Topic 1 - Financial Decision Making

Question 1

Present Value Formula

Answer 1

PV = Future Savings / (1 + r)^n

Question 2

Future Value Formula

Answer 2

FV = Present Savings x (1 + r)^n

Question 3

Net Present Value Formula

Answer 3

NPV = PV (benefits) - PV (costs)

• ALWAYS use NPV to compare 2 projects/ investments

Question 4

The Law of One Price

Answer 4

States that in an efficient market, identical goods should sell for the same price regardless of where they are sold.

Question 4

Arbitrage Opportunity

Answer 4

A trading strategy that yields profit without taking risk or making any investment. Once people recognize an arbitrage opportunity the price quickly rises.
(EG. money lying on the street, once spotted disappears quickly)

Question 5

Effective Annual rate formula (EAR)

Answer 5

EAR = ( 1 + i/n )^n - 1

Question 6

EAR definition

Answer 6

Effective Annual Rate is used to calculate the actual return on an investment or loan when interest is compounded more frequently that annually.

Question 7

Separation Principle

Answer 7

we can separate a firms investment decisions from its financing choice.

Question 8

Term Structure

Answer 8

The relationship between the investment term and the interest rate is called the term structure of interest rates.
It is determined in the market based on the individuals willingness to borrow and lend.

Question 9

Annuity Definition

Answer 9

A special stream of cash flows that pays the same amount regularly for an finite number of periods

Question 10

Perpetuity Definition

Answer 10

A special stream of cash flows that pays the same amount regularly for an infinite number of periods

Question 11

Present Value of an annuity

Answer 11

PV = C/r - C/r(1+ r)^N

Question 12

Present value of a perpetuity

Answer 12

PV = C/r

Question 13

Time Value of Money

Answer 13

The difference in value between money today and money in the future.

Question 14

Risk free interest rate

Answer 14

The rate at which money can be borrowed or lent without risk

Question 15

The 3 Rules of Time Travel

Answer 15

1. Only possible to compare or combine values at the same point in time
2. To move CF forward we must compound it
3. To move CF backward we must discount it

Question 16

APR

Answer 16

Annual Percentage Rate, is the amount of simple interest earned in one year, without considering the effects of compounding interest

Question 17

Mutually Exclusive

Answer 17

when 2 projects can’t happen simultaneously

Question 18

Factors that influence willingness to borrow and lend

Answer 18

• Inflation
• Government Policy
• Expectations of future growth/ future interest rate changes

Question 19

PV growing perpetuity formula

Answer 19

PV = C/r-g