Module 5: Discounted Cash Flow Valuation

Question 1

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.

Answer 1

True; you don’t have to grow it by anything since it’s already in that FV year.

Question 1

How do you calculate the FV of multiple cash flows? For example, how would you do this if there were two cash flows?

Answer 1

1. Calculate the FV of the first.
2. Calculate the FV of the second.
3. Add them together.

Question 2

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.

Answer 2

True (getting them to same time period to combine)

Question 3

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 ______.

Answer 3

the same; beginning; end

Question 4

a fixed cash flow that occurs each period for a certain fixed amount of time.

Answer 4

annuity

Question 5

How do we calculate the cash flow if we have an annuity? (What key do we use on calculator for annuities)

Answer 5

Put the amount of the annuity that is repetitive into the PMT key, instead of calculating these cash flows separately.

Question 6

T or F: every set of cash flows can be rewritten as an annuity.

Answer 6

False; not when you have a differing number in the MIDDLE.

Question 7

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)

Answer 7

Hit 2nd, then PMT (or BGN).
Then, change this from END to BEGINNING by hitting 2nd, then ENTER (or SET)

Question 8

when the annuity cash flows occur at the end of each period.

Answer 8

ordinary annuity

Question 9

when the payments occur at the beginning of each period.

Answer 9

annuity due

Question 10

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?

Answer 10

Because the payments will have more time to grow this way

Question 11

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)?

Answer 11

the CF button (it will bring up a menu we can start putting Cash Flows in)

Question 12

When you first hit the CF button, we will see CFo, which stands for:

Answer 12

Cash flow at time zero

Question 13

The Cash Flow keys are great for calculating (present/future) value, however, we cannot calculate (present/future) value directly.

Answer 13

present; future

Question 14

How do we use NPV?

Answer 14

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.

Question 15

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)

Answer 15

True

Question 16

What do the F’s stand for under the Cash Flow Buttons?

Answer 16

Frequency

Question 17

If the cash flow annuity was $1,500 for 3 years, how could you use frequency on the Cash Flow buttons?

Answer 17

Set F as 3, so we don’t have to enter each cash flow separately (like doing CO1= 1,500, C02= 1,500, etc.)

Question 18

If we have F as 3, it just means to ______ this cash flow 3 times.

Answer 18

repeat (Then, if you entered another cash flow after that, it would then be Cash Flow 4, even though it would still say C02. )

Question 19

An infinite # of payments (mostly will value stocks like this)

Answer 19

perpetuities

Question 20

T or F: Not a way to do perpetuities in the calculator using our keys.

Answer 20

True

Question 21

What is the equation to calculate perpetuity?

Answer 21

PVo = Cash flow / interest rate

In the calculator, this would be: PMT / interest rate

Question 22

T or F: When solving for a perpetuity, you want to enter your interest rate as a decimal.

Answer 22

True (ex: 10%, we need to enter in as .10)

Question 23

a perpetuity where the cash flow increases at a constant rate, g, each period.

Answer 23

Growing Perpetuity

Question 24

T or F: We have to have a bigger g (growth rate) than r (interest rate) for the growing perpetuity formula to work.

Answer 24

False; need a bigger r (interest rate) than g (growth rate) for it to work

Question 25

What is the formula for calculating PV as of year 0 when a growing perpetuity is involved?

Answer 25

PVo (present value as of year 0) = C1 (PMT in year 1) / (r-g) (interest rate - growth rate)

Question 26

T or F: We need next years cash flow (CF1) to get the value today (PVo) for growing perpetuity problems.

Answer 26

True

Question 27

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.

Answer 27

declining

Question 28

the stated annual rate which ignores compounding

Answer 28

Annual Percentage Rate (APR)

Question 29

How is Annual Percentage Rate (APR) calculated?

Answer 29

Periodic rate x # of periods

Question 30

the annual rate that would be equivalent to the periodic rate once compounding is taken into account.

Answer 30

Effective Annual Rate (EAR)

Question 31

How do you calculate Effective Annual Rate (EAR)?

Answer 31

EAR = (1 + (APR/m)^m - 1

• APR / m → number of periods per year
• m → number of periods

Question 32

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).

Answer 32

amortized loan

Question 33

Typically, consumer loans will be _______ (ex: you’ll have a fixed payment for a car loan, or mortgage).

Answer 33

month

Question 34

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).

Answer 34

Effective Annual Rate (EAR)

Question 35

What do you set the FV to for an amortized loan?

Answer 35

0 (since you’re paying it down)

Question 36

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.

Answer 36

1. Decline
2. Increase
3. Decline
4. Stay the same