Corporate Finance, 8th Canadian Edition by Stephen A. Ross - Test Bank

Corporate Finance, 8th Canadian Edition by Stephen A. Ross – Test Bank

 

Instant Download – Complete Test Bank With Answers

 

 

Sample Questions Are Posted Below

 

Chapter 05

The Time Value of Money

 

 

Multiple Choice Questions

1. The time value of money concept can be defined as:
   A.the time in your life when you receive an inheritance.
   B. the relationship between money spent versus money received.
   C. the relationship between a dollar to be received in the future and a dollar today.
   D. the relationship of interest rate stated and amount paid.

 

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: Easy
Topic: 05-01 The One-Period Case

2. The compound value is defined as:
   A.the value of a dollar received tomorrow.
   B. the value of a sum after investing over one or more periods.
   C. the value of a sum today to received in the future.
   D. the rate of growth in a sum today.

 

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: Easy
Topic: 05-01 The One-Period Case

3. Present value may be defined as:
   A.future cash flows discounted to the present.
   B. official prescribed price.
   C. present cash flows compounded into the future.
   D. the average of the bid and asked price.

 

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: Easy
Topic: 05-01 The One-Period Case

 

 

4. Find the present value of $5325.00 to be received in one period if the rate is 6.50%.
   A.$5,000.00
   B. $5,071.43
   C. $5,671.13
   D. $5,591.25

 

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: Easy
Topic: 05-01 The One-Period Case

5. The present value of future cash flows minus initial cost is called:
   A.the future savings of the project.
   B. the net present value of the project.
   C. the equivalent sum of the investment.
   D. the initial investment risk equivalent value.

 

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Easy
Topic: 05-01 The One-Period Case

6. What is the future value of the following cash flows at the end of year 3 if the interest rate is 6%? The cash flows occur at the end of each year.

Year 1	Year 2	Year 3
$5,180	$9,600	$2,250

 

916. $15,916.78
     B. $18,109.08
     C. $18,246.25
     D. $19,341.02
     E. $19,608.07

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-02 The Multiperiod Case

7. Discounting cash flows involves:
   A.reducing cash flows that occur beyond 10 years in the future.
   B. discounting expected cash flows beyond a certain number of years in the future, which varies with the riskiness of the project.
   C. reducing expected cash flows to achieve certainty equivalence.
   D. reducing the value of future cash flows to reflect the time value of money.
   E. taking the cash discount offered on trade merchandise.

 

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Easy
Topic: 05-02 The Multiperiod Case

8. Beatrice invests $1,000 in an account that pays 4% simple interest. How much more could she have earned over a five-year period if the interest had compounded annually?
   A.$15.45
   B. $15.97
   C. $16.65
   D. $17.09
   E. $21.67

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Easy
Topic: 05-02 The Multiperiod Case

9. In the equation, NPV = -Cost + PV, the term Cost is the:
   A.current value of the commitment fee today.
   B. current value of the terminal cash flow.
   C. initial cash outflow.
   D. present value of the variable costs.

 

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Easy
Topic: 05-02 The Multiperiod Case

10. If you have a choice to earn simple interest on $10,000 for three years at 8% or compound interest at 7.5% for three years which one will pay more and by how much?
    A.Simple interest by $1,500.
    B. Compound interest by $22.97.
    C. Compound interest by $150.75.
    D. Simple interest by $150.00.

 

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: Medium
Topic: 05-02 The Multiperiod Case

11. The equation [Ct/(1 + r)^t] provides:
    A.the compound value of a series of payments with a single interest rate.
    B. the compound value of a series of payments with a series of interest rates.
    C. the compound value of a single payment.
    D. the present value of a series of payments with a single interest rate.
    E. the present value of a single payment.

 

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Easy
Topic: 05-02 The Multiperiod Case

12. The future value table provides the factors for the:
    A.compound interest rate for 1/N periods for a specified interest rate.
    B. compound value of a dollar for 1/N periods for a specified interest rates.
    C. single value of a dollar for N periods for a specified interest rate.
    D. simple interest rate for N periods.

