Unit 2: Fundamental Concepts in Financial Calculations

Question 1

What is a Discounted Cash Flow (DCF)?

Answer 1

The present value of a future cash flow.

Question 2

What is simple interest?

Answer 2

Interest earned only on the original principal amount invested.

Question 3

What is “interest on interest”?

Answer 3

Interest earned on the reinvestment of previous interest payments

Question 4

What is Future Value?

Answer 4

The amount an investment is worth after one more more periods. Also compound value.

Question 5

The 3 ways to calculate time value of money are….

Answer 5

1. Use A financial calculator
2. Use a mathematical formula
3. Use a (present/future) value factor table

Question 6

The rule of 72 is calculated as…..

Answer 6

72/ the interest rate

Note: interest rate is NOT in decimal format.

e.g. 72/8% = 72/8

(not 72/0.08)

Question 7

(Calculator Question)

What is the order you should always enter values in the financial calculator?

Answer 7

• N
• I/Y
• PV
• PMT
• FV

Question 8

True or false:

A dollar’s worth will be worth as much in the future as it is today.

Answer 8

False.

Question 9

What is the formula for Present Value Factor?

Answer 9

PVF = 1/(1+r)^t

r = discount rate

t = time (or interval)

Question 10

What is the basic Future Value formula?

Answer 10

FV = PV * (1+r)^t

Question 11

The higher the risk, the _____

Answer 11

larger the discount rate and the lower the present value.

Question 12

As you increase the length of time involved, what happens to future values?

Answer 12

It increases

Question 13

As you increase the length of time involved, what happens to present values?

Answer 13

It descreases

Question 14

The discount rate is also called…

Answer 14

The rate of return.

Question 15

True or false

Assuming positive cash flows, both the present and future value of an annuity will rise

Answer 15

True

Question 16

What is the formula for Future Value Factor?

Answer 16

(1+r)^t

r = interest rate

t = time (or interval)

Question 17

True or False:

Inflation will make a dollar in the future be worth less than a dollar today.

Answer 17

True.

Question 18

True or false:

The value of money will remain constant across different time horizons.

Answer 18

False

Question 19

Calculator question:

When will you use the I/Y button?

Answer 19

When you hear one of these terms

• Cost of Capital
• Interest rate
• Discounted rate
• Opportunity cost

Question 20

What si the formula for Present Value Interest Factor for Annuities (PVIFA)?

Answer 20

PVIFA = 1 - PVF/ r

PVF = Present Value Factor

r = discount rate

Question 21

What is the difference between an “Ordinary Annuity” and an “Annuity Due”?

Answer 21

• Oridnary annuity: Cash flow occurs at the end of each period
• Annuity Due: Cash flow occurs at the beginning of each period

Question 22

_______ will make a dollar in the future be worth less than a dollar today.

Answer 22

Inflation.

Question 23

What is compound interest?

Answer 23

Interest earned on both the initial principal and the interest reinvested from prior periods

Question 24

What happens to Present Value when the discount rate goes up?

Answer 24

Present value goes down.

Question 25

What is the formula for Annuity Future Value Factor?

Answer 25

(FVF - 1)/r FVF = Future Value Factor r = interest rate

Question 26

Interest earned on both the initial principal and the interest reinvested from prior periods is called ________ \_\_\_\_\_\_\_\_\_

Answer 26

Compound Interest.

Question 27

The Present Value of a future cash flow is commonly called...

Answer 27

Discounted Cash Flow (DCF)

Question 28

What is a discount rate?

Answer 28

The rate used to calculate the presnt value of future cash flows

Question 29

\_\_\_\_\_\_\_ means to calculate the present value of a future amount.

Answer 29

Discounting

Question 30

What is the basic Present Value formula?

Answer 30

PV = FV/(1+r)^t

Question 31

What happens to the discount rate when risk of cash flow increases?

Answer 31

The discount rate goes up.

Question 32

What is Present Value?

Answer 32

The current value of a future cash flows discounted at the appropriate discount rate

Question 33

True or false: The discount rate is also called the rate of return.

Answer 33

True.

Question 34

What are the four factors of evaluating Annuity Present Value?

Answer 34

* PV: Present Value * *C* : Periodic Cash Flow * *r* : discount rate * *t :* number of payments (or life of annuity)

Question 35

True or false: Discounting is the opposite of compounding.

Answer 35

True

Question 36

Using your calculator: When entering in values a **cash outflow** should be represented by...

Answer 36

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

Question 37

What does EAR stand for?

Answer 37

Effective Annual Rate

Question 38

What is "discounting"?

Answer 38

to calculate the present value of some future amount

Question 39

What is the "rule of 72"?

Answer 39

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.

Question 40

What is Compounding?

Answer 40

The process of accumulating interest in an investment over time to earn more interest

Question 41

What is the formula for calculating Interest Rate?

Answer 41

r = (FV/PV) ^(1/n) -1