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Unit 4 Quizzes and Homework
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Terms in this set (88)
What are the two interest calculations?
Compounding; discounting
What are the two basic TVM cash flows?
Lump sum; series of cash flows
What is the definition of TVM?
A dollar today is worth more than a dollar tomorrow
To add/subtract/compare numbers, you must _______.
bring each cash flow to the same point in time
What is the Rule of 72 equation?
72/i
About how many years will it take $375.00 to grow to $825.00 with an annual interest rate of 6%?
13.5 years
N: ?
I: 6%
PV: -375
PMT: 0
FV: 825
About how much would be in your savings account in 7 years after depositing $275.00 today if the bank pays 4% annual interest?
$361.88
FV = PV * ( 1 + i )^n
FV = 275 * ( 1 + .04)^7
Compute the PV of a $13,395.00 payment made in 7 years when the discount rate is 7.23%.
$8,217.29
N: 7
I: 7.23
PV: ?
PMT: 0
FV: 13,395
You have $3,000.00 in an account that pays 3.2% annual interest. About how many additional dollars of interest would you earn over a two years period if you moved the money to an account earning 5.1%?
$118.73
FV(1) = 3,000 * (1 + .032)^2
FV(1) = 3,195.072
FV(2) = 3,000 * (1 + .051)^2
FV(2) = 3,313.803
3,313.803 - 3,195.072 = 118.73
You deposit $425.00 into an account which pays 1.25% for the first two years. However, the rate of interest drops to 0.75% thereafter. About what is the value of your investment five years from today [assume annual compounding]?
$445.57
N: 2
I: 1.25%
PMT: 0
PV: -425
FV: ? = 435.69
N: 3
I: .75
PMT: 0
PV: -435.69
FV: ? = 445.57
What is the Rule of 72?
For a given "i," how long it takes to double your money.
When given a PV and a FV, what must you do when inputting the variables into a financial calculator.
Input one of the variables as a negative number
What type of planning can you do when you calculate an "i"?
What if?
If the amount of money you are investing into an account to reach a goal is not sufficient to reach your goal, why do you NOT want to invest more money into the account?
because it would reduce current consumption
What is "i" in TVM calculations?
Nominal interest rate
What is "i" in the Lump Sum FV/PV calculations?
Nominal interest rate
What is Compound interest?
Interest on interest
What is the relationship between the PV Factor and the FV Factor?
Inverse
When you calculate a PV, what are you typically calculating?
What something is worth
What happens when you compound interest more frequently?
You earn more interest.
Why is a dollar today worth more than a dollar one year from now?
- Due to its potential earning power
- You have the opportunity to invest it and earn interest
What is compounding?
- The process of converting the initial [principal] amount into a future value
- You calculate the value at the end of a time period [future value] by assuming the initial investment will earn interest.
What is compounding interest?
- Compound interest is interest earned on interest
How does changing the compounding period affect the amount of interest earned?
- The more frequent the compounding the more interest earned
- Compounding quarterly will provide more interest at the end of the year than compounding semi-annually
What is the present value? How is it used?
- The amount a future value is worth today given a certain return rate (or discount rate).
- It is used to calculate how much money you need today to reach a financial goal some time in the future.
What is the discount rate?
The interest rate used to determine the present value
What is the relationship between the present value factor and the future value factor?
The present value factor is the inverse of the future value factor.
PV: 1/(1 + r)^n
FV: (1 + r)^n
What is the difference between the Interest Rate (r) and the growth Rate (g)?
- They represent the same concept and are essentially the same
- The GROWTH RATE is used when dealing with sales or change over time.
- The INTEREST RATE is used when dealing with investing money.
Today's value is the ____.
Present value
Tomorrow's value is the ___.
Future value
What two calculation methods are used to solve Time Value of Money problems in the videos?
Financial Calculator and Formulas
Why should you set up a chart of the given variables?
Because you can see which variables are not given so you can solve for the appropriate missing variable
What is a Time Line?
A visual representation of the problem
What type of cash flows is most frequently used in business spending and investment?
Series of unequal cash flows
Discounted cash flows are the ____.
basis of financial analysis decisions
The basic calculation procedure of discounting ____.
divides back to today
Why is a dollar today worth more than a dollar tomorrow?
Because we can invest it now to earn interest
What are the two types of multiple cash flows?
1. Series of Equal Payments
2. Series of Unequal Payments
About what is the FV of a $6,000 annual payment, beginning today for 7 payments. The payments are expected to earn 5.2%?
$51,706 (BEG)
FV: ?
PV: 0
PMT: -6,000
I: 5.2%
N: 7
You borrowed $23,290 at 4.30% interest. You will make annual payments of $4,486.33. About how long will it take you to pay off the loan?
6.0 years
FV: 0
PV: 23,290
PMT: -4,486.33
I: 4.30
N: ?
You have $250,000 in an IRA. You want to receive $15,000 in annual payments for 27 years. About how much must you earn on the $250,000 to reach your goal?
3.82%
FV: 0
PV: 250,000
PMT: -15000
I: ?
