15. Financial Mathematical Techniques

Question 1

What is simple interest and what is the formula.

Answer 1

The interest earned in equal amounts, as a percentage of the original amount invested. S = X + nrX.
X = the original sum invested
r = the interest rate
n = the number of periods
S = the sum that is generated by the investment after n periods

Question 2

What is the formula for compound interest?

Answer 2

S = x(1+r)^n

X = the original sum invested 
r = the interest rate 
n = the number of periods 
S = the sum generated by the investment after n periods

Question 3

What is EAR and what is its formula?

Answer 3

The equivalent annual rate is used to give a single interest rate that is representative of a weekly or monthly interest rate.

The formula is (1+R) = (1+r)^N

R = effective annual rate 
r = period rate 
n = number of periods in a year

Question 4

What is net present value?

Answer 4

If the discounted value of the future cash inflows is higher than the cost of setting up a project today then the project is said to have a positive net present value.

Question 5

What is an annuity?

Answer 5

A series of equal cash flows

Question 6

What is the formula for discount factor to perpetuity?

Answer 6

1 / Cost of capital