Finance DCF (Single) notes Exam II

Discounted Cash Flow (DCF)

The process of calculating the present value of a future stream of cash flows.

TVM (Time Value of Money)

What typically refers to a single cash flow

DCF (discounted cash flow)

What typically refers to multiple cash flows

Time Value of Money (TVM)

represents the idea that money has different values at different points in time.

Present Value

When you hear about the "value" of something, what does that typically refer to?

Present Value (PV)

the value today of future cash flows discounted at the appropriate discount rate

Future Value (FV)

the value of an investment or stream of cash flows at some future period.

compound value

What can future value also be called?

Compounding

The process of reinvesting each interest payment to earn more interest. It is based on the idea that the interest itself becomes principal and therefore also earns interest in subsequent periods.

Compounding Interest

Interest that is earned both on the initial principal and interest earned in previous periods.

Discounting

The process of calculating the present value of future cash flows. This process is the opposite of compounding.

Discount Rate

The rate used in calculating the present value of future cash flows.

Principal

If you take out a loan, your ____ is your initial value.

Future Value (FV) of a Single Cash Flow

$194.87

Today, you decide to invest $100 in a security that earns 10% annual compound interest. How much will your investment be worth in 7 years?

What type of cash flow is this?

Time

Holding all other variables constant, the longer you stay invested, the higher your future value. As _____ increases, the future value of an investment will increase

Increase

As the compound rate increases, the investment's future value will _____.

Present Value (PV) of a Single Cash Flow

$7,628.95

Suppose you need $10,000 in 4 years for the down payment on a new car. If you can earn 7% annually, how much do you need to invest today?

What type of cash flow is this?

1st Option: $11,907.48

2nd Option: $12,594.29

Difference: -$686.81

Suppose you need $15,000 in 3 years. You are considering two investment options. The first option earns 8%, and the second option earns 6%.

If you invest in the first option, would you have to invest more or less today than with the second option?

3.71%

You are looking at an investment that will pay $1,200 in 5 years if you invest $1,000 today. What is the implied rate of interest?

3.02 years

You want to buy a new car and are willing to pay $20,000. If you can invest at 10% per year and you currently have $15,000, how long will it take to save enough to pay cash for the car?

Simple Interest

Interest calculated based only on the original principal amount. (Interest on interest is not earned)

1. $120.00

2. $447,189.84

Suppose you deposited $10 with 5.5% interest 200 years ago.

How much would the investment be worth today if it earned simple interest?

How much would the investment be worth today if it earned compound interest?

The Rule of 72

Provides an approximation of how long it takes for an

investment to double in value.

72/interest rate (percentage form)

The Rule of 72 equation

In simple interest, time is no longer exponential

What is the key difference between compound and simple interest formulas?

Expense Ratio

Reflects how much a mutual fund or an ETF pays for portfolio management, administration, marketing, distribution, and other expenses. Typically expressed as a percentage of the fund's average net assets.