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B54
SOLUTIONS
CHAPTER 5
INTRODUCTION TO VALUATION: THE
TIME VALUE OF MONEY
Answers to Concepts Review and Critical Thinking Questions
1.
The four parts are the present value (PV), the future value (FV), the discount rate (
r
), and the life of
the investment (
t
).
2.
Compounding refers to the growth of a dollar amount through time via reinvestment of interest
earned. It is also the process of determining the future value of an investment. Discounting is the
process of determining the value today of an amount to be received in the future.
3.
Future values grow (assuming a positive rate of return); present values shrink.
4.
The future value rises (assuming it’s positive); the present value falls.
5.
It would appear to be both deceptive and unethical to run such an ad without a disclaimer or
explanation.
6.
It’s a reflection of the time value of money. GMAC gets to use the $500 immediately. If GMAC uses
it wisely, it will be worth more than $10,000 in thirty years.
7.
Oddly enough, it actually makes it more desirable since GMAC only has the right to pay the full
$10,000 before it is due. This is an example of a “call” feature. Such features are discussed at length
in a later chapter.
8.
The key considerations would be: (1) Is the rate of return implicit in the offer attractive relative to
other, similar risk investments? and (2) How risky is the investment; i.e., how certain are we that we
will actually get the $10,000? Thus, our answer does depend on who is making the promise to repay.
9.
The Treasury security would have a somewhat higher price because the Treasury is the strongest of
all borrowers.
10.
The price would be higher because, as time passes, the price of the security will tend to rise toward
$10,000. This rise is just a reflection of the time value of money. As time passes, the time until
receipt of the $10,000 grows shorter, and the present value rises. In 2008, the price will probably be
higher for the same reason. We cannot be sure, however, because interest rates could be much
higher, or GMAC’s financial position could deteriorate. Either event would tend to depress the
security’s price.
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View Full DocumentCHAPTER 5
B55
Solutions to Questions and Problems
NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this
solutions manual, rounding may appear to have occurred. However, the final answer for each problem is
found without rounding during any step in the problem.
Basic
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 Spring '08
 Polkovnichenko
 Time Value Of Money, Corporate Finance, Future Value, Valuation

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