Chapter 04 - Introduction to Valuation: The Time Value of Money
4-1
CHAPTER 4
INTRODUCTION TO VALUATION: THE
TIME VALUE OF MONEY
Answers to Concepts Review and Critical Thinking Questions
1.
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.
2.
Future values grow (assuming a positive rate of return); present values shrink.
3.
The future value rises (assuming a positive rate of return); the present value falls.
4.
It depends. The large deposit will have a larger future value for some period, but after time, the
smaller deposit with the larger interest rate will eventually become larger. The length of time for the
smaller deposit to overtake the larger deposit depends on the amount deposited in each account and
the interest rates.
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. TMCC gets to use the $24,099. If TMCC uses it wisely,
it will be worth more than $100,000 in thirty years.
7.
This will probably make the security less desirable. TMCC will only repurchase the security prior to
maturity if it to its advantage, i.e. interest rates decline. Given the drop in interest rates needed to
make this viable for TMCC, it is unlikely the company will repurchase the security. 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 $100,000? 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
$100,000. This rise is just a reflection of the time value of money. As time passes, the time until
receipt of the $100,000 grows shorter, and the present value rises. In 2018, the price will probably be
higher for the same reason. We cannot be sure, however, because interest rates could be much
higher, or TMCC’s financial position could deteriorate.
Either event would tend to depress the
security’s price.

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*Sign up*Chapter 04 - Introduction to Valuation: The Time Value of Money
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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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