Problem Format

by Maestri

To help you understand the various types of time value problems, we generally use a standard format. First, we state the problem in words. Next, we diagram the problem on a time line. Then, beneath the time line, we show the equation that must be solved. Finally, we present the three alternative procedures for solving the equation to obtain the answer: (1) use a regular calculator to obtain a numerical solution, (2) use a ?nancial calculator, and (3) use a spreadsheet program. For some very easy problems, we will not show a spreadsheet solution, and for some dif?cult problems, we will not show numerical solutions because they are too inef?cient.

1. NUMERICAL SOLUTION

2. FINANCIAL CALCULATOR SOLUTION

3. SPREADSHEET SOLUTION

Graphic View of the Compounding Process: Growth Figure 2-1 shows how $1 (or any other lump sum) grows over time at various interest rates. We generated the data and then made the graph with a spreadsheet model in the file Ch 02 Tool Kit.xls. The higher the rate of interest, the faster the rate of growth. The interest rate is, in fact, a growth rate: If a sum is deposited and earns 5 percent interest, then the funds on deposit will grow at a rate of 5
percent per period. Note also that time value concepts can be applied to anything that is growing—sales, population, earnings per share, or your future salary.

Explain what is meant by the following statement: “A dollar in hand today is worth more than a dollar to be received next year.”

What is compounding? Explain why earning “interest on interest” is called “compound interest.”
Explain the following equation: FV1 = PV+ INT.
Set up a time line that shows the following situation: (1) Your initial deposit is $100. (2) The account pays 5 percent interest annually. (3) You want to know how much money you will have at the end of three years.
Write out an equation that could be used to solve the preceding problem.
What are the ?ve TVM (time value of money) input keys on a ?nancial calculator? List them (horizontally) in the proper order.

Taken From : Five-Minute MBA – Corporate Finance

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