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
