Question 1

A firm is considering an investment that will cost $2 million today and $2 million a year from now. It will generate revenues of $1 million a year for five years, beginning two years from now. If the interest rate is 10 percent, the firm should

Accepted Answer

To determine whether this investment is worthwhile, we need to calculate the net present value of the investment. We can use the formula:

NPV = (CF1 / (1+r)^1) + (CF2 / (1+r)^2) + ... + (CFn / (1+r)^n) - Initial Investment

where:
CF = cash flows
r = discount rate
n = number of periods

Using the information given in the problem:

NPV = (0 + 0 + 1 + 1 + 1 + 1) / (1+0.1)^2 - 2 - 2(1+0.1)^(-1) = -0.17

Since the NPV is negative, the present value of the net revenues is less than the present value of the investment spending. Therefore, the firm should not make the investment, making choice A the best answer.

Question 2

The real interest rate is the

Accepted Answer

The real interest rate is defined as the nominal interest rate minus the anticipated inflation rate. This is because inflation erodes the purchasing power of money over time, so the real interest rate reflects the actual increase in purchasing power that the lender will receive after accounting for inflation.

Question 3

What is the present value of $104.25 that you could receive one year from now, given that the rate of interest is 4.25 percent?

Accepted Answer

The present value (PV) is calculated using the formula PV = FV / (1 + r)^n, where FV is the future value ($104.25), r is the interest rate (4.25%), and n is the number of periods (1 year). Plugging in the values gives PV = $104.25 / (1 + 0.0425) = $100.

Question 4

The present value of a sum to be received in the future is greater

Accepted Answer

The present value of a future sum increases as the time period before receiving that sum decreases, because there is less time for the value to be discounted. Higher interest or discount rates actually decrease the present value, as they increase the rate at which future values are discounted back to the present. Inflation rate is not directly related to the calculation of present value in the context of this question.

Question 5

If the annual interest rate remains unchanged over the next two years, and the present value of $120 to be received one year from now is $100, what will $100 be worth two years from now?

Accepted Answer

If the present value of $120 to be received one year from now is $100, it means the interest rate is 20%. Therefore, $100 will be worth $120 after one year. 
Since the interest rate is assumed to remain the same over the next two years, the value of $120 after the first year will be worth $144 after the second year (20% of $120 is $24, so $120 + $24 = $144).

Question 6

The difference between the nominal rate of interest and the real rate of interest is

Accepted Answer

The nominal rate of interest is the stated rate of interest on a loan or investment, whereas the real rate of interest is the nominal rate adjusted for inflation. In other words, the real rate of interest is the nominal rate minus the anticipated rate of inflation. Therefore, the difference between the nominal rate and the real rate is the expected inflation rate.

Question 7

How much money would you have to put into a savings account today to be worth $500 three years from now at a market rate of interest equal to 8 percent?

Accepted Answer

To find the present value, use the formula: PV = FV / (1 + r)^n. Here, FV = $500, r = 0.08, and n = 3. PV = 500 / (1.08)^3 = $397.14, which rounds to $397.

Question 8

A star basketball player signs a contract that newspaper reports say is worth $10 million. The player receives $5 million on signing, and $5 million a year for three years. The contract is worth

Accepted Answer

The contract is worth less than $10 million in present value terms because the $5 million received in future years is worth less than $5 million today, due to the time value of money.

Question 9

The greater the risk of nonrepayment of a loan, other things being equal

Accepted Answer

When there is a greater risk of non-repayment of a loan, lenders will generally charge a higher rate of interest to compensate for the additional risk they are taking on. This is because they will need to earn more income from the loan to offset the potential losses from defaults. So, the higher the risk of non-repayment, the higher the rate of interest charged.

Question 10

Assuming a market rate of interest equal to 7 percent and anticipated inflation is 2 percent, what is the real (adjusted for inflation) present value of $200 to be received one year from today?

Accepted Answer

The real present value is calculated as the present value divided by (1 + inflation rate). In this case, the present value is $200 / (1 + 0.02) = $196.08.

Question 11

The general form for discounting is

Accepted Answer

The answer of The general form for discounting is
...

Question 12

Assuming a market rate of interest equal to 7 percent, what is the present value of $200 to be received one year from today?

Accepted Answer

The present value (PV) can be calculated using the formula PV = FV / (1 + r)^n, where FV is the future value ($200), r is the interest rate (0.07), and n is the number of periods (1 year). Plugging in the values gives PV = $200 / (1 + 0.07)^1 = $200 / 1.07 = $186.92, which rounds to $187.

Question 13

The present value of $100 to be received one year from now

Accepted Answer

The present value of a future amount of money cannot be accurately determined without knowing the interest rate, as it is essential for discounting the future amount back to its present value.

Question 14

The higher the expected rate of inflation,

Accepted Answer

The Fisher effect states that the nominal interest rate is equal to the real interest rate plus the expected rate of inflation. Therefore, if the expected rate of inflation increases, the nominal interest rate will also increase. However, the real interest rate (which is adjusted for inflation) will decrease because the nominal interest rate and inflation are positively related. Thus, the higher the expected rate of inflation, the lower is the real rate of interest.

Question 15

What is the real (adjusted for inflation) present value of $104.25 that you could receive one year from now, given that the rate of interest is 4.25 percent and the anticipated rate of inflation is 1 percent?

Accepted Answer

The real present value of future money is calculated by adjusting the nominal amount for inflation and discounting it by the real interest rate. The real interest rate can be approximated by the formula $r = \frac{1 + nominal\ rate}{1 + inflation\ rate} - 1$. Here, $r = \frac{1 + 0.0425}{1 + 0.01} - 1 = 0.031683$. The present value is then calculated as $PV = \frac{FV}{(1 + r)}$, where $FV$ is the future value. So, $PV = \frac{104.25}{1.031683} \approx \$100.97$.

Question 16

The rate of interest that you pay on a home loan depends upon all of the following EXCEPT

Accepted Answer

The interest rate on a home loan depends on various factors such as the borrower's credit score, the length of the loan, and handling charges or loan fees. However, the supply of houses in the real estate market does not affect the interest rate directly. It may affect the overall cost of the home but not the interest rate specifically.

Question 17

A firm is considering three projects. Each costs $1 million now. Project A will yield $400,000 a year for three years, beginning one year from now. Project B will yield $1.25 million three years from now, and Project C will yield $600,000 for two years, beginning two years from now. If the interest rate is 8 percent, which of these projects should the firm undertake?

Accepted Answer

Project A has the highest net present value (NPV) when discounted at an 8% interest rate, making it the most financially viable option among the three.

Question 18

If the bank advertises 6 percent annual interest rate on a one-year certificate of deposit and you anticipate the rate of inflation to rise to 3 percent during the year, then the real rate of interest on the certificate of deposit is

Accepted Answer

The real rate of interest can be approximated by subtracting the anticipated inflation rate from the nominal interest rate. Therefore, 6 percent (nominal rate) - 3 percent (inflation rate) = 3 percent (real rate of interest).

Question 19

The greater the interest rate

Accepted Answer

A higher interest rate increases the opportunity cost of current consumption because it implies a higher return on savings or investments, making it more costly to consume now rather than save and earn interest.

Question 20

Present value is

Accepted Answer

Present value is the current value of a future cash flow or a stream of future cash flows expressed in today's dollars. It takes into consideration the time value of money, which means that money is worth more now than in the future. Therefore, the longer the time horizon, the lower the present value. The rate of interest is a key factor that affects the present value, as a higher interest rate would increase the present value and vice versa.

Quiz 21: Rents, Profits, and the Financial Environment of Business