Financial Functions

Microsoft Excel provides a series of functions destined to perform various types of financially related operations. These functions use common factors depending on the value that is being calculated. Many of these functions deal with investments or loan financing.

The Present Value is the current value of an investment or a loan. For a savings account, a customer could pledge to make a set amount of deposit on a bank account every month. The initial value that the customer deposits or has in the account is the Present Value. The sign of the variable, when passed to a function, depends on the position of the customer. If the customer is making deposits, this value must be negative. If the customer is receiving money (lottery installment, family inheritance, etc), this value should be positive.

The Future Value is the value the loan or investment will have when the loan is paid off or when the investment is over. For a car loan, a musical instrument loan, a financed refrigerator, a boat, etc, this is usually 0 because the company that is lending the money will not take that item back (they didn't give it to the customer in the first place, they only lend him or her some money to buy the item). This means that at the end of the loan, the item (such as a car, boat, guitar, etc) belongs to the customer and it is most likely still worth something.

As described above and in reality, the Future Value is the amount the item would be worth at the end. In most, if not all, loans, it would be 0. On the other hand, if a customer is borrowing money to buy something like a car, a boat, a piano, etc, the salesperson would ask if the customer wants to put a "down payment", which is an advance of money. Then, the salesperson or loan officer can either use that down payment as the Future Value parameter or simply subtract it from the Present Value and then apply the calculation to the difference. Therefore, you can apply some type of down payment to your functions as the Future Value.

The Number Of Periods is the number of payments that make up a full cycle of a loan or an investment.

The Interest Rate is a fixed percent value applied during the life of the loan or the investment. The rate does not change during the length of the Periods.

It is very important to understand how these two arguments are passed to a function. The period could be the number of months of a year, which is 12; but it could be another length. Suppose a customer is getting a car loan that would be financed in 5 years. This is equivalent to 5 * 12 = 60 months. In the same way, a cash loan can stretch from 0 to 18 months, a carpenter truck loan can have a life financing of 40 months, and a condominium can be financed for 15 years of 12 months plus an additional 8 months; this is equivalent to (15 * 12) + 8 = 188 months. Here is the tricky part, especially as far as Microsoft Excel deals with its finance functions. If you pass the number of Periods in terms of years, such as 5 for a car loan that stretches over 5 years, then you can pass the Rate as a percentage value, such as 8.75%. If you pass the number of Periods in terms of months, for example you can pass it as 44 for a car that is financed in 3 years and 8 months, then you must communicate this to the Rate argument by dividing the Rate by 12. In other words, a Rate of 8.75% would be passed as 8.75%/12. If the Rate was typed in a cell named B2 that displays 8.75%, you can pass it as B2/12.

For deposits made in a savings account, because their payments are made monthly, the rate is divided by the number of Periods of a year, which is 12. If an investment has an interest rate set at 14.50%, the Rate would be 14.50/12 = 1.208. Because the Rate is a percentage value, its actual value must be divided by 100 before passing it to the function. For a loan of 14.50% interest rate, this would be 14.50/12 = 1.208/100 = 0.012.

The Payment is the amount the customer will be paying. For a savings account where a customer has pledged to pay a certain amount in order to save a set (goal) amount, this would be the amount the customer would pay every month. If the customer is making payments (car loan, mortgage, deposits to a savings account, etc), this value must be negative. If the customer is receiving money (lottery installment or annuity, family inheritance, etc), this value must be positive.

The Payment Type specifies whether the payment is made at the beginning or the end of the period. For a monthly payment of an item financed like a car, a boat, a guitar, or a house this could be the end of every month.

To calculate the future value of an investment, you can use the FV() function. The syntax of this function is:

FV(Rate, Periods, Payment, PresentValue, PaymentType)

1. Start a new workbook and fill up Sheet1 as follows:
    
2. Save it as Business
3. Double-click Sheet1 to put its label into edit mode. Type Future Value and press Enter
4. Click cell C8 and, on the main menu, click Insert -> Function...
5. In the Paste Function dialog box, in the Function Category list, click Financial. In the Function Name list, double-click FV and move the FV window so you can see the values on the worksheet
6. Click the box to the right of Rate and, on the worksheet, click cell C5 and type /12
7. In the FV window, click the box to the right of Nper and, on the worksheet, click cell C7
8. In the FV window, click the box to the right of Pmt and type -
9. On the worksheet, click cell C6
10. In the FV window, click the box to the right of Pv and type -
11. On the worksheet, click cell C4
12. Since this is a loan, the payments are expected at the end of the month. Therefore, in the FV window, click the box to the right of Type and type 0
     
13. Click OK

To calculate the number of periods of an investment or a loan, you can use the NPER() function. Its syntax is:

NPER(Rate, Payment, PresentValue, FutureValue, PaymentType);

Here is an example:

The PMT() function is used to calculate the regular payment of loan or an investment. Its syntax is:

PMT(Rate, NPeriods, PresentValue, FutureValue, PaymentType)

In the following example, a customer is applying for a car loan. The cost of the car will be entered in cell C4. It will be financed at a rate entered in cell C6 for a period set in cell C7. The dealer estimates that the car will have a value of $0.00 when it is paid off.

