Chap 006

Chapter 06 - Discounted Cash Flow Valuation
Chapter 06
Discounted Cash Flow Valuation

Multiple Choice Questions

1. An ordinary annuity is best defined by which one of the following?
A. increasing payents paid for a definiti!e period of tie
". increasing payents paid fore!er
C. e#ual payents paid at regular inter!als o!er a stated tie period
D. e#ual payents paid at regular inter!als of tie on an ongoing basis
$. une#ual payents that occur at set inter!als for a liited period of tie

%. &hich one of the following accurately defines a perpetuity?
A. a liited nuber of e#ual payents paid in e!en tie increents
". payents of e#ual aounts that are paid irregularly but indefinitely
C. !arying aounts that are paid at e!en inter!als fore!er
D. unending e#ual payents paid at e#ual tie inter!als
$. unending e#ual payents paid at either e#ual or une#ual tie inter!als

'. &hich one of the following ters is used to identify a "ritish perpetuity?
A. ordinary annuity
". aorti(ed cash flow
C. annuity due
D. discounted loan
$. consol

). *he interest rate that is #uoted by a lender is referred to as which one of the following?
A. stated interest rate
". copound rate
C. effecti!e annual rate
D. siple rate
$. coon rate

6-1
+. A onthly interest rate e,pressed as an annual rate would be an e,aple of which one of
the following rates?
A. stated rate
". discounted annual rate
D. periodic onthly rate
$. consolidated onthly rate

6. &hat is the interest rate charged per period ultiplied by the nuber of periods per year
called?
A. effecti!e annual rate
". annual percentage rate
C. periodic interest rate
D. copound interest rate
$. daily interest rate

-. A loan where the borrower recei!es oney today and repays a single lup su on a future
date is called a.n/ 00000 loan.
A. aorti(ed
". continuous
C. balloon
D. pure discount
$. interest-only

1. &hich one of the following ters is used to describe a loan that calls for periodic interest
payents and a lup su principal payent?
A. aorti(ed loan
". odified loan
C. balloon loan
D. pure discount loan
$. interest-only loan

6-%
2. &hich one of the following ters is used to describe a loan wherein each payent is e#ual
in aount and includes both interest and principal?
A. aorti(ed loan
". odified loan
C. balloon loan

10. &hich one of the following ters is defined as a loan wherein the regular payents3
including both interest and principal aounts3 are insufficient to retire the entire loan aount3
which then ust be repaid in one lup su?
A. aorti(ed loan
". continuing loan
C. balloon loan
D. reainder loan

11. 4ou are coparing two annuities which offer #uarterly payents of 5%3+00 for fi!e years
and pay 0.-+ percent interest per onth. Annuity A will pay you on the first of each onth
while annuity " will pay you on the last day of each onth. &hich one of the following
stateents is correct concerning these two annuities?
A. *hese two annuities ha!e e#ual present !alues but une#ual futures !alues at the end of year
fi!e.
". *hese two annuities ha!e e#ual present !alues as of today and e#ual future !alues at the
end of year fi!e.
C. Annuity " is an annuity due.
D. Annuity A has a saller future !alue than annuity ".
$. Annuity " has a saller present !alue than annuity A.

6-'
1%. 4ou are coparing two in!estent options that each pay + percent interest3 copounded
annually. "oth options will pro!ide you with 51%3000 of incoe. 6ption A pays three annual
payents starting with 5%3000 the first year followed by two annual payents of 5+3000 each.
6ption " pays three annual payents of 5)3000 each. &hich one of the following stateents
is correct gi!en these two in!estent options?
A. "oth options are of e#ual !alue gi!en that they both pro!ide 51%3000 of incoe.
". 6ption A has the higher future !alue at the end of year three.
C. 6ption " has a higher present !alue at tie (ero than does option A.
D. 6ption " is a perpetuity.
$. 6ption A is an annuity.

1'. 4ou are considering two pro7ects with the following cash flows8

&hich of the following stateents are true concerning these two pro7ects?
9. "oth pro7ects ha!e the sae future !alue at the end of year )3 gi!en a positi!e rate of return.
99. "oth pro7ects ha!e the sae future !alue gi!en a (ero rate of return.
999. :ro7ect ; has a higher present !alue than :ro7ect 43 gi!en a positi!e discount rate.
9V. :ro7ect 4 has a higher present !alue than :ro7ect ;3 gi!en a positi!e discount rate.
A. 99 only
". 9 and 999 only
C. 99 and 999 only
D. 99 and 9V only
$. 93 993 and 9V only

6-)
1). &hich one of the following stateents is correct gi!en the following two sets of pro7ect
cash flows?

A. *he cash flows for :ro7ect " are an annuity3 but those of :ro7ect A are not.
". "oth sets of cash flows ha!e e#ual present !alues as of tie (ero gi!en a positi!e discount
rate.
C. *he present !alue at tie (ero of the final cash flow for :ro7ect A will be discounted using
an e,ponent of three.
D. *he present !alue of :ro7ect A cannot be coputed because the second cash flow is e#ual
to (ero.
$. As long as the discount rate is positi!e3 :ro7ect " will always be worth less today than will
:ro7ect A.

1+. &hich one of the following stateents related to annuities and perpetuities is correct?
A. An ordinary annuity is worth ore than an annuity due gi!en e#ual annual cash flows for
ten years at - percent interest3 copounded annually.
". A perpetuity coprised of 5100 onthly payents is worth ore than an annuity
coprised of 5100 onthly payents3 gi!en an interest rate of 1% percent3 copounded
onthly.
C. <ost loans are a for of a perpetuity.
D. *he present !alue of a perpetuity cannot be coputed3 but the future !alue can.
$. :erpetuities are finite but annuities are not.

6-+
16. &hich of the following stateents related to interest rates are correct?
9. Annual interest rates consider the effect of interest earned on rein!ested interest payents.
99. &hen coparing loans3 you should copare the effecti!e annual rates.
999. =enders are re#uired by law to disclose the effecti!e annual rate of a loan to prospecti!e
borrowers.
9V. Annual and effecti!e interest rates are e#ual when interest is copounded annually.
A. 9 and 99 only
". 99 and 999 only
C. 99 and 9V only
D. 93 993 and 999 only
$. 993 9993 and 9V only

1-. &hich one of the following stateents concerning interest rates is correct?
A. >a!ers would prefer annual copounding o!er onthly copounding.
". *he effecti!e annual rate decreases as the nuber of copounding periods per year
increases.
C. *he effecti!e annual rate e#uals the annual percentage rate when interest is copounded
annually.
D. "orrowers would prefer onthly copounding o!er annual copounding.
$. For any positi!e rate of interest3 the effecti!e annual rate will always e,ceed the annual
percentage rate.

11. &hich one of these stateents related to growing annuities and perpetuities is correct?
A. *he cash flow used in the growing annuity forula is the initial cash flow at tie (ero.
". ?rowth rates cannot be applied to perpetuities if you wish to copute the present !alue.
C. *he future !alue of an annuity will decrease if the growth rate is increased.
D. An increase in the rate of growth will decrease the present !alue of an annuity.
$. *he present !alue of a growing perpetuity will decrease if the discount rate is increased.

12. &hich one of the following stateents correctly states a relationship?
A. *ie and future !alues are in!ersely related3 all else held constant.
". 9nterest rates and tie are positi!ely related3 all else held constant.
C. An increase in the discount rate increases the present !alue3 gi!en positi!e rates.
D. An increase in tie increases the future !alue gi!en a (ero rate of interest.
$. *ie and present !alue are in!ersely related3 all else held constant.

6-6
%0. &hich one of the following copounding periods will yield the sallest present !alue
gi!en a stated future !alue and annual percentage rate?
A. annual
". sei-annual
C. onthly
D. daily
$. continuous

%1. *he entire repayent of which one of the following loans is coputed siply by
coputing a single future !alue?
A. interest-only loan
". balloon loan
C. aorti(ed loan
$. bullet loan

%%. @ow is the principal aount of an interest-only loan repaid?
A. *he principal is forgi!en o!er the loan period so does not ha!e to be repaid.
". *he principal is repaid in e#ual increents and included in each loan payent.
C. *he principal is repaid in a lup su at the end of the loan period.
D. *he principal is repaid in e#ual annual payents.
$. *he principal is repaid in increasing increents through regular onthly payents.

%'. An aorti(ed loan8
A. re#uires the principal aount to be repaid in e!en increents o!er the life of the loan.
". ay ha!e e#ual or increasing aounts applied to the principal fro each loan payent.
C. re#uires that all interest be repaid on a onthly basis while the principal is repaid at the
end of the loan ter.
D. re#uires that all payents be e#ual in aount and include both principal and interest.
$. repays both the principal and the interest in one lup su at the end of the loan ter.

6--
%). 4ou need 5%+3000 today and ha!e decided to taAe out a loan at - percent for fi!e years.
&hich one of the following loans would be the least e,pensi!e? Assue all loans re#uire
onthly payents and that interest is copounded on a onthly basis.
". aorti(ed loan with e#ual principal payents
C. aorti(ed loan with e#ual loan payents
D. discount loan
$. balloon loan where +0 percent of the principal is repaid as a balloon payent

%+. 4our grandother is gifting you 5100 a onth for four years while you attend college to
earn your bachelorBs degree. At a +.+ percent discount rate3 what are these payents worth to
you on the day you enter college?
A. 5)3%01.16
". 5)3%22.11
C. 5)3+02.12
D. 5)3601.1-
$. 5)3100.00

%6. 4ou 7ust won the grand pri(e in a national writing contestC As your pri(e3 you will recei!e
5%3000 a onth for ten years. 9f you can earn - percent on your oney3 what is this pri(e
worth to you today?
A. 51-%3%+%.-1
". 51-13)11.06
C. 51113''1.)0
D. 511+3'''.''
$. 51203)+0.%+

%-. :hil can afford 5110 a onth for + years for a car loan. 9f the interest rate is 1.6 percent3
how uch can he afford to borrow to purchase a car?
A. 5-3-+0.00
". 513')1.0'
C. 513-+%.1)
D. 523%66.6-
$. 523)00.00

6-1
%1. 4ou are the beneficiary of a life insurance policy. *he insurance copany infors you
that you ha!e two options for recei!ing the insurance proceeds. 4ou can recei!e a lup su
of 5%003000 today or recei!e payents of 513)00 a onth for %0 years. 4ou can earn 6
percent on your oney. &hich option should you taAe and why?
A. 4ou should accept the payents because they are worth 5%023)1) to you today.
". 4ou should accept the payents because they are worth 5%)-3100 to you today.
C. 4ou should accept the payents because they are worth 5''63000 to you today.
D. 4ou should accept the 5%003000 because the payents are only worth 51123'11 to you
today.
$. 4ou should accept the 5%003000 because the payents are only worth 512+3)1' to you
today.

%2. 4our eployer contributes 5-+ a weeA to your retireent plan. Assue that you worA for
your eployer for another %0 years and that the applicable discount rate is -.+ percent. ?i!en
these assuptions3 what is this eployee benefit worth to you today?
A. 5)03'1).62
". 5)%3611.)6
C. 5))3%11.11
D. 5))3'06.16
$. 5))321-.-)

'0. *he Design *ea 7ust decided to sa!e 513+00 a onth for the ne,t + years as a safety net
for recessionary periods. *he oney will be set aside in a separate sa!ings account which
pays ).+ percent interest copounded onthly. *he first deposit will be ade today. &hat
would todayBs deposit aount ha!e to be if the fir opted for one lup su deposit today that
would yield the sae aount of sa!ings as the onthly deposits after + years?
A. 5103)+2.0-
". 5103-60.-2
C. 5113061.11
D. 5113'''.''
$. 5113+)1.%0

6-2
'1. 4ou need soe oney today and the only friend you ha!e that has any is your iserly
friend. @e agrees to loan you the oney you need3 if you aAe payents of 5%+ a onth for
the ne,t si, onths. 9n Aeeping with his reputation3 he re#uires that the first payent be paid
today. @e also charges you 1.+ percent interest per onth. @ow uch oney are you
borrowing?
A. 51').02
". 51'1.%%
C. 51'2.+0
D. 51)%.61
$. 51)).+-

'%. 4ou buy an annuity that will pay you 5%)3000 a year for %+ years. *he payents are paid
on the first day of each year. &hat is the !alue of this annuity today if the discount rate is 1.+
percent?
A. 5%)13'02
". 5%)+36%1
C. 5%+13)02
D. 5%+13'12
$. 5%663)21

''. 4ou are scheduled to recei!e annual payents of 5)3100 for each of the ne,t - years. *he
discount rate is 1 percent. &hat is the difference in the present !alue if you recei!e these
payents at the beginning of each year rather than at the end of each year?
A. 513222
". 5%301'
C. 5%3%%1
D. 5%3%%-
$. 5%3'0)

'). 4ou are coparing two annuities with e#ual present !alues. *he applicable discount rate
is 1.-+ percent. 6ne annuity pays 5+3000 on the first day of each year for %0 years. @ow uch
does the second annuity pay each year for %0 years if it pays at the end of each year?
A. 5+3%11
". 5+3%6-
C. 5+3'02
D. 5+3'20
$. 5+3)'1

6-10
'+. *rish recei!es 5)10 on the first of each onth. Dosh recei!es 5)10 on the last day of each
onth. "oth *rish and Dosh will recei!e payents for ne,t three years. At a 2.+ percent
discount rate3 what is the difference in the present !alue of these two sets of payents?
A. 5111.6'
". 51%1.06
C. 51%).'0
D. 51%2.01
$. 51'%.+0

'6. &hat is the future !alue of 513%00 a year for )0 years at 1 percent interest? Assue annual
copounding.
A. 5'01311+
". 5'063)2%
C. 5'103161
D. 5')%3201
$. 5')-3%6-

'-. &hat is the future !alue of 51+3000 a year for '0 years at 1% percent interest?
A. 5%31-13)06
". 5'36123220
C. 5'3-113)1)
D. 5'32123)-6
$. 5)30%13%%'

'1. Ale,a plans on sa!ing 5'3000 a year and e,pects to earn an annual rate of 10.%+ percent.
@ow uch will she ha!e in her account at the end of )+ years?
A. 5131063)%2
". 5131'13'62
C. 5%3%113)0-
D. 5%3'''3+-%
$. 5%3+013'16

6-11
'2. *heresa adds 513000 to her sa!ings account on the first day of each year. <arcus adds
513000 to his sa!ings account on the last day of each year. *hey both earn 6.+ percent annual
interest. &hat is the difference in their sa!ings account balances at the end of '+ years?
A. 51306%
". 51311'
C. 5131%-
D. 513%11
$. 513%12

)0. 4ou are borrowing 51-3100 to buy a car. *he ters of the loan call for onthly payents
for + years at 1.6 percent interest. &hat is the aount of each payent?
A. 5%1-.-1
". 5%21.)0
C. 5'01.1%
D. 5')%.-6
$. 5'66.0+

