Exam 3: The Time Value of Money

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?

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

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

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

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

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

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?

An annuity is a series of

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

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

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?

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.

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 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?

Discounting

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?

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 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?

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

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?