What is the value in year 3 of a $500 cash flow made in year 5 when interest rates are 6 percent?

An investor is considering the purchase of a small office building. The NOI is expected to be the following: Year 1, $232,000; Year 2, $242,000; Year 3, $252,000; Year 4, $262,000; Year 5, $272,000. T...

Chapter 4 Solutions Cornett, Adair, and Nofsinger

CHAPTER 4 – TIME VALUE OF MONEY 1: ANALYZING SINGLE CASH

FLOWS

Questions

LG11. List and describe the purpose of each part of a time line with an initial cash inflow and

a future cash outflow. Which cash flows should be negative and which positive? Why?

The cash flow timeline is a visual depiction of inflows and outflows relative to the period

under consideration. Cash flows are illustrated above the cash flow line with the

corresponding periods that apply appearing under the cash flow diagram. Inflows are

represented by positive numbers and outflows by negative numbers.

LG22. How are the present value and future value related?

The measure that relates present values to future values is the interest rate i. A present

value can be moved forward in time with interest to arrive at the future value (



N

NiPVFV1years Nin valueFuture

). A future value can be discounted back to

the present by rearranging the equation so that the FV is divided by the interest factor.

LG33. Would you prefer to have an investment earning 5 percent for 40 years or an investment

earning 10 percent for 20 years? Explain.

Investments of $1 will grow to $7.04 in 40 years (= $1.0540) and $1 will grow to $6.73 in

20 years (= $1.1020). The 5 percent investment for 40 years is worth more. This example

illustrates the importance of time in building wealth.

LG44. How are present values affected by changes in interest rates?

Interest rates have an inverse relationship to present values. Increases in expected interest

rates result in lower present values because future values are discounted at a high rate to

become smaller present values. Decreases in expected interest rates result in higher

present values because future values are discounted at a lower rate.

LG55. What do you think about the following statement. “I am going to receive $100 two

years from now and $200 three years from now, so I am getting a $300 future value.”

How could the two cash flows be compared or combined?

Cash flows may only be combined when they are moved to the same point in time. The

statement above is incorrect in that it compares the $100 cash flow after year 2 with the

$200 cash flow after year 3. To make comparisons meaningful, the cash flows need to be

considered at the same point in time. Either the $100, 2nd year cash flow could be moved

to year 3, or the $200, 3rd year cash flow could be moved to year 2 for combining.

4-1

How do you calculate the number of years needed to grow an investment?

How are present values affected by changes in interest rates quizlet?

Which of the following will increase the present value of an annuity quizlet?