)1. 4ou borrow 516+3000 to buy a house. *he ortgage rate is -.+ percent and the loan period
is '0 years. :ayents are ade onthly. 9f you pay the ortgage according to the loan
agreeent3 how uch total interest will you pay?
A. 5%063)01
". 5%%230-2
C. 5%+03''%
D. 5%6)3'12
$. 5%213)06

)%. @oliday *ours .@*/ has an eployent contract with its newly hired C$6. *he contract
re#uires a lup su payent of 510.) illion be paid to the C$6 upon the successful
copletion of her first three years of ser!ice. @* wants to set aside an e#ual aount of oney
at the end of each year to co!er this anticipated cash outflow and will earn +.6+ percent on the
funds. @ow uch ust @* set aside each year for this purpose?
A. 5'311)3)6-
". 5'3%--32-'
C. 5'30063)02
D. 5'3'113120
$. 5'3)66366-

6-1%
)'. Eadine is retiring at age 6% and e,pects to li!e to age 1+. 6n the day she retires3 she has
5')13%12 in her retireent sa!ings account. >he is soewhat conser!ati!e with her oney
and e,pects to earn 6 percent during her retireent years. @ow uch can she withdraw fro
her retireent sa!ings each onth if she plans to spend her last penny on the orning of her
death?
A. 513602.2%
". 5131)-.-1
C. 513212.)6
D. 5%3116.01
$. 5%3'%2.0+

)). Fingston De!elopent Corp. purchased a piece of property for 5%.-2 illion. *he fir
paid a down payent of 1+ percent in cash and financed the balance. *he loan ters re#uire
onthly payents for 1+ years at an annual percentage rate of -.-+ percent3 copounded
onthly. &hat is the aount of each ortgage payent?
A. 5%%3'%%.'+
". 5%'3)12.2-
C. 5%'360-.11
D. 5%)31-1.1+
$. 5%+3'01.16

)+. 4ou estiate that you will owe 5)%3100 in student loans by the tie you graduate. *he
interest rate is ).%+ percent. 9f you want to ha!e this debt paid in full within si, years3 how
uch ust you pay each onth?
A. 5611.02
". 56-).+0
C. 5-1).%1
D. 5-'6.0+
$. 5-)%.+0

6-1'
)6. 4ou are buying a pre!iously owned car today at a price of 5'3+00. 4ou are paying 5'00
down in cash and financing the balance for '6 onths at 1.+ percent. &hat is the aount of
each loan payent?
A. 5101.0%
". 511%.%'
C. 5111.)-
D. 51%1.60
$. 51%).)0

)-. Atlas 9nsurance wants to sell you an annuity which will pay you 5'3)00 per #uarter for %+
years. 4ou want to earn a iniu rate of return of 6.+ percent. &hat is the ost you are
willing to pay as a lup su today to buy this annuity?
A. 51+13001.%)
". 51+)3%01.16
C. 516-3)12.11
D. 51-'3001.10
$. 51-132%-.+2

)1. 4our car dealer is willing to lease you a new car for 5%)+ a onth for )1 onths.
:ayents are due on the first day of each onth starting with the day you sign the lease
contract. 9f your cost of oney is 6.+ percent3 what is the current !alue of the lease?
A. 5103''1.0'
". 5103'16.22
C. 51%312-.-)
D. 51%3%0'.1)
$. 51'3001.'1

)2. 4our great aunt left you an inheritance in the for of a trust. *he trust agreeent states
that you are to recei!e 5'3600 on the first day of each year3 starting iediately and
continuing for %0 years. &hat is the !alue of this inheritance today if the applicable discount
rate is 6.-+ percent?
A. 5'13120.11
". 5)03'11.16
C. 5)13+16.01
D. 5)%3202.%2
$. 5)'3'''.''

6-1)
+0. 4ou 7ust recei!ed an insurance settleent offer related to an accident you had si, years
ago. *he offer gi!es you a choice of one of the following three offers8

4ou can earn -.+ percent on your in!estents. 4ou do not care if you personally recei!e the
funds or if they are paid to your heirs should you die within the settleent period. &hich one
of the following stateents is correct gi!en this inforation?
A. 6ption A is the best choice as it pro!ides the largest onthly payent.
". 6ption " is the best choice because it pays the largest total aount.
C. 6ption C is the best choice because it is has the largest current !alue.
D. 6ption " is the best choice because you will recei!e the ost payents.
$. 4ou are indifferent to the three options as they are all e#ual in !alue.

+1. >auelson $ngines wants to sa!e 5-+03000 to buy soe new e#uipent si, years fro
now. *he plan is to set aside an e#ual aount of oney on the first day of each #uarter
starting today. *he fir can earn ).-+ percent on its sa!ings. @ow uch does the fir ha!e to
sa!e each #uarter to achie!e its goal?
A. 5%631-%.2)
". 5%63262.-0
C. 5%-312%.0+
D. 5%-3)12.%2
$. 5%-3211.01

+%. >tephanie is going to contribute 5'00 on the first of each onth3 starting today3 to her
retireent account. @er eployer will pro!ide a +0 percent atch. 9n other words3 her
eployer will contribute +0 percent of the aount >tephanie sa!es. 9f both >tephanie and her
eployer continue to do this and she can earn a onthly rate of 0.20 percent3 how uch will
she ha!e in her retireent account '+ years fro now?
A. 5132'63%6)
". 5132)'3%16
C. 5132123'1%
D. 5%30613)11
$. 5%31%'300-

6-1+
+'. 4ou are considering an annuity which costs 51603000 today. *he annuity pays 51131%6 a
year at an annual interest rate of -.+0 percent. &hat is the length of the annuity tie period?
A. 1% years
". 1' years
C. 1) years
D. 1+ years
$. 16 years

+). *oday3 you borrowed 563%00 on your credit card to purchase soe furniture. *he interest
rate is 1).2 percent3 copounded onthly. @ow long will it taAe you to pay off this debt
assuing that you do not charge anything else and aAe regular onthly payents of 51%0?
A. +.1- years
". 6.)0 years
C. 6.2' years
D. -.%' years
$. -.'1 years

++. <eadow "rooA <anor would liAe to buy soe additional land and build a new assisted
li!ing center. *he anticipated total cost is 5%'.6 illion. *he C$6 of the fir is #uite
conser!ati!e and will only do this when the copany has sufficient funds to pay cash for the
entire construction pro7ect. <anageent has decided to sa!e 51.% illion a #uarter for this
purpose. *he fir earns 6.%+ percent3 copounded #uarterly3 on the funds it sa!es. @ow long
does the copany ha!e to wait before e,panding its operations?
A. ).02 years
". ).'% years
C. ).)6 years
D. ).1% years
$. ).21 years

6-16
+6. *oday3 you are retiring. 4ou ha!e a total of 5)113016 in your retireent sa!ings and ha!e
the funds in!ested such that you e,pect to earn an a!erage of -.10 percent3 copounded
onthly3 on this oney throughout your retireent years. 4ou want to withdraw 5%3+00 at the
beginning of e!ery onth3 starting today. @ow long will it be until you run out of oney?
A. '1.2- years
". ').+6 years
C. )%.0' year
D. )1.12 years
$. 4ou will ne!er run out of oney.

+-. ?eneBs Art ?allery is notoriously Anown as a slow-payer. *he fir currently needs to
borrow 5%-3+00 and only one copany will e!en deal with the. *he ters of the loan call
for daily payents of 5100. *he first payent is due today. *he interest rate is %1.2 percent3
copounded daily. &hat is the tie period of this loan? Assue a '6+ day year.
A. %6).'6 days
". %10.11 days
C. '00.)' days
D. '16.)6 days
$. ')1.02 days

+1. *he &ine :ress is considering a pro7ect which has an initial cash re#uireent of
511-3)00. *he pro7ect will yield cash flows of 5%31'% onthly for 1) onths. &hat is the rate
of return on this pro7ect?
A. 6.2- percent
". -.0) percent
C. -.%1 percent
D. -.)1 percent
$. -.+6 percent

+2. 4our insurance agent is trying to sell you an annuity that costs 5%003000 today. "y buying
this annuity3 your agent proises that you will recei!e payents of 513%%+ a onth for the
ne,t '0 years. &hat is the rate of return on this in!estent?
A. +.-+ percent
". +.2- percent
C. 6.%0 percent
D. 6.)+ percent
$. 6.6- percent

6-1-
60. 4ou ha!e been in!esting 5%+0 a onth for the last 1' years. *oday3 your in!estent
account is worth 5-'3%6%. &hat is your a!erage rate of return on your in!estents?
A. 1.2) percent
". 2.%' percent
C. 2.'6 percent
D. 2.)1 percent
$. 2.-1 percent

61. &ill has been purchasing 5%+3000 worth of Eew *eA stocA annually for the past 11 years.
@is holdings are now worth 5+213100. &hat is his annual rate of return on this stocA?
A. 1).1' percent
". 1).%) percent
C. 1).%2 percent
D. 1).'- percent
$. 1).61 percent

6%. 4our father helped you start sa!ing 5%0 a onth beginning on your +
th
birthday. @e always
ade you deposit the oney into your sa!ings account on the first day of each onth 7ust to
Gstart the onth out right.G *oday copletes your 1-
th
year of sa!ing and you now ha!e
563+%1.21 in this account. &hat is the rate of return on your sa!ings?
A. +.1+ percent
". +.'0 percent
C. +.)- percent
D. +.21 percent
$. 6.1% percent

6'. *oday3 you turn %'. 4our birthday wish is that you will be a illionaire by your )0
th

birthday. 9n an attept to reach this goal3 you decide to sa!e 5+0 a day3 e!ery day until you
turn )0. 4ou open an in!estent account and deposit your first 5+0 today. &hat rate of return
ust you earn to achie!e your goal?
A. 10.6- percent
". 11.1+ percent
C. 1%.20 percent
D. 1'.06 percent
$. 1'.+) percent

6-11
6). 4ou 7ust settled an insurance clai. *he settleent calls for increasing payents o!er a
10-year period. *he first payent will be paid one year fro now in the aount of 5103000.
*he following payents will increase by ).+ percent annually. &hat is the !alue of this
settleent to you today if you can earn 1 percent on your in!estents?
A. 5-63)01.%1
". 510312%.-6
C. 51%30%'.0+
D. 51)31)1.1)
$. 51+3001.16

6+. 4our grandfather left you an inheritance that will pro!ide an annual incoe for the ne,t
10 years. 4ou will recei!e the first payent one year fro now in the aount of 5)3000.
$!ery year after that3 the payent aount will increase by 6 percent. &hat is your inheritance
worth to you today if you can earn 2.+ percent on your in!estents?
A. 5'13622.1+
". 5'63666.6-
C. 5)131%1.%1
D. 5)'3)6).1%
$. 5)63201.1-

66. 4ou 7ust won a national sweepstaAesC For your pri(e3 you opted to recei!e ne!er-ending
payents. *he first payent will be 51%3+00 and will be paid one year fro today. $!ery year
thereafter3 the payents will increase by '.+ percent annually. &hat is the present !alue of
your pri(e at a discount rate of 1 percent?
A. 51663666.6-
". 5%)13)02.12
C. 5%--3---.-1
D. 5%213006.1%
$. 5'003000.00

6-12
6-. A wealthy benefactor 7ust donated soe oney to the local college. *his gift was
established to pro!ide scholarships for worthy students. *he first scholarships will be granted
one year fro now for a total of 5'+3000. Annually thereafter3 the scholarship aount will be
increased by +.+ percent to help offset the effects of inflation. *he scholarship fund will last
indefinitely. &hat is the !alue of this gift today at a discount rate of 1 percent?
A. 5)'-3+00
". 5-+03000
C. 513%003000
D. 513)003000
$. 513)+03-+0

61. >outhern *ours is considering ac#uiring @oliday Vacations. <anageent belie!es @oliday
Vacations can generate cash flows of 511-30003 5%%030003 and 5%)+3000 o!er the ne,t three
years3 respecti!ely. After that tie3 they feel the business will be worthless. >outhern *ours
has deterined that a 1'.+ percent rate of return is applicable to this potential ac#uisition.
&hat is >outhern *ours willing to pay today to ac#uire @oliday Vacations?
A. 5+0'3021
". 5+'1361+
C. 5+)+32%0
D. 56013%%6
$. 56'13)0-

62. 4ou are considering two sa!ings options. "oth options offer a -.) percent rate of return.
*he first option is to sa!e 52003 5%31003 and 5'3000 at the end of each year for the ne,t three
years3 respecti!ely. *he other option is to sa!e one lup su aount today. 9f you want to
ha!e the sae balance in your sa!ings account at the end of the three years3 regardless of the
sa!ings ethod you select3 how uch do you need to sa!e today if you select the lup su
option?
A. 5)3)10
". 5)3+'0
C. 5)3600
D. 5+3010
$. 5+3%60

6-%0
-0. 4our parents ha!e ade you two offers. *he first offer includes annual gifts of 51030003
51130003 and 51%3000 at the end of each of the ne,t three years3 respecti!ely. *he other offer is
the payent of one lup su aount today. 4ou are trying to decide which offer to accept
gi!en the fact that your discount rate is 1 percent. &hat is the iniu aount that you will
accept today if you are to select the lup su offer?
A. 5%13%16
". 5%23)0-
C. 5%23'6-
D. 5'03)'2
$. 5'03621

-1. 4ou are considering changing 7obs. 4our goal is to worA for three years and then return to
school full-tie in pursuit of an ad!anced degree. A potential eployer 7ust offered you an
annual salary of 5)130003 5))30003 and 5)63000 a year for the ne,t three years3 respecti!ely.
All salary payents are ade as lup su payents at the end of each year. *he offer also
includes a starting bonus of 5%3+00 payable iediately. &hat is this offer worth to you
today at a discount rate of 6.-+ percent?
A. 511%3)06
". 511+3+)+
C. 511-3'''
D. 51%13%1%
$. 51')362-

-%. 4ou are considering a pro7ect which will pro!ide annual cash inflows of 5)3+003 5+3-003
and 513000 at the end of each year for the ne,t three years3 respecti!ely. &hat is the present
!alue of these cash flows3 gi!en a 2 percent discount rate?
A. 51)31--
". 51+310'
C. 51+3)%2
D. 5163'11
$. 51631)-

6-%1
-'. 4ou 7ust signed a consulting contract that will pay you 5'+30003 5+%30003 and 5103000
annually at the end of the ne,t three years3 respecti!ely. &hat is the present !alue of these
cash flows gi!en a 10.+ percent discount rate?
A. 51''3++)
". 51)%3'0-
C. 51)13110
D. 51+131'1
$. 51+63210

-). 4ou ha!e soe property for sale and ha!e recei!ed two offers. *he first offer is for
5123+00 today in cash. *he second offer is the payent of 5'+3000 today and an additional
5-03000 two years fro today. 9f the applicable discount rate is 11.+ percent3 which offer
should you accept and why?
A. 4ou should accept the 5123+00 today because it has the higher net present !alue.
". 4ou should accept the 5123+00 today because it has the lower future !alue.
C. 4ou should accept the first offer as it has the greatest !alue to you.
D. 4ou should accept the second offer because it has the larger net present !alue.
$. 9t does not atter which offer you accept as they are e#ually !aluable.

