ch05
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ch05

Module Code: ECON 102, Spring 2013

University or Institution: Havering College

Word Count: 9398

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Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy 1. Time value of money is based on the belief that people have a positive time preference for consumption. A) True B) False Ans: A Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy 2. Individuals prefer to consume goods in the future rather than right away. A) True B) False Ans: B Format: True/False Learning Objective: LO 1...

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True/False Format: Learning Objective: LO 1 Level of Difficulty: Easy 1. Time value of money is based on the belief that people have a positive time preference for consumption. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy 2. Individuals prefer to consume goods in the future rather than right away. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy 3. The value of a dollar invested at positive interest rate grows over time. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 1 Level of Difficulty: Medium 4. The value of a dollar invested at positive interest rate grows over time but at an increasingly slower rate further into the future. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 1 Level of Difficulty: Easy 5. The further in the future you receive a dollar, the more it is worth today. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium 6. The higher the rate of interest, the more likely you will elect to invest your funds and forego current consumption. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium 7. Future value focuses on the valuation of cash flows received over time, while present value focuses on the valuation of cash flows received at a point in time. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy 8. The present value technique uses discounting to find the present value of each cash flow at the beginning of the project. A) True B) False Register to View Answer Test Bank, Fundamentals of Corporate Finance, 2e Format: True/False Learning Objective: LO 3 Level of Difficulty: Easy 9. The present value technique uses compounding to find the present value of each cash flow at the beginning of the project. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy 10. The future value technique uses discounting to find the future value of each cash flow at the end of the project's life. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy 11. The future value technique uses compounding to find the future value of each cash flow at the end of the project's life. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy 12. Compounding is the process by which interest earned on an investment is reinvested so that in future periods, interest is earned on the interest as well as the principal. A) True B) False Register to View Answer 5-3 Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy 13. Compound interest consists of both simple interest and interest-on-interest. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium 14. Compound interest consists only of interest-on-interest. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 2 Level of Difficulty: Easy 15. Compounding accelerates the growth of the total interest earned. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium 16. The growth rate over time is linear. A) True B) False Register to View Answer Test Bank, Fundamentals of Corporate Finance, 2e Format: True/False Learning Objective: LO 4 Level of Difficulty: Medium 17. The growth rate over time is exponential. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium 18. Berrian invested $5,000 in an account earning 10 percent for one year. If he had left his investment in that account for another two years, he would expect the total interest earned over the three years to be higher by exactly $1,000. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium 19. The higher the interest rate on an investment, the more money that is accumulated for any time period. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium 20. The more frequently the interest payments are compounded, the larger the future value of $1 for a given time period. A) True B) False Register to View Answer 5-5 Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium 21. If Bank A pays interest on a monthly basis and Bank B pays the same interest on a quarterly basis, then investing $1,000 in Bank B will lead to a higher future value than investing the same amount in Bank A. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium 22. The present value can be thought of as the discounted value of a future amount. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium 23. The present value is simply the current value of a future cash flow that has been discounted at the appropriate discount rate. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy 24. The Rule of 72 allows one to calculate the return earned on an investment over six years. A) True B) False Register to View Answer Test Bank, Fundamentals of Corporate Finance, 2e Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy 25. The Rule of 72 allows one to calculate the approximate time needed to double an investment. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 4 Level of Difficulty: Easy 26. Compound growth occurs when the initial value of a number increases or decreases each period by the factor (1 + growth rate). A) True B) False Register to View Answer Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium 27. The future value of an investment of $5,000 earning an annual interest of 10 percent equals $6,000 at the end of one year. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium 28. The present value of an investment of $1,000 to be received in three years at a discount rate of 10 percent is $751.31. A) True B) False Register to View Answer 5-7 Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium 29. The present value of an investment of $1,000 to be received in three years at a discount rate of 10 percent is $1,331. