S5: Time Value of Money

Question 1

Present value

Answer 1

How much something is worth in today’s $

Question 2

Future value

Answer 2

How much something will be worth at a specified point in the future

Question 3

Interest rate (r)

Answer 3

“price” of borrowing/ “return” on investments

Question 4

Periods (t)

Answer 4

Time over which money is borrowed or invested

Question 5

TVM

Answer 5

Time value of money: $ today is worth more than $ in the future because money can earn a rate of return over time

Question 6

What are the 5 TMV applications?

Answer 6

1. Stock Valuation
2. Bond Valuation
3. Company Valuation
4. Project Valuation
5. Personal Finance

BCPPS Valuation & Finance

Question 7

What is the formulaic relationship between PV & FV?

Answer 7

PV=FV/(1+r)^t

Question 8

Stock Valuation

Answer 8

1/5 of TMV applications - Determines what a stock is worth based on PV of its dividend or “free cash flows” the firm generates

Question 9

Bond Valuation

Answer 9

1/5 of TMV applications - Determines what a bond is worth based on PV of its interest payments and the principal to be paid in maturity

Question 10

Company Valuation

Answer 10

1/5 of TMV applications - Determines what a firm is worth based on PV of its future cash flows

Question 11

Project Valuation

Answer 11

1/5 of TMV applications - Determines where a firm should take on a project based on PV of projected cash flows

Question 12

Personal Finance

Answer 12

1/5 of TMV applications - Determines how much is needed to save today for a down payment on a home or for retirement

Question 13

Compounding vs Discounting

Answer 13

Compounding: PV -> FV, Discounting: FV -> PV

Question 14

Compounding interest (FV factor)

Answer 14

Accumulation of $ based on “new interest earned on interest previously earned” -> (1+r)^t

Question 15

Simple interest

Answer 15

Does not compound, IR % of principle -> (1+r)

Question 16

Discount rate (PV factor)

Answer 16

The % used to determine the PV of future cash flows -> 1/(1+r)^2

Question 17

PV Factor

Answer 17

In the equation PV=FV/(1+r)^t, 1/(1+r)^2 is the PV factor

Question 18

FV Factor

Answer 18

In the equation FV=PV*(1+r)^2, (1+r)^2 is the FV factor