Time Value of Money Equations quiz #1 Flashcards
Time Value of Money Equations quiz #1
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What is the time value of money concept?
The time value of money concept states that a dollar today is worth more than a dollar in the future due to its potential to earn interest. What is compounding in the context of time value of money?
Compounding is the process of earning interest on both the principal and previously earned interest over time. What does discounting mean in time value of money calculations?
Discounting is the process of determining the present value of a future sum by removing the interest that would have been earned over time. Write the basic time value of money equation and define its variables.
The equation is FV = PV × (1 + r)^n, where FV is future value, PV is present value, r is the interest rate, and n is the number of periods. How do you calculate the future value of a lump sum using the time value of money equation?
Multiply the present value by (1 + r) raised to the power of n: FV = PV × (1 + r)^n. What is present value (PV)?
Present value is the value of a sum of money today. What is future value (FV)?
Future value is the value of a sum of money at a specific point in the future, considering interest earned. In the time value of money equation, what does 'r' represent and how should it be expressed?
'r' represents the market interest rate and should be expressed as a decimal (e.g., 10% as 0.10). What does 'n' stand for in the time value of money equation?
'n' stands for the number of periods, usually measured in years. If you invest $100 at 10% interest for 3 years, what is the future value?
The future value is $133.10, calculated as $100 × (1.10)^3. Why is a dollar today worth more than a dollar in the future?
Because a dollar today can be invested to earn interest, making it worth more in the future. What is an annuity?
An annuity is a series of equal payments made at regular intervals over a specified period. What is an ordinary annuity?
An ordinary annuity is an annuity where payments start one period from now and are made at regular intervals. How is the present value of an annuity typically calculated in this course?
The present value of an annuity is usually calculated using present value tables rather than complex formulas. What are the key characteristics of an annuity?
An annuity consists of equal payments made at regular, equal intervals. Why do we use timelines in time value of money problems?
Timelines help visualize cash flows and the timing of payments or receipts. What is the difference between compounding and discounting?
Compounding calculates future value from present value, while discounting finds present value from a future sum. When calculating the time value of money, which interest rate should be used?
The market interest rate should be used in time value of money calculations. What is the payment (PMT) in the context of an annuity?
PMT is the fixed amount paid or received in each period of an annuity. If you receive $10,000 annually for 5 years starting one year from now, what type of annuity is this?
This is an ordinary annuity. Why is it easier to use present value tables for annuities instead of formulas?
Present value tables simplify calculations by providing factors to multiply by the payment amount, avoiding complex formulas. What must be true for a series of payments to be considered an annuity?
The payments must be equal in amount and made at regular, equal intervals. How can you find the present value of a single future sum?
By discounting the future sum using the formula PV = FV / (1 + r)^n. What is the main use of time value of money concepts in this accounting course?
Time value of money is mainly used for valuing bonds payable. What is the effect of compounding interest over multiple periods?
Interest is earned on both the initial principal and the accumulated interest from previous periods, increasing the total amount. How does the number of periods (n) affect the future value in compounding?
The more periods, the greater the future value due to more opportunities for interest to compound. What is the formula to calculate the present value of a lump sum?
PV = FV / (1 + r)^n. If you are offered $1,000 today or $1,500 in 5 years, what should you consider to make a decision?
You should compare the present value of $1,500 in 5 years to $1,000 today using the appropriate interest rate. What is the main difference between a lump sum and an annuity?
A lump sum is a single payment, while an annuity is a series of equal payments at regular intervals. Why do ordinary annuities start payments one period from now?
By definition, ordinary annuities have their first payment at the end of the first period, not immediately. What is the purpose of using the exponent 'n' in the time value of money equation?
The exponent 'n' represents the number of compounding periods, affecting how much interest accumulates. How do you express a 10% interest rate in the time value of money formula?
Express 10% as 0.10 in the formula. What is the present value of $1,000 to be received 3 years from now at a 10% interest rate?
PV = $1,000 / (1.10)^3 ≈ $751.31. What is the future value of $500 invested for 4 years at 8% interest?
FV = $500 × (1.08)^4 ≈ $680.24. What is the main advantage of compounding interest?
Compounding allows you to earn interest on both the principal and previously earned interest, increasing total returns. How does the time value of money relate to investment decisions?
It helps compare the value of money received or paid at different times, guiding better investment choices. What is the present value of an annuity?
The present value of an annuity is the current worth of a series of equal payments made at regular intervals. Why is it important that annuity payments are equal and at regular intervals?
This consistency allows for simplified calculations and the use of present value tables. What is the difference between an ordinary annuity and other types of annuities?
An ordinary annuity starts payments one period from now, while other types may start payments immediately or at different intervals. How do you use a present value table for an annuity?
Find the factor for the given interest rate and number of periods, then multiply it by the payment amount.
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