Annual Percentage Rate (APR)
Definition: Periodic rate times the number of periods in a year.
How it is used: The APR is used to determine the interest rate on a certain amount invested or borrowed.
m= periods per year
r= periodic rate
Example: A customer walks into a bank to get a loan for a new car, they find out that the interest rate of the loan
is 2% a month (12 months in a year). What is the APR?
Therefore the APR would be 24%
erest rate of the loan
Rate of Return (ROR)
Definition: The ratio of money that was gained or lost in an investment. Another way of saying it
is the amount of money returned per unit of time expressed as a percentage of the cost
How it is used: The ROR is used based on the loss or gain of an investment.
Say you bought stock for $30.00 and it paid you $0.50 dividend at the end of the year, and is now worth $45.50.
Plug in those numbers into the Rate of Return Formula as follows.
The rate of return for the above example would be a 53%
y of saying it
rcentage of the cost
s now worth $45.50.
Net Present Value (NPV)
Internal Rate of Return (IRR)
Definition: (NPV) The difference between present value cash inflows and the present value of cash outflows.
(IRR) The rate of growth a project is expected to get back.
How it is used: Does the capital budget expected return exceed the required return?
The table below shows the numbers that we can imput into the formula.
Year (n) Cash Flow (Cn)
1000 1330 1680 1500
������������10%= -1500+(1.10)1 + (1.10)2 +(1.10)3 + (1.10)4 = +2795
Future Value Formula (FV)
Definition: To find out the future value of an investment.
How it is used: Using this formula will help a manager decide what an investment will be worth in the future.
Example: An investor invests in a stock that is $3,000 and pays an interest rate of 10% per year for 10 years.
What would the future value be?
The future value of the $3,000 purchase (as long as the interest rate stays the same) is $7,781
orth in the future.
ear for 10 years.
Present Value Formula (PV)
Definition: The amount of an investment that is made at the time of purchase.
How it is used: To know how much you would have to invest if wanting a certain amount of profit.
A client wants to know the present value of $5,000 to be received 10 years from today if the return is 10% per year.
What would the present value be?
So if the client wanted to make $5,000 in the next 10 years then he would have to put down $1,927.72.
e return is 10% per year.
Profitability Index Formula (PI)
Definition: The present value of the future cash flows divided by the initial investment. Also known as the benefit-cost ratio.
How it is used: This method is used to evaluate capital budgeting projects. A manager should approve the project if the PI is g
A new business has an NPV of $350 and required an initial cash flow of $-2,000. What would the businesses PI be?
So, with a PI of 1.18 a firm would get back $1.18 of present value back for every $1 that was invested or an NPV of $0.18 for e
known as the benefit-cost ratio.
d approve the project if the PI is greater than 1.0.
What would the businesses PI be?
s invested or an NPV of $0.18 for every dollar invested.