 

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Easy
Topic: 05-03 Future Value and Compounding

13. Jim Mayer has deposited $7,000 in a guaranteed investment account with a promised rate of 7% compounded annually. He plans to leave it there for 4 full years when he will make a down payment on a car after graduation. How much of a down payment will he be able to make?
    A.$8,960.00
    B. $1,960.00
    C. $2,175.57
    D. $9,175.57

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-02 The Multiperiod Case

14. Which of the following statements is true?
    A.Regardless of the value of the interest rate, increasing the compounding frequency will decrease the future value.
    B. Regardless of the value of the interest rate, increasing the compounding frequency will increase the future value.
    C. There is a relationship between the future value of investment and the effect of compounding frequency. At high interest rates, increases in compounding frequency will decrease the future value.
    D. There is a relationship between the future value of investment and the effect of compounding frequency. At low interest rates, increases in compounding frequency will decrease the future value.

 

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Easy
Topic: 05-03 Future Value and Compounding

15. The discount rate is adjusted:
    A.upward to reflect higher risk and to increase the future cash flows.
    B. upward to reflect higher risk and to reduce the future cash flows.
    C. downward to reflect higher risk and to increase the future cash flows.
    D. downward to reflect higher risk and to reduce the future cash flows.

 

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

16. The great grandparents of one of your classmates sold their munitions factory to the government in beginning of 1898 during the Spanish-American War for $150,000. If these proceeds had been invested at 6% from then until the end of 2001, what would the legacy to your classmate’s family be worth at the end of 2001 (assume whole years)?
    A.$936,000
    B. $64,254,159.44
    C. $1,086,000
    D. $60,617,131.54
    E. $60,467,131.54

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

17. The present value factor is:
    A.the dollar amount of the future value.
    B. the rate that equates the present value with the future value.
    C. the process of calculating future or present values.
    D. the value of $1 to be received in T periods at a given interest rate.

 

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Medium
Topic: 05-02 The Multiperiod Case

18. Your parents are giving you $100 a month for four years while you are in college. At a 6% discount rate, what are these payments worth to you when you first start college?
    A.$3,797.40
    B. $4,167.09
    C. $4,198.79
    D. $4,258.03
    E. $4,279.32

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Easy
Topic: 05-03 Future Value and Compounding

19. The equation (1 + (r/m))^m-1 gives the:
    A.effective annual interest rate, and r is the stated annual interest rate.
    B. effective annual interest rate, and m is the number of years to maturity.
    C. stated annual interest rate, and r is the effective annual interest rate.
    D. stated annual interest rate, and m is the number of years to maturity.

 

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Medium
Topic: 05-03 Future Value and Compounding

20. You have a sub-contracting job with a local manufacturing firm. Your agreement calls for annual payments of $50,000 for the next five years. At a discount rate of 12%, what is this job worth to you today?
    A.$180,238.81
    B. $201,867.47
    C. $210,618.19
    D. $223,162.50
    E. $224,267.10

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-03 Future Value and Compounding

21. You have deposited $1,500 in an account that promises to pay 8% compounded quarterly for the next five years. How much will you have in the account at the end?
    A.$1,598.33
    B. $2,228.92
    C. $2,203.99
    D. $6,991.44

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Hard
Topic: 05-03 Future Value and Compounding

22. Which of the following amounts is closest to the end value of investing $9,000 for 7 years at a continuously compounded rate of 11%?
    A.$18,685.44
    B. $19,369.83
    C. $15,930.00
    D. $19,437.90

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Hard
Topic: 05-03 Future Value and Compounding

23. Which of the following amounts is closest to the end value of investing $3,000 for 3/4 year at a continuously compounded rate of 12%?
    A.$3,163
    B. $3,283
    C. $3,263
    D. $3,287
    E. $3,317

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Hard
Topic: 05-03 Future Value and Compounding

