This chapter rounds out your understanding of fundamental concepts related to the time
value of money and discounted cash flow valuation. Several important topics were covered,
including:
There are two ways of calculating present and future values when there are multiple
cash flows. Both approaches are straightforward extensions of our earlier analysis of
single cash flows.
A series of constant cash flows that arrive or are paid at the end of each period is
called an ordinary annuity, and we described some useful shortcuts for determining
the present and future values of annuities.
Interest rates can be quoted in a variety of ways. For financial decisions, it is
important that any rates being compared be first converted to effective rates. The
relationship between a quoted rate, such as an annual percentage rate, or APR,
and an effective annual rate, or EAR, is given by:
EAR = (1 + Quoted rate/m)m − 1
where m is the number of times during the year the money is compounded, or,
equivalently, the number of payments during the year.
Many loans are annuities. The process of paying off a loan gradually is called
amortizing the loan, and we discussed how amortization schedules are prepared
and interpreted.
