Tine Value Of Money Flashcards
Present value
Earlier money on a timeline
Future value
Later money on a timeline
Interest rate
“Exchange rate” between earlier money and later money (We also call “r” discount rate; cost of capital; opportunity cost of capital; and required return).
Discount rate (K)
The rate used to calculate the PV of future cash flows
COST OF CAPITAL
(K,WACC,r,i)
Total cost of a company’s debt and equity - key in financial decisions
Opportunity cost
Expected return that is forgone by investing in a project rather in comparable financial securities.
Required return
Rate of return required by capital suppliers such as shareholders and bondholders
The value of money (FV/PV)
• The phrase Time Value of Money means a dollar in hand is worth more than a dollar in the future
– Why is this true?
• Simple interest – interest is not reinvested / interest is earned only on the original principal:
• Compound interest – interest earned in prior periods is reinvested / earning interest on interest.
Power of Compouding
• Futurevaluesdependupontheassumedinterestrate, particularly for long-lived investments
• Theeffectofcompoundingbecomesmoresignificantas time increases
• Theeffectofmorefrequentcompoundinggivesa higher value than less frequent compounding- example quarterly compounding compared to annual compounding
Present value and discounting
• Present value is the reverse of future value. Instead of compounding the money forward into
the future, we discount it back to the present.
• Formula:
What is discounting cash flow (DCF) valuation
Calculating the present value of a future cash flow to determine its worth today
Present values
How much do I have to invest today to have some specified amount in the future?
What do we mean when we talk about discounting
finding the present value of some future amount.
What are we talking about when we say the “value” of smth
we are talking about the present value unless we specifically indicate that we want the future value.
Implied interest rate
Difference between spot rate and interest rate for the futures and forward.
