Chapter 05 - Introduction to Valuation: The Time Value of Money

Chapter 05 Introduction to Valuation: The Time Value of Money

Multiple Choice Questions

1. You are investin !100 today in a savin s account at your local "an#. $hich one of the follo%in terms refers to the value of this investment one year from no%& '. future value (. present value C. principal amounts ). discounted value *. invested principal

+. Tracy invested !1,000 five years a o and earns - percent interest on her investment. (y leavin her interest earnin s in her account, she increases the amount of interest she earns each year. The %ay she is handlin her interest income is referred to as %hich one of the follo%in & '. simplifyin (. compoundin C. a re ation ). accumulation *. discountin

.. /teve invested !100 t%o years a o at 10 percent interest. The first year, he earned !10 interest on his !100 investment. 0e reinvested the !10. The second year, he earned !11 interest on his !110 investment. The e1tra !1 he earned in interest the second year is referred to as: '. free interest. (. "onus income. C. simple interest. ). interest on interest. *. present value interest.

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Chapter 05 - Introduction to Valuation: The Time Value of Money

-. Interest earned on "oth the initial principal and the interest reinvested from prior periods is called: '. free interest. (. dual interest. C. simple interest. ). interest on interest. *. compound interest.

5. /ara invested !500 si1 years a o at 5 percent interest. /he spends her earnin s as soon as she earns any interest so she only receives interest on her initial !500 investment. $hich type of interest is /ara earnin & '. free interest (. comple1 interest C. simple interest ). interest on interest *. compound interest

2. /helley %on a lottery and %ill receive !1,000 a year for the ne1t ten years. The value of her %innin s today discounted at her discount rate is called %hich one of the follo%in & '. sin le amount (. future value C. present value ). simple amount *. compounded value

3. Terry is calculatin the present value of a "onus he %ill receive ne1t year. The process he is usin is called: '. ro%th analysis. (. discountin . C. accumulatin . ). compoundin . *. reducin .

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Chapter 05 - Introduction to Valuation: The Time Value of Money

4. /teve 5ust computed the present value of a !10,000 "onus he %ill receive in the future. The interest rate he used in this process is referred to as %hich one of the follo%in & '. current yield (. effective rate C. compound rate ). simple rate *. discount rate

6. The process of determinin the present value of future cash flo%s in order to #no% their %orth today is called %hich one of the follo%in & '. compound interest valuation (. interest on interest computation C. discounted cash flo% valuation ). present value interest factorin *. comple1 factorin

10. 'ndy deposited !.,000 this mornin into an account that pays 5 percent interest, compounded annually. (ar" also deposited !.,000 this mornin into an account that pays 5 percent interest, compounded annually. 'ndy %ill %ithdra% his interest earnin s and spend it as soon as possi"le. (ar" %ill reinvest her interest earnin s into her account. 7iven this, %hich one of the follo%in statements is true& '. (ar" %ill earn more interest the first year than 'ndy %ill. (. 'ndy %ill earn more interest in year three than (ar" %ill. C. (ar" %ill earn interest on interest. ). 'fter five years, 'ndy and (ar" %ill "oth have earned the same amount of interest. *. 'ndy %ill earn compound interest.

11. /ue and 8eal are t%ins. /ue invests !5,000 at 3 percent %hen she is +5 years old. 8eal invests !5,000 at 3 percent %hen he is .0 years old. (oth investments compound interest annually. (oth /ue and 8eal retire at a e 20. $hich one of the follo%in statements is correct assumin that neither /ue nor 8eal has %ithdra%n any money from their accounts& '. /ue %ill have less money %hen she retires than 8eal. (. 8eal %ill earn more interest on interest than /ue. C. 8eal %ill earn more compound interest than /ue. ). If "oth /ue and 8eal %ait to a e 30 to retire, then they %ill have e9ual amounts of savin s. *. /ue %ill have more money than 8eal as lon as they retire at the same time.

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Chapter 05 - Introduction to Valuation: The Time Value of Money

1+. /amantha opened a savin s account this mornin . 0er money %ill earn 5 percent interest, compounded annually. 'fter five years, her savin s account %ill "e %orth !5,200. 'ssume she %ill not ma#e any %ithdra%als. 7iven this, %hich one of the follo%in statements is true& '. /amantha deposited more than !5,200 this mornin . (. The present value of /amantha:s account is !5,200. C. /amantha could have deposited less money and still had !5,200 in five years if she could have earned 5.5 percent interest. ). /amantha %ould have had to deposit more money to have !5,200 in five years if she could have earned 2 percent interest. *. /amantha %ill earn an e9ual amount of interest every year for the ne1t five years.

1.. This afternoon, you deposited !1,000 into a retirement savin s account. The account %ill compound interest at 2 percent annually. You %ill not %ithdra% any principal or interest until you retire in forty years. $hich one of the follo%in statements is correct& '. The interest you earn si1 years from no% %ill e9ual the interest you earn ten years from no%. (. The interest amount you earn %ill dou"le in value every year. C. The total amount of interest you %ill earn %ill e9ual !1,000 .02 -0. ). The present value of this investment is e9ual to !1,000. *. The future value of this amount is e9ual to !1,000 ;1 < -0=.02.

1-. Your randmother has promised to ive you !5,000 %hen you raduate from colle e. /he is e1pectin you to raduate t%o years from no%. $hat happens to the present value of this ift if you delay your raduation "y one year and raduate three years from no%& '. remains constant (. increases C. decreases ). "ecomes ne ative *. cannot "e determined from the information provided

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Chapter 05 - Introduction to Valuation: The Time Value of Money

15. >uis is oin to receive !+0,000 si1 years from no%. /oo >ee is oin to receive !+0,000 nine years from no%. $hich one of the follo%in statements is correct if "oth >uis and /oo >ee apply a 3 percent discount rate to these amounts& '. The present values of >uis and /oo >ee:s monies are e9ual. (. In future dollars, /oo >ee:s money is %orth more than >uis: money. C. In today:s dollars, >uis: money is %orth more than /oo >ee:s. ). T%enty years from no%, the value of >uis: money %ill "e e9ual to the value of /oo >ee:s money. *. /oo >ee:s money is %orth more than >uis: money iven the 3 percent discount rate.

12. $hich one of the follo%in varia"les is the e1ponent in the present value formula& '. present value (. future value C. interest rate ). time *. There is no e1ponent in the present value formula.

13. You %ant to have !1 million in your savin s account %hen you retire. You plan on investin a sin le lump sum today to fund this oal. You are plannin on investin in an account %hich %ill pay 3.5 percent annual interest. $hich of the follo%in %ill reduce the amount that you must deposit today if you are to have your desired !1 million on the day you retire& I. Invest in a different account payin a hi her rate of interest. II. Invest in a different account payin a lo%er rate of interest. III. ?etire later. IV. ?etire sooner. '. I only (. II only C. I and III only ). I and IV only *. II and III only

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Chapter 05 - Introduction to Valuation: The Time Value of Money

14. $hich one of the follo%in %ill produce the hi hest present value interest factor& '. 2 percent interest for five years (. 2 percent interest for ei ht years C. 2 percent interest for ten years ). 4 percent interest for five years *. 4 percent interest for ten years

16. $hat is the relationship "et%een present value and future value interest factors& '. The present value and future value factors are e9ual to each other. (. The present value factor is the e1ponent of the future value factor. C. The future value factor is the e1ponent of the present value factor. ). The factors are reciprocals of each other. *. There is no relationship "et%een these t%o factors.

+0. Martin invested !1,000 si1 years a o and e1pected to have !1,500 today. 0e has not added or %ithdra%n any money from this account since his initial investment. 'll interest %as reinvested in the account. 's it turns out, Martin only has !1,-+0 in his account today. $hich one of the follo%in must "e true& '. Martin earned simple interest rather than compound interest. (. Martin earned a lo%er interest rate than he e1pected. C. Martin did not earn any interest on interest as he e1pected. ). Martin i nored the ?ule of 3+ %hich caused his account to decrease in value. *. The future value interest factor turned out to "e hi her than Martin e1pected.