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium 30. The future value of an investment of $1,000 to be received in three years at a discount rate of 10 percent is $1,331. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium 31. The higher the discount rate, the lower the present value of a future cash flow. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium 32. The lower the discount rate, the lower the present value of a future cash flow. A) True B) False Register to View Answer Test Bank, Fundamentals of Corporate Finance, 2e Format: True/False Learning Objective: LO 3 Level of Difficulty: Medium 33. If you had a choice of choosing a payment of $5,000 to be received in five years being discounted at 8 percent or at 10 percent, you should always choose the higher rate because it gives you the higher present value. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium 34. Randy has to choose between two cash flows. He could either receive the future value of an investment of $1,000 at 8 percent annually in three years or in five years. Randy should always choose the shorter investment term because it is worth more today. A) True B) False Register to View Answer Format: True/False Learning Objective: LO 2 Level of Difficulty: Medium 35. If Laura has to choose between a loan that charges quarterly interest and a loan that charges monthly interest, she should always choose the one charging quarterly interest. A) True B) False Register to View Answer 5-9 Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 36. The time value of money refers to the issue of A) what the value of the stream of future cash flows is today. B) why a dollar received tomorrow is worth more than a dollar received today. C) D) why a dollar received tomorrow is worth the same as a dollar received today. None of the above. Register to View Answer Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 37. Which one of the following statements is NOT true? A) The time value money refers to what the value of the stream of future cash flows today is. B) A dollar received today is worth more than a dollar received tomorrow. C) D) A dollar received tomorrow is worth less than a dollar received today. A dollar received today is worth less than a dollar received tomorrow. Register to View Answer Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 38. Which one of the following statements is NOT true? A) The value of a dollar invested at a positive interest rate grows over time. B) The further in the future you receive a dollar, the less it is worth today. C) D) A dollar in hand today is worth more than a dollar to be received in the future. The further in the future you receive a dollar, the more it is worth today. Register to View Answer Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 39. Future value measures A) what one or more cash flows are worth at the end of a specified period. B) what one or more cash flows that is to be received in the future will be worth today. C) D) both a and b None of the above Register to View Answer Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 40. Which one of the following statements is true? A) Individuals prefer to consume goods right away rather than in the future. B) Individuals prefer to consume goods in the future rather than right away. C) D) The time of consumption is irrelevant to individuals. None of the above. Register to View Answer Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: easy 41. The process of converting an amount given at the present time into a future value is called A) time value of money. B) discounting. C) D) compounding. None of the above. Register to View Answer 5-11 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 42. The process of converting future cash flows to what its present value is A) time value of money. B) discounting. C) D) compounding. none of the above. Register to View Answer Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 43. Which one of the following statements is NOT true? A) Present value calculations involve bringing a future amount back to the present. B) The present value (PV) is often called the discounted value of future cash payments. C) D) The present value factor is more commonly called the discount factor. All of the above are true statements. Register to View Answer Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 44. Which one of the following statements is NOT true? A) Present value calculations involve bringing a future amount back to the present. B) The future value is often called the discounted value of future cash payments. C) D) The present value factor is more commonly called the discount factor. The higher the discount rate, the lower the present value of a dollar. Register to View Answer Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy 45. The Rule of 72 A) can be used to determine the amount of time it takes to double an investment. B) is fairly accurate for interest rates between 25 and 50 percent. C) D) states that the time to double your money (TDM) approximately equals 72/i, where 72 represents the years it takes to double your investment. None of the above describe the Rule of 72. Register to View Answer Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 46. Using higher discount rates will A) not affect the present value of the future cash flow. B) increase the present value of any future cash flow. C) D) decrease the present value of any future cash flow. None of the above. Register to View Answer Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 47. Using higher interest rates will A) not affect the future value of the investment. B) increase the future value of any investment. C) D) decrease the future value of any investment. None of the above. Register to View Answer 5-13 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 48. Using