FIN 350 Lecture Notes - Lecture 4: Accrued Interest, Cash Flow, Net Present Value

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20 May 2018

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Interest

opportunity cost of holding dollars

principal (PV)

initial balance at the beginning of the period

accrued interest

rPV

compound interest

accrues interest not only from initial principal investment but also from past interest that has accrued in

the account as well

We use what form of interest

compound interest

Future cash flow

what is one's willingness to pay in present dollar terms for a cash flow with payments occurring in the

future

net present value

net discounted value

convert all future dollar cash flows to present dollars and add them up

discounting

used to refer to NPV calculations because deflating by taking away interest rate

rate of return

implied interest rate on a cash flow

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Measure of an investment's strength

rate of return

net present value

Internal rate of return

not affected by interest rate unlike NPV

where you break even from buying an investment

find where cash flow is 0!

IRR can not be calculated when

all cash flow is positive

do you want higher or lower NPV

higher!

If the investment decision does not lead to reinvest then use

NPV

If the investment decision does lead to reinvest then use

IRR

discount rate

per period rate of interest r

discount factor

without the t

discount factor seen as

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Document Summary

We use what form of interest compound interest. Measure of an investment"s strength rate of return net present value. Internal rate of return not affected by interest rate unlike npv where you break even from buying an investment find where cash flow is 0! Irr can not be calculated when all cash flow is positive do you want higher or lower npv higher! If the investment decision does not lead to reinvest then use. If the investment decision does lead to reinvest then use. Irr discount rate per period rate of interest r discount factor without the t discount factor seen as little delta delta is in between. Want money back faster less patient high interest rate want money back faster discount factor (delta)measures patience in foregoing present payments delta = 1 more patient delta = 0 less patient. If super impatient take the limit of delta to zero with the normal npv.

Related Questions

Question 1 5 pts

0 multiple_choice_question 22046808

The internal rate of return (IRR) is the interest rate that sets the net present value of the future cash flows equal to ________.

Question 2 5 pts

On a timeline, the space between date 0 and date 1 represents the _______ between dates. Letâs assume it is the first year of the loan. Date 0 is the beginning of the first year, and date 1 is the end of the first year.

Question 3 5 pts

As the interest rate __________, present value decreases.

Question 4 5 pts

The present value (PV) of a stream of cash flows is the _______ the present values of each individual cash flow

Question 5 5 pts

When a constant cash flow will occur at regular intervals for a finite number of periods of time, it is called a(n) __________.

Question 6 5 pts

Edit this Question Delete this Question

0 multiple_choice_question 22047052

There are two basic types of annuities:

Discounted and compounded annuities

Ordinary annuities and annuities due.

Future value and present value annuities

None of the above

Question 7 5 pts

The NPV measures the ______ change in shareholder wealth that arises from undertaking a project.

Question 8 5 pts

The Net Present Value rule implies that we should compare a projectâs net present value (NPV) to ________

Question 9 5 pts

To endow a perpetuity is the same as calculating the present value (PV) of a perpetuity. Say you want to endow an annual graduation party at your alma mater. You want the event to be a memorable one, so you budget $30,000 per year forever for the party. If the university earns 8% per year on its investments, and if the first party is in one yearâs time, how much will you need to donate to endow the party?

The formula for PV of a perpetuity = C\r; = $30,000 \ 0.08; =

Question 10 5 pts

With an Ordinary Annuity, payments are required at the ________ of each period. An example of this is bonds which usually pay coupon payments at the end of every six months until the bond's maturity date.

beginning

middle

end

payments are not required

limemacaw827

Amongst corporations, sole proprietorships and partnerships, approximately what percentage of revenues are generated by corporations?

50%

42%

33%

82%

Question 2

What should be the financial goal of any firm?

attracting and acquiring capital and investing it

maximization of the ownersâ wealth

offering quality products at fair prices

quality customer service

Question 3
4 pts
Which of the following statement(s) is \ are true regarding the corporate management team?

In a corporation, ownership and direct control are typically separate.

Board of Directors is elected by shareholders and has ultimate decision-making authority

The Chief Executive Officer (CEO) â the Board typically delegates day-to-day decision making to the CEO.

All of the above

Question 4
4 pts
When calculating the present value of either a future single sum or a future annuity, it involves a process called discounting. The applicable interest rate to perform the discounting function is usually called the

yield to maturity

compound interest rate

discount rate

none of the above

Question 5
4 pts
_________________ are used to present additional information about items included in the financial statements and to present additional financial information.

stock certificates

Notes to financial statements

Preferred stocks

Convertible securities
Question 6
4 pts
What should be the financial goal of any firm?

maximization of the ownersâ wealth

attracting and acquiring capital and investing it

offering quality products at fair prices

quality customer service

Question 7
4 pts
A competitive market is one in which a _____ numbers of producers compete with each other to satisfy the wants and needs of a _____ number of consumers.

