Accounting - Chapter 11 Time Value of Money 11-2 Learning...

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Unformatted text preview: Chapter 11 Time Value of Money 11-2 Learning Objectives LO1 Explain the risk/return relationship . LO2 Use the time value of money concepts to solve present and future value problems. 11-3 What is the Difference between Return Of and Return On an Investment? Return OF Return of the initial amount invested Return ON Additional amount returned in excess (or less than) the amount invested 11-4 Return on Investment Bob invested $100 Bob invested $100 and after a year and after a year received $111. received $111. Bob received a return Bob received a return OF OF his investment of $100 his investment of $100 and a return and a return ON ON his investment of $11 his investment of $11 11-5 Any amount you get back in excess of your original investment is your return on investment. Investment #1: On January 1 you invest $10,000 and on December 31 the investment is worth $11,000. Investment #2: On January 1 you invest $5,000 and on December 31 the investment is worth $5,800. Which investment is better? Rate of Return Return on investment = $1,000 Return on investment = $800 11-6 Rate of Return (RoR) RoR is a common-size ratio that allows us to rank and compare different investments regardless of size. return return on on investment investment Rate of Return = ------------------------ Rate of Return = ------------------------ the amount invested the amount invested RoR is a percentage measure of the return on investment relative to the amount invested. 11-7 1,000 10,000 =10% 800 5,000 =16% RoR RoR Investment #1: On January 1 you invest $10,000 and on December 31 the investment is worth $11,000. Return on investment = $1,000. Investment #2: On January 1 you invest $5,000 and on December 31 the investment is worth $5,800. Return on investment = $800. Now which investment is better? Now which investment is better? Rate of Return 11-8 What is Risk ? Investment A Investment A Investment B Investment B Likelihood Return Likelihood Return 100% $15,000 50% $30,000 50% $0 Average Expected Average Expected Return Return $15,000 $15,000 Average Expected Average Expected Return Return $15,000 $15,000 Which investment do you prefer? Which investment do you prefer? 11-9 With investment A, the return is certain. With investment B, there is a risk of receiving no return for the perio and a chance to receive a greater return. If you prefer investment A prefer investment A you are If you prefer investment B prefer investment B you are If you are like both equally like both equally you are Risk Averse Risk Seeking Risk Neutral What is Risk? There is no right answer! 11-10 Generally, the average investor is risk averse....
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Accounting - Chapter 11 Time Value of Money 11-2 Learning...

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