Appendix II – Compound Interest and the Concept of Present Value
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APPENDIX II
COMPOUND INTEREST AND THE CONCEPT OF PRESENT VALUE
Learning Objectives
2. Compute the future value and present value of cash flows occurring over several
time periods.
Appendix II – Compound Interest and the Concept of Present Value
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Appendix Overview
I. The Concept of Present Value
A. Compound interest
Appendix II – Compound Interest and the Concept of Present Value
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Key Lecture Concepts
I. The Concept of Present Value
• Capital-budgeting projects often require an initial major outflow of cash,
followed by subsequent inflows of cash over a number of years. To
compare inflows over time to today’s outflow, future dollars must be
• The concept of compound interest is based on the fact that an amount
invested (i.e., the principal) will grow over time because of interest that
accumulates.
➢ The amount that the principal will grow to in the future is known
as the investment’s future value.
➢ The appropriate formula is:
Teaching Tip: Because of rapidly rising costs, many parents are making
early plans to fund their children‘s higher education. The parents often
participate in one of the many prepaid tuition plans that have been
• Taking the opposite approach, the future amount can be brought back to
the present to see how much it is worth in today’s dollars (i.e., the
investment’s present value).
Appendix II – Compound Interest and the Concept of Present Value
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➢ The process to calculate this amount is known as discounting.
• Future value and present value can be used with individual cash flow
amounts as well as with a series of equal cash flows over a number of
years (i.e., an annuity).
➢ With both of these concepts, an analyst can multiply the yearly cash
flows by the factors for single-sum amounts or multiply the
Appendix II – Compound Interest and the Concept of Present Value
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Teaching Overview
As noted in the teaching overview that accompanies Chapter 16, I usually include a
short overview of compound interest and present value concepts/mechanics whenever
Links to the Text
Homework Grid
Item No.
Learning
Objectives
Completion
Time (min.)
Exercises:
II-7
1, 2
25
II-8
1, 2
45
II-9
1, 2
20