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FINS1613 Lecture Notes - Lecture 2: Cash Flow, Discounting, Arbitrage

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UNSW, UNSW Sydney
Department
Finance
Course
FINS1613
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All

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Document Summary

The difference in value between money today and money in the future. Or, the observation that two cash flows at two different points in time have different values. A dollar today is worth more than a dollar tomorrow due to its potential earning capacity (e. g. interest in a bank). In order to compare or combine cash flows at different times, it is necessary to convert all values to the same units/point in time. A timeline is a linear representation of the timing of (potential) cash flows. He has agreed to repay the loan by making two payments of at the end of each of the next two years. To calculate the equivalent future value of a cash flow, multiply the (cid:272)ash flo(cid:449)"s present (cid:448)alue (cid:271)y the interest rate factor (1+r)n, associated with the intervening time periods. This process is used to move a cash flow forward in time.

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Related Questions

QUESTION 1 The time value of money refers to the issue of: A. what the value of the stream of future cash flows is today. B. why a dollar received tomorrow is worth more than a dollar received today. C. what the time required to double an amount of money. D. why people prefer to consume things at some time in the future rather than today.

QUESTION 2 The process of converting an amount given at the present time into a future value is called: A. annualizing. B. discounting. C. compounding. D. capital budgeting. 2 points

QUESTION 3 Juan Vinson is planning to buy a house in five years. He is looking to invest $25,000 today in an index mutual fund that will provide him a return of 12 percent annually. How much will he have at the end of five years? (Round to the nearest dollar.) A. $45,000 B. $28,000 C. $44,059 D. $28,530 2 points

QUESTION 4 Which of the following statements is true with respect to the present value of a future amount? A. The higher the discount rate, the higher the present value of a single sum for a given time period. B. The relation between present value and time is exponential. C. The greater the time period, the higher the present value of a single sum for a given interest rate. D. The lower the discount rate, the lower the present value of a single sum for a given time period. 2 points

QUESTION 5 Which of the following statements is true of the rule of 72? A. It can be used to determine the amount of time it takes to double an investment. B. It is fairly accurate for interest rates between 25 and 50 percent. C. It states that the time to double your money (TDM) approximately equals 72/i, where i represents the years it takes to double your investment. D. It can be used to estimate approximate compound interest earned for a period of 72 days. 2 points

QUESTION 6 The present value of future cash flows are computed by multiplying future value with the: A. discounting factor. B. compound factor. C. interest rate. D. number of periods. 2 points

QUESTION 7 The present value of multiple cash flows is: A. greater than the sum of the cash flows. B. equal to the sum of all the cash flows. C. less than the sum of the cash flows. D. higher or lower than the cash flows depending on the interest rate. 2 points

QUESTION 8 Cash flows associated with annuities are considered to be: A. an uneven cash flow stream. B. a constant cash flow stream. C. a mix of constant and uneven cash flow streams. D. a cash flow stream with decreasing trend. 2 points

QUESTION 9 The annuity transformation method is used to transform: A. a present value annuity to a future value annuity. B. a present value annuity to an annuity due. C. an ordinary annuity to an annuity due. D. a perpetuity to an annuity. 2 points

QUESTION 10 The true cost of borrowing is the: A. annual percentage rate. B. effective annual rate. C. quoted interest rate. D. periodic rate.

Your daughter is currently 6 years old. You anticipate that she will be going to college in 12 years. You would like to have $137,000 in a savings account to fund her education at that time. If the account promises to pay a fixed interest rate of 12% per​ year, how much money do you need to put into the account today to ensure that you will have $137,000 in 12 ​years?

Your deposit today should be

​$.

​ (Round to the nearest​ dollar.)

Suppose you receive $180 at the end of each year for the next three years.

a. If the interest rate is 7%​, what is the present value of these cash​ flows?

b. What is the future value in three years of the present value you computed in (a​)?

c. Suppose you deposit the cash flows in a bank account that pays 7% interest per year. What is the balance in the account at the end of each of the next three years​ (after your deposit is​ made)? How does the final bank balance compare with your answer in ​(b​)?

a. If the interest rate is 7%​, what is the present value of these cash​ flows?

