Deck 3: The Time Value of Money

Question 1

Discounting

A)expresses the present in the future
B)brings the future back to the present
C)is synonymous with compounding
D)depends on the rate of interest

Answer 1

B

Question 2

Compounding refers to the earning of interest on interest earned previously.

Answer 2

True

Question 3

Which is the largest if the interest rate is 7 percent?

A)$100 compounded for three years
B)the future value of a $100 annuity for three years
C)the present value of $100 after three years
D)the present value of a $100 annuity

Answer 3

B

Question 4

The future value of an annuity of $100 at 3 percent for ten years exceeds $1,000.

Question 5

The future value of an ordinary annuity will exceed the future value of an annuity due.

Question 6

The concept of the time value of money is a means to bring together the present and the future.

Question 7

If a bank pays 2 percent compounded daily, the true rate of interest is greater than 2 percent.

Question 8

The present value of an annuity due exceeds the present value of an ordinary annuity.

Question 9

If interest rates are 0 percent, an annuity of $100 for ten years is the same as $1,000 today.

Question 10

If the first payment made by an annuity is today, that is an "ordinary annuity" and not an "annuity due."

Question 11

A series of equal payments is called an annuity.

Question 12

The future value of a dollar
1. increases with higher interest rates
2. decreases with higher interest rates
3. increases as the time period increases
4. decreases as the time period increases

A)1 and 3
B)1 and 4
C)2 and 3
D)2 and 4

Question 13

The present value of a dollar increases as the number of years increases.

Question 14

The present value of an annuity increases as the number of years increases.

Question 15

The future value of an annuity is
1. larger the higher the rate of interest
2. smaller the higher the rate of interest
3. larger the greater the number of years
4. smaller the greater the number of years

A)1 and 3
B)1 and 4
C)2 and 3
D)2 and 4

Question 16

The larger the rate of interest, the smaller is the future value of a dollar.

Question 17

The present value of an annuity due is not affected by the frequency of compounding.

Question 18

The present value of a dollar
1. increases as the interest rate increases
2. decreases as the interest rate increases
3. increases as the time period increases
4. decreases as the time period increases

A)1 and 3
B)1 and 4
C)2 and 3
D)2 and 4

Question 19

An annuity is a series of

A)rising annual payments
B)random payments
C)equal payments
D)unequal payments

Question 20

An increase in the rate of interest from 4 percent to 5 percent increases the present value of an annuity.

Question 21

An investment offers $10,000 at the end of each year for ten years. (a)If you can earn 5 percent annually, what is this investment worth today? (b)If you do not spend the annual payment but invest it at 5 percent, how much will you have after the ten years have lapsed?

Question 22

EEM, INC has a $1,000,000 debt outstanding that is due after 15 years. The contract requires that after five years, the firm must set aside annually an amount so the debt is retired in full at maturity. If EEM can earn 8 percent on invested funds, how much must the company set aside each year?

Question 23

AIR National's capacity is 120 passengers per flight. It currently carries 74 passengers per flight. Growth in passengers is expected to be 6 percent annually. New plans will have to be ordered when the company is carrying 90 percent of capacity. How long will it be before the firm must order new planes?

Question 24

A state's lottery winner is promised $200,000 a year for twenty years (starting at the end of the first year). How much must the state invest now to guarantee the prize if the state can earn annually 7 percent on its funds? How much must the state invest if the annual payments are to be made at the beginning of the year?

Question 25

Your brother, who is prone to bearing substantial risk, suggests that you buy a security for $10,000 that promises to pay you $100,000 at the end of 15 years. What is the implied annual return or yield on this investment?

Question 26

Worker A annually invests $1,000 in an IRA for nine years (ages 27 through 35)and never makes another contribution. Worker B annually invests $1,000 in an IRA for thirty years (ages 36 through 65). Which worker will have more in his or her account when he or she retires if they both earn 8 percent on their investments, assuming both investors work for a duration of thirty years?

Question 27

The future value of an annuity will be larger if
1. the annuity is an ordinary annuity
2. the annuity is an annuity due
3. the payments are made at the beginning of the year
4. the payments are made at the end of the year

A)1 and 3
B)1 and 4
C)2 and 3
D)2 and 4

Question 28

A firm currently earns $1.00 per share. A financial analyst believes that earnings will grow annually at the rate of 10 percent for five years and then decline to 5 percent. What are the expected earnings after ten years?

Question 29

A piece of rental property will generate $10,000 a year for five years, $12,000 for the next five years, and then be sold at the end of the tenth year for $100,000. If you can earn 10 percent on your funds, what is the maximum you should pay for the property? Note that there are unequal payments to consider.

Question 30

You are hurt in a car accident and your lawyer wins a $100,000 settlement to be distributed as follows:
$20,000 immediate payment
$5,000 a year for ten years
$30,000 after ten years.
If the lawyer's fee is $10,000, what is the net value of this settlement if the interest rate is 6 percent?

Question 31

Time value concepts may be used to determine
1. the annual growth rate in dividends
2. the amount in an IRA account after ten years
3. the tax owed on a capital gain

A)1 and 2
B)1 and 3
C)2 and 3
D)only 2

Question 32

A firm has a $1,000,000 debt (e.g., a bond)outstanding that matures after 10 years. The sinking fund requires the firm to set aside annually an amount so the debt may be retired at maturity. If the firm can earn 10% annually on these funds, how much must it invest annually to meet the sinking fund?

Question 33

A homeowner has a ten-year home-improvement loan for $36,875. What are the annual payments required by the loan if the annual rate of interest is 4 percent?

Question 34

If you open an IRA and invest $3,000 a year (at the end of the year), how much will be in the account after twenty-five years if the funds earn 5 percent annually? How much would be in the account if payments were made at the beginning of the year?

Question 35

Which is the smallest if the interest rate is 8 percent?

A)$100 to be received after five years
B)the present value of an annuity of $100 for five years
C)$100 received in the present
D)$100 received for two years

Question 36

Time value concepts may not be used to determine

A)the present value of an annuity
B)the margin required on a stock purchase
C)the future value of $100 deposited in a bank
D)the present value of a lump sum

Question 37

You wish to have $100,000 after ten years for a major purchase such as a boat. How much must you invest at the end of each year if you earn 8 percent annually on your funds?

Question 38

Your uncle plans to leave you an inheritance of $200,000. If his life expectancy is twenty years, what is your inheritance currently worth if the anticipated return on investments is 9 percent?

Question 39

An investor expects the price of a stock to double after eight years. What is the expected annual rate of growth?

Question 40

The present value of an annuity is
1. larger the greater the rate of interest
2. smaller the greater the rate of interest
3. larger as the number of years increases
4. smaller as the number of years increases

A)1 and 3
B)1 and 4
C)2 and 3
D)2 and 4

Question 41

A state lotto awarded a prize of $560,000 a year for the next 20 years starting today. If the state sold $21,900,000 in lotto tickets, what proportion of the sales will the state distribute if it earns 8% annually on invested funds?