lower discount rates will A) not affect the present value of the future cash flow. B) increase the present value of any future cash flow. C) D) decrease the present value of any future cash flow. None of the above. Register to View Answer Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 49. Using lower interest rates will A) decrease the future value of any investment. B) increase the future value of any investment. C) D) not affect the future value of the investment. None of the above. Register to View Answer Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 50. Your aunt is looking to invest a certain amount today. Which of the following choices should she opt for? A) three-year CD at 6.5% annual rate B) three-year CD at 6.75% annual rate C) D) three-year CD at 6.25% annual rate three-year CD at 7% annual rate Register to View Answer Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 51. Future value: You are interested in investing $10,000, a gift from your grandparents, for the next four years in a mutual fund that will earn an annual return of 8 percent. What will your investment be worth at the end of four years? (Round to the nearest dollar.) A) $10,800 B) $13,605 C) D) $13,200 None of the above Register to View AnswerFeedback: Present value of the investment = PV = $10,000 Return on mutual fund = i = 8% No. of years = n = 4. 0 1 2 3 4 -$10,000 FV=? FV4 = PV (1 + i )n = $10,000 (1.08) 4 = $13,604.89 5-15 Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 52. Future value: Ning Gao is planning to buy a house in five years. She is looking to invest $25,000 today in an index mutual fund that will provide her a return of 12 percent annually. How much will she have at the end of five years? (Round to the nearest dollar.) A) $45,000 B) $28,000 C) D) $44,059 None of the above Register to View AnswerFeedback: Present value of the investment = PV = $25,000 Return on mutual fund = i = 12% No. of years = n = 5. 0 1 2 3 4 5 -$25,000 FV = ? FV5 = PV (1 + i ) n = $25,000 (1.12)5 = $44, 058.54 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 53. Future value: Carlos Lopes is looking to invest for the next three years. He is looking to invest $7,500 today in a bank CD that will earn interest at 5.75 percent annually. How much will he have at the end of three years? (Round to the nearest dollar.) A) $8,870 B) $8,000 C) D) $8,681 None of the above Register to View AnswerFeedback: Present value of the investment = PV = $7,500 Interest rate on CD = i = 5.75% No. of years = n = 3. 0 1 2 3 -$7,500 FV=? FV3 = PV (1 + i ) n = $7,500 (1.0.0575)3 = $8, 869.57 5-17 Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 54. Future value: Wes Ottey would like to buy a condo in Florida in six years. He is looking to invest $75,000 today in a stock that is expected to earn a return of 18.3 percent annually. How much will he have at the end of six years? (Round to the nearest dollar.) A) $205,575 B) $157,350 C) D) $184,681 None of the above Register to View AnswerFeedback: Present value of the investment = PV = $75,000 Return on stock = i = 18.3% No. of years = n = 6. 0 1 2 3 4 5 6 -$75,000 FV=? FV6 = PV (1 + i )n = $75,000 (1.183)6 = $205, 574.73 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 55. Future value: Brittany Willis is looking to invest for retirement, which she hopes will be in 20 years. She is looking to invest $22,500 today in U.S. Treasury bonds that will earn interest at 6.25 percent annually. How much will she have at the end of 20 years? (Round to the nearest dollar.) A) $68,870 B) $50,625 C) D) $75,642 None of the above Register to View AnswerFeedback: Present value of the investment = PV = $22,500 Return on Treasury bonds = i = 6.25% No. of years = n = 20. 0 1 2 3 19 20 ............... -$22,500 FV=? FV20 = PV (1 + i )n = $22,500 (1.0.0625) 20 = $75,641.70 5-19 Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 56. Multiple compounding periods (FV): Your brother has asked you to help him with choosing an investment. He has $5,000 to invest today for a period of two years. You identify a bank CD that pays an interest rate of 4.25 percent with the interest being paid quarterly. What will be the value of the investment in two years? A) $5,434 B) $5,441 C) D) $5,107 $5,216 Register to View AnswerFeedback: 0 2 years PV = $5,000 FV = ? Amount invested today = PV = $5,000 Interest rate on CD = i = 4.25% Duration of investment = n = 2 years Frequency of compounding = m = 4 Value of investment after 4 years = FV4 i 0.0425 FV2 = PV 1 + = $5,000 1 + 4 m = $5,000 (1.010625)8 = $5,441.15 mn 4 2 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 57. Multiple compounding periods (FV): Normandy Textiles had a cash inflow of $1 million, which it needs for a long-term investment at the end of one year. It plans to deposit this money in a bank CD that pays daily interest at 3.75 percent. What will be the value of the investment at the end of the year? (Round to the nearest dollar.) A) $1,211,375 B) $1,000,103 C) D) $1,037,500 $1,038,210 Register to View AnswerFeedback: 0 1 PV = $1,000,000 FV = ? Amount invested today = PV = $1,000,000 Interest rate on CD = i = 3.75% Duration of investment = n = 1 year Frequency of compounding = m = 365 Value of investment after 1 year = FV1 i 0.0375 FV1 = PV 1 + = $1,000,000 1 + 365 m = $1,000,000 (1.00010274)365 = $1,038, 210 mn 3651 5-21 Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium Test Bank, Fundamentals of Corporate Finance, 2e 58. Multiple compounding periods (FV): Your mother is trying to choose one of the following bank CDs to deposit $10,000. Which one will have the highest future value if she plans to invest for three years? 