CHAPTER 5TIME VALUE OF MONEY1.Which of the following statements is CORRECT?

a.A time line is not meaningful unless all cash flows occur annually.b.Time lines are useful for visualizing complex problems prior to doing actual calculations.c.Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.d.Time lines cannot be constructed for annuities where the payments occur at the beginning of the periods.e.Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.Answer: b

2.Which of the following statements is CORRECT?

a.A time line is not meaningful unless all cash flows occur annually.b.Time lines are not useful for visualizing complex problems prior to doing actual calculations.c.Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.d.Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods.e.Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.Answer: d

3.Which of the following statements is CORRECT?

a.A time line is not meaningful unless all cash flows occur annually.b.Time lines are not useful for visualizing complex problems prior to doing actual calculations.c.Time lines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.d.Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities.e.Time lines cannot be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.Answer: c

4.Which of the following statements is CORRECT?

a.A time line is not meaningful unless all cash flows occur annually.b.Time lines are not useful for visualizing complex problems prior to doing actual calculations.c.Time lines cannot be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.d.Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities.e.Time lines can be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.Answer: e

5.You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would lower the calculated value of the investment?

a.The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000.b.The discount rate increases.c.The riskiness of the investments cash flows decreases.d.The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years.e.The discount rate decreases.Answer: b

6.You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would increase the calculated value of the investment?

a.The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for 10 years rather than 5 years, hence that each payment is for $10,000 rather than for $20,000.b.The discount rate decreases.c.The riskiness of the investments cash flows increases.d.The total amount of cash flows remains the same, but more of the cash flows are received in the later years and less are received in the earlier years.e.The discount rate increases.Answer: b

7.Your bank account pays a 6% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?

a.The periodic rate of interest is 1.5% and the effective rate of interest is 3%.b.The periodic rate of interest is 6% and the effective rate of interest is greater than 6%.c.The periodic rate of interest is 1.5% and the effective rate of interest is greater than 6%.d.The periodic rate of interest is 3% and the effective rate of interest is 6%.e.The periodic rate of interest is 6% and the effective rate of interest is also 6%.Answer: c

8.Your bank account pays an 8% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?

a.The periodic rate of interest is 2% and the effective rate of interest is 4%.b.The periodic rate of interest is 8% and the effective rate of interest is greater than 8%.c.The periodic rate of interest is 4% and the effective rate of interest is less than 8%.d.The periodic rate of interest is 2% and the effective rate of interest is greater than 8%.e.The periodic rate of interest is 8% and the effective rate of interest is also 8%.Answer: d

9.A $50,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT?

a.The annual payments would be larger if the interest rate were lower.b.If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 7-year amortization plan.c.The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower.d.The last payment would have a higher proportion of interest than the first payment.e.The proportion of interest versus principal repayment would be the same for each of the 7 payments.Answer: ca, d, and e can be ruled out as incorrect by simple reasoning. b is also incorrect because interest in the first year would be Loan amount interest rate regardless of the life of the loan, so the interest payment would be identical for the first payment. Think about the situation where r = 0%, statement c is the "most logical guess." One could also set up an amortization schedule and change the numbers to confirm that only c is correct.

10.A $150,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT?

a.The annual payments would be larger if the interest rate were lower.b.If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 7-year amortization plan.c.The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were lower.d.The proportion of each payment that represents interest versus repayment of principal would be higher if the interest rate were higher.e.The proportion of interest versus principal repayment would be the same for each of the 7 payments.Answer: da, c, and e are obviously incorrect. b is also incorrect because interest in the first year would be Loan amount interest rate regardless of the life of the loan. That makes d the "most logical guess." One could also set up an amortization schedule and change the numbers to confirm that only d is correct.

11.Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)

a.The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years.b.Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant.c.Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant.d.The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year.e.The outstanding balance declines at a slower rate in the later years of the loans life.Answer: bb is the correct answer. Thinking through the question, the other answers can all be eliminated. One could also set up an amortization schedule to prove that only statement b is correct.

