5-Time Value of Money - Definitions

perpetuity

A financial instrument that pays an equal cash flow per period into the indefinite future (that is, infinity).

annuity due

A series of equal periodic payments or receipts that occur at the beginning of each period.

ordinary annuity

A series of equal periodic payments or receipts that occur at the end of each period.

principal

An amount of money that has been borrowed or invested.

capital recovery problem

An annuity amount necessary to recover a capital investment.

sinking fund problem

An annuity amount that must be invested each period (year) to produce a future value.

simple interest

Interest paid or earned on the principal only.

compound interest

Interest that is paid not only on the principal but also on any interest earned but not withdrawn during earlier periods.

effective interest rate

The actual rate of interest paid by the borrower or earned by the lender.

annuity

The payment or receipt of a series of equal cash flows per period for a specified amount of time. In an ordinary annuity, payments are made at the end of each period; in an annuity due, payments are made at the beginning of each period.

rate of interest

The percentage on the principal that the borrower pays the lender per time period as compensation for forgoing other investment or consumption opportunities.

nominal interest rate

The periodic rate of interest that is stated in a loan agreement or security. Frequently, the effective interest rate is greater than the nominal rate because of such factors as the frequency of compounding and the deduction of interest in advance.

net present value (NPV)

The present value of the stream of net cash flows resulting from a project, discounted at the firm's cost of capital, minus the project's net investment. It is used to evaluate, rank, and select from among various investment projects; the contribution of an investment to shareholder wealth.

discount rate

The rate of interest used in the process of finding present values; also called the required rate of return.

Interest

The return earned by or the amount paid to an individual who forgoes current consumption or alternative investments and "rents" money to a business, bank, the government, some other form of institution, or another individual.

future value

The value at some future point in time of a present payment (or a series of payments) evaluated at the appropriate interest (growth) rate.

present value

The value today of a future payment (or a series of future payments) evaluated at the appropriate discount rate.