UB MGF 401 - chap004 (35 pages)

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4 1 Chapter 4 Topics Covered Future Values and Compound Interest Present Values Multiple Cash Flows Level Cash Flows Perpetuities and Annuities Inflation Time Value Effective Annual Interest Rate McGraw Hill Irwin Copyright 2007 by The McGraw Hill Companies Inc All rights 4 2 Future Values Future Value Amount to which an investment will grow after earning interest Compound Interest Interest earned on interest Simple Interest Interest earned only on the original investment McGraw Hill Irwin Copyright 2007 by The McGraw Hill Companies Inc All rights 4 3 Future Values Example Simple Interest Interest earned at a rate of 6 for five years on a principal balance of 100 Interest Earned Per Year 100 x 06 6 McGraw Hill Irwin Copyright 2007 by The McGraw Hill Companies Inc All rights 4 4 Future Values Example Simple Interest Interest earned at a rate of 6 for five years on a principal balance of 100 Today Future Years 1 2 3 4 5 Interest Earned 6 6 Value 100 106 112 6 118 6 124 6 130 Value at the end of Year 5 130 McGraw Hill Irwin Copyright 2007 by The McGraw Hill Companies Inc All rights 4 5 Future Values Example Compound Interest Interest earned at a rate of 6 for five years on the previous year s balance Interest Earned Per Year Prior Year Balance x 06 McGraw Hill Irwin Copyright 2007 by The McGraw Hill Companies Inc All rights 4 6 Future Values Example Compound Interest Interest earned at a rate of 6 for five years on the previous year s balance Today Interest Earned Value 100 Future Years 1 2 3 4 5 6 6 36 6 74 7 15 7 57 106 112 36 119 10 126 25 133 82 Value at the end of Year 5 133 82 McGraw Hill Irwin Copyright 2007 by The McGraw Hill Companies Inc All rights 4 7 Future Values Future Value of 100 FV FV 100 1 r McGraw Hill Irwin t Copyright 2007 by The McGraw Hill Companies Inc All rights 4 8 Future Values FV 100 1 r t Example FV What is the future value of 100 if interest is compounded annually at a rate of 6 for five years 5 FV 100 1 06 133 82 McGraw Hill Irwin