Chapter 5
As financial managers and pursuing either the maximization of the firm’s stock price or our own
material well-being, we need a set of tools to plan for different sets of cash inflows (income, gifts,
inheritance, future property or various asset sales, bonuses, retirement proceeds, etc.) and outflows
(retirement and education funding, home and auto purchases, durable housing goods purchases,
children’s expenses, parent’s expenses, etc.). We need a manner with which we can compare the
impact of each of these flows to one-another; we need a way to contrast the impacts of differing cash
flows occurring years apart. The material in chapters 4-8 begins to provide those tools.
First, the material from Ch. 4 (review our chapter 4 handout), then on with ch. 5.
Key ideas from chapter 4 include all the issues and calculations in table 4.4 on p.106.
Similarly, key ideas from ch. 5 include all the issues and calculations in table5.2 on p.129.
These are the tasks you need to be able to perform from chapter 5:
1. Breakdown of the annuity and perpetuity functions.(Recalling that multiple, equally
spaced cash flows - like car loans and mortgages - are annuities {ordinary annuities vs. annuities
due}. Endless, equally sized and equally spaced cash flows - like British Consols or preferred stocks
in the US - are perpetuities)
2. Future values of multiple cash flows (saving for retirement, home purchase, educ.)
3. Present values of multiple cash flows (to express varying cash flows occurring in the
future in present value terms to make them comparable)
4. Valuing annuities and perpetuities.
5. Calculating mortgage payments, number of years to pay, effective cost of borrowing, limit
of borrowing given limits on affordable payments, required payments to fund
retirement/house/education, present and future values of multiple cash flows...deja vu all over again?
6. Draw all of your studies from sections 5.3 and 5.4 from your class notes. You will be
tested on these sections. (Actually, you will be examined on all the topics mentioned above.)
Remember most critically from these sections that to compare interest rates, we ought always
convert rates to Aeffective annual rates.@
7. Pay close attention to and be comfortable with all the examples in class.
Work with your classmates on the problems from chapters 4 and 5; braced on the tasks above, you
are in good shape with your intro to the TVOM and should be well on the way to developing a long
and intimate relationship with your BA-II Plus...life is good, isn’t it?
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