Chapter 5 - Time Value of Money Flashcards
What is a Time Line?
Tool used in time value analysis; a graphical representation used to
show the timing of cash flows.
Cash flows are shown directly below the tick marks, relevant interest rate is shown just above the time line. Unknown cash flows, which you are trying to
find, are indicated by question marks.
What do the intervals on a timeline depict?
The intervals are time periods such as years, months, quarters or days.
Time 0 is today, and it is the beginning of Period 1; Time 1 is one period from today, and it is both the end of Period 1 and the beginning of Period 2; and so forth.
Each tick mark corresponds to
both the end of one period and the beginning of the next one. Thus, if the
periods are years, the tick mark at Time 2 represents the end of Year 2 and the
beginning of Year 3.
What is Future Value (FV)?
The amount to which a cash flow or series of cash flows will grow over a given period of time when compounded at a
given interest rate.
Ending amount of account after N periods.
What is Present Value (PV)?
The value today of a future cash flow or series of cash flows. Beginning amount.
What is Compounding?
The process of moving cash flows forward in time or up the time line.
What is CFt?
Cash flow.
Cash flows can be positive or negative. The cash flow for a particular period is often given as a subscript, CFt, where t is the period.
Thus, CF0 = PV = the cash flow at Time 0, whereas CF3 is the cash flow at the end of Period 3.
What does I stand for?
What does r stand for?
Interest rate earned per year.
Rate of return - interchangeable
Interest earned is based on the balance at the beginning of each year, and we assume that it is paid at the end of the year.
What does INT stand for?
Dollars of interest earned during the year = Beginning amount X I.
In our example, INT= $100(0.05)= $5.
What does N or n stand for?
Number of periods involved in the analysis.
How do you calculate Future Values using the step by step approach?
Multiply the initial amount and each succeeding amount by (1+I)
Ex. 5% interest would be (1+0.05) = 1.05
How do you calculate Future Values (with compound interest) using the formula approach?
FVn = PV ( 1 + I ) ^n
What is compound interest?
It is when interest is earned on prior periods’ interest.
What is simple interest?
It is when interest is not earned on interest.
How do you calculate Future Values (with simple interest) using the formula approach?
FV= PV + PV(I)(N)
What does PMT stand for on a financial calculator?
Payment.
This key is used when we have a series of equal, or constant, payments.
