HTM 3222

Financial Management
in Hospitality, Tourism
and Events

Lecture 5

Tiffany Cheng
TH810, 3400-2235
[email protected]
Recap from last time

Why is the value of money different today than in

the future?
What are the three characteristics of an annuity?

Go over test on Week 4

 Additional applications of time value of money
Building on the four basic concepts we learned last
week, we will discuss four major applications:
• Present value of non-constant cash flows
• Compounding other periods
• Amortized loans and loan tables
• Perpetuity
• Present value of deferred annuity
Present Value of Non-Constant Cash Flows

Non-constant cash flows just means cash flows that

are not the same
• use this method when cash flows are not annuities
• use this method together with the annuity formulas
• sum together the PVs or FVs of the individual cash
flows

FV = CF1*(1+i)1 + CF2*(1+i)2 + ………. CFn*(1+i)n

CF1 CF2 CFn
PV    .............
1  i  1  i 
1 2
1  i n
Example of FV of non-constant cash flows
If you deposit $100 in one year, $300 in three
years, $500 in five years. How much will you have
after 7 years at 7% interest?

How much will you have after 10 years if you don’t

deposit additional amounts?
Example using MS Excel
You are offered an investment that will pay
$200 in year 1, $400 the next year, $600 the
following year, and $800 at the end of the 4 th year.
You can earn 12% on similar investments, what is
the most you should pay for this investment?
 Adjusting for non-annual periods
Interest rates are usually quotes as annual interest rates. You need
to make adjustments when you are working with other periods.
You ALWAYS need to make sure that the interest rate and the time
period match.
• Annual periods  annual rate.
• Monthly periods  monthly rate
The cash flows should not be adjusted, that will defeat the concept
of time value of money

mxn
 i nom 
FVn PV x  1  
 m 
 Effective annual rates
When compounding periods are not annual, the actual annual
interest rate paid is referred to as effective annual rate
• An effective annual rate is an annual compounding rate
• E.g. 10% nominal annual rate, compounded
semiannually, provides an effective annual interest rate of
$10.25/$100 = 10.25%
General equation for calculating an effective annual rate
m
 i 
Effective Annual Rate  1  nom   1
 m 

For a meaningful comparison of interest rates that are

compounded differently, always convert the interest rates to
effective annual rates
Amortized Loans and Loan Tables
Amortized loans are paid off in equal payments over a set
period of time and can be viewed as the PVA
• Such as student loans
• The original loan amount borrowed is the present value of the
future contracted payments
• At the end of the loan period (future value) the loan is paid so
FV is $0.
 1 
1 
 1  i n 
PVn PMT x  
 i 
 

• PV = loan amount
• PMT = contracted payment per period
• n = number of payments
• i = contracted interest rate
 Example of Amortized Loans
Suppose a car loan for $12,000 will require 48 equal
monthly payments at a 9% annual rate, what is the
amount that must be repaid each month for the loan.

• Solve for PMT after adjusting to a monthly rate

 1 
1 -
 1  0.75%  
48
9%
i= = 0.75% $12,000 PMT x  
12  0.75% 
 

• Each car loan payment =$298.62

Amortization (Loan) Table
The table is useful for understanding how the loan payments are
paying off the interest and the principal loan over the periods. It
clearly shows the remaining loan balance after each payment.
Note that the loan payments do not change.
A $120,000 home mortgage for 30 years with a contract interest
rate of 9% annually and monthly payments. What is the monthly
payment?

Month Payment Interest Principal Balance

0 $120,000.00
1 $965.55 $900.00 $65.55 119,934.45
2 965.55 899.51 66.04 119,868.41
3 965.55 899.01 66.53 119,801.88
4 965.55 898.51 67.03 119,734.85
… … … … …
357 965.55 28.43 937.12 2,853.73
358 965.55 21.40 944.14 1,909.58
359 965.55 14.32 951.23 958.36
360 965.55 7.19 958.36 0.00
Practice now
Consider a 4-year loan with annual payments. The
interest rate is 8% and the principal amount is
$5000. Compute the amortization table for this loan.

Year Loan Payment Interest paid Principal paid Remaining

Balance
Perpetuity- A Special Annuity
It is an infinite series of uniform payments

Present Value Perpetuity formula: PV = PMT / I

An investment which costs you $900 today and promises to pay

you $90 at the end of each year forever. What is your interest
rate (Interest rate of return) of this investment ?
 So Many Tools, So Many Methods
Instead of memorizing, it is better to follow your own
method to solve problems by deconstructing the
problem part by part based on the tools that you
have.
1. Draw timeline. See what information is provided.
2. Decide which tools you can use based on which
ones you are most comfortable with
3. It is okay for your method to be different than
others
 Present Value of Deferred Annuity
Deferred annuity
• The first payment is made two or more periods in the
future
• Different than annuity due and ordinary annuity

An investment promises to pay $100 annually beginning at the end

of 5 years and continuing until the end of 10 years. What is the
value of this investment today at a 7% interest rate?
How would you solve this?
 How it can be solved?
1. Present value of non-constant cash flows
2. Future value of non-constant cash flows -> discount the
lump sum back 10 years
3. Present value of an ordinary annuity  discounting the
lump sum back 4 years
4. Present value of an annuity due  discounting the lump
sum back 5 years
5. Future value of an ordinary annuity  discounting the lump
sum back 10 years
6. Future value of an annuity due  discounting the lump sum
back 11 years
 Practice 1
You plan to provide $25,000 annually for your child education.
You need the first $25,000 at the end of 15 years, for four years.
If you earn 8% annually, what lump sum do you need to invest
today?
 Practice 2
Tammy just celebrated her 25 th birthday today. She plans to
invest $2,000 annually, with the first $2,000 on her 26 th birthday
and the last invested on her 60 th birthday. What is the value of
Tammy’s investment on her 61st birthday if all invested funds earn
6% annually?
Next week
• Lecture
• Capital budgeting
• Cash flows of investment projects

• Tutorial
• Another mini case study
 Thank you

Tiffany Cheng
TH810, 3400-2235
[email protected]
u.hk