Underneath that we lay out our cash flows, denoted by CF.

The subscript denotes the time period, and this is nothing more than a visual

representation of when money is coming or going.

That's it.

Get in the habit of placing cash flows on a time line.

When you work in Excel, it almost automatically does that for you.

But it's a great tool to emphasize the point that money arrived at

different points in time, has a different time unit and cannot be added, right?

Don't add money at different points in time.

Let me say it one more time.

Never add money received at different points in time.

Now I put a little asterisk there because some people will say, well,

what if the money arrives very close in time.

Then it's not such a sin, but get in the habit of just not doing it.

And I say it multiple times because you'll do it,

your friends will do it, people in finance do it all the time.

But it's really not a good thing to do, and you'll see why in just a moment.

What we need is we need rate for time, to convert to a common time unit, and

that exchange rate is called the discount factor.

Our discount factor is given by 1+R raised to the power t.

t, that's just the number of the time periods into the future, if t is

greater than 0, or past, if t is less than 0, that we want to move the cash flows.

R, that gets its own slide.

R is the rate of return offered by investment alternatives in the capital

markets of equivalent risk.

And that's a mouthful.