Chapter 4 - The Time Value of Money Flashcards
NPV
Express net benefit of the project in terms of cash today
Stream of Cash Flows
Series of cash flows lasting several periods
Future Value*
Value of cash flow that is moved forward
Time Value of Money
Difference in value between money today and money in the future
Compound Interest
Earning interest on interest
Compounding
Moving the cash flow from the beginning to the end of the year
Geometric or exponential growth
The type of growth that results in compounding
Discounting
Process of moving a value or cash flow backward in time (finding the equivalent value today of a future cash flow)
**arrow going in the direction to the left shows that the value is being moved back or discounted
Perpetuity
Stream of equal cash flows that occur at regular intervals and last forever
“Law of one price”
Payment in Arrears
Cash flow arrives at the end of the 1st period
Annuity
A stream of N equal cash flows paid at regular intervals.
**Difference between perpetuity and annuity: annuity ends after some fixed number of payments.
Examples of Annuities: car loans, mortgages
Annuity Due
When the payment begins immediately
Growing Perpetuity
A stream of cash flows that occur at regular intervals and grow at a constant rate forever. The first payment does not grow!
Growing Annuity
A stream of N growing cash flows, paid at regular intervals. It is a growing perpetuity that eventually comes to an end.
*The first cash flow arrives at the end of the first period. The first cash flow does not grow.
3 Rules of Time Travel
- It is only possible to compare or combine values at the same point in time
- To move a cash flow forward in time, you must compound it
- To move a cash flow back in time, we must discount it
