Module 5: Discounted Cash Flow Valuation Flashcards
T or F: When calculating the FV of multiple cash flows, if the last cash flow is in the FV year, you just add that cash flow number to the rest.
True; you don’t have to grow it by anything since it’s already in that FV year.
How do you calculate the FV of multiple cash flows? For example, how would you do this if there were two cash flows?
- Calculate the FV of the first.
- Calculate the FV of the second.
- Add them together.
T or F: To calculate the future value of multiple cash flows, you just move all the cash flows to the end (the FV year) and add them up.
True (getting them to same time period to combine)
To use our PMT key, we need cash flows that occur each period that are ____ _____. In addition to those, we could have extra cash flows at the _______ or ______.
the same; beginning; end
a fixed cash flow that occurs each period for a certain fixed amount of time.
annuity
How do we calculate the cash flow if we have an annuity? (What key do we use on calculator for annuities)
Put the amount of the annuity that is repetitive into the PMT key, instead of calculating these cash flows separately.
T or F: every set of cash flows can be rewritten as an annuity.
False; not when you have a differing number in the MIDDLE.
To get the FV at the beginning of the year, we need to change a calculator setting. How do we do this? (For questions when it says you make the deposits at the BEGINNING of the year)
Hit 2nd, then PMT (or BGN).
Then, change this from END to BEGINNING by hitting 2nd, then ENTER (or SET)
when the annuity cash flows occur at the end of each period.
ordinary annuity
when the payments occur at the beginning of each period.
annuity due
Why would the future value of payments be bigger if we deposited them at the beginning of each year compared to if we deposited them at the end of each year?
Because the payments will have more time to grow this way
What is a way to enter cash flows into the calculator if we can’t think about how to convert them into an annuity (what button on the calculator can we use)?
the CF button (it will bring up a menu we can start putting Cash Flows in)
When you first hit the CF button, we will see CFo, which stands for:
Cash flow at time zero
The Cash Flow keys are great for calculating (present/future) value, however, we cannot calculate (present/future) value directly.
present; future
How do we use NPV?
We use the NPV button to enter interest for the problem where it says I, then use the down button to get to NPV and hit CPT after using the CF button to enter cash flows.
T or F:
- Annuity Keys = we need to have even cash flows
- Cash Flow buttons = we can enter any pattern of cash flows we wanted (don’t have to be even)
True
What do the F’s stand for under the Cash Flow Buttons?
Frequency
If the cash flow annuity was $1,500 for 3 years, how could you use frequency on the Cash Flow buttons?
Set F as 3, so we don’t have to enter each cash flow separately (like doing CO1= 1,500, C02= 1,500, etc.)
If we have F as 3, it just means to ______ this cash flow 3 times.
repeat (Then, if you entered another cash flow after that, it would then be Cash Flow 4, even though it would still say C02. )
An infinite # of payments (mostly will value stocks like this)
perpetuities
T or F: Not a way to do perpetuities in the calculator using our keys.
True
What is the equation to calculate perpetuity?
PVo = Cash flow / interest rate
In the calculator, this would be: PMT / interest rate
T or F: When solving for a perpetuity, you want to enter your interest rate as a decimal.
True (ex: 10%, we need to enter in as .10)
a perpetuity where the cash flow increases at a constant rate, g, each period.
Growing Perpetuity
T or F: We have to have a bigger g (growth rate) than r (interest rate) for the growing perpetuity formula to work.
False; need a bigger r (interest rate) than g (growth rate) for it to work
What is the formula for calculating PV as of year 0 when a growing perpetuity is involved?
PVo (present value as of year 0) = C1 (PMT in year 1) / (r-g) (interest rate - growth rate)
T or F: We need next years cash flow (CF1) to get the value today (PVo) for growing perpetuity problems.
True
For growing perpetuity problems:
If we’re earning less than the amount we want it to grow by (interest rate is less than growth rate), there’s no way we can pay out money without reaching a ________. balance.
declining
the stated annual rate which ignores compounding
Annual Percentage Rate (APR)
How is Annual Percentage Rate (APR) calculated?
Periodic rate x # of periods
the annual rate that would be equivalent to the periodic rate once compounding is taken into account.
Effective Annual Rate (EAR)
How do you calculate Effective Annual Rate (EAR)?
EAR = (1 + (APR/m)^m - 1
- APR / m → number of periods per year
- m → number of periods
a loan where the balance will get paid down over time if we’ve got a constant payment. So, you will make a constant payment every month (or whatever period the loan is).
amortized loan
Typically, consumer loans will be _______ (ex: you’ll have a fixed payment for a car loan, or mortgage).
month
When determining which loan is most attractive when using EAR and APR, we want to calculate _______ because what matters most is how much total we are paying (or receiving if an investment).
Effective Annual Rate (EAR)
What do you set the FV to for an amortized loan?
0 (since you’re paying it down)
For amortizing:
1. Interest will (decline/increase/ stay the same) over time.
2. Principal will (decline/increase/ stay the same) over time.
3. Ending and beginning balance will (decline/increase/ stay the same) over time.
4. Payment will (decline/increase/stay the same) over time.
- Decline
- Increase
- Decline
- Stay the same
