Module 3 - Chapter 5

Question 1

Define:

Time Value of Money

Answer 1

A dollar that you will receive in the future is not worth as much today as a dollar you already have

Question 2

List:

What is Needed to Answer any Time Value of Money Problem

Answer 2

1. the cash flows
2. when the cash flows occurred
3. Expected rate of return or discount rate
4. time period

Question 3

List:

What do do if we don’t have an interest rate

Answer 3

1. determine opportunity cost of capital

OR

2. we are looking at solving for interest rate not value

Question 4

Define:

Opportunity Cost of Capital

Answer 4

The rate we can obtain elsewhere for an investment with similar risk to our cash flows

Question 5

Define:

Timeline

Answer 5

Drawing out where your cash flows occur

Question 6

Acronym:

PV

Answer 6

Present Value

Question 7

Define:

Present Value (PV)

Answer 7

Cash in today’s dollars

Earlier money on a timeline

Question 8

Acronym:

FV

Answer 8

Future Value

Question 9

Define:

Future Value (FV)

Answer 9

Cash in future dollars

Later money on a timeline

Question 10

Define:

Payments in Single Cash Flows

Answer 10

Same payment each period
(Ex - car payment, mortgage)

Amount to invest to accumulate a certain/specific FV

Question 11

Define:

Interest Rate

Answer 11

“Exchange Rate” between earlier money and later money

Question 12

List:

Types of Interest Rates

Answer 12

1. Discount Rate
2. Cost of Capital
3. Opportunity Cost of Capital
4. Required Return or Required Rate of Return

Question 13

Answer:

A timeline allows us to ___(a)___ the cash flows to see ___(b)___ relative to ___(c)___

Answer 13

a. graph out
b. when they occur
c. when we want to determine the value

Question 14

Answer:

A cash flow received at time 0 can also be referred to as a ___(a)___

Answer 14

a. cash flow at the beginning of period/year 1

Question 15

Answer:

A cash flow received at time 1 is typically referred to as a ___(a)___ or as a ___(b)____

Answer 15

a. cash flow at the end of year 1

b. cash flow at the beginning of year 2

Question 16

Answer:

Unless otherwise indicated, cash flows/payments are assumed to occur at ___(a)___

Answer 16

a. the end of each period

Question 17

Acronym:

r

Answer 17

Interest Rate

Question 18

Answer:

Interest rate is almost always stated as a/an ___(a)___

Answer 18

a. annual rate

Question 19

Acronym:

n

Answer 19

total number of periods

Question 20

Acronym:

m

Answer 20

the total number of periods per year

Question 21

Define:

Compounding Interest

Answer 21

The process of accumulating interest on an investment over time to earn more interest

Question 22

Define:

Interest on Interest

Answer 22

Interest earned on the reinvestment of previous interest payments

Question 23

Define:

Compound Interest

Answer 23

Interest earned on both the initial principal and the interest reinvested prom prior periods

Question 24

Define:

Simple Interest

Answer 24

Interest earned only on the original principal amount invested