+1. 7erold invested !2,+00 in an account that pays 5 percent simple interest. 0o% much money %ill he have at the end of ten years& '. !4,310 (. !6,000 C. !6,.00 ). !6,234 *. !10,066

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Chapter 05 - Introduction to Valuation: The Time Value of Money

++. 'le1 invested !10,500 in an account that pays 2 percent simple interest. 0o% much money %ill he have at the end of four years& '. !1+,250 (. !1+,623 C. !1.,0+0 ). !1.,+52 *. !1.,500

+.. You invested !1,250 in an account that pays 5 percent simple interest. 0o% much more could you have earned over a +0-year period if the interest had compounded annually& '. !4-6.++ (. !6.0.11 C. !64+.16 ). !1,0+1.15 *. !1,033.6-

+-. Travis invested !6,+50 in an account that pays 2 percent simple interest. 0o% much more could he have earned over a 3-year period if the interest had compounded annually& '. !3-1.-1 (. !33..54 C. !40+.12 ). !4..... *. !454.06

+5. $hat is the future value of !3,146 invested for +. years at 6.+5 percent compounded annually& '. !++,-4..20 (. !+3,460.43 C. !.4,661.03 ). !51,006.1. *. !5-,666.44

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Chapter 05 - Introduction to Valuation: The Time Value of Money

+2. Today, you earn a salary of !.2,000. $hat %ill "e your annual salary t%elve years from no% if you earn annual raises of ..2 percent& '. !55,0.+.5(. !53,-1-.02 C. !54,+.5.+). !56,1++.04 *. !56,.20.-5

+3. You o%n a classic automo"ile that is currently valued at !1-3,600. If the value increases "y 2.5 percent annually, ho% much %ill the automo"ile "e %orth ten years from no%& '. !+--,0.5.00 (. !+51,004.13 C. !+30,01...4 ). !+33,2+4.2. *. !+61,-40.14

+4. You hope to "uy your dream car four years from no%. Today, that car costs !4+,500. You e1pect the price to increase "y an avera e of -.4 percent per year over the ne1t four years. 0o% much %ill your dream car cost "y the time you are ready to "uy it& '. !64,.-0.00 (. !64,222.23 C. !66,513.-1 ). !66,414.0+ *. !100,0+..12

+6. This mornin , T> Truc#in invested !40,000 to help fund a company e1pansion pro5ect planned for - years from no%. 0o% much additional money %ill the firm have - years from no% if it can earn 5 percent rather than - percent on its savin s& '. !+,6-0.06 (. !.,251.4+ C. !-,004.13 ). !-,+16.24 *. !-,311.04

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Chapter 05 - Introduction to Valuation: The Time Value of Money

.0. You 5ust received !++5,000 from an insurance settlement. You have decided to set this money aside and invest it for your retirement. Currently, your oal is to retire +5 years from today. 0o% much more %ill you have in your account on the day you retire if you can earn an avera e return of 10.5 percent rather than 5ust 4 percent& '. !-13,1.3 (. !246,506 C. !1,050,-+. ). !1,146,532 *. !1,414,.-+

.1. You 5ust received a !5,000 ift from your randmother. You have decided to save this money so that you can ift it to your randchildren 50 years from no%. 0o% much additional money %ill you have to ift to your randchildren if you can earn an avera e of 4.5 percent instead of 5ust 4 percent on your savin s& '. !-3,.14.06 (. !5+,-2-.36 C. !55,+11.12 ). !54,411.66 *. !20,6+..5+

.+. You are depositin !1,500 in a retirement account today and e1pect to earn an avera e return of 3.5 percent on this money. 0o% much additional income %ill you earn if you leave the money invested for -5 years instead of 5ust -0 years& '. !10,3+..04 (. !11,360.60 C. !1+,--1.52 ). !1+,604.16 *. !1.,560.6.

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Chapter 05 - Introduction to Valuation: The Time Value of Money

... You collect old coins. Today, you have t%o coins each of %hich is valued at !+50. @ne coin is e1pected to increase in value "y 2 percent annually %hile the other coin is e1pected to increase in value "y -.5 percent annually. $hat %ill "e the difference in the value of the t%o coins 15 years from no%& '. !115..+ (. !+04.0C. !+-1.36 ). !+5-.+*. !+40.15

.-. Your father invested a lump sum +2 years a o at -.+5 percent interest. Today, he ave you the proceeds of that investment %hich totaled !51,-40.36. 0o% much did your father ori inally invest& '. !15,6+6.-3 (. !12,500.00 C. !13,---.42 ). !13,500.00 *. !13,666.-5

.5. $hat is the present value of !150,000 to "e received 4 years from today if the discount rate is 11 percent& '. !25,044.63 (. !31,1-3.03 C. !3-,1-1.-1 ). !36,402.14 *. !4.,+61.02

.2. You %ould li#e to ive your dau hter !35,000 to%ards her colle e education 13 years from no%. 0o% much money must you set aside today for this purpose if you can earn 4 percent on your investments& '. !14,.44.16 (. !+0,+30.13 C. !+4,-13.23 ). !+6,.11.1. *. !.+,-44..3

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Chapter 05 - Introduction to Valuation: The Time Value of Money

.3. You %ant to have !.5,000 saved 2 years from no% to "uy a house. 0o% much less do you have to deposit today to reach this oal if you can earn 5.5 percent rather than 5 percent on your savin s& Today:s deposit is the only deposit you %ill ma#e to this savin s account. '. !3...6(. !361.14 C. !4+-.20 ). !4-5.11 *. !616.0+

.4. Your older sister deposited !5,000 today at 4.5 percent interest for 5 years. You %ould li#e to have 5ust as much money at the end of the ne1t 5 years as your sister %ill have. 0o%ever, you can only earn 3 percent interest. 0o% much more money must you deposit today than your sister did if you are to have the same amount at the end of the 5 years& '. !.+1.16 (. !.20.-. C. !.43.34 ). !-01.+1 *. !-1...6

.6. ' year a o, you deposited !.0,000 into a retirement savin s account at a fi1ed rate of 5.5 percent. Today, you could earn a fi1ed rate of 2.5 percent on a similar type account. 0o%ever, your rate is fi1ed and cannot "e ad5usted. 0o% much less could you have deposited last year if you could have earned a fi1ed rate of 2.5 percent and still have the same amount as you currently %ill %hen you retire .4 years from today& '. !+,114.-+ less (. !.,...... less C. !5,-13.06 less ). !3,+3-.1+ less *. !6,+.-.63 less

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Chapter 05 - Introduction to Valuation: The Time Value of Money

-0. $hen you retire -0 years from no%, you %ant to have !1.+ million. You thin# you can earn an avera e of 1+ percent on your investments. To meet your oal, you are tryin to decide %hether to deposit a lump sum today, or to %ait and deposit a lump sum + years from today. 0o% much more %ill you have to deposit as a lump sum if you %ait for + years "efore ma#in the deposit& '. !1,-1-.1(. !+,.16.-3 C. !+,461.11 ). !.,+40.34 *. !.,-02.34

-1. Theo needs !-0,000 as a do%n payment for a house 2 years from no%. 0e earns ..5 percent on his savin s. Theo can either deposit one lump sum today for this purpose or he can %ait a year and deposit a lump sum. 0o% much additional money must he deposit if he %aits for one year rather than ma#in the deposit today& '. !434.64 (. !611.1. C. !1,1.4.60 ). !1,.-4.0. *. !1,-+0.14

-+. @ne year a o, you invested !1,400. Today it is %orth !1,6+-.2+. $hat rate of interest did you earn& '. 2.56 percent (. 2.23 percent C. 2.44 percent ). 2.6+ percent *. 3.01 percent

-.. 'ccordin to the ?ule of 3+, you can do %hich one of the follo%in & '. dou"le your money in five years at 3.+ percent interest (. dou"le your money in 3.+ years at 4 percent interest C. dou"le your money in 4 years at 6 percent interest ). triple your money in 3.+ years at 5 percent interest *. triple your money at 10 percent interest in 3.+ years

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Chapter 05 - Introduction to Valuation: The Time Value of Money

--. Aorty years a o, your mother invested !5,000. Today, that investment is %orth !-.0,025.11. $hat is the avera e annual rate of return she earned on this investment& '. 11.24 percent (. 11.31 percent C. 11.34 percent ). 11.61 percent *. 1+.0+ percent

-5. /i1teen years a o, 'licia invested !1,000. *i ht years a o, Travis invested !+,000. Today, "oth 'licia:s and Travis: investments are each %orth !+,-00. 'ssume that "oth 'licia and Travis continue to earn their respective rates of return. $hich one of the follo%in statements is correct concernin these investments& '. Three years from today, Travis: investment %ill "e %orth more than 'licia:s. (. @ne year a o, 'licia:s investment %as %orth less than Travis: investment. C. Travis earns a hi her rate of return than 'licia. ). Travis has earned an avera e annual interest rate of ...3 percent. *. 'licia has earned an avera e annual interest rate of 2.01 percent.

