152 Part 2 Fundamental Concepts in Financial Management
Therefore, the borrower must pay the lender $23,739.64 per year for the next
5 years.
Each payment will consist of two parts—interest and repayment of principal.
This breakdown is shown on an amortization schedule such as the one in Table 5-4.
The interest component is relatively high in the! rst year, but it declines as the loan
balance decreases. For tax purposes, the borrower would deduct the interest com-
ponent while the lender would report the same amount as taxable income.Amortization Schedule
A table showing precisely
how a loan will be repaid.
It gives the required
payment on each
payment date and a
breakdown of the
payment, showing how
much is interest and how
much is repayment of
principal.Amortization Schedule
A table showing precisely
how a loan will be repaid.
It gives the required
payment on each
payment date and a
breakdown of the
payment, showing how
much is interest and how
much is repayment of
principal.SELF^ TEST Suppose you borrowed $30,000 on a student loan at a rate of 8% and must
repay it in three equal installments at the end of each of the next 3 years.
How large would your payments be, how much of the! rst payment would
represent interest, how much would be principal, and what would your end-
ing balance be after the! rst year? (PMT! $11,641.01; Interest! $2,400;
Principal! $9,241.01; Balance at end of Year 1! $20,758.99)In this chapter, we worked with single payments, ordinary annuities, annuities
due, perpetuities, and uneven cash # ow streams. One fundamental equation, Equa-
tion 5-1, is used to calculate the future value of a given amount. The equation can be
transformed to Equation 5-2 and then used to! nd the present value of a given future
amount. We used time lines to show when cash # ows occur; and we saw that time
value problems can be solved in a step-by-step manner when we work with individ-
ual cash # ows, with formulas that streamline the approach, with! nancial calcula-
tors, and with spreadsheets.
As we noted at the outset, TVM is the single most important concept in! nance
and the procedures developed in Chapter 5 are used throughout this book. Time
value analysis is used to! nd the values of stocks, bonds, and capital budgeting proj-
ects. It is also used to analyze personal! nance problems, such as the retirement
issue set forth in the opening vignette. You will become more familiar with time value
analysis as you go through the book, but we strongly recommend that you get a good
handle on Chapter 5 before you continue.KEY TERMS Define each of the following terms:
a. Time line
b. FVN ; PV; I; INT; N; FVAN ; PMT; PVAN
c. Compounding; discounting
d. Simple interest; compound interest
e. Opportunity cost
f. Annuity; ordinary (deferred) annuity; annuity due
g. Consol; perpetuitySELF!TEST QUESTIONS AND PROBLEMS
"Solutions Appear in Appendix A
SELF!TEST QUESTIONS AND PROBLEMS
"Solutions Appear in Appendix A
ST-1ST-1
T Y I N G I T A L L T O G E T H E R