5-23 A) B) C) D) Ans: 3.5% compounded daily 3.25% compounded monthly 3.4% compounded quarterly 3.75% compounded annually A Test Bank, Fundamentals of Corporate Finance, 2e Feedback: A) Interest rate on CD = i = 3.5% Frequency of compounding = m = 365 Value of investment after 3 years = FV3 i 0.035 FV1 = PV 1 + = $10,000 1 + 365 m = $10,000 (1.00009589)1095 = $11,107.05 B) Interest rate on CD = i = 3.25% Frequency of compounding = m = 12 Value of investment after 3 years = FV3 i 0.0325 FV1 = PV 1 + = $10,000 1 + 12 m = $10,000 (1.002708333)36 = $11,022.66 C) Interest rate on CD = i = 3.4% Frequency of compounding = m = 4 Value of investment after 3 years = FV3 i 0.034 FV1 = PV 1 + = $10,000 1 + 4 m = $10,000 (1.0085)12 = $11,069.06 mn 43 mn 123 mn 3653 5-25 D) Interest rate on CD = i = 3.75% Frequency of compounding = m = 1 Value of investment after 3 years = FV3 = $10,000 x (1.0375)3 = $11,167.71 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 59. Multiple compounding periods (FV): Carlyn Botti wants to invest $3,500 today in a money market fund that pays quarterly interest at 5.5 percent. She plans to fund a scholarship with the proceeds at her alma mater, Towson University. How much will Carlyn have at the end of seven years? (Round to the nearest dollar.) A) $5,091 B) $3,548 C) D) $5,130 $5,075 Register to View AnswerFeedback: Amount invested today = PV = $3,500 Interest rate on money market account = i = 5.5% Duration of investment = n = 7 years Frequency of compounding = m = 4 Value of investment after 7 years = FV7 i 0.055 FV7 = PV 1 + = $3,500 1 + 4 m = $3,500 (1.01375)28 = $5,130.18 mn 47 5-27 Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 60. Multiple compounding periods (FV): Hector Cervantes started on his first job last year and plans to save for a down payment on a house in 10 years. He will be able to invest $12,000 today in a money market account that will pay him an interest of 6.25 percent on a monthly basis. How much will he have at the end of 10 years? A) $12,640 B) $22,383 C) D) $24,839 None of the above Register to View AnswerFeedback: Amount invested today = PV = $12,000 Interest rate on money market account = i = 6.25% Duration of investment = n = 10 years Frequency of compounding = m = 12 Value of investment after 10 years = FV10 i 0.0625 FV10 = PV 1 + = $12,000 1 + 12 m = $12,000 (1.005208333)120 = $22, 382.62 mn 1210 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 61. Compounding: Trish Harris has deposited $2,500 today in an account paying 6 percent interest annually. What would be the simple interest earned on this investment in five years? If the account paid compound interest, what would be the interest-on-interest in five years? A) $750; $95.56 B) $150; $845.56 C) D) $150; $95.56 $95.56; $845.56 Register to View AnswerFeedback: Deposit today = PV = $2,500 Interest rate = i = 6% No. of years = n = 5 Simple interest: Simple interest per year = $2,500 (0.06) = $150.00 Simple interest for 5 years = $150 x 5 = $750.00 Future value with compound interest: FV5 = $2,500 (1 + 0.06)5 = $3,345.56 Simple interest = $750 Interest on interest = $3,345.56 $2,500 $750 = $95.56 5-29 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 62. Compounding: Joachim Noah is investing $5,000 in an account paying 6.75 percent annually for three years. What is the interest-on-interest if interest is compounded? A) $1,012.50 B) $1,082.38 C) D) $82.38 $69.88 Register to View AnswerFeedback: Deposit today = PV = $5,000 Interest rate = i = 6.75% No. of years = n = 3 Simple interest: Simple interest per year = $5,000 (0.0675) = $337.50 Simple interest for 3 years = $337.50 x 3 = $1,012.50 Future value with compound interest: FV3 = $5,000 (1 + 0.0675)3 = $6,082.38 Simple interest = $1,012.50 Interest on interest = $6,082.38 $5,000 $1,012.50 = $69.88 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 63. Compounding: Chung Lee wants to invest $3,000 in an account paying 5.25 percent compounded quarterly. What is the interest on interest after four years? A) $695.98 B) $65.98 C) D) $630.00 None of the above Register to View AnswerFeedback: Deposit today = PV = $3,000 Interest rate = i = 5.25% No. of years = n = 4 Frequency of compounding = m = 4 Simple interest: Simple interest per year = $3,000 (0.0525) = $157.50 Simple interest for 4 years = $157.50 x 4 = $630 Future value with compound interest: mn 4 4 i 0.0525 FV4 = PV 1 + = $3,000 1 + 4 m = $3,000 (1.013125)16 = $3,695.98 Simple interest = $630 Interest on interest = $3,695.98 $3,000 $630 = $65.98 5-31 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 64. Compounding: Dat Nguyen is depositing $17,500 in an account paying an annual interest rate of 8.25 percent compounded monthly. What is the interest-on-interest after six years? A) $8,662.50 B) $10,925 C) D) $2,497.63 $1,092.48 Register to View AnswerFeedback: Deposit today = PV = $17,500 Interest rate = i = 8.25% No. of years = n = 6 Frequency of compounding = m = 2 Simple interest: Simple interest per year = $17,500 (0.0825) = $1,443.75 Simple interest for 6 years = $1,443.75 x 6 = $8,662.50 Future value with compound interest: mn 126 i 0.0825 FV6 = PV 1 + = $17,500 1 + 12 m = $17,500 (1.006875)72 = $28, 660.13 Simple interest = $8,662.50 Interest on interest = $28,660.13 $17,500 $8,662.50 = $2,497.63 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 65. Compounding: Richard Delgado invested $10,000 in a money market account that will pay 5.75 percent compounded daily. How much will the interest-on-interest be after two years? A) $1,218.63 B) $1,150.00 C) D) $33.06 $68.63 Register to View AnswerFeedback: Deposit today = PV = $10,000 Interest rate = i = 5.75% No. of years = n = 2 Frequency of compounding = m = 365 Simple interest: Simple interest per year = $10,000 (0.0575) = $575 Simple interest for 2 years = $575 x 2 = $1,150 Future value with compound interest: mn 3652 i 0.0575 FV2 = PV 1 + = $10,000 1 + 365 m = $10,000 (1.000157534)730 = $11, 218.63 Simple interest = $575 Interest-on-interest = $11,218.63 $10,000 $1,150 = $68.63 5-33 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 66. Present value: Tommie Harris is considering an investment that pays 6.5 percent annually. How much must he invest today such that he will have $25,000 in seven years? to (Round the nearest dollar.) A) $23,474 B) $38,850 C) D) $26,625 $16,088 Register to View AnswerFeedback: 0 7 years PV = ? i = 6.5% FV = $25,000 Value of investment after 7 years = FV7 = $25,000 Return expected from investment = i = 6.5% Duration of investment = n = 7 years Amount to be invested today = PV FVn $25,000 PV = = = $16,087.66 n (1 + i ) (1.065)7 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 67. Present value: Jack Robbins is saving for a new car. He needs to have $ 21,000 for the car in three years. How much will he have to invest today in an account paying 8 percent annually to achieve his target? (Round to nearest dollar.) A) $22,680 B) $26,454 C) D) $16,670 $19,444 Register to View AnswerFeedback: 0 3 years PV = ? i = 8% FV = $21,000 Value of investment after 7 years = FV3 = $21,000 Return expected from investment = i = 8% Duration of investment = n = 3 years Amount to be invested today = PV FVn $21,000 PV = = = $16, 670.48 n (1 + i ) (1.08)3 5-35 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 68. Present value: Derek's friend, Jackson, is asking to borrow today with a promise to repay $7,418.87 in four years. If Derek could earn 5.45 percent annually on the any investment he makes today, how much would he be willing to lend Jackson today? (Round to nearest dollar.) A) $6,000 B) $7,035 C) D) $6,500 $7,150 Register to View AnswerFeedback: 0 4 years PV = ? i = 5.45% FV = $7,418.87 Loan repayment amount after 4 years = FV4 = $7,418.87 Return expected from loan = i = 5.45% Duration of loan = n = 4 years Amount to be loaned today = PV FVn $7,418.87 PV = = = $6,000 n (1 + i ) (1.0545)4 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 69. Present value: Becky Sayers wants to buy a house in six years. She hopes to be able to put down $25,000 at that time. If the bank CD she wants to invest in will pay 7.5 percent annually, how much will she have to invest today? (Round to the nearest dollar.) A) $18,472 B) $13,987 C) D) $16,199 $23,256 Register to View AnswerFeedback: 0 6 years PV = ? i = 7.5% FV = $25,000 Amount needed for down payment after 6 years = FV6 = $25,000 Return expected from investment = i = 7.5% Duration of investment = n = 6 years Amount to be invested today = PV FVn $25,000 PV = = = $16,199 n ( 1 + i ) (1.075)6 5-37 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 70. Present value: John Hsu wants to start a business in 10 years. He hopes to have $100,000 at that time to invest in the business. To reach his goal, he plans to invest a certain amount today in a bank CD that will pay him 9.50 percent annually. How much will he have to invest today to achieve his target? (Round to the nearest dollar.) A) $54,233 B) $63,837 C) D) $91,324 $40,351 Register to View AnswerFeedback: 0 10 years PV = ? i = 9.5% FV = $100,000 Value of investment after 10 years = FV10 = $100,000 Return expected from investment = i = 9.5% Duration of investment = n = 10 years Amount to be invested today = PV FVn $100,000 PV = = = $40, 351.42 n (1 + i ) (1.08)10 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 71. Multiple compounding (PV): Rick Rodriquez plans to invest some money today so that he will receive $7,500 in three years. If the investment he is considering will pay 3.65 percent compounded daily, how much will he have to invest today? A) $5,276 B) $6,722 C) D) $6,897 $7,140 Register to View AnswerFeedback: 0 3 years PV = ? i = 3.65% FV = $7,500 Return expected from investment = i = 3.65% Duration of investment = n = 3 years Frequency of compounding = m = 365 Target investment proceeds in 3 years = FV3 = $7,500 Present value of amount = PV FV3 $7,500 $7,500 PV = = = mn 3653 (1.0001)1095 i 0.0365 1+ 1+ 365 m = $6,722.15 5-39 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 72. Multiple compounding (PV): You need to have $15,000 in five years to payoff a home equity loan. You can invest in an account that pays 5.75 percent compounded quarterly. How much will you have to invest today to attain your target in five years? (Round to the nearest dollar.) A) $4,903 B) $11,275 C) D) $14,184 $12,250 Register to View AnswerFeedback: 0 5 years PV = ? i = 5.75% FV = $15,000 Return expected from investment = i = 5.75% Duration of investment = n = 5 years Frequency of compounding = m = 4 Target investment proceeds in 5 years = FV5 = $15,000 Present Value of amount = PV FVn $15,000 $15,000 PV = = = mn 54 (1.014375)20 i 0.0575 1 + 1 + 4 m = $11, 275.10 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 73. Multiple compounding (PV): Marcie Witter is saving for her daughter's college education. She wants to have $50,000 available when her daughter graduates from high school in four years. If the investment she is considering will pay 8.25 percent compounded monthly, how much will she have to invest today to reach her target? (Round to the nearest dollar.) A) $35,987 B) $49,659 C) D) $41,275 $36,450 Register to View AnswerFeedback: 0 4 years PV = ? i = 8.25% FV = $50,000 Return expected from investment = i = 8.25% Duration of investment = n = 4 years Frequency of compounding = m = 12 Target investment proceeds in 4 years = FV4 = $50,000 Present value of amount = PV FV4 $50,000 $50,000 PV = = = mn 124 (1.006875)48 i 0.0825 1+ 1+ 12 m = $35,986.80 5-41 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 74. Multiple compounding (PV): Darius Miller is seeking to accumulate $50,000 in six years to invest in a real estate venture. He can earn 6.35 percent annual interest with monthly compounding in a private investment. How much will he have invest today to reach his goal? (Round to the nearest dollar.) A) $37,527 B) $47,015 C) D) $34,193 $31,648 Register to View AnswerFeedback: 0 6 years PV = ? i = 6.35% FV = $50,000 Return expected from investment = i = 6.35% Duration of investment = n = 6 years Frequency of compounding = m = 12 Target investment proceeds in 6 years = FV6 = $50,000 Present value of amount = PV FVn $50,000 $50,000 PV = = = mn 126 (1.006875)72 i 0.0635 1 + 1 + 12 m = $34,193.23 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 75. Multiple