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TMP 421 - Exam 2 Review
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TMP 421 - Exam 2 Review 2024-2025Time value of money - underlying principles - ANSWER 1) opportunity cost
2) risk (time = risk)
Interest - ANSWER - the reward for lending
- the cost of borrowing
- a bridge between present and future value
Simple interest - ANSWER don't earn (charge) interest on interest
Compound interest - ANSWER Interest is earned (charged) on interest
What is your bank balance on a $1,000 deposit earning 4% per year after 3 years? -
ANSWER I = Prt
Interest for year 1 = (1,000)(0.04)(1) = $40
Interest for year 2 = (1,040)(0.04)(1) = $41.60
Interest for year 3 = (1,081.60)(0.04)(1) = $43.26
Interest earned = $40 + $41.60 + $43.26 = $124.86
Bank balance = $1,124,86
OR using FV
FV = $1,000(1.04)3 = $1,124.86
,Future Value - ANSWER FV = PV(1+i)n
PV = Present value, or current principal amount
i = interest rate earned per period of compounding
n = number of compounding periods that the money will be invested
Calculate the future value in 4 years of a $3,000 investment that earns 8% simple
interest annually paid at the end of each year.
Calculate the same as above expect with compound interest.
Calculate the same as above except with compound interest paid every 6 months. -
ANSWER 1) I = 3,000 + (3,000*0.08*4) = $3,960
2) FV = 3,000 * (1+0.08)^4 = $4,163.20
3) A = 3,000 * (1.08/2)^(6*2) = $4,228.43
Why do we prefer Present Value? - ANSWER Because in business we usually make
decisions in the present (time zero)
Basic patterns of cash flow - ANSWER A single amount: A lump sum amount either held
currently or expected at some future date.
An annuity: A level periodic stream of cash flow.
A mixed stream: A stream of unequal periodic cash flows
, Financial decisions based on mixed-stream cash flows are most common in business!
Types of annuities - ANSWER - ordinary annuity: cash flow occurs at the
(Current) Annuity Due - cash flow occurs at the BEGINNING of the period. rent is "due"
at the beginning of the month
perpetuity - an annuity that runs forever
Future Value of a Lump Sum - ANSWER the future value of a lump sum amount for n
periods and at i rate of return
FV = PV(1+i)^n
Using the tables:
FV = PV(FVF)
FVF = future value factor = (1+i)^n
You deposit $10,000 earning 5% interest for a 10 year period compounded annually.
What is the future value of this investment after 10 years? - ANSWER FV = 10,000(1+
0.05)^10 = $16,289
A wedding today costs $20,000, how much will the wedding cost 10 years from now if
inflation averages 4% a year? - ANSWER FV = 20,000(1+0.04)^10 = $29,604
Present value of a future lump sum - ANSWER the present value of a future lump sum
amount for n periods at an i rate of return
PV = FV(1/(1+i)^n)
How much do you have to deposit today if you want a value of $10,000,000 in 7 years
(assume interest rate of 6%) - ANSWER PV = 10,000,000(1/(1+0.06)^7) = $6,650,571.14
Future value of an ordinary annuity - ANSWER the future value of a stream of payments
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