Interest Rates And Rates Of Return Flashcards
What is the cost of capital?
The percentage required by investors to provide capital either in the form of debt or equity
What are the reasons for applying a cost of capital for the investor?
- Time impatience - prefer to receive money now over promise of sum to be received in the future
- Risk - investment actual return may be much lower than expected return
- Inflation - money is continually losing value over time
What should the cost of capital represent for investors?
The overall % return expected by investors
What must investors be compensated with when they make the decision to save and invest?
Return or interest
From the firm’s point of view, what is the % cost of capital?
The % rate the firm pays to acquire capital funds
For the firm, if investments do not produce a % return at least equal to the % rate the firm pays to acquire capital funds, what does that mean?
They are not covering the cost of capital and should not be undertaken
What is the % cost of capital also known as?
Discount rate
What is a return?
What you get back from an investment
How do you calculate the % return?
((Overall return - initial investment)/investment) x 100
Or
Overall return investment - 1
What translates a present value into a future value?
Interest rate
What is the interest rate’s counterpart?
Discount rate
What translates a future value back into a present value?
Discount rate
How would you calculate the rate of return for one period of investment?
FV1/PV - 1
Example:
Consider the application of 10% interest compounding to a deposit of €100 for one and then two periods
One period ahead:
FV1 = (1+0.1)xPV
Two periods ahead:
FV2 = (1+0.1)2^2 x PV
