1.2 Time Value of Money
Time value of money concepts are essential for capital budgeting, bond pricing, and retirement income planning. The Series 66 emphasizes conceptual understanding of NPV and IRR rather than complex manual compounding.
Key NASAA Exam Takeaways
- A dollar today is worth more than a dollar received in the future due to its potential earning capacity.
- Future Value (FV) = PV * (1 + r)^n.
- Net Present Value (NPV) = Present Value of Cash Inflows - Initial Investment Cost.
- A project with a positive NPV (> 0) creates economic value and should be accepted.
- Internal Rate of Return (IRR) is the discount rate that sets NPV equal to exactly zero.
NPV Decision Rule
If NPV > 0, the investment generates a return exceeding the required discount rate (hurdle rate). If NPV < 0, the expected return is less than the hurdle rate and the investment should be rejected.
IRR vs. Required Rate of Return
When the project's IRR exceeds the required rate of return, the NPV is positive. When the IRR is less than the required rate of return, the NPV is negative.
Knowledge Checkpoint • Section 1.2
If an investment has an Internal Rate of Return (IRR) of 9% and the client's required rate of return is 7%, which of the following statements is true?