Time Value of Money

Question 1

Future Value

Answer 1

Amount to which an investment will grow after interest.

FV= PV( 1+r )^t

Question 2

Present Value

Answer 2

Value today of a future cashflow.

PV=C/( 1+r)^t

Question 3

Net Present Value

Answer 3

It is the present value of the sum of all future cash flows minus the required investment.

Question 4

Discount Rate

Answer 4

Interest rate used to compute present values of future cash flows.
1/(1+r)^t.
Also known an the opportunity cost of a particular project.

Question 5

Internal Rate of Return

Answer 5

The discount rate at which the NPV of the cash flow is equal to zero.

Question 6

How is the IRR estimated?

Answer 6

By calculating the NPV using a different r, until we find the NPV to be zero.

Question 7

Perpetuities

Answer 7

It is an annuity that continues forever.

PV= C/r

Question 8

Example of a Perpetuity

Answer 8

Consols

Question 9

Annuities

Answer 9

It is an asset that pays a fixed sum each year for a specified number of years.
(A2 in the PV Table)

Question 10

Growing Perpetuity

Answer 10

PV=C/(r-g)

where g is the growth rate.