lecture 2: time value of money

Question 1

financial goal of a corporation is ..?

Answer 1

to maximize shareholder’s wealth

Question 2

managers can add value for the firm and its shareholders by:

Answer 2

keeping and reinvesting cash in “value-added” projects
OR
returning it to investors

Question 3

aim of investment decisions?

Answer 3

• to create value for its owners
• the manager searches for investments that offer rates of return HIGHER THAN the opportunity cost of equity capital (equity capital is usually abbreviated as re (small e) or ke (small e)

Question 4

opportunity cost of equity capital is also called.. (2)

Answer 4

–required rate of return on equity
–cost of equity

Question 5

what are cash flows (CFs) of investment projects?

Answer 5

Cash flow of a project is the amount of money being transferred into or out of a firm by implementing the project

if money is in: cash inflow
if money is out: cash outflow

Question 6

what are cash inflows sometimes referred to as and what can be done with these cash inflows?

Answer 6

–cash inflows are sometimes referred to as “free cash flows” that can be paid out to shareholders OR reinvested on their behalf

Question 7

cash flows are computed after..

Answer 7

after considering revenues, expenses, and taxes related to the project

Question 8

based on cash flows..what do financial managers do?

Answer 8

financial managers asses if a project is “value-added” or contributes to the shareholders’ wealth maximization

Question 9

what does time value of money refer to and why(4 reasons)?

Answer 9

time value of money refers to the fact that a pound in the hand today is worth more than a pound promised at some time in the future
1. inflation:recovering the loss of purchasing power
2. time preference: always prefer $ now to the same $ in the future
3. risk: compensating for variability (acknowledging the future is uncertain and that there needs to be compensation for risks and uncertainties people might face in the future when it comes to investments or loans)
4. opportunity cost: what can be done elsewhere

Question 10

effect of inflation on the time value of money

Question 11

effect of time preference on the time value of money

Question 12

effect of risk on the time value of money

Question 13

effect of opportunity cost of capital of the time value of money

Question 14

OVERALL..what does the time value of money tell us (3 things)

Question 15

future value definition

Question 16

future value assumptions

Question 17

cash inflows are designed with a positive or negative sign?

Answer 17

positive

Question 18

cash outflows are designed with positive or negative signs?

Answer 18

negative

Question 19

when do interest rates remain constant?

Answer 19

they remain constant throughout ALL FUTURE TIME PERIODS ..unless stated otherwise

Question 20

what is compounding

Answer 20

the process of leaving your money and any accumulated interest in an investment for more than one period, and thereby reinvesting the interest

Question 21

what does compounding the interest mean?

Question 22

simple interest?