Chapter 5

Future Values General Formula

FV = PV(1 + r)^t

Compounding Interest

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

Simple Interest

Interest earned only on the original principal amount invested

Basic Present Value Equation

PV = FV/(1+r)^t

Rule of 72

The number of years it takes for a certain amount to double in value is equal to 72 divided by its annual rate of interest.

the discount rate is called

rate of return on the investment

Future Value

the amount of money an investment will grow to over some period of time

Present Value

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

the longer the time period,

the lower the present value

Time Value of Money

the principle that a dollar received today is worth more than a dollar received in the future

Compounding

the process of leaving money and any accumulated interest in an investment for more than one period, thereby reinvesting the interest

the higher the interest rate,

the smaller the present value

Future Value Factor

(1 + r)^t

Present Value Factor

1/(1+r)^t

Discounted Cash Flow

calculating the present value of a future cash flow to determine its value today

Interest on Interest

interest earned on the reinvestment of previous interest payments