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Chapter 4: The Time Value of Money
4-1
Chapter 4
THE TIME VALUE OF MONEY
ANSWERS TO 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 two years is 1.210, whereas the
present value interest factor for 10 percent and two years is 0.826.
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 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 4-6 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 4-7, the more frequent the compounding period, the lower the
present values.
7. a.
A marketing manager might use present value concepts to evaluate the success of
an advertising or other promotional campaign, the benefits of which are likely to extend
beyond one year in time.
Also, a firm selling capital goods must be familiar with the type
of present value economic analysis that customers will use to evaluate purchases.
b. A personnel manager may need to use present value concepts to evaluate alternative
insurance and pension plans.
8. 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.
9. 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 which can be
solved using PVIF factors can also be solved using FVIF factors.
10. 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.
11. As the required rate of return increases, (a) the present value of an annuity decreases

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*Sign up*Chapter 4: The Time Value of Money
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and (b) the future value of an annuity increases.

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