Exam 9: Time Value of Money

Bank One currently charges a 10 percent simple rate on a car loan where the interest is compounded semiannually.Bank Two offers a car loan where the interest is compounded quarterly.What simple rate would Bank Two have to charge in order to earn the same effective annual rate that is earned by Bank One?

Union Atlantic Corporation, which has a required rate of return equal to 14 percent, is evaluating a capital budgeting project that has the following characteristics: Union Atlantic's capital budgeting manager has determined that the project's net present value is $7,008.According to this information, which of the following statements is correct?

Suppose an investor can earn a steady 5% annually with investment A, while investment B will yield a constant 12% annually.Within 11 years' time, the compounded value of investment B will be more than twice the compounded value of investment A (ignore risk).

Supposed someone offered you the choice of two equally risky annuities, each paying $10,000 per year for five years.One is an ordinary (or deferred) annuity, the other is an annuity due.Which of the following statements is most correct?

The future value of a cash flow is positively related to interest rate and negatively related to the amount of time until maturity.

You want to buy a Nissan 300ZX on your 27th birthday.You have priced these cars and found that they currently sell for $30,000.You believe that the price will increase by 5 percent per year until you are ready to buy.You can presently invest to earn 14 percent.If you just turned 20 years old, how much must you invest at the end of each of the next 7 years to be able to purchase the Nissan in 7 years?

South Penn Trucking is financing a new truck with a loan of $10,000 to be repaid in 5 annual end-of-year installments of $2,504.56.What annual interest rate is the company paying?

Solving for the interest rate associated with a stream of uneven cash flows, without the use of a calculator, usually involves a trial and error process.

A capital budgeting project is acceptable if the rate of return required for such a project is greater than the project's internal rate of return.

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

When a loan is amortized, the largest portion of the periodic payment goes to reduce principal in the early years of the loan such that the accumulated interest can be spread out over the life of the loan.

What is the future value of a 5-year ordinary annuity with annual payments of $200, evaluated at a 15 percent interest rate?

The process of discounting or finding the present value of a cash flow to be received in the future is really the reverse of compounding.

You want to borrow $1,000 from a friend for one year, and you propose to pay her $1,120 at the end of the year.She agrees to lend you the $1,000, but she wants you to pay her $10 of interest at the end of each of the first 11 months plus $1,010 at the end of the 12th month.How much higher is the effective annual rate under your friend's proposal than under your proposal?

Steaks Galore needs to arrange financing for its expansion program.One bank offers to lend the required $1,000,000 on a loan which requires interest to be paid at the end of each quarter.The quoted rate is 10 percent, and the principal must be repaid at the end of the year.A second lender offers 9 percent, daily compounding (365-day year), with interest and principal due at the end of the year.What is the difference in the effective annual rates (EFF%) charged by the two banks?

The effective annual rate is always greater than the simple rate as a result of compounding effects.

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?

You will receive a $100 annual perpetuity starting at Year 0, a $300 annual perpetuity with the first payment at the end of Year 5, and a $200 semiannual perpetuity ^1/2 − 1.0 = 7%.)

The ____ involves comparing the actual results with those predicted by the project's sponsors and explaining why any differences occur.

A $10,000 loan is to be amortized over 5 years, with annual end-of-year payments.Given the following facts, which of these statements is correct?