Lump sum

Definition

A lump sum is a single payment of money, as opposed to multiple payments made over time. It is often used in the context of investments, loans, or settlements where all funds are transferred at once.

5 Must Know Facts For Your Next Test

1. The present value of a lump sum can be calculated using the formula PV = FV / (1 + r)^n, where PV is present value, FV is future value, r is the discount rate, and n is the number of periods.
2. Future value of a lump sum can be calculated using the formula FV = PV * (1 + r)^n.
3. When evaluating capital budgeting decisions, understanding the time value of money helps in comparing the value of lump sums received at different times.
4. Discounting a future lump sum converts it into its equivalent present value.
5. A higher discount rate will reduce the present value of a future lump sum.

Review Questions

• How do you calculate the present value of a lump sum?
• Why is understanding the time value of money important when evaluating lump sums?
• What effect does increasing the discount rate have on the present value of a future lump sum?

Related terms

Present Value:

The current worth of a future sum of money given a specified rate of return.

Future Value:

The value of an investment after it has grown over time through interest or returns.

Discount Rate:

The interest rate used to calculate the present value of future cash flows.