1.3. The Time Value of Money

Question 1

What is a Stream of Cash Flows and how can it be represented?

Answer 1

a series of cash flows lasting several periods
can be represented on a timeline

Question 2

If someone offers you to pay equal installements for a payment its best to…

Answer 2

… pay it back as soon as possible, bc the further in the future, the less value it has for you now (inflation, gut feeling, security)
if you have to pay it anyway, choose to pay as late as possible

Question 3

What are the three Rules of Time Travel?

1.
2.
3.

Answer 3

1. Comparing and Combining Values - it is only possible to compare or combine values at the same point in time
2. Moving Cash Flows forward in time (right) - to move a cash flow forward in time. we must compound it
3. Moving Cash Flows back in time (left) - to move a cash flow back in time, we must discount it (dividing by the interest rate factor, (1+r) (for each period))

Question 4

Time Value of Money | Definition

Answer 4

the difference in value between money today and money in the future

Question 5

Interest Rate | Definition

Answer 5

rate at which we can exchange money today for money in the future

Question 6

Future Value (FV)
vs
Present Value (PV)

Answer 6

value in terms of dollars in the future (at the end of timeline)
vs
value in terms of dollars today (at beginning of timeline)

Question 7

One year risk-free interest rate factor
vs
One year risk-free discount factor

Answer 7

(1+r)
vs
1/ (1+r)

Question 8

How to Value a Stream of Cash Flows

1.
2.

Answer 8

• computing the present value of each individual cash flow
• then, once the cash flows are in common uits of dollars today, we combine (+/-) them (!! in FV, N-n)

Question 9

Concept of Net Present Value for Decision Making

Answer 9

investment decision based on cost-benefit comparison of a project

Question 10

What is the net present Value (NPV) of investment opportunity?

Answer 10

PV (benefits) - PV (costs) = PV (benefits-costs) = NPV

Question 11

if benefits are cash inflows and costs are cash outflows, then the NPV of investment opportunity…

Answer 11

… equals present value of the stream of cash flows of the opportunity

Question 12

receiving a project´s stream of future cash flows is equivalent to receiving…

Answer 12

… its NPV in cash today

Question 13

What to keep in mind when choosing an investment opportunity

1.
2.

Answer 13

• choose all stand-alone projects with positive NPV
• when selecting among investment decisions take the alternative with the highest, positive NPV

Question 14

Exercise: What is meant by cost of a delay?

Answer 14

Value of future year in present year