CHAPTER 5
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 46 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 47, 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.
46
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The Time Value of Money
10. An
ordinary annuity
involves a series of equal,
endofperiod
payments or receipts.
The
interest payments on most bonds are ordinary annuities.
An
annuity due
involves a series of
equal,
beginningofperiod
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 and (b)
the future value of an annuity increases.
12. The sinking fund problem tries to find the annuity amount that must be invested each year
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 Spring '08
 bradley
 Time Value Of Money, Interest

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