12.Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)

a.The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years.b.Because the outstanding balance declines over time, the monthly payments will also decline over time.c.Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant.d.The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year.e.The outstanding balance declines at a faster rate in the later years of the loans life.Answer: ee is the correct answer. Thinking through the question, the other answers can all be eliminated. One could also set up an amortization schedule to prove that only statement e is correct.

13.Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT?

a.The monthly payments will decline over time.b.A smaller proportion of the last monthly payment will be interest, and a larger proportion will be principal, than for the first monthly payment.c.The total dollar amount of principal being paid off each month gets smaller as the loan approaches maturity.d.The amount representing interest in the first payment would be higher if the nominal interest rate were 7% rather than 10%.e.Exactly 10% of the first monthly payment represents interest.Answer: bb is correct. a is clearly wrong, as are c and d. It is not obvious whether e is correct or not, but we could set up an example to see:

Loan100000Term30Rate10%Periods/Year12Periodic rate0.008333333Total periods360

Payment-$877.57Interest, Month 1$833.33Interest as % of total #360 payment:1%Interest, Month 360$7.25Principal as % of total #360 payment99%Principal, Month 360$870.32

14.Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT?

a.The monthly payments will increase over time.b.A larger proportion of the first monthly payment will be interest, and a smaller proportion will be principal, than for the last monthly payment.c.The total dollar amount of interest being paid off each month gets larger as the loan approaches maturity.d.The amount representing interest in the first payment would be higher if the nominal interest rate were 7% rather than 10%.e.Exactly 10% of the first monthly payment represents interest.Answer: bb is correct. a is clearly wrong, as are c and d. It is not obvious whether e is correct or not, but we could set up an example to see:

Loan100000Term30Rate10%Periods/Year12Periodic rate0.00833333Total periods360

Payment-$877.57Interest Month 1$833.33Interest as % of total payment:95%, which is much larger than 10%.

15.A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT?

a.The periodic interest rate is greater than 3%.b.The periodic rate is less than 3%.c.The present value would be greater if the lump sum were discounted back for more periods.d.The present value of the $1,000 would be smaller if interest were compounded monthly rather than semiannually.e.The PV of the $1,000 lump sum has a higher present value than the PV of a 3-year, $333.33 ordinary annuity.Answer: d

16.A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT?

a.The periodic interest rate is greater than 3%.b.The periodic rate is less than 3%.c.The present value would be greater if the lump sum were discounted back for more periods.d.The present value of the $1,000 would be larger if interest were compounded monthly rather than semiannually.e.The PV of the $1,000 lump sum has a smaller present value than the PV of a 3-year, $333.33 ordinary annuity.Answer: e

17.Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?

a.The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity.b.A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.c.A bank loan's nominal interest rate will always be equal to or less than its effective annual rate.d.If an investment pays 10% interest, compounded annually, its effective annual rate will be less than 10%.e.Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.Answer: c

18.Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?

a.The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity.b.A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.c.A bank loan's nominal interest rate will always be equal to or greater than its effective annual rate.d.If an investment pays 10% interest, compounded quarterly, its effective annual rate will be greater than 10%.e.Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.Answer: d

19.Which of the following statements is CORRECT?

a.The present value of a 3-year, $150 annuity due will exceed the present value of a 3-year, $150 ordinary annuity.b.If a loan has a nominal annual rate of 8%, then the effective rate can never be greater than 8%. c.If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different.d.The proportion of the payment that goes toward interest on a fully amortized loan increases over time.e.An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%.Answer: a

20.Which of the following statements is CORRECT?

a.The present value of a 3-year, $150 ordinary annuity will exceed the present value of a 3-year, $150 annuity due.b.If a loan has a nominal annual rate of 8%, then the effective rate will never be less than 8%. c.If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different.d.The proportion of the payment that goes toward interest on a fully amortized loan increases over time.e.An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%.Answer: b

21.You are considering two equally risky annuities, each of which pays $5,000 per year for 10 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT?

a.The present value of ORD must exceed the present value of DUE, but the future value of ORD may be less than the future value of DUE.b.The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD.c.The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE.d.The present value of DUE exceeds the present value of ORD, and the future value of DUE also exceeds the future value of ORD.e.If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and the present value of DUE would remain constant.Answer: d