-+. 4our local tra!el agent is ad!ertising an upscale winter !acation pacAage for tra!el three
years fro now to Antarctica. *he pacAage re#uires that you pay 5%+3000 today3 5'03000 one
year fro today3 and a final payent of 5)+3000 on the day you depart three years fro today.
&hat is the cost of this !acation in todayBs dollars if the discount rate is 2.-+ percent?
A. 5163'-6
". 512362+
C. 5213%12
D. 5213)0-
$. 52'3)-1

6-%%
-6. 6ne year ago3 Deltona <otor :arts deposited 5163+00 in an in!estent account for the
purpose of buying new e#uipent three years fro today. *oday3 it is adding another 51%3000
to this account. *he copany plans on aAing a final deposit of 5%03000 to the account one
year fro today. @ow uch will be a!ailable when it is ready to buy the e#uipent3 assuing
the account pays +.+ interest?
A. 5+'3)01
". 5+'3212
C. 5+63%11
D. 5+63-2%
$. 5+130%1

--. =ucas will recei!e 5631003 513-003 and 51%3+00 each year starting at the end of year one.
&hat is the future !alue of these cash flows at the end of year fi!e if the interest rate is -
percent?
A. 5'%3)11
". 5'%320-
C. 5''311'
D. 5'+3)11
$. 5'63%++

-1. 4ou plan on sa!ing 5+3%00 this year3 nothing ne,t year3 and 5-3+00 the following year.
4ou will deposit these aounts into your in!estent account at the end of each year. &hat
will your in!estent account be worth at the end of year three if you can earn 1.+ percent on
your funds?
A. 51'3+%1.1%
". 51'36%1.+-
C. 51'320-.11
D. 51)3+%6.+0
$. 51)3--2.)0

6-%'
-2. <iley e,pects to recei!e the following payents8 4ear 1 H 5603000I 4ear % H 5'+3000I
4ear ' H 51%3000. All of this oney will be sa!ed for her retireent. 9f she can earn an
a!erage of 10.+ percent on her in!estents3 how uch will she ha!e in her account %+ years
after aAing her first deposit?
A. 52-%3'-'
". 52123)+-
C. 5130063'11
D. 5131)-3+02
$. 513%'13--6

10. "lacAwell3 9nc. has a 5-+3000 liability it ust pay three years fro today. *he copany is
opening a sa!ings account so that the entire aount will be a!ailable when this debt needs to
be paid. *he plan is to aAe an initial deposit today and then deposit an additional 51+3000
each year for the ne,t three years3 starting one year fro today. *he account pays a ).+
percent rate of return. @ow uch does the fir need to deposit today?
A. 5113%22.2+
". 5%030-%.21
C. 5%13)00.''
D. 5%)3)1-.-1
$. 5'130-6.+6

11. *he go!ernent has iposed a fine on the Corner *a!ern. *he fine calls for annual
payents of 51+030003 510030003 5-+30003 and 5+030003 respecti!ely3 o!er the ne,t four
years. *he first payent is due one year fro today. *he go!ernent plans to in!est the funds
until the final payent is collected and then donate the entire aount3 including the
in!estent earnings3 to help the local counity shelter. *he go!ernent will earn 6.%+
percent on the funds held. @ow uch will the counity shelter recei!e four years fro
today?
A. 5')236-).06
". 5'6631-+.00
C. 5)%%3)2-.+6
D. 5)+13+-%.-1
$. 5+1+3-'-.6-

6-%)
1%. &icAer 9ports established a trust fund that pro!ides 5203000 in scholarships each year
for needy students. *he trust fund earns a fi,ed 6 percent rate of return. @ow uch oney did
the fir contribute to the fund assuing that only the interest incoe is distributed?
A. 5131+03000
". 513%003000
C. 513'''3'''
D. 513+003000
$. 5136003000

1'. A preferred stocA pays an annual di!idend of 5%.60. &hat is one share of this stocA worth
today if the rate of return is 11.-+ percent?
A. 511.)1
". 5%0.00
C. 5%%.1'
D. 5%1.10
$. 5'0.++

1). 4ou would liAe to establish a trust fund that will pro!ide 51%03000 a year fore!er for your
heirs. *he trust fund is going to be in!ested !ery conser!ati!ely so the e,pected rate of return
is only +.-+ percent. @ow uch oney ust you deposit today to fund this gift for your
heirs?
A. 5%301632+-
". 5%31%13%1%
C. 5%3'003000
D. 5%3)+131%%
$. 5%3+003000

1+. 4ou 7ust paid 5-+03000 for an annuity that will pay you and your heirs 5)+3000 a year
fore!er. &hat rate of return are you earning on this policy?
A. +.%+ percent
". +.+0 percent
C. +.-+ percent
D. 6.00 percent
$. 6.%+ percent

6-%+
16. 4ou grandfather won a lottery years ago. *he !alue of his winnings at the tie was
5+03000. @e in!ested this oney such that it will pro!ide annual payents of 5%3)00 a year to
his heirs fore!er. &hat is the rate of return?
A. ).-+ percent
". ).10 percent
C. +.00 percent
D. +.10 percent
$. +.1+ percent

1-. *he preferred stocA of Casco has a +.)1 percent di!idend yield. *he stocA is currently
priced at 5+2.'0 per share. &hat is the aount of the annual di!idend?
A. 5%.10
". 5%.2+
C. 5'.10
D. 5'.%+
$. 5'.)0

11. 4our credit card copany charges you 1.6+ percent interest per onth. &hat is the annual
percentage rate on your account?
A. 11.2+ percent
". 12.10 percent
C. %0.20 percent
D. %1.%+ percent
$. %1.-0 percent

12. &hat is the annual percentage rate on a loan with a stated rate of %.%+ percent per
#uarter?
A. 2.00 percent
". 2.02 percent
C. 2.11 percent
D. 2.%- percent
$. 2.'1 percent

6-%6
20. 4ou are paying an effecti!e annual rate of 11.2-) percent on your credit card. *he interest
is copounded onthly. &hat is the annual percentage rate on this account?
A. 1-.+0 percent
". 11.00 percent
C. 11.%+ percent
D. 11.6) percent
$. 12.00 percent

21. &hat is the effecti!e annual rate if a banA charges you 2.+0 percent copounded
#uarterly?
A. 2.6% percent
". 2.61 percent
C. 2.-% percent
D. 2.1) percent
$. 2.21 percent

2%. 4our credit card copany #uotes you a rate of 1-.2 percent. 9nterest is billed onthly.
&hat is the actual rate of interest you are paying?
A. 12.0' percent
". 12.%1 percent
C. 12.)) percent
D. 12.+- percent
$. 12.-% percent

2'. *he :awn >hop loans oney at an annual rate of %1 percent and copounds interest
weeAly. &hat is the actual rate being charged on these loans?
A. %'.16 percent
". %'.'% percent
C. %'.)2 percent
D. %'.+6 percent
$. %'.6) percent

6-%-
2). 4ou are considering two loans. *he ters of the two loans are e#ui!alent with the
e,ception of the interest rates. =oan A offers a rate of -.-+ percent3 copounded daily. =oan "
offers a rate of 1 percent3 copounded sei-annually. &hich loan should you select and
why?
A. AI the effecti!e annual rate is 1.06 percent.
". AI the annual percentage rate is -.-+ percent.
C. "I the annual percentage rate is -.61 percent.
D. "I the effecti!e annual rate is 1.16 percent.
$. *he loans are e#ui!alent offers so you can select either one.

2+. 4ou ha!e 5+3600 that you want to use to open a sa!ings account. *here are fi!e banAs
located in your area. *he rates paid by banAs A through $3 respecti!ely3 are gi!en below.
&hich banA should you select if your goal is to a,ii(e your interest incoe?
A. '.%6 percent3 copounded annually
". '.%0 percent3 copounded onthly
C. '.%+ percent3 copounded sei-annually
D. '.10 percent3 copounded continuously
$. '.1+ percent3 copounded #uarterly

26. &hat is the effecti!e annual rate of 1).2 percent copounded continuously?
A. 1+.+2 percent
". 1+.6% percent
C. 1+.62 percent
D. 1+.1) percent
$. 16.0- percent

2-. &hat is the effecti!e annual rate of 2.-+ percent copounded continuously?
A. 10.1- percent
". 10.%) percent
C. 10.%2 percent
D. 10.'' percent
$. 10.)- percent

6-%1
21. City "anA wants to appear copetiti!e based on #uoted loan rates and thus ust offer a
-.-+ percent annual percentage rate on its loans. &hat is the a,iu rate the banA can
actually earn based on the #uoted rate?
A. 1.06 percent
". 1.1) percent
C. 1.%1 percent
D. 1.%6 percent
$. 1.+1 percent

22. 4ou are going to loan a friend 5200 for one year at a + percent rate of interest3
copounded annually. @ow uch additional interest could you ha!e earned if you had
copounded the rate continuously rather than annually?
A. 50.2-
". 51.1)
C. 51.%'
D. 51.'6
$. 51.)1

100. 4ou are borrowing oney today at 1.)1 percent3 copounded annually. 4ou will repay
the principal plus all the interest in one lup su of 51%3100 two years fro today. @ow
uch are you borrowing?
A. 523200.00
". 5103%11.16
C. 51031--.0)
D. 5113)01.16
$. 5113%+0.00

101. *his orning3 you borrowed 523+00 at -.6+ percent annual interest. 4ou are to repay the
loan principal plus all of the loan interest in one lup su four years fro today. @ow uch
will you ha!e to repay?
A. 51%3-+-.2%
". 51%3101.1'
C. 51%3211.12
D. 51'3006.01
$. 51'3))1.%0

6-%2
10%. 6n this date last year3 you borrowed 5'3)00. 4ou ha!e to repay the loan principal plus all
of the interest si, years fro today. *he payent that is re#uired at that tie is 563000. &hat
is the interest rate on this loan?
A. 1.01 percent
". 1.)+ percent
C. 1.-1 percent
D. 2.)- percent
$. 2.2' percent

10'. DohnBs Auto Jepair 7ust tooA out an 51230003 10-year3 1 percent3 interest-only loan fro
the banA. :ayents are ade annually. &hat is the aount of the loan payent in year 10?
A. 5-31%0
". 5131+0
C. 51'3%6)
D. 5123000
$. 52631%0

10). 6n the day you entered college3 you borrowed 5113000 on an interest-only3 four-year
loan at +.%+ percent fro your local banA. :ayents are to be paid annually. &hat is the
aount of your loan payent in year %?
A. 52)+
". 513120
C. 5'3600
D. 5+3106
$. 563%+0

10+. 6n the day you entered college you borrowed 5%+3000 fro your local banA. *he ters
of the loan include an interest rate of ).-+ percent. *he ters stipulate that the principal is due
in full one year after you graduate. 9nterest is to be paid annually at the end of each year.
Assue that you coplete college in four years. @ow uch total interest will you pay on this
loan?
A. 5+3%66.6-
". 5+3)00.00
C. 5+32'-.+0
D. 563+%2.00
$. 56360-.11

6-'0
106. 4ou 7ust ac#uired a ortgage in the aount of 5%)23+00 at 6.-+ percent interest3
copounded onthly. $#ual payents are to be ade at the end of each onth for thirty
years. @ow uch of the first loan payent is interest? .Assue each onth is e#ual to 1K1%
of a year./
A. 52%+.%0
". 513%06.16
C. 513)0'.))
D. 513+11.%1
$. 513+)1.60

10-. 6n Dune 13 you borrowed 5%1%3000 to buy a house. *he ortgage rate is 1.%+ percent.
*he loan is to be repaid in e#ual onthly payents o!er 1+ years. *he first payent is due on
Duly 1. @ow uch of the second payent applies to the principal balance? .Assue that each
onth is e#ual to 1K1% of a year./
A. 560'.'%
". 5621.1)
C. 513'+1.+6
D. 513)+'.'1
$. 5%30+6.-0

101. *his orning3 you borrowed 51+03000 to buy a house. *he ortgage rate is -.'+ percent.
*he loan is to be repaid in e#ual onthly payents o!er %0 years. *he first payent is due
one onth fro today. @ow uch of the second payent applies to the principal balance?
.Assue that each onth is e#ual to 1K1% of a year./
A. 5%61.1)
". 5%--.61
C. 521-.06
D. 52%+.1'
$. 51312).6-

6-'1
Essay Questions

102. $,plain the difference between the effecti!e annual rate .$AJ/ and the annual
percentage rate .A:J/. 6f the two3 which one has the greater iportance and why?

110. 4ou are considering two annuities3 both of which pay a total of 5%03000 o!er the life of
the annuity. Annuity A pays 5%3000 at the end of each year for the ne,t 10 years. Annuity "
pays 513000 at the end of each year for the ne,t %0 years. &hich annuity has the greater !alue
today? 9s there any circustance where the two annuities would ha!e e#ual !alues as of
today? $,plain.

6-'%
111. &hy ight a borrower select an interest-only loan instead of an aorti(ed loan3 which
would be cheaper?

11%. Fristie owns a perpetuity which pays 51%3000 at the end of each year. >he coes to you
and offers to sell you all of the payents to be recei!ed after the 10
th
year. $,plain how you
can deterine the !alue of this offer.