Practical Learning: Calculating the Monthly Payments of a Loan

1. Double-click Sheet3 to put it in edit mode. Type Payments Amount and press Enter
2. Complete the worksheet as follows
    
3. Click cell C8 and type =PMT(
4. Click cell C6 and type /12,
5. Click cell C7 and type ,-
6. Click cell C4 and type ,
7. Click cell C5
8. Type ,0) and, on the Formula Bar, click the Enter button
    
9. Suppose that, during the evaluation, a customer decides that she doesn't need a brand new car anymore. Also, she thinks that a 5-year car loan is too long. Furthermore, she wants to make a $4500.00 down payment to reduce the monthly payments. On the other side of the desk, the salesperson who wants to make a juicy commission on this loan has decided to increase the interest rate.
   Change the new values of the worksheet as follows and see the result
    
10. Save the workbook
     

The Amount Paid As Interest During a Period

When a customer is applying for a loan, an investment company must be very interested to know how much money it would collect as interest. This allows the company to know whether the loan is worth giving. Because the interest earned is related to the interest rate, a company can play with the rate (and also the length) of the loan to get a fair (?) amount.

The IPMT() function is used to calculate the amount paid as interest on a loan during a period of the lifetime of a loan or an investment. It is important to understand what this function calculates. Suppose a customer is applying for a car loan and the salesperson decides (or agrees with the customer) that the loan will be spread over 5 years (5 years * 12 months each = 60 months). The salesperson then applies a certain interest rate.

The IPMT() function can help you calculate the amount of interest that the lending institution would earn during a certain period. In essence, you can use it to know how much money the company would earn in the 3rd year, or in the 4th year, or in the 1st year. Based on this, this function has an argument called Period, which specifies the year you want to find out the interest earned in.

The syntax of the IPMT() function is:

IPMT(Rate, Period, NPeriods, PresentValue, FutureValue, PaymentType)

The Rate argument is a fixed percent value applied during the life of the loan.

The PresentValue is the current value of the loan or investment. It could be the marked value of the car, the current mortgage value of a house, or the cash amount that a bank is lending.

The FutureValue is the value the loan or investment will have when the loan is paid off.

The NPeriods is the number of periods that occur during the lifetime of the loan. For example, if a car is financed in 5 years, this value would be (5 years * 12 months each =) 60 months. When passing this argument, you must remember to pass the right amount.

The Period argument represents the payment period. For example, it could be 3 to represent the 3rd year of a 5 year loan. In this case, the IPMT() function would calculate the interest earned in the 3rd year only.

The PaymentType specifies whether the periodic (such as monthly) payment of the loan is made at the beginning (1) or at the end (1) of the period.

The FutureValue and the PaymentType arguments are not required.
 

Practical Learning: Calculating the Monthly Payments of a Loan

1. To add a new worksheet, on the main menu, click Insert -> Worksheet
2. Double-click the new Sheet1 tab to put it in edit mode. Type Periodic Interest Earned and press Enter
3. Move the new worksheet to be the most right
4. Complete the worksheet as follows
    
5. Click cell C9 and type =IPMT(
6. Click cell C5 and type /12,
7. Click cell C6 and type ,
8. Click cell C7 and type ,-
9. Click cell C4 and type ,
10. Click cell C8 and type ,
11. Type ,0) and, on the Formula Bar, click the Enter button
     
12. Save the workbook
     

The Amount Paid as Principal

While the IPMT() function calculates the amount paid as interest for a period of a loan or an investment, the PPMT() function calculates the actual amount that applies to the balance of the loan. This is referred to as the principal. Its syntax is:

PPMT(Rate, Period, NPeriods, PresentValue, FutureValue, PaymentType)

The arguments are the same as described in the previous sections.

