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6 (Calculators)-0
Example 6.1
6 (Calculators)-1
Multiple Cash Flows –Future Value
Example 6.1
ValueBetter:
at year 4:
FV3=8,817.98+4,665.60+4,320+4,000
1 N; 83N,
I/Y;8I/Y,-7000PV,-4000PMT,
-21,803.58 PV; CPT FV CPT FV
= 23,547.87
= 21,803.58
FV3?
8%
t=0 1 2 3
-7000 -4000 -4000 -4000
-4,320.00
-4,665.60
-8,817.98
6 (Calculators)-2
Multiple Cash Flows – FV
Example 2
Suppose you
Basic invest $500 in a mutual
Solution
2 N, 9 I/Y, -500 PV, CPT FV=594.05
fund today and $600 in one year. If the
1N,9 I/Y,-600 PV, CPT FV=654
fund pays
Total:9%
594.05annually,
+654=1,248.05how much will
you have in two years?
FV?
9%
t=0 1 2 3
-500 -600
6 (Calculators)-3
Multiple Cash Flows – FV
Example 2
Suppose
Smart Solutionyou invest $500 in a mutual
Add PMT2=-600 and Subtract it from the FV
fund today
2N,9 I/Y,-500 and
PV,-600 $600
PMT, in one year. If the
CPT FV=1,848.05
fund pays
Subtract: 9%
1,848.05 annually, how much will
– 600=1,248.05
6 (Calculators)-4
Multiple Cash Flows – Example 2
Continued
How much will you have in 5 years if you make no further
deposits?
FV?
9%
0 1 … 5
-500 -600
First way:
Year 0 CF: 5 N; -500 PV; 9 I/Y; CPT FV = 769.31
Year 1 CF: 4 N; -600 PV; 9 I/Y; CPT FV = 846.95
Total FV = 769.31 + 846.95 = 1,616.26
Second way – use value at year 2:
3 N; -1,248.05 PV; 9 I/Y; CPT FV = 1,616.26
6 (Calculators)-5
Multiple Cash Flows – FV
Example 3
Suppose you plan to deposit $100 into an account in
one year and $300 into the account in three years.
How much will be in the account in five years if the
interest rate is 8%? FV?
8%
0 1 3 5
-100 -300
Year 1 CF: 4 N; -100 PV; 8 I/Y; CPT FV [136.05]; STO 1
Year 3 CF: 2 N; -300 PV; 8 I/Y; CPT FV [349.92]; STO 2
Total FV: +RCL 1= 485.97
6 (Calculators)-6
Example 6.3
You are offered an investment that will pay you $200 in
one year, $400 the nextYear year, $600 the next year, and
1 CF:
$800 at the1 N;
end of the Year 2year.
fourth CF: You can earn 12%/y
12 I/Y; 200 FV; CPT 3
Year PV [-178.57]; STO 1
CF:
2 N; 12 I/Y; 400 FV; Year
CPT 4 PV [-318.88]; STO 2
CF:
on very similar
3 N;investment.
12 I/Y; 600 FV;What
CPT PV is[-427.07];
Total CF: the most STOyou
3
4 N; 12
should pay for this+one?I/Y; 800 FV; CPT PV [-508.41]; STO 4
RCL 1 + RCL 2 + RCL 3= 1,432.93
PV? 12%
0 1 2 3 4
200 400 600 800
6 (Calculators)-7
Example 6.3- Using CF
STEP1: Clear ALL CF memory:
STEP 2: Enter Cash Flows
CF ; 2 nd CLR WORK
You are offered an investment
CFo 0 ENTER that
↓ will pay you $200 in
one year, $400 the C01next year, $600
200 ENTER ↓ F01[1]the
↓ next year, and
$800 at the end ofC02 the fourth
400 ENTERyear. You
↓ F01[1] ↓ can earn 12%/y
on very similar investment.
