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Questions and Answers
What is the formula for calculating the future value of an investment?
What is the formula for calculating the future value of an investment?
- Future value = present value * (1 - interest rate)^number of periods
- Future value = present value * (1 + interest rate)^number of periods (correct)
- Future value = present value / (1 + interest rate)^number of periods
- Future value = present value / (1 - interest rate)^number of periods
What does the concept of compounding interest entail?
What does the concept of compounding interest entail?
- Earning interest on the initial investment but not on the accumulated interest over time
- Earning interest on the initial investment and on the accumulated interest over time (correct)
- Earning interest only on the initial investment
- Earning a fixed interest rate regardless of the time period
How is present value calculated?
How is present value calculated?
- Present value = future cash flow / (1 + interest rate)^number of years (correct)
- Present value = future cash flow * (1 - interest rate)^number of years
- Present value = future cash flow / (1 - interest rate)^number of years
- Present value = future cash flow * (1 + interest rate)^number of years
What is the result of $5,000 invested at 10% interest for 5 years?
What is the result of $5,000 invested at 10% interest for 5 years?
What is the future value of $100 invested at 6% annual interest for 3 years?
What is the future value of $100 invested at 6% annual interest for 3 years?
Why is present value preferred in finance?
Why is present value preferred in finance?
What does a cash flow timeline visually represent?
What does a cash flow timeline visually represent?
What does the R represent in the present value equation?
What does the R represent in the present value equation?
How is the present value of a dollar received in the future affected by the expected rate of interest or level of risk?
How is the present value of a dollar received in the future affected by the expected rate of interest or level of risk?
What is the Net Present Value (NPV) a sum of?
What is the Net Present Value (NPV) a sum of?
How is the Internal Rate of Return (IRR) calculated?
How is the Internal Rate of Return (IRR) calculated?
What does a positive Net Present Value (NPV) indicate about a project?
What does a positive Net Present Value (NPV) indicate about a project?
What does the concept of break-even in a project or investment help determine?
What does the concept of break-even in a project or investment help determine?
What is the relationship between variable costs and fixed costs in financial analysis?
What is the relationship between variable costs and fixed costs in financial analysis?
What are the three major factors involved in understanding the time value of money?
What are the three major factors involved in understanding the time value of money?
What concept is used to find out the worth of a cash flow received in the future?
What concept is used to find out the worth of a cash flow received in the future?
If $100 is invested at a 6% rate of interest, how much will it be worth in three years?
If $100 is invested at a 6% rate of interest, how much will it be worth in three years?
What does the time value of money allow finance people to compare?
What does the time value of money allow finance people to compare?
What is the core principle associated with the time value of money if we have some cash we invest today?
What is the core principle associated with the time value of money if we have some cash we invest today?
What formula is used to calculate the future value of an investment?
What formula is used to calculate the future value of an investment?
What does the present value of a cash flow represent?
What does the present value of a cash flow represent?
What is an example of a fixed cost?
What is an example of a fixed cost?
What is the impact of producing more units on the per unit cost of a fixed cost?
What is the impact of producing more units on the per unit cost of a fixed cost?
How is the breakeven point estimated?
How is the breakeven point estimated?
What does the contribution margin contribute to covering?
What does the contribution margin contribute to covering?
How do fixed costs impact the breakeven point?
How do fixed costs impact the breakeven point?
What happens to the breakeven point if the variable cost per unit increases?
What happens to the breakeven point if the variable cost per unit increases?
How does the contribution margin impact the breakeven point?
How does the contribution margin impact the breakeven point?
What is the relationship between cash flow and breakeven point?
What is the relationship between cash flow and breakeven point?
What happens to the breakeven point if the price per unit increases?
What happens to the breakeven point if the price per unit increases?
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Study Notes
Understanding Present Value, Net Present Value, and Internal Rate of Return
- The R in the equation represents the risk-based expected rate of return for an investment or the rate used to bring money back to the present.
- A discount factor table can be used to visualize the present value of future cash flows at different interest rates over various periods.
- The present value of a dollar received in the future decreases as the expected rate of interest or the level of risk increases.
- Present value is related to the concept of time value of money, where spending money in the future costs less in present value terms.
- The present value of a future cash flow can be calculated using a discount factor table, which multiplies the cash flow by the discount factor to determine its present value.
- Net Present Value (NPV) is the sum of all cash flows at the same time, adjusted for the time value of money, and is expressed in dollars.
- A project with a positive NPV generates more cash than spent, while a negative NPV means the project does not create enough value.
- NPV is used to quantify the overall value of a project and is helpful in ranking projects when choosing between multiple options.
- The Internal Rate of Return (IRR) represents the average rate of return earned on cash over the project's life and is calculated by solving for the interest rate that makes the project's cash flows equal NPV 0.
- IRR and NPV provide different insights; IRR indicates the return on investment, while NPV reflects the magnitude of value created or destroyed.
- The concept of break-even is used to determine the point at which a project or investment starts earning a positive cash flow, taking into account variable and fixed costs.
- Variable costs change with volume, while fixed costs remain constant, and understanding cost behavior is crucial in financial analysis.
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