24. Your employer contributes $25 a week to your retirement plan. Assume that you work for your employer for another twenty years and that the applicable discount rate is 5%. Given these assumptions, what is this employee benefit worth to you today?
    A.$13,144.43
    B. $15,920.55
    C. $16,430.54
    D. $16,446.34
    E. $16,519.02

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-03 Future Value and Compounding

25. Which of the following amounts is closest to the end value of investing $5,000 for 14 months at a stated annual interest rate of 6 percent compounded monthly?
    A.$5,352
    B. $5,362
    C. $5,350
    D. $5,293
    E. $6,183

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-03 Future Value and Compounding

26. You are the beneficiary of a life insurance policy. The insurance company informs you that you have two options for receiving the insurance proceeds. You can receive a lump sum of $50,000 today or receive payments of $641 a month for ten years. You can earn 6.5% on your money. Which option should you take and why?
    A.You should accept the payments because they are worth $56,451.91 today.
    B. You should accept the payments because they are worth $56,523.74 today.
    C. You should accept the payments because they are worth $56,737.08 today.
    D. You should accept the $50,000 because the payments are only worth $47,757.69 today.
    E. You should accept the $50,000 because the payments are only worth $47,808.17 today.

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-03 Future Value and Compounding

27. Which of the following amounts is closest to the end value of investing $10,000 for 1 1/2 years at a stated annual interest rate of 12% compounded quarterly?
    A.$11,800
    B. $11,852
    C. $11,941
    D. $11,961

 

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: Medium
Topic: 05-03 Future Value and Compounding

28. The present value table provides the factors for the:
    A.simple interest rate for N periods.
    B. discount value of a dollar for N periods for a specified interest rate.
    C. discount value of a dollar for 1/N periods for a specified interest rate.
    D. simple interest value of an investment for N periods.
    E. simple interest value of an investment for 1/N periods.

 

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Medium
Topic: 05-02 The Multiperiod Case

29. Which of the following amounts is closest to the end value of investing $7,500 for 2 1/2 years at an effective annual interest rate of 12.36%? Interest is compounded semiannually.
    A.$7,531
    B. $8,427
    C. $9,818
    D. $9,469
    E. $10,122

 

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: Medium
Topic: 05-03 Future Value and Compounding

30. The present value of a set of cash flows is:
    A.the sum of the present value of the individual cash flows.
    B. the sum of individual cash flows which are then discounted.
    C. not equal to the sum of the present value of the individual cash flows.
    D. always greater than the present value of the investment.

 

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Medium
Topic: 05-02 The Multiperiod Case

31. If the compound period is greater than one:
    A.the effective annual interest rate is always equal to the annual percentage rate.
    B. the effective annual interest rate is always less than the annual percentage rate.
    C. the effective annual interest rate is always greater than the annual percentage rate.
    D. the effective annual interest rate is never greater than the annual percentage rate.

 

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Medium
Topic: 05-03 Future Value and Compounding

32. A court settlement awarded an accident victim four payments of $50,000 to be paid at the end of each of the next four years. Using a discount rate of 4%, calculate the present value of the annuity.
    A.$173,255
    B. $178,495
    C. $181,495
    D. $184,095
    E. $200,000

 

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: Medium
Topic: 05-03 Future Value and Compounding

33. The interest rate charged per period multiplied by the number of periods per year is called the _____ rate.
    A.effective annual
    B. annual percentage
    C. periodic interest
    D. compound interest

 

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Easy
Topic: 05-03 Future Value and Compounding

34. Which one of the following statements concerning interest rates is correct?
    A.The stated rate is the same as the effective annual rate.
    B. An effective annual rate is the rate that applies if interest were charged annually.
    C. The annual percentage rate increases as the number of compounding periods per year increases.
    D. Banks prefer more frequent compounding on their savings accounts.
    E. For any positive rate of interest, the effective annual rate will always exceed the annual percentage rate.

