Time Value of Money

Question 1

Annuity Due definition

Answer 1

annuity begin at the beginning of a period (or at time period zero on the time line).

Question 2

Annuity Due Calc Mode

Answer 2

BGN

Question 3

Annuity Due examples

Answer 3

Examples of an Annuity Due include education tuition payments, retirement income, and rent payments.

Question 4

Ordinary Annuity Definition

Answer 4

annuity can begin at the end of a period (or at time period 1 on the time line)

Question 5

Ordinary Annuity Calc Mode

Answer 5

END

Question 6

Ordinary Annuity Examples

Answer 6

Examples of an Ordinary Annuity include all debt payments such as a mortgage or car payment.

Question 7

NPV decision Criteria

Answer 7

The NPV decision rule is to accept projects or investments with a positive or zero NPV and to reject projects with negative NPVs.

Question 8

NPV Formula

Answer 8

NPV = Present Value of the Cash Flows – Cost or Initial Investment.

Question 9

Interpret NPV = 0

Answer 9

An NPV of zero indicates that the cash inflows and the cash outflows of the investment are identical, and exactly ade-quate to repay the invested capital.

Accept the project

Question 10

Which project should you select if projects are mutually exclusive. No capital rationing.

Answer 10

Project with the highest NPV.

Question 11

Which project should you select if projects are mutually exclusive, consider capital rationing.

Answer 11

most affordable project with the highest NPV should be selected.

Question 12

what happens to discount rate as risk increases

Answer 12

discount rate increases

Question 13

What factors does the discount rate consider

Answer 13

Viewed as the opportunity cost of capital

1. The risk of the investment (greater the risk, greater the discount rate)
2. The cost of any opportunity forgone

Question 14

Interpret Negative NPV

Answer 14

This result (a negative NPV) is a clear indication that the investment should be rejected on the basis that the cash flow of the project is inadequate to return to the investor the sum originally invested once risk or opportunity cost is fac-tored into the equation.

Question 15

IRR definition

Answer 15

Discount rate in which NPV = zero

Breakeven interest rate

Rate at which cash inflow and outflow are identical

Question 16

What happens if discount rate is more than IRR

Answer 16

Opportunity cost of capital is greater than internal rate of return. Reject project.

Question 17

When should you not use IRR

Answer 17

When projects are mutally exclusive

Question 18

Why is IRR limited due to its assumptions?

Answer 18

IRR assumes that cash inflows are going to be reinvested at IRR itself.

Issue when one of a kind project is being under-taken or extraordinary return has been obtained

Question 19

When is it appropriate to use inflation-adjusted return?

Answer 19

When the following occurs
SIMULTANEOUSLY

1) You have an investment growing at one rate of return AND
2) You have an expense growing at a different rate of return.

Question 20

2 step process when working through all Education & Retirement FUNDING questions

Answer 20

1) determine the NPV of the cash flow stream at time period zero.
2) determine the savings required