Unit 2 Notes: Corporate Finance Mathematics
Corporate Finance lecture notes for the EMBA at UNSW.
Time value of money
- Time affects value – we would rather to have money now so that we can invest money now and then have a lot in 10 years’ time.
[table th=”0″]
Future Value,,
Present Value,PV = ,
Annuities~~
Conditions/Assumptions~~
Regular sets of cash flows~~
Identical~~
Repeated amount for set period of time~~
The first amount occurs in the next period,,
Perpetuity – cash flows that goes on forever,
Growing Perpetuity~~
Use in shares~~
Real rate of return = no inflation,
Equivalent Rates~~,
Annual Equivalent Rate (AER),
Generic AER,
Part period rate,
[/table]
Applying to Mortgage
Calculating principle outstanding
Forward Method
Remaining Periods | Principle at start | Repayment per month | Interest on principal | Principle reduction | Principle at end |
Order of Calc | (1) | (2) | (3) | (4) | (5) |
Calculation | PV of Annuity formula | (1) x j/m | (1) – (3) | (1) – (4) |
Backward Method
Remaining Periods | Principle at start | Repayment per month | Interest on principal | Principle reduction | Principle at end |
Order of Calc | (1) | (2) | (5) | (4) | (3) |
Calculation | PV of Annuity formula | (2) – (4) | (1) – (3) | PV of all future repayments at the start of the next period |
Lookout
- Different n in the PV formula for (1) and (3) gives you the amount for that period.
- n to calculate (1) and (3) is the number of remaining period usually in months
- Repayment is per month (2). May need to be adjusted to calculate Interest on Principal.
i.e Repayment per month x 12 subtract Principle reduction in 1 year