Chapter 5 - The Time Value of Money, Discounted Cash Flows, and Valuation

Chapter 5 - The Time Value of Money, Discounted Cash Flows, and Valuation

1. 5.1 - The Time Value of Money

   • Consuming Today or Tomorrow
     • Time value of money - the difference in value between a dollar in hand today and a dollar promised in the future; a dollar today is worth more than a dollar in the future
   • Timelines as Aids to Problem Solving
     • Time zero - the beginning of a transaction; often the current point in time
   • Financial Calulator

2. 5.2 - Future and Compounding

   • Future value - the value of an investment after it earns interest for one or more periods
   • Single-Period Investment
   • Two-Period Investment
     • Principal - the amount of money on which interest is paid
     • Simple interest - interest earned on the original principal amount only
     • Interest on interest - interest earned on interest that was earned in previous periods
     • Compounding - the process by which interest earned on an investment is reinvested, so in future periods interest is earned on the interest as well as the principal
     • Compound Interest - interest earned both on the original principal amount and on interest previously earned
   • The Future Value Equation
   • The Future Value Factor
   • Future Value Factor Tables
   • Applying the Future Value Formula
   • Calculator Tips for Future Value Problems

3. 5.3 - Present Value and Discounting

   • Single-Period Investment
     • Discounting - the process by which the present value of future cash flows is obtained
     • Discount rate - the interest rate used in the discounting process to find thepresent value of future cash flows
     • Present value (PV) - the current value of future cash flows discounted at the appropriate discount rate
   • Multiple-Period Investment
   • The Present Value Equation
   • Future and Present Value Equations are the Same
   • Applying The Present Value Formula
   • The Relations Among Time, the Discount Rate, and Present Value
   • Calculator Tips for Present Value Problems
   • Future Value versus Present Value
   • Finding the Interest Rate
   • Finding How Many Periods it Takes an Investment to Grow a Certain Amount

4. 5.4 - Multiple Cash Flows

   • Future Value of Multiple Cash Flows
   • Present Value of Multiple Cash Flows

5. 5.5 - Level Cash Flows: Annuities and Perpetuities

   • Annuity - a series of equally spaced and level cash flows extending over a finite number of periods
   • Perpetuity - a series of level cash flows that continue forever
   • Ordinary annuity - an annuity in which payments are made at the ends of the periods
   • Present Value of an Annuity
     • Present value of an annuity (PVA) - the present value of the cash flows from an annuity, discounted at the appropriate discount rate
     • Amortising loan - a loan for which each loan payment contains repayment of some principal and a payment of interest that is based on the remaining principal to be repaid
     • Aoritsation schedule - a table that shows the loan balance at teh beginning and end of each period, the payment made during that period, and how much of that payment represents interest and how much represents repayment of principal
   • Future Value of an Annuity
     • Future value of an annuity (FVA) - the value of an annuity at some point in the future
   • Annuities Due
     • Annuity due - an annuity in which payments are made at the beginning of each period
   • Perpetuities

6. 5.6 - Cash Flows that Grow at a Constant Rate

   • Growing Annutity
     • Growing annuity - an annuity in which the cash flows increase at a constant rate
   • Growing Perpetuity
     • Growing perpetuity - a cash flow stream that grows at a constant rate forever

7. 5.7 - The Effective Annual Interest Rate

   • Why the Confusion?
     • Annual percentage rate (APR) - the simple interest rate charged per period multiplied by the number of periods per year
   • Calculating the Effective Annual Interest Rate
     • Effective annual interest rate (EAR) - the annual interest rate that reflects compunding within a year
     • Quoted interest rate - a simple annual interest rate, such as the APR
   • Comparing Interest Rates
   • Consumer Protection Acts and Interest Rate Disclosure
     • Truth-in-Lending Act - a federal law requiring lenders to fully inform borrowers of important information related to loans, including the annual interest percentage rate charged
     • Truth-in-Saving Act - a federal law requiring institutions offering consumer savings vehicles, such as certificates of deposit (CDs), to fully inform consumers of important information about the savings vehicles, including the annual percentage rate paid
   • The Appropriate Interest Rate Factor