Session 3 - Time Value of Money and Valuation (Chapter 4)
All page numbers are references to Corporate Finance: A Focused Approach 5th edition by Ehrhardt and Brigham (Cengage South-Western, 2014)
Need to know almost everything plus you need to learn how to use your financial calculator. Specifically, you can solve for any of the variables (present value, future value, payment, interest rate, and number of periods) for present value, future value, and annuity problems. You should be able to solve for the present value of; annuities, perpetuities, growing perpetuities, and a stream of uneven cash flows. You should be able to convert simple interest (aka APR, stated rate, quoted rate, and a few other names for an uncompounded annual interest rate) to an effective annual interest rate and/or a periodic rate. You should be able to solve multiple step time value of money problems. You should be able to solve all of the end-of-chapter questions and problems. Note, that some variation all of those questions and problems have appeared in past quizzes and exams. I consider the following problems to be exam level problems 5, 8, 18, 19, 21b, 24, and 27-34.
This chapter develops the valuation techniques that we use for the rest of the course. This is the most important chapter in the course. The rest of the course will apply techniques learned in this chapter.
Do not need to know - Growing Annuity (until we get to the stock valuation chapter).
This textbook has no instruction to assist in using calculators and spreadsheets. You will need to be able to use a financial calculator for the quizzes and exams. It is critical that you �set up�� your calculator correctly. Here is a link to simple instructions for most calculators.
Here are the manufacturer web sites, I do not find them to be that useful.
Note, that your calculator is probably set to 12 payments per year and 2 decimal places. You need to change this to 1 payment per year and at least 4 decimal places.
1. Watch the Chapter Introduction and Overview video. The Powerpoints for all of this chapter’s videos are located here. An important concept, and the most common loan in your personal life, is the amortized loan. This video discusses Amortized Loans in detail. If you find yourself making lots of errors, watch this video that discusses the most common TVM errors.
2. Easy Concepts and Calculations. A key part of learning time value of money is recognizing problems. Below are some audio solutions (courtesy of Dr. Ron Best) to simple problems from this chapter. Use these problems to verify your calculator and/or spreadsheet are set up correctly.
a. Audio solution to: If you wish to accumulate $140,000 in 13 years, how much must you deposit today in an account that pays an annual interest rate of 14%?
b. Audio solution to: What will $247,000 grow to be in 9 years if it is invested today in an account with an annual interest rate of 11%?
c. Audio solution to: How many years will it take for $136,000 to grow to be $468,000 if it is invested in an account with an annual interest rate of 8%?
d. Audio solution to: At what annual interest rate must $137,000 be invested so that it will grow to be $475,000 in 14 years?
4. More Difficult Concepts and Calculations. Be able to solve all of the chapter examples and end of chapter problems. A key part of learning time value of money is recognizing problems. Below are audio solutions (courtesy of Dr. Ron Best) to more difficult problems from this chapter.
a. Audio solution to: If you wish to accumulate $197,000 in 5 years, how much must you deposit today in an account that pays a quoted annual interest rate of 13% with semi-annual compounding of interest?
b. Audio solution to: What will $153,000 grow to be in 13 years if it is invested today in an account with a quoted annual interest rate of 10% with monthly compounding of interest?
c. Audio solution to: How many years will it take for $197,000 to grow to be $554,000 if it is invested in an account with a quoted annual interest rate of 8% with monthly compounding of interest?
d. Audio solution to: At what quoted annual interest rate must $134,000 be invested so that it will grow to be $459,000 in 15 years if interest is compounded weekly?
e. Audio solution to: You are offered an investment with a quoted annual interest rate of 13% with quarterly compounding of interest. What is your effective annual interest rate?
5. Additional Support Material. There is some good internet support material for this topic.
a. Here is a (rather slow) financial simulation that teaches Time Value of Money concepts,http://www.mhhe.com/business/finance/interactivefinsims/timevaluemoney/. If you are completely lost, the Khan Academy has some very low level tutorials, https://www.khanacademy.org/economics-finance-domain/core-finance/interest-tutorial.
c. Students tend to make the certain errors as they learn about Time Value of Money. If you find yourself making lots of errors, watch this video (same video as above) that discusses the most common TVM errors.
7. There is a longer quiz for this chapter, as the only way to learn this material is to do many, many problems.
Revised January 21, 2016