-2. Benn /tation is savin money to "uild a ne% loadin platform. T%o years a o, they set aside !+-,000 for this purpose. Today, that account is %orth !+4,.66. $hat rate of interest is Benn /tation earnin on this investment& '. 2..6 percent (. 3.-3 percent C. 4.34 percent ). 6.+. percent *. 6.23 percent

-3. Aifteen years a o, Cac#son /upply set aside !1.0,000 in case of a financial emer ency. Today, that account has increased in value to !..0,56+. $hat rate of interest is the firm earnin on this money& '. 5.40 percent (. 2.-+ percent C. 2.35 percent ). 3.+4 percent *. 3.5. percent

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Chapter 05 - Introduction to Valuation: The Time Value of Money

-4. Aourteen years a o, your parents set aside !3,500 to help fund your colle e education. Today, that fund is valued at !+2,140. $hat rate of interest is "ein earned on this account& '. 3.66 percent (. 4..2 percent C. 4.51 percent ). 6..- percent *. 10.02 percent

-6. /ome time a o, Culie purchased eleven acres of land costin !.2,600. Today, that land is valued at !+1-,400. 0o% lon has she o%ned this land if the price of the land has "een increasin at 10.5 percent per year& '. 1.... years (. 12.64 years C. 13.2- years ). 16.+6 years *. +1.04 years

50. @n your ninth "irthday, you received !.00 %hich you invested at -.5 percent interest, compounded annually. Your investment is no% %orth !352. 0o% old are you today& '. a e +6 (. a e .0 C. a e .1 ). a e .+ *. a e ..

Essay Questions

51. You %ant to deposit sufficient money today into a savin s account so that you %ill have !1,000 in the account three years from today. *1plain %hy you could deposit less money today if you could earn ..5 percent interest rather than . percent interest.

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Chapter 05 - Introduction to Valuation: The Time Value of Money

5+. You are considerin t%o separate investments. (oth investments pay 3 percent interest. Investment ' pays simple interest and Investment ( pays compound interest. $hich investment should you choose, and %hy, if you plan on investin for a period of 5 years&

5.. $hat lesson does the future value formula provide for youn %or#ers %ho are loo#in ahead to retirin some day&

5-. You are considerin t%o lottery payment options: @ption ' pays !10,000 today and @ption ( pays !+0,000 at the end of ten years. 'ssume you can earn 2 percent on your savin s. $hich option %ill you choose if you "ase your decision on present values& $hich option %ill you choose if you "ase your decision on future values& *1plain %hy your ans%ers are either the same or different.

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Chapter 05 - Introduction to Valuation: The Time Value of Money

55. 't an interest rate of 10 percent and usin the ?ule of 3+, ho% lon %ill it ta#e to dou"le the value of a lump sum invested today& 0o% lon %ill it ta#e after that until the account ro%s to four times the initial investment& 7iven the po%er of compoundin , shouldn:t it ta#e less time for the money to dou"le the second time&

Multiple Choice Questions

52. 'ssume the total cost of a colle e education %ill "e !.00,000 %hen your child enters colle e in 12 years. You presently have !35,521 to invest. $hat rate of interest must you earn on your investment to cover the cost of your child:s colle e education& '. 3.35 percent (. 4.50 percent C. 6.00 percent ). 6.+5 percent *. 6.50 percent

53. 't 11 percent interest, ho% lon %ould it ta#e to 9uadruple your money& '. 2.55 years (. 2.2- years C. 1..06 years ). 1..+4 years *. 1..52 years

54. 'ssume the avera e vehicle sellin price in the Dnited /tates last year %as !-1,662. The avera e price 6 years earlier %as !+6,000. $hat %as the annual increase in the sellin price over this time period& '. ..46 percent (. -.+0 percent C. -.52 percent ). 5.01 percent *. 5.-0 percent

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Chapter 05 - Introduction to Valuation: The Time Value of Money

56. You:re tryin to save to "uy a ne% !120,000 Aerrari. You have !52,000 today that can "e invested at your "an#. The "an# pays 2 percent annual interest on its accounts. 0o% many years %ill it "e "efore you have enou h to "uy the car& 'ssume the price of the car remains constant. '. 12.23 years (. 13.0- years C. 13.-1 years ). 13.43 years *. 14.0+ years

20. Imprudential, Inc. has an unfunded pension lia"ility of !450 million that must "e paid in +5 years. To assess the value of the firm:s stoc#, financial analysts %ant to discount this lia"ility "ac# to the present. The relevant discount rate is 2.5 percent. $hat is the present value of this lia"ility& '. !156,40.,12+ (. !131,-.4,603 C. !132,023,.11 ). !14-,516,-4*. !161,511,.23

21. You have 5ust received notification that you have %on the !1.- million first priEe in the Centennial >ottery. 0o%ever, the priEe %ill "e a%arded on your 100th "irthday, 30 years from no%. The appropriate discount rate is 4 percent. $hat is the present value of your %innin s& '. !-,+44.12 (. !2,-0-.+0 C. !15,.06.61 ). !+.,...... *. !+5,000.00

2+. Your coin collection contains fifty-four 16-1 silver dollars. Your randparents purchased them for their face value %hen they %ere ne%. These coins have appreciated at a 10 percent annual rate. 0o% much %ill your collection "e %orth %hen you retire in +020& '. !.,211,004 (. !.,643,-52 C. !-,1++,.6). !-,-+1,004 *. !-,551,13+

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Chapter 05 - Introduction to Valuation: The Time Value of Money

2.. In 1465, the %inner of a competition %as paid !110. In +002, the %inner:s priEe %as !30,000. $hat %ill the %inner:s priEe "e in +0-0 if the priEe continues increasin at the same rate& '. !.46,-00 (. !-+1,1++ C. !-36,.11 ). !505,263 *. !5-4,1+1

2-. /uppose that the first comic "oo# of a classic series %as sold in 165-. In +000, the estimated price for this comic "oo# in ood condition %as a"out !.-0,000. This represented a return of +3 percent per year. Aor this to "e true, %hat %as the ori inal price of the comic "oo# in 165-& '. !5.00 (. !5.+4 C. !5.50 ). !5.31 *. !2.00

25. /uppose you are committed to o%nin a !1-0,000 Aerrari. You "elieve your mutual fund can achieve an annual rate of return of 6 percent and you %ant to "uy the car in 3 years. 0o% much must you invest today to fund this purchase assumin the price of the car remains constant& '. !3-,+04.12 (. !32,54-.36 C. !33,611.04 ). !34,016.4+ *. !36,--2.20

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Chapter 05 - Introduction to Valuation: The Time Value of Money

22. You have 5ust made a !1,500 contri"ution to your individual retirement account. 'ssume you earn a 1+ percent rate of return and ma#e no additional contri"utions. 0o% much more %ill your account "e %orth %hen you retire in +5 years than it %ould "e if you %aited another 10 years "efore ma#in this contri"ution& '. !4,.02.12 (. !6,254.33 C. !12,.11.14 ). !12,603.13 *. !13,+46.35

23. You are scheduled to receive !.0,000 in t%o years. $hen you receive it, you %ill invest it for 5 more years, at 4 percent per year. 0o% much money %ill you have 3 years from no%& '. !.6,606.16 (. !-1,.41.12 C. !--,036.4). !-3,+06.16 *. !51,-1-.3.