Large, small

Small, small

Large, large

Small, large

Question 8
4 pts
The Valuation Principle is an analysis between the value of the ______ of a financial alternative and the value of its ______.

revenues, income

benefits, costs

expenses, costs

Question 9
4 pts
The Net Present Value rule implies that we should compare a projectâs net present value (NPV) to___________. (zero \ future value \ the past).

Zero

Future Value

The Past

An Estimate

Question 10
4 pts
The internal rate of return (IRR) rule will _______ agree with the Net Present Value rule on a given investment project.

always

never

sometimes

none of the above

Question 11
5 pts
The law of one price exists due to arbitrage opportunities. If the price of a security, commodity or asset is different in two different markets, then an arbitrageur will ______ the asset in the more expensive market and ________ it where prices are lower.

sell, purchase

purchase, sell

purchase, purchase

sell, sell

Question 12
5 pts
Approaching every problem using a timeline is a(n) ________ idea because timelines identify events in a transaction or investment which might otherwise be easily overlooked.

good

bad

indifferent

unrealistic

Question 13
5 pts
The present value (PV) of a stream of cash flows is the _______ the present values of each individual cash flow

difference between

product of

sum of

same as

Question 14
5 pts
As the number of periods increases, present value (increases\decreases\stays the same).

increases

decreases

stays the same

is unrelated

Question 15
5 pts
When a constant cash flow will occur at regular intervals for a finite number of periods of time, it is called a(n) __________.

annuity

perpetuity

interest payment

principle payment

Question 16
5 pts
When a constant cash flow will occur at regular intervals forever, it is called a(n) ___________.

annuity

perpetuity

interest payment

principle payment

Question 17
5 pts
The NPV measures the ______ change in shareholder wealth that arises from undertaking a project.

consistent

dollar

annual

semi-annual

Question 18
5 pts
When calculating the present value of either a future single sum or a future annuity, the applicable interest rate is usually called the _______ rate

compounding

inverted

market

discount

Question 19
5 pts
To endow a perpetuity is the same as calculating the present value (PV) of a perpetuity. Say you want to endow an annual graduation party at your alma mater. You want the event to be a memorable one, so you budget $30,000 per year forever for the party. If the university earns 8% per year on its investments, and if the first party is in one yearâs time, how much will you need to donate to endow the party?
The formula for PV of a perpetuity = C\r; = $30,000 \ 0.08; =

$3,750

$37,500

$375,000

$3,750,000

Question 20
5 pts
With an Ordinary Annuity, payments are required at the ________ of each period. An example of this is bonds which usually pay coupon payments at the end of every six months until the bond's maturity date.

beginning

middle

end

payments are not required

Question 21
5 pts
Sales of securities that the seller does not own is called a:

stop-loss order

short sale

limit order

maintenance margin

Question 22
5 pts
What is the name of the market where money market securities, bonds, and mortgages are originated and traded?

debt securities market

foreign exchange market

derivative securities market

equity securities market

Question 23
5 pts
If an investor feels the price of a stock will decline in the future, which trade should the investor undertake?

market order

buy on margin

limit order

short sale

Question 24
5 pts
For risk averse investors, how much return is expected for taking on more risk?

lower

equal

zero

higher

Question 25
5 pts
A ___________________ is a highly regulated document which details the issuers operations and finances and must be provided to each buyer of a newly issued security.

Prospectus

An underwriting agreement

A best efforts agreement

none of the above

Question 26
5 pts
Which of the following statements about liquidity ratios is true?

The lower the quick ratio relative to the current ratio, the safer a firm is in terms of liquidity.

The higher the current ratio, the more likely a firm is able to pay its short-term obligations.

The quick ratio is always between 0 and 1.

All the above statements are true.

Question 27
5 pts
The ability of a firm to meet its short-term debt obligations as they come due is indicated by which of the following ratios:

liquidity ratios

asset utilization ratios

financial leverage ratios

profitability ratios

Question 28
5 pts
Which one of the following financial statements reports a firmâs assets and the claims on assets?

balance sheet

income statement

statement of changes in financial position

cash flow statement

Question 29
5 pts
The extent to which assets are used to support sales is indicated by which of the following ratios:

liquidity ratios

asset utilization ratios

financial leverage ratios

profitability ratios

Question 30
5 pts
The extent to which assets are financed by borrowed funds and other liabilities is indicated by:

liquidity ratios

asset utilization ratios

financial leverage ratios

profitability ratios

Question 31
5 pts
The basic price that equates the demand for and supply of loanable funds in the financial markets is the __________:

interest rate

yield curve

term structure

cash price

none of the above

Question 32
5 pts
Federal obligations usually issued for maturities of two to ten years are called:

