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Corporate Finance > Topic 4 - Time Value Money And DCF > Flashcards

Topic 4 - Time Value Money And DCF Flashcards

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1
Q

What is the time value of money?

A

The principle that money today is worth more than the same amount in the future due to its potential earning capacity.

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2
Q

What is present value?

A

The current worth of a future sum of money given a specific rate of return.

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3
Q

What is future value?

A

The value of a current asset at a future date based on an assumed rate of growth.

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4
Q

What is compounding?

A

The process of earning interest on both the initial principal and the accumulated interest from previous periods.

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5
Q

What is discounting?

A

The process of determining the present value of a future amount by applying a discount rate.

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6
Q

What is a discount rate?

A

The interest rate used to calculate the present value of future cash flows.

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7
Q

What is an annuity?

A

A series of equal payments made at regular intervals over a period of time.

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8
Q

What is a perpetuity?

A

A series of equal payments made at regular intervals that continue indefinitely.

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9
Q

What is the formula for the present value of a perpetuity?

A

PV = C / r, where C is the cash flow per period and r is the discount rate.

Example sentence: If the cash flow per period is $100 and the discount rate is 5%, the present value would be $2,000.

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10
Q

What is the formula for future value with compounding interest?

A

FV = PV * (1 + r)^n, where PV is the present value, r is the interest rate, and n is the number of periods.

Example sentence: If the present value is $1,000, the interest rate is 3%, and there are 5 periods, the future value would be $1,159.27.

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11
Q

What is the formula for present value with discounting?

A

PV = FV / (1 + r)^n, where FV is the future value, r is the interest rate, and n is the number of periods.

Example sentence: If the future value is $5,000, the interest rate is 4%, and there are 3 periods, the present value would be $4,310.34.

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12
Q

What is the difference between simple interest and compound interest?

A

Simple interest is calculated only on the principal, while compound interest is calculated on the principal and previously earned interest.

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13
Q

What is an ordinary annuity?

A

An annuity where payments are made at the end of each period.

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14
Q

What is an annuity due?

A

An annuity where payments are made at the beginning of each period.

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15
Q

What is the formula for the future value of an annuity?

A

FV = C * [(1 + r)^n - 1] / r, where C is the payment per period, r is the interest rate, and n is the number of periods.

Example sentence: If the payment per period is $200, the interest rate is 6%, and there are 4 periods, the future value would be $902.36.

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16
Q

What is the formula for the present value of an annuity?

A

PV = C * [1 - (1 + r)^-n] / r, where C is the payment per period, r is the interest rate, and n is the number of periods.

Example sentence: If the payment per period is $150, the interest rate is 4%, and there are 6 periods, the present value would be $774.83.

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17
Q

What is the difference between nominal and real interest rates?

A

Nominal interest rates do not account for inflation, while real interest rates are adjusted for inflation.

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18
Q

What is the effective annual rate (EAR)?

A

The annual rate of interest that accounts for compounding within the year.

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19
Q

What is the formula for the effective annual rate (EAR)?

A

EAR = (1 + r/n)^n - 1, where r is the nominal interest rate and n is the number of compounding periods per year.

Example sentence: If the nominal interest rate is 8% and there are 4 compounding periods per year, the effective annual rate would be 8.39%.

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20
Q

What is the present value of a lump sum?

A

The value today of a single future payment, discounted at the appropriate rate.

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21
Q

What is the future value of a lump sum?

A

The value at a specific future date of a single payment made today, grown at the appropriate rate.

22
Q

How does an increase in the discount rate affect present value?

A

An increase in the discount rate decreases the present value of future cash flows.

23
Q

What is the rule of 72?

A

A quick formula to estimate the number of years required to double an investment at a given annual rate of return. Divide 72 by the interest rate.

24
Q

What is continuous compounding?

A

A scenario where interest is compounded an infinite number of times per year, rather than a finite number.

25
Q

What is the formula for future value with continuous compounding?

A

FV = PV * e^(r * t), where e is the base of the natural logarithm, r is the interest rate, and t is time.

