Session 3- Discounted Cash Flow Valuation Flashcards
What is present value
Earlier money on a timeline
What is FV
Future value is later money on a TL
What is the interest rate
“Exchange rate” between earlier money and later money
Synonyms for Int. Rate
Required Rate of return
Disc. Rate
Cost of capital
Opportunity cost of capital
FV formula
FV= PV (1+r)^t
FV int. Factor
(1+r)^t
What does discounting mean in terms of PV and FV
Finding the present val of some future value
What do we mean when we’re trying to find the value of something
Finding the PV
Normal PV formula
PV= FV/(1+r)^t
PV formula for 1 year/period
C1/1+r
What is the PV of $500 to be receive in 5 years? 10 years? The discount rate is 10%. Why is one answer lower than the other?
To get $500 in 5 years, you would need to invest 310.56 TODAY
To get $500 in 10 years, you would need to invest 192.75 TODAY
This is the because for a given int. Rate the longer the period, the lower the present value because the money has more time to grow or compound
What is the PV of $500 received in 5 years if the interest rate is 10%? If the int. Rate is 15% all else remaining constant? Why is one PV larger than the other
10%= 310.46
15%= 248.58
At 15% the PV is lower because the rate at which it compounds is higher. Instead of getting 10% compounded to your investment each year, you get 15%
How to calculate interest rate (r) using FV formula
Original formula: FV=PV(1+r)^t
Solve for r
FV/PV=(1+r)^t
(FV/PV)^1/t= 1+r
(FV/PV)^1/t-1=r
r= (FV/PV)^1/t-1
What is the rule of 72? Formula?
Quick way to estimate how long it will take for your investment to double or double your money
72÷ rate as % (NUMERATOR)
Eg.
72/7
= 10.3 years
At at rate of 7% it will take me 10.3 years to double my money
What is EAR?
EAR- Effective Annual Rate
This is the actual rate paid (or received) after accounting for compounding that occurs during the year.
usually higher than original interest rate
