90 CHAPTER 2 Time Value of Money
- FINANCIAL CALCULATOR SOLUTION
Inputs: 3 6 1000 0
Output: 374.11
Enter N 3, I 6, PV 1000, and FV 0, and then press the PMT key to find
PMT $374.11.
- SPREADSHEET SOLUTION
The spreadsheet is ideal for developing amortization tables. The setup is similar to
Table 2–2, but you would want to include “input” cells for the interest rate, principal
value, and the length of the loan. This would make the spreadsheet flexible in the
sense that the loan terms could be changed and a new amortization table would be re-
calculated instantly. Then use the function wizard to find the payment. If you had I
6% in B1, N 3 in B2, and PV 1000 in B3, then the function PMT(B1, B2, B3)
would return a result of $374.11.
Therefore, the firm must pay the lender $374.11 at the end of each of the next
three years, and the percentage cost to the borrower, which is also the rate of return
to the lender, will be 6 percent. Each payment consists partly of interest and partly of
repayment of principal. This breakdown is given in the amortization schedule
shown in Table 2–2. The interest component is largest in the first year, and it declines
as the outstanding balance of the loan decreases. For tax purposes, a business bor-
rower or homeowner reports the interest component shown in Column 3 as a
deductible cost each year, while the lender reports this same amount as taxable
income.
Financial calculators are programmed to calculate amortization tables—you sim-
ply enter the input data, and then press one key to get each entry in Table 2–2. If you
have a financial calculator, it is worthwhile to read the appropriate section of the cal-
culator manual and learn how to use its amortization feature. As we show in the model
for this chapter, with a spreadsheet such as Excelit is easy to set up and print out a full
amortization schedule.
To construct an amortization schedule, how do you determine the amount of the
periodic payments?
How do you determine the amount of each payment that goes to interest and to
principal?
Summary
Most financial decisions involve situations in which someone pays money at one
point in time and receives money at some later time. Dollars paid or received at
two different points in time are different, and this difference is recognized and ac-
counted for bytime value of money (TVM) analysis.We summarize below the types
of TVM analysis and the key concepts covered in this chapter, using the data
See Ch 02 Tool Kit.xls for
details.
88 Time Value of Money