Example sentence: If the present value is $500, the interest rate is 2%, and the time is 3 years, the future value would be $530.58.

26
Q

What is the present value of an uneven cash flow stream?

A

The sum of the present values of each individual cash flow in the stream, discounted at the appropriate rate.

27
Q

What is the future value of an uneven cash flow stream?

A

The sum of the future values of each individual cash flow in the stream, compounded at the appropriate rate.

28
Q

How does an increase in time affect future value?

A

An increase in time generally increases future value due to the effect of compounding.

29
Q

How does an increase in time affect present value?

A

An increase in time generally decreases present value as future cash flows are discounted more.

30
Q

What is an interest-only loan?

A

A loan where the borrower pays only interest during the loan term, with the principal repaid at the end.

31
Q

What is an amortizing loan?

A

A loan where the borrower repays both interest and principal in each payment.

32
Q

What is the present value of a growing perpetuity?

A

PV = C / (r - g), where C is the first cash flow, r is the discount rate, and g is the growth rate of the cash flows.

Example sentence: If the first cash flow is $150, the discount rate is 6%, and the growth rate is 3%, the present value would be $3,000.

33
Q

What is the present value of a growing annuity?

A

PV = C * [1 - ((1 + g) / (1 + r))^n] / (r - g), where C is the cash flow, r is the discount rate, g is the growth rate, and n is the number of periods.

Example sentence: If the cash flow per period is $100, the discount rate is 5%, the growth rate is 2%, and there are 5 periods, the present value would be $421.51.

34
Q

What is the future value of a growing annuity?

A

FV = C * [(1 + r)^n - (1 + g)^n] / (r - g)

35
Q

What is the present value of a growing annuity?

A

PV = C * [1 - ((1 + g) / (1 + r))^n] / (r - g)

C is the cash flow, r is the discount rate, g is the growth rate, and n is the number of periods.

36
Q

What is the future value of a growing annuity?

A

FV = C * [(1 + r)^n - (1 + g)^n] / (r - g)

C is the cash flow, r is the interest rate, g is the growth rate, and n is the number of periods.

37
Q

What is a zero-coupon bond?

A

A bond that pays no periodic interest but is issued at a discount and repays the face value at maturity.

38
Q

What is the time value of money’s role in bond pricing?

A

Bond prices reflect the present value of future cash flows (coupon payments and principal repayment) discounted at the market interest rate.

39
Q

How does compounding frequency affect future value?

A

More frequent compounding increases future value as interest is earned on previously earned interest more often.

40
Q

How does compounding frequency affect present value?

A

More frequent compounding decreases present value, as future cash flows are discounted more frequently.

41
Q

What is a deferred annuity?

A

An annuity where the payments begin at a future date, rather than immediately or within one period.

42
Q

What is the present value of a deferred annuity?

A

The present value of an annuity that starts payments at a future date, discounted to the present day.

43
Q

What is the present value of a growing perpetuity?

A

PV = C / (r - g)

C is the first cash flow, r is the discount rate, and g is the growth rate.

44
Q

What is a sinking fund?

A

A sinking fund is a reserve set aside by the bond issuer to repay the bond at maturity or to buy back bonds early.

45
Q

What is the difference between ordinary annuity and annuity due?

A

In an ordinary annuity, payments are made at the end of each period. In an annuity due, payments are made at the beginning of each period.

46
Q

What is the future value of a lump sum?

A

The amount that a present sum of money will grow to in the future at a specified interest rate.

47
Q

What is an effective interest rate?

A

The actual interest rate when compounding is considered.

48
Q

What is a nominal interest rate?

A

The stated interest rate before adjusting for compounding or inflation.

49
Q

What is simple interest?

A

Interest calculated only on the principal amount of a loan or deposit.

50
Q

How do interest rates affect the time value of money?

A

Higher interest rates increase future value and decrease present value.

51
Q

What is a cash flow stream?

A

A series of cash inflows and outflows over a period of time.

52
Q

What is the difference between a lump sum and an annuity?

A

A lump sum is a one-time payment, while an annuity is a series of equal payments over time.

Corporate Finance (5 decks)

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