24. You e1pect to receive !6,000 at raduation in + years. You plan on investin this money at 10 percent until you have !20,000. 0o% many years %ill it "e until this occurs& '. 14.34 years (. 16.62 years C. +1.60 years ). +..04 years *. +5.00 years

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Chapter 05 - Introduction to Valuation: The Time Value of Money

Chapter 05 Introduction to Valuation: The Time Value of Money 'ns%er Fey

Multiple Choice Questions

1. You are investin !100 today in a savin s account at your local "an#. $hich one of the follo%in terms refers to the value of this investment one year from no%& A. future value (. present value C. principal amounts ). discounted value *. invested principal ?efer to section 5.1

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$ Section: "%$ &o'ic: (uture !alue

+. Tracy invested !1,000 five years a o and earns - percent interest on her investment. (y leavin her interest earnin s in her account, she increases the amount of interest she earns each year. The %ay she is handlin her interest income is referred to as %hich one of the follo%in & '. simplifyin B. compoundin C. a re ation ). accumulation *. discountin ?efer to section 5.1

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$ Section: "%$ &o'ic: Com'ounding

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Chapter 05 - Introduction to Valuation: The Time Value of Money

.. /teve invested !100 t%o years a o at 10 percent interest. The first year, he earned !10 interest on his !100 investment. 0e reinvested the !10. The second year, he earned !11 interest on his !110 investment. The e1tra !1 he earned in interest the second year is referred to as: '. free interest. (. "onus income. C. simple interest. . interest on interest. *. present value interest. ?efer to section 5.1

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$ Section: "%$ &o'ic: )nterest on interest

-. Interest earned on "oth the initial principal and the interest reinvested from prior periods is called: '. free interest. (. dual interest. C. simple interest. ). interest on interest. E. compound interest. ?efer to section 5.1

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$ Section: "%$ &o'ic: Com'ound interest

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Chapter 05 - Introduction to Valuation: The Time Value of Money

5. /ara invested !500 si1 years a o at 5 percent interest. /he spends her earnin s as soon as she earns any interest so she only receives interest on her initial !500 investment. $hich type of interest is /ara earnin & '. free interest (. comple1 interest C. simple interest ). interest on interest *. compound interest ?efer to section 5.1

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$ Section: "%$ &o'ic: Sim'le interest

2. /helley %on a lottery and %ill receive !1,000 a year for the ne1t ten years. The value of her %innin s today discounted at her discount rate is called %hich one of the follo%in & '. sin le amount (. future value C. present value ). simple amount *. compounded value ?efer to section 5.+

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#* Section: "%* &o'ic: +resent !alue

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Chapter 05 - Introduction to Valuation: The Time Value of Money

3. Terry is calculatin the present value of a "onus he %ill receive ne1t year. The process he is usin is called: '. ro%th analysis. B. discountin . C. accumulatin . ). compoundin . *. reducin . ?efer to section 5.+

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#* Section: "%* &o'ic: Discounting

4. /teve 5ust computed the present value of a !10,000 "onus he %ill receive in the future. The interest rate he used in this process is referred to as %hich one of the follo%in & '. current yield (. effective rate C. compound rate ). simple rate E. discount rate ?efer to section 5.+

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#* Section: "%* &o'ic: Discount rate

5-+.

Chapter 05 - Introduction to Valuation: The Time Value of Money

6. The process of determinin the present value of future cash flo%s in order to #no% their %orth today is called %hich one of the follo%in & '. compound interest valuation (. interest on interest computation C. discounted cash flo% valuation ). present value interest factorin *. comple1 factorin ?efer to section 5.+

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#* Section: "%* &o'ic: Discounted cas, flow !aluation

10. 'ndy deposited !.,000 this mornin into an account that pays 5 percent interest, compounded annually. (ar" also deposited !.,000 this mornin into an account that pays 5 percent interest, compounded annually. 'ndy %ill %ithdra% his interest earnin s and spend it as soon as possi"le. (ar" %ill reinvest her interest earnin s into her account. 7iven this, %hich one of the follo%in statements is true& '. (ar" %ill earn more interest the first year than 'ndy %ill. (. 'ndy %ill earn more interest in year three than (ar" %ill. C. (ar" %ill earn interest on interest. ). 'fter five years, 'ndy and (ar" %ill "oth have earned the same amount of interest. *. 'ndy %ill earn compound interest. ?efer to section 5.1

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$ Section: "%$ &o'ic: Com'ound interest

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Chapter 05 - Introduction to Valuation: The Time Value of Money

11. /ue and 8eal are t%ins. /ue invests !5,000 at 3 percent %hen she is +5 years old. 8eal invests !5,000 at 3 percent %hen he is .0 years old. (oth investments compound interest annually. (oth /ue and 8eal retire at a e 20. $hich one of the follo%in statements is correct assumin that neither /ue nor 8eal has %ithdra%n any money from their accounts& '. /ue %ill have less money %hen she retires than 8eal. (. 8eal %ill earn more interest on interest than /ue. C. 8eal %ill earn more compound interest than /ue. ). If "oth /ue and 8eal %ait to a e 30 to retire, then they %ill have e9ual amounts of savin s. E. /ue %ill have more money than 8eal as lon as they retire at the same time. ?efer to section 5.1

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$ Section: "%$ &o'ic: (uture !alue

1+. /amantha opened a savin s account this mornin . 0er money %ill earn 5 percent interest, compounded annually. 'fter five years, her savin s account %ill "e %orth !5,200. 'ssume she %ill not ma#e any %ithdra%als. 7iven this, %hich one of the follo%in statements is true& '. /amantha deposited more than !5,200 this mornin . (. The present value of /amantha:s account is !5,200. C. /amantha could have deposited less money and still had !5,200 in five years if she could have earned 5.5 percent interest. ). /amantha %ould have had to deposit more money to have !5,200 in five years if she could have earned 2 percent interest. *. /amantha %ill earn an e9ual amount of interest every year for the ne1t five years. ?efer to section 5.+

AACSB: N/A Bloom's: Com're,ension Difficulty: )ntermediate Learning Ob ecti!e: "#* Section: "%* &o'ic: +resent !alue

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Chapter 05 - Introduction to Valuation: The Time Value of Money

1.. This afternoon, you deposited !1,000 into a retirement savin s account. The account %ill compound interest at 2 percent annually. You %ill not %ithdra% any principal or interest until you retire in forty years. $hich one of the follo%in statements is correct& '. The interest you earn si1 years from no% %ill e9ual the interest you earn ten years from no%. (. The interest amount you earn %ill dou"le in value every year. C. The total amount of interest you %ill earn %ill e9ual !1,000 .02 -0. . The present value of this investment is e9ual to !1,000. *. The future value of this amount is e9ual to !1,000 ;1 < -0=.02. ?efer to sections 5.1 and 5.+

AACSB: N/A Bloom's: Com're,ension Difficulty: )ntermediate Learning Ob ecti!e: "#$ and "#* Section: "%$ and "%* &o'ic: +resent and future !alues

1-. Your randmother has promised to ive you !5,000 %hen you raduate from colle e. /he is e1pectin you to raduate t%o years from no%. $hat happens to the present value of this ift if you delay your raduation "y one year and raduate three years from no%& '. remains constant (. increases C. decreases ). "ecomes ne ative *. cannot "e determined from the information provided ?efer to section 5.+

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#* Section: "%* &o'ic: +resent !alue

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Chapter 05 - Introduction to Valuation: The Time Value of Money

15. >uis is oin to receive !+0,000 si1 years from no%. /oo >ee is oin to receive !+0,000 nine years from no%. $hich one of the follo%in statements is correct if "oth >uis and /oo >ee apply a 3 percent discount rate to these amounts& '. The present values of >uis and /oo >ee:s monies are e9ual. (. In future dollars, /oo >ee:s money is %orth more than >uis: money. C. In today:s dollars, >uis: money is %orth more than /oo >ee:s. ). T%enty years from no%, the value of >uis: money %ill "e e9ual to the value of /oo >ee:s money. *. /oo >ee:s money is %orth more than >uis: money iven the 3 percent discount rate. ?efer to sections 5.1 and 5.+