Practical Learning: Evaluating the Amount Paid As Principal

1. Change the Periodic Interest Earned worksheet as follows
    
2. Click cell C10 and type =PPMT(
3. Click cell C5 and type /12,
4. Click cell C6 and type ,
5. Click cell C7 and type ,-
6. Click cell C4 and type ,
7. Click cell C8 and type ,
8. Type ,0) and, on the Formula Bar, click the Enter button
    
9. Save the workbook

The Present Value of a Loan or an Investment

The PV() function calculates the total amount that a future investment is worth currently. Its syntax is:

PV(Rate, NPeriods, Payment, FutureValue, PaymentType)

The arguments are the same as described earlier.

The Interest Rate

Suppose a customer comes to a car dealer and wants to buy a car. The salesperson would first present the available cars to the customer so the customer can decide what car he likes. After this process and during the evaluation, the sales person may tell the customer that the monthly payments would be $384.48. The customer may then say, "Wooooh, I can't afford that, man". Then the salesperson would ask, "What type of monthly payment suits you". From now on, both would continue the discussion. Since the salesperson still wants to make some money but without losing the customer because of a high monthly payment, the salesperson would need to find a reasonable rate that can accommodate an affordable monthly payment for the customer. 

The RATE() function is used to calculate the interest applied on a loan or an investment. Its syntax is:

RATE(NPeriods, Payment, PresentValue, FutureValue, PaymentType, Guess)

All of the arguments are the same as described for the other functions, except for the Guess. This argument allows you to give some type of guess for a rate. This argument is not required. If you omit it, its value is assumed to be 10.
 

Practical Learning: Calculating the Interest Rate

1. To add a new worksheet, on the main menu, click Insert -> Worksheet
2. Double-click the new Sheet1 tab to put it in edit mode. Type Interest Rate and press Enter
3. Move the new worksheet to be the most right
4. Change the Interest Rate worksheet as follows
    
5. Click cell C8 and type =-RATE(
6. Click cell C7 and type ,
7. Click cell C6 and type ,-
8. Click cell C4 and type ,
9. Click cell C5 and type ,0)*12 and, on the Formula Bar, click the Enter button
    
10. To use the ABS() function, change the function in cell C14 to 
    =ABS(RATE(C7,C6,-C4, C5, 0)*12) and press Enter
11. Save the workbook

The Internal Rate of Return

The IRR() function is used to calculate an internal rate of return based on a series of investments. Its syntax is:

IRR(Values, Guess)

The Values argument is a series (also called an array or a collection) of cash amounts that a customer has made on an investment. For example, a customer could make monthly deposits in a savings or credit union account. Another customer could be running a business and receiving different amounts of money as the business is flowing (or losing money). The cash flows don't have to be the same at different intervals but they should (or must) occur at regular intervals such as weekly (amount cut from a paycheck), bi-weekly (401k directly cut from paycheck), monthly (regular investment), or yearly (income).

The Values argument must be passed as a collection of values, such as a range of selected cells, and not an amount. Otherwise you would receive an error.

The Guess parameter is an estimate interest rate of return of the investment.
 

Practical Learning: Calculating the Internal Rate of Return

1. To add a new worksheet, on the main menu, click Insert -> Worksheet
2. Double-click the new Sheet1 tab to put it in edit mode. Type Internal Rate of Return and press Enter
3. Move the new worksheet to be the most right
4. Change the worksheet as follows
    
5. Click cell D12 and type =IRR(
6. Select cells D4:D10 and, on the Formula Bar, click the Enter button
    
7. In cell D11, type 12 and click cell D12
8. In the Formula Bar, change the function to =IRR(D4:D10, D11) and press Enter (you shouldn't need any significant difference unless you change the range of cells such as D4:D8)
9. Save the workbook

The Net Present Value

The NPV() function uses a series of cash flows to calculate the present value of an investment. Its syntax is:

NPV(Rate, Value1, Value2, ...)

The Rate parameter is the rate of discount during one period of the investment.

As the NPV() function doesn't take a fixed number of arguments, you can add a series of values as Value1, Value2, etc. These are regularly made payments for each period involved. Because this function uses a series of payments, any payment made in the past should have a positive value (because it was made already). Any future payment should have a negative value (because it has not been made yet).
 

Practical Learning: Calculating the Net Present Value

1. To add a new worksheet, on the main menu, click Insert -> Worksheet
2. Double-click the new Sheet1 tab to put it in edit mode. Type Net Present Value and press Enter
3. Move the new worksheet to be the most right
4. Change the worksheet as follows
    
5. Click cell C14 and type =-NPV(
6. Click cell C13 and type ,
7. Select cells C4:C12 and, on the Formula Bar, click the Enter button
    
8. To use the ABS() function, change the function in cell C14 to =ABS(NPV(C13,C4:C12)) and press Enter
9. Save the workbook