 

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Easy
Topic: 05-03 Future Value and Compounding

35. Which of the following amounts is closest to the net present value of a project that contributes $10,000 at the end of the first year and $5,000 at the end of the second year. The initial cost is $8,000 and the appropriate interest rate is 10%.
    A.$5,223
    B. $5,951
    C. $7,000
    D. $21,223
    E. $23,000

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-02 The Multiperiod Case

36. What is the net present value of a project that contributes $25,000 at the end of the first year and $12,000 at the end of the second year. The initial cost is $33,000. The appropriate interest rate is 7% for the first year and 10% for the second year.
    A.$1,579.44
    B. $559.90
    C. $281.85
    D. -$2,148.26

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-02 The Multiperiod Case

37. The government imposed a fine on the Not-So-Legal Company. The fine calls for a payment of $100,000 today, $150,000 one year from today, and $200,000 two years from today. The government will hold the funds until the final payment is collected and then donate the entire amount to charity. The government has agreed to pay annual interest of 3 percent on the held funds. How much will be donated to charity in two years?
    A.$475,000.00
    B. $460,590.00
    C. $447,174.76
    D. $451,050.05
    E. $474,407.70

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-02 The Multiperiod Case

38. What is the effective annual rate if a bank charges you 7.64% compounded quarterly?
    A.7.79%
    B. 7.86%
    C. 7.95%
    D. 7.98%
    E. 8.01%

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Easy
Topic: 05-03 Future Value and Compounding

39. You are to receive $75 per year indefinitely. The market rate of interest for these types of payments is 8%. The price you would pay for this stream is:
    A.$9.38
    B. $81.00
    C. $93.75
    D. $937.50

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Easy
Topic: 05-04 The Power of Compounding: A Digression

40. Aunt Clarisse has promised to leave you an annuity that will pay $60 next year and grow at an annual rate of 4%. The payments are expected to go on indefinitely and the interest rate is 9%. What is the value of the growing perpetuity?
    A.$667
    B. $693
    C. $1,200
    D. $1,248

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

41. Which of the following amounts is closest to the present value of a payment of $21,000 three years from now if the effective annual interest rate is 4%?
    A.$18,669
    B. $18,658
    C. $19,218
    D. $18,480
    E. $17,951

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-02 The Multiperiod Case

42. Thorton will receive an inheritance of $500,000 three years from now. Thorton’s personal discount rate corresponds to a 10% interest rate compounded semiannually. Which of the following values is closest to the amount that Thorton should accept today for the right to his inheritance?
    A.$373,108
    B. $375,657
    C. $665,500
    D. $670,048

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-03 Future Value and Compounding

43. A mortgage instrument pays $1.5 million at the end of each of the next two years. An investor has an alternative investment with the same amount of risk that will pay interest at 8% compounded semiannually. Which of the following amounts is closest to what the investor should pay for the mortgage instrument?
    A.$1.28 million.
    B. $1.39 million.
    C. $2.67 million.
    D. $2.72 million.

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

44. An equal stream of payments that lasts forever is:
    A.a growing annuity.
    B. a zero-coupon bond.
    C. a perpetuity.
    D. valueless.

 

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Easy
Topic: 05-04 The Power of Compounding: A Digression

45. An annuity:
    A.is a debt instrument that pays no interest.
    B. is a stream of payments that varies with current market interest.
    C. is a series of equal payments through time.
    D. has no value.

 

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Easy
Topic: 05-04 The Power of Compounding: A Digression

46. A perpetuity differs from an annuity because:
    A.perpetuity payments vary with the rate of inflation.
    B. perpetuity payments vary with the market rate of interest.
    C. perpetuity payments are variable while annuity payments are constant.
    D. perpetuity payments never cease.
    E. annuity payments never cease.

 

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Easy
Topic: 05-04 The Power of Compounding: A Digression

47. An annuity factor:
    A.can be used to determine the present value of a level stream of payments.
    B. consists entirely of maturation and interest.
    C. is a variable that can never be greater than one.
    D. is any factor that affects the price of a bond.