C03 STEP 3: What
600 ENTER isNPV=
↓ F01[1]
Calculate the
↓ most
CF0 + you
PV
should pay for this C02 NPV; I 12 ENTER;
800 ENTER
one? ↓; CPT
↓ F01[1] ↓ [1,432.93]
PV? 12%
0 1 2 3 4
200 400 600 800
6 (Calculators)-8
Example 6.3 Timeline
0 1 2 3 4
318.88
427.07
508.41
1,432.93
6 (Calculators)-10
Multiple Uneven Cash Flows –
Using the Calculator
Another way to use the financial calculator for uneven
cash flows is to use the cash flow keys
Press CF and enter the cash flows beginning with year 0.
You have to press the “Enter” key for each cash flow
Use the down arrow key to move to the next cash flow
The “F” is the number of times a given cash flow occurs
in consecutive periods
Use the NPV key to compute the present value by
entering the interest rate for I, pressing the down arrow,
and then computing the answer
Clear the cash flow worksheet by pressing CF and then
2nd CLR Work
6 (Calculators)-12
Decisions, Decisions
Your broker calls you and tells you that he has this great
investment opportunity. If you invest $100 today, you will
receive $40 in one year and $75 in two years. If you
require a 15% return on investments of this risk, should
you take the investment?
Use the CF keys to compute the value of the
investment
CF; CF0 = 0; C01 = 40; F01 = 1; C02 = 75; F02 = 1
NPV; I = 15; CPT NPV = 91.49
No – the broker is charging more than you would be willing to
pay.
If you enter CF0 = -100, NPV= -8.51 <0 negative investment
6 (Calculators)-13
Saving For Retirement
6 (Calculators)-14
Saving For Retirement Timeline
0 1 2 … 39 40 41 42 43 44
6 (Calculators)-16
Perpetuity
r Perpetuity
0 1 2 … Infinite
100 100 100 100
6 (Calculators)-17
Annuities and Perpetuities – Basic
Formulas
Perpetuity: PV = C / r
Annuities:
1
1
(1 r ) t
PV C
r
(1 r ) t 1
FV C
r
6 (Calculators)-18
Annuities and the Calculator
Most problems are ordinary annuities
You can switch your calculator between
the two types
2nd BGN 2nd Set
If you see “BGN” or “Begin” in the
display of your calculator, you have it
set for an annuity due
6 (Calculators)-19
Annuity Due
You are saving for a new house and you put $10,000 per year in
an account paying 8%. The first payment is made today. How
much will you have at the end of 3 years (before the 4th payment)?
8% Annuity Due
0 1 2 3
10K 10K 10K ?
2nd BGN 2nd Set (you should see BGN in the display)
3 N ; -10,000 PMT; 8 I/Y; CPT FV = 35,061.12
2nd BGN 2nd Set (be sure to change it back to an ordinary
annuity)
Alternatively: 3 N ; -10,000 PMT; 8 I/Y; CPT FV [32,464]; *1.08
6 (Calculators)-24
Compounding again!
• Deposit $1,000 at 8% nominal annual interest rate, how
much will you have at the end of 2 years?
• If compounded annually:
• FV= 1000*(1+.08)^2= 1,166.40
• Earn 8%/year
If compounded quarterly:
N=4*2=8 quarters, I/Y=8%/4=2%/quarter
FV= 1000*(1+.02)^8=1,171.66
How much do you effectively earn if compounded
quarterly?
1000*(1+EAR)^2=1,171.66 (Effective Annual Rate)
Solve for EAR: 8.24%
Alternatively, EAR=(1+.08/4)^4-1=8.24%
6 (Calculators)-28
EAR - Formula
m
APR
EAR 1 1
m
Remember that the APR is the quoted rate
m is the number of compounding periods per year
6 (Calculators)-29
Effective Annual Rate (EAR)
6 (Calculators)-30
Annual Percentage Rate
This is the annual rate that is quoted by law
By definition APR = period rate times the
number of periods per year
Consequently, to get the period rate we
rearrange the APR equation:
Period rate = APR / number of periods per year
You should NEVER divide the effective rate by
the number of periods per year – it will NOT
give you the period rate
6 (Calculators)-31
Computing APRs
6 (Calculators)-32
Computing EARs - Example
Suppose you can earn 1% per month on $1
invested today.
