# 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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