Ch 4: Time Value of Money Pt 1 Flashcards
Simple Interest
Interest that is paid out over only one interest earning period
Future Value Formula
FV = PV(1+r)^n
PV
Present value of the principle or investment
r
Interest rate, yield, ROR
n
number of periods
FV
Future value of the investment, includes amount invested plus return/profit
When is interest compounded?
When an investment is held for more than one interest paying period
Compounding period
Interest paying period
What factor, ROR or time, has a greatest influence on FV?
Time
Present Value
The value of today (the value in today’s dollars) of a future cash flow or series of cash flows
Discounting
The process of going from future values to present values, the reverse of compounding
Present Value Formula
PV = FV/(1+r)^n
Discount rate
When ‘r’ is used to discount
Financial Valuation Process
The theoretical value of any financial asset is determined by discounting all future expected cash flows to the present and adding them up
How is the theoretical value of any financial asset determined?
Financial Valuation Process
Net Present Value
Discounted Future Cash Flows - Initial Costs or PV of Benefits - PV of Costs
When are you able to use net present value to compare investments?
Values at the same point in time, same time value of money; N and I/Y must be same for both investments
How are ROR expressed?
Annual ROR
Annuities
A series of equal payments made at fixed intervals for a specific number of periods
Annuity in Arrears
Ordinary annuity; payments occur at the end of each period
Ordinay Annuity Future Value Formula
FV = CF(1+r)^2+CF(1+r)^1+CF
Ordinary Annuity Present Value Formula
PV = CF/(1+r)^1+CF/(1+r)^2+CF(1+r)^3
Annuity Due
An annuity in which payments occur at the beginning of a period, ex. lease
Examples of ordinary annuities
Borrowing of intangible assets, ex. loans
Annuity Due Present Value Formula
PV = CF+CF/(1+r)^1+CF/(1+r)^2
What is the payment timing for annuity due?
BGN
What is the payment timing for ordinary annuity?
END
Annuity Due Future Value Formula
FV = CF(1+r)^3+CF(1+r)^2+CF(1+r)^1
Opportunity Cost of Capital
Discount/compound rate
