MBUS 3000 March 5th 2013 Lecture 17 FV, PV, Loan amortization and

MBUS 3000March 5th 2013

Lecture 17FV, PV, Loan amortization and Homework assignments

pt 1 2, and 3

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last thursday we learned this.memorize!

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Homework part 1Future value calculation.....

FV of $25,000 loan. 2 years. 8 percent annual interest. calculated monthly.

FV of $25,000 loan. 2 years 8 percent interest calculated quarterly.

FV of $1000 loan. 6 months. 25% annual interest calculated daily.

due tuesday 3/19/2013 by 3:30pm

show workhardcopy no emailing!!

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PV Homework

1. What is the PV of a Risk Free $2000 4 years from now

2. What is the PV of a risk free $10,000 30 years from now

Homework part III’ll explain later in lecture

Due march 19 3:30pmhard copy do not email

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Homework part IIIcalculate a loan amortization table

use it to record Gnucash loan payment.March 19th

Email profit and loss sheetEmail balance sheet

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loan amortization

What if we want to pay the 5 year loan a little each month? how do we calculate that? take the 1283.38 and divide it by 60?

No! we use this very simple formula here;

A = amount of monthly payment, p= principal, r = rate, n = number of periods.memorize this you will be tested on this.

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joking about memorizing that.

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Amortizing a Loan.Interest. Principal

http://bretwhissel.net/amortization/use this one cause you can calculate weekly, quarterly, annually

$15,0005 years

monthly payments 12 times yearinterest calculated monthly 12 times a year

7% interestLoan begins 1/1/2012

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$50,0002 years

payments quarterly 4 times a year.interest calculated quarterly 4 times a year.

5% interestLoan begins

1/1/2012

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Make sure payment field is blank !erase payment from last calc

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Principal reduces liablilityinterest is an expense.

<whiteboard examples>

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“Future Value”of 50k

calculated quarterlyat 5% interest

2 years from now

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dEaDbUg Loan 10,0003 years

11% interestcalculated monthly

homework part 2

1. Payment amount2. first month principal amount3. first month interest amount

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Principal reduces liabilityInterest is an expense.

In order to do this problem you must computeloan amortization schedule just as I’ve been showing

New expense accountExpenses: Interest expense

Add a loan payment to checking account$327.39 (hint loan amout)

“Split” between long term liabilities vehicle loan

and Expense: Interest Expense

Homework Due Tues 3/19

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Present value

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What is the present value of a lump sum of money in the future?

What is the present value of a stream of monthly payments (example pension, royalties etc) in the future?

Why would you need to know this?

Divorce! Any of you going in to family law or accounting will eventually encounter this problem.

Buying out a partner in a business.

Buying out a member of the band.

Value of a life insurance policy.

Getting an advance against royalties owed in the future?

Calculating a recording advance

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What interest rate do we use?

Interest rate represents the market expectation of inflation + risk.

If we assume this amount is risk free the only thing the interest rate represents is expectations of inflation.

in this case use the interest rate for US treasuries for that period of time.

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www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

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absolutely risk free $100,000 due 30 years from now. we always calculate interest annuallywhen we are calculating a lump sum!!

treasury 30 year yield is 3.22% (per year)

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Calculate PV of 5000 dollars (risk free) payable 10 years from now.10 year treasury is %2.26

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More risk results in those countries paying a lot higher interest rate than the expected rate based on inflation. There is more risk.

$10,000 from the government of Greece due 10 years from now. compare that to$10,000 from the government of France due 10 years from now.

France vs Greece

Greece 10 year yield = 26.9%French 10 year yield =3.017%

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As the interest rate increases PV decreasesAs the interest rate decreases PV increases

also note

As the interest rate increases FV increasesAS the interest rate decreases FV decreases

As the risk increases PV decreasesAs the risk decreases PV increases

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Q.How do we calculate PV for an individual or entity?There is no market to “price” their debt to suggest an interest rate.

A. We guess or estimate.

Example I’m gonna give you $1000 dollars a year from now. But i’m known to sometimes not pay my debts. You guess there is a 1/4 chance of me not paying you. So to value this right now you would

calculate PV using a interest rate of 25% + a little more to take into account inflation.

Or consider that David Barbe is gonna give you $1000 a year from now. David is known to almost always pay his debts. you guess there is only a slight chance he will be unable to pay. Say 3%. To value this promise right now you would calculate PV using the interest rate of 3% + a

little more to account for inflation.

PV of DB $1000 > PV of DL $1000

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Not Risk FreeMarket does not exist to price risk or set interest rates

so someone somewhere guesses. it could be a highly educated guess. could be a wild guess.

David Barbe reliable debtor. Known to pay debts.PV of $100,000 3 years from now. Your supervisor tells you to use and interest rate of 7%

David Lowery is not a reliable debtor. Known to sometimes not pay his debts.PV of $100,000 3 years from now. Your supervisor tells you to use an interest rate of 23%

note: as risk increases PV decreases!

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The Recording AdvanceAs a present value

Unknown/New Artist12% royalty

Implied Interest rate 88%$70,000 Advance

Established Successful Artist18% artist royalty

Implied Interest Rate 82%250,000 Advance

close

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as the interest rate increases PV decreasesas the interest rate decreases PV increases

As the risk increases PV decreasesAs the risk decreases PV increases

New artists advance $70,000Established artists advance $250,00

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