Treasury bonds

Treasury notes

Treasury bills

Agency issues

Question 33
5 pts
An increase in the demand for loan-able funds, holding supply constant, will cause interest rates to:

increase

decrease

stay the same

none of the above

Question 34
5 pts
As interest rates rise, the prices of existing bonds will:

rise

stay the same

fall

either a or b

Question 35
5 pts
In an inflationary period, interest rates have a tendency to:

rise

fall

stay the same

act erratically

salmonhound248

Assume that you are nearing graduation and that you have appliedfor a job with a local bank. As part of the bankâs evaluationprocess, you have been asked to take an examination that coversseveral financial analysis techniques. The first section of thetest addresses time value of money analysis. See how you would doby answering the following questions:

a. Drawcash flow time lines for (1) a $100 lump-sum cash flow at the endof Year 2, (2) an ordinary annuity of $100 per year for threeyears, (3) an uneven cash flow stream of $50, $100, $75, and $50 atthe end of Years 0 through 3.

b. (1)What is the future value of an initial $100 after three years if itis invested in an account paying 10%annual interest?

(2) What is the present value of $100 to bereceived in three years if the appropriate interest rate is10%?

c. Wesometimes need to find how long it will take a sum of money (oranything else) to grow to some specified amount. For example, if acompanyâs sales are growing at a rate of 20%per year, approximatelyhow long will it take sales to triple?

d. Whatis the difference between an ordinary annuity and an annuity due?What type of annuity is shown in the following cash flow time line?How would you change it to the other type of annuity?

0 1 2 3

100 100 100

e. (1)What is the future value of a 3-year ordinary annuity of $100 ifthe appropriate interest rate is 10%?

(2) What is the present value of the annuity?

(3) What would the future and present values be ifthe annuity were an annuity due?

f. What is the present value of the following uneven cash flow stream?The appropriate interest rate is 10%, compounded annually.

0 1 2 3 4

100 300 300 150

g. Whatannual interest rate will cause $100 to grow to $125.97 in 3years?

h. (1)Will the future value be larger or smaller if we compound aninitial amount more often than annuallyâfor example, every 6months, or semiannuallyâholding the stated interest rateconstant? Why?

(2) Define the stated, or quoted, or simple, rate,(r_SIMPLE), annual percentage rate (APR), the periodicrate (r_PER), and the effective annual rate(r_EAR).

(3) What is the effective annual rate for a simplerate of 10%, compounded semiannually? Compounded quarterly?Compounded daily?

(4) What is the future value of $100 after threeyears under 10%semiannual compounding? Quarterly compounding?

i. Will the effective annual rate ever be equal to the simple (quoted)rate? Explain.

j. (1) What is the value at the end of Year 3 of thefollowing cash flow stream if the quoted interest rate is 10%,compounded semiannually?

0 1 2 3

100 100 100

(2) What is the PV of the same stream?

(3) Is the stream an annuity?

(4) An important rule is that you should nevershow a simple rate on a time line or use it in calculations unlesswhat condition holds? (Hint: Think of annual compounding,when r_SIMPLE = r_EAR = r_PER.) Whatwould be wrong with your answer to parts (1) and (2) if you usedthe simple rate 10%rather than the periodic rater_SIMPLE/2 = 10%/2 = 5%?

k. (1)Construct an amortization schedule for a $1,000 loan that has a10%annual interest rate that is repaid in three equalinstallments.

(2) What is the annual interest expense for theborrower, and the annual interest income for the lender, duringYear 2?

l. Suppose on January 1 you deposit $100 in an account that pays asimple, or quoted, interest rate of 11.33463%, with interest added(compounded) daily. How much will you have in your account onOctober 1, or after 9 months?

m. Now suppose youleave your money in the bank for 21 months. Thus, on January 1 youdeposit $100 in an account that pays a 11.33463%compounded daily.How much will be in your account on October 1 of the followingyear?

n. Suppose someone offered to sell you a note that calls for a $1,000payment 15 months from today. The person offers to sell the notefor $850. You have $850 in a bank time deposit (savings instrument)that pays a 6.76649%simple rate with daily compounding, which is a7%effective annual interest rate; and you plan to leave this moneyin the bank unless you buy the note. The note is not riskyâthat is,you are sure it will be paid on schedule. Should you buy the note?Check the decision in three ways: (1) by comparing your futurevalue if you buy the note versus leaving your money in the bank,(2) by comparing the PV of the note with your current bankinvestment, and (3) by comparing the r_EAR on the notewith that of the bank investment.

o. Suppose the note discussed in part n, above, costs $850, but callsfor five quarterly payments of $190 each, with the first paymentdue in 3 months rather than $1,000 at the end of 15 months. Wouldit be a good investment?

pearsalmon693

FIN 350 Lecture Notes - Lecture 4: Accrued Interest, Cash Flow, Net Present Value

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