Question 1

Which one of the following would have the greatest value assuming each has Year 1 annual cash flows of $100 and a discount rate of 8 percent,compounded annually?

Accepted Answer

A growing perpetuity has increasing cash flows each year, which would result in a greater value compared to a standard perpetuity or annuity. A growing annuity would also have increasing cash flows, but it would not be perpetual like a growing perpetuity, so C is the better choice.

Question 2

By federal law,lenders must disclose which one of these?

Accepted Answer

Federal law requires lenders to disclose the APR (Annual Percentage Rate), which includes fees and other noninterest charges. This is the most inclusive and accurate representation of the loan's cost to the borrower. EAR (Effective Annual Rate) is not a required disclosure by federal law.

Question 3

The value of a firm is best defined as the:

Accepted Answer

The value of a firm is the present value of all of its future cash flows. Therefore, the total present value of all of the firm's future cash flows (option D) best defines the value of a firm.

Question 4

In which type of loan does the borrower initially receive the present value of the future lump sum loan repayment amount?

Accepted Answer

The borrower initially receives the present value of the future lump sum loan repayment amount in pure discount loans. This means that the loan is issued at a discount, with the borrower receiving less than the total amount to be repaid in the future. The borrower then repays the loan in a single lump sum at maturity, which is equal to the face value of the loan.

Question 5

The interest rate expressed as if it were compounded once per year is called the:

Accepted Answer

The effective annual rate (EAR) is the interest rate expressed as if it were compounded once per year, taking into account the effects of compounding over multiple periods within the year.

Question 6

You are comparing two investments,A and B,with unequal annual cash flows and varying numbers of years.Which one of these statements is correct regarding this comparison?

Accepted Answer

The answer of You are comparing two investments,A and B,with...

Question 7

Which of these are basic assumptions of the growing perpetuity present value formula?
I.The cash flow is the Time 0 cash flow.
II.The time periods are regular and discrete.
III.g < r
IV.The number of time periods is finite.

Accepted Answer

The growing perpetuity formula assumes that cash flow is received at regular and discrete time periods and that the growth rate is less than the discount rate. It does not assume that the cash flow is the Time 0 cash flow or that the number of time periods is finite. Therefore, options A, C, D, and E are incorrect. Option B includes only the correct assumptions.

Question 8

Lew's Tours is just about to pay an annual dividend of $1.20 a share.The dividend is expected to increase by 2 percent annually and the applicable discount rate is 13 percent.Which one of these is the correct formula for computing the current value of this stock?

Accepted Answer

The formula for computing the current value of a stock using the dividend growth model is: 
Current Value = Dividend / (Discount rate - Dividend growth rate)

Plugging in the given values: 
Dividend = $1.20 
Dividend growth rate = 2% = 0.02 
Discount rate = 13% = 0.13

Current Value = $1.20 / (0.13 - 0.02) 
Current Value = $1.20 / 0.11 
Current Value = $10.91

Therefore, the correct formula is option E: $1.20 + ($1.20 × 1.02)/(.13 - .02).

Question 9

Which term applies to a set of cash flows that are finite in number and increase in amount at a steady rate?

Accepted Answer

A growing annuity refers to a set of cash flows that are finite in number (i.e. they stop after a certain period of time) and increase in amount at a steady rate. This is different from a perpetuity, which has an infinite number of cash flows, and a growing perpetuity, which has an infinite number of cash flows that increase at a steady rate. An annuity is a set of cash flows that are of equal amounts and that occur at regular intervals, but they may not increase at a steady rate. A lump sum payment refers to a single payment of a certain amount, rather than a set of cash flows.

Question 10

Given a firm with positive annual cash flows,which one of the following will increase the current value of that firm?

Accepted Answer

Increasing the annual growth rate of the cash flows will increase the current value of the firm because it means future cash flows will be larger, enhancing the present value when discounted back to the present.

Question 11

An annuity stream where the payments occur forever is called a(n):

Accepted Answer

A perpetuity is an annuity stream with infinite payments occurring forever. An annuity due has payments that occur at the beginning of each period, while an ordinary annuity has payments that occur at the end of each period. Indemnity refers to compensation for losses or damages, and an amortized cash flow stream refers to a series of payments that gradually pay off a debt over time.

