3 Time Value of Money Free Online FlashCards

What principle explains why money's value depends on when it is available?

Money available now can be invested or used sooner, so it has a different value from the same amount received later.

What is compounding?

Compounding earns returns on both the original amount and returns already earned.

What formula calculates the future value of one invested amount?

For a single amount invested at a fixed rate per period, use $FV = PV(1+r)^n$, where $r$ is the rate per period and $n$ is the number of periods.

How do you calculate future value with compounding more than once yearly?

Use $FV = PV(1+r/m)^{mt}$, where $m$ is compounding periods per year and $t$ is years. Match the periodic rate with the number of periods.

What does discounting do?

Discounting converts a future amount into its equivalent value today using a discount rate.

What formula discounts one future amount to present value?

For one future cash flow, use $PV = \frac{FV}{(1+r)^n}$, where $r$ is the rate per period and $n$ is the number of periods.

What generally happens to present value when the discount rate or waiting time increases?

A higher discount rate or a longer wait generally lowers present value.

How do ordinary annuity and annuity-due payment timings differ?

An annuity is a series of equal payments at regular intervals. An ordinary annuity pays at each period's end; an annuity due pays at each period's beginning.

What formula gives the present value of an ordinary annuity?

For an ordinary annuity, use $PV_{annuity} = PMT\left(\frac{1-(1+r)^{-n}}{r}\right)$, where $PMT$ is the payment, $r$ the periodic rate, and $n$ the number of payments.

What formula gives the future value of an ordinary annuity?

For an ordinary annuity, use $FV_{annuity} = PMT\left(\frac{(1+r)^n-1}{r}\right)$, where $PMT$ is the payment, $r$ the periodic rate, and $n$ the number of payments.

How do you adjust an ordinary-annuity value for an annuity due?

Multiply the corresponding ordinary-annuity value by $(1+r)$, because every annuity-due payment occurs one period earlier.

How do you find present value for uneven cash flows?

Discount each cash flow separately and add the results: $PV = \sum_{t=1}^{n}\frac{CF_t}{(1+r)^t}$.