5 Chapter Test Questions
Question 1
As the discount rate increases, the present value of $500 to be received six years from
now:
a. remains constant.
b. also increases.
c. decreases.
d. becomes negative.
e. will vary but the direction of the change is unknown.
Answer Question 1
As the discount rate increases the present value of any amount given in the future will
decrease. Present Value = Future Value / (1+i)t where i is the discount rate and t is
time.
Answer : C
Question 2
Today you earn a salary of $28,500. What will be your annual salary fifteen years from
now if you earn annual raises of 3.5 percent?
a. $47,035.35
b. $47,522.89
c. $47,747.44
d. $48,091.91
e. None of the above
Answer Question 2
For this we use our Financial Calculator. We know that PV = $28,500, Int/Yr = 3.5% and
N = 15. Solving for FV gives you $47,747.44 .
Answer : C
Question 3
Your grandmother invested one lump sum 17 years ago at 4.25 percent interest. Today,
she gave you the proceeds of that investment which totaled $5,539.92. How much
did your grandmother originally invest?
a. $2,700.00
b. $2,730.30
c. $2,750.00
d. $2,768.40
e. None of the above
Answer Question 3
For this we use our Financial Calculator. We know that FV = $5,539.92, Int/Yr = 4.25%
and N = 17. Solving for PV gives you $2,730.30 .
Answer : B
Question 4
On your tenth birthday, you received $100 which you invested at 4.5 percent interest,
compounded annually. That investment is now worth $3,000. How old are you
today? (round to nearest year)
a. age 77
b. age 82
c. age 84
d. age 85
e. None of the above
Answer Question 4
For this we use our Financial Calculator. We know that FV = -$3,000, Int/Yr = 4.5% and
PV = $100. Solving for N gives you 77.3. You are thus 77.3+10 = 87.3 years old.
Answer : E
Question 5
You are the beneficiary of a life insurance policy. The insurance company informs you
that you have two options for receiving the insurance proceeds. You can receive a
lump sum of $50,000 today or receive payments of $641 a month for ten years. You
can earn 6.5 percent on your money. Which option should you take and why?
Assume end-of-month payments
a. You should accept the payments because they are worth $56,451.91 today.
b. You should accept the payments because they are worth $56,523.74 today.
c. You should accept the payments because they are worth $56,737.08 today.
d. You should accept the $50,000 because the payments are only worth $47,757.69
today.
e. You should accept the $50,000 because the payments are only worth $9,856.38
today.
Answer Question 5
For this we use our Financial Calculator. We know that PMT = $641, Int/Month =
6.5%/12 = .5416667% and N = 12*10=120. Solving for PV gives you $56,451.91.
Since the payments are worth more than the lump sum you should take the
payments.
Answer : A
Question 6
You are scheduled to receive annual payments of $10,000 for each of the next 25 years.
Your discount rate is 8.5 percent. What is the difference in the present value if you
receive these payments at the beginning of each year rather than at the end of each
year?
a. $8,699
b. $9,217
c. $9,706
d. $10,851
e. None of the above
Answer Question 6
For this we use our Financial Calculator. We know that PMT = $10,000, Int/Yr = 8.5%
and N = 25. Solving for PV in end mode gives you $102,342. Solving for PV in
begin mode gives you $111,041. The difference is $8,699.
Answer : A
Question 7
You borrow $149,000 to buy a house. The mortgage rate is 7.5 percent and the loan
period is 30 years. Payments are made monthly. If you pay for the house according
to the loan agreement, how much total interest will you pay?
a. $138,086
b. $218,161
c. $226,059
d. $287,086
e. None of the above
Answer Question 7
For this we use our Financial Calculator. We know that PV = $149,000, Int/Month =
7.5%/12 = .625% and N = 30*12 = 360. Solving for PMT gives you $1,041.83.
Take PMT * 360 Loan to get the total interest. $1,041.83*360 - $149,000 =
$226,059
Answer : C
Question 8
What is the effective annual rate if a bank charges you 7.64 percent compounded
quarterly?
a. 7.79 percent
b. 7.86 percent
c. 7.95 percent
d. 7.98 percent
e. 8.01 percent
Answer Question 8
For this we use our Financial Calculator. We know that Int/Quarter = 7.64%/4 = 1.91%,
N = 1*4 = 4, and we will assume that PV = $100 for ease of calculating. Solving
for FV gives you $107.86. Now use your calculator by putting N = 1, PV = $100,
FV = -$107.86 and solve for Int/year = 7.86% (or, 107.86/100 1)
Answer : B
Question 9
On December 1, you borrow $210,000 to buy a house. The mortgage rate is 8.25 percent.
The loan is to be repaid in equal monthly payments over 20 years. The first
payment is due on January 1. Consider whether the following statements are true
assuming that you repay the loan as agreed?
I. The total amount paid (principle plus interest) is about $429,441.
II. The monthly payment is $882.27
III. The total interest paid is $278,952.
IV. The monthly interest rate is .75 percent.
V. The first payment reduces the principle balance by $345.59
How many of the statements are correct?
a. 0
b. 1
c. 2
d. 3
e. 4
Answer Question 9
For this we use our Financial Calculator in end mode. We know that Int/Month =
8.25%/12 = .6875%, N = 20*12 = 240, and PV = $210,000. Solving for PMT
gives you $1,789.34. Thus total payments would be $1,789.34*240 = $429,441.
Total Interest is then $429,441 - $210,000 = $219,441. Finally to calculate the
interest on the first payment we take $210,000 * .6875% = $1,443.75. So principal
is reduced by $1,789.34 - $1,443.75 = $345.59. With this data we can see that only
the first statement and the last are correct.
