Time Value

Question 1

The Time Value of Money is the concept that

Answer 1

money is worth more today that it is in the future.

Question 2

Being given $100 today is better than being given $100 in the future because

Answer 2

you don’t have to wait for your money.

Question 3

The process of determining how much a future cash flow is worth today is called

Answer 3

discounting

Question 4

Discounting

Answer 4

the process of determining how much money paid/received in the future is worth today. You discount future values of cash back to the present using the discount rate.

Question 5

Single-period investments use

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a specified way of calculating future and present value.

Question 6

Multi-period investment:

Answer 6

an investment that takes place over more than one periods.

Question 7

Simple interest increases the balance linearly, while compound interest increases it

Answer 7

exponentially

Question 8

The Future Value can be calculated by knowing the

Answer 8

present value, interest rate, and number of periods, and plugging them into an equation.

Question 9

The future value of a present value is calculated by

Answer 9

plugging the present value, interest rate, and number of periods into one of two equations.

Question 10

Calculating FV is a matter of identifying

Answer 10

PV, i (or r), and t (or n), and then plugging them into the compound or simple interest formula.

Question 11

Simple Interest Formula:

Answer 11

Simple interest is when interest is only paid on the amount you originally invested (the principal). You don’t earn interest on interest you previously earned.

Question 12

The time value of money framework says that

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money in the future is not worth as much as money in the present.

Question 13

Future Value:

Answer 13

the value of an asset at a specific date. It measures the nominal future sum of money that a given sum of money is “worth” at a specified time in the future, assuming a certain interest rate, or more generally, rate of return, it is the present value multiplied by the accumulation function.

Question 14

Present Value:

Answer 14

also known as present discounted value, is the value on a given date of a payment or series of payments made at other times. If the payments are in the future, they are discounted to reflect the time value of money and other factors such as investment risk. If they are in the past, their value is correspondingly enhanced to reflect that those payments have been (or could have been) earning interest in the intervening time. Present value calculations are widely used in business and economics to provide a means to compare cash flows at different times on a meaningful “like-to-like” basis.

Question 15

Time period assumption:

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Business profit or losses are measured on a timely basis.

Question 16

The Fisher Equation

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approximates the amount of interest accrued after accounting for inflation.

Question 17

A company will theoretically only invest if

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the expected return is higher than their cost of capital, even if the return has a high nominal value.

Question 18

Fisher Equation:

Answer 18

The nominal interest rate is approximately the sum of the real interest rate and inflation.

Question 19

Explain the importance of the five components of TVM, as applied in a calculation

Answer 19

(discount rate, duration, payment, present value, future value).

Question 20

Amortization of a loan is

Answer 20

the process of identifying a payment amount for each period of repayment on a given outstanding debt.

Question 21

Amortization:

Answer 21

This is the process of scheduling intervals of payment over time to pay back an existing debt, taking into account the time value of money.

Question 22

The present value of a perpetuity is simply

Answer 22

the payment size divided by the interest rate and there is no future value.

Question 23

Perpetuities are a special type of annuity; a perpetuity is an

Answer 23

annuity that has no end, or a stream of cash payments that continues forever.

Question 24

To find the future value of a perpetuity requires having a

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future date, which effectively converts the perpetuity to an ordinary annuity until that point.

Question 25

Perpetuities with growing payments are called

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Growing Perpetuities; the growth rate is subtracted from the interest rate in the present value equation.

Question 26

The future value (FV) measures the

Answer 26

nominal future sum of money that a given sum of money is “worth” at a specified time in the future assuming a certain interest rate, or more generally, rate of return. The FV is calculated by multiplying the present value by the accumulation function.

Question 27

The FV of multiple cash flows is the sum of

Answer 27

the FV of each cash flow.

Question 28

Annuity:

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a specified income payable at stated intervals for a fixed or a contingent period, often for the recipient’s life, in consideration of a stipulated premium paid either in prior installment payments or in a single payment. For example, a retirement annuity paid to a public officer following his or her retirement.

Question 29

Incremental cash flows:

Answer 29

the additional money flowing in or out of a business due to a project.

Question 30

FV of a single payment:

Answer 30

The FV of multiple cash flows is the sum of the future values of each cash flow.

Question 31

The PV of multiple cash flows is simply the

Answer 31

sum of the present values of each individual cash flow.

Question 32

Sum FV:

Answer 32

The PV of an investment is the sum of the present values of all its payments.

Question 33

You have $300,000 that you want to invest in a one year Certificate of Deposit (CD) with a 4% annual interest rate. What will be the value of that CD in a year?

Answer 33

FV = $300,000 × 1.04 = $312,000 Using Calculator: N = 1, I/Y = 4, PV = 300,000. [CPT] FV = $312,000.

Question 34

What is the future value in 30 years of $100,000 invested today in a savings account earning a 1% compound interest rate every year (rounded up to the nearest dollar)?

Answer 34

FV = $100,000 × 1.0130 = $134,785 Using Calculator: N = 30, I/Y = 1, PV = 100,000. [CPT] FV = $134,785

Question 35

You plan to invest $100,000 in a 3 year Certificate of Deposit that has a 5% compound interest rate. What is its future value?

Answer 35

FV = $100,000 × 1.053 = $115,763 Using Calculator: N = 3, I/Y = 5, PV = 100,000. [CPT] FV = $115,763.

Question 36

You plan to invest $100,000 in a 3 year Certificate of Deposit that has a simple interest rate of 5%. What is its future value?

Answer 36

FV = $100,000 + (3 × 5% × $100,000) = $115,000.

Question 37

What is the future value in 30 years of $100,000 invested today in a savings account earning a 1% simple interest rate every year (rounded up to the nearest dollar)?

Answer 37

FV = $100,000 + (30 × 1% × $100,000) = $130,000.