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. 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 is 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 2019, 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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B2
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
 perlin
 Interest Rates, Time Value Of Money, Corporate Finance, Future Value, Valuation, TMCC

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