D775 WGU Section 3

risk

. The possibility of not receiving the money in the future is known as

Inflation

erodes the purchasing power of a dollar.

opportunity

if you opt to receive the money now, you can use the money immediately in any way you find fit.

Compounding

The process of moving money into the future

Discounting

refers to moving distant cash flows closer to today

compound interest

the interest earned on both the initial principal and any accumulated interest from previous periods. This results in significant growth over time, as interest is earned on an increasing balance.

Present Value

The amount you loaned today is referred to as

Future Value

The amount you are repaid in the future

PVIF

used to determine the present value (PV) of a future sum of money.

future value interest factor (FVIF)

used to determine the future value (FV) of a lump sum of money.

annuity

make or receive regular, equal-sized payments over time

future value of an annuity (FVA)

the total value of a series of annuity payments (i.e., equal payments made at regular intervals) It represents how much the annuity will be worth at a future date, considering the effects of interest growth.

present value of annuity (PVA)

It represents how much the annuity will be worth at a present date, .

Compounding frequency

how often interest is added to the principal amount in an investment or loan.

FVIFA

simplifies the calculation of the FV of a series of equal payments. Increasing the number of payments increases the FVIFA, resulting in a higher future value (FV).

PVIFA

find the present value (PV) of a series of future payments. Higher interest rates decrease the PVIFA, resulting in a lower PV.

NET PRESENT VALUE

financial tool used to evaluate the profitability of an investment or project by comparing the value of future cash inflows to the initial cost. By adjusting future cash flows for the time value

Net present value (NPV)

financial tool used to evaluate the profitability of an investment or project by comparing the value of future cash inflows to the initial cost.

The net present value rule

states that a project should be accepted if NPV is greater than zero, as this indicates profitity, and rejected if NPV a loss.

Net present value (NPV) advantages

Accounts for the Time Value of Money (TVM), Considers All Cash Flows, Provides a Clear Profitability Measure, Incorporates Risk via the Discount Rate, Facilitates Comparisons

Initial investment

The amount of money required to start a new project

discount rate

The interest rate used to calculate the present value of future cash flows

NPV

A financial tool used to evaluate the profitability of an investment or project by comparing the value of future cash inflows to the initial cost

PVIFA

A multiplier used to calculate the present value of a series of equal payments (an annuity) made at regular intervals and discounted at a specific interest rate

Future cash flows

The amounts of money you expect to receive from an investment in the future

Present value of cash flows

The value of future cash flows expressed in today's dollars

Decision rule

A straightforward guideline for determining whether to accept or reject a project based on the results of analysis

Cost-benefit analysis

Comparing the costs and benefits of different projects or investments, considering the time value of money.

Time value of money (TVM)

The recognition that a dollar today is worth more than a dollar in the future

internal rate of return (IRR)

is the discount rate that makes the net present value (NPV) of an investment equal to zero, representing the project's expected rate of return.

cost of capital

the required rate of return (aka the "hurdle rate") is the return a company needs to earn on its investments to cover the costs of financing

internal rate of return (IRR) decision rule

states that a project should be accepted if the IRR is greater than the required rate of return, as this indicates sufficient profitability, and rejected if it is lower, as this indicates insufficient profitability.

Payback Period

"How long will it take for me to recover my initial investment?" the amount of time required for an investment to generate enough cash inflows to recover its initial cost.

cutoff period

is typically set by the business based on its risk tolerance, liquidity needs, and strategic goals

Limitations of the Payback Period

Ignores Time Value of Money (TVM), Excludes Post-Payback Cash Flows, No Profitability Measure