Introduction to Financial Management

Introduction to Financial Management

Computing APRs What is the APR if the monthly rate is .5%? What is the APR if the semiannual rate is .5%? What is the monthly rate if the APR is 12% with monthly compounding? 5-1 Computing EAR and APR Suppose you can earn 1% per month on $1 invested today. What is the APR? 1(12) = 12% How much are you effectively earning? 5-2 Computing EAR and APR

Suppose if you put it in another account, you earn 3% per quarter. What is the APR? How much are you effectively earning? 5-3 Computing APRs from EARs APR m (1 EAR) 1 m

-1 M = number of compounding periods per year 5-4 APR - Example Suppose you want to earn an effective rate of 12% and you are looking at an account that compounds on a monthly basis. What APR must they pay? 5-5 Computing Payments with APRs

Suppose you want to buy a new computer. The store is willing to allow you to make monthly payments. The entire computer system costs $3,500. The loan period is for 2 years. The interest rate is 16.9% with monthly compounding. What is your monthly payment? 2(12) = 24 16.9 / 12 = 1.40833 3500 0

CPT PMT = -172.88 N I/Y PV FV =PMT(0.0140833,24,3500,0) 5-6 Future Values with Monthly Compounding Suppose you deposit $50 a month into an account that has an APR of 9%, based on monthly compounding. How much will you have in the account in 35 years?

420 N(35*12) 0.75 I/Y(9/12) 0 PV -50 PMT CPT FV = 147,089.22 =FV(0.0075,420,-50,0) 5-7 Present Value with Daily Compounding You need $15,000 in 3 years for a new car. If you can deposit money into an account that pays an APR of

5.5% based on daily compounding, how much would you need to deposit? 1095 N(3*365) .015068493 I/Y(5.5/365) 0 PMT 15,000 FV CPT PV = -12,718.56 =PV(0.00015,1095,0,15000) 5-8 Pure Discount Loans Treasury bills are excellent examples of pure discount

loans. Principal amount is repaid at some future date No periodic interest payments If a T-bill promises to repay $10,000 in 12 months and the market interest rate is 7 percent, how much will the bill sell for in the market? 1 N; 10,000 FV; 7 I/Y; CPT PV = -9345.79 =PV(.07,1,0,10000) Return to Quick Quiz 5-9 Amortized Loan with Fixed Payment Example Each payment covers the interest expense plus

reduces principal Consider a 4-year loan with annual payments. The interest rate is 8% and the principal amount is $5000. What is the annual payment? 5,000 = PMT[1 1 / 1.084] / .08 PMT = 1,509.60 =PMT(0.08,4,5000,0) = 1509.60 4 N; 8 I/Y; 5000 PV, 0 FV, CPT PMT = 1509.60 Return to Quick Quiz 5-10 Amortized Loan with Fixed Payment Example Year 1 2

3 4 Totals Beginning Balance $ 5,000.00 $ 3,890.40 $ 2,692.03 $ 1,397.79 Total Payment Payment $ 1,509.60 $ 1,509.60 $ 1,509.60 $ 1,509.60

$ 6,038.40 $ $ $ $ $ Interest Paid 400.00 311.23 215.36 111.82 1,038.42 Principal

Ending Paid Balance $ 1,109.60 $ 3,890.40 $ 1,198.37 $ 2,692.03 $ 1,294.24 $ 1,397.79 $ 1,397.79 $ $ 5,000.00 Interest Paid = Beginning Balance * Rate (8%) Principal Paid = Total Payment Interest Paid Ending Balance = Beginning Balance Principal Paid 5-11 Quick Quiz: Part 6 What is a pure discount loan?

What is a good example of a pure discount loan? (Slide 5.72) What is an amortized loan? What is a good example of an amortized loan? (Slide 5.73) 5-12 Example: Work the Web Several Web sites have calculators that will prepare amortization tables quickly One such site is Bankrate.com Click on the Web surfer, select Calculators, Mortgage Payment Calculator, and enter the following information: Loan amount = $20,000

Term = 10 years Interest rate = 7.625% What is the monthly payment? 5-13 Chapter 5 END

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