Time Value of Money
Discounting
Cash flow which is expected to occur in the future, is converted to its present value
Compounding
Cash flow today is converted into its expected future value
Present Value
The present value can be calculated by using the formula
PV = FV/ (1 + r )^n
Future Value
The future value can be calculated by using the formula
FV = PV * (1 + r )^n
Annuity
- Ordinary Annuity
– Cash flow at end of the period
- Annuity Due
– Cash flow at beginning of the period
Net Present Value
NPV = Present value of cash inflow – Present value of cash out flow
NPV>0 — Accept
NPV<0 — Reject
NPV=0 — Neutral
Opportunity Cost
– Benchmark for making investment decision
Effective Interest Rate
Effective Interest Rate = ( 1 + r /n )^n – 1