week 5 finance - time value of money - Flashcards in University Business Management

future value

the amount an invesmtnet is wort after 1 or more periods

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compunding

the process of accumalting interest on an inves,tnet over time to earn more interest

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interest on interest

interest earned on the reinvestment of previous interest payments

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compound interest

interest owned on both the initial principle and the interest reinvested from periods before

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simple interest

interest earned only on the original principle amount invested

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present value

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

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discount rate

the rate used to calculate the present value of future cash flows

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dicounted cash flow valuation

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

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Assume the total cost of a university education will be €290,000 when your child enters college in 18 years. You currently have €40,000 to invest. What annual rate of interest must you earn on your investment to cover the cost of your child’s univer

we can either solve for fv or pv - personally i will solve for fv - you need to solve for r (use formula)

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At 6 per cent interest, how long does it take to double your money? To quadruple it?

with these type of questions we use trial and error - you put a value in t e.g. to get £1 to £2 it will take 12 years

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if asked about percentage increase

use the r formula

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if you are asked "what rate of return?"

they are asking for the interest rate so you have to find r

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if aksed about years....

you MAY have to take them away from eachother

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You expect to receive €10,000 at graduation in two years. You plan on investing it at 10 per cent until you have €75,000. How long will you have to wait from now?

USE TRIAL AND ERROR FOR THIS TYPE OF QUESTION - then once you have the answer remember to check if the answer says if you have to wait a while till you get the money - if so remember to add it on

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if asked why is a 10 year value worth less than a 1 year value:

because of the time value of money - then do workings to support this (pv)

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aside from the time value effect, what other factor influences how future cash flows are viewed?

risks and uncertainty - cash flows that occur further into the future are subject to a much higher degree of risk and uncertainty. It is very difficult, if not impossible, to accurately predict the future and so it is only a very rough approximation

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week 5 finance - time value of money

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