 

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

48. Charles Carr borrowed $3,500 to consolidate his debts. Since Charles had an excellent credit rating, he was able to borrow at a 12% effective annual rate. Charles is required to make monthly payments. Charles will make equal payments for the next 36 months. Which one of the following values is closest to his monthly payments?
    A.$121
    B. $122
    C. $115
    D. $118
    E. $123

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

49. Tina is able to pay $160 a month for five years for a car. If the interest rate is 4.9%, how much can Tina afford to borrow to buy a car?
    A.$6,961.36
    B. $8,499.13
    C. $8,533.84
    D. $8,686.82
    E. $9,588.05

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

50. What is the present value of 10 payments of $500 each received every 24 months at a discount rate of 12%?
    A.$1,840.93
    B. $1,332.60
    C. $2,825.11.
    D. $1,761.66

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Easy
Topic: 05-04 The Power of Compounding: A Digression

51. If a student borrows $20,000 to start a business as a 5 year, 10% loan, the annual payment is:
    A.$2,000.00
    B. $3,275.95
    C. $4,000.00
    D. $5,275.95

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

52. A “little seven” accounting firm offers to pay you a year-end bonus of $5,000 for 3 years if you will accept employment with them and stay for the entire 3-year period. Which of the following amounts is closest to the present value of the bonus if the interest rate is 10%?
    A.$5,000.
    B. $11,270.
    C. $12,434.
    D. $15,000.
    E. $31,576.

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Easy
Topic: 05-03 Future Value and Compounding

53. An S&L provides a loan with 15 yearly repayments of $8,000 with the first payment beginning immediately. Which of the following amounts comes closest to the present value of the loan if the interest rate is 7%?
    A.$72,863.
    B. $77,964.
    C. $115,648.
    D. $120,000.

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

54. Suzette is going to receive $10,000 today as the result of an insurance settlement. In addition, she will receive $15,000 one year from today and $25,000 two years from today. She plans on saving all of this money and investing it for her retirement. If Suzette can earn an average of 11% on her investments, how much will she have in her account if she retires 25 years from today?
    A.$536,124.93
    B. $541,414.14
    C. $546,072.91
    D. $570,008.77
    E. $595,098.67

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Hard
Topic: 05-04 The Power of Compounding: A Digression

55. A sports team in an effort to solve the salary cap problem has offered a player a contract of $1 million dollars a year for the next season with the payments growing at 7% per year for the next 25 years. The player believes the discount rate for such payments is 13%. What is the value today of taking this contract?
    A.$12,405,955.40
    B. $16,666,666.67
    C. $884,956.09
    D. $5,824,965.76

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

56. The Ajax Co. just decided to save $1,500 a month for the next five years as a safety net for recessionary periods. The money will be set aside in a separate savings account which pays 3.25% interest compounded monthly. It deposits the first $1,500 today. If the company had wanted to deposit an equivalent lump sum today, how much would it have had to deposit?
    A.$82,964.59
    B. $83,189.29
    C. $83,428.87
    D. $83,687.23
    E. $84,998.01

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Hard
Topic: 05-04 The Power of Compounding: A Digression

57. As an excellent student in environmental ecology you have been awarded the “Clean Effluent Prize” by state agency. You (or your estate) are to receive $300 forever from the state or the agency will allow you to choose $400 over the next 25 years. Payments are to be received semi-annually and if the market rate of interest is 6% what is the value of the two options respectively?
    A.$30,000; $10,000.25
    B. $5,000; $5,145.95
    C. $10,000; $6,304.74
    D. $2,500; $3,859.46
    E. $6,666.67; $5,113.34

 

Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

58. You are comparing two investment options. The cost to invest in either option is the same today. Both options will provide you with $20,000 of income. Option A pays five annual payments starting with $8,000 the first year followed by four annual payments of $3,000 each. Option B pays five annual payments of $4,000 each. Which one of the following statements is correct given these two investment options?
    A.Both options are of equal value given that they both provide $20,000 of income.
    B. Option A is the better choice of the two given any positive rate of return.
    C. Option B has a higher present value than option A given a positive rate of return.
    D. Option B has a lower future value at year 5 than option A given a zero rate of return.
    E. Option A is preferable because it is an annuity due.

