Chapter 4

Growing Annuity

Finite number of growing cash flows

Simple Interest

Interest NOT re-invested

Compound Interest

Interest re-invested

Present Value. What rate goes with it?

The amount of money you would need to deposit now in order to have a desired amount in the future (what it's worth TODAY) - Discount rate: rate of return associated with PV calculations

Compounding may occur more frequently than once a year a. True b. False

A

The present value of a sum can be calculated by hand, by calculator, or with the help of a time value of money table. a. True b. False

A

You invest $500 at 10 percent interest per annum. At the end of 2 years with simple interest you will have ____ and with compound interest you will have ____. a. $600; $605 b. $550; $600 c. $605; $600 d. $550; $605

A - Simple interest: 500(.10) = 50/year - x2 years = 100 total - 500+100 = $600 - Compound interest: 500(1.10)^2 = $605

What are the implications of the time value of money concept? Select all that apply a. A dollar tomorrow is worth less than a dollar today b. A dollar today is worth more than a dollar tomorrow c. A dollar today is worth less than a dollar tomorrow d. A dollar has the same value no matter which day it is

A & B

If you invest $1,000 and the present value of the incoming cash flows over the following year is $800, then the NPV is ____. a. -$200 b. +$200 c. $800 d. $1,800

A (-1,000+800)

If the interest rate is 10% per year, then what is today's value of $100 received one year from today? a. $90.91 b. $90 c. $110 d. $86.78

A (100/1.10)

Which of the following will result in a lower present value for a given future cash flow? Select all that apply a. A higher interest rate b. Less time c. More risk d. Less risk e. A lower interest rate f. More time

A, C, & F

APR vs. EAR

APR: Meaningful only if the compounding interval is given EAR: Meaningful without a compounding interval

Which of the following is the opposite of compounding? a. Amortizing b. Discounting c. Investing d. Budgeting

B

Interest-Only Loans

Borrower pays interest each period and repays the entire principal at some point in the future

Pure Discount Loans

Borrower receives money today and repays a single lump sum at some time in the future

A positive NPV will ____ wealth a. Decrease b. Befuddle c. Increase d. Mask

C

You invest $100 today. With positive interest rates, the concept of future value implies that the future value of your $100 will be ____ $100. a. exactly b. less than c. greater than

C

If the future value is $500 in 1 year and the interest rate is 12 percent per year, what is the present value? a. $488 b. $512 c. $446.43 d. $462.18

C (500/1.12)

What is 1 approach to find what a firm is worth?

Calculate the present value of its future cash flows

Perpetuity

Constant stream of cash flows that doesn't end

Annuity

Level stream of regular payments that last for a fixed number of periods - Delayed Annuity: Begins at a date many periods in the future - Annuity Due: First payment begins a full period from now - Ordinary Annuity: Payments are made at the end of the period - Infrequent Annuity Payments occur less frequently than once a year

Amortized Loans

Loan is paid off by making regular principal reductions

Net Present Value (NPV)

Present value of future cash flows minus the present value of the cost of the investment

Discounting

Process of calculating the present value of a future cash flow

Future Value (Compound Value)

Value of a sum after investing over 1 or more periods

Growing Perpetuity

When a cash flow stream increases indefinitely