SM132 Exam 1 Flashcards

Financial Manager

The individual responsible for maximizing the value of the firm through investment and financing decisions.

Cost-Benefit Analysis

A method to evaluate whether the benefits of a decision exceed its costs.

Law of One Price

The principle stating that identical goods must sell for the same price in competitive markets to avoid arbitrage.

Net Value in Trade

Calculated as Benefit - Cost, representing the value received minus the cost given up.

Arbitrage

The practice of profiting from price differences of equivalent goods through simultaneous buying and selling.

Market Prices in Cost-Benefit Analysis

Essential for reflecting the true value of goods and enabling objective comparisons of costs and benefits.

Time Value of Money

The concept that a dollar today is worth more than a dollar in the future due to its earning potential.

Future Value (FV) Formula

FV = PV × (1 + r)^n, where r is the interest rate and n is the number of periods.

Present Value (PV) Calculation

PV = FV / (1 + r)^n, where r is the interest rate and n is the number of periods.

Discount Factor

The factor used to determine the present value of future cash flows, being the inverse of the interest rate factor.

Interest Rate Impact on Present Value

An increase in interest rates results in a decrease in the present value of future cash flows.

Future Money Worth

Money in the future is worth less today due to the opportunity to earn interest or returns on current money.

Time Line in Finance

A visual tool representing cash flows at various points in time.

Compound Interest

Interest calculated on the initial principal and also on the accumulated interest from previous periods.

Present Value of $1000 in 5 Years at 8%

$680.58.

Rule 1 for Cash Flow Comparison

Cash flows must be valued at the same point in time for accurate comparisons.

Future Value of $1000 in 10 Years at 6%

$1790.85.

Discounting a Future Cash Flow

The process of determining its present value by adjusting for the interest rate over time.

Present Value of a Series of Cash Flows

Calculated by discounting each future cash flow back to the present and summing them.

HP 10bII Calculator for Present Value

Input N, I/Y, PMT, and FV, then solve for PV.

Time Impact on Present Value

Longer time periods result in lower present values of future cash flows, assuming a positive interest rate.

Excel Present Value Formula

PV = PV(rate, NPER, PMT, FV), where rate is the interest rate, NPER is the number of periods, and PMT is the payment.

Perpetuity

A stream of equal cash flows paid at regular intervals that continue indefinitely.

Present Value of a Perpetuity

Calculated as PV = C / r, where C is the cash flow and r is the interest rate.

Growing Perpetuity

A stream of cash flows that grow at a constant rate and continue indefinitely.

Present Value of a Growing Perpetuity

PV = C / (r - g), where C is the initial cash flow, r is the interest rate, and g is the growth rate.

Annuity

A series of equal cash flows paid at regular intervals for a fixed number of periods.

Annuity vs

An annuity has a fixed number of payments, while a perpetuity continues indefinitely.

Present Value of an Annuity

PV = C × [1 - (1 / (1 + r)^n)] / r, where C is the cash flow, r is the interest rate, and n is the number of periods.

Future Value of an Annuity

FV = C × [(1 + r)^n - 1] / r, where C is the cash flow, r is the interest rate, and n is the number of periods.

HP 10bII Calculator for Future Value of Annuity

Enter N, I/Y, PMT, and solve for FV.

Present Value and Future Value Relationship

Present value is the discounted sum of future cash flows, while future value is the compounded total of cash flows.

Present Value of a Delayed Perpetuity

Calculate the perpetuity value at the point before the first payment, then discount it back to today.

Future Value of an Annuity with Future Payments

Calculate as if payments started immediately, then compound the result forward until the first payment.