Financial Management Flashcards
Present value
Estimated current value of a future amount to be received, discounted at an appropriate rate, usually at the cost of capital rate (the current market interest rate).
PV = Expected cash inflow / (1 + discount rate)^ number of periods
Present value
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Future value, compound value
The value of a sum after investing over one or more periods.
FV = cash to be invested x (1 + interest rate)^ number of periods over which the cash is invested
Discount rate
Rate at which a bill of exchange or an Accounts Receivable is paid (discounted) before it’s maturity date.
Net present value (NPV)
The difference between the present value of the expected future cash flows from an investment and the cost of the investment. A zero net present value means the project repays original investment plus the required rate of return. A positive net present value means a better return, and a negative net present value means a worse return.
NPV = -Co + C1/(1+r) + C2/(1+r)^2 + …
Compounding
The process of estimating the future value of a present investment by applying compound interest rates. Opposite of discounting.
Simple interest
Interest computed only on the principal and not on principle plus interest earned or incurred in previous periods. The interest is not reinvested.
Compound interest
Interest on interest; each interest payment is reinvested. Interest computed on the principal amount to which interest earned to-date has been added.
Discounting
The process of calculating the present value, or discounted value, of an expected future cash flow. The opposite of compounding.
Present value factor
Multiplier used to calculate the present value of future cash flow.
Stated annual interest rate, annual percentage rate (APR)
The annual interest rate that accrues, without considering the effect of compounding.
Effective annual rate (EAR), effective annual yield (EAY)
The actual annual interest rate that accrues, after taking into consideration the effects of compounding (when compounding occurs more than once per year).
Continuous compounding
The process of compounding interest at every infinitesimal instant.
Perpetuity
A constant stream of cash flows without end.
PV = C/r
Growing perpetuity
A gradually increasing stream of cash flows over an indefinite period of time.
PV = C/(r-G)
Annuity
A series of regular payments that lasts for a fixed number of periods.
Annuity factor
The multiplier used to compute the present value of the stream of level payments, C, for T years.
Pure discount loan
A loan in which the borrower receives money today and repays a single lump sum at sometime in the future.
Interest-only loan
A loan in which the borrower pays interest each period and repays the entire principal at some point in the future.
Amortized loan
A loan in which the lender requires the borrower to repay parts of the loan amount over time.
Amortizing the loan
The process of providing for a loan to be paid off by making regular principal reduction.
