DR. NARGUNDKARPERS 2002

Finance Basics

Classification

Corporate Finance Capital Budgeting – where should we invest? Capital Structure – where do we get the money from? Net Working Capital – how do we manage day-to-day

transactions?

Personal Finance

Time Value of Money

Present ValueFuture Value

Interest Rates Nominal Periodic Effective

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Interest Rates

A bank charges 24% APR on a loan, payable monthly. What are the nominal, periodic and effective rates?

APR of is the Annual Percentage Rate, and is the nominal rate for a year. Thus nominal rate = 24%

If you pay monthly, you pay over 12 periods. The periodic rate is 24/12 =2% per month.

The effective rate is based on what is actually paid out over the year. If you borrowed $100, you pay

100(1+0.02)12 = 100(1.2682) = $126.82

Thus the effective interest rate is 26.82%.

Present and Future Values

You borrow $1000 now, with a promise to pay 8% per year in interest, compounded annually. If you pay if all off at the end of 5 years, what is the amount you must pay?

PV = 1000i = 8%n = 5

FV = PV(1+i)n = 1000(1.08)5 = 100(1.4693) = $146.93

Present and Future Values - Exercise

What is the present value of $ 1,000,000 that you hope to inherit in 20 years, if you assume an annual interest rate of 10%?