D076 Finance Skills for Managers - Unit 3

Interest Rate - the percentage of the principal that a lender charges a borrower for the use of assets. Annual precentage rate (APR) - The annual interest rate that is charged for borrowing money or that is earned through investment. Discount Rate - The name for interest rate when used in time value of money calculations. Cost of Capital - The cost to a firm to use an investor's capital; see interest rate 2 Types of interest - Simple and Compound Simple Interest - The interest earned only on the principal. Annual Interest = Principal x Interest Rate - Simple Interest Compounding Interest - The interest on the principal plus the interest on earned interest. Total Interest=Principal×(1+Interest Rate)^Number of Periods−Principal - Compounding Interest What is the term for the percentage of the principal that a lender charges a borrower for the use of assets? - Interest rate How is the interest rate expressed? - As a percentage What is the main purpose of charging interest? - It allows borrowers to pay to use the assets of another entity to accomplish their own goals. Required rate of return - the rate of return or compensation that an investor or a lender will accept for investments such as stocks, bonds, or loans. 3 Things that determines interest rates - 1. Opportunity Cost 2. Risk 3. Inflation Opportunity Cost - the loss of potential gain from other alternatives when one alternative is chosen. Risk - the possibility that the realized or actual return will differ from the expected return. Inflation - the rate which the average price level of goods and services in an economy increases over a period of time. What is a component of the required rate of return? - Hurdle Rate - Simple Interest - Compound Interest - Opportunity Cost - Opportunity Cost