N: 27
About what is the most you would pay for $12,000 annual payments over 9 years if you must earn 6.5% interest on similar risk investments?
$79,873
FV: 0
PV: ?
PMT: -12,000
I: 6.5%
N: 9
XYZ Corp borrowed money from Credit Corp at 15% for 8 annual payments. The loan calls for annual payments of $868,913.43 starting today. About what is the amount of the loan?
$4,483,958 (BEG)
FV: 0
PV: ?
PMT: -868,913.43
I: 15%
N: 8
Sara is 30 years old. She plans to invest $3,600 annually into an IRA, beginning today, until she turns 50 and retires. If the IRA can earn 6% interest, about how much will she have in the IRA when she turns 50?
$140,374 (BEG)
PV: 0
FV: ?
PMT: -3,600
I: 6%
N: 20
You want to retire with $2,500,000 in your IRA. You plan to make annual, end of year $7,200 deposits into your IRA. You expect the IRA can earn 6% annual interest each year. About how long before you can retire?
53 years
PV: 0
FV: 2,500,000
PMT: -7,200
I: 6%
N: ?
You can borrow $3,000 from your best friend if you agree to pay back $3,200 in two years. Alternatively, you can borrow from the bank at 3.26% interest. Should you borrow from your best friend or the bank?
Borrow from the bank at 3.26% interest as it is cheapest loan.
Friend= 3.28
Bank= 3.26
N: 2
I: ?
PMT: 0
FV: 3,200
PV: -3,000
A couple will retire in 30 years. They plan to spend $130,000 a year in retirement, which they expect to last 30 years. They believe they can earn 6% interest on their retirement savings.
About how much must be in their retirement savings when they retire?
$1,789,428
PV: ?
FV: 0
PMT: -130,000
I: 6%
N: 30
A couple will retire in 34 years. They plan to spend $130,000 a year in retirement, which they expect to last 30 years. They believe they can earn 6% interest on their retirement savings.
About how much must they save each year while working to reach their goal?
$17,176
PV: 0
FV: -1,789,428
PMT: ?
I: 6%
N: 34
In computing monthly payments for an Amortized Loan, can you calculate an annual payment and divide by 12? Why or Why not?
No; you would be ignoring compounding
What does the Balance sheet show the financier?
Sources and Uses of Funds
What are the two types of Annuities?
Ordinary and Annuity Due
What equation is used to calculate the PMT for an Amortized Loan?
PV of an Ordinary Annuity
What two things can a firm do with Net Income?
Pay dividends or reinvest it into the firm as Retained Earnings
What does "n" equal in an Amortized Loan?
The time remaining until the maturity of the loan
Would you pay less than an asset is worth? Why?
Yes; you would earn more than the required "i"
What is an Amortized Loan?
A series of equal payments consisting of P + I such that when the last payment is made, the loan balance is zero
What mode must your calculator be in when calculating an Annuity Due?
BEG
When calculating the answer for a TVM problem, how many variables are you usually given?
3
What is the difference between "n" in a normal TVM problem and a perpetuity?
Normal TVM problem, "n" is finite; perpetuity, "n" is infinite
What is the key variable of the five TVM variables?
"i"
What are you normally calculating when you calculate a PV?
What something is worth
Why would you pay no more than the PV for an asset?
Because you would not earn the required "i"
What is a perpetuity?
A series of equal payments forever
What must you do with your calculator to calculate an Annuity Due?
Put the calculator into the BEG mode
What is an Annuity Due?
A series of equal payments that start at the beginning of the period
What is an Annuity?
A series of equal payments
What is an Ordinary Annuity?
A series of equal payments starting at the end of the period
In the Time Value of Money calculations, what is "i"?
The nominal interest rate
What is the Rule of 72?
For a given interest rate, how long it takes to double your money
How can you compute the PV of an entire investment?
By summing the PV of each individual cash flow
What is APR?
Annual Percentage Rate (APR)
What is EAR?
Effective Annual Interest Rate (EAR)
Why use a Time Line?
It helps visualize the problem
When will the nominal interest rate differ from the effective interest rate?
When interest is compounded more than once a period.
What is the effective interest rate?
The interest rate actually paid or earned
What interest rate is used in Time Value of Money calculations?
Nominal Interest
Why do you want to calculate the effective interest on loans?
To compare loans using the true cost of borrowing
What is the nominal interest rate?
The state rate
Where can you find information about using your calculator?
Your users manual and online web sites
What symbol is used to represent the number of periods in a year?
m
What is "c/y"? What is c/y equal to?
Calculations per year; m
What is "p/y"?
payments per year
What change must you make in each equation with respect to "i"?
divide "i" by "m"
In solving problems with uneven cash flows, how do you treat each cash flow?
As a Lump sum
Should you pay more than an asset is worth? Why or Why not?
No; you would not receive your required return ["i"]
You [can/cannot] add/subtract/compare cash at different points in time because ____.
cannot; each cash flow can be invested to earn interest
Why do firms want present value calculations of future cash flows for investment decisions?
The investment decisions are made in the present day
With uneven cash flow, what do you do with each cash flow?
Bring them to the same point in time [discount or compound] and add them together
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