and that the loan is still
paid off over 5 years.
Problem 4-20: part a
• With a financial calculator, enter N = 5, I/YR = 10, PV = -25000, and FV
= 0, and then press the PMT key to get PMT = $6,594.94
4-20: Part b
• Here the loan size is doubled, so the payments also double in size to
$13,189.87:
• enter N = 5, I/YR = 10, PV = -50000, and FV = 0, and then press the
PMT key to get PMT = $13,189.87.
4-30: part 1
• Your company is planning to borrow $1 million on a 5-year, 15%,
annual payment, fully amortized term loan. What fraction of the
payment made at the end of the second year will represent
repayment of principal?
• First, find PMT by using a financial calculator: N = 5, I/YR = 15, PV = -
1000000, and FV = 0. Solve for PMT = $298,315.55.
Home practice
• 4-14: uneven cash flows (PV)
• 4-15 : calculate Interest rate using financial calculator
• 4-25 calculate N using financial calculator