 

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

59. Alan Burnie has just started work and has been wanting to buy a sleek powerboat for sometime. Rather than purchase and finance now, he plans to save every three months and increase the deposits by 3% per annum as he expects raises at least that large. How much must the first deposit be if the boat costs $25,000 today and he expects to earn 10% on the money over the next five years?
    A.$1,501.56
    B. $2,081.99
    C. $1,561.49
    D. $6,097.27
    E. $2,359.82

 

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Blooms: Analyze
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

60. Luis has a management contract which grants him a lump sum payment of $20 million be paid upon the completion of his first five years of service. The company wants to set aside an equal amount of funds each year to cover this anticipated cash outflow. The company can earn 4.5 percent on these funds. How much must the company set aside each year for this purpose?
    A.$3,775,042.93
    B. $3,798,346.17
    C. $3,801,033.67
    D. $3,655,832.79
    E. $4,038,018.22

 

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Blooms: Analyze
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

61. You are comparing two annuities with equal present values. The applicable discount rate is 6.5 percent. One annuity will pay $2,000 annually, starting today, for 20 years. The second annuity will pay annually, starting one year from today, for 20 years. What is the annual payment for the second annuity?
    A.$2,225
    B. $2,075
    C. $2,000
    D. $2,130
    E. $2,405

 

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Blooms: Analyze
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

62. Kay owns two annuities that will each pay $500 a month for the next 12 years. One payment is received at the beginning of each month while the other is received at the end of each month. At a discount rate of 7.25 percent, compounded monthly, what is the difference in the present values of these annuities?
    A.$289.98
    B. $265.42
    C. $299.01
    D. $308.00
    E. $312.50

 

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Blooms: Analyze
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

63. The potential owner/managers of the yet to be formed new In-Line Blade Company are evaluating the prospects for the business. The new equipment is expected to be $5.5 million and have after tax cash flows of $400,000 for the first two years, $750,000 in the next two years, and $1,200,000 thereafter indefinitely. The owners estimate that they require a 15% rate of return. What is the value of the In-Line Blade Company; should they go forward with the investment?
    A.$3,872,122; yes.
    B. $4,072,236; yes.
    C. -$2,000,000; no.
    D. $943,596; yes.
    E. $105,185; yes.

 

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Blooms: Analyze
Difficulty: Medium
Topic: 05-05 Present Value and Discounting

64. The BobIU Computer Graphics Co. has just produced a new multimedia graphics chip which will cost $6,000,000 this year to put into production. They anticipate net cash flows of $3 million next year, $2million, $1 million, $.5 million, $.25 million and then $0 over each of the following years. The two owners require a 15% return on their investment. The value of this investment to the firm is:
    A.$750,000.10
    B. -$811,329.97
    C. $556,462.71
    D. $652,173.91
    E. -$371,782.85

 

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Blooms: Analyze
Difficulty: Easy
Topic: 05-05 Present Value and Discounting

 

Short Answer Questions

65. Mr. Miser, who is 35 years old, has just inherited $11,000 and decides to use the windfall towards his retirement. He places the money in a bank, which promises a return of 6% per year until his planned retirement at age 65. If his funds earn 6% interest compounded annually, how much will he have at retirement? Repeat the analysis for both semi-annual and continuous compounding.

$11,000(1.06)30 = $63,178.40
$11,000(1.03)60 = $64,867.63
$11,000. e(.06)(30) = $66,546.12

 

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Blooms: Analyze
Difficulty: Hard
Topic: 05-03 Future Value and Compounding

66. An investment today of $3300 is worth $10,000 in 8 years. At what rate has your investment been growing (annually) over the 8 years?

