Quantitative Methods - Time Value Of Money

Question 1

What is terminal or future value?

Answer 1

The value of a deposit at the end of a period of time having received interest over that period

Question 2

What is a present value?

Answer 2

The equivalent value of the same deposit before the effects of interest

Question 3

What does calculating terminal or present values enable.

Answer 3

It provides a means of appraising investment opportunities

Question 4

What do terminal/future value calculations consider?

Answer 4

Each cash flow generated by an investment
The timing of the cash flow

They calculate how much cash could be generated to the end of the investment period if earlier returns were banked each year to generate additional compound interest.

Question 5

What determines whether we accept the investment?

Answer 5

If the returns plus the interest that they can accumulate exceeds the total that could be generated had we simply banked the cash at the outset, then we accept the investment.

Question 6

How could decision criteria be stated as?

Answer 6

An investment should be accepted if it produces a surplus in cash terms after accounting for interest.

Question 7

What does the dividend valuation model state?

Answer 7

The market value of a security is the present value of the future expected receipts, discounted at the investors required rate of return.

Question 8

What is Net Terminal Value?

Answer 8

The surplus or deficient between the investments you are investigating and the alternative

Question 9

What is the drawback of net terminal values?

Answer 9

If we are trying to evaluate investments with different end dates, we cannot compare the terminal value of one directly to the terminal value of another

Question 10

How would you go about comparing investments with different end dates?

Answer 10

Compound the interest out to a common end date

Question 11

What do present value calculation consider for an investment?

Answer 11

Each relevant cash flow
The timing of the cash flow

And calculate how much cash we would need to have invested now to generate these same amounts of cash at these same future dates

Question 12

What situations can we establish discount factor formulae to make manual calculations more straightforward?

Answer 12

Level annuities and level perpetuities

Question 13

What is an annuity?

Answer 13

It describes the situation where we have equal annual cash flows for a set period.

Question 14

How can you simplify the terminal value calculation for an annuity?

Answer 14

Multiply one years payment by the sum of the compound factors)

Question 15

When doing a terminal value calculation for an annuity what is the figure reached for sum of the compound factors called?

Answer 15

The n year annuity compound factor at whatever the rate is

Question 16

What is a perpetuity?

Answer 16

An equal annual cash flow which will continue indefinitely

Question 17

What is another way of describing the interest rate?

Answer 17

Required rate of return or cost of capital

Question 18

What are the two alternative methods for annuities and perpetuity?

Answer 18

Deducting unwanted years and discounting back

Question 19

How does the deducting unwanted years methods work for annuities and perpetuities?

Answer 19

You use the annuity or perpetuity discount factor and for the years before you are interested you simply minus then from the highest year you are interested in

Question 20

How does the discounting back method work for annuities and perpetuities?

Answer 20

You do the calculation for the number of years you are interested in multiplied by those you aren’t

Question 21

What is the relationship between present and future values?

Answer 21

If you compound the present value up for the right amount of years you will get the future value. This idea can be used to calculate the terminal value of anything for which we can calculate a present value or net present value (other than a perpetuity)

Question 22

What two factors determine the market value of a security?

Answer 22

The returns (dividends/interest/capital growth) that the investors expect
The rate of return that the investors require