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Answer Financial Management Chapter Time Value of Money, Study notes of Financial Accounting

Universitas Atma Jaya Yogyakarta (UAJY)Financial Accounting

This is answer to some financial management chapter time value of money

Typology: Study notes

2018/2019

Uploaded on 03/08/2019

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1. In learning time value of money, you need to set up a timeline.
What is timeline? Do timelines deal only with years, or can other
periods be used?
Answer:
Timeline is an important tool used in time value analysis; it is a graphical
representation used to show the timing of cash flows. Timelines are useful for
visualizing complex problems prior to doing actual calculations. Timelines
can be constructed to deal with situations where some of the cash flows occur annually but others
occur quarterly. Timelines can be constructed where some of the payments constitute an annuity
but others are unequal and thus are not part of the annuity. Timelines can be constructed for
annuities where the payments occur at either the beginning or the end of the periods.
2. What is discounting, and how is it related to compounding? How is the future value
equation is related to the present value equation?
Answer:
Discounting is a way to compute the present value of future money. The discounting
technique helps to ascertain the present value of future cash flows by applying a discount rate.
Compounding and discounting are simply opposite to each other. Compounding converts the
present value into future value and discounting converts the future value into present value. So,
we can say that if we reverse compounding it will become discounting.
PV and FV are related, which reflects compounding interest (simple interest has n multiplied
by і, instead of as the exponent). Since it's really rare to use simple interest, this formula is the
important one.
PV and FV vary directly: when one increases, the other increases, assuming that the interest
rate and the number of periods remain constant.
The interest rate (or discount rate) and the number of periods are the two other variables that
affect the FV and PV. The higher the interest rate, the lower the PV and the higher the FV. The
same relationships apply for the number of periods. The more time that passes, or the more
interest accrued per period, the higher the FV will be if the PV is constant, and vice versa.
The formula implicitly assumes that there is only a single payment. If there are multiple
payments, the PV is the sum of the present values of each payment and the FV is the sum of the
future values of each payment.
3. How does the present value of future payment change as the time to receipt is
lengthened?
Answer:
As the time to receipt is lengthened, the present value would decrease because it would take
less to become the future value.
4. Explain the following terms:
• Simple interest, compound interest
• Opportunity cost
FV = PV (1 + і)
pf2

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Download Answer Financial Management Chapter Time Value of Money and more Study notes Financial Accounting in PDF only on Docsity!

1. In learning time value of money, you need to set up a timeline.

What is timeline? Do timelines deal only with years, or can other

periods be used?

Answer:

Timeline is an important tool used in time value analysis; it is a graphical representation used to show the timing of cash flows. Timelines are useful for visualizing complex problems prior to doing actual calculations. Timelines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly. Timelines can be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity. Timelines can be constructed for annuities where the payments occur at either the beginning or the end of the periods.

2. What is discounting, and how is it related to compounding? How is the future value

equation is related to the present value equation?

Answer:

Discounting is a way to compute the present value of future money. The discounting technique helps to ascertain the present value of future cash flows by applying a discount rate. Compounding and discounting are simply opposite to each other. Compounding converts the present value into future value and discounting converts the future value into present value. So, we can say that if we reverse compounding it will become discounting.

PV and FV are related, which reflects compounding interest (simple interest has n multiplied by і, instead of as the exponent). Since it's really rare to use simple interest, this formula is the important one. PV and FV vary directly: when one increases, the other increases, assuming that the interest rate and the number of periods remain constant. The interest rate (or discount rate) and the number of periods are the two other variables that affect the FV and PV. The higher the interest rate, the lower the PV and the higher the FV. The same relationships apply for the number of periods. The more time that passes, or the more interest accrued per period, the higher the FV will be if the PV is constant, and vice versa. The formula implicitly assumes that there is only a single payment. If there are multiple payments, the PV is the sum of the present values of each payment and the FV is the sum of the future values of each payment.

3. How does the present value of future payment change as the time to receipt is

lengthened?

Answer:

As the time to receipt is lengthened, the present value would decrease because it would take less to become the future value.

4. Explain the following terms:

• Simple interest, compound interest

• Opportunity cost

FV = PV (1 + і)

•Annuity, ordinary (deferred) equity, annuity due

•Consol, perpetuity

•Amortized load, amortization schedule

Answer:

Simple interest is when interest is only paid on the amount you originally invested (the principal). You don’t earn interest on the interest you previously earned. Simple interest is determined by multiplying the daily interest rate by the principal by the number of days that elapse between payments.

Compound Interest is an Interest that is paid at the total amount in the account, which may include interest earned in previous periods. Compound interest is interest, as, on a loan or a bank account, that is calculated on the total on the principal plus accumulated unpaid interest.

The opportunity cost rate is the rate of interest one could earn on an alternative investment with a risk equal to the risk of the investment in question. This is the value of i in the TVM equations, and it is shown on the top of a timeline, between the first and second tick marks. It is not a single rate-the opportunity cost rate varies depending on the riskiness and maturity of an investment, and it also varies from year to year depending on inflationary expectations. An annuity is a type of investment in which regular payments are made over the course of multiple periods. An annuity is a series of payments of a fixed amount for a specified number of periods. A single sum, or lump sum payment, as opposed to an annuity, consists of one payment occurring now or at some future time. Cash flow can be an inflow (a receipt) or an outflow (a deposit, a cost, or an amount paid). We distinguish between the terms cash flow and PMT. We use the term cash flow for uneven streams, while we use the term PMT for annuities or constant payment amounts. An uneven cash flow stream is a series of cash flows in which the amount varies from one period to the next. The PV (or FV (^) n ) of an uneven payment stream is merely the sum of the present values (or future values) of each individual payment. Annuity-due is an investment with fixed-payments that occur at regular intervals, paid at the beginning of each period. Annuity-due is a stream of fixed payments where payments are made at the beginning of each period For example, if a period is one month, payments are made on the first of each month.

FV = PV (1 + rt)FV = PV (1 + і) t