FIN 3303 Exam 2 Vocab

future value (FV)

The amount an investment is worth after one or more periods. Also compound value.

compounding

The process of accumulating interest in an investment over time to earn more interest

interest on interest

Interest earned on the reinvestment of previous interest payments.

compound interest

Interest earned on both the initial principal and the interest reinvested from prior periods.

simple interest

Interest earned only on the original principal amount invested.

present value (PV)

The current value of future cash flows discounted at the appropriate discount rate.

discount rate

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

discounted cash flow (DCF) valuation

(a) Calculating the present value of a future cash flow to determine its value today.
(b) The process of valuing an investment by discounting its future cash flows.

annuity

A level stream of cash flows for a fixed period of time.

annuity due

An annuity for which the cash flows occur at the beginning of the period.

perpetuity

An annuity in which the cash flows continue forever.

consol

A type of perpetuity

stated interest rate

The interest rate expressed in terms of the interest payment made each period. Also quoted interest rate.

effective annual rate (EAR)

The interest rate expressed as if it were compounded once per year.

annual percentage rate (APR)

The interest rate charged per period multiplied by the number of periods per year.

net present value (NPV)

The difference between an investment's market value and its cost.

payback period

The amount of time required for an investment to generate cash flows sufficient to recover its initial cost.

average accounting return (AAR)

An investment's average net income divided by its average book value

internal rate of return (IRR)

The discount rate that makes the net present value of an investment zero.

net present value profile

A graphical representation of the relationship between an investment's net present value and various discount rates.

multiple rates of return

The possibility that more than one discount rate will make the net present value of an investment zero.

profitability index (PI)

The present value of an investment’s future cash flows divided by its initial cost. ALso benefit-cost ratio.