Exam 9: Time Value of Money

Two firms evaluated the same capital budgeting project to determine whether to purchase it.The CFO of Anchor Weights Corporation (AWC)reported that she determined that the project's internal rate of return equals 9 percent,and she recommended that the project be purchased.The CFO of Sectional Spas Incorporated (SSI)simply reported that the project was unacceptable to his firm when he evaluated it using one of the capital budgeting techniques that consider the time value of money.Given this information,which of the following statements is correct?

All of the following factors can complicate the post-audit process except

You have just taken out a 30-year mortgage on your new home for $120,000.This mortgage is to be repaid in 360 equal monthly installments.If the stated (simple)annual interest rate is 14.75 percent,what is the amount of each of the monthly installments?

You are currently saving for your child's college education.The current cost of college is $10,000 a year.You expect that college costs will continue to increase at a rate of 5 percent a year.Your child is scheduled to begin attending a four-year college 10 years from now .You currently have $25,000 in an account which earns 6 percent after taxes.You would like to have all of the necessary savings by the time your child enters college,and you would like to contribute a constant amount at the beginning of each of the next 10 years in order to provide the necessary amount.(You want to make 10 equal contributions starting in Year 0 and ending at Year 9. )How much should you contribute to the account each year in order to fully provide for your child's education?

Hillary is trying to determine the cost of health care to college students,and parents' ability to cover those costs.She assumes that the cost of one year of health care for a college student is $1,000 today,that the average student is 18 when he or she enters college,that inflation in health care cost is rising at the rate of 10 percent per year,and that parents can save $100 per year to help cover their children's costs.All payments occur at the end of the relevant period,and the $100/year savings will stop the day the child enters college (hence 18 payments will be made).Savings can be invested at a simple rate of 6 percent,annual compounding.Hillary wants a health care plan which covers the fully inflated cost of health care for a student for 4 years,during years 19 through 22 (with payments made at the end of years 19 through 22).How much would the government have to set aside now (when a child is born),to supplement the average parent's share of a child's college health care cost? The lump sum the government sets aside will also be invested at 6 percent,annual compounding.

Benefits of the post-audit include all of the following except

Perpetuities represent a series of even cash flows over a finite period of time.

Find the present value of an income stream which has a negative flow of $100 per year for 3 years,a positive flow of $200 in the 4th year,and a positive flow of $300 per year in Years 5 through 8.The appropriate discount rate is 4 percent for each of the first 3 years and 5 percent for each of the later years.Thus,a cash flow accruing in Year 8 should be discounted at 5 percent for some years and 4 percent in other years.All payments occur at year-end.

Which of the following statements is most correct?

The NPV method implicitly assumes that the rate at which cash flows can be reinvested is the required rate of return,whereas the IRR method implies that the firm has the opportunity to reinvest at the project's IRR.

NPV and IRR will always lead to the same accept/reject decision for mutually exclusive projects.

Tara is evaluating two mutually exclusive capital budgeting projects that have the following characteristics: If the firm's required rate of return (r)is 10 percent,which project should be purchased?

Your client just turned 75 years old and plans on retiring in 10 years on her 85th birthday.She is saving money today for her retirement and is establishing a retirement account with your office.She would like to withdraw money from her retirement account on her birthday each year until she dies.She would ideally like to withdraw $50,000 on her 85th birthday,and increase her withdrawals 10 percent a year through her 89th birthday (i.e. ,she would like to withdraw $73,205 on her 89th birthday).She plans to die on her 90th birthday,at which time she would like to leave $200,000 to her descendants.Your client currently has $100,000.You estimate that the money in the retirement account will earn 8 percent a year over the next 15 years.Your client plans to contribute an equal amount of money each year until her retirement.Her first contribution will come in one year;her tenth and final contribution will come in ten years (on her 85th birthday).How much should she contribute each year in order to meet her objectives?

In its first year of operations,2001,the Gourmet Cheese Shoppe had earnings per share (EPS)of $0.26.Four years later,in 2005,EPS was up to $0.38,and 7 years after that,in 2012,EPS was up to $0.535.It appears that the first 4 years represented a supernormal growth situation and since then a more normal growth rate has been sustained.What are the rates of growth for the earlier period and for the later period?

The advantage of the payback period over other capital budgeting techniques is that

Cash flow time lines are used primarily for decisions involving paying off debt or investing in financial securities.They cannot be used when making decisions about investments in physical assets.

On January 1,2006,a graduate student developed a 5-year financial plan which would provide enough money at the end of her graduate work (January 1,2011)to open a business of her own.Her plan was to deposit $8,000 per year for 5 years,starting immediately,into an account paying 10 percent compounded annually.Her activities proceeded according to plan except that at the end of her third year (1/1/09)she withdrew $5,000 to take a Caribbean cruise,at the end of the fourth year (1/1/10)she withdrew $5,000 to buy a used Prelude,and at the end of the fifth year (1/1/11)she had to withdraw $5,000 to pay to have her dissertation typed.Her account,at the end of the fifth year,was less than the amount she had originally planned on by how much?

You are considering an investment in a 40-year security.The security will pay $25 a year at the end of each of the first three years.The security will then pay $30 a year at the end of each of the next 20 years.The simple interest rate is assumed to be 8 percent,and the current price (present value)of the security is $360.39.Given this information,what is the equal annual payment to be received from Year 24 through Year 40 (i.e. ,for 17 years)?

Which of the following statements is most correct?

Your subscription to Jogger's World Monthly is about to run out and you have the choice of renewing it by sending in the $10 a year regular rate or of getting a lifetime subscription to the magazine by paying $100.Your opportunity cost is 7 percent.How many years would you have to live to make the lifetime subscription the better buy? Payments for the regular subscription are made at the beginning of each year.(Round up if necessary to obtain a whole number of years. )