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Flashcards in SU5 - Time Value of Money Deck (10):

Explain Nominal interest rate

The nominal interest rate is the rate quoted in loan and deposit agreements.

The equation that links nominal and real interest rates is: (1 + nominal rate) = (1 + real interest rate) (1 + inflation rate).

It can be approximated as nominal rate = real interest rate + inflation rate.


The Formula for Future Value

FVn = PV(1 + i)n


Explain an annuity

It is a series of equal cash flows for each of a specified number of periods.


There are two types of annuities. Name and explain.

1. an ordinary annuity - money deposited/received at the END of the period
2. an annuity due - money deposited/received at the BEGINNING of the period


Formula for Present Value

PV = FV / (1 + i)n


What is the first step of a loan amortising schedule?

Calculate PMT
PMT = PVn / PVIFAi,n

Amortising a loan actually involves creating an annuity out of a present amount.


Investment decisions are made by means of capital budgeting techniques. Name them.

1. Payback Period
2. Net Present Value
3. Profitability Index
4. Internal Rate of Return


Show formula for profitability index and explain.

1. It is calculated by dividing the present value of cash inflows by the initial investment.

2. This index measures the present value of the return per rand invested.


Define internal rate of return

It is defined as the discount rate that equates the present value of cash inflows with the initial investment associated with a project.


Value of a firm can be calculated how?

Value = (interest paid x PVIFAi,n) + (principal x PVIFi,n)