FNCE10001 Chapter Notes - Chapter 4: Cash Flow, Compound Interest, Net Present Value

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orangemole587

25 May 2018

School

University of Melbourne

Department

Finance

Course

FNCE10001

Professor

Asjeet Lamba

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Stream of cash flows = series of cash flows lasting several periods of time

Timeline = linear representation of the timing of expected cash flows

Timeline

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For cash flows that occur at different points in time, convert into same units or move to same

point in time

Rule 1: It is only possible to compare or combine values at the same point in time

Multiply by interest rate

Geometric/exponential growth

○

Compound interest = interest on interest

= C(1+r)

Rule 2: To move a cash flow forward in time, you must compound it

Divide by interest rate

PV = C/(1+r)

Rule 3: To move a cash flow back in time, you must discount it

Rules of Time Travel

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PV =

∑





(







)



⎯









= PV

(1+r)

Valuing a Stream of Cash Flows

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Document Summary

Stream of cash flows = series of cash flows lasting several periods of time. Timeline = linear representation of the timing of expected cash flows. Rule 1: it is only possible to compare or combine values at the same point in time. For cash flows that occur at different points in time, convert into same units or move to same point in time. Rule 2: to move a cash flow forward in time, you must compound it. Rule 3: to move a cash flow back in time, you must discount it. Perpetuity = stream of equal cash flows that occur at regular intervals and last forever. Annuity = stream of n equal cash flows paid at regular intervals. Pv(annuity of c for n periods) = p - pv(p in period n) Pv(annuity of c for n periods with interest rate r) = c x 1/r(1 - 1/(1+r)^n)

Related Questions

QUESTION 1 The time value of money refers to the issue of: A. what the value of the stream of future cash flows is today. B. why a dollar received tomorrow is worth more than a dollar received today. C. what the time required to double an amount of money. D. why people prefer to consume things at some time in the future rather than today.

QUESTION 2 The process of converting an amount given at the present time into a future value is called: A. annualizing. B. discounting. C. compounding. D. capital budgeting. 2 points

QUESTION 3 Juan Vinson is planning to buy a house in five years. He is looking to invest $25,000 today in an index mutual fund that will provide him a return of 12 percent annually. How much will he have at the end of five years? (Round to the nearest dollar.) A. $45,000 B. $28,000 C. $44,059 D. $28,530 2 points

QUESTION 4 Which of the following statements is true with respect to the present value of a future amount? A. The higher the discount rate, the higher the present value of a single sum for a given time period. B. The relation between present value and time is exponential. C. The greater the time period, the higher the present value of a single sum for a given interest rate. D. The lower the discount rate, the lower the present value of a single sum for a given time period. 2 points

QUESTION 5 Which of the following statements is true of the rule of 72? A. It can be used to determine the amount of time it takes to double an investment. B. It is fairly accurate for interest rates between 25 and 50 percent. C. It states that the time to double your money (TDM) approximately equals 72/i, where i represents the years it takes to double your investment. D. It can be used to estimate approximate compound interest earned for a period of 72 days. 2 points

QUESTION 6 The present value of future cash flows are computed by multiplying future value with the: A. discounting factor. B. compound factor. C. interest rate. D. number of periods. 2 points

QUESTION 7 The present value of multiple cash flows is: A. greater than the sum of the cash flows. B. equal to the sum of all the cash flows. C. less than the sum of the cash flows. D. higher or lower than the cash flows depending on the interest rate. 2 points

QUESTION 8 Cash flows associated with annuities are considered to be: A. an uneven cash flow stream. B. a constant cash flow stream. C. a mix of constant and uneven cash flow streams. D. a cash flow stream with decreasing trend. 2 points

QUESTION 9 The annuity transformation method is used to transform: A. a present value annuity to a future value annuity. B. a present value annuity to an annuity due. C. an ordinary annuity to an annuity due. D. a perpetuity to an annuity. 2 points

QUESTION 10 The true cost of borrowing is the: A. annual percentage rate. B. effective annual rate. C. quoted interest rate. D. periodic rate.

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

the rate of return earned on an investment of 50,000 today that guarantees an annuity of 10,489 for six years is approximately

A. 7%

B. 10%

C.12%

D.5%

2.Find the present value of the following stream of a firm's cash flows, assuming that the firm's opportunity cost is 9 percent

Year Amount
1-5 10,0000 yr
6-10 16,000 yr

A. 10,972
B. 79,345
C. 141,588
D. 13,252

3.The purpose of the debt convenant that prohibits borrows from entering into certain types of leases is to

A. Protect the lender by controlling the risk and marketability of the borrower's security investments alternatives
B. Limit the amount of fixed-payment obligations
C. ensure a cash shortage does not cause inability to meet current obligations
D. limit the annual cash dividends paid by the firm

4.The return expected from an asset is fully defined by its

A.Discount rate

B.Cash flow & timing

C. Risk and cash flow

D. Beta

skyyellowjacket635

FNCE10001 Chapter Notes - Chapter 4: Cash Flow, Compound Interest, Net Present Value

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