THE TIME VALUE OF MONEY (L2) Flashcards
Future Value
Value of money at a specific time period in the future
Present Value
The value of of the future amount right now, eg. if we need £100 a year from now, how much should we deposit today
How to calculate future value
FV= PV*(1+r)^t
How to calculate present value
PV=FV/(1+r)^t
Discounted cashflow
The present value of a future amount, how much you’ll invest knowing what the interest rate is (say you know how much you want to get back after)
Alternate names for interest rate
Discount rate
Required rate of return
Opportunity cost of capital
Required rate of return
Interest rate required/demanded from an investment
Opportunity cost of capital
Foregone return of the best alternative investment
Rule to find the present value of a cashflow
sum of PV of the individual cashflows (how much you get that year), to find PV, divide cashflow by interest rate
Present value of a perpetuity
Cash flow sequence that pays a fixed amount forever eg consol bond.
PV=C/r
Present value of a growing perpetuity
The cashflow sequence increases by g each time eg you invest £10 more each time
PV= C/r-g
Present value of Annuity
Fixed cashflows for a fixed number of periods eg car loans (limited amount of time you have to pay it)
C/r - (C/r x 1/(1+r)^T)
John will start college next year and wants to make a single deposit so he can withdraw £20,000 each year for the next 5 years. If the IR is 10% how much should he deposit today?
75815.74
Future value of an Annuity
What the present value of your money would be, T years from today.
FV=Cx((1+r)^t-1/r)
Compounding
When our money receives interest with higher frequency within the year
