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Unformatted text preview: CHAPTER 6 THE TIME VALUE OF MONEY ANSWERS TO END OF CHAPTER QUESTIONS: 1. The investment paying five percent compound interest is more attractive because you will receive interest not only on the principal amount each year, but interest will be earned on the previous year's interest as well. 2. The future value interest factor for 10 percent and 2 years will be greater than the present value interest factor for 10 percent and 2 years. The future value interest factor for 10 percent and two years is 1.210, whereas the present value interest factor for 10 percent and two years is 0.826. Also, recall that as long as interest rates are greater than zero, PVIF values will be less than one while corresponding FVIF values will be greater than one. 3. As the interest rate increases, any annuity amount is being discounted by a higher value, thereby reducing the present value of the annuity. This can be seen in Table IV (See interest factor tables textbook insert) by looking across any row of successively higher interest rates. In contrast, the future value of an annuity increases as the interest (compounding) rate increases. (See Table III.) 4. Daily compounding is preferred because you will earn interest on the interest earned in the account each day. Table 6.5 illustrates this. 5. Annuity due computations are common for lease contracts and insurance policies, where payments are generally made at the beginning of each period. 6. As can be seen in Table 6.6, the more frequent the compounding period, the lower the present values. 7. The Rule of 72 can be used to determine the approximate number of years it takes for an amount of money to double, given an interest rate. It also can be used to determine the effective interest rate required for a sum of money to double, given a number of years. To solve for the number of years, the number "72" is divided by the interest rate (in percent). To solve for the percentage interest rate, the number "72" is divided by the number of years. 8. Present value and future value concepts are closely related. For example, PVIF factors are simply the reciprocal of FVIF factors and vice versa. Any problem that can be solved by using PVIF factors can also be solved using FVIF factors. 9. An ordinary annuity involves a series of equal, end-of-period payments or receipts. The interest payments on most bonds are ordinary annuities. An annuity due involves a series of equal, beginning-of-period payments or receipts, such as in a lease or some insurance policies. 10. If you have the same number of cash flows (deposits), the future value of an annuity due will be greater than the future value of an ordinary annuity—in the case of the annuity due each deposit will be compounded for one additional year....
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