Topic 2- The Time Value of Money Flashcards
What is the equation for the Future Value (FV) of a cash flow (C)?
Future Value = Cash flow x (1+interest rate)^time
FV = C x (1+r)^t
What is an annuity?
A stream of equal cash flows that occurs yearly over a given period
What is the equation for the Future Value (FV) of an annuity?
FV = C/r x [(1+r)^t - 1]
What is the equation for the Present Value (PV) of a future cash flow (C)?
PV = C/(1+r)^t
What is the Discount Factor (DF)?
1/(1+r)^t
What is the equation for the present value of multiple cash flows?
PV_0 = C1/(1+r)^1 + C2/(1+r)^2 +…+ Ct/(1+r)^t
How can you calculate the PV of multiple cash flows when all cash flows are equal?
- Formula for PV of annuity when t is a finite number
- Formula for PV of perpetuity when t is an infinite number
What is the formula for the PV of an annuity?
PV = C/r x [1 - 1/(1+r)^t]
What is Net Present Value (NPV)?
The NPV of a project or investment is the difference between the present value of its benefits and the required investment
What is the formula for NPV?
Net Present Value = Initial investment + Present value of multiple cash flows
NPV_0 = C_0 + PV_0
What is the NPV rule and why is it so?
Accept investments with positive NPVs because by doing so, the manager is fulfilling their objective of increasing the firm’s value
What is a perpetuity?
Like an annuity but goes on forever
What is the formula for the PV of a perpetuity?
PV = C/r
What is the formula for PV of a growing annuity?
PV = C_1/r-g x [1 - (1+g/1+r)^t]
where g is the annual growth rate of the cash flow
What is the formula for the PV of a growing perpetuity?
PV = C1/r-g
