C214 Financial Management Topic 5 The Time Value of Money Introduction

5.1 The Time Value of Money Introduction
Assessment Section 1
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In time value of money analysis, what is the nominal discount rate, r, equal to?

 Discount Rate – Inflation
 Discount Rate × Payments / Number of Periods
 Real Risk-Free Rate × Risk Premium
 Correct


Real Risk-Free Rate + Inflation + Risk Premium

The nominal discount rate is the sum of the rate earned on riskless investments with 0%
inflation, inflation rate, and compensation for bearing the risk of a particular investment.

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Which three variables does time value of money analysis bring together?

 Correct


Amount of cash flows, timing of cash flows, discount rate

 Source of cash flows, amount of cash flows, rate of return
 Risk, return, cost of capital
 Inflation, market volatility, interest rate

The time value of money brings together the amount of the cash flows, the timing of each
cash flow, and the rate at which the value of each cash flow changes due to the passage of
time to help us understand the standardized value of cash flows.

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What is the time value of money?

 The measures enacted by central banks to regulate the value of a dollar
 Correct


The concept that a dollar today is worth more than a dollar in the future

 The process of deciding exactly when to invest to receive the highest returns

,  The idea that a dollar today is worth less than a dollar in the future due to inflation

The time value of money is the idea that money that is available at the present time is worth
more than the same amount in the future. It does not have to do with investors deciding
exactly when to invest, nor does it have to do with regulation. Further, when there is
inflation, the purchasing power of consumers decreases in the future relative to today with
the same dollar amount.

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Which effect does inflation have on the time value of money?

 Inflation has little effect on the time value of money.
 Inflation reduces the uncertainty involved in investing.
 Correct


Inflation causes the purchasing power of a dollar to decrease.

 Inflation boosts the purchasing power of a dollar in the future.

Inflation is a term describes a rise in prices of goods, which can be translated as the
decrease of purchasing power over time. Inflation does not boost purchasing power—
rather, it diminishes the purchasing power of a dollar in the future. Inflation does not affect
the uncertainty involved in making investment decisions. Finally, inflation is one of the three
variables that affect the time value of money.

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Why should you consider opportunity in the time value of money?

 If you expect cash in the future, you have the chance to use it for any purposes you
wish.
 You Selected


If you have cash today, you can buy more than you could with the same dollar
amount in the future.

Incorrect. This explains how the time value of money considers inflation.

 If you expect cash in the future, you have a chance of not getting it.
 Correct


If you have cash today, you can use it for different purposes.

Correct. The time value of money considers opportunity in that if you have cash
today, you can use it for different purposes.

, The time value of money considers opportunity in that if you have cash today, you can use it
for different purposes.

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Which relationship is a key principle in financial decision-making?

 Inflation rate
 Risk
 Opportunity costs
 Correct


The time value of money

Correct. The time value of money is the relationship between risk, opportunity costs,
and inflation rate, and it is a key principle in financial decision-making.

The time value of money is the relationship between risk, opportunity costs, and inflation
rate, and it is a key principle in financial decision-making.


5.2 Single Sum Calculations
Assessment Section 1
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Which type of cash flow is one payment of $100 made in one year from today?

 Annuity
 Correct


Single sum

 Present sum
 Perpetuity

This cash flow is a single sum, which is an amount of money that is paid at one time. A
perpetuity is a fixed amount of money paid every fixed interval indefinitely. “Present sum” is
not a term used in finance. An annuity is a fixed amount of money paid every fixed interval
for a definite duration.

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