22.You are considering two equally risky annuities, each of which pays $5,000 per year for 10 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT?

a.A rational investor would be willing to pay more for DUE than for ORD, so their market prices should differ.b.The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD.c.The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE.d.The present value of ORD exceeds the present value of DUE, while the future value of DUE exceeds the future value of ORD.e.If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and the present value of DUE would remain constant.Answer: a

23.You have a chance to buy an annuity that pays $550 at the beginning of each year for 3 years. You could earn 5.5% on your money in other investments with equal risk. What is the most you should pay for the annuity?

a.$1,412.84b.$1,487.20c.$1,565.48d.$1,643.75e.$1,725.94Answer: cBEGIN ModeN3I/YR5.5%PMT$550FV$0.00PV$1,565.48

24.You have a chance to buy an annuity that pays $5,000 at the beginning of each year for 5 years. You could earn 4.5% on your money in other investments with equal risk. What is the most you should pay for the annuity?

a20,701b.$21,791c.$22,938d.$24,085e.$25,289Answer: cBEGIN ModeN5I/YR4.5%PMT$5,000FV$0.00PV$22,938

25.Your uncle is about to retire, and he wants to buy an annuity that will provide him with $75,000 of income a year for 20 years, with the first payment coming immediately. The going rate on such annuities is 5.25%. How much would it cost him to buy the annuity today?

a.$825,835b.$869,300c.$915,052d.$963,213e.$1,011,374Answer: dBEGIN ModeN20I/YR5.25%PMT$75,000FV$0.00PV$963,213

26.Your father is about to retire, and he wants to buy an annuity that will provide him with $85,000 of income a year for 25 years, with the first payment coming immediately. The going rate on such annuities is 5.15%. How much would it cost him to buy the annuity today?

a.$1,063,968b.$1,119,966c.$1,178,912d.$1,240,960e.$1,303,008Answer: dBEGIN ModeN25I/YR5.15%PMT$85,000FV$0.00PV$1,240,960

27.You inherited an oil well that will pay you $25,000 per year for 25 years, with the first payment being made today. If you think a fair return on the well is 7.5%, how much should you ask for it if you decide to sell it?

a.$284,595b.$299,574c.$314,553d.$330,281e.$346,795Answer: bBEGIN ModeN25I/YR7.5%PMT$25,000FV$0.00PV$299,574

28.Sam was injured in an accident, and the insurance company has offered him the choice of $25,000 per year for 15 years, with the first payment being made today, or a lump sum. If a fair return is 7.5%, how large must the lump sum be to leave him as well off financially as with the annuity?

a.$225,367b.$237,229c.$249,090d.$261,545e.$274,622Answer: bBEGIN ModeN15I/YR7.5%PMT$25,000FV$0.00PV$237,229

29.Whats the present value of a 4-year ordinary annuity of $2,250 per year plus an additional $3,000 at the end of Year 4 if the interest rate is 5%?

a.$8,509b.$8,957c.$9,428d.$9,924e.$10,446Answer: eAlternative setup:N401234I/YR5.0%$2,250$2,250$2,250$2,250PMT$2,250$3,000FV$3,000$2,250$2,250$2,250$5,250PV$10,446PV = $10,446.50

30.Suppose you inherited $275,000 and invested it at 8.25% per year. How much could you withdraw at the end of each of the next 20 years?

a.$28,532b.$29,959c.$31,457d.$33,030e.$34,681Answer: aN20I/YR8.25%PV$275,000FV$0.00PMT$28,532

31.Your uncle has $375,000 and wants to retire. He expects to live for another 25 years and to earn 7.5% on his invested funds. How much could he withdraw at the end of each of the next 25 years and end up with zero in the account?

a.$28,843.38b.$30,361.46c.$31,959.43d.$33,641.50e.$35,323.58Answer: dN25I/YR7.5%PV$375,000FV$0.00PMT$33,641.50

