Chapter 4 - Introduction to Valuation: Time Value of Money

Question 1

investing for a single period

Answer 1

if you invest for one period at an interest rate of r, your investment will grow to (1 +r) per dollar invested

Question 1

future value

Answer 1

the amount an investment is worth after one or more periods (compound value)

• refers to the amount of money an investment will grow to over some period of time at some given interest rate

Question 2

compounding

Answer 2

the process of accumulating interest in an investment over time to earn more interest

Question 3

interest on interest

Answer 3

interest earned on the investment of previous interest payments

Question 4

compound interest

Answer 4

interest earned on both the initial principal and the interest reinvested from prior periods

Question 5

simple interest

Answer 5

interest earned only on the original principal amount invested

Question 6

effect of compounding

Answer 6

not great over short time periods, but it really starts to add up as the time horizon grows

Question 7

present value

Answer 7

the current value of future cash flows discounted at the appropriate discount rate

Question 8

discount

Answer 8

calculation of the present value of some future amount

Question 9

discount rate

Answer 9

the rate used to calculate the present value of future cash flows

Question 10

discounted cash flow (DCF) valuation

Answer 10

• calculating the present value of a future cash flow to determine its value today
• the process of valuing an investment by discounting its future cash flows

Question 11

present versus future value

Answer 11

what we called the present value factor is just the reciprocal of (that is, 1 divided by) the fitter value factor:

Question 12

determining the discount rate

Answer 12

it will turn that we frequently need to determine what discount rate is implicit in an investment