ACST101 Lecture Notes - Lecture 2: Interest, Cash Flow, Investment
ACST101 LECTURE – 8/3/18
WK2; TIME VALUE OF MONEY
DEFINITIONS:
TVM: the difference in value between a dollar in hand today and a dollar promised in the
future.
Time Line: identifies the rate of interest, magnitude and timing of cash flows.
Future Value (FV): accumulated value. The value of an investment after it earns interest for
one or more periods.
Present Value (PV): the equivalent value at an earlier date (like today) of a future sum(s) of
money.
Simple Interest: interest earned on the original principal only.
Compound Interest: interest earned on the original principal and on the interest earned.
Siple iterest = iterest-on-iterest.
Compounding: process by which interest earned on an investment is reinvested, so in
future periods interest is earned on the interest as well as the principle.
Discounting: process by which the present value of future cash flow is obtained - reverse of
compounding.
COMPOUND INTEREST
FV=PV(1+r) ^n
FV: Future Value
PV: Present Value
r: Interest Rate
n: Number of Periods
SIMPLE INTEREST
I=Prn
I: Interest
P: Principle
r: Rate
n: Number of Periods
FUTURE VALUE AND COMPOUNDING
- The greater the interest rate the greater the FV
- The longer the time period, the greater the effect of compounding die to interest-
on-interest
- The opposite is true too – the greater the interest rate and time period, the less is
the present value of some future amount
- Compound interest does not grow to an infinitely large sum (unless the starting
amount is infinitely large)
- An upper bound exists for the amount of compound interest
- As the number compounding periods tends to infinity, compound interest tends to a
limit
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Document Summary
Tvm: the difference in value between a dollar in hand today and a dollar promised in the future. Time line: identifies the rate of interest, magnitude and timing of cash flows. The value of an investment after it earns interest for one or more periods. Present value (pv): the equivalent value at an earlier date (like today) of a future sum(s) of money. Simple interest: interest earned on the original principal only. Compound interest: interest earned on the original principal and on the interest earned. Compounding: process by which interest earned on an investment is reinvested, so in future periods interest is earned on the interest as well as the principle. Discounting: process by which the present value of future cash flow is obtained - reverse of compounding. Pv: present value r: interest rate n: number of periods. P: principle r: rate n: number of periods. The greater the interest rate the greater the fv.