32.Your uncle has $375,000 and wants to retire. He expects to live for another 25 years, and he also expects to earn 7.5% on his invested funds. How much could he withdraw at the beginning of each of the next 25 years and end up with zero in the account?

a.$28,243.21b.$29,729.70c.$31,294.42d.$32,859.14e.$34,502.10Answer: cBEGIN ModeN25I/YR7.5%PV$375,000FV$0.00PMT$31,294.42

33.Your grandmother just died and left you $100,000 in a trust fund that pays 6.5% interest. You must spend the money on your college education, and you must withdraw the money in 4 equal installments, beginning immediately. How much could you withdraw today and at the beginning of each of the next 3 years and end up with zero in the account?

a.$24,736b.$26,038c.$27,409d.$28,779e.$30,218Answer: cBEGIN ModeN4I/YR6.5%PV$100,000FV$0.00PMT$27,409

34.Suppose you inherited $275,000 and invested it at 8.25% per year. How much could you withdraw at the beginning of each of the next 20 years?

a.$22,598.63b.$23,788.03c.$25,040.03d.$26,357.92e.$27,675.82Answer: dBEGIN ModeN20I/YR8.25%PV$275,000FV$0.00PMT$26,357.92

35.Your father's employer was just acquired, and he was given a severance payment of $375,000, which he invested at a 7.5% annual rate. He now plans to retire, and he wants to withdraw $35,000 at the end of each year, starting at the end of this year. How many years will it take to exhaust his funds, i.e., run the account down to zero?

a.22.50b.23.63c.24.81d.26.05e.27.35Answer: aI/YR7.5%PV$375,000PMT$35,000FV$0.00N22.50

36.Your uncle has $300,000 invested at 7.5%, and he now wants to retire. He wants to withdraw $35,000 at the end of each year, starting at the end of this year. He also wants to have $25,000 left to give you when he ceases to withdraw funds from the account. For how many years can he make the $35,000 withdrawals and still have $25,000 left in the end?

a.14.21b.14.96c.15.71d.16.49e.17.32Answer: bI/YR7.50%PV$300,000PMT$35,000FV$25,000N14.96

37.Your Aunt Ruth has $500,000 invested at 6.5%, and she plans to retire. She wants to withdraw $40,000 at the beginning of each year, starting immediately. How many years will it take to exhaust her funds, i.e., run the account down to zero?

a.18.62b.19.60c.20.63d.21.71e.22.86Answer: eBEGIN ModeI/YR6.5%PV$500,000PMT$40,000FV$0.00N22.86

38.Your aunt has $500,000 invested at 5.5%, and she now wants to retire. She wants to withdraw $45,000 at the beginning of each year, beginning immediately. She also wants to have $50,000 left to give you when she ceases to withdraw funds from the account. For how many years can she make the $45,000 withdrawals and still have $50,000 left in the end?

a.15.54b.16.36c.17.22d.18.08e.18.99Answer: cBEGIN ModeI/YR5.5%PV$500,000PMT$45,000FV$50,000N17.22

39.Suppose you just won the state lottery, and you have a choice between receiving $2,550,000 today or a 20-year annuity of $250,000, with the first payment coming one year from today. What rate of return is built into the annuity? Disregard taxes.

a.7.12%b.7.49%c.7.87%d.8.26%e.8.67%Answer: bN20PV$2,550,000PMT$250,000FV$0.00I/YR7.49%

40.Your girlfriend just won the Florida lottery. She has the choice of $15,000,000 today or a 20-year annuity of $1,050,000, with the first payment coming one year from today. What rate of return is built into the annuity?

a.3.44%b.3.79%c.4.17%d.4.58%e.5.04%Answer: aN20PV$15,000,000PMT$1,050,000FV$0.00I/YR3.44%

41.Assume that you own an annuity that will pay you $15,000 per year for 12 years, with the first payment being made today. You need money today to start a new business, and your uncle offers to give you $120,000 for the annuity. If you sell it, what rate of return would your uncle earn on his investment?

a.6.85%b.7.21%c.7.59%d.7.99%e.8.41%Answer: eBEGIN ModeN12PV$120,000PMT$15,000FV$0.00I/YR8.41%

42.What annual payment must you receive in order to earn a 6.5% rate of return on a perpetuity that has a cost of $1,250?

a.$77.19b.$81.25c.$85.31d.$89.58e.$94.06Answer: bCost (PV)$1,250I/YR6.5%PMT$81.25Multiply Cost by I/YR.