6-''


11'. &estern "anA offers you a 5%130003 6-year ter loan at 1 percent annual interest. &hat is
the aount of your annual loan payent?
A. 5)3%%1.+0
". 5)3+)%.6%
C. 5)3666.6-
D. 5)3201.11
$. 5+3'11.0-

11). First Century "anA wants to earn an effecti!e annual return on its consuer loans of 10
percent per year. *he banA uses daily copounding on its loans. "y law3 what interest rate is
the banA re#uired to report to potential borrowers?
A. 2.%' percent
". 2.'1 percent
C. 2.+' percent
D. 2.-% percent
$. 10.00 percent

11+. Downtown "anA is offering '.) percent copounded daily on its sa!ings accounts. 4ou
deposit 513000 today. @ow uch will you ha!e in your account 11 years fro now?
A. 51136%1.02
". 5113-1).06
C. 51%3%0).+0
D. 51%3''6.11
$. 51%3)1).1)

116. 4ou want to buy a new sports coupe for 5)13-+03 and the finance office at the dealership
has #uoted you an 1.6 percent A:J loan copounded onthly for )1 onths to buy the car.
&hat is the effecti!e interest rate on this loan?
A. 1.%1 percent
". 1.)1 percent
C. 1.-% percent
D. 1.1- percent
$. 1.2+ percent

6-')
11-. "eginning three onths fro now3 you want to be able to withdraw 513+00 each #uarter
fro your banA account to co!er college e,penses o!er the ne,t ) years. *he account pays
1.%+ percent interest per #uarter. @ow uch do you need to ha!e in your account today to
eet your e,pense needs o!er the ne,t ) years?
A. 5%136'0.))
". 5%131)-.1+
C. 5%%3061.00
D. 5%%3)+).02
$. 5%%3-11.11

111. 4ou are planning to sa!e for retireent o!er the ne,t 1+ years. *o do this3 you will in!est
513100 a onth in a stocA account and 5+00 a onth in a bond account. *he return on the
stocA account is e,pected to be - percent3 and the bond account will pay ) percent. &hen you
retire3 you will cobine your oney into an account with a + percent return. @ow uch can
you withdraw each onth during retireent assuing a %0-year withdrawal period?
A. 5%36'6.12
". 5%320).11
C. 5'3001.%1
D. 5'311'.0)
$. 5'3)06.2-

112. 4ou want to be a illionaire when you retire in )0 years. 4ou can earn an 11 percent
annual return. @ow uch ore will you ha!e to sa!e each onth if you wait 10 years to start
sa!ing !ersus if you start sa!ing at the end of this onth?
A. 5-2.%%
". 511).1'
C. 5161.)-
D. 5%01.1+
$. 5%)0.%2

6-'+
1%0. 4ou ha!e 7ust won the lottery and will recei!e 5+)03000 as your first payent one year
fro now. 4ou will recei!e payents for %6 years. *he payents will increase in !alue by )
percent each year. *he appropriate discount rate is 10 percent. &hat is the present !alue of
your winnings?
A. 563%%13)0-
". 5632063'-%
C. 5-3++2361'
D. 5-31113)06
$. 51300'.11

1%1. 4ou are preparing to aAe onthly payents of 56+3 beginning at the end of this onth3
into an account that pays 6 percent interest copounded onthly. @ow any payents will
you ha!e ade when your account balance reaches 523%-1?
A. 2-
". 101
C. 112
D. 1%)
$. 1'1

1%%. 4ou want to borrow 5)-31-0 fro your local banA to buy a new sailboat. 4ou can afford
to aAe onthly payents of 5131603 but no ore. Assue onthly copounding. &hat is
the highest rate you can afford on a )1-onth A:J loan?
A. 1.'1 percent
". 1.6- percent
C. 1.1% percent
D. 2.01 percent
$. 2.11 percent

6-'6
1%'. 4ou need a %+-year3 fi,ed-rate ortgage to buy a new hoe for 5%)03000. 4our
ortgage banA will lend you the oney at a -.+ percent A:J for this '00-onth loan3 with
interest copounded onthly. @owe!er3 you can only afford onthly payents of 51+03 so
you offer to pay off any reaining loan balance at the end of the loan in the for of a single
balloon payent. &hat will be the aount of the balloon payent if you are to Aeep your
onthly payents at 51+0?
A. 5-'13)6)
". 5-)+3'16
C. 5-6-3)10
D. 51103%%0
$. 51)-3'1+

1%). *he present !alue of the following cash flow strea is 5+32''.16 when discounted at 11
percent annually. &hat is the !alue of the issing cash flow?

A. 513+00
". 513-+0
C. 5%3000
D. 5%3%+0
$. 5%3+00

1%+. 4ou ha!e 7ust purchased a new warehouse. *o finance the purchase3 youB!e arranged for
a '0-year ortgage loan for 10 percent of the 5%36003000 purchase price. *he onthly
payent on this loan will be 5113000. &hat is the effecti!e annual rate on this loan?
A. ).21 percent
". +.%+ percent
C. +.)6 percent
D. 6.01 percent
$. 6.+0 percent

6-'-
1%6. Consider a fir with a contract to sell an asset ' years fro now for 5203000. *he asset
costs 5-13000 to produce today. At what rate will the fir 7ust breaA e!en on this contract?
A. -.1- percent
". 1.01 percent
C. 1.%' percent
D. 1.+- percent
$. 1.20 percent

1%-. &hat is the present !alue of 513100 per year3 at a discount rate of 10 percent if the first
payent is recei!ed 6 years fro now and the last payent is recei!ed %1 years fro now?
A. 56306-.'6
". 5631'1.1-
C. 563'''.''
D. 563)%0.1%
$. 563+11.01

1%1. 4ou ha!e your choice of two in!estent accounts. 9n!estent A is a +-year annuity that
features end-of-onth 5%3+00 payents and has an interest rate of 11.+ percent copounded
onthly. 9n!estent " is a 10.+ percent continuously copounded lup su in!estent3 also
good for fi!e years. @ow uch would you need to in!est in " today for it to be worth as uch
as in!estent A fi!e years fro now?
A. 51013%06.6-
". 511231-6.06
C. 51%)3'11.01
D. 51%23)0-.1-
$. 51'13001.1+

1%2. ?i!en an interest rate of 1 percent per year3 what is the !alue at date t H 2 of a perpetual
strea of 5+00 annual payents that begins at date t H 1-?
A. 5'36)6.11
". 5)3102.12
C. 5)3'0-.-1
D. 563%+0.00
$. 563)1-.1-

6-'1
1'0. 4ou want to buy a new sports car for 5++3000. *he contract is in the for of a 60-onth
annuity due at a 6 percent A:J3 copounded onthly. &hat will your onthly payent be?
A. 5130)-.20
". 5130+'.1-
C. 5130+1.01
D. 51306'.'0
$. 5130-%.11

1'1. 4ou are looAing at a one-year loan of 5103000. *he interest rate is #uoted as 10 percent
plus + points. A point on a loan is siply 1 percent .one percentage point/ of the loan aount.
Luotes siilar to this one are !ery coon with hoe ortgages. *he interest rate #uotation
in this e,aple re#uires the borrower to pay + points to the lender up front and repay the loan
later with 10 percent interest. &hat is the actual rate you are paying on this loan?
A. 1+.00 percent
". 1+.)- percent
C. 1+.++ percent
D. 1+.-2 percent
$. 1+.1) percent

1'%. 4our holiday sAi !acation was great3 but it unfortunately ran a bit o!er budget. All is not
lost. 4ou 7ust recei!ed an offer in the ail to transfer your 5+3000 balance fro your current
credit card3 which charges an annual rate of 11.- percent3 to a new credit card charging a rate
of 2.) percent. 4ou plan to aAe payents of 5+10 a onth on this debt. @ow any less
payents will you ha!e to aAe to pay off this debt if you transfer the balance to the new
card?
A. 0.'6 payents
". 0.)1 payents
C. 1.10 payents
D. 1.%' payents
$. %.)2 payents

6-'2
Chapter 06 Discounted Cash Flow Valuation Answer Fey


1. An ordinary annuity is best defined by which one of the following?
A. increasing payents paid for a definiti!e period of tie
". increasing payents paid fore!er
C. e#ual payents paid at regular inter!als o!er a stated tie period
D. e#ual payents paid at regular inter!als of tie on an ongoing basis
$. une#ual payents that occur at set inter!als for a liited period of tie
Jefer to section 6.%

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Obecti!e: "#$
Section: "%$
&o'ic: Annuity

%. &hich one of the following accurately defines a perpetuity?
A. a liited nuber of e#ual payents paid in e!en tie increents
". payents of e#ual aounts that are paid irregularly but indefinitely
C. !arying aounts that are paid at e!en inter!als fore!er
D. unending e#ual payents paid at e#ual tie inter!als
$. unending e#ual payents paid at either e#ual or une#ual tie inter!als

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%$
&o'ic: (er'etuity

6-)0
'. &hich one of the following ters is used to identify a "ritish perpetuity?
A. ordinary annuity
". aorti(ed cash flow
C. annuity due
D. discounted loan
E. consol

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%$
&o'ic: Consol

). *he interest rate that is #uoted by a lender is referred to as which one of the following?
A. stated interest rate
". copound rate
D. siple rate
$. coon rate
Jefer to section 6.'

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Obecti!e: "#)
Section: "%*
&o'ic: Stated rate

6-)1
+. A onthly interest rate e,pressed as an annual rate would be an e,aple of which one of
the following rates?
A. stated rate
". discounted annual rate
D. periodic onthly rate
$. consolidated onthly rate

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%*
&o'ic: +ffecti!e annual rate

6. &hat is the interest rate charged per period ultiplied by the nuber of periods per year
called?
A. effecti!e annual rate
B. annual percentage rate
C. periodic interest rate
D. copound interest rate
$. daily interest rate

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%*
&o'ic: Annual 'ercentage rate

6-)%
-. A loan where the borrower recei!es oney today and repays a single lup su on a future
date is called a.n/ 00000 loan.
A. aorti(ed
". continuous
C. balloon
D. pure discount
$. interest-only
Jefer to section 6.)

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Obecti!e: "#*
Section: "%)
&o'ic: (ure discount loan

1. &hich one of the following ters is used to describe a loan that calls for periodic interest
payents and a lup su principal payent?
A. aorti(ed loan
". odified loan
C. balloon loan
E. interest-only loan

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%)
&o'ic: ,nterest#only loan

6-)'
2. &hich one of the following ters is used to describe a loan wherein each payent is e#ual
in aount and includes both interest and principal?
A. aorti(ed loan
". odified loan
C. balloon loan

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%)
&o'ic: Amorti-ed loan

10. &hich one of the following ters is defined as a loan wherein the regular payents3
including both interest and principal aounts3 are insufficient to retire the entire loan aount3
which then ust be repaid in one lup su?
A. aorti(ed loan
". continuing loan
C. balloon loan
D. reainder loan

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%)
&o'ic: Balloon loan

6-))
11. 4ou are coparing two annuities which offer #uarterly payents of 5%3+00 for fi!e years
and pay 0.-+ percent interest per onth. Annuity A will pay you on the first of each onth
while annuity " will pay you on the last day of each onth. &hich one of the following
stateents is correct concerning these two annuities?
A. *hese two annuities ha!e e#ual present !alues but une#ual futures !alues at the end of year
fi!e.
". *hese two annuities ha!e e#ual present !alues as of today and e#ual future !alues at the
end of year fi!e.
C. Annuity " is an annuity due.
D. Annuity A has a saller future !alue than annuity ".
E. Annuity " has a saller present !alue than annuity A.

AACSB: N/A
Bloom's: Com're.ension
Difficulty: Basic
Section: "%$
&o'ic: Annuity 'resent and future !alues

1%. 4ou are coparing two in!estent options that each pay + percent interest3 copounded
annually. "oth options will pro!ide you with 51%3000 of incoe. 6ption A pays three annual
payents starting with 5%3000 the first year followed by two annual payents of 5+3000 each.
6ption " pays three annual payents of 5)3000 each. &hich one of the following stateents
is correct gi!en these two in!estent options?
A. "oth options are of e#ual !alue gi!en that they both pro!ide 51%3000 of incoe.
". 6ption A has the higher future !alue at the end of year three.
C. 6ption " has a higher present !alue at tie (ero than does option A.
D. 6ption " is a perpetuity.
$. 6ption A is an annuity.
Jefer to sections 6.1 and 6.%

AACSB: N/A
Difficulty: Basic
Section: "%/ and "%$
&o'ic: (resent and future !alues

6-)+
1'. 4ou are considering two pro7ects with the following cash flows8

&hich of the following stateents are true concerning these two pro7ects?
9. "oth pro7ects ha!e the sae future !alue at the end of year )3 gi!en a positi!e rate of return.
99. "oth pro7ects ha!e the sae future !alue gi!en a (ero rate of return.
999. :ro7ect ; has a higher present !alue than :ro7ect 43 gi!en a positi!e discount rate.
9V. :ro7ect 4 has a higher present !alue than :ro7ect ;3 gi!en a positi!e discount rate.
A. 99 only
". 9 and 999 only
C. 99 and 999 only
D. 99 and 9V only
$. 93 993 and 9V only
Jefer to section 6.1

AACSB: N/A
Difficulty: Basic
Learning Obecti!e: "#/
Section: "%/

6-)6
1). &hich one of the following stateents is correct gi!en the following two sets of pro7ect
cash flows?

A. *he cash flows for :ro7ect " are an annuity3 but those of :ro7ect A are not.
". "oth sets of cash flows ha!e e#ual present !alues as of tie (ero gi!en a positi!e discount
rate.
C. *he present !alue at tie (ero of the final cash flow for :ro7ect A will be discounted using
an e,ponent of three.
D. *he present !alue of :ro7ect A cannot be coputed because the second cash flow is e#ual
to (ero.
E. As long as the discount rate is positi!e3 :ro7ect " will always be worth less today than will
:ro7ect A.
Jefer to section 6.1

AACSB: N/A
Difficulty: Basic
Section: "%/
&o'ic: (resent !alue

6-)-
1+. &hich one of the following stateents related to annuities and perpetuities is correct?
A. An ordinary annuity is worth ore than an annuity due gi!en e#ual annual cash flows for
ten years at - percent interest3 copounded annually.
B. A perpetuity coprised of 5100 onthly payents is worth ore than an annuity
coprised of 5100 onthly payents3 gi!en an interest rate of 1% percent3 copounded
onthly.
C. <ost loans are a for of a perpetuity.
D. *he present !alue of a perpetuity cannot be coputed3 but the future !alue can.
$. :erpetuities are finite but annuities are not.

AACSB: N/A
Difficulty: Basic
Section: "%$
&o'ic: Annuities and 'er'etuities

16. &hich of the following stateents related to interest rates are correct?
9. Annual interest rates consider the effect of interest earned on rein!ested interest payents.
99. &hen coparing loans3 you should copare the effecti!e annual rates.
999. =enders are re#uired by law to disclose the effecti!e annual rate of a loan to prospecti!e
borrowers.
9V. Annual and effecti!e interest rates are e#ual when interest is copounded annually.
A. 9 and 99 only
". 99 and 999 only
C. 99 and 9V only
D. 93 993 and 999 only
$. 993 9993 and 9V only

AACSB: N/A
Difficulty: Basic
Section: "%*
&o'ic: ,nterest rate

6-)1
1-. &hich one of the following stateents concerning interest rates is correct?
A. >a!ers would prefer annual copounding o!er onthly copounding.
". *he effecti!e annual rate decreases as the nuber of copounding periods per year
increases.
C. *he effecti!e annual rate e#uals the annual percentage rate when interest is copounded
annually.
D. "orrowers would prefer onthly copounding o!er annual copounding.
$. For any positi!e rate of interest3 the effecti!e annual rate will always e,ceed the annual
percentage rate.

