Unit 2: Fundamental Concepts in Financial Calculations Flashcards
What is a Discounted Cash Flow (DCF)?
The present value of a future cash flow.
What is simple interest?
Interest earned only on the original principal amount invested.
What is “interest on interest”?
Interest earned on the reinvestment of previous interest payments
What is Future Value?
The amount an investment is worth after one more more periods. Also compound value.
The 3 ways to calculate time value of money are….
- Use A financial calculator
- Use a mathematical formula
- Use a (present/future) value factor table
The rule of 72 is calculated as…..
72/ the interest rate
Note: interest rate is NOT in decimal format.
e.g. 72/8% = 72/8
(not 72/0.08)
(Calculator Question)
What is the order you should always enter values in the financial calculator?
- N
- I/Y
- PV
- PMT
- FV
True or false:
A dollar’s worth will be worth as much in the future as it is today.
False.
What is the formula for Present Value Factor?
PVF = 1/(1+r)t
r = discount rate
t = time (or interval)
What is the basic Future Value formula?
FV = PV * (1+r)t
The higher the risk, the _____
larger the discount rate and the lower the present value.
As you increase the length of time involved, what happens to future values?
It increases
As you increase the length of time involved, what happens to present values?
It descreases
The discount rate is also called…
The rate of return.
True or false
Assuming positive cash flows, both the present and future value of an annuity will rise
True
What is the formula for Future Value Factor?
(1+r)t
r = interest rate
t = time (or interval)
True or False:
Inflation will make a dollar in the future be worth less than a dollar today.
True.
True or false:
The value of money will remain constant across different time horizons.
False
Calculator question:
When will you use the I/Y button?
When you hear one of these terms
- Cost of Capital
- Interest rate
- Discounted rate
- Opportunity cost
What si the formula for Present Value Interest Factor for Annuities (PVIFA)?
PVIFA = 1 - PVF/ r
PVF = Present Value Factor
r = discount rate
What is the difference between an “Ordinary Annuity” and an “Annuity Due”?
- Oridnary annuity: Cash flow occurs at the end of each period
- Annuity Due: Cash flow occurs at the beginning of each period
_______ will make a dollar in the future be worth less than a dollar today.
Inflation.
What is compound interest?
Interest earned on both the initial principal and the interest reinvested from prior periods
What happens to Present Value when the discount rate goes up?
Present value goes down.
What is the formula for Annuity Future Value Factor?
(FVF - 1)/r
FVF = Future Value Factor
r = interest rate
Interest earned on both the initial principal and the interest reinvested from prior periods is called ________ _________
Compound Interest.
The Present Value of a future cash flow is commonly called…
Discounted Cash Flow (DCF)
What is a discount rate?
The rate used to calculate the presnt value of future cash flows
_______ means to calculate the present value of a future amount.
Discounting
What is the basic Present Value formula?
PV = FV/(1+r)t
What happens to the discount rate when risk of cash flow increases?
The discount rate goes up.
What is Present Value?
The current value of a future cash flows discounted at the appropriate discount rate
True or false:
The discount rate is also called the rate of return.
True.
What are the four factors of evaluating Annuity Present Value?
- PV: Present Value
- C : Periodic Cash Flow
- r : discount rate
- t : number of payments (or life of annuity)
True or false:
Discounting is the opposite of compounding.
True
Using your calculator:
When entering in values a cash outflow should be represented by…
a (-) sign.
Note: This is usually used when entering Present Value.
Note: When computing for Present Value a (-) sign should be taken as a positive value
What does EAR stand for?
Effective Annual Rate
What is “discounting”?
to calculate the present value of some future amount
What is the “rule of 72”?
The rule of 72 is a shortcut to estimate the number of years required to double your money at a given annual rate of return.
The rule states that you divide the rate, expressed as a percentage, into 72: Years required to double investment = 72 ÷ compound annual interest rate.
What is Compounding?
The process of accumulating interest in an investment over time to earn more interest
What is the formula for calculating Interest Rate?
r = (FV/PV) (1/n) -1
