Table of contents

1. Introduction to Accounting1h 21m
2. Transaction Analysis1h 13m
3. Accrual Accounting Concepts2h 38m
4. Merchandising Operations2h 30m
5. Inventory1h 55m
6. Internal Controls and Reporting Cash1h 16m
7. Receivables and Investments3h 8m
8. Long Lived Assets5h 1m
9. Current Liabilities2h 19m
10. Time Value of Money1h 23m
- Time Value of Money Equations
  35m
- Using Time Value of Money Tables
  47m
11. Long Term Liabilities2h 45m
12. Stockholders' Equity2h 15m
13. Statement of Cash Flows2h 24m
14. Financial Statement Analysis5h 25m
15. GAAP vs IFRS56m

10. Time Value of Money

Time Value of Money Equations

Financial Accounting

10. Time Value of Money

Time Value of Money Equations

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Multiple Choice

Which formula is used to calculate the present value (PV) of a perpetuity given a constant perpetual cash flow (C) and a discount rate (r)?

PV = C \times (1 + r)

PV = C \times r

PV = \frac{C}{r}

PV = \frac{C}{1 + r}

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Verified step by step guidance

Understand the concept of perpetuity: A perpetuity is a type of financial instrument that provides constant cash flows indefinitely. The present value (PV) of a perpetuity represents the value today of all future cash flows.

Identify the variables in the formula: 'C' represents the constant perpetual cash flow, and 'r' represents the discount rate. The discount rate is used to account for the time value of money.

Recall the formula for the present value of a perpetuity: The correct formula is PV = \frac{C}{r}. This formula is derived from the principle that the present value of an infinite series of cash flows is calculated by dividing the cash flow by the discount rate.

Understand why the other formulas are incorrect: For example, PV = C \times (1 + r) incorrectly multiplies the cash flow by the discount rate plus one, which does not account for the perpetuity concept. Similarly, PV = \frac{C}{1 + r} incorrectly divides the cash flow by the discount rate plus one, which is not the correct method for perpetuities.

Apply the correct formula: To calculate the present value of a perpetuity, divide the constant cash flow (C) by the discount rate (r) using the formula PV = \frac{C}{r}. Ensure that the discount rate is expressed as a decimal (e.g., 5% as 0.05) before performing the calculation.