Business Finance - Time Value of Money (TVM) Part 1: Lump Sums

Vocabulary flashcards covering the key concepts, formulas, and terminology from Chapter TVM Part 1 on Lump Sums.

Time Value of Money (TVM)

The financial principle stating that a dollar in hand today is worth more than a dollar received in the future, because today's dollar can be invested to earn interest.

Cash Outflow

A payment or movement of money outward, represented on a time line by placing a negative sign in front of the dollar amount.

Cash Inflow

A receipt or movement of money inward, represented on a time line by placing a positive sign in front of the dollar amount.

Future Value (FV)

An amount that an earlier investment will grow into over a given time period; the later money on a time line.

Compounding

The process of calculating future values from present values by earning interest on both the original principal and accumulated interest.

Future Value Interest Factor

The mathematical factor $(1 + r)^t$ used to multiply a present value to determine its future value over $t$ periods at rate $r$.

Present Value (PV)

The amount needed earlier in order to achieve a given later amount; the earlier money on a time line.

Discounting

The process of finding present values from future values by reducing the future amount by the interest rate earned over time.

Simple Interest

Interest earned strictly on the original starting principal amount, resulting in an equal amount of interest earned during each period.

Compound Interest

Interest earned on both the original principal and all interest accumulated during preceding periods.

Discount Rate ($r$)

The interest or growth rate per period used to convert cash flows between present and future value, which reflects the riskiness of the cash flow.

Future Value Formula

The general equation $FV = PV \times (1 + r)^t$, where $FV$ is future value, $PV$ is present value, $r$ is period rate, and $t$ is number of periods.

Present Value Formula

The general equation $PV = \frac{FV}{(1 + r)^t}$, where $PV$ is present value, $FV$ is future value, $r$ is period discount rate, and $t$ is number of periods.

Rate Formula ($r$)

The equation r = \right(\frac{FV}{PV}\right)^{1/t} - 1, used to solve for the interest rate, discount rate, or annual rate of change.

Number of Periods Formula ($t$)

The equation $t = \frac{\frac{\text{ln}(FV)}{\text{ln}(PV)}}{\text{ln}(1 + r)}$, used to solve for the number of periods needed for a present value to grow into a future value at rate $r$.