Chapter 11: Time Value of Money & Cost Benefit Analysis Flashcards
Time Value of Money (TVM)
Since money can earn interest under normal economic and financial circumstances, it is worth more the sooner it can be obtained
Annuity
A fixed sum of money distributed on a regular basis, whether monthly, quarterly, yearly, or at some other regular interval
Benefit-Cost Ratio (BCR)
Also known as cost-benefit ratio.
A measure of program efficiency; the ratio of the benefits of a project relative to its costs, all expressed in monetary terms
Cost-Benefit Analysis (CBA)
A method of determining whether or not a certain project should be done. CBA involves finding and quantifying all the positive factors (benefits) and all the negative factors (costs) of a proposed action and determining the difference between them (the net) to decide whether or not the action is advisable.
Discount Rate
The interest rate used to discount future cash flows to determine the present value of an investment
Future Value
The value of cash or another type of asset at a future date that is equivalent in value to a specified sum now
Interest Rate
The percentage rate at which interest is charged on a loan for a period
Internal Rate of Return (IRR)
A measurement of the return on an investment. The IRR is the discount rate at which a project’s net present value equals zero.
Net Present Value (NPV)
The difference between cash inflows and cash outflows, both discounted to their present values.
Present Value
The value of cash or another type of asset on a given date of a future payment or series of future payments; discounted to reflect the time value of money
Simple Interest Rate Method
Adds interest to the principal at the end of each period. Interest is calculated on principal only. Uncommon method.
Compound Interest Rate Method
Interest is earned on the principal + interest accumulated in previous investment periods.
FV = pv * (1+i)^n
FV = Future Value
pv = principal/present value of investment
i = interest rate
n = number of compounding time periods
Annuity Future Value
calculation
FV = PMT [((1+i)^n - 1)/i] FV = Future Value PMT = amount of payment or receipt i = interest rate n = the number of compounding time periods
Annuity Present Value
calculation
PV = PMT [(1-1/(1+i)^n)/i] FV = Future Value PMT = amount of payment or receipt i = interest rate n = the number of compounding time periods
Net Present Value (NPV)
definition
Difference between cash inflows and cash outflows, both discounted to their present values
If NPV > 0, project/investment creates value (accept)
If NPV = 0, then project/investment neither creates nor destroys value
If NPV < 0, project/investment destroys value (reject)
Net Present Value (NPV)
calculation
NPV = n sum t=0 * [(bt - ct)/((1+t)^t)] b = cash inflows c = cash outflows i = discount rate t = time period n = number of time periods
Ex Ante Analysis (CBA)
Takes place before project is implemented. Allows analyst to investigate/compare potential alternatives of programs to advise decision-making.
Ex Post Analysis (CBA)
Takes place after the project is implemented. Assesses efficiency of the program. Used for accountability auditing, to be used for decision making for future programs & investments.
CBA Steps (8)
- Determining standing and perspectives
- Determining alternatives or basis for comparison
- Listing impacts
- Monetizing impacts, including costs and benefits
- Discounting future impacts
- Calculating & using net present value as decision rule
- Performing sensitivity analysis
- Selecting alternative with largest net social benefits
Social Cost Benefit Analysis (CBA)
Interests of all people in the jurisdiction are taken into consideration
Determining “standing”
Determining whose interest counts. Usually determined by the project sponsor, and the nonprofit that provides the services.
Status Quo
The existing situation or program, used as a baseline comparison to a potential different use of funds
