Reversionary Factor

Definition

The Reversionary Factor is a mathematical formula used to determine the present value of one dollar to be received at a future date. It helps in understanding the time value of money by applying a discount rate to future cash flows. The reversionary factor is synonymous with the concept of the Present Value of 1.

Formula

The formula to calculate the Reversionary Factor is:

\[ \text{Reversionary Factor} = \frac{1}{(1 + i)^n} \]

$ i $ is the interest rate.
$ n $ is the number of years (or periods).

Example

Suppose you want to determine the present value of $1 to be received 5 years from now, given an annual interest rate of 6%. The reversionary factor can be calculated as follows:

\[ \text{Reversionary Factor} = \frac{1}{(1 + 0.06)^5} = \frac{1}{1.338225} \approx 0.747 \]

This means that $1 received five years from now is worth approximately $0.747 today, considering a 6% interest rate.

Frequently Asked Questions (FAQs)

What is the purpose of a Reversionary Factor?

The Reversionary Factor is used to discount future cash flows to their present value, aiding in financial analysis, investment decisions, and understanding the real worth of future amounts.

How does the interest rate affect the Reversionary Factor?

The higher the interest rate, the lower the present value of future cash flows, thus resulting in a smaller Reversionary Factor.

Is the Reversionary Factor the same as the Discount Factor?

Yes, the Reversionary Factor is essentially the same as the Discount Factor; both are used to convert future dollars into present dollars.

Can the Reversionary Factor be used for periods other than years?

Yes, the formula is versatile and can be adapted for different periods, such as months or quarters, by adjusting the interest rate and time accordingly.

How is the Reversionary Factor different from Future Value?

The Reversionary Factor is used to calculate the present value of future cash flows, while Future Value calculations aim to determine the worth of current cash flows at a future date.

Discounted Cash Flow (DCF): A valuation method used to estimate the value of an investment based on its expected future cash flows, discounted to present value.
Present Value (PV): The current value of a future amount of money or stream of cash flows given a specified rate of return.

Online References

Suggested Books for Further Studies

“Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Franklin Allen: This foundational text covers various aspects of corporate finance, including valuation and the time value of money.
“Investments” by Zvi Bodie, Alex Kane, and Alan J. Marcus: A detailed book that explains investment strategies and the importance of discounting future cash flows.
“Financial Management: Theory & Practice” by Eugene F. Brigham and Michael C. Ehrhardt: Comprehensive coverage on financial management concepts, including the application of present value principles.

Fundamentals of Reversionary Factor: Finance Basics Quiz

### What does a Reversionary Factor help determine? - [ ] Future value of money - [x] Present value of future money - [ ] Current depreciation - [ ] Annual interest earned > **Explanation:** A Reversionary Factor helps determine the present value of a future amount of money, showing what a dollar received in the future is worth today. ### Which of these signifies the formula for the Reversionary Factor? - [ ] \\[ (1 + i)^n \\] - [ ] \\[ PV = \frac{FV}{(1 + r)^n} \\] - [x] \\[ \frac{1}{(1 + i)^n} \\] - [ ] \\[ FV \times (1 - i)^n \\] > **Explanation:** The correct formula for calculating the Reversionary Factor is \\[ \frac{1}{(1 + i)^n} \\] where \$ i \$ is the interest rate and \$ n \$ is the number of periods. ### What happens to the Reversionary Factor as the interest rate increases? - [ ] It increases - [ ] It remains the same - [x] It decreases - [ ] It doubles > **Explanation:** As the interest rate increases, the Reversionary Factor decreases, meaning the present value of future dollars becomes smaller. ### If the interest rate is 10%, what is the Reversionary Factor for 3 years? - [x] 0.751 - [ ] 1.000 - [ ] 0.909 - [ ] 0.751 > **Explanation:** Using the formula \\[ \frac{1}{(1 + 0.10)^3} = 0.751 \\]. This means $1 received in 3 years at a 10% interest rate is worth $0.751 today. ### What is the other name commonly associated with the Reversionary Factor? - [x] Discount Factor - [ ] Future Factor - [ ] Gain Multiplier - [ ] Interest Converter > **Explanation:** The Reversionary Factor is also commonly known as the Discount Factor, as it applies a discount rate to future amounts. ### How does time affect the Reversionary Factor, assuming rate constant? - [ ] It decreases with time - [x] It increases with time - [ ] It remains unchanged - [ ] None of the above > **Explanation:** For a constant interest rate, the Reversionary Factor decreases as time increases, meaning more distant future cash flows have smaller present values. ### In financial analysis, why is the Reversionary Factor important? - [ ] For understanding current liabilities - [ ] For forecasting market trends - [x] For valuing future cash flows in present terms - [ ] For calculating tax liabilities > **Explanation:** The Reversionary Factor is crucial in financial analysis for valuing future cash flows in present terms, essential for investment and finance decisions. ### Which related term often coexists with the Reversionary Factor in time value of money studies? - [x] Present Value - [ ] Dividend Yield - [ ] Inflation Rate - [ ] Operating Leverage > **Explanation:** Present Value often coexists with the Reversionary Factor as both terms deal with evaluating the current worth of future financial benefits. ### What is the Reversionary Factor for $1 after 2 years at an annual interest rate of 5%? - [x] 0.907 - [ ] 1.100 - [ ] 0.913 - [ ] 0.900 > **Explanation:** The Reversionary Factor is \\[ \frac{1}{(1 + 0.05)^2} = 0.907 \\]. This means $1 after 2 years at a 5% interest rate is worth $0.907 today. ### What field of study frequently utilizes Reversionary Factors for assessments? - [ ] Medical Studies - [ ] Literature Reviews - [x] Finance and Economics - [ ] Automobile Engineering > **Explanation:** Finance and Economics frequently utilize Reversionary Factors to assess and value future cash flows, investments, and financial plans.

Thank you for exploring the comprehensive understanding of Reversionary Factors in financial analysis and undertakng the quiz. Continue enhancing your knowledge in finance!

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