AACSB: N/A Bloom's: Com're,ension Difficulty: )ntermediate Learning Ob ecti!e: "#$ and "#* Section: "%$ and "%* &o'ic: +resent and future !alues

12. $hich one of the follo%in varia"les is the e1ponent in the present value formula& '. present value (. future value C. interest rate . time *. There is no e1ponent in the present value formula. ?efer to section 5.+

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#* Section: "%* &o'ic: +resent !alue

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Chapter 05 - Introduction to Valuation: The Time Value of Money

13. You %ant to have !1 million in your savin s account %hen you retire. You plan on investin a sin le lump sum today to fund this oal. You are plannin on investin in an account %hich %ill pay 3.5 percent annual interest. $hich of the follo%in %ill reduce the amount that you must deposit today if you are to have your desired !1 million on the day you retire& I. Invest in a different account payin a hi her rate of interest. II. Invest in a different account payin a lo%er rate of interest. III. ?etire later. IV. ?etire sooner. '. I only (. II only C. I and III only ). I and IV only *. II and III only ?efer to section 5.+

AACSB: N/A Bloom's: Com're,ension Difficulty: )ntermediate Learning Ob ecti!e: "#* Section: "%* &o'ic: +resent !alue

14. $hich one of the follo%in %ill produce the hi hest present value interest factor& A. 2 percent interest for five years (. 2 percent interest for ei ht years C. 2 percent interest for ten years ). 4 percent interest for five years *. 4 percent interest for ten years ?efer to sections 5.+

AACSB: N/A Bloom's: Com're,ension Difficulty: )ntermediate Learning Ob ecti!e: "#* Section: "%* &o'ic: +resent !alue factor

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Chapter 05 - Introduction to Valuation: The Time Value of Money

16. $hat is the relationship "et%een present value and future value interest factors& '. The present value and future value factors are e9ual to each other. (. The present value factor is the e1ponent of the future value factor. C. The future value factor is the e1ponent of the present value factor. . The factors are reciprocals of each other. *. There is no relationship "et%een these t%o factors. ?efer to section 5..

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#Section: "%&o'ic: +resent and future !alue factors

+0. Martin invested !1,000 si1 years a o and e1pected to have !1,500 today. 0e has not added or %ithdra%n any money from this account since his initial investment. 'll interest %as reinvested in the account. 's it turns out, Martin only has !1,-+0 in his account today. $hich one of the follo%in must "e true& '. Martin earned simple interest rather than compound interest. B. Martin earned a lo%er interest rate than he e1pected. C. Martin did not earn any interest on interest as he e1pected. ). Martin i nored the ?ule of 3+ %hich caused his account to decrease in value. *. The future value interest factor turned out to "e hi her than Martin e1pected. ?efer to sections 5.1 and 5..

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Chapter 05 - Introduction to Valuation: The Time Value of Money

+1. 7erold invested !2,+00 in an account that pays 5 percent simple interest. 0o% much money %ill he have at the end of ten years& '. !4,310 (. !6,000 C. !6,.00 ). !6,234 *. !10,066 *ndin value G !2,+00 < ;!2,+00 .05 10= G !6,.00

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$ Section: "%$ &o'ic: (uture !alue

++. 'le1 invested !10,500 in an account that pays 2 percent simple interest. 0o% much money %ill he have at the end of four years& '. !1+,250 (. !1+,623 C. !1.,0+0 ). !1.,+52 *. !1.,500 *ndin value G !10,500 < ;!10,500 .02 -= G !1.,0+0

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$ Section: "%$ &o'ic: (uture !alue

5-.0

Chapter 05 - Introduction to Valuation: The Time Value of Money

+.. You invested !1,250 in an account that pays 5 percent simple interest. 0o% much more could you have earned over a +0-year period if the interest had compounded annually& '. !4-6.++ (. !6.0.11 C. !64+.16 ). !1,0+1.15 E. !1,033.6/imple interest G !1,250 < ;!1,250 .05 +0= G !.,.00 'nnual compoundin G !1,250 ;1.05=+0 G !-,.33.6)ifference G !-,.33.6- - !.,.00 G !1,033.6-

AACSB: Analytic Bloom's: A''lication Difficulty: )ntermediate Learning Ob ecti!e: "#$ Section: "%$ &o'ic: Sim'le !ersus com'ound interest

5-.1

Chapter 05 - Introduction to Valuation: The Time Value of Money

+-. Travis invested !6,+50 in an account that pays 2 percent simple interest. 0o% much more could he have earned over a 3-year period if the interest had compounded annually& '. !3-1.-1 B. !33..54 C. !40+.12 ). !4..... *. !454.06 /imple interest G !6,+50 < ;!6,+50 .02 3= G !1.,1.5 Compound interest G !6,+50 ;1 < .02=3 G !1.,604.54 )ifference G !1.,604.54 - !1.,1.5 G !33..54

AACSB: Analytic Bloom's: A''lication Difficulty: )ntermediate Learning Ob ecti!e: "#$ Section: "%$ &o'ic: Sim'le !ersus com'ound interest

+5. $hat is the future value of !3,146 invested for +. years at 6.+5 percent compounded annually& '. !++,-4..20 (. !+3,460.43 C. !.4,661.03 ). !51,006.1. E. !5-,666.44 Auture value G !3,146 ;1 < .06+5=+. G !5-,666.44

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$ Section: "%$ &o'ic: (uture !alue

5-.+

Chapter 05 - Introduction to Valuation: The Time Value of Money

+2. Today, you earn a salary of !.2,000. $hat %ill "e your annual salary t%elve years from no% if you earn annual raises of ..2 percent& A. !55,0.+.5(. !53,-1-.02 C. !54,+.5.+). !56,1++.04 *. !56,.20.-5 Auture value G !.2,000 ;1 < .0.2=1+ G !55,0.+.5-

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$ Section: "%$ &o'ic: (uture !alue

+3. You o%n a classic automo"ile that is currently valued at !1-3,600. If the value increases "y 2.5 percent annually, ho% much %ill the automo"ile "e %orth ten years from no%& '. !+--,0.5.00 (. !+51,004.13 C. !+30,01...4 . !+33,2+4.2. *. !+61,-40.14 Auture value G !1-3,600 ;1 < .025=10 G !+33,2+4.2.

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$ Section: "%$ &o'ic: (uture !alue

5-..

Chapter 05 - Introduction to Valuation: The Time Value of Money

+4. You hope to "uy your dream car four years from no%. Today, that car costs !4+,500. You e1pect the price to increase "y an avera e of -.4 percent per year over the ne1t four years. 0o% much %ill your dream car cost "y the time you are ready to "uy it& '. !64,.-0.00 (. !64,222.23 C. !66,513.-1 ). !66,414.0+ *. !100,0+..12 Auture value G !4+,500 ;1 < .0-4=- G !66,513.-1

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$ Section: "%$ &o'ic: (uture !alue

5-.-

Chapter 05 - Introduction to Valuation: The Time Value of Money

+6. This mornin , T> Truc#in invested !40,000 to help fund a company e1pansion pro5ect planned for - years from no%. 0o% much additional money %ill the firm have - years from no% if it can earn 5 percent rather than - percent on its savin s& '. !+,6-0.06 B. !.,251.4+ C. !-,004.13 ). !-,+16.24 *. !-,311.04 Auture value G !40,000 ;1 < .05=- G !63,+-0.50 Auture value G !40,000 ;1 < .0-=- G !6.,544.24 )ifference G !63,+-0.50 - !6.,544.24 G !.,251.4+

AACSB: Analytic Bloom's: Analysis Difficulty: )ntermediate Learning Ob ecti!e: "#$ Section: "%$ &o'ic: (uture !alue

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Chapter 05 - Introduction to Valuation: The Time Value of Money