compounding (PV): Joan Alexander wants to go on a cruise in three years. She could earn 8.2 percent compounded monthly in an account if she were to deposit the money today. She needs to have $10,000 in three years. How much will she have to deposit today? (Round to the nearest dollar.) A) $6,432 B) $7,826 C) D) $8,148 $7,763 Register to View AnswerFeedback: 0 3 years PV = ? i = 8.2% FV = $10,000 Return expected from investment = i = 8.2% Duration of investment = n = 3 years Frequency of compounding = m = 12 Target investment proceeds in 3 years = FV3 = $10,000 Present value of amount = PV PV = FVn mn i 1 + m = $7,825.77 = $10,000 0.082 1 + 12 123 = $10,000 (1.0068333)36 5-43 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 76. Interest rate: Your tuition for the coming year is due today. You borrow $8,000 from your uncle and agree to repay in the three years an amount of $9,250. What is the interest rate on this loan? Round to the nearest percent. A) 5% B) 6% C) D) 7% 8% Register to View AnswerFeedback: 0 3 years PV = $8,000 FV = $9,250 Amount to be borrowed = PV = $8,000 Amount to be paid back after 3 years = FV3 = $9,250 Interest rate on investment = i = ? Duration of investment = n = 3 years. Present value of investment = PV FVn PV = (1 + i )n $9,250 $8,000 = (1 + i )3 $9,250 (1 + i )3 = = 1.15625 $8,000 (1 + i ) = (1.15625) i = 4.96% 1 3 = 1.0496 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 77. Interest rate: Rachael Steele wants to borrow $6,000 for a period of four years. She has two choices. Her bank is offering to lend her the amount at 7.25 percent compounded annually. She can also borrow from her firm and will have to repay a total of $8,130.93 at the end of four years. Should Rachael go with her bank or the firm, and what is the interest rate if she borrows from her firm? (Round to the nearest percent.) A) Bank: 9% B) Firm: 7% C) D) Bank: 8% Firm: 6% Register to View AnswerFeedback: 0 4 years PV = $6,000 FV = $8,130.93 Amount to be borrowed = PV = $6,000 Amount to be paid back after 4 years = FV = $8,130.93 Interest rate on investment = i = ? Duration of investment = n = 4 years. Present value of investment = PV FVn PV = (1 + i )n $8,130.93 $6,000 = (1 + i )4 $8,130.93 (1 + i ) 4 = = 1.355155 $6,000 (1 + i ) = (1.355155) i = 7.89% 1 4 = 1.07894 Since borrowing from her firm results in a loan rate of 8 percent, she should take the bank loan at 7.25 percent. 5-45 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 78. Interest rate: Ray Seo has $5,000 to invest in a small business venture. His partner has promised to pay him back $8,200 in five years. What is the return earned on this investment? A) 9.3% B) 8.7% C) D) 11.1% 10.4% Register to View AnswerFeedback: 0 5 years PV = $5,000 FV = $8,200 Amount being invested = PV = $5,000 Amount to be paid back after 5 years = FV = $8,200 Interest rate on investment = i = ? Duration of investment = n = 5 years. Present value of investment = PV FVn PV = (1 + i )n $8,200 $5,000 = (1 + i )5 $8,200 (1 + i )5 = = 1.6400 $5,000 (1 + i ) = (1.6400) i = 10.4% 1 5 = 1.103999 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 79. Interest rate: Pedro Martinez wants to invest $25,000 in a spa that his sister is starting. He will triple his investment in six years. What is the rate of return that Pedro is being promised? (Rounded to the nearest percent.) A) 18% B) 20% C) D) 12% 25% Register to View AnswerFeedback: 0 6 years PV = $25,000 FV = $75,000 Amount being invested = PV = $25,000 Amount to be paid back after 6 years = FV = $75,000 Interest rate on investment = i = ? Duration of investment = n = 6 years. Present value of investment = PV FVn PV = (1 + i ) n $75,000 $25,000 = (1 + i )6 $75,000 (1 + i )6 = = 3.0000 $25,000 (1 + i ) = (3.0000) i = 20% 1 6 = 1.200937 5-47 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 80. Interest rate: Trayne Rice has $3,000 to invest for three years. He wants to receive $5,000 at the end of the three years. What invest rate would his investment have to earn to achieve his goal? (Round to the nearest percent.) A) 19% B) 21% C) D) 13% 16% Register to View AnswerFeedback: 0 3 years PV = $3,000 FV = $5,000 Amount being invested = PV = $3,000 Amount to be paid back after 3 years = FV = $5,000 Interest rate on investment = i = ? Duration of investment = n = 3 years. Present value of investment = PV FVn PV = (1 + i )n $5,000 $3,000 = (1 + i )3 $5,000 (1 + i )3 = = 1.66667 $3,000 (1 + i ) = (1.6667) i = 18.6% 1 3 = 1.1856 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 81. Growth rate: Trojan Traps manufactures an innovative mouse trap. Sales this year are $325,000. The company expects its sales to go up to $500,000 in five years. What is the expected growth rate in sales for this firm? (Round to the nearest percent.) A) 9% B) 11% C) D) 6% 12% Register to View AnswerFeedback: 0 5 years PV = $325,000 FV = $500,000 Current sales = PV = $325,000 Expected sales five years from now = $500,000 To calculate the expected sales growth rate, we set up the future value equation. FV5 = PV (1 + g )5 $500,000 = $325,000(1 + g )5 $500,000 (1 + g )5 = = 1.538461538 $325,000 g = (1.538461538) 5 - 1 = 8.99% 1 5-49 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 82. Growth rate: Petry Corp. is a growing company with sales of $1.25 million this year. The firm expects to grow at an annual rate of 25 percent for the next three years, followed by a growth of 20 percent per year for the next two years. What will be Petry's sales at the end of five years? (Round to the nearest percent.) A) $2,160,000 B) $3,515,625 C) D) $1,875,000 $2,929,688 Register to View AnswerFeedback: 0 5 years g1-3 = 25% g4-5 = 20% PV = $1.25 million FV = $? Current sales = PV = $1,025,000 Expected sales five years from now = FV To calculate the expected sales, we set up the future value equation. FV5 = PV (1 + g1 )3 (1 + g 2 )2 = $1,025,000(1.25)3 (1.20)2 = $3, 515,625 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 83. Growth rate: Cleargen, a detergent