nterest Rates and Rates of Return

Question 1

what is the cost of capital

Answer 1

The cost of capital is simply the return expected by the investors to provide capital for the business, either in the form of debt or equity.

Question 2

Reasons for applying a % cost of capital – The Investor

Answer 2

1. Time impatience. Most people would prefer money now over a promise of the sum to be received at some point in the future.
   •2. Risk. Investments are inherently uncertain. The actual return may be much lower than the expected return.
   •3. Inflation. Money is continually losing value over time.

For all of the reasons above, investors must be compensated with return or interest when they make the decision to save and invest.

Question 3

Reasons for applying a % cost of capital – The Firm

And what If the investments do not produce a percentage return at least equal to this %

Answer 3

From the firm’s point of view, this is the % rate the firm pays to acquire capital funds.

If investments do not produce a percentage return at least equal to this %, they are not covering the cost of capital and should not be undertaken.

Question 4

The % cost of capital is also known as the…

Answer 4

discount rate

Question 5

what is a return in basic terms

Answer 5

A return is what you get back from an investment

Question 6

percentage return formula

Answer 6

(Overall Return – Initial Investment)/Investment

Question 7

What deos the interest rate do to the present value ?

Answer 7

An interest rate translates a present value (PV) into a future value (FV)

Question 8

What does a discount rate do to the future value?

Answer 8

A discount rate translates a future value (FV) back into a present value (PV)

Question 9

AER Bof 10% split into 4 parcels of interest

Answer 9

(1.025)^4 – 1 = 10.38%

Question 10

FVn = (1 + r)n × PV
how to find n using log

Answer 10

n = log(FVn /PV)/log(1+r)