TIME VALUATION OF MONEY Flashcards
What are the three rules of time travel?
The value of money today is not the same as the value of money tomorrow, you can only compare values at the same point in time
To send a cash flow forward you must compound it
To send it backwards you must discount it
How is compound interest calculated?
On the principal and simple interest
How do you value a stream of cash flows?
You sum the present value of all cashflows
How can you evaluate an investment decision?
By finding the NPV of the Project
How do you know a project is worth undertaking?
When the NPV is positive => always try to maximize your NPV
What does the NPV represent?
The money that you can spend right now (you can take a loan for the value of the NPV at no extra cost)
What does the NPV compare?
The value of the PV of outflows and the PV of inflows
What is accepting a project yielding a positive NPV equivalent to?
Receiving that NPV in cash today
What is accepting a project yielding a negative NPV equivalent to?
Reducing the wealth of investors
Characteristics of a perpetuity
- Constant cashflow
- Constant interval
- Starts at year 1 (not 0)
- Constant interest rate
- Goes on forever
Formula of a perpetuity
PV(perpetuity): C/r
Characteristics of an annuity
- constant cashflow
- constant interval
- starts at year 1
- constant interest rate
- goes up until year N
Formula of an annuity
PV(annuity): C/r*(1-(1/1+r^n)
Growing perpetuity
Your periodic payment is gonna grow at a constant rate g
Can only be done when r>g
Formula of growing perpetuity
C/(r-g)
