# How Bad to Screw Up Time Value of Money Practice Questions?

So, I just recently started studying for L1.

When I was going through ethics I had no trouble with the end of chapter practice questions.

When I got to time value of money I had a really hard time memorizing the formulas and ended up getting a 55% on the end of chapter questions.

I was just wondering how bad an indicator this is as to how the rest of the practice questions are going to go for me. Are most of the rest of the readings as densely packed with formulas as Time Value of Money? I skimmed stats methods and it looks like there are far fewer formulas per page in that chapter. Can anyone comment on which readings and/or topics have the most formulas to memorize, and maybe what I should be doing to memorize formulas better?

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To be honest, this chapter must be one the easiest throughout the course (at least to me).

Once you’re familiar with the idea of discounting and compounding, calculating PV and FV should be fairly intuitive. Actually, you don’t really even have to memorize those PV and FV formulas, as your calculator should be able to do the job for you (using the TVM table).

Uneven cash flows are just about calculating PVs and FVs of multiple cash flows and then summing them up, and can also be easily handled by your calculator (using the CF table).

So I assume the biggest problems for you are those annuities and perpetuities things. Fortunately, the only formula you really need to memorize is that for the PV of perpetuities (C / r). Annuities can be easily calculated with your calculator (using the TVM table), and annuities due can be handled gracefully by switching your calculator to the BGN cash flow mode.

If you still wish to understand those annuities formulas, then here’s the intuition. Think of annuities as the difference between two perpetuities. Say you’ve got a 3-year annuity that pays in year ends, then you can break it down into two perpetuities, one starting from this year end, the other starting from the fourth year end, that is:

P1 –> C, C, C, C, C, C……

P4 –> 0, 0, 0, C, C, C……

Then PV of P1 minus PV of P4 will be the PV of the annuity (C, C, C). Since the formula for the PV of perpetuities (C / r) is fairly easy to memorize, thinking this way may help you memorize those annuities formulas more easily (if you really intend to).

Deriving the formula for the PV of perpetuities (C / r) itself is another story. It’s very simple, though. You may Google it if you’re interested.

^ Just a word of caution:  the value of P4 is C/r at time 3, but then you still have to discount that amount by 3 years to time 0  If you start with the basic immediate annuity formula, you can prove that it is the difference between 2 perpetuities.

PV = C * [1 - (1+r)-3]/r

= C * [1/r - (1+r)-3/r].

= C/r - [(1+r)-3] * (C/r)

QED

“Mmmmmm, something…” - H. Simpson

Learn how to use your financial calculator - it will save you memorizing all the annuity formulas.

ROA    You have to leave all yer crap off to the side, but they LET YOU BRING IN AN APPROVED CALCULATOR!!!! “Mmmmmm, something…” - H. Simpson