Valuation Chapter: Time Value of Money

Questions and Answers

What does the time value of money (TVM) concept primarily indicate about present and future sums of money?

Present sums have greater value due to their potential earning capacity. (correct)

Present sums are always more valuable than future sums regardless of interest rates.

Future sums can be considered equivalent to present sums when discounted properly.

Future sums are more valuable due to inflation impacting their purchasing power.

In the context of cash flow timelines, what is a cash inflow?

A receipt of cash from investments or other sources. (correct)

The depreciation of an asset over time.

A payment made for expenses or investments.

A short-term borrowing from financial institutions.

What is the primary purpose of calculating present value (PV) in financial contexts?

To determine how much future cash flows are worth today. (correct)

To compare cash flows across different time periods.

To measure the interest earned over a time period.

To predict the future value of existing cash flows.

Which statement correctly defines future value (FV) in the context of TVM?

FV is the amount to which a cash flow will grow when compounded at a specific interest rate over time. Signup and view all the answers

How does the percentage change in value relate to the time value of money?

It signifies the earning potential of money during a specific time gap. Signup and view all the answers

What is the formula to calculate the future value of an investment after two years at a 3% interest rate, starting with a principal of Tk.5000?

5000 * (1 + 0.03)^2 Signup and view all the answers

What is the value of Tk.5000 after three years with a 3% annual interest rate?

Tk.5463.61 Signup and view all the answers

How much interest will be earned after two years on an investment of Tk.5000 at a 3% interest rate?

Tk.304.5 Signup and view all the answers

Which statement accurately describes compound interest?

It earns interest on the initial principal and accumulated interest. Signup and view all the answers

Which of the following represents the value of Tk.5000 after four years at an interest rate of 3% when using the compounding formula?

Tk.5627.544 Signup and view all the answers

Study Notes

Time Value of Money (TVM)

TVM concept states that current money is worth more than the same amount in the future due to earning capacity.
Money can earn interest, making earlier receipts more valuable.

Cash Flow Timelines

A cash flow timeline visually represents the timing of cash inflows and outflows.
Cash outflow represents payments for expenses or investments, while cash inflow is money received from investments or employers.

Future Value (FV) and Present Value (PV)

Future Value (FV): The amount a cash flow will grow to over time with compounded interest.
Present Value (PV): The current value of future cash flows, calculated using the formula ( PV = \frac{FV}{(1 + r)^n} ).

Compounding Interest

Compounding involves earning interest on both the initial principal and previously earned interest, resulting in increased total value over time.
Example calculations show values growing with time and interest rate effects, demonstrating the impact of compounding.

Opportunity Cost and Investment Decisions

Opportunity cost rate reflects returns from the best alternative investment available.
Investment decisions should consider opportunity cost; if an investment promises a higher return than the cost, it's advisable to proceed.

Solving for Interest Rates and Time

Equations for PV, FV, rate, and time have four variables: ( PV, FV, r, n ).
If three variables are known, the fourth can be calculated.

Rule of 72

A method for estimating the period needed for an investment to double, calculated as ( \frac{72}{r} = n ).
Useful for quick assessments of investment potential.

Annuities

Annuity: Equal payment series made at fixed intervals.
Ordinary (deferred) annuity: Payments at the end of each period.
Annuity due: Payments at the beginning of each period.

Future Value of an Annuity

Future value of an ordinary annuity can be calculated by computing the FV of each payment and summing the results.

Perpetuity

A perpetuity is a bond or investment that pays fixed cash flows indefinitely.
Example includes British consols, which were perpetual bonds prior to 2015.

Uneven Cash Flow Streams

Uneven cash flow streams consist of cash flows of varied amounts over time.
Present Value and Future Value for these streams require summing individual cash flows adjusted for time and interest.

Terminal Value

The future value of a cash flow stream is termed terminal value.
Essential for evaluating inconsistent cash flows over specific periods.

Description

Explore the fundamental concepts of the Time Value of Money (TVM) through this quiz. Learn about future values, present values, and important relationships in valuation. Test your understanding of how money's value changes over time and the tools needed to calculate these values.