The present value of these cash flows is

​$ .

​ (Round to the nearest​ cent.)

You have just received a windfall from an investment you made in a​ friend's business. He will be paying you $31,004 at the end of this​ year, $62,008 at the end of the following​ year, and $93,012 at the end of the year after that​ (three years from​ today). The interest rate is 13.3% per year.

a. What is the present value of your​ windfall?

b. What is the future value of your windfall in three years​ (on the date of the last​ payment)?

a. What is the present value of your​ windfall?

The present value of your windfall is

​$.

​ (Round to the nearest​ dollar.)

Question 1 5 pts

0 multiple_choice_question 22046808

The internal rate of return (IRR) is the interest rate that sets the net present value of the future cash flows equal to ________.

The internal rate of return (IRR) is the interest rate that sets the net present value of the future cash flows equal to ________.

zero
one
one hundred
none of the above

Question 2 5 pts

On a timeline, the space between date 0 and date 1 represents the _______ between dates. Let’s assume it is the first year of the loan. Date 0 is the beginning of the first year, and date 1 is the end of the first year.

On a timeline, the space between date 0 and date 1 represents the _______ between dates. Let’s assume it is the first year of the loan. Date 0 is the beginning of the first year, and date 1 is the end of the first year.

dollar amount
present value
time period
future value

Question 3 5 pts

As the interest rate __________, present value decreases.

As the interest rate __________, present value decreases.

decreases
increases
remains unchanged
is unrelated

Question 4 5 pts

The present value (PV) of a stream of cash flows is the _______ the present values of each individual cash flow

The present value (PV) of a stream of cash flows is the _______ the present values of each individual cash flow

difference between
product of
sum of
same as

Question 5 5 pts

When a constant cash flow will occur at regular intervals for a finite number of periods of time, it is called a(n) __________.

When a constant cash flow will occur at regular intervals for a finite number of periods of time, it is called a(n) __________.

annuity
perpetuity
interest payment
principle payment

Question 6 5 pts

Edit this Question Delete this Question

0 multiple_choice_question 22047052

There are two basic types of annuities:

There are two basic types of annuities:

Discounted and compounded annuities
Ordinary annuities and annuities due.
Future value and present value annuities
None of the above

Question 7 5 pts

The NPV measures the ______ change in shareholder wealth that arises from undertaking a project.

The NPV measures the ______ change in shareholder wealth that arises from undertaking a project.

consistent
dollar
annual
semi-annual

Question 8 5 pts

The Net Present Value rule implies that we should compare a project’s net present value (NPV) to ________

The Net Present Value rule implies that we should compare a project’s net present value (NPV) to ________

zero
one
100
none of the above

Question 9 5 pts

To endow a perpetuity is the same as calculating the present value (PV) of a perpetuity. Say you want to endow an annual graduation party at your alma mater. You want the event to be a memorable one, so you budget $30,000 per year forever for the party. If the university earns 8% per year on its investments, and if the first party is in one year’s time, how much will you need to donate to endow the party?

The formula for PV of a perpetuity = C\r; = $30,000 \ 0.08; =

To endow a perpetuity is the same as calculating the present value (PV) of a perpetuity. Say you want to endow an annual graduation party at your alma mater. You want the event to be a memorable one, so you budget $30,000 per year forever for the party. If the university earns 8% per year on its investments, and if the first party is in one year’s time, how much will you need to donate to endow the party?

The formula for PV of a perpetuity = C\r; = $30,000 \ 0.08; =

$3,750
$37,500
$375,000
$3,750,000

Question 10 5 pts

With an Ordinary Annuity, payments are required at the ________ of each period. An example of this is bonds which usually pay coupon payments at the end of every six months until the bond's maturity date.

With an Ordinary Annuity, payments are required at the ________ of each period. An example of this is bonds which usually pay coupon payments at the end of every six months until the bond's maturity date.

beginning
middle
end
payments are not required