Question 12

Which of the following will increase the effective annual rate (EAR)of a loan?

Accepted Answer

Increasing either the annual percentage rate (APR) or the compounding frequency will increase the effective annual rate (EAR) of a loan. Decreasing the frequency of the interest rate compounding or applying only simple interest will decrease the EAR. Changing from continuous compounding to daily compounding of interest may increase or decrease the EAR depending on the interest rate and compounding frequency. Decreasing the annual percentage rate (APR) will also decrease the EAR.

Question 13

The interest rate charged per period multiplied by the number of periods per year is called the:

Accepted Answer

The answer of The interest rate charged per period multiplied...

Question 14

Annuities with payments occurring at the end of each time period are called _____,whereas annuities with payments occurring at the beginning of each time period are called _____.

Accepted Answer

Annuities with payments occurring at the end of each time period are called ordinary annuities, whereas annuities with payments occurring at the beginning of each time period are called annuities due. Therefore, the correct choice is B, ordinary annuities and annuities due.

Question 15

Which type(s)of loan can be repaid with annuity payments?

Accepted Answer

Only an amortized loan can be repaid with annuity payments as it involves paying both principal and interest in equal installments over the life of the loan. Pure discount and interest-only loans involve a lump sum repayment at maturity and are not suitable for annuity payments.

Question 16

Assume you start saving for retirement today.Which one of these is most apt to decrease the amount you have saved by the day you retire?

Accepted Answer

Delaying any additions to your savings by one year means that you will miss out on compounding interest for that year, which could decrease the amount you have saved by the time you retire. A one-year delay in retirement (choice A) would actually allow you to save more money and benefit from an extra year of compounding interest. Increasing your investment's average rate of return (choice B) or selecting an investment that compounds continuously (choice D) would both lead to an increase in the amount you have saved at retirement. Increasing the amount you save each year (choice C) would also lead to a higher overall amount saved at retirement.

Question 17

Which type(s)of loan repays the interest as an annuity and the principal as a lump sum?

Accepted Answer

The answer of Which type(s)of loan repays the interest as...

Question 18

Which one of these statements concerning two annuities is correct? Assume both annuities have $1,000 annual cash flows for four years.

Accepted Answer

An annuity due is more valuable than an ordinary annuity because it pays at the beginning of each period, allowing for an extra period of compounding. Therefore, the annuity due will have a higher present value compared to the ordinary annuity. The other statements are incorrect: A) The ordinary annuity pays at the end of each period, not the beginning. C) The annuity due will have the same number of payments as the ordinary annuity since both have four cash flows. D) The value of both annuities will be the same at the end of Year 4 only if the discount rate is zero. Otherwise, the annuity due will have a higher value at the end of Year 4 due to the extra period of compounding. E) Both annuities are not of equal value given any discount rate; the annuity due will have a higher present value.

Question 19

Jennings Lumber just paid an annual dividend of $1.20 a share.The dividend is expected to increase by 2 percent annually and the applicable discount rate is 13 percent.Which one of these is the correct formula for computing the current value of this stock?

Accepted Answer

The correct formula for computing the current value of a stock with constant growth is the Gordon Growth Model: P = D1 / (r - g), where D1 is the next year's dividend, r is the discount rate, and g is the growth rate. Here, D1 = $1.20 × 1.02, r = 0.13, and g = 0.02.

Question 20

A growing annuity is a set of:

Accepted Answer

A growing annuity refers to a series of cash flows that increase at a constant rate for a fixed number of periods. This distinguishes it from a perpetuity (answer B), which has level cash flows occurring indefinitely, and an ordinary annuity (answer E), which has level cash flows for a fixed period of time. Answer A is a general definition that does not accurately describe a growing annuity, and answer D is incorrect because it describes an annuity with increasing cash flows that occur indefinitely, which is not a common financial arrangement.

Quiz 4: Discounted Cash Flow Valuation