Ch. 9 Time Value Analysis Flashcards
Financial value of any asset including real asset, such as piece of diagnostic equipment or an ambulatory surgery center, is based on future cash flows.
Current dollars are worth more than future dollars.
Compounding: The process of going from today’s values (present values) to future values
The present value tells us what amount would have to be invested to earn the opportunity cost rate
If the investment can be obtained for a lesser amount, a higher rate will be earned
**Discounting: Finding the present value / Reverse of compounding **
Bond: A type of debt security in which an investor loans some amount of principal to a company
The company pormises to pay interest over the life of the bond and return the principal amount at maturity.
Cash flows expected to be earned form any investment must be discounted at a rate that reflects the return that could be earned on forgone investment opportunities
Forgone investments: Rate that could be earned on alternative investments with similar risks
Opportunity Cost = Discount rate
Discounting a potential investment at 10% prodeces a present value that provides a 10% return.
If the investment can be obtained for less than its present value, it will earn more than its opportunity cost rate and hence is a good investment.
Annuity: A series of equal payments at fixed intervals for a specified number of periods.
Ordinary Annuity: Also known as deferred annuity: Payments occure at the end of the period.
Annuity due: Payments are made at the beginning of each period.
Ordinary Annuity
When payments (PMT) are made, they replace the PV / FV
Perpetuties: Annuities that go on perpetually
Present Value of Perpetutiy = Payment / Interest Rate
Because the payments last forever, the future value of a perpetutiy is undefined.
Interest Rate (opportunity cost / Discount rate) dramatically impact the value of a perpetuity
Value of a perpetuity increases if interest rates fall
Value of a perpetuity decreases if interest rates rise
Cash Flow: A series of uneven lump sum amounts.
When a series of uneven cashflows are used, use the (CF) function.
Present Value:
Sum of the Present Value of the individual Cash flows.
NPV = Sum or net of the present values of a cash flow stream.
Express ROI in dollar terms or % terms.
Rate of Return
- Percentage Return
- Measures the interest rate that must be earned on the investment outlay to generate the expected cash flows.
- Expected periodic rate of return
Stated Rate: Also called the Nominal Rate
Effective Annual Rate: Is the rate that produces the same ending (future) value under annual compounding.
EAR = (1 + Istated / M)M - 1.0
Istated = Stated annual rate
M = Number of compounding periods
Istated / M = Periodic Interest rate
EAR = (1 + Periodic rate)M<span></span>- 1.0
Amortized Loan: A loan that is repaid in equal periodic amounts that include both principal and interest payments