AACSB: N/A
Difficulty: Basic
Section: "%*

11. &hich one of these stateents related to growing annuities and perpetuities is correct?
A. *he cash flow used in the growing annuity forula is the initial cash flow at tie (ero.
". ?rowth rates cannot be applied to perpetuities if you wish to copute the present !alue.
C. *he future !alue of an annuity will decrease if the growth rate is increased.
D. An increase in the rate of growth will decrease the present !alue of an annuity.
E. *he present !alue of a growing perpetuity will decrease if the discount rate is increased.

AACSB: N/A
Difficulty: ,ntermediate
Section: "%$
&o'ic: 0rowing annuities and 'er'etuities

6-)2
12. &hich one of the following stateents correctly states a relationship?
A. *ie and future !alues are in!ersely related3 all else held constant.
". 9nterest rates and tie are positi!ely related3 all else held constant.
C. An increase in the discount rate increases the present !alue3 gi!en positi!e rates.
D. An increase in tie increases the future !alue gi!en a (ero rate of interest.
E. *ie and present !alue are in!ersely related3 all else held constant.

AACSB: N/A
Section: "%*
&o'ic: &ime !alue relations.i's

%0. &hich one of the following copounding periods will yield the sallest present !alue
gi!en a stated future !alue and annual percentage rate?
A. annual
". sei-annual
C. onthly
D. daily
E. continuous

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%*
&o'ic: ,nterest com'ounding

6-+0
%1. *he entire repayent of which one of the following loans is coputed siply by
coputing a single future !alue?
". balloon loan
C. aorti(ed loan
$. bullet loan

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%)

%%. @ow is the principal aount of an interest-only loan repaid?
A. *he principal is forgi!en o!er the loan period so does not ha!e to be repaid.
". *he principal is repaid in e#ual increents and included in each loan payent.
C. *he principal is repaid in a lup su at the end of the loan period.
D. *he principal is repaid in e#ual annual payents.
$. *he principal is repaid in increasing increents through regular onthly payents.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%)

6-+1
%'. An aorti(ed loan8
A. re#uires the principal aount to be repaid in e!en increents o!er the life of the loan.
B. ay ha!e e#ual or increasing aounts applied to the principal fro each loan payent.
C. re#uires that all interest be repaid on a onthly basis while the principal is repaid at the
end of the loan ter.
D. re#uires that all payents be e#ual in aount and include both principal and interest.
$. repays both the principal and the interest in one lup su at the end of the loan ter.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%)

%). 4ou need 5%+3000 today and ha!e decided to taAe out a loan at - percent for fi!e years.
&hich one of the following loans would be the least e,pensi!e? Assue all loans re#uire
onthly payents and that interest is copounded on a onthly basis.
B. aorti(ed loan with e#ual principal payents
C. aorti(ed loan with e#ual loan payents
D. discount loan
$. balloon loan where +0 percent of the principal is repaid as a balloon payent

AACSB: N/A
Section: "%)
&o'ic: Loan ty'es

6-+%
%+. 4our grandother is gifting you 5100 a onth for four years while you attend college to
earn your bachelorBs degree. At a +.+ percent discount rate3 what are these payents worth to
you on the day you enter college?
A. 5)3%01.16
B. 5)3%22.11
C. 5)3+02.12
D. 5)3601.1-
$. 5)3100.00

AACSB: Analytic
Bloom's: A''lication
Difficulty: Basic
Section: "%$
&o'ic: Annuity 'resent !alue

6-+'
%6. 4ou 7ust won the grand pri(e in a national writing contestC As your pri(e3 you will recei!e
5%3000 a onth for ten years. 9f you can earn - percent on your oney3 what is this pri(e
worth to you today?
A. 51-%3%+%.-1
". 51-13)11.06
C. 51113''1.)0
D. 511+3'''.''
$. 51203)+0.%+

AACSB: Analytic
Difficulty: Basic
Section: "%$

6-+)
%-. :hil can afford 5110 a onth for + years for a car loan. 9f the interest rate is 1.6 percent3
how uch can he afford to borrow to purchase a car?
A. 5-3-+0.00
". 513')1.0'
C. 513-+%.1)
D. 523%66.6-
$. 523)00.00

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: Loan amount

6-++
%1. 4ou are the beneficiary of a life insurance policy. *he insurance copany infors you
that you ha!e two options for recei!ing the insurance proceeds. 4ou can recei!e a lup su
of 5%003000 today or recei!e payents of 513)00 a onth for %0 years. 4ou can earn 6
percent on your oney. &hich option should you taAe and why?
A. 4ou should accept the payents because they are worth 5%023)1) to you today.
". 4ou should accept the payents because they are worth 5%)-3100 to you today.
C. 4ou should accept the payents because they are worth 5''63000 to you today.
D. 4ou should accept the 5%003000 because the payents are only worth 51123'11 to you
today.
E. 4ou should accept the 5%003000 because the payents are only worth 512+3)1' to you
today.

AACSB: Analytic
Difficulty: Basic
Section: "%$

6-+6
%2. 4our eployer contributes 5-+ a weeA to your retireent plan. Assue that you worA for
your eployer for another %0 years and that the applicable discount rate is -.+ percent. ?i!en
these assuptions3 what is this eployee benefit worth to you today?
A. 5)03'1).62
". 5)%3611.)6
C. 5))3%11.11
D. 5))3'06.16
$. 5))321-.-)

AACSB: Analytic
Difficulty: Basic
Section: "%$

6-+-
'0. *he Design *ea 7ust decided to sa!e 513+00 a onth for the ne,t + years as a safety net
for recessionary periods. *he oney will be set aside in a separate sa!ings account which
pays ).+ percent interest copounded onthly. *he first deposit will be ade today. &hat
would todayBs deposit aount ha!e to be if the fir opted for one lup su deposit today that
would yield the sae aount of sa!ings as the onthly deposits after + years?
A. 5103)+2.0-
B. 5103-60.-2
C. 5113061.11
D. 5113'''.''
$. 5113+)1.%0

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: Annuity due 'resent !alue

6-+1
'1. 4ou need soe oney today and the only friend you ha!e that has any is your iserly
friend. @e agrees to loan you the oney you need3 if you aAe payents of 5%+ a onth for
the ne,t si, onths. 9n Aeeping with his reputation3 he re#uires that the first payent be paid
today. @e also charges you 1.+ percent interest per onth. @ow uch oney are you
borrowing?
A. 51').02
". 51'1.%%
C. 51'2.+0
D. 51)%.61
E. 51)).+-

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: Loan 'resent !alue

6-+2
'%. 4ou buy an annuity that will pay you 5%)3000 a year for %+ years. *he payents are paid
on the first day of each year. &hat is the !alue of this annuity today if the discount rate is 1.+
percent?
A. 5%)13'02
". 5%)+36%1
C. 5%+13)02
D. 5%+13'12
E. 5%663)21

AACSB: Analytic
Difficulty: Basic
Section: "%$

6-60
''. 4ou are scheduled to recei!e annual payents of 5)3100 for each of the ne,t - years. *he
discount rate is 1 percent. &hat is the difference in the present !alue if you recei!e these
payents at the beginning of each year rather than at the end of each year?
A. 513222
". 5%301'
C. 5%3%%1
D. 5%3%%-
$. 5%3'0)
Difference H 5%63220 - 5%)3221 H 513222
Eote8 *he difference H 0.01 5%)3221 H 513222

AACSB: Analytic
Bloom's: Analysis
Section: "%$

6-61
'). 4ou are coparing two annuities with e#ual present !alues. *he applicable discount rate
is 1.-+ percent. 6ne annuity pays 5+3000 on the first day of each year for %0 years. @ow uch
does the second annuity pay each year for %0 years if it pays at the end of each year?
A. 5+3%11
". 5+3%6-
C. 5+3'02
D. 5+3'20
E. 5+3)'1
"ecause each payent is recei!ed one year later3 then the cash flow has to e#ual8
5+3000 .1 M 0.01-+/ H 5+3)'1

AACSB: Analytic
Bloom's: Analysis
Section: "%$
&o'ic: Annuity com'arison

6-6%
'+. *rish recei!es 5)10 on the first of each onth. Dosh recei!es 5)10 on the last day of each
onth. "oth *rish and Dosh will recei!e payents for ne,t three years. At a 2.+ percent
discount rate3 what is the difference in the present !alue of these two sets of payents?
A. 5111.6'
". 51%1.06
C. 51%).'0
D. 51%2.01
$. 51'%.+0

AACSB: Analytic
Bloom's: Analysis
Section: "%$

6-6'
'6. &hat is the future !alue of 513%00 a year for )0 years at 1 percent interest? Assue annual
copounding.
A. 5'01311+
". 5'063)2%
C. 5'103161
D. 5')%3201
$. 5')-3%6-

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: Annuity future !alue

'-. &hat is the future !alue of 51+3000 a year for '0 years at 1% percent interest?
A. 5%31-13)06
B. 5'36123220
C. 5'3-113)1)
D. 5'32123)-6
$. 5)30%13%%'

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: 1uture !alue

6-6)
'1. Ale,a plans on sa!ing 5'3000 a year and e,pects to earn an annual rate of 10.%+ percent.
@ow uch will she ha!e in her account at the end of )+ years?
A. 5131063)%2
". 5131'13'62
C. 5%3%113)0-
D. 5%3'''3+-%
$. 5%3+013'16

AACSB: Analytic
Difficulty: Basic
Section: "%$

6-6+
'2. *heresa adds 513000 to her sa!ings account on the first day of each year. <arcus adds
513000 to his sa!ings account on the last day of each year. *hey both earn 6.+ percent annual
interest. &hat is the difference in their sa!ings account balances at the end of '+ years?
A. 51306%
". 51311'
C. 5131%-
D. 513%11
$. 513%12
Difference H 51'%3026.2+ - 51%)30').62 H 51306%
Eote8 Difference H 51%)30').62 0.06+ H 51306%

AACSB: Analytic
Bloom's: Analysis
Section: "%$

6-66
)0. 4ou are borrowing 51-3100 to buy a car. *he ters of the loan call for onthly payents
for + years at 1.6 percent interest. &hat is the aount of each payent?
A. 5%1-.-1
". 5%21.)0
C. 5'01.1%
D. 5')%.-6
E. 5'66.0+

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: Loan 'ayment

6-6-
)1. 4ou borrow 516+3000 to buy a house. *he ortgage rate is -.+ percent and the loan period
is '0 years. :ayents are ade onthly. 9f you pay the ortgage according to the loan
agreeent3 how uch total interest will you pay?
A. 5%063)01
". 5%%230-2
C. 5%+03''%
D. 5%6)3'12
$. 5%213)06

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Section: "%$
&o'ic: Loan interest

6-61
)%. @oliday *ours .@*/ has an eployent contract with its newly hired C$6. *he contract
re#uires a lup su payent of 510.) illion be paid to the C$6 upon the successful
copletion of her first three years of ser!ice. @* wants to set aside an e#ual aount of oney
at the end of each year to co!er this anticipated cash outflow and will earn +.6+ percent on the
funds. @ow uch ust @* set aside each year for this purpose?
A. 5'311)3)6-
B. 5'3%--32-'
C. 5'30063)02
D. 5'3'113120
$. 5'3)66366-

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: Annuity 'ayment

6-62
)'. Eadine is retiring at age 6% and e,pects to li!e to age 1+. 6n the day she retires3 she has
5')13%12 in her retireent sa!ings account. >he is soewhat conser!ati!e with her oney
and e,pects to earn 6 percent during her retireent years. @ow uch can she withdraw fro
her retireent sa!ings each onth if she plans to spend her last penny on the orning of her
death?
A. 513602.2%
". 5131)-.-1
C. 513212.)6
D. 5%3116.01
E. 5%3'%2.0+

AACSB: Analytic
Difficulty: Basic
Section: "%$

6--0
)). Fingston De!elopent Corp. purchased a piece of property for 5%.-2 illion. *he fir
paid a down payent of 1+ percent in cash and financed the balance. *he loan ters re#uire
onthly payents for 1+ years at an annual percentage rate of -.-+ percent3 copounded
onthly. &hat is the aount of each ortgage payent?
A. 5%%3'%%.'+
". 5%'3)12.2-
C. 5%'360-.11
D. 5%)31-1.1+
$. 5%+3'01.16
Aount financed H 5%3-203000 .1 - 0.1+/ H 5%3'-13+00

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: Loan 'ayment

6--1
)+. 4ou estiate that you will owe 5)%3100 in student loans by the tie you graduate. *he
interest rate is ).%+ percent. 9f you want to ha!e this debt paid in full within si, years3 how
uch ust you pay each onth?
A. 5611.02
B. 56-).+0
C. 5-1).%1
D. 5-'6.0+
$. 5-)%.+0

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: Loan 'ayment

6--%
)6. 4ou are buying a pre!iously owned car today at a price of 5'3+00. 4ou are paying 5'00
down in cash and financing the balance for '6 onths at 1.+ percent. &hat is the aount of
each loan payent?
A. 5101.0%
". 511%.%'
C. 5111.)-
D. 51%1.60
$. 51%).)0
Aount financed H 5'3+00 - 5'00 H 5'3%00

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: Loan 'ayment

6--'
)-. Atlas 9nsurance wants to sell you an annuity which will pay you 5'3)00 per #uarter for %+
years. 4ou want to earn a iniu rate of return of 6.+ percent. &hat is the ost you are
willing to pay as a lup su today to buy this annuity?
A. 51+13001.%)
". 51+)3%01.16
C. 516-3)12.11
D. 51-'3001.10
$. 51-132%-.+2

AACSB: Analytic
Difficulty: Basic
Section: "%$

6--)
)1. 4our car dealer is willing to lease you a new car for 5%)+ a onth for )1 onths.
:ayents are due on the first day of each onth starting with the day you sign the lease
contract. 9f your cost of oney is 6.+ percent3 what is the current !alue of the lease?
A. 5103''1.0'
B. 5103'16.22
C. 51%312-.-)
D. 51%3%0'.1)
$. 51'3001.'1

AACSB: Analytic
Difficulty: Basic
Section: "%$

6--+
)2. 4our great aunt left you an inheritance in the for of a trust. *he trust agreeent states
that you are to recei!e 5'3600 on the first day of each year3 starting iediately and
continuing for %0 years. &hat is the !alue of this inheritance today if the applicable discount
rate is 6.-+ percent?
A. 5'13120.11
". 5)03'11.16
C. 5)13+16.01
D. 5)%3202.%2
$. 5)'3'''.''