.0. You 5ust received !++5,000 from an insurance settlement. You have decided to set this money aside and invest it for your retirement. Currently, your oal is to retire +5 years from today. 0o% much more %ill you have in your account on the day you retire if you can earn an avera e return of 10.5 percent rather than 5ust 4 percent& '. !-13,1.3 (. !246,506 C. !1,050,-+. . !1,146,532 *. !1,414,.-+ Auture value G !++5,000 ;1 < .105=+5 G !+,3.0,-4. Auture value G !++5,000 ;1 < .04=+5 G !1,5-0,603 )ifference G !+,3.0,-4. - !1,5-0,603 G !1,146,532

AACSB: Analytic Bloom's: Analysis Difficulty: )ntermediate Learning Ob ecti!e: "#$ Section: "%$ &o'ic: (uture !alue

5-.2

Chapter 05 - Introduction to Valuation: The Time Value of Money

.1. You 5ust received a !5,000 ift from your randmother. You have decided to save this money so that you can ift it to your randchildren 50 years from no%. 0o% much additional money %ill you have to ift to your randchildren if you can earn an avera e of 4.5 percent instead of 5ust 4 percent on your savin s& '. !-3,.14.06 (. !5+,-2-.36 C. !55,+11.12 ). !54,411.66 E. !20,6+..5+ Auture value G !5,000 ;1 < .045=50 G !+65,-.1.54 Auture value G !5,000 ;1 < .04=50 G !+.-,504.02 )ifference G !+65,-.1.54 - !+.-,504.02 G !20,6+..5+

AACSB: Analytic Bloom's: Analysis Difficulty: )ntermediate Learning Ob ecti!e: "#$ Section: "%$ &o'ic: (uture !alue

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Chapter 05 - Introduction to Valuation: The Time Value of Money

.+. You are depositin !1,500 in a retirement account today and e1pect to earn an avera e return of 3.5 percent on this money. 0o% much additional income %ill you earn if you leave the money invested for -5 years instead of 5ust -0 years& '. !10,3+..04 B. !11,360.60 C. !1+,--1.52 ). !1+,604.16 *. !1.,560.6. Auture value G !1,500 ;1 < .035=-5 G !.4,453.+2 Auture value G !1,500 ;1 < .035=-0 G !+3,022..2 )ifference G !.4,453.+2 - !+3,022..2 G !11,360.60

AACSB: Analytic Bloom's: Analysis Difficulty: )ntermediate Learning Ob ecti!e: "#$ Section: "%$ &o'ic: (uture !alue

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Chapter 05 - Introduction to Valuation: The Time Value of Money

... You collect old coins. Today, you have t%o coins each of %hich is valued at !+50. @ne coin is e1pected to increase in value "y 2 percent annually %hile the other coin is e1pected to increase in value "y -.5 percent annually. $hat %ill "e the difference in the value of the t%o coins 15 years from no%& A. !115..+ (. !+04.0C. !+-1.36 ). !+5-.+*. !+40.15 Auture value G !+50 ;1 < .02=15 G !566.1Auture value G !+50 ;1 < .0-5=15 G !-4..4+ )ifference G !566.1- - !-4..4+ G !115..+

AACSB: Analytic Bloom's: Analysis Difficulty: )ntermediate Learning Ob ecti!e: "#$ Section: "%$ &o'ic: (uture !alue

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Chapter 05 - Introduction to Valuation: The Time Value of Money

.-. Your father invested a lump sum +2 years a o at -.+5 percent interest. Today, he ave you the proceeds of that investment %hich totaled !51,-40.36. 0o% much did your father ori inally invest& '. !15,6+6.-3 (. !12,500.00 C. !13,---.42 ). !13,500.00 *. !13,666.-5 Bresent value G !51,-40.36 H1I;1 < .0-+5=+2J G !13,---.42

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#* Section: "%* &o'ic: +resent !alue

.5. $hat is the present value of !150,000 to "e received 4 years from today if the discount rate is 11 percent& A. !25,044.63 (. !31,1-3.03 C. !3-,1-1.-1 ). !36,402.14 *. !4.,+61.02 Bresent value G !150,000 H1I1 < .11=4J G !25,044.63

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#* Section: "%* &o'ic: +resent !alue

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Chapter 05 - Introduction to Valuation: The Time Value of Money

.2. You %ould li#e to ive your dau hter !35,000 to%ards her colle e education 13 years from no%. 0o% much money must you set aside today for this purpose if you can earn 4 percent on your investments& '. !14,.44.16 B. !+0,+30.13 C. !+4,-13.23 ). !+6,.11.1. *. !.+,-44..3 Bresent value G !35,000 H1I;1 < .04=13J G !+0,+30.13

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#* Section: "%* &o'ic: +resent !alue

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Chapter 05 - Introduction to Valuation: The Time Value of Money

.3. You %ant to have !.5,000 saved 2 years from no% to "uy a house. 0o% much less do you have to deposit today to reach this oal if you can earn 5.5 percent rather than 5 percent on your savin s& Today:s deposit is the only deposit you %ill ma#e to this savin s account. A. !3...6(. !361.14 C. !4+-.20 ). !4-5.11 *. !616.0+ Bresent value G !.5,000 H1I;1 < .05=2J G !+2,113.5Bresent value G !.5,000 H1I;1 < .055=2J G !+5,.4..20 )ifference G !+2,113.5- - !+5,.4..20 G !3...6-

AACSB: Analytic Bloom's: A''lication Difficulty: )ntermediate Learning Ob ecti!e: "#* Section: "%* &o'ic: +resent !alue

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Chapter 05 - Introduction to Valuation: The Time Value of Money

.4. Your older sister deposited !5,000 today at 4.5 percent interest for 5 years. You %ould li#e to have 5ust as much money at the end of the ne1t 5 years as your sister %ill have. 0o%ever, you can only earn 3 percent interest. 0o% much more money must you deposit today than your sister did if you are to have the same amount at the end of the 5 years& '. !.+1.16 B. !.20.-. C. !.43.34 ). !-01.+1 *. !-1...6 Auture value G !5,000 ;1 < .045=5 G !3,514.+4 Bresent value G !3,514.+4 H1I;1 < .03=5J G !5,.20.-. )ifference G !5,.20.-. - !5,000 G !.20.-.

AACSB: Analytic Bloom's: Analysis Difficulty: )ntermediate Learning Ob ecti!e: "#$ and "#* Section: "%$ and "%* &o'ic: +resent and future !alues

5--.

Chapter 05 - Introduction to Valuation: The Time Value of Money

.6. ' year a o, you deposited !.0,000 into a retirement savin s account at a fi1ed rate of 5.5 percent. Today, you could earn a fi1ed rate of 2.5 percent on a similar type account. 0o%ever, your rate is fi1ed and cannot "e ad5usted. 0o% much less could you have deposited last year if you could have earned a fi1ed rate of 2.5 percent and still have the same amount as you currently %ill %hen you retire .4 years from today& '. !+,114.-+ less (. !.,...... less C. !5,-13.06 less ). !3,+3-.1+ less E. !6,+.-.63 less Auture value G !.0,000 ;1 < .055=.4<1 G !+-+,04-.21 Bresent value G !+-+,04-.21 H1I;1 < .025=.4<1J G !+0,325.0. )ifference G !.0,000 - !+0,325.0. G !6,+.-.63

AACSB: Analytic Bloom's: Analysis Difficulty: )ntermediate Learning Ob ecti!e: "#$ and "#* Section: "%$ and "%* &o'ic: +resent and future !alues

5---

Chapter 05 - Introduction to Valuation: The Time Value of Money

-0. $hen you retire -0 years from no%, you %ant to have !1.+ million. You thin# you can earn an avera e of 1+ percent on your investments. To meet your oal, you are tryin to decide %hether to deposit a lump sum today, or to %ait and deposit a lump sum + years from today. 0o% much more %ill you have to deposit as a lump sum if you %ait for + years "efore ma#in the deposit& '. !1,-1-.1(. !+,.16.-3 C. !+,461.11 . !.,+40.34 *. !.,-02.34 Bresent value G !1,+00,000 H1I;1 < .1+=-0J G !1+,462.12 Bresent value G !1,+00,000 H1I;1 < .1+=.4J G !12,132.6)ifference G !12,132.6- - !1+,462.12 G !.,+40.34

