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# Acct 2102 Week 1 8/24 - 8/28 ACCT 2102

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This 4 page Class Notes was uploaded by Libby Fleck on Monday August 31, 2015. The Class Notes belongs to ACCT 2102 at Georgia State University taught by Kathleen S. Partridge (P) in Fall 2015. Since its upload, it has received 254 views. For similar materials see PRIN OF ACCT II in Accounting at Georgia State University.

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Date Created: 08/31/15

Week 1 Chapter 11 The Time Value of Money Learning Objectives for CH 11 L01 Explain the riskreturn relationship L02 Use the time value of money concepts to solve present and future value problems Of vs On 0 Return OF Investment 0 Return of the initial amount invested 0 Return ON Investment 0 Additional amount returned in excess or less than the amount invested o EX Bob invested 100 and after a year received 111 0 His return of investment is 100 0 His return on investment is 11 Rate of Return 0 Any amount you get back in excess of your original investment is your quotreturn on investment 0 RoR is a percentage measure of the return on investment relative to the amount invested return on investment Rate 0 Return f the amount invested o RoR is a commonsize ratio that allows us to rank and compare different investments regardless of size 0 Which investment is better 0 Investment 1 On January 1 you invest 10000 and on December 31 the investment is worth 11000 0 Investment 2 On January 1 you invest 5000 and on December 31 the investment is worth 5800 0 Investment 2 is the better investment There is a 16 rate of return 8005000 compared to 10 rate of return 100010000 in Investment 1 Risk 0 Which investment do you prefer 0 Investment A o Likelihood 100 Return 15000 I Average Expected Return 15000 0 Investment B o Likelihood 50 Return 30000 0 Likelihood 50 Return 0 I Average Expected Return 15000 0 With investment A the return is certain With investment B there is a risk of receiving no return for the period and a chance to receive a greater return No right answer 0 If you prefer investment A you are Risk Averse o If you prefer investment B you are Risk Seeking o If you are like both equally you are Risk Neutral RiskReturn Relationships 0 Generally the average investor is risk averse 0 Risk averse investors don t like to take risks and require compensation in order to take on risk 0 Compensation in this setting means a quotrisk premium meaning higher rates of return 0 Expected rate of return 0 Estimated rate of return on an investment 0 Risk premium 0 Expected rate of return adjusted for inflation business and liquidity risk 0 Note The greater the risk the higher the expected rate of return Types of Risk 0 Risk 0 The chance of an unfavorable outcome 0 Inflation risk 0 Risk of changing price levels 0 Business risk 0 Risk of a particular company going out of business 0 Liquidity risk 0 Risk that an investment cannot be converted into cash when needed EXERCISE 111 Each of the following three investments costs 400000 Calculate the expected rates of return on these investments Each possible outcome will occur at the end of one year Possible Outcome Probability Investment A 40000 03 4000003 12000 50000400000 50000 04 5000004 20000 125 60000 03 6000003 18000 Investment B 50000 01 5000001 5000 58000400000 55000 04 5500004 22000 145 60000 03 6000003 18000 65000 02 6500002 13000 Investment C 60000 04 6000004 24000 69000400000 70000 03 2100003 21000 1725 80000 03 2400003 24000 Interest 0 What is interest 0 The cost of borrowing money 0 Simple Interest 0 Interest is calculated on principal only 0 Interest 1 Principal Rate Time 0 Interest 2 Principal Rate Time I Example If we deposit 1000 in the bank today at 10 simple interest what would it be worth in two years 0 Interest is calculated on principal only 0 Year11000x010x 1 100 0 Year2 1000X01OX 1 100 0 Total Simple Interest 200 0 Add Principal 1000 0 Total amount of investment 1200 Compound Interest 0 Interest is calculated on principal plus accumulated interest 0 Interest 1 Principal Rate Time 0 Interest 2 Principal Interest 1 Rate Time I Example We deposit 1000 for 2 years at a 10 interest rate that is compounded annually What would our investment be worth in 2 years 0 Interest is calculated on principal and interest 0 Year11000x010x 1 100 0 Year21100x010x1 110 0 Total Compound Interest 210 0 Add Principal m 0 Total amount of investment M Compound Interest semiannual 0 Interest is calculated on principal plus accumulated interest 0 Interest 1 Principal Rate Time 0 Interest 2 Principal Interest 1 Rate Time I Example We deposit 1000 for 2 years at a 10 interest rate that is compounded semiannually What would our investment be worth in 2 years 0 Interest is calculated on principal and interest 0 6 months 1000x010 x 12 5000 0 12 months 1050x010 x 12 5250 0 18 months 110250x010 x 12 5512 0 24 months 115762 x 010 x 12 5788 0 Total Compound Interest 21550 0 Add Principal 100000 0 Total amount of investment 121550 Time Value of Money Components FV future value PV present value c compoundingspayments per year r annual interest rate rc period interest rate n total number of compoundingspayments ANN annuity Future Value of 1 0 What amount will 1 grow to at some point in the future 0 Example If we invest 2000 today what will it be worth in 5 years if we earn 8 percent interest compounded quarterly Present Value of 1 FV future value PV present value 2000 c compoundingspaymentsyr 4 r annual interest rate 8 rc period interest rate 84 2 n total number of compoundingspayments 45 yrs 20 FV future value 148592000 297180 0 What is 1 at some point in the future worth today 0 Example If we receive 2000 in 5 years what is it worth todayhow much would we need to invest if we could invest at 8 percent interest compounded quarterly FV 2000 PV r 8 c 4 n 20 rc 2 PV Factor 6730 PV 134594 0 Example What is today s equivalent of 8000 five years from now if interest is 10 compounded annually FV 8000 PV r 10 C 1 rc101 n5 PV 8000 x 62092 4967 rounded

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