The Time Value of Money Flashcards
In what scenario can cash flows be compared and combined?
Cash flows can only be compared or combined at the same point in time
How do you determine the future value of a cash flow?
-FVn= C*(1+r)^n
-r= cost of capital
How do you determine the present value of future cash flows?
PV= C/(1+r)^n
-r= cost of capital
How do you calculate the present value of a stream of future cash flows?
Sum the present value of each individual cash flow, discounted appropriately using the cost of capital and the amount of time n until the cash flow
What is a perpetuity?
-A perpetuity is a stream of equal cash flows that occurs at regular intervals and lasts forever
-The first cash flow arrives at the end of the first priod
What is the equation for the present value of a perpetuity?
PV= C/r
What is an annuity?
-A perpetuity is a stream of N equal cash flows paid at regular intervals
What is the equation for the present value of an annuity?
PV= (C/r)* [1- 1/(1+r)^N]
What is the equation for the future value of an annuity?
FV= (C/r) *[(1+r)^N-1]
What is the difference between an annuity and a perpetuity?
An annuity ends after some fixed number of payments N whereas a perpetuity continues forever
What is a growing perpetuity?
A growing perpetuity is a stream of cash flows that occur at regular intervals and grow at a constant rate forever
What is the present value of a growing perpetuity?
-PV= C/ (r-g)
-g cannot be greater than r as if it was then the perpetuity would grow to some infinitely large number
What is a growing annuity?
A growing annuity is a stream of N cash flows paid at regular intervals. Each cash flow grows at a fixed rate until the end of the period
What is the present value of a growing annuity?
PV= [C/(r-g)]*[1-[(1+g)/(1+r)^n]]
What is the IRR?
This is the discount rate that sets the NPV = 0
