SM132 Exam 1 Flashcards

Class #1: Cost Benefit and Introduction to Time Value of Money

1. Q: What is the role of the financial manager?

   • A: To maximize the value of the firm by making investment and financing decisions.

2. Q: What is the goal of cost-benefit analysis?

   • A: To assess whether the benefits of a decision outweigh its costs.

3. Q: What is the Law of One Price?

   • A: In competitive markets, identical goods must sell for the same price to prevent arbitrage.

4. Q: How do you calculate net value in a trade?

   • A: Net Value = Benefit - Cost (e.g., the value of gold received minus the cost of silver given up).

5. Q: What is arbitrage?

   • A: Arbitrage is the practice of buying and selling equivalent goods to profit from price differences without risk.

6. Q: Why is it important to use market prices in cost-benefit analysis?

   • A: Market prices reflect the true value of goods and help in comparing costs and benefits objectively.

7. Q: What is the time value of money?

   • A: The principle that a dollar today is worth more than a dollar in the future due to its earning potential.

8. Q: What is the formula for future value (FV)?

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

9. Q: How do you calculate present value (PV)?

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

10. Q: What is the discount factor?

• A: The factor used to calculate the present value of future cash flows. It is the inverse of the interest rate factor.

11. Q: How does increasing the interest rate affect present value?

• A: A higher interest rate decreases the present value of future cash flows because future money is worth less today.

12. Q: Why is money in the future worth less today?

• A: Due to the time value of money, which reflects the opportunity to earn interest or returns on money today.

Class #2: Series of Cash Flows and Calculator Introduction

1. Q: What is a time line in finance?

   • A: A visual representation of cash flows occurring at different points in time.

2. Q: What happens to present value when the interest rate increases?

   • A: Present value decreases as higher interest rates reduce the value of future cash flows.

3. Q: What is compound interest?

   • A: Interest earned on both the initial principal and the accumulated interest from previous periods.

4. Q: How do you calculate the future value of a single cash flow?

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

5. Q: What is the present value of $1000 received in 5 years at an 8% interest rate?

   • A: $680.58.

6. Q: What is Rule 1 for comparing cash flows at different points in time?

   • A: Cash flows must be valued at the same point in time to make an accurate comparison.

7. Q: What is the future value of $1000 in 10 years at a 6% interest rate?

   • A: $1790.85.

8. Q: What does it mean to discount a future cash flow?

   • A: To determine its present value by adjusting for the interest rate over time.

9. Q: How do you calculate the present value of a series of cash flows?

   • A: Discount each future cash flow back to the present and sum them up.

10. Q: How do you use the HP 10bII calculator to find present value?

• A: Enter the known variables: N (number of periods), I/Y (interest rate), PMT (payment), and FV (future value), then solve for PV.

11. Q: What is the impact of time on present value?

• A: The longer the time period, the lower the present value of a future cash flow, assuming a positive interest rate.

12. Q: What is the formula for calculating present value in Excel?

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

Class #3: Annuities and Perpetuities

1. Q: What is a perpetuity?

   • A: A perpetuity is a stream of equal cash flows paid at regular intervals that continue forever.

2. Q: How do you calculate the present value of a perpetuity?

   • A: PV = C / r, where C is the cash flow and r is the interest rate.

3. Q: What is a growing perpetuity?

   • A: A growing perpetuity is a stream of cash flows that grow at a constant rate and continue indefinitely.

4. Q: What is the formula for the present value of a growing perpetuity?

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

5. Q: What is an annuity?

   • A: An annuity is a series of equal cash flows paid at regular intervals for a fixed number of periods.

6. Q: How does an annuity differ from a perpetuity?

   • A: An annuity has a fixed number of payments, whereas a perpetuity continues indefinitely.

7. Q: How do you calculate the present value of an annuity?

   • A: 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.

8. Q: How do you calculate the future value of an annuity?

   • A: 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.

9. Q: How do you use the HP 10bII calculator to find the future value of an annuity?

   • A: Enter N (number of periods), I/Y (interest rate), PMT (cash flow), and solve for FV.

10. Q: What is the relationship between present value and future value for a stream of cash flows?

    • A: The present value is the discounted sum of future cash flows, while the future value is the compounded total of cash flows projected into the future.

11. Q: How do you calculate the present value of a delayed perpetuity?

    • A: First, calculate the value of the perpetuity at the point one period before the first payment, then discount it back to today.

12. Q: What is the future value of an annuity if payments begin in the future?

    • A: First calculate the future value as if payments started immediately, then compound the result forward by the number of periods until the first payment.