$10,000 = 3300(1 + r)8; 10,000/3300 = 3.0303 = (1 + r)8; 1 + r = 1.14864482 or 14.86%; PV = -3300, FV = 10,000 N = 8 PMT = 0 I/YR = ? = 14.86%

 

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Blooms: Analyze
Difficulty: Easy
Topic: 05-02 The Multiperiod Case

67. Joe, a freshman in college, needs $55,000 in 4 years to buy the car of his dreams. If his investments earn 6% interest per year, how much must he invest today to have that amount at graduation? If he invested once a year for four years beginning today until the end of the 4 years how much must he invest?

$55000/(1.06)⁴ = 43,565.15; $55,000/4.6371 = 11,860.86

 

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Blooms: Analyze
Difficulty: Medium
Topic: 05-02 The Multiperiod Case

68. There are three factors that affect the present value of an annuity. Explain what these three factors are and discuss how an increase in each will impact the present value of the annuity.

The factors are the interest rate, payment amount, and number of payments. An increase in the payment and number of payments will increase the present value, while an increase in the interest rate will decrease the present value.

 

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Blooms: Understand
Difficulty: Medium
Topic: 05-03 Future Value and Compounding

69. There are three factors that affect the future value of an annuity. Explain what these three factors are and discuss how an increase in each will impact the future value of the annuity.

The factors are the interest rate, payment amount, and number of payments. An increase in any of these three will increase the future value of the annuity.

 

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Blooms: Analyze
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

70. As the winner of the Housecleaners sweepstakes, you are entitled to one of the following prizes:

    A. $999,999 immediately.
    B. $100,000 per year forever.
    C. $180,000 per year for the next 10 years starting immediately.
    D. $400,000 payable every 2 years over 20 years.
    E. $39,000 next year growing by 6% forever.

    In terms of present values, which prize should be chosen if r = 9%?

PV = $999,999
PV = $1,111,111
PV = $1,259,144
PV = $1,747,090
PV = $1,300,000

 

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Blooms: Analyze
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

71. Your aunt, in her will, left you the sum of $5,000 a year forever with payments starting immediately. However, the news is better. She has specified that the amount should grow at 5% per year to maintain purchasing power. Given an interest rate of 12%, what is the PV of the inheritance?

$5,000 + $5,000(1.05)/(.12 – .05) = $80,000

 

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Blooms: Analyze
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression

72. If you invest $100,000 today at 12% per year over the next 15 years, what is the most you can spend in equal amounts out of the fund each year over that time.

$100,000 = Annuity Payment * Ann. Factor(.12,15)6.8109

 

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Blooms: Analyze
Difficulty: Easy
Topic: 05-04 The Power of Compounding: A Digression

73. Tobi owns a perpetuity that will pay $1,500 a year, starting one year from now. He offers to sell you all of the remaining payments after the next 25 payments have been paid. What price should you offer him for payments 26 onward if you desire a rate of return of 8 percent? What does your offer price illustrate about the value of perpetuities?

Perpetuity value:

PV = $1,500 /.08 = $18,750

Value of payments for first 25 years:

PV = $1,500 ´ ({1 – [1 / (1 + .08)25]} /.08) = $16,012.16

Value of payments after the first 25 years:

PV = $18,750 – 16,012.16 = $2,737.84

This can also be calculated as:

PV = $18,750 / 1.0825 = $2,737.84

The present value of the perpetuity at any point in time is $18,750 at a discount rate of 8 percent. The present value of the next 25 payments is $16,012.16 while the present value of the remaining payments is only $2,737.84. This illustrates the value of a perpetuity is derived primarily from the payments received early in the annuity’s remaining life while the payments to be received later have little worth today.

 

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Blooms: Analyze
Difficulty: Easy
Topic: 05-04 The Power of Compounding: A Digression

74. What is meant by “amortizing a loan”?

Amortizing a loan is when the borrower pays back the loan, both in principal and interest, over time. The process of providing for a loan to be paid off by making regular principal reductions is called amortizing the loan.

 

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Blooms: Understand
Difficulty: Medium
Topic: 05-04 The Power of Compounding: A Digression