AACSB: Analytic
Difficulty: Basic
Section: "%$

6--6
+0. 4ou 7ust recei!ed an insurance settleent offer related to an accident you had si, years
ago. *he offer gi!es you a choice of one of the following three offers8

4ou can earn -.+ percent on your in!estents. 4ou do not care if you personally recei!e the
funds or if they are paid to your heirs should you die within the settleent period. &hich one
of the following stateents is correct gi!en this inforation?
A. 6ption A is the best choice as it pro!ides the largest onthly payent.
". 6ption " is the best choice because it pays the largest total aount.
C. 6ption C is the best choice because it is has the largest current !alue.
D. 6ption " is the best choice because you will recei!e the ost payents.
$. 4ou are indifferent to the three options as they are all e#ual in !alue.
6ption A has a present !alue of 5203+1).16 at -.+ percent.
6ption " has a present !alue of 51+3%++.61 at -.+ percent.
6ption C has a present !alue of 51003000.
6ption C is the best choice since it has the largest present !alue.

6---
AACSB: Analytic
Bloom's: Analysis
Section: "%$

+1. >auelson $ngines wants to sa!e 5-+03000 to buy soe new e#uipent si, years fro
now. *he plan is to set aside an e#ual aount of oney on the first day of each #uarter
starting today. *he fir can earn ).-+ percent on its sa!ings. @ow uch does the fir ha!e to
sa!e each #uarter to achie!e its goal?
A. 5%631-%.2)
". 5%63262.-0
C. 5%-312%.0+
D. 5%-3)12.%2
$. 5%-3211.01

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: Annuity due 'ayment

6--1
+%. >tephanie is going to contribute 5'00 on the first of each onth3 starting today3 to her
retireent account. @er eployer will pro!ide a +0 percent atch. 9n other words3 her
eployer will contribute +0 percent of the aount >tephanie sa!es. 9f both >tephanie and her
eployer continue to do this and she can earn a onthly rate of 0.20 percent3 how uch will
she ha!e in her retireent account '+ years fro now?
A. 5132'63%6)
". 5132)'3%16
C. 5132123'1%
D. 5%30613)11
E. 5%31%'300-

AACSB: Analytic
Difficulty: Basic
Section: "%$

6--2
+'. 4ou are considering an annuity which costs 51603000 today. *he annuity pays 51131%6 a
year at an annual interest rate of -.+0 percent. &hat is the length of the annuity tie period?
A. 1% years
". 1' years
C. 1) years
D. 1+ years
$. 16 years

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: Annuity time 'eriod

6-10
+). *oday3 you borrowed 563%00 on your credit card to purchase soe furniture. *he interest
rate is 1).2 percent3 copounded onthly. @ow long will it taAe you to pay off this debt
assuing that you do not charge anything else and aAe regular onthly payents of 51%0?
A. +.1- years
". 6.)0 years
C. 6.2' years
D. -.%' years
$. -.'1 years
1'.1) onthsK1% H 6.2' years

AACSB: Analytic
Difficulty: Basic
Section: "%$

6-11
++. <eadow "rooA <anor would liAe to buy soe additional land and build a new assisted
li!ing center. *he anticipated total cost is 5%'.6 illion. *he C$6 of the fir is #uite
conser!ati!e and will only do this when the copany has sufficient funds to pay cash for the
entire construction pro7ect. <anageent has decided to sa!e 51.% illion a #uarter for this
purpose. *he fir earns 6.%+ percent3 copounded #uarterly3 on the funds it sa!es. @ow long
does the copany ha!e to wait before e,panding its operations?
A. ).02 years
B. ).'% years
C. ).)6 years
D. ).1% years
$. ).21 years
t H 1-.%1%2% #uartersK) H ).'% years

AACSB: Analytic
Section: "%$

6-1%
+6. *oday3 you are retiring. 4ou ha!e a total of 5)113016 in your retireent sa!ings and ha!e
the funds in!ested such that you e,pect to earn an a!erage of -.10 percent3 copounded
onthly3 on this oney throughout your retireent years. 4ou want to withdraw 5%3+00 at the
beginning of e!ery onth3 starting today. @ow long will it be until you run out of oney?
A. '1.2- years
". ').+6 years
C. )%.0' year
D. )1.12 years
$. 4ou will ne!er run out of oney.
t H +-1.''611 onthsK1% H )1.12 years

AACSB: Analytic
Section: "%$

6-1'
+-. ?eneBs Art ?allery is notoriously Anown as a slow-payer. *he fir currently needs to
borrow 5%-3+00 and only one copany will e!en deal with the. *he ters of the loan call
for daily payents of 5100. *he first payent is due today. *he interest rate is %1.2 percent3
copounded daily. &hat is the tie period of this loan? Assue a '6+ day year.
A. %6).'6 days
". %10.11 days
C. '00.)' days
D. '16.)6 days
$. ')1.02 days

AACSB: Analytic
Difficulty: Basic
Section: "%$

6-1)
+1. *he &ine :ress is considering a pro7ect which has an initial cash re#uireent of
511-3)00. *he pro7ect will yield cash flows of 5%31'% onthly for 1) onths. &hat is the rate
of return on this pro7ect?
A. 6.2- percent
B. -.0) percent
C. -.%1 percent
D. -.)1 percent
$. -.+6 percent

AACSB: Analytic
Difficulty: Basic
Section: "%$

6-1+
+2. 4our insurance agent is trying to sell you an annuity that costs 5%003000 today. "y buying
this annuity3 your agent proises that you will recei!e payents of 513%%+ a onth for the
ne,t '0 years. &hat is the rate of return on this in!estent?
A. +.-+ percent
". +.2- percent
C. 6.%0 percent
D. 6.)+ percent
$. 6.6- percent

AACSB: Analytic
Difficulty: Basic
Section: "%$

6-16
60. 4ou ha!e been in!esting 5%+0 a onth for the last 1' years. *oday3 your in!estent
account is worth 5-'3%6%. &hat is your a!erage rate of return on your in!estents?
A. 1.2) percent
". 2.%' percent
C. 2.'6 percent
D. 2.)1 percent
$. 2.-1 percent

AACSB: Analytic
Difficulty: Basic
Section: "%$

6-1-
61. &ill has been purchasing 5%+3000 worth of Eew *eA stocA annually for the past 11 years.
@is holdings are now worth 5+213100. &hat is his annual rate of return on this stocA?
A. 1).1' percent
". 1).%) percent
C. 1).%2 percent
D. 1).'- percent
E. 1).61 percent

AACSB: Analytic
Difficulty: Basic
Section: "%$

6-11
6%. 4our father helped you start sa!ing 5%0 a onth beginning on your +
th
birthday. @e always
ade you deposit the oney into your sa!ings account on the first day of each onth 7ust to
Gstart the onth out right.G *oday copletes your 1-
th
year of sa!ing and you now ha!e
563+%1.21 in this account. &hat is the rate of return on your sa!ings?
A. +.1+ percent
". +.'0 percent
C. +.)- percent
D. +.21 percent
$. 6.1% percent

AACSB: Analytic
Difficulty: Basic
Section: "%$

6-12
6'. *oday3 you turn %'. 4our birthday wish is that you will be a illionaire by your )0
th

birthday. 9n an attept to reach this goal3 you decide to sa!e 5+0 a day3 e!ery day until you
turn )0. 4ou open an in!estent account and deposit your first 5+0 today. &hat rate of return
ust you earn to achie!e your goal?
A. 10.6- percent
B. 11.1+ percent
C. 1%.20 percent
D. 1'.06 percent
$. 1'.+) percent

AACSB: Analytic
Difficulty: Basic
Section: "%$

6-20
6). 4ou 7ust settled an insurance clai. *he settleent calls for increasing payents o!er a
10-year period. *he first payent will be paid one year fro now in the aount of 5103000.
*he following payents will increase by ).+ percent annually. &hat is the !alue of this
settleent to you today if you can earn 1 percent on your in!estents?
A. 5-63)01.%1
B. 510312%.-6
C. 51%30%'.0+
D. 51)31)1.1)
$. 51+3001.16

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: 0rowing annuity

6-21
6+. 4our grandfather left you an inheritance that will pro!ide an annual incoe for the ne,t
10 years. 4ou will recei!e the first payent one year fro now in the aount of 5)3000.
$!ery year after that3 the payent aount will increase by 6 percent. &hat is your inheritance
worth to you today if you can earn 2.+ percent on your in!estents?
A. 5'13622.1+
". 5'63666.6-
C. 5)131%1.%1
D. 5)'3)6).1%
$. 5)63201.1-

AACSB: Analytic
Difficulty: Basic
Section: "%$

66. 4ou 7ust won a national sweepstaAesC For your pri(e3 you opted to recei!e ne!er-ending
payents. *he first payent will be 51%3+00 and will be paid one year fro today. $!ery year
thereafter3 the payents will increase by '.+ percent annually. &hat is the present !alue of
your pri(e at a discount rate of 1 percent?
A. 51663666.6-
". 5%)13)02.12
C. 5%--3---.-1
D. 5%213006.1%
$. 5'003000.00

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: 0rowing 'er'etuity

6-2%
6-. A wealthy benefactor 7ust donated soe oney to the local college. *his gift was
established to pro!ide scholarships for worthy students. *he first scholarships will be granted
one year fro now for a total of 5'+3000. Annually thereafter3 the scholarship aount will be
increased by +.+ percent to help offset the effects of inflation. *he scholarship fund will last
indefinitely. &hat is the !alue of this gift today at a discount rate of 1 percent?
A. 5)'-3+00
". 5-+03000
C. 513%003000
D. 513)003000
$. 513)+03-+0

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: 0rowing 'er'etuity

61. >outhern *ours is considering ac#uiring @oliday Vacations. <anageent belie!es @oliday
Vacations can generate cash flows of 511-30003 5%%030003 and 5%)+3000 o!er the ne,t three
years3 respecti!ely. After that tie3 they feel the business will be worthless. >outhern *ours
has deterined that a 1'.+ percent rate of return is applicable to this potential ac#uisition.
&hat is >outhern *ours willing to pay today to ac#uire @oliday Vacations?
A. 5+0'3021
". 5+'1361+
C. 5+)+32%0
D. 56013%%6
$. 56'13)0-

AACSB: Analytic
Difficulty: Basic
Section: "%/

6-2'
62. 4ou are considering two sa!ings options. "oth options offer a -.) percent rate of return.
*he first option is to sa!e 52003 5%31003 and 5'3000 at the end of each year for the ne,t three
years3 respecti!ely. *he other option is to sa!e one lup su aount today. 9f you want to
ha!e the sae balance in your sa!ings account at the end of the three years3 regardless of the
sa!ings ethod you select3 how uch do you need to sa!e today if you select the lup su
option?
A. 5)3)10
". 5)3+'0
C. 5)3600
D. 5+3010
$. 5+3%60

AACSB: Analytic
Difficulty: Basic
Section: "%/

6-2)
-0. 4our parents ha!e ade you two offers. *he first offer includes annual gifts of 51030003
51130003 and 51%3000 at the end of each of the ne,t three years3 respecti!ely. *he other offer is
the payent of one lup su aount today. 4ou are trying to decide which offer to accept
gi!en the fact that your discount rate is 1 percent. &hat is the iniu aount that you will
accept today if you are to select the lup su offer?
A. 5%13%16
". 5%23)0-
C. 5%23'6-
D. 5'03)'2
$. 5'03621

AACSB: Analytic
Difficulty: Basic
Section: "%/

6-2+
-1. 4ou are considering changing 7obs. 4our goal is to worA for three years and then return to
school full-tie in pursuit of an ad!anced degree. A potential eployer 7ust offered you an
annual salary of 5)130003 5))30003 and 5)63000 a year for the ne,t three years3 respecti!ely.
All salary payents are ade as lup su payents at the end of each year. *he offer also
includes a starting bonus of 5%3+00 payable iediately. &hat is this offer worth to you
today at a discount rate of 6.-+ percent?
A. 511%3)06
". 511+3+)+
C. 511-3'''
D. 51%13%1%
$. 51')362-

AACSB: Analytic
Difficulty: Basic
Section: "%/

-%. 4ou are considering a pro7ect which will pro!ide annual cash inflows of 5)3+003 5+3-003
and 513000 at the end of each year for the ne,t three years3 respecti!ely. &hat is the present
!alue of these cash flows3 gi!en a 2 percent discount rate?
A. 51)31--
B. 51+310'
C. 51+3)%2
D. 5163'11
$. 51631)-

AACSB: Analytic
Difficulty: Basic
Section: "%/

6-26
-'. 4ou 7ust signed a consulting contract that will pay you 5'+30003 5+%30003 and 5103000
annually at the end of the ne,t three years3 respecti!ely. &hat is the present !alue of these
cash flows gi!en a 10.+ percent discount rate?
A. 51''3++)
". 51)%3'0-
C. 51)13110
D. 51+131'1
$. 51+63210

AACSB: Analytic
Difficulty: Basic
Section: "%/

-). 4ou ha!e soe property for sale and ha!e recei!ed two offers. *he first offer is for
5123+00 today in cash. *he second offer is the payent of 5'+3000 today and an additional
5-03000 two years fro today. 9f the applicable discount rate is 11.+ percent3 which offer
should you accept and why?
A. 4ou should accept the 5123+00 today because it has the higher net present !alue.
". 4ou should accept the 5123+00 today because it has the lower future !alue.
C. 4ou should accept the first offer as it has the greatest !alue to you.
D. 4ou should accept the second offer because it has the larger net present !alue.
$. 9t does not atter which offer you accept as they are e#ually !aluable.

