Chapter 5: Time Value of Money

Type Future Value PV

A. Single amount

B. Ordinary Annuity
[ ] [ ]

C. Annuity Due
[ ] [ ]

D. Mixed Streams ∑
∑

E. Perpetuity

F. Compounding interest more

( )
frequently than annually

G. Continuous Compounding

Effective Annual Rate: ( )

Capital Budgeting Techniques

A. Payback Method
a) Equal CF
𝐶𝐹0
𝑃𝑎𝑦𝑏𝑎𝑐𝑘 𝑃𝑒𝑟𝑖𝑜𝑑
𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝐹

b) Unequal CF
𝐵𝑎𝑙𝑎𝑛𝑐𝑒
𝑃𝑎𝑦𝑏𝑎𝑐𝑘 𝑃𝑒𝑟𝑖𝑜𝑑 𝑛 𝑦𝑒𝑎𝑟𝑠
𝐹𝑖𝑛𝑎𝑙 𝑌𝑒𝑎𝑟 ′ 𝑠𝐶𝐹

B. Net Present Value (NPV)

∑𝑛
𝑡=1 𝐶𝐹
𝑁𝑃𝑉 𝐶𝐹0 or 𝑁𝑃𝑉 𝑃𝑉 𝐶𝐹0
+𝑟 𝑡
C. Internal Rate of Return (IRR)

NPV = 0

𝐶𝐹0 𝑃𝑉

D. Decision Criteria

Method Accept Reject

a) Payback Period < maximum acceptable PP > maximum acceptable PP

b) Net Present Value (NPV) > $0 < $0

c) Internal Rate of Return (IRR) > Cost of Capital < Cost of Capital
Risk and Return

Single Asset Portfolio

1) Total Rate of Return ( )

∑

2) Expected Value of Return ( ̅ )

̅ ∑
SAME

or

̅ ∑

3) Standard Deviation,

√∑( ̅)

SAME
or
Note:

√∑ ( ̅)

Capital Asset Pricing Model

1) Portfolio Beta, 𝜷𝒑
𝑛

𝛽𝑝 ∑ 𝑤𝑖 𝑥 𝛽𝑖 Analysis:
𝑗 Beta = 1 (Less risky)

2) CAPM

𝑟𝑗 𝑅𝐹+ 𝛽𝑖 𝑥 𝑟𝑚 𝑅𝐹

Analysis:

 Check correlation
 Expected returns

Impact of change in Market Return = Increase/decrease in rm x