FINS1613 Lecture Notes - Lecture 2: Kolmogorov Space, Cash Flow

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29 May 2018

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Fiacial Matheatics II

Valuing a Stream of Cash Flows

• ALWAYS START BY DRAWING A TIMELINE – Makes complicated cash

flos easier to isualise so you do’t ake istakes.

• Calculate the PV of the timeline – Bring all individual cash flows to time

0. Sum them to find the PV of all cash flows.

APR vs EAR

APR (Annual Percentage Rate)

• Total interest earned in a year without compounding

• APR = Per period interest rate * Number of compounding periods

EAR (Effective Annual Rate)

• How much interest you will earn in a year with compounding

• EAR = (1+r)m – 1 where r= (APR/m) and m = periods of compounding

Annuities

• Stream of a specified number

• Equal cash flow

• Occur at regular intervals (Not necessarily every year – must find

according interest rate per period)

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Document Summary

Apr (annual percentage rate: total interest earned in a year without compounding, apr = per period interest rate * number of compounding periods. Ear (effective annual rate: how much interest you will earn in a year with compounding, ear = (1+r)m 1 where r= (apr/m) and m = periods of compounding. Annuities: stream of a specified number, equal cash flow, occur at regular intervals (not necessarily every year must find according interest rate per period, note cash flow starts at t=1 but is valued at t=0. Perpetuity: stream of equal cash flows, occur at regular intervals, make payments forever, note cash flow starts at t=1 but is valued at t=0. Instead of equal payments each period, each payment grows at a rate of (1+g) compared to the previous payment. Note cash flow starts at t=1 but is valued at t=0.

Related Questions

Use a calculator to solve all quantitative problems, and be sure to show calculator format!!!

(n, I, pmt, pv, fv CFo,I,CF1, CF2â¦.)

8) Three years ago a company had sales of $300,000. Now sales are $1,000,000. At what rate have

sales been growing?

9) Define each of the following:

a) Quoted rate (APR)

b) Periodic rate

c) Effective annual rate (EAR)

10) What are the following Effective Annual Rates (EAR) for 12%:

a) Compounded semiannually?

b) Compounded quarterly?

c) Compounded daily?

11) What would the value of $500 be after 4 years, assuming a return of 8% per year:

a) with semiannual compounding?

b) with quarterly compounding?

12)A. You plan to invest in a preferred stock issue that pays a $60 dividend at the end of each year. Based

on market conditions, you want to get a 5% return. What are you willing to pay for this security?

12)A You want to buy a car today!! The used car you are looking at costs $21,500. The car dealer will

charge you 5% interest on the three year car loan you need. You will be borrowing the whole $21,500. What will your car payment be, if you will make monthly payments?

13. Your company has invested $2500 in a vending machine today. You expect the machine to last 10 years and to produce the following after tax cash flows per year:

Year 1 $100

Year2 $250

Year 3 $250

Year 4 $300

Year 5 $300

Year 6 $300

Year 7 $300

Year 8 $300

Year 9 $350

Year 10 $350

If you have a required return on your investment of 7%, did you pay too much for the vending machine?

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 ________.

Question 2 5 pts

On a timeline, the space between date 0 and date 1 represents the _______ between dates. Letâs 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.

Question 3 5 pts

As the interest rate __________, present value decreases.

Question 4 5 pts

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

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) __________.

Question 6 5 pts

Edit this Question Delete this Question

0 multiple_choice_question 22047052

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.

Question 8 5 pts

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

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 yearâs 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; =

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.

beginning

middle

end

payments are not required

limemacaw827

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.

FINS1613 Lecture Notes - Lecture 2: Kolmogorov Space, Cash Flow

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