AACSB: Analytic
Difficulty: Basic
Section: "%/

6-2-
-+. 4our local tra!el agent is ad!ertising an upscale winter !acation pacAage for tra!el three
years fro now to Antarctica. *he pacAage re#uires that you pay 5%+3000 today3 5'03000 one
year fro today3 and a final payent of 5)+3000 on the day you depart three years fro today.
&hat is the cost of this !acation in todayBs dollars if the discount rate is 2.-+ percent?
A. 5163'-6
". 512362+
C. 5213%12
D. 5213)0-
$. 52'3)-1

AACSB: Analytic
Section: "%/

-6. 6ne year ago3 Deltona <otor :arts deposited 5163+00 in an in!estent account for the
purpose of buying new e#uipent three years fro today. *oday3 it is adding another 51%3000
to this account. *he copany plans on aAing a final deposit of 5%03000 to the account one
year fro today. @ow uch will be a!ailable when it is ready to buy the e#uipent3 assuing
the account pays +.+ interest?
A. 5+'3)01
". 5+'3212
C. 5+63%11
D. 5+63-2%
$. 5+130%1

AACSB: Analytic
Bloom's: Analysis
Section: "%/
&o'ic: 1uture !alue

6-21
--. =ucas will recei!e 5631003 513-003 and 51%3+00 each year starting at the end of year one.
&hat is the future !alue of these cash flows at the end of year fi!e if the interest rate is -
percent?
A. 5'%3)11
". 5'%320-
C. 5''311'
D. 5'+3)11
$. 5'63%++

AACSB: Analytic
Bloom's: Analysis
Section: "%/
&o'ic: 1uture !alue

-1. 4ou plan on sa!ing 5+3%00 this year3 nothing ne,t year3 and 5-3+00 the following year.
4ou will deposit these aounts into your in!estent account at the end of each year. &hat
will your in!estent account be worth at the end of year three if you can earn 1.+ percent on
your funds?
A. 51'3+%1.1%
B. 51'36%1.+-
C. 51'320-.11
D. 51)3+%6.+0
$. 51)3--2.)0

AACSB: Analytic
Bloom's: Analysis
Section: "%/
&o'ic: 1uture !alue

6-22
-2. <iley e,pects to recei!e the following payents8 4ear 1 H 5603000I 4ear % H 5'+3000I
4ear ' H 51%3000. All of this oney will be sa!ed for her retireent. 9f she can earn an
a!erage of 10.+ percent on her in!estents3 how uch will she ha!e in her account %+ years
after aAing her first deposit?
A. 52-%3'-'
". 52123)+-
C. 5130063'11
D. 5131)-3+02
E. 513%'13--6

AACSB: Analytic
Difficulty: Basic
Section: "%/
&o'ic: 1uture !alue

6-100
10. "lacAwell3 9nc. has a 5-+3000 liability it ust pay three years fro today. *he copany is
opening a sa!ings account so that the entire aount will be a!ailable when this debt needs to
be paid. *he plan is to aAe an initial deposit today and then deposit an additional 51+3000
each year for the ne,t three years3 starting one year fro today. *he account pays a ).+
percent rate of return. @ow uch does the fir need to deposit today?
A. 5113%22.2+
". 5%030-%.21
C. 5%13)00.''
D. 5%)3)1-.-1
$. 5'130-6.+6

AACSB: Analytic
Difficulty: Basic
Section: "%/
&o'ic: 1uture !alue

6-101
11. *he go!ernent has iposed a fine on the Corner *a!ern. *he fine calls for annual
payents of 51+030003 510030003 5-+30003 and 5+030003 respecti!ely3 o!er the ne,t four
years. *he first payent is due one year fro today. *he go!ernent plans to in!est the funds
until the final payent is collected and then donate the entire aount3 including the
in!estent earnings3 to help the local counity shelter. *he go!ernent will earn 6.%+
percent on the funds held. @ow uch will the counity shelter recei!e four years fro
today?
A. 5')236-).06
". 5'6631-+.00
C. 5)%%3)2-.+6
D. 5)+13+-%.-1
$. 5+1+3-'-.6-

AACSB: Analytic
Difficulty: Basic
Section: "%/
&o'ic: 1uture !alue

1%. &icAer 9ports established a trust fund that pro!ides 5203000 in scholarships each year
for needy students. *he trust fund earns a fi,ed 6 percent rate of return. @ow uch oney did
the fir contribute to the fund assuing that only the interest incoe is distributed?
A. 5131+03000
". 513%003000
C. 513'''3'''
D. 513+003000
$. 5136003000

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: (er'etuity 'resent !alue

6-10%
1'. A preferred stocA pays an annual di!idend of 5%.60. &hat is one share of this stocA worth
today if the rate of return is 11.-+ percent?
A. 511.)1
". 5%0.00
C. 5%%.1'
D. 5%1.10
$. 5'0.++

AACSB: Analytic
Difficulty: Basic
Section: "%$

1). 4ou would liAe to establish a trust fund that will pro!ide 51%03000 a year fore!er for your
heirs. *he trust fund is going to be in!ested !ery conser!ati!ely so the e,pected rate of return
is only +.-+ percent. @ow uch oney ust you deposit today to fund this gift for your
heirs?
A. 5%301632+-
". 5%31%13%1%
C. 5%3'003000
D. 5%3)+131%%
$. 5%3+003000

AACSB: Analytic
Difficulty: Basic
Section: "%$

6-10'
1+. 4ou 7ust paid 5-+03000 for an annuity that will pay you and your heirs 5)+3000 a year
fore!er. &hat rate of return are you earning on this policy?
A. +.%+ percent
". +.+0 percent
C. +.-+ percent
D. 6.00 percent
$. 6.%+ percent

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: (er'etuity

16. 4ou grandfather won a lottery years ago. *he !alue of his winnings at the tie was
5+03000. @e in!ested this oney such that it will pro!ide annual payents of 5%3)00 a year to
his heirs fore!er. &hat is the rate of return?
A. ).-+ percent
B. ).10 percent
C. +.00 percent
D. +.10 percent
$. +.1+ percent

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: (er'etuity rate

6-10)
1-. *he preferred stocA of Casco has a +.)1 percent di!idend yield. *he stocA is currently
priced at 5+2.'0 per share. &hat is the aount of the annual di!idend?
A. 5%.10
". 5%.2+
C. 5'.10
D. 5'.%+
$. 5'.)0
C H 5+2.'0 0.0+)1 H 5'.%+

AACSB: Analytic
Difficulty: Basic
Section: "%$

11. 4our credit card copany charges you 1.6+ percent interest per onth. &hat is the annual
percentage rate on your account?
A. 11.2+ percent
B. 12.10 percent
C. %0.20 percent
D. %1.%+ percent
$. %1.-0 percent
A:J H 0.016+ 1% H 12.10 percent

AACSB: Analytic
Difficulty: Basic
Section: "%*

6-10+
12. &hat is the annual percentage rate on a loan with a stated rate of %.%+ percent per
#uarter?
A. 2.00 percent
". 2.02 percent
C. 2.11 percent
D. 2.%- percent
$. 2.'1 percent
A:J H 0.0%%+ ) H 2.00 percent

AACSB: Analytic
Difficulty: Basic
Section: "%*

20. 4ou are paying an effecti!e annual rate of 11.2-) percent on your credit card. *he interest
is copounded onthly. &hat is the annual percentage rate on this account?
A. 1-.+0 percent
". 11.00 percent
C. 11.%+ percent
D. 11.6) percent
$. 12.00 percent

AACSB: Analytic
Difficulty: Basic
Section: "%*

6-106
21. &hat is the effecti!e annual rate if a banA charges you 2.+0 percent copounded
#uarterly?
A. 2.6% percent
". 2.61 percent
C. 2.-% percent
D. 2.1) percent
$. 2.21 percent

AACSB: Analytic
Difficulty: Basic
Section: "%*

2%. 4our credit card copany #uotes you a rate of 1-.2 percent. 9nterest is billed onthly.
&hat is the actual rate of interest you are paying?
A. 12.0' percent
". 12.%1 percent
C. 12.)) percent
D. 12.+- percent
$. 12.-% percent

AACSB: Analytic
Difficulty: Basic
Section: "%*
&o'ic: +ffecti!e interest rate

6-10-
2'. *he :awn >hop loans oney at an annual rate of %1 percent and copounds interest
weeAly. &hat is the actual rate being charged on these loans?
A. %'.16 percent
B. %'.'% percent
C. %'.)2 percent
D. %'.+6 percent
$. %'.6) percent

AACSB: Analytic
Difficulty: Basic
Section: "%*

2). 4ou are considering two loans. *he ters of the two loans are e#ui!alent with the
e,ception of the interest rates. =oan A offers a rate of -.-+ percent3 copounded daily. =oan "
offers a rate of 1 percent3 copounded sei-annually. &hich loan should you select and
why?
A. AI the effecti!e annual rate is 1.06 percent.
". AI the annual percentage rate is -.-+ percent.
C. "I the annual percentage rate is -.61 percent.
D. "I the effecti!e annual rate is 1.16 percent.
$. *he loans are e#ui!alent offers so you can select either one.

AACSB: Analytic
Bloom's: Analysis
Section: "%*

6-101
2+. 4ou ha!e 5+3600 that you want to use to open a sa!ings account. *here are fi!e banAs
located in your area. *he rates paid by banAs A through $3 respecti!ely3 are gi!en below.
&hich banA should you select if your goal is to a,ii(e your interest incoe?
A. '.%6 percent3 copounded annually
". '.%0 percent3 copounded onthly
C. '.%+ percent3 copounded sei-annually
D. '.10 percent3 copounded continuously
$. '.1+ percent3 copounded #uarterly
$AJA H '.%6 percent
"anA C offers the highest effecti!e annual rate at '.%-6 percent.

AACSB: Analytic
Bloom's: Analysis
Section: "%*

6-102
26. &hat is the effecti!e annual rate of 1).2 percent copounded continuously?
A. 1+.+2 percent
". 1+.6% percent
C. 1+.62 percent
D. 1+.1) percent
E. 16.0- percent

AACSB: Analytic
Difficulty: Basic
Section: "%*
&o'ic: Continuous com'ounding

2-. &hat is the effecti!e annual rate of 2.-+ percent copounded continuously?
A. 10.1- percent
B. 10.%) percent
C. 10.%2 percent
D. 10.'' percent
$. 10.)- percent

AACSB: Analytic
Difficulty: Basic
Section: "%*

6-110
21. City "anA wants to appear copetiti!e based on #uoted loan rates and thus ust offer a
-.-+ percent annual percentage rate on its loans. &hat is the a,iu rate the banA can
actually earn based on the #uoted rate?
A. 1.06 percent
". 1.1) percent
C. 1.%1 percent
D. 1.%6 percent
$. 1.+1 percent

AACSB: Analytic
Difficulty: Basic
Section: "%*

22. 4ou are going to loan a friend 5200 for one year at a + percent rate of interest3
copounded annually. @ow uch additional interest could you ha!e earned if you had
copounded the rate continuously rather than annually?
A. 50.2-
B. 51.1)
C. 51.%'
D. 51.'6
$. 51.)1
Additional interest H 5200 .0.0+1%-11 - 0.0+/ H 51.1)

AACSB: Analytic
Bloom's: Analysis
Section: "%*
&o'ic: ,nterest com'ounding

6-111
100. 4ou are borrowing oney today at 1.)1 percent3 copounded annually. 4ou will repay
the principal plus all the interest in one lup su of 51%3100 two years fro today. @ow
uch are you borrowing?
A. 523200.00
". 5103%11.16
C. 51031--.0)
D. 5113)01.16
$. 5113%+0.00

AACSB: Analytic
Difficulty: Basic
Section: "%)

6-11%
101. *his orning3 you borrowed 523+00 at -.6+ percent annual interest. 4ou are to repay the
loan principal plus all of the loan interest in one lup su four years fro today. @ow uch
will you ha!e to repay?
A. 51%3-+-.2%
". 51%3101.1'
C. 51%3211.12
D. 51'3006.01
$. 51'3))1.%0

AACSB: Analytic
Difficulty: Basic
Section: "%)

10%. 6n this date last year3 you borrowed 5'3)00. 4ou ha!e to repay the loan principal plus all
of the interest si, years fro today. *he payent that is re#uired at that tie is 563000. &hat
is the interest rate on this loan?
A. 1.01 percent
B. 1.)+ percent
C. 1.-1 percent
D. 2.)- percent
$. 2.2' percent

AACSB: Analytic
Difficulty: Basic
Section: "%)

6-11'
10'. DohnBs Auto Jepair 7ust tooA out an 51230003 10-year3 1 percent3 interest-only loan fro
the banA. :ayents are ade annually. &hat is the aount of the loan payent in year 10?
A. 5-31%0
". 5131+0
C. 51'3%6)
D. 5123000
E. 52631%0
:ayent in year 10 H 5123000 M .5123000 0.01/ H 52631%0

AACSB: Analytic
Difficulty: Basic
Section: "%)

10). 6n the day you entered college3 you borrowed 5113000 on an interest-only3 four-year
loan at +.%+ percent fro your local banA. :ayents are to be paid annually. &hat is the
aount of your loan payent in year %?
A. 52)+
". 513120
C. 5'3600
D. 5+3106
$. 563%+0
:ayent in year % H 5113000 0.0+%+ H 52)+

AACSB: Analytic
Difficulty: Basic
Section: "%)

6-11)
10+. 6n the day you entered college you borrowed 5%+3000 fro your local banA. *he ters
of the loan include an interest rate of ).-+ percent. *he ters stipulate that the principal is due
in full one year after you graduate. 9nterest is to be paid annually at the end of each year.
Assue that you coplete college in four years. @ow uch total interest will you pay on this
loan?
A. 5+3%66.6-
". 5+3)00.00
C. 5+32'-.+0
D. 563+%2.00
$. 56360-.11
*otal interest paid H 5%+3000 0.0)-+ + H 5+32'-.+0

AACSB: Analytic
Difficulty: Basic
Section: "%)

106. 4ou 7ust ac#uired a ortgage in the aount of 5%)23+00 at 6.-+ percent interest3
copounded onthly. $#ual payents are to be ade at the end of each onth for thirty
years. @ow uch of the first loan payent is interest? .Assue each onth is e#ual to 1K1%
of a year./
A. 52%+.%0
". 513%06.16
C. 513)0'.))
D. 513+11.%1
$. 513+)1.60
9nterest portion of first loan payent H

AACSB: Analytic
Bloom's: Analysis
Section: "%)

6-11+
10-. 6n Dune 13 you borrowed 5%1%3000 to buy a house. *he ortgage rate is 1.%+ percent.
*he loan is to be repaid in e#ual onthly payents o!er 1+ years. *he first payent is due on
Duly 1. @ow uch of the second payent applies to the principal balance? .Assue that each
onth is e#ual to 1K1% of a year./
A. 560'.'%
". 5621.1)
C. 513'+1.+6
D. 513)+'.'1
$. 5%30+6.-0

AACSB: Analytic
Bloom's: Analysis
Section: "%$

6-116
101. *his orning3 you borrowed 51+03000 to buy a house. *he ortgage rate is -.'+ percent.
*he loan is to be repaid in e#ual onthly payents o!er %0 years. *he first payent is due
one onth fro today. @ow uch of the second payent applies to the principal balance?
.Assue that each onth is e#ual to 1K1% of a year./
A. 5%61.1)
B. 5%--.61
C. 521-.06
D. 52%+.1'
$. 51312).6-

AACSB: Analytic
Bloom's: Analysis
Section: "%$

6-11-
Essay Questions

102. $,plain the difference between the effecti!e annual rate .$AJ/ and the annual
percentage rate .A:J/. 6f the two3 which one has the greater iportance and why?
*he A:J is a stated rate and is coputed as .r n/3 where r is the rate per period and n is the
nuber of periods per year. *he $AJ considers copounding and is coputed as .1 M r/
n
- 13
where r is the rate per period and n is the nuber of periods per year. *he effecti!e annual rate
will always be higher than the annual percentage rate as long as the account is copounded
ore than once a year and the interest rate is greater than (ero. *he $AJ is the e#ui!alent rate
based on annual copounding. *he $AJ has greater iportance because it is the actual cost
of a loan.
FeedbacA8 Jefer to section 6.'