What is the APR? 1(12) = 12%
How much are you effectively earning?
FV = 1(1.01)12 = 1.1268
Rate = (1.1268 – 1) / 1 = .1268 = 12.68%
Suppose you put it in another account and earn
3% per quarter.
What is the APR? 3(4) = 12%
How much are you effectively earning?
FV = 1(1.03)4 = 1.1255
Rate = (1.1255 – 1) / 1 = .1255 = 12.55%
6 (Calculators)-33
Decisions, Decisions II
6 (Calculators)-34
Decisions, Decisions II Continued
Let’s verify the choice. Suppose you
invest $100 in each account. How much
will you have in each account in one
year?
First Account:
365 N; 5.25 / 365 = .014383562 I/Y; 100 PV; CPT FV =
105.39
Second Account:
2 N; 5.3 / 2 = 2.65 I/Y; 100 PV; CPT FV = 105.37
You have more money in the first
account.
6 (Calculators)-35
Computing APRs from EARs
APR m (1 EAR)
1
m
-1
6 (Calculators)-36
APR - Example
APR 12 (1 .12)1 / 12
1 .1138655152
or 11.39%
6 (Calculators)-37
Future Values with Monthly
Compounding
Suppose you deposit $50 a month into an
account that has an APR of 9%, based
on monthly compounding. How much will
you have in the account in 35 years?
35(12) = 420 N
9 / 12 = .75 I/Y
50 PMT
CPT FV = 147,089.22
6 (Calculators)-39
Present Value with Daily
Compounding
You need $15,000 in 3 years for a new
car. If you can deposit money into an
account that pays an APR of 5.5% based
on daily compounding, how much would
you need to deposit?
3(365) = 1,095 N
5.5 / 365 = .015068493 I/Y
15,000 FV
CPT PV = -12,718.56
6 (Calculators)-40
Continuous Compounding
Sometimes investments or loans are
figured based on continuous
compounding
EAR = eq – 1
The e is a special function on the calculator
normally denoted by ex
Example: What is the effective annual
rate of 7% compounded continuously?
EAR = e.07 – 1 = .0725 or 7.25%
6 (Calculators)-41
Remember
6 (Calculators)-42
How to lie, cheat, and steal with
interest rates:
RIPOV RETAILING
Going out for business sale!
$1,000 instant credit!
12% simple interest!
Three years to pay!
Low, low monthly payments!
Assume you buy $1,000 worth of furniture from this store and
agree to the above credit terms. What is the APR of this loan?
The EAR?
6 (Calculators)-43
How to lie, cheat, and steal with
interest rates:
1. Borrow $1,000 today at 12% per year for
three years, you will owe
$1,000 + $1000(.12)(3) = $1,360.
6 (Calculators)-44
Types of loan
6 (Calculators)-45
Amortized Loan with Fixed
Payment - Example
Each payment covers the interest expense plus
reduces principal
Consider a 4 year loan with annual payments.
The interest rate is 8% and the principal
amount is $5000.
What is the annual payment?
4N
8 I/Y
5000 PV
CPT PMT = -1509.60
Click on the Excel icon to see the amortization
table
6 (Calculators)-46
6
Calculators
End of Chapter
McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Comprehensive Problem
An investment will provide you with $100 at the
end of each year for the next 10 years. What is
the present value of that annuity if the discount
rate is 8% annually?
What is the present value of the above if the
payments are received at the beginning of
each year?
If you deposit those payments into an account
earning 8%, what will the future value be in 10
years?
What will the future value be if you open the
account with $1,000 today, and then make the
$100 deposits at the end of each year?
6 (Calculators)-48