C1: Cash Flows and Interest

Question 1

Symbol:

i orr

Answer 1

Effective interest rate ( i)

Nominal interest rate ( r )

interest expressed as a percentage of the original amount per time period.

Question 2

Symbol:

(generic meaning)

Answer 2

Interest ( I ) – General form

Interest earned or Interest paid over time based on an initial amount P and interest rate i

I = F – P

Interest = final amount – principal

Question 3

CF

Answer 3

1 ) the flow of money into and out of a project or company. (i.e. Cash Inflows & Outflows)

2) future expenditures and revenues that are estimated for each alternative.

Question 4

CF_i

examples

Answer 4

Receipts Incomes

Revenues Savings

CF_i = Cash Inflows

Assets gained due to business activities

Question 5

CF_o

examples

Answer 5

Disbursements Costs

Expenses Taxes

CF_o = Cash Outflows

Assets lost due to business activities

Question 6

NCF

Answer 6

NCF = R – D

NCF = CF_i – CF_o
(Inflows - Outflows)

Net Cash Flow = Resulting, actual amount of cash that flows in or out during a time period.

(Receipts - Disbursements)

Question 7

Cash flow element

Answer 7

A single line-item in a list of cash flows

Question 8

AOC

Answer 8

annual operating cost = estimated annual costs to maintain and support an alternative.

Question 9

Equity

Answer 9

an individual’s claim’s on the assets of an entity

Question 10

time value of money

Answer 10

TVM = a concept:

Money has value depending on the date the money will be used or spent. As time progresses, the purchasing power of that money may increase or decrease depending on whether the nation’s economy is experiencing inflation or deflation.

This is referred to as the time value of money.

Question 11

P

Answer 11

P = Present Value = Present Worth

The value of an amount of money today.

Question 12

F

Answer 12

F = Future Value = Future Worth

The value of an amount of money at some time in the future.

Question 13

A

Answer 13

A = A repeating amount

= Equivalent uniform Annual Worth

1) The value of a fixed constant amount of money during each time period.
2) The equivalent uniform annual worth of all cash flows over an estimated life.

Question 14

n

Answer 14

n = number of interest time periods

Question 15

i

Answer 15

i = interest rate percent

(but expressed as decimal)

Question 16

ROR

Answer 16

ROR = Rate Of Return (on investment)

Question 17

equivalence

Answer 17

The concept of equivalence means that two different amounts of money may have the same purchasing power if they are separated by a specific number of time periods at an agreed upon interest rate.

For example,
if a loaf of bread costs $2.50 today
and a loaf of bread costs $3.00 one year from now,
then $2.50 today is equivalent to $3.00 one year from now.

Question 18

simple interest

Answer 18

Simple interest (I_s )

Interest is only paid/earned on the principal; it’s not paid on any interest earned during the life of the investment.

Question 19

compound interest

Answer 19

Compound interest (I_{<span>c</span>} )

Interest is paid/earned on the principal AND on all accumulated interest earned during the life of the investment.

Question 20

Q1.1:

Explain the concept of time value of money with inflation and deflation

Answer 20

Question 21

Q1.2:

Define both simple interest and compound interest

Answer 21

Question 22

Q1.3:

A major retailer has agreed to purchase one of its competitors for $35 million in order to reduce management and other costs by $3 million per year.

If the savings result as expected, then calculate the rate of return on the investment.

Answer 22

ROR=(Savings / Investment)100

= [($3 M) / ($35 M)] x 100

= 8.57%

Question 23

Q1.4:

If the simple interest rate is 6% per year, then $1,000 today is equivalent to how much:

(a) 1 year from now, and
(b) 1 year ago?

Answer 23

(a) Equivalent Future Amount one year from now:
F = ? i = 0.06
P = $1,000, n = 1
F = P + P (i) (n)
F = $1,000 + $1,000 (0.06) (1)
F = $1,060.00

(b) Equivalent Past Amount one year ago:
F = $1,000, P = ? n = 1
F = P + P (i) (n)
$1,000 = P + P (0.06) (1)
P = $1,000 / 1.06 = $943.40

Question 24

Q1.5:

A certificate of deposit accrues simple interest at 5% per year. If a company invests $100,000 now in a certificate of deposit, then how much total money will the company have at the end of 4 years?

Answer 24

F = ? P = $100,000
i = 0.05, n = 4

F=$100,000 + $100,000(.05)(4)
F = $120,000.00

Question 25

Q1.6: A major bank is offering to pay compound interest of 2% per year on new savings accounts. Another bank is offering 2.05% per year simple interest on a 5-year certificate of deposit. Which investment will earn the most money at the end of 5-years if $5,000 is deposited now?

Answer 25

F = ? P = $5,000 n = 5 Compound Interest: i = 0.02 F = P (1 + i)^n = $5,000 (1.02)^5 = **$5,520.40** Simple Interest: i = 0.0205 F = P + P (i) (n) = $5,000 + $5,000(0.0205)(5) = **$5,512.50** Compound Interest is better by $5,520.40 - $5,512.50 = $7.90