SU5 - Time Value of Money

Question 1

Explain Nominal interest rate

Answer 1

The nominal interest rate is the rate quoted in loan and deposit agreements.

The equation that links nominal and real interest rates is: (1 + nominal rate) = (1 + real interest rate) (1 + inflation rate).

It can be approximated as nominal rate = real interest rate + inflation rate.

Question 2

The Formula for Future Value

Answer 2

FVn = PV(1 + i)n

Question 3

Explain an annuity

Answer 3

It is a series of equal cash flows for each of a specified number of periods.

Question 4

There are two types of annuities. Name and explain.

Answer 4

1. an ordinary annuity - money deposited/received at the END of the period
2. an annuity due - money deposited/received at the BEGINNING of the period

Question 5

Formula for Present Value

Answer 5

PV = FV / (1 + i)n

Question 6

What is the first step of a loan amortising schedule?

Answer 6

Calculate PMT
PMT = PVn / PVIFAi,n

Amortising a loan actually involves creating an annuity out of a present amount.

Question 7

Investment decisions are made by means of capital budgeting techniques. Name them.

Answer 7

1. Payback Period
2. Net Present Value
3. Profitability Index
4. Internal Rate of Return

Question 8

Show formula for profitability index and explain.

Answer 8

1. It is calculated by dividing the present value of cash inflows by the initial investment.
2. This index measures the present value of the return per rand invested.

Question 9

Define internal rate of return

Answer 9

It is defined as the discount rate that equates the present value of cash inflows with the initial investment associated with a project.

Question 10

Value of a firm can be calculated how?

Answer 10

Value = (interest paid x PVIFAi,n) + (principal x PVIFi,n)