Unit 2: Fundamental Concepts in Financial Calculations

Question 1

What is Compounding?

Answer 1

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

Question 2

What is Present Value?

Answer 2

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

Question 3

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

Answer 3

Inflation.

Question 4

(Calculator Question)

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

Answer 4

• N
• I/Y
• PV
• PMT
• FV

Question 5

_______ means to calculate the present value of a future amount.

Answer 5

Discounting

Question 6

Using your calculator:

When entering in values a cash outflow should be represented by…

Answer 6

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 7

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

Answer 7

Present value goes down.

Question 8

What is simple interest?

Answer 8

Interest earned only on the original principal amount invested.

Question 9

What is the formula for Annuity Future Value Factor?

Answer 9

(FVF - 1)/r

FVF = Future Value Factor

r = interest rate

Question 10

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

Answer 10

PVIFA = 1 - PVF/ r

PVF = Present Value Factor

r = discount rate

Question 11

What is “interest on interest”?

Answer 11

Interest earned on the reinvestment of previous interest payments

Question 12

Calculator question:

When will you use the I/Y button?

Answer 12

When you hear one of these terms

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

Question 13

What is a discount rate?

Answer 13

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

Question 14

What is “discounting”?

Answer 14

to calculate the present value of some future amount

Question 15

The discount rate is also called…

Answer 15

The rate of return.

Question 16

What is the formula for Present Value Factor?

Answer 16

PVF = 1/(1+r)^t

r = discount rate

t = time (or interval)

Question 17

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

Answer 17

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

Question 18

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

Answer 18

It descreases

Question 19

The higher the risk, the _____

Answer 19

larger the discount rate and the lower the present value.

Question 20

What is Future Value?

Answer 20

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

Question 21

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

Answer 21

The discount rate goes up.

Question 22

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

Answer 22

It increases

Question 23

True or false:

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

Answer 23

False

Question 24

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

Answer 24

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

Question 25

True or False:

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

Answer 25

True.

Question 26

What is the “rule of 72”?

Answer 26

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 27

What is compound interest?

Answer 27

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

Question 28

What is the formula for Future Value Factor?

Answer 28

(1+r)^t

r = interest rate

t = time (or interval)

Question 29

What is the basic Future Value formula?

Answer 29

FV = PV * (1+r)^t

Question 30

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

Answer 30

Discounted Cash Flow (DCF)

Question 31

What is the basic Present Value formula?

Answer 31

PV = FV/(1+r)^t

Question 32

True or false:

The discount rate is also called the rate of return.

Answer 32

True.

Question 33

The rule of 72 is calculated as…..

Answer 33

72/ the interest rate

Note: interest rate is NOT in decimal format.

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

(not 72/0.08)

Question 34

True or false:

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

Answer 34

False.

Question 35

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

Answer 35

Compound Interest.

Question 36

What is a Discounted Cash Flow (DCF)?

Answer 36

The present value of a future cash flow.

Question 37

What is the formula for calculating Interest Rate?

Answer 37

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

Question 38

True or false:

Discounting is the opposite of compounding.

Answer 38

True