43.What is the present value of the following cash flow stream at a rate of 6.25%?

Years:01234|||||CFs:$0$75$225$0$300

a.$411.57b.$433.23c.$456.03d.$480.03e.$505.30Answer: eI/YR = 6.25%

01234CFs:$0$75$225$0$300PV of CFs:$0$71$199$0$235

PV = $505.30PV = $505.30

You can find the individual PVs and sum them. Alternately, you can automate the process using Excel or a calculator, by inputting the data into the cash flow register and pressing the NPV key.

44.What is the present value of the following cash flow stream at a rate of 12.0%?

Years:01234|||||CFs:$0$1,500$3,000$4,500$6,000

a.$9,699b.$10,210c.$10,747d.$11,284e.$11,849Answer: cI/YR = 12.0%

01234CFs:$0$1,500$3,000$4,500$6,000PV of CFs:$0$1,339$2,392$3,203$3,813

PV = $10,747Found using the Excel NPV function.PV = $10,747Found by summing individual PVs.PV = $10,747Found using the calculator NPV key.

45.What is the present value of the following cash flow stream at a rate of 8.0%?

Years:0123||||CFs:$750$2,450$3,175$4,400

a.$7,917b.$8,333c.$8,772d.$9,233e.$9,695Answer: dI/YR = 8.0%

0123CFs:$750$2,450$3,175$4,400

PV of CFs:$750$2,269$2,722$3,493PV = $9,233Found by summing individual PVs.PV = $9,233Found with a calculator or Excel to automate the process. With a calculator, input the cash flows and I into the cash flow register, then press the NPV key.

46.You sold a car and accepted a note with the following cash flow stream as your payment. What was the effective price you received for the car assuming an interest rate of 6.0%?

Years:01234|||||CFs:$0$1,000$2,000$2,000$2,000

a.$5,987b.$6,286c.$6,600d.$6,930e.$7,277Answer: aI/YR = 6.0%

01234CFs:$0$1,000$2,000$2,000$2,000PV of CFs:$0$943$1,780$1,679$1,584

PV = $5,987Found using the Excel NPV function.PV = $5,987Found by summing individual PVs.PV = $5,987Found using the calculator NPV key.

47.At a rate of 6.5%, what is the future value of the following cash flow stream?

Years:01234|||||CFs:$0$75$225$0$300

a.$526.01b.$553.69c.$582.83d.$613.51e.$645.80Answer: eI/YR = 6.5%

01234CFs:$0$75$225$0$300FV of CFs:$0$91$255$0$300

FV = $645.80Found by summing individual FVs.FV = $645.80Found with the NFV key in some calculators.FV = $645.80Found with a calculator by first finding the PV of the stream, then finding the FV of that PV.

PV of the stream:$501.99FV of the PV:$645.80

48.Your father paid $10,000 (CF at t = 0) for an investment that promises to pay $750 at the end of each of the next 5 years, then an additional lump sum payment of $10,000 at the end of the 5th year. What is the expected rate of return on this investment?

a.6.77%b.7.13%c.7.50%d.7.88%e.8.27%Answer: c012345CFs:-$10,000$750$750$750$750$750$10,000-$10,000$750$750$750$750$10,750

I/YR7.50%I is the discount rate that causes the PV of the inflows to equal the initial negative CF, and is found with Excel's IRR function or by inputting the CFs into a calculator and pressing the IRR key.

49.You are offered a chance to buy an asset for $7,250 that is expected to produce cash flows of $750 at the end of Year 1, $1,000 at the end of Year 2, $850 at the end of Year 3, and $6,250 at the end of Year 4. What rate of return would you earn if you bought this asset?

a.4.93%b.5.19%c.5.46%d.5.75%e.6.05%Answer: e01234CFs:-$7,250$750$1,000$850$6,250

I/YR6.05%I is the discount rate that causes the PV of the positive inflows to equal the initial negative CF. I can be found using Excel's IRR function or by inputting the CFs into a calculator and pressing the IRR key.

