Chapter #3

Question 1

What are lump sums?

Answer 1

Lump sums are one time cash flows

Question 2

What are PV/FVs?

Answer 2

• PVs are earlier values

- FVs are later values

Question 3

Where on a timeline are PV/FVs?

Answer 3

• PVs are leftward on a timeline

- FVs are rightward on a timeline

Question 4

What do FVs represent?

Answer 4

FVs represent the amount that an earlier amount will grow into

Question 5

What do PVs represent?

Answer 5

PVs represent what you need to invest earlier to have it grow into a specified later amount

Question 6

What is discounting/compounding?

Answer 6

• Discounting is used to find PV

- Compounding is used to find FV

Question 7

What is discounted from FV to find PV?

Answer 7

The interest part

Question 8

What type of interest is earned every period only on the original starting amount?

Answer 8

Simple Interest

Question 9

What kind of interest does a debtor prefer?

Answer 9

Simple interest because it adds less to what they owe

Question 10

What kind of interest does a depositor prefer?

Answer 10

Compund interest because it adds more to what they earn

Question 11

What are the four variables in the basic TVM Formulas?

Answer 11

• PV
• FV
• r
• n

Question 12

In which equation do the right hand side variables represent the 3 key factors in determining stock prices?

Answer 12

-PV Formula (FV future cash flows, r risk, n timing of cash flows)

Question 13

What is the relationship between FV and r?

Answer 13

They are directly related

Question 14

What is the rule of 72?

Answer 14

Says that the number of years it would take an investment to double is approximately equal to 72 divided by the annual interest rate

Question 15

What can FV show us?

Answer 15

• Determines the attractiveness of alternative investments

- See the effect of inflation

Question 16

What can PV show us?

Answer 16

• Discounts interest that would have been earned overtime

- Determines value of an asset today that will be received in future

Question 17

What are the applications of TVM?

Answer 17

• Calculate amount of saving needed for retirement
• Calculate cost of loan
• Calculate growth rates/periods of cash flows

Question 18

Why do we need TVM

Answer 18

Otherwise, we can’t compare/combine cash flows in different years/time periods

Question 19

What do timelines show us?

Answer 19

• Amount
• Time period
• Inflows/outflows

Question 20

What is a PV?

Answer 20

• Earlier Values

- The value you give today to money you will receive in the future

Question 21

What is a FV?

Answer 21

• Later values

- Amount an earlier investment will grow into

Question 22

Compounding

Answer 22

• PV to FV

- Adds interest

Question 23

Discounting

Answer 23

• FV to PV

- Subtracts interest

Question 24

What causes FV to increase (decrease)?

Answer 24

• PV increases (decreases)
• R increases (decreases)
• N increases (decreases)

Question 25

What causes PV to increase (decrease)?

Answer 25

- FV increases (decreases) - R decreases (increases) - N decreases (increases)

Question 26

Relationship between PV and R

Answer 26

- Bonds --> Pb --> Yield to Maturity - Stocks --> PPS --> Required Rate of Return - Capital Budgeting --> NPV --> Cost of Capital