Module 24 Time Value of Money Time Value

Module 24 Time Value of Money

Time Value of Money • Having a dollar today is worth more than having a dollar tomorrow • Why? Opportunity cost & inflation • This is the reason for charging & paying interest

Time Value of Money • • • FV = future value of $ PV = present value of $ r = real interest rate (nominal rate – inflation rate) in decimal form n = years k = number of times interest is charged per year • Simple Interest Formula: FV = PV * ( 1 + r )n • “Compound” Interest Formula: FV = PV * ( 1 + r/k )nk

Practice Question 1 • Inflation is expected to be 3% & the nominal interest rate on simple interest savings is 1% • Calculate the future value of $1 after 1 year

Practice Question 1 • Inflation is expected to be 3% & the nominal interest rate on simple interest savings is 1% • Calculate the future value of $1 after 1 year • Step 1: Calculate the real interest rate r% = i% - p% r% = 1% - 3% = -2% = -0. 02 • Step 2: Calculate the future value FV = PV * (1 + r/k )nk FV = 1 * [1 + (-. 02/1)]1*1 FV = 1 *0. 98 FV = $0. 98

Assignment Using the formulas on slide 3, please complete the following 5 practice questions and send to Mr. Ventura.

Practice Question 2 • Inflation is still expected to be 3% but the nominal interest rate on simple interest savings is now 4% • Calculate the future value of $1 after 1 year

Practice Question 3 • Inflation is expected to be 2. 5% & the annual nominal interest rate on a 10 year CD is 5% compounded monthly • Calculate the future value of $1, 000 after 10 years

More Practice Questions 1. What is the present value of $1, 000 realized 2 years from now if the interest rate is 4%? 2. If the interest rate is 2%, what is the amount received 1 year from now as a result of lending $100 today? 3. If the interest rate is 3%, what is the present value of $1 paid to you 1 year from now?