AACSB: Analytic Bloom's: Analysis Difficulty: )ntermediate Learning Ob ecti!e: "#* Section: "%* &o'ic: +resent !alue

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Chapter 05 - Introduction to Valuation: The Time Value of Money

-1. Theo needs !-0,000 as a do%n payment for a house 2 years from no%. 0e earns ..5 percent on his savin s. Theo can either deposit one lump sum today for this purpose or he can %ait a year and deposit a lump sum. 0o% much additional money must he deposit if he %aits for one year rather than ma#in the deposit today& '. !434.64 (. !611.1. C. !1,1.4.60 ). !1,.-4.0. *. !1,-+0.14 Bresent value G !-0,000 H1I;1 < .0.5=2J G !.+,5-0.0. Bresent value G !+2,000 H1I;1 < .0.5=5J G !..,234.6. )ifference G !..,234.6. - !.+,5-0.0. G !1,1.4.60

AACSB: Analytic Bloom's: Analysis Difficulty: )ntermediate Learning Ob ecti!e: "#* Section: "%* &o'ic: +resent !alue

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Chapter 05 - Introduction to Valuation: The Time Value of Money

-+. @ne year a o, you invested !1,400. Today it is %orth !1,6+-.2+. $hat rate of interest did you earn& '. 2.56 percent (. 2.23 percent C. 2.44 percent . 2.6+ percent *. 3.01 percent !1,6+-.2+ G !1,400 ;1 < r=1K r G 2.6+ percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#Section: "%&o'ic: )nterest rate

-.. 'ccordin to the ?ule of 3+, you can do %hich one of the follo%in & '. dou"le your money in five years at 3.+ percent interest (. dou"le your money in 3.+ years at 4 percent interest C. dou"le your money in 4 years at 6 percent interest ). triple your money in 3.+ years at 5 percent interest *. triple your money at 10 percent interest in 3.+ years ?ule of 3+ G 3+I4 years G 6 percent interest

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#Section: "%&o'ic: )nterest rate

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Chapter 05 - Introduction to Valuation: The Time Value of Money

--. Aorty years a o, your mother invested !5,000. Today, that investment is %orth !-.0,025.11. $hat is the avera e annual rate of return she earned on this investment& '. 11.24 percent (. 11.31 percent C. 11.34 percent ). 11.61 percent *. 1+.0+ percent !-.0,025.11 G !5,000 ;1 < r=-0K r G 11.34 percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#Section: "%&o'ic: )nterest rate

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Chapter 05 - Introduction to Valuation: The Time Value of Money

-5. /i1teen years a o, 'licia invested !1,000. *i ht years a o, Travis invested !+,000. Today, "oth 'licia:s and Travis: investments are each %orth !+,-00. 'ssume that "oth 'licia and Travis continue to earn their respective rates of return. $hich one of the follo%in statements is correct concernin these investments& '. Three years from today, Travis: investment %ill "e %orth more than 'licia:s. B. @ne year a o, 'licia:s investment %as %orth less than Travis: investment. C. Travis earns a hi her rate of return than 'licia. ). Travis has earned an avera e annual interest rate of ...3 percent. *. 'licia has earned an avera e annual interest rate of 2.01 percent. 'licia: !+,-00 G !1,000 ;1 < r=12K r G 5.2+ percent Travis: !+,-00 G !+,000 ;1 < r=4K r G +..1 percent

/ince "oth 'licia and Travis have e9ual account values today and since 'licia earns the hi her rate of return, her account had to "e %orth less than Travis: account one year a o.

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Chapter 05 - Introduction to Valuation: The Time Value of Money

-2. Benn /tation is savin money to "uild a ne% loadin platform. T%o years a o, they set aside !+-,000 for this purpose. Today, that account is %orth !+4,.66. $hat rate of interest is Benn /tation earnin on this investment& '. 2..6 percent (. 3.-3 percent C. 4.34 percent ). 6.+. percent *. 6.23 percent !+4,.66 G !+-,000 ;1 < r=+K r G 4.34 percent

AACSB: Analytic Bloom's: Analysis Difficulty: Basic Learning Ob ecti!e: "#Section: "%&o'ic: )nterest rate

-3. Aifteen years a o, Cac#son /upply set aside !1.0,000 in case of a financial emer ency. Today, that account has increased in value to !..0,56+. $hat rate of interest is the firm earnin on this money& '. 5.40 percent B. 2.-+ percent C. 2.35 percent ). 3.+4 percent *. 3.5. percent !..0,56+ G !1.0,000 ;1 < r=15K r G 2.-+ percent

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Chapter 05 - Introduction to Valuation: The Time Value of Money

-4. Aourteen years a o, your parents set aside !3,500 to help fund your colle e education. Today, that fund is valued at !+2,140. $hat rate of interest is "ein earned on this account& '. 3.66 percent (. 4..2 percent C. 4.51 percent . 6..- percent *. 10.02 percent !+2,140 G !3,500 ;1 < r=1-K r G 6..- percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#Section: "%&o'ic: )nterest rate

-6. /ome time a o, Culie purchased eleven acres of land costin !.2,600. Today, that land is valued at !+1-,400. 0o% lon has she o%ned this land if the price of the land has "een increasin at 10.5 percent per year& '. 1.... years (. 12.64 years C. 13.2- years ). 16.+6 years *. +1.04 years !+1-,400 G !.2,600 ;1 < .105=tK t G 13.2- years

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Chapter 05 - Introduction to Valuation: The Time Value of Money

50. @n your ninth "irthday, you received !.00 %hich you invested at -.5 percent interest, compounded annually. Your investment is no% %orth !352. 0o% old are you today& '. a e +6 B. a e .0 C. a e .1 ). a e .+ *. a e .. !352 G !.00 ;1 < .0-5=tK t G +1 yearsK ' e today G 6 < +1 G .0

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#. Section: "%&o'ic: &ime 'eriod

Essay Questions

51. You %ant to deposit sufficient money today into a savin s account so that you %ill have !1,000 in the account three years from today. *1plain %hy you could deposit less money today if you could earn ..5 percent interest rather than . percent interest. /tudent ans%ers %ill vary "ut should present the idea that %hen you can earn more interest, you need less of your o%n money to reach the same future dollar amount. They can also "ase their ans%er on the present value formula. Aeed"ac#: ?efer to section 5.+

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Chapter 05 - Introduction to Valuation: The Time Value of Money

5+. You are considerin t%o separate investments. (oth investments pay 3 percent interest. Investment ' pays simple interest and Investment ( pays compound interest. $hich investment should you choose, and %hy, if you plan on investin for a period of 5 years& /imple interest is interest earned on the initial principal amount only. Compound interest is interest earned on "oth the initial principal and all prior interest earnin s that have "een reinvested. You should choose Investment ( %hich pays compound interest as you %ill earn more interest income over the 5 years "y doin so. Aeed"ac#: ?efer to section 5.1

AACSB: /eflecti!e t,in0ing Bloom's: Analysis Difficulty: Basic Learning Ob ecti!e: "#$ Section: "%$ &o'ic: Sim'le and com'ound interest

5.. $hat lesson does the future value formula provide for youn %or#ers %ho are loo#in ahead to retirin some day& The future value formula is: AV G BV ;1 < r=t. Time is the e1ponent. $hile the rate of return is important and has a direct affect on the ro%th of an investment account, time is critical. To ma1imiEe retirement income, %or#ers need to commence savin %hen they are youn so that reinvested earnin s have time to compound. Aeed"ac#: ?efer to section 5.1

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Chapter 05 - Introduction to Valuation: The Time Value of Money

5-. You are considerin t%o lottery payment options: @ption ' pays !10,000 today and @ption ( pays !+0,000 at the end of ten years. 'ssume you can earn 2 percent on your savin s. $hich option %ill you choose if you "ase your decision on present values& $hich option %ill you choose if you "ase your decision on future values& *1plain %hy your ans%ers are either the same or different. BV of ' G !10,000K BV of ( G !11,123.60K AV of ' G !13,604.-4K AV of ( G !+0,000. (ased on "oth present values and future values, ( is the "etter choice. /tudents should e1plain that computin present values and computin future values are simply inverse processes of one another, and that choosin "et%een t%o lump sums "ased on present values %ill al%ays ive the same result as choosin "et%een the same t%o lump sums "ased on future values. Aeed"ac#: ?efer to sections 5.1 and 5.+

