FIN-610_Wk-3_Time-Value-of-Money

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Feb 20, 2024

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Apply the "Time Value of Money" Concepts in Managerial Decision-Making 1. What is the discount factor equal to? Please explain. The discount factor is equal to: 1/(1*(1+Discount Rate)^Period Number) It is a decimal number that can be multiplied by a cash flow value to discount it back down to its present value (CFI, n.d.). It can be used to calculate net present value or assist with financial modeling and discounted cash flow analysis (GoCardless, n.d.). 2. Do discount factors always have to be less than one? If so, why? Yes, discount factors always has to be less than one. This is because a discount factor equation assumes that the present value will be less than the future value due to factors such as inflation (GoCardless, n.d.). As noted about in Q1, the formula to calculate the discount factor uses the period interest rate (discount rate). Interest rates are always positive and therefore based on the calculations, the discount factor will always be between zero and one. 3. If you believe that interest rates will dramatically increase, should you select a loan that is payable upon maturity or select a loan that requires fixed annual payments? If you believe that interest rates will dramatically increase, you should select a loan that requires fixed annual payments instead of a loan that is payable upon maturity. Fixed annual payments use an interest rate that stays consistent for the entirety of the loan’s terms. Conversely, a loan that is payable upon maturity will likely have a variable annual interest rate. If interest rate is increasing, locking in a lower rate is likely more beneficial. CFI. (n.d.). Discount Factor . Corporate Finance Institute. https://corporatefinanceinstitute.com/resources/knowledge/modeling/discount-factor/ GoCardless. (n.d.). Discount factor table and definition. https://gocardless.com/en-us/guides/posts/discount-factor-table-and-definition/#:~:text=The %20general%20discount%20factor%20formula,number%20of%20payments%20per%20year .
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