Answer : C
Question 10
The Eternal Gift Insurance Company is offering you a policy that will pay you and your
heirs $10,000 a year forever. The cost of the policy is $285,000. is What the rate of
return on this policy?
a. 2.85 percent
b. 3.25 percent
c. 3.46 percent
d. 3.51 percent
e. 3.60 percent
Answer Question 10
For this we use the annuity formula. We know from this that PV = PMT/Rate. Solving
for Rate gives you PMT/PV = $10,000/$285,000 = 3.51%.
Answer : D
Question 11
The government has imposed a fine on the Not-So-Legal Company. The fine calls for
annual payments of $100,000, $250,000, and $250,000, respectively over the next
three years. The first payment is due one year from today. The government plans to
invest the funds until the final payment is collected and then donate the entire
amount, including investment earnings, to a national health center. The government
will earn 3.5 percent on the funds held. How much will the national health center
receive three years from today?
a. $613,590.00
b. $614,622.50
c. $615,872.50
d. $637,428.03
e. None of the above
Answer Question 11
For this we use our Financial Calculators. For the first payment we put in PV =
$100,000, Int/Yr = 3.5%, and N = 2 (we used 2 because there is only 2 years the
funds are held once received at the end of year 1). Solving for FV = $107,122.50 .
Now for the second payment we put in PV = $250,000, Int/Yr = 3.5% and N = 1.
Solving for FV = $258,750. The third payment is received at the same time as the
donation so now we just add $250,000 + $258,750 + $107,122.50 = $615,872.50.
Answer : C
Question 12
You are comparing two annuities with equal present values. The applicable discount rate
is 7.5 percent. One annuity pays $5,000 on the first day of each year for twenty
years. How much does the second annuity pay each year for twenty years if it pays
at the end of each year?
a. $4,651
b. $5,075
c. $5,000
d. $5,375
e. $5,405
Answer Question 12
For this we use our Financial Calculators. First we must find the PV in Begin Mode. We
know that Int/Yr = 7.5%, PMT = $5,000 and N = 20. Solving for PV = $54,795.39.
Now in End Mode we put PV = $54,795.39, Int/Yr = 7.5% and N = 20. Solving for
PMT = $5,375.
Answer : D
Question 13
Alpha, Inc. is saving money to build a new factory. Six years ago they set aside
$250,000 for this purpose. Today, that account is worth $306,958. What rate of
interest is Alpha earning on this money?
a. 3.43 percent
b. 3.45 percent
c. 3.48 percent
d. 3.52 percent
e. None of the above
Answer Question 13
For this we use our Financial Calculators. We know that PV = -$250,000, N = 6 and FV =
$306,958. Solving for INT =3.48%
Answer : C
Question 14
Today you buy a piece of land for $285,000. What will the land be worth if it appreciates
at a rate of 3.5 percent for the next 15 years?
a. $470,353
b. $475,228
c. $477,474
d. $480,919
e. None of the above
Answer Question 14
For this we use our Financial Calculators. We know that PV = $285,000, N = 15 and
Int/Yr = 3.5%. Solving for FV = $477,474.
Answer : C
Question 15
Toni adds $3,000 to her savings on the first day of each year (starting this year). Tim adds
$3,000 to his savings on the last day of each year (starting this year). They both
earn a 9 percent rate of return. What is the difference in their savings account
balances at the end of thirty years?
a. $35,822
b. $36,803
c. $38,911
d. $39,803
e. $40,115
Answer Question 15
For this we use our Financial Calculators. First in Begin Mode. We know that PMT =
$3,000, N = 30 and Int/Yr = 9.0%. Solving for FV = $445,726. Now do the same
in End Mode, FV = $408,923. The difference is $36,803.
Answer : B
Question 16
You recently filed suit against a company. Today, you received three settlement options as
follows:
Option A: $10,000 on the first day of each year for 25 years
Option B: $880 on the first day of each month for 25 years
Option C: $119,830 as a lump sum payment today
You can earn 7.5 percent on your investments. Options A and B provide their first
payments today. You do not care if you personally receive the funds or if they are
paid to your heirs should you die within the next 25 years. Which one of the
following statements is correct given this information?
a. Option C is clearly the best choice since you can earn 7.5 percent on the entire
lump sum starting immediately.
b. Option B is clearly the best choice since it offers the largest number of payments.
c. Option A is clearly the best choice since it has by far the largest future value.
d. Option B is clearly the best choice since it has by far the largest present value.
e. You are indifferent to the three options as they are approximately equal in present
value (i.e., give or take $10).
Answer Question 16
For this we use our Financial Calculators in Begin Mode.
Option A: Int/Yr = 7.5%, PMT = $10,000 and N = 25. PV = $119,830.
Option B: Int/Month = 7.5/12 = .625%, PMT = $880 and N = 25*12 = 300. PV =
$119,826
Option C: PV = $119,830
Answer : E
Question 17
Jane is organizing her retirement plan and gathers the following data:
She will retire in 33 years
She wants to make monthly contribution to her traditional 401k starting at the end of this
month
She needs $3 million to retire comfortably
Her employer will match all contributions to her retirement account on a 1-for-1 basis
She can earn 10% on all invested funds
Her tax rate is 40%
Given this information, how much spendable money (i.e., after-tax income) does she
have to forego each month in order to meet her goal?
a. About $128
b. About $291
c. About $486
d. About $583
e. About $971
Answer Question 17
For this we use our Financial Calculators. N = 33*12 = 396, FV = $3,000,000, and
Int/Month = 10/12 = .833%. Solving for PMT = $971.08. Half of this comes from
her employer so that she contributes before taxes $485.54. To get the after tax
spendable income she must forego we take the before tax amount and multiply by
1-tax rate or $485.54 * 60% = $291.33.
Answer : B