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Derek Chau (11)
Chapter 5

Chapter 5 Notes

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Derek Chau

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Chapter 5 Time Value of Money Notes 5.1 Opportunity Cost time value of money the idea that money invested today has more value than the same amount invested later medium of exchange something that can be used to facilitate transactions the opportunity cost of money is the interest rate that would be earned by investing itinterest rate is called the price of money required rate of return or discount rate the market interest rate (k) or the investors opportunity cost simple interest interest paid or received on only the initial investment (the principal) 5.3 Compound Interest Compounding (Computing Future Values) compound interest interest that is earned on the principal amount invested and on any accrued interest compound interest growth is directly related to the length of the period, as well as to the level of return earned reinvest to keep interest earned on any investment fully invested compound value interest factor (CVIF) represents future value of an investment at an interest rate and for a number of periods basis point 1100 of 1 percent Discounting (Computing Present Values) discounting finding the present value of a future value by accounting for the time value of money discount factors (the PVIF) are always less than one, which means that future dollars are worth less than the same dollars today discount factors are the reciprocals of their corresponding compound factors and vice versa (PVIF = 1 CVIF) 5.4 Annuities and Perpetuities annuity regular payments on an investment that are for the same amount and are paid at the same interval cash flows the actual cash generated from an investment ordinary annuities equal payments that are made at the end of each period lessee a person who leases an item annuity due an annuity (such as a lease) for which the payments are made at the beginning of each period perpetuities special annuities that provide payments forever effective rate rate at which a dollar invested grows over a given period; stated in percentage terms based on an annual period Summary of Learning Objectives 1. Explain the importance of the time value of money and how it is related to an investors opportunity costs. Time value
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