Finance Part 2 Test 1 Flashcards
Time Value Analysis
The use of time value of money techniques to value future cast flows, sometimes called discounted cash flow analysis
Time Line
A graphical representation of time and cash flows, may be an actual line or cells on a spreadsheet
Is an investment positive or negative on a number line?
Negative because you are losing the money
Why is sign convention important in Time Value Analysis?
essential to show whether it is an inflow or outflow of money, positive or negative, inflow = positive
Present Value
the beginning amount of an investment of a lump sum, an annuity, or a series of unequal cash flows
Compounding
The process of finding the future value of a lump sum, an annuity, or series of unequal cash flows
What is a lump sum?
type of compounding, there is a single starting point
What is compounding?
process of finding the future value
What is interest on interest?
compound interest, interest earned when interest payments are reinvested
How does the Future Value of a lump sum change as the time extended and interest rate increases?
Time extended leads to FV increase
Interest Rate Increases leads to FV increases
Discounting
the process of finding the PV of a lump sum, annuity, or a series of unequal cash flows
How is Discounting related to Compounding?
its the reverse of compounding
How does PV of a lump sum to be received in future change?
Time extended, longer the time, lower the PV
Interest Rate Increase, higher the rate, lower the PV
Opportunity Cost
cost associated with alternative uses the same funds
Example of Opportunity Cost
if money is used for one investment, it is no longer available for other uses
Why does an investment have an opportunity cost?
the money could be used for another investment or use applies to all investments no matter what
How are OC rates established?
the OC rate applied to an investment cash flow is the rate that could be earned on alternative investments of similar risk
the primary determinant is the riskiness of the cash flows being discounted
Does the OC rate depend on the source of the investment funds?
No, it depends only on the riskiness of cash flows and returns available on alt investments of similar risk
Future Value
later money on a time line
Interest Rate
“exchange rate” between earlier and later money
also called discount rate, cost of capital, OC of capital, and required return
FV formula
FV = PV (1+R)^T
Future Value Int Factor
(1+R)^T
PV Formula
PV = FV/(1+R)^T
Simple Interest Formula
Money Amount + (Number of Periods)(Money Amt)(Int Rate)
Examples of Financial Decisions that Typically involve uneven cash flows
the financial evaluation of a proposed outpatient clinic or MRI facility rarely involves constant cash flows
How are PV of uneven cash flows found using a calculator?
Find the PV of each amt and then add them up
How are PV of uneven cash flows found using excel?
=NPV (INT rate cell, Begin Amt:End Amt)
Amts go down, usually the first column
What is meant by Net Present Value?
Function in excel, assumes that cash flows occur at the end of each period, calculated as of the beginning of the period of the first cash flow
Annuity
includes the words “constant amt”
payments are the same in each period
a series of payments of a fixed amt for a specified number of equal periods
What to use on excel to find NPER?
use it to solve for time
What to use on excel to find RATE?
use it to solve for Interest rate
What is the rule of 72?
(72)/(int rate) = years for money to double in value
(72)/(years) = interest rate required to double money in an account
simple and quick method for judging the effect of different interest rates on the growth of lump sum deposit
Payment
PMT
in TVA, the dollar amt of an annuity cash flow
Ordinary ( Regular ) Annuity
annuity with payments occurring at the end of each period
Annuity Due
An annuity with payments occurring at the beginning of each period
Future Value of Annuity Due = FV of an ordinary annuity x (1 + Int Rate)
Which type of annuity has a greater Future Value?
Annuity due because it is compounded for one additional unit
Greater by 1+Int
Which annuity has a greater PV?
Annuity Due is larger than that of a similar regular annuity, payments are shifted left, discount for 1 less year
Perpetuity
an annuity that lasts forever (has no maturity date)
Perpetuity Formula
PV(Perpetuity) = Payment / Interest Rate
PMT/I
What happens to the val of a perpetuity when int rate increases or decreases?
When the rate increases, value decreases
When the rate decreases, value increases
Rate Formula
R = (FV/PV)^1/T - 1
Time Formula
T = ln(FV/PV) / ln(1+r)
How to determine the T value when their are multi cash flows when FV?
You take the total number of years minus what year the cash flow was made
How to determine the T value when their are multi cash flows when PV?
The T amount is what year is was when the cash flow was made
What is the FV function on excel?
FV(int rate, t value, , negative cash flow)
How to decided whether or not you should make the investment?
If the FV of the investment is less than the PV or what you invest, then you should not
Future Value in One Year
principal plus interest
find the interest by taking the rate and multiplying it by the investment amt
PV on excel
when calculating the FV
should be negative
FV on excel
When calculating the PV
should be negative
Rate on excel
PV should be negative
FV should be positive
NPER on excel
PV should be negative
FV should be positive
Perpetuity Formula
PV = C/r
C is PMT on excel
Annuity Formula PV
C((1-(1/((1+r)^t)))/r)
Annuity Formula FV
C(((1+r)^t - 1 ) / r )
PV on excel formula of an annuity
=PV(rate,years,payments)
FV on excel formula of an annuity
=-FV(rate, nper, pmt)
make sure that it’s negative to make result positive
PMT on excel
PMT(rate, nper, pv, fv)
if pmt is left negative, it shows that its a cash outflow
NPER function on excel
NPER(rate, pmt, pv)
Rate function on excel
RATE ( NPER, PMT, PV)
Annuity due on excel
indicated by a 1 on type field
