EZC 1 WGU CHAPTER 5

STEPS involved in computing the future value of cash flows

- Prepare a timeline to identify the size and timing of cash flows - calculate the future value of each individual cash flow using an appropriate discount rate - Add up the present values of the individual cash flows to obtain the present value of a cash flow stream

Compounding

Moving a sum of money further into the future (from left to right on the timeline)

Present Value

PV= FV/ (1+i)^ n

Discount Rate

Rate = risk free rate + risk premium = Rf + risk premium

A dollar today is worth more than a dollar tomorrow.

The answer is true. Inflation, risk, and opportunity all make a dollar today worth more than a dollar in the future.

The discount rate consists of the risk free rate plus the risk premium.

This is true. From the text, the equation is: Rate = risk free rate + risk premium = Rf + risk premium. There is also a call-out box with the same equation.

Discounting

moving a sum from the future back toward the present (or right to left on the timeline),

Future value of an annuity

FV= PMT x {[(1+ i)^n]-1/i} Compounding and Discounting Annuities where: PMT = annuity payment n = number of payments i = discount rate

Future Value

FV= PV x (1+i) ^n Future Value= Present value + (1+interest rate) ^number of payments

In order to determine the future value of some lump sum, we must use the process of _________________.

compounding

If we were to receive some lump sum in the future and we wanted to determine the value of the lump sum in today's dollars, we must _______________ this future cash flow.

discount