AACSB: /eflecti!e t,in0ing Bloom's: 1!aluation Difficulty: )ntermediate Learning Ob ecti!e: "#$ and "#* Section: "%$ and "%* &o'ic: +resent and future !alues

55. 't an interest rate of 10 percent and usin the ?ule of 3+, ho% lon %ill it ta#e to dou"le the value of a lump sum invested today& 0o% lon %ill it ta#e after that until the account ro%s to four times the initial investment& 7iven the po%er of compoundin , shouldn:t it ta#e less time for the money to dou"le the second time& It %ill ta#e 3.+ years to dou"le the initial investment, then another 3.+ years to dou"le it a ain. That is, it ta#es 1-.- years for the value to reach four times the initial investment. Compoundin doesn:t affect the amount of time it ta#es for an investment to dou"le in value. 0o%ever, you should note that durin the first 3.+ years, the interest earned is e9ual to 100 percent of the initial investment. )urin the second 3.+ years, the interest earned is e9ual to +00 percent of the initial investment. That is the po%er of compoundin . Aeed"ac#: ?efer to section 5..

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Chapter 05 - Introduction to Valuation: The Time Value of Money

Multiple Choice Questions

52. 'ssume the total cost of a colle e education %ill "e !.00,000 %hen your child enters colle e in 12 years. You presently have !35,521 to invest. $hat rate of interest must you earn on your investment to cover the cost of your child:s colle e education& '. 3.35 percent (. 4.50 percent C. 6.00 percent ). 6.+5 percent *. 6.50 percent !.00,000 G !35,521 ;1 < r=12K r G 6 percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic 1OC 3: "#4 Learning Ob ecti!e: "#Section: "%&o'ic: )nterest rate

53. 't 11 percent interest, ho% lon %ould it ta#e to 9uadruple your money& '. 2.55 years (. 2.2- years C. 1..06 years . 1..+4 years *. 1..52 years !- G !1 ;1 < .11=tK t G 1..+4 years

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Chapter 05 - Introduction to Valuation: The Time Value of Money

54. 'ssume the avera e vehicle sellin price in the Dnited /tates last year %as !-1,662. The avera e price 6 years earlier %as !+6,000. $hat %as the annual increase in the sellin price over this time period& '. ..46 percent B. -.+0 percent C. -.52 percent ). 5.01 percent *. 5.-0 percent !-1,662 G !+6,000 ;1 < r=6K r G -.+0 percent

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Chapter 05 - Introduction to Valuation: The Time Value of Money

56. You:re tryin to save to "uy a ne% !120,000 Aerrari. You have !52,000 today that can "e invested at your "an#. The "an# pays 2 percent annual interest on its accounts. 0o% many years %ill it "e "efore you have enou h to "uy the car& 'ssume the price of the car remains constant. '. 12.23 years (. 13.0- years C. 13.-1 years ). 13.43 years E. 14.0+ years !120,000 G !52,000 ;1 < .02=tK t G 14.0+ years

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Chapter 05 - Introduction to Valuation: The Time Value of Money

20. Imprudential, Inc. has an unfunded pension lia"ility of !450 million that must "e paid in +5 years. To assess the value of the firm:s stoc#, financial analysts %ant to discount this lia"ility "ac# to the present. The relevant discount rate is 2.5 percent. $hat is the present value of this lia"ility& '. !156,40.,12+ (. !131,-.4,603 C. !132,023,.11 ). !14-,516,-4*. !161,511,.23 BV G !450,000,000 H1I;1.025=+5J G !132,023,.11

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Chapter 05 - Introduction to Valuation: The Time Value of Money

21. You have 5ust received notification that you have %on the !1.- million first priEe in the Centennial >ottery. 0o%ever, the priEe %ill "e a%arded on your 100th "irthday, 30 years from no%. The appropriate discount rate is 4 percent. $hat is the present value of your %innin s& '. !-,+44.12 B. !2,-0-.+0 C. !15,.06.61 ). !+.,...... *. !+5,000.00 BV G !1,-00,000 H1I;1.04=30J G !2,-0-.+0

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Chapter 05 - Introduction to Valuation: The Time Value of Money

2+. Your coin collection contains fifty-four 16-1 silver dollars. Your randparents purchased them for their face value %hen they %ere ne%. These coins have appreciated at a 10 percent annual rate. 0o% much %ill your collection "e %orth %hen you retire in +020& '. !.,211,004 (. !.,643,-52 C. !-,1++,.6). !-,-+1,004 E. !-,551,13+ AV G !5- ;1.10=116 G !-,551,13+

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Chapter 05 - Introduction to Valuation: The Time Value of Money

2.. In 1465, the %inner of a competition %as paid !110. In +002, the %inner:s priEe %as !30,000. $hat %ill the %inner:s priEe "e in +0-0 if the priEe continues increasin at the same rate& '. !.46,-00 (. !-+1,1++ C. !-36,.11 . !505,263 *. !5-4,1+1 !30,000 G !110 ;1 G r=111K r G 5.644-22 percent AV G !30,000 ;1 < .05644-22=.- G !505,263

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Chapter 05 - Introduction to Valuation: The Time Value of Money

2-. /uppose that the first comic "oo# of a classic series %as sold in 165-. In +000, the estimated price for this comic "oo# in ood condition %as a"out !.-0,000. This represented a return of +3 percent per year. Aor this to "e true, %hat %as the ori inal price of the comic "oo# in 165-& '. !5.00 (. !5.+4 C. !5.50 . !5.31 *. !2.00 BV G !.-0,000 H1I;1 < .+3=-2K BV G !5.31

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Chapter 05 - Introduction to Valuation: The Time Value of Money

25. /uppose you are committed to o%nin a !1-0,000 Aerrari. You "elieve your mutual fund can achieve an annual rate of return of 6 percent and you %ant to "uy the car in 3 years. 0o% much must you invest today to fund this purchase assumin the price of the car remains constant& '. !3-,+04.12 B. !32,54-.36 C. !33,611.04 ). !34,016.4+ *. !36,--2.20 BV G !1-0,000 H1I;1 < .06=3K BV G !32,54-.36

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5-2.

Chapter 05 - Introduction to Valuation: The Time Value of Money

22. You have 5ust made a !1,500 contri"ution to your individual retirement account. 'ssume you earn a 1+ percent rate of return and ma#e no additional contri"utions. 0o% much more %ill your account "e %orth %hen you retire in +5 years than it %ould "e if you %aited another 10 years "efore ma#in this contri"ution& '. !4,.02.12 (. !6,254.33 C. !12,.11.14 ). !12,603.13 E. !13,+46.35 AV G !1,500 ;1 < .1+=+5 G !+5,500.10 AV G !1,500 ;1 < .1+=15 G !4,+10..5 )ifference G !13,+46.35

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Chapter 05 - Introduction to Valuation: The Time Value of Money

23. You are scheduled to receive !.0,000 in t%o years. $hen you receive it, you %ill invest it for 5 more years, at 4 percent per year. 0o% much money %ill you have 3 years from no%& '. !.6,606.16 (. !-1,.41.12 C. !--,036.4). !-3,+06.16 *. !51,-1-.3. AV G !.0,000 ;1 < .04=;3-+= G !--,036.4-

AACSB: Analytic Bloom's: A''lication Difficulty: )ntermediate 1OC 3: "#$6 Learning Ob ecti!e: "#$ Section: "%$ &o'ic: (uture !alue

24. You e1pect to receive !6,000 at raduation in + years. You plan on investin this money at 10 percent until you have !20,000. 0o% many years %ill it "e until this occurs& '. 14.34 years (. 16.62 years C. +1.60 years ). +..04 years *. +5.00 years !20,000 G !6,000 ;1 < .10=tK t G 16.60 years Total time G + < 16.60 G +1.60 years

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