AACSB: 2eflecti!e t.in3ing
Bloom's: Analysis
Section: "%*
&o'ic: Annual and effecti!e rates

110. 4ou are considering two annuities3 both of which pay a total of 5%03000 o!er the life of
the annuity. Annuity A pays 5%3000 at the end of each year for the ne,t 10 years. Annuity "
pays 513000 at the end of each year for the ne,t %0 years. &hich annuity has the greater !alue
today? 9s there any circustance where the two annuities would ha!e e#ual !alues as of
today? $,plain.
As long as the discount rate is positi!e3 Annuity A will ha!e the greater !alue. 9f the discount
rate is (ero3 then both annuities ha!e e#ual !alues as both would ha!e a current !alue of
5%03000.
FeedbacA8 Jefer to section 6.%

Bloom's: Analysis
Section: "%$

6-111
111. &hy ight a borrower select an interest-only loan instead of an aorti(ed loan3 which
would be cheaper?
*he borrower ight need the entire principal aount for the length of the loan period. &ith
an aorti(ed loan3 the principal aount is repaid o!er the loan ter and thus the borrower
does not ha!e all of the loan proceeds a!ailable for his or her use during the loan ter.
FeedbacA8 Jefer to section 6.)

Bloom's: Synt.esis
Section: "%)
&o'ic: Loan re'ayment

6-112
11%. Fristie owns a perpetuity which pays 51%3000 at the end of each year. >he coes to you
and offers to sell you all of the payents to be recei!ed after the 10
th
year. $,plain how you
can deterine the !alue of this offer.
4ou should deterine the present !alue of the perpetuity and also the present !alue of the first
10 payents at your discount rate. *he difference between the two !alues is the a,iu
aount you should pay for this offer. .Assuing a noral rate of interest3 the offer will ost
liAely be worth less than +0 percent of the perpetuityBs total !alue./
@ereBs an e,aple that can be used to e,plain this answer using an assued 1 percent rate of
interest.

Value of offer at 1 percent H 51+03000 - 5103+%0.21 H 5623)-2.0%
FeedbacA8 Jefer to section 6.%

AACSB: Analytic and reflecti!e t.in3ing
Bloom's: +!aluation
Section: "%$
&o'ic: (er'etuity and annuity !alues

6-1%0

11'. &estern "anA offers you a 5%130003 6-year ter loan at 1 percent annual interest. &hat is
the aount of your annual loan payent?
A. 5)3%%1.+0
B. 5)3+)%.6%
C. 5)3666.6-
D. 5)3201.11
$. 5+3'11.0-

AACSB: Analytic
Difficulty: Basic
+OC 4: "#5
Section: "%$
&o'ic: Loan 'ayment

11). First Century "anA wants to earn an effecti!e annual return on its consuer loans of 10
percent per year. *he banA uses daily copounding on its loans. "y law3 what interest rate is
the banA re#uired to report to potential borrowers?
A. 2.%' percent
". 2.'1 percent
C. 2.+' percent
D. 2.-% percent
$. 10.00 percent
A:J H '6+ N.1 M 0.10/
1K'6+
- 1O H 2.+' percent

AACSB: Analytic
+OC 4: "#/6
Section: "%*

6-1%1
11+. Downtown "anA is offering '.) percent copounded daily on its sa!ings accounts. 4ou
deposit 513000 today. @ow uch will you ha!e in your account 11 years fro now?
A. 51136%1.02
". 5113-1).06
C. 51%3%0).+0
D. 51%3''6.11
$. 51%3)1).1)
FV H 513000 N1 M .0.0')K'6+/O
11

'6+
H 51136%1.02

AACSB: Analytic
Difficulty: Basic
+OC 4: "#/7
Section: "%/
&o'ic: 1uture !alue

116. 4ou want to buy a new sports coupe for 5)13-+03 and the finance office at the dealership
has #uoted you an 1.6 percent A:J loan copounded onthly for )1 onths to buy the car.
&hat is the effecti!e interest rate on this loan?
A. 1.%1 percent
". 1.)1 percent
C. 1.-% percent
D. 1.1- percent
E. 1.2+ percent
$AJ H N1 M ..016K1%/O
1%
- 1 H 1.2+ percent

AACSB: Analytic
Difficulty: Basic
+OC 4: "#$8
Section: "%*
&o'ic: +ffecti!e interest rate

6-1%%
11-. "eginning three onths fro now3 you want to be able to withdraw 513+00 each #uarter
fro your banA account to co!er college e,penses o!er the ne,t ) years. *he account pays
1.%+ percent interest per #uarter. @ow uch do you need to ha!e in your account today to
eet your e,pense needs o!er the ne,t ) years?
A. 5%136'0.))
". 5%131)-.1+
C. 5%%3061.00
D. 5%%3)+).02
$. 5%%3-11.11

AACSB: Analytic
Difficulty: Basic
+OC 4: "#$"
Section: "%/

6-1%'
111. 4ou are planning to sa!e for retireent o!er the ne,t 1+ years. *o do this3 you will in!est
513100 a onth in a stocA account and 5+00 a onth in a bond account. *he return on the
stocA account is e,pected to be - percent3 and the bond account will pay ) percent. &hen you
retire3 you will cobine your oney into an account with a + percent return. @ow uch can
you withdraw each onth during retireent assuing a %0-year withdrawal period?
A. 5%36'6.12
". 5%320).11
C. 5'3001.%1
D. 5'311'.0)
$. 5'3)06.2-

AACSB: Analytic
Bloom's: Analysis
+OC 4: "#*$
Section: "%$

6-1%)
112. 4ou want to be a illionaire when you retire in )0 years. 4ou can earn an 11 percent
annual return. @ow uch ore will you ha!e to sa!e each onth if you wait 10 years to start
sa!ing !ersus if you start sa!ing at the end of this onth?
A. 5-2.%%
". 511).1'
C. 5161.)-
D. 5%01.1+
E. 5%)0.%2
FVA)0 years H 5130003000 H C NPN1 M .0.11K1%/O
)0

1%
I C H 5116.%1
FVA'0 years H 5130003000 H C NPN1 M .0.11K1%/O
'0

1%
I C H 5'+6.+-
Difference H 5'+6.+- - 5116.%1 H 5%)0.%2

AACSB: Analytic
Bloom's: Analysis
+OC 4: "#*)
Section: "%$

1%0. 4ou ha!e 7ust won the lottery and will recei!e 5+)03000 as your first payent one year
fro now. 4ou will recei!e payents for %6 years. *he payents will increase in !alue by )
percent each year. *he appropriate discount rate is 10 percent. &hat is the present !alue of
your winnings?
A. 563%%13)0-
B. 5632063'-%
C. 5-3++2361'
D. 5-31113)06
$. 51300'.11

AACSB: Analytic
+OC 4: "#*7
Section: "%$

6-1%+
1%1. 4ou are preparing to aAe onthly payents of 56+3 beginning at the end of this onth3
into an account that pays 6 percent interest copounded onthly. @ow any payents will
you ha!e ade when your account balance reaches 523%-1?
A. 2-
B. 101
C. 112
D. 1%)
$. 1'1
t H ln 1.-1'-Kln 1.00+I t H 101 payents

AACSB: Analytic
+OC 4: "#)8
Section: "%$
&o'ic: Number of 'ayments

1%%. 4ou want to borrow 5)-31-0 fro your local banA to buy a new sailboat. 4ou can afford
to aAe onthly payents of 5131603 but no ore. Assue onthly copounding. &hat is
the highest rate you can afford on a )1-onth A:J loan?
A. 1.'1 percent
". 1.6- percent
C. 1.1% percent
D. 2.01 percent
$. 2.11 percent

AACSB: Analytic
+OC 4: "#)/
Section: "%$

6-1%6
1%'. 4ou need a %+-year3 fi,ed-rate ortgage to buy a new hoe for 5%)03000. 4our
ortgage banA will lend you the oney at a -.+ percent A:J for this '00-onth loan3 with
interest copounded onthly. @owe!er3 you can only afford onthly payents of 51+03 so
you offer to pay off any reaining loan balance at the end of the loan in the for of a single
balloon payent. &hat will be the aount of the balloon payent if you are to Aeep your
onthly payents at 51+0?
A. 5-'13)6)
". 5-)+3'16
C. 5-6-3)10
D. 51103%%0
$. 51)-3'1+
Jeaining principal H 5%)03000 - 511+30%1.6- H 51%)32-1.''
"alloon payent H 51%)32-1.'' N1 M .0.0-+K1%/O
%+

1%
H 51103%%0

AACSB: Analytic
Bloom's: Analysis
+OC 4: "#)$
Section: "%$
&o'ic: Loan 'ayment

6-1%-
1%). *he present !alue of the following cash flow strea is 5+32''.16 when discounted at 11
percent annually. &hat is the !alue of the issing cash flow?

A. 513+00
". 513-+0
C. 5%3000
D. 5%3%+0
E. 5%3+00
:V of issing cash flow H 5+32''.16 - .5%3000K1.11/ - .513-+0K1.11
'
/ - .513%+0K1.11
)
/ H
5%30%2.06
CF% H 5%30%2.06 1.11
%
H 5%3+00

AACSB: Analytic
+OC 4: "#)*
Section: "%/

6-1%1
1%+. 4ou ha!e 7ust purchased a new warehouse. *o finance the purchase3 youB!e arranged for
a '0-year ortgage loan for 10 percent of the 5%36003000 purchase price. *he onthly
payent on this loan will be 5113000. &hat is the effecti!e annual rate on this loan?
A. ).21 percent
". +.%+ percent
C. +.)6 percent
D. 6.01 percent
$. 6.+0 percent
=oan aount H 5%36003000 0.10 H 5%30103000
$AJ H N1 M ..0)1-K1%/O
1%
- 1 H ).21 percent

AACSB: Analytic
Bloom's: Analysis
+OC 4: "#)6
Section: "%*

1%6. Consider a fir with a contract to sell an asset ' years fro now for 5203000. *he asset
costs 5-13000 to produce today. At what rate will the fir 7ust breaA e!en on this contract?
A. -.1- percent
". 1.01 percent
C. 1.%' percent
D. 1.+- percent
$. 1.20 percent
5203000 H 5-13000 .1 M r/
'
I r H 1.%' percent

AACSB: Analytic
Bloom's: Analysis
+OC 4: "#)"
Section: "%$
&o'ic: Brea3#e!en interest

6-1%2
1%-. &hat is the present !alue of 513100 per year3 at a discount rate of 10 percent if the first
payent is recei!ed 6 years fro now and the last payent is recei!ed %1 years fro now?
A. 56306-.'6
". 5631'1.1-
C. 563'''.''
D. 563)%0.1%
$. 563+11.01
:V H 523--1.+)K1.1
+
H 56306-.'6

AACSB: Analytic
+OC 4: "#)7
Section: "%$

1%1. 4ou ha!e your choice of two in!estent accounts. 9n!estent A is a +-year annuity that
features end-of-onth 5%3+00 payents and has an interest rate of 11.+ percent copounded
onthly. 9n!estent " is a 10.+ percent continuously copounded lup su in!estent3 also
good for fi!e years. @ow uch would you need to in!est in " today for it to be worth as uch
as in!estent A fi!e years fro now?
A. 51013%06.6-
B. 511231-6.06
C. 51%)3'11.01
D. 51%23)0-.1-
$. 51'13001.1+
FVA H 5%3+00 NPN1 M .0.11+K1%/O
+

1%
-1QK.0.11+K1%/O H 5%013)6%.%'
:V H 5%013)6%.%' e
-1

0.10+

+
H 511231-6.06

AACSB: Analytic
+OC 4: "#)5
Section: "%*

6-1'0
1%2. ?i!en an interest rate of 1 percent per year3 what is the !alue at date t H 2 of a perpetual
strea of 5+00 annual payents that begins at date t H 1-?
A. 5'36)6.11
". 5)3102.12
C. 5)3'0-.-1
D. 563%+0.00
$. 563)1-.1-
:Vt H 16 H 5+00K.01 H 563%+0
:Vt H 2 H 563%+0K1.01
16-2
H 5'36)6.11

AACSB: Analytic
+OC 4: "#68
Section: "%$

1'0. 4ou want to buy a new sports car for 5++3000. *he contract is in the for of a 60-onth
annuity due at a 6 percent A:J3 copounded onthly. &hat will your onthly payent be?
A. 5130)-.20
". 5130+'.1-
C. 5130+1.01
D. 51306'.'0
$. 5130-%.11

AACSB: Analytic
+OC 4: "#6)
Section: "%$
&o'ic: Annuity due

6-1'1
1'1. 4ou are looAing at a one-year loan of 5103000. *he interest rate is #uoted as 10 percent
plus + points. A point on a loan is siply 1 percent .one percentage point/ of the loan aount.
Luotes siilar to this one are !ery coon with hoe ortgages. *he interest rate #uotation
in this e,aple re#uires the borrower to pay + points to the lender up front and repay the loan
later with 10 percent interest. &hat is the actual rate you are paying on this loan?
A. 1+.00 percent
". 1+.)- percent
C. 1+.++ percent
D. 1+.-2 percent
$. 1+.1) percent
=oan aount recei!ed H 5103000 .1 - .0+/ H 523+00
=oan repayent aount H 5103000 1.10
1
H 5113000
5113000 H 523+00 .1 M r/
1
I r H 1+.-2 percent

AACSB: Analytic
Bloom's: Synt.esis
Difficulty: C.allenge
+OC 4: "#"$
Section: "%)
&o'ic: +ffecti!e rate wit. 'oints

6-1'%
1'%. 4our holiday sAi !acation was great3 but it unfortunately ran a bit o!er budget. All is not
lost. 4ou 7ust recei!ed an offer in the ail to transfer your 5+3000 balance fro your current
credit card3 which charges an annual rate of 11.- percent3 to a new credit card charging a rate
of 2.) percent. 4ou plan to aAe payents of 5+10 a onth on this debt. @ow any less
payents will you ha!e to aAe to pay off this debt if you transfer the balance to the new
card?
A. 0.'6 payents
B. 0.)1 payents
C. 1.10 payents
D. 1.%' payents
$. %.)2 payents
5+3000 H 5+10 N.1 - P1 M .0.02)K1%/OQ
t
/K.0.02)K1%/O
t H ln .1K0.2%'%/Kln 1.00-1''I t H 10.%) payents
Difference H 10.-% - 10.%) H 0.)1 payents

AACSB: Analytic
Bloom's: Analysis
Difficulty: C.allenge
+OC 4: "#"7
Section: "%$
&o'ic: Number of 'eriods

6-1''

Chap 006

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chap 006

Uploaded by

Copyright:

Available Formats

Chapter 06 - Discounted Cash Flow Valuation

You might also like