manufacturer, has announced this year's net income as $832,500. It expects its net earnings to grow at a rate of 15 percent per year for the next two years, before dropping to 12 percent for each of the following two years. What is the firm's net income after four years? (Round to the nearest dollar.) A) $1,381,071 B) $1,266,128 C) D) $1,233,099 $1,072,260 Register to View AnswerFeedback: 0 4 years g1-2 = 15% g3-4 = 12% PV = $832,500 FV = $? Current net income = PV = $832,500 Expected net income four years from now = FV To calculate the expected net earnings, we set up the future value equation. FV4 = PV (1 + g1 )2 (1 + g 2 )2 = $832,500(1.15)2 (1.12)2 = $1, 381,070.88 5-51 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 84. Growth rate: Peterson Electrical Supplies has generated a net income of $161,424 this year. The firm expects to see an annual growth of 30 percent for the next five years, followed by a growth rate of 15 percent for each of the next three years. What will be the firm's expected net income in eight years? (Round to the nearest dollar.) A) $319,157 B) $241,329 C) D) $911,546 $689,259 Register to View AnswerFeedback: 0 5 8 years g1-5 = 30% g6-8 = 15% PV = $161,424 FV = $? Current net income = PV = $161,424 Expected net income four years from now = FV To calculate the expected net earnings, we set up the future value equation. FV8 = PV (1 + g1 )5 (1 + g 2 )3 = $161,424(1.30)5 (1.15)3 = $911, 545.58 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 85. Growth rate: Vidmar Agencies is a fast-growing advertising agency. Currently, their sales are at $700,000. They expect their sales to grow at an annual rate of 35 percent in the next two years, followed by an annual rate of 25 percent in years 3 through 7. Finally, their growth rate would slow down to 10 percent in years 810. What will be their sales as of year 10? (Round to the nearest dollar.) A) $1,698,023 B) $2,843,323 C) D) $3,893,280 $5,181,956 Register to View AnswerFeedback: 0 5 10 years g1-2 = 35% g3-7 = 25% g8-10 = 10% PV = $700,000 FV = $? Current sales = PV = $700,000 Expected sales 10 years from now = FV To calculate the expected sales, we set up the future value equation. FV10 = PV (1 + g1 )2 (1 + g 2 )5 (1 + g 3 )3 = $700,000(1.35)2 (1.25)5 (1.10)3 = $5,181, 955.72 5-53 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 86. Time to attain goal: Your uncle is looking to double his investment of $10,000. He claims he can get earn 14 percent on his investment. How long will it be before he can double his investment? Use the Rule of 72 and round to the nearest year. A) 5 years B) 14 years C) D) 10 years None of the above Register to View AnswerFeedback: Initial investment = $10,000 Rate of return on investment = i = 14% Time to double the investment = TDM = 72/i = 72 / 14 = 5.14 years Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 87. Time to attain goal: Elegant Designers have generated sales of $625,000 for the current year. If they can grow their sales at a rate of 12 percent every year, how long will they take to triple their sales? (Round off to the nearest year.) A) 8 years B) 7 years C) D) 10 years 9 years Register to View AnswerFeedback: Enter 9.69 12% -$625,000 $1,875,000 N g (i)% PMT PV FV 5-55 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 88. Time to attain goal: Franklin Foods announced that its sales were $1,233,450 this year. The company forecasts a growth rate of 16 percent for the foreseeable future. How long will it take the firm to produce earnings of $3 million? (Round off to the nearest year.) A) 7 years B) 6 years C) D) 8 years 10 years Register to View AnswerFeedback: Enter 5.99 16% -$1,233,450 $3,000,000 N g (i)% PMT PV FV Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 89. Time to attain goal: Ryan Holmes wants to deposit $4,500 in a bank account that pays 8.25 percent annually. How many years will it take for his investment to grow to $10,000? (Round off to the nearest year.) A) 8 years B) 11 years C) D) 10 years 12 years Register to View AnswerFeedback: Enter 10.21 8.25% -$4,500 $10,000 N i% PMT PV FV 5-57 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Hard 90. Time to attain goal: Cheryl Merriweather wants to invest in a bank CD that will pay her 7.8 percent annually. If she is investing $11,500 today, when will she reach her goal of $15,000? (Round off to the nearest year.) A) 5 years B) 7 years C) D) 2 years 4 years Register to View AnswerFeedback: Enter 3.56 7.8% -$11,500 $15,000 N g (i)% PMT PV FV Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 91. Which of the following statements is true? A) A dollar received today is worth more than a dollar to be received in the future because future dollars are not affected by inflation. B) A dollar to be received in the future is worth more than a dollar received today because of the positive impact of rates of return. C) D) A dollar received today is worth more than a dollar to be received in the future because funds received today can be invested to earn a return. A dollar to be received in the future is worth more than a dollar received today because it would have less risk associated with it. Register to View Answer Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 92. Which of the following statements is true? A) The longer the time period that funds are invested, the greater the future value, regardless of investment rate. B) The lower the discount rate that funds are invested at, the greater the future value. C) D) The shorter the time period that funds are invested, the greater the future value, regardless of investment rate. The higher the interest rate, the slower the value of an investment will grow. Register to View Answer 5-59 Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Medium 93. Future Value: Herbert Hall just received an inheritance of $35,775 from his great aunt. He plans to invest the funds for retirement. If Herbert can earn 4.75% per year with quarterly compounding for 32 years, how much will he have