Ch.

1 Time Value of Money

● Future value
○ Compounding (reinvested, make even more profits)
○ Simple interest (no reinvestment, profits: same every year)
○ Future value: usually compounding
■ FV=PVx(1+r)n
○ Effect of compounding: the difference of compounding and simple
○ ⬆️principal/interest rate/number of periods, ⬆️FV

● Present value
○ Discounting (reverse of compounding)
○ Present value (the current value of an amount of money you will receive/pay in
the future)
■ PV=FV/(1+r)n
○ Interest rate(to calculate PV): discount rate/cost of capital/opportunity cost
○ ⬆️principal, ⬆️PV
○ ⬆️interest rate/number of periods⬇️PV
● Rule of 72
○ years to double an investment(approximation) = 72 / annual rate of return in
percent(the number before the % sign)

● Net present value (Multiple cash flows) (purpose: helps to determine if it’s a
worthwhile investment)
○ Initial/upfront cost (year 0)
○ Residue/scrap/salvage value (year 3)
○ Inflows(+)/outflows(-)
○ *draw timeline 0——1——2——3
 ○ Invest?
time weighted value NPV > 0

time weighted loss NPV < 0

neutral, consider other factors e.g. qualitative factors NPV = 0

■ If NPV is greater than cash flow therefore there’s time-weighted value ➡️
invest
■ If NPV is less than 0, there’s a time weighted loss ➡️✖invest
️

● Future value (Multiple cash flow)

○ Timeline 0——1——2
○ contribute money each year ➡️- money contributed ➡️money raised

● Nominal vs. Effective rate of return

○ Rate of return: (%) (how much profits will the investor earn) (=yield)
○ Effective return: the true/actual return an investor will earn
○ Interest-bearing period: e.g. compounded four times a year ➡️3 months
 ○ Compare different banks that have different interest-bearing period
● Nominal interest rate
○ The rate written on the document or financial security
○ All investors usually have the same nominal rate
● Effective interest rate
○ Reflects the actual return from the financial security
○ Used to compare different interest plans
○ May be different for each investor