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Financial Managment > Chapter 4: Time Value of Money > Flashcards

Chapter 4: Time Value of Money Flashcards

1
Q

WACC

A

Weighted average cost of capital - average rate of return required by all of the firm’s investors (equity and debt)

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2
Q

Intrinsic value of a company

A

Value of all expected free cash flows discounted at the weighted average cost of capital

aka PRESENT VALUE of expected future cash flows

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3
Q

Discounted cash flow analysis

A

Basically time value of money. method of determining today’s value of a cash flow to be received in the future

can be used to estimate a financial asset’s value by discounting the asset’s expected cash flows at a rate that reflects the asset’s risk

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4
Q

Compounding

A

Process of finding the future value of a single payment or series of payments based generally based on a periodic interest rate (unless continuous compounding)

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5
Q

Notes on compounding interest

A

Interest earned is based on balance at beginning of each year (and assumed to be paid at the end of the year)

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6
Q

FV[N]

A

= PV (1+I)^N

where I= interest rate and N = number of periods

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7
Q

Time value equation as built into financial caluclator

A

PV(1+I)^N + PMT(((1+I)^N-1)/I)+FV = 0

EITHER PV OR FV MUST BE ENTERED AS 0 (assuming I is less than 100%)

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8
Q

Entering the interest rate on a calculator

A

Entered as I/Y (interest/year)

automatically converts a whole number percentage into the appropriate decimal

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9
Q

When to use positive or negative sign for outflows on calculator

A

There are three cash flows in the time value of money equation. At least one must be negative and one positive when you enter information. Two possibilities:

  • one negative cash flow out and two positive cash flows in (receiving back interest and principal)
  • two negative cash flows out and one positive cash flow in (paying out interest and principal)
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10
Q

Time value of money in excel

A

=FV (I, N, PMT, PV, 0 or 1)
or
= PV(I, N, PMT, FV, 0 or 1)

I = interest rate (as decimal, unless using a reference cell formatted as a percentage)
N = number of periods
PMT = regular cash flows
PV= present value
FV = Future value
0 = end of period payment
1 = beginning of period payment

same rules for negative and positive values as a financial calcuator

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11
Q

Compound interest

A

interest that is earned or charged on interest from prior periods as well as principal

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12
Q

simple interest

A

aka regular interest

interest earned or charged only on the principal

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13
Q

FV of principal with simple interest

A

= PV + (PVIN)

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14
Q

opportunity costs (for the sake of investing)

A

A cash flow a firm must forgo in order to accept a project.

rate of return that would be earned on an alternative investment

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15
Q

Present value

A

the amount that, if it were on hand today, would grow to equal the given future amount in the given number of years

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16
Q

discounting

A

the process of finding the present value of a single payment or series of payments

reverse of compounding

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17
Q

PV formula

A

= FV[N] / (1+I)^N

= future value at n periods / (1+ interest rate) to the power of N

18
Q

Change in present value of a sum to be received as periods extend into the future

A

PV decreases with more periods

19
Q

Change in present value of a sum to be received as interest rate rises

A

higher the interest rate the faster the present value falls

20
Q

Finding I if PV, FV, and N are known

A

= (FV/PV)^(1/N) - 1

21
Q

Finding the interest rate in excel

A

=Rate(N, PMT, PV, FV, 0 or 1)

0 for end of period payments
1 for beginning of period payments

22
Q

perpetuity

A

series of payments of a fixed amount that continue indefinitely

23
Q

Present value of a perpetuity

A

PMT / I

PMT = payment received each period
I= rate

24
Q

relationship of present value to interest rate

A

inverse. If one rises the other falls

25
Q

Annuity

A

equal payments made at fixed intervals

26
Q

Ordinary annuity

A

also deferred annuity

payments at the END of each period

assumed unless otherwise stated

27
Q

Annuity due

A

Payments at the BEGINNING of each period

28
Q

Future value of an ordinary annuity

A

= PMT x (((1+I)^N -1)/I)

29
Q

Future Value of an annuity Due

A

= (PMT x (((1+I)^N -1)/I))*(1+I)

payments earn interest for one additional period over an ordinary annuity

30
Q

Present value of ordinary annuity

A

= PMT x ((1/I) - (1/(I(1+I)^N)))

31
Q

Present value of annuity due

A

= (PMT x ((1/I) - (1/(I(1+I)^N)))) * (1+I)

payments discounted for one less period than an ordinary annuity

32
Q

Difference between an ordinary annuity payment and annuity due payment

A

ordinary annuity payment / (1+ rate) = annuity due payment

33
Q

Excel function to find payments

A

= PMT(rate, nper, pv, fv, 0 or 1)

0= end of period
1= beginning of the period

34
Q

Excel function to find number of periods required to save given amount

A

= NPER (rate, pmt, pv, fv, 0 or 1)

0= ordinary annuity
1 = annuity due

35
Q

types of uneven cash flows

A

1) stream of annuity payments + additional lump sum in year N (bonds)

2) other uneven streams (stocks and capital investments)

36
Q

PV of annuity + final payment on financial calculator

A

N = number of periods
I/Y = interest rate
PMT = annuity
FV = lump sum
PV = solved for

37
Q

PV of irregular cash flow on financial calculator

A

CF button
enter after each value to lock in
down to enter next value

quit out

NPV button
I/Y enter
will show NPV
hit compute to get result

begin with Time 0 cash flow

38
Q

using excel to get present value of uneven cash flows

A

Use =NPV function

make sure outflows are negative and inflows are positive

begin with Time 1 cash flow

39
Q

Net future value of an uneven cash flow

A

= NPV * (1+I)^N

(unless NFV key is available)

40
Q

Time period 0

A

starting point, present time

41
Q

periods

A

number of time interest compounts

42
Q

Rule of 72

A

Product of the interest rate and number of years it will take to double your money is 72

if FV = 2PV
iN = 72

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