accumulated? (Round off to the nearest dollar.) A) $237,416 B) $ 71,550 C) D) $184,622 $162,113 Register to View AnswerFeedback: Amount invested today = PV = $35,775 Frequency of compounding = m = 4 Interest rate = i = 4.75% 4 = 1.1875% Duration of investment = n = 32 years 4 = 128 periods Value of investment after 7 years, or 128 periods = FV128 = $162,113.25 i 0.0475 FV32 = PV 1 + = $35,775 1 + 4 m = $35,775 (1.011875)128 = $35,775 4.531467 = $162,113.25 mn 432 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 94. Which of the following statements is false with respect to the present value of a future amount? A) The higher the discount rate, the lower the present value of a single sum for a given time period. B) The relation between present value and time is exponential. C) D) The greater the time period, the lower the present value of a single sum for a given interest rate. The lower the discount rate, the lower the present value of a single sum for a given time period. Register to View Answer 5-61 Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 95. Present Value: Juan and Carla Herman plan to buy a time-share in six years in the amount of $16,860. In order to have adequate funds to do so, the Herman's want to make a deposit to their money market fund today. Assume that they will be able to earn an investment rate of 5.75%, compounded annually. How much will Juan and Carla need to deposit today to achieve their goal? (Round off to the nearest dollar.) A) $19,138 B) $ 8,885 C) D) $12,055 $14,243 Register to View AnswerFeedback: Amount needed = FV = $16,860 Interest rate = i = 5.75% Duration of investment = n = 6 years Present Value = PV6 = $12,055.22 PV6 = FV $16,860 = n (1 + i ) (1.0575)6 $16,860 = 1.398564 = $12, 055.22 Test Bank, Fundamentals of Corporate Finance, 2e Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 96. Number of Periods it Takes an Investment to Grow a Certain Amount: Sally Wilson is planning her retirement. She is presently investing in a 401(k) but needs an additional $500,000 to reach her retirement goal. As luck would have it, Sally just won a brand new car that is worth $36,000 in a raffle. If Sally were to sell the car and invest the $36,000 proceeds at a rate of 6.50%, compounded annually, how long will it be before Sally could retire? (Round off to the nearest 1/10 of a year) A) 36.6 years B) 41.8 years C) D) 52.2 years 24.0 years Register to View AnswerPresent Value = PV = $36,000 Future Value = FV = $500,000 Interest rate = i = 6.50% Number of Periods = n = 41.8 years FVn = PV (1 + i )n = FVn = (1 + i )n PV $500,000 = (1.065)n = 13.88889 = (1.065)n $36,000 nLN (1.065) = LN (13.88889) LN (13.888889) 2.631089 n= = = 41.78 years LN (1.065) .062975 5-63 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 97. Rate of growth: Link Net, Inc. just generated earnings per share of $3.75 for the fiscal year ending September 30, 2010. The firm is expected to achieve earnings per share of $8.76 in 5-years. At what rate will Link Net, Inc.'s earnings per share be growing over this 5-year period? (Round off to the nearest 1/10 percent) A) 15.7% B) 18.5% C) D) 21.3% 13.4% Register to View AnswerFeedback: Present Value = PV = $3.75 Period = n = 5 years Future Value = FV5 = $8.76 Interest rate = i = 18.49% FV 5 i= -1 PV $8.76 5 = -1 $3.75 = ( 2.336 ) 5 - 1 = 1.184935 - 1 = .184935 1 1 1 Format: Essay Learning Objective: LO 2 98. Explain the difference between simple interest and compound interest. Ans: Simple interest refers to the interest earned on the initial investment over the investment period. Compound interest includes not only simple interest but also interest earned on the reinvestment of previously earned interest. Thus, compound interest includes both the simple interest and the interest-on-interest. Test Bank, Fundamentals of Corporate Finance, 2e Format: Essay Learning Objective: LO 4 99. Suppose you win $10 million in a lottery. You have a choice of how you will receive your winnings. The first choice is to receive a certain lump sum today. The second choice is to receive a certain amount at the end of five years. How will you evaluate your choices to make your decision? Ans: In order to make the correct choice, one has to make the comparison on the same plane. That is, you calculate the future value of the lump sum invested today at your opportunity cost and compare it to the future value under your second choice. Or you discount the future value of the amount in your second choice to its present value and compare it to the lump sum in your first choice. Either of the two approaches would allow you to select the choice that provides you the highest amount. 100. Format: Essay Learning Objective: 5.5.0 Summarize the fundamental concepts and skills related to the time value of money. Suppose that you just attended a lecture on Time Value of Money. On your way home, you stopped in to get a cup of coffee. One of your classmates, who missed the lecture, joined you for coffee and asked you to explain to them the key concepts of Time Value of Money and how you could use it to solve some of life's financial problems. What would you tell them? Answer: Time value of money has to do with making decisions about investments; e.g., how much should one pay today for a share of common stock, for an apartment building, etc. This amount is known as the Present Value. The answer involves a number of important concepts: (1.) the expected/required rate of return; this is known as Rate. (2.) The expected time that the investment will be held; this is known as Number of Periods. (3.) The expected cash flow(s); this is known as Future Value, or if a series of Future Values it is known as Payments. (4) The frequency at which the rate is compounded or discounted; i.e., annually, quarterly, monthly, etc. The way in which these types of problems can be solved is by usage of mathematical formulas, financial calculators, or spreadsheet models. 5-65
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