Appendix C Accounting 225
Key Point 4
Cash payments of equal amounts over equal time intervals are called an annuity. The future value of an annuity is the sume of the future values of a series of cash payments. Similarly, the present value of an annuity is the sum of the present values of a series of cash payments.
Discount Rate
Discount Rate is the rate at which we would be willing to give up currenet dollars for future dollars. If you would be willing to give up $100 today to receive $108 in the future, then the discount rate is 8%.
Future Value of a Single Amount
FV= I(1+i)^n or FV= I x FV factor (from table Future Value of $1)
Time Value of Money
Interests causess the value of money recieved today to be greater than the value of that same amount of money recieved in the future
Compound interest =
Outstanding balance x interest rate "interest on interest" what we use when calculating the time value of money
Key Point 3
Present Valye is precisely the opposite of future value. Instead of telling us how much some amount today will grow to be in the future, the present value tells us the value today of receiving some larger amount in the future.
Key Point 1
Simple interest is interest we earn on the initial investment only. Compound interest is the interest we earnon the initial investment plys previous interest. We use compound interest in calculating the time value of money.
Key Point 2
The more frequent the rate of compounding, the more interest we earn on previous interest resulting in a higer future value.
For exmaple, assume the three-year $1000 investment earns 10% compounded semiannually, or twice per year.
The number of periods over three years is now six. The interest rate per period is now 5% (10% annual rate/2). The future valye of the three year, $1000 investment that earns 10% compounded semiannually is equal to $1,340.
Let's try to determine the present value of $1,331 to be received in three years.
We first need to determine the discount rate. Let's assume the discount rate is 10%. In this case, the present value of receiving $1331 in three years is $1000. PV= FV divided by (1+i)^n
Present Value
how much an amount in the future is worth today
Future Value
how much an amount today will grow to be at some point in the future
Simple Interest =
initial investment x interest rate
Compund Interest
interest earned on the initial investment and on previous interes
Simple Interest
interest earned on the initial investment only