Exam 5: The Time Value of Money

Interest rate: Your tuition for the coming year is due today. You borrow $8,000 from your uncle and agree to repay in the three years an amount of $9,250. What is the interest rate on this loan? Round to the nearest per cent.

The Rule of 72 allows one to calculate the approximate time needed to double an investment.

Which one of the following statements is NOT true?

The further in the future you receive a dollar, the more it is worth today.

The higher the rate of interest, the more likely you will elect to invest your funds and forego current consumption.

The present value is simply the current value of a future cash flow that has been discounted at the appropriate discount rate.

Future value: Wes Ottey would like to buy an apartment in Sydney in six years. He is looking to invest $75,000 today in a share that is expected to earn a return of 18.3 percent annually. How much will he have at the end of six years? (Round to the nearest dollar.)

Suppose you win $10 million in a lottery. You have a choice of how you will receive your winnings. The first choice is to receive a certain lump sum today. The second choice is to receive a certain amount at the end of five years. How will you evaluate your choices to make your decision?

Individuals prefer to consume goods in the future rather than right away.

Using lower interest rates will:

The future value technique uses compounding to find the future value of each cash flow at the end of the project's life.

Growth rate: Petry Company is a growing company with sales of $1.25 million this year. The company expects to grow at an annual rate of 25 percent for the next three years, followed by a growth of 20 percent per year for the next two years. What will be Petry's sales at the end of five years? (Round to the nearest percent.)

Time to attain goal: Cheryl Merriweather wants to invest in a bank term deposit that will pay her 7.8 percent annually. If she is investing $11,500 today, when will she reach her goal of $15,000? (Round off to the nearest year.)

Compound growth occurs when the initial value of a number increases or decreases each period by the factor (1 + growth rate).

The growth rate over time is exponential.

Compounding accelerates the growth of the total interest earned.

Future value: Brittany Willis is looking to invest for retirement, which she hopes will be in 20 years. She is looking to invest $22,500 today in an Australian fixed interest mutual fund that will earn interest at 6.25 percent annually. How much will she have at the end of 20 years? (Round to the nearest dollar.)

If you had a choice of choosing a payment of $5,000 to be received in five years being discounted at 8 percent or at 10 percent, you should always choose the higher rate because it gives you the higher present value.

Future value: Ning Gao is planning to buy a house in five years. She is looking to invest $25,000 today in an index managed fund that will provide her a return of 12 percent annually. How much will she have at the end of five years? (Round to the nearest dollar.)

Compounding: Joachim Noah is investing $5,000 in an account paying 6.75 percent annually for three years. What is the interest-on-interest if interest is compounded?