Unit 2: Fundamental Concepts in Financial Calculations Flashcards
What is Compounding?
The process of accumulating interest in an investment over time to earn more interest
What is Present Value?
The current value of a future cash flows discounted at the appropriate discount rate
_______ will make a dollar in the future be worth less than a dollar today.
Inflation.
(Calculator Question)
What is the order you should always enter values in the financial calculator?
- N
- I/Y
- PV
- PMT
- FV
_______ means to calculate the present value of a future amount.
Discounting
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 happens to Present Value when the discount rate goes up?
Present value goes down.
What is simple interest?
Interest earned only on the original principal amount invested.
What is the formula for Annuity Future Value Factor?
(FVF - 1)/r
FVF = Future Value Factor
r = interest rate
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 “interest on interest”?
Interest earned on the reinvestment of previous interest payments
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 is a discount rate?
The rate used to calculate the presnt value of future cash flows
What is “discounting”?
to calculate the present value of some future amount
The discount rate is also called…
The rate of return.
What is the formula for Present Value Factor?
PVF = 1/(1+r)t
r = discount rate
t = time (or interval)
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
As you increase the length of time involved, what happens to present values?
It descreases
The higher the risk, the _____
larger the discount rate and the lower the present value.
What is Future Value?
The amount an investment is worth after one more more periods. Also compound value.
What happens to the discount rate when risk of cash flow increases?
The discount rate goes up.
As you increase the length of time involved, what happens to future values?
It increases
True or false:
The value of money will remain constant across different time horizons.
False
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
True or False:
Inflation will make a dollar in the future be worth less than a dollar today.
True.
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 compound interest?
Interest earned on both the initial principal and the interest reinvested from prior periods
What is the formula for Future Value Factor?
(1+r)t
r = interest rate
t = time (or interval)
What is the basic Future Value formula?
FV = PV * (1+r)t
The Present Value of a future cash flow is commonly called…
Discounted Cash Flow (DCF)
What is the basic Present Value formula?
PV = FV/(1+r)t
True or false:
The discount rate is also called the rate of return.
True.
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)
True or false:
A dollar’s worth will be worth as much in the future as it is today.
False.
Interest earned on both the initial principal and the interest reinvested from prior periods is called ________ _________
Compound Interest.
What is a Discounted Cash Flow (DCF)?
The present value of a future cash flow.
What is the formula for calculating Interest Rate?
r = (FV/PV) (1/n) -1
True or false:
Discounting is the opposite of compounding.
True
