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Chapter 6 Time Value of Money
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Terms in this set (24)
What is the time value of money?
The time value of money is the concept that money invested today can grow into a larger amount in the future. Money can also decrease in value over time.
What is Interest?
Interest is rent paid for the use of money.
What is simple interest?
Simple interest is Initial invest x Interest rate x Number of Periods.
What is compound interest?
Compound interest includes interest not only on the initial investment but also on accumulated interest in previous periods.
Effective rate
The actual rate at which money grows per year.
What is semiannually?
Every six months. Being compounded twice a year.
What is quarterly?
Every four months. Being compounded four times a year.
What is monthly?
Every month. Being compounded twelve times a year
What is daily compounding common for?
Savings accounts
What is interest typically stated as regardless of the length of the compounding period involved?
An annual rate.
What is future value?
The future value of a single amount is the amount of money that a dollar will grow to at some point in the future.
FV= I(1+i)^n
How do present and future value tables work in terms of interest rate and periods?
The further into the future you go, and depending on the interest rate, your $1 will either increase or decrease.
What is present value?
The present value of a single amount is today's equivalent to a particular amount in the future.
PV= FV/(1+i)^n
Would you rather have $740 now invested at 10% for 3 years or $1,000 3 years from now?
The answer would be $1,000 three years from now because the 740 invested would only grow into $984.94 (740 x 1.331)
What are the four variables in the process of adjusting single cash flow amounts for the time value of money?
Present Value (PV), future value (FV), Number of compounding years (N), Interest rate (i)
How do you determine an unknown interest rate?
Assuming you have PV,FV, and n. Divide PV by FV and use that value to find the interest rate on either the present value or future value chart.
How do you determine an unknown number of periods?
Divid PV by FV or FV by PV then look at PV or FV chart to find the periods by searching for the value obtained with assistance from the interest known.
Monetary Assets
money and claims to receive money, the amount of which is fixed or determinable.
Monetary Liabilities
Obligations to pay amounts of cash, the amount of which is fixed or determinable.
What are monetary receivables and payables valued based on?
They are valued at the present value of future cash flows.
IASB Standard (Revenue Recognition)
In addition to requiring the time value of money to be appropriately accounted for with long term receivables, the new standard also requires the time value of money to be accounted for with long-term (longer than one year) prepayments.
What is Statement of Financial Accounting Concepts No. 7(issued by fasb)?
It provides a framework for using future cash flows in accounting measurements. Objective is to value an asset or liability using present value to approximate the fair value of an asset or liability. Uncertainty should be taken into account concerning the timing and amount of the cash flows.
How has uncertainty been considered in present value traditionally?
By discounting the "best estimate" of future cash flows applying a discount rate that has been adjusted to reflect the uncertainty or risk of th
Expected Cash Flow Approach
Method of calculating present value that uses a range of cash flows and incorporates the probability of those cash flows to provide as accurate as possible measure of expected future cash flows.
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