50.Whats the future value of $1,500 after 5 years if the appropriate interest rate is 6%, compounded semiannually?

a.$1,819b.$1,915c.$2,016d.$2,117e.$2,223Answer: cYears5Periods/Yr2Nom. I/YR6.0%

N = Periods10PMT$0I = I/Period3.0%PV$1,500Could be found using a calculator, an equation, or Excel.FV = $2,016Note that we must first convert to periods and rate per period.

51.Whats the present value of $4,500 discounted back 5 years if the appropriate interest rate is 4.5%, compounded semiannually?

a.$3,089b.$3,251c.$3,422d.$3,602e.$3,782Answer: dYears5Periods/Yr2Nom. I/YR4.5%

FV$4,500N = Periods10PMT$0I = I/Period2.25%Could be found using a calculator, the equation, or Excel.PV = $3,602Note that we must first convert to periods and rate per period.

52.Whats the future value of $1,200 after 5 years if the appropriate interest rate is 6%, compounded monthly?

a.$1,537.69b.$1,618.62c.$1,699.55d.$1,784.53e.$1,873.76Answer: bYears5Periods/Yr12Nom. I/YR6.0%

N = Periods60PMT$0I/Period0.5%PV$1,200Could be found using a calculator, the equation, or Excel.FV$1,618.62Note that we must first convert to periods and rate per period.

53.Whats the present value of $1,525 discounted back 5 years if the appropriate interest rate is 6%, compounded monthly?

a.$969b.$1,020c.$1,074d.$1,131e.$1,187Answer: dYears5Periods/Yr12Nom. I/YR6.0%

N=Periods60PMT$0I/Period0.5%FV$1,525PV = $1,131 = FV/(1+rPer)NPV = $1,131Found using a calculator or Excel

54.Master Card and other credit card issuers must by law print the Annual Percentage Rate (APR) on their monthly statements. If the APR is stated to be 18.00%, with interest paid monthly, what is the card's EFF%?

a.18.58%b.19.56%c.20.54%d.21.57%e.22.65%Answer: bAPR = Nominal rate18.00%Periods/yr12EFF% =(1+(rNOM/N))N 1 =19.56%

55.Riverside Bank offers to lend you $50,000 at a nominal rate of 6.5%, compounded monthly. The loan (principal plus interest) must be repaid at the end of the year. Midwest Bank also offers to lend you the $50,000, but it will charge an annual rate of 7.0%, with no interest due until the end of the year. How much higher or lower is the effective annual rate charged by Midwest versus the rate charged by Riverside?

a.0.52%b.0.44%c.0.36%d.0.30%e.0.24%Answer: dThis problem can be worked using the interest conversion feature of a calculator or Excel. It could also be worked using the conversion formula. We used the conversion formula.

Nominal rate, Riverside6.5%Nominal rate, Midwest7.0%Periods/yr, Riverside12Periods/yr, Midwest1EFF% Riverside = (1+(rNOM/N))N 1 =6.70%EFF% Midwest7.00%Difference0.30%

56.Suppose Community Bank offers to lend you $10,000 for one year at a nominal annual rate of 8.00%, but you must make interest payments at the end of each quarter and then pay off the $10,000 principal amount at the end of the year. What is the effective annual rate on the loan?

a.8.24%b.8.45%c.8.66%d.8.88%e.9.10%Answer: aNominal I/YR8.00%Periods/yr4EFF% = (1+(rNOM/N))N 1= 8.24%

You could also find the EFF% as follows:Interest paid each quarter = Loan rate/4 = Qtrly PMT = $200.00Then find the IRR as a quarterly rate and convert to an annual rate. This procedure is obviously longer.

01234CFs:10,000.00-200.00-200.00-200.00-200.00-10,000.0010,000.00-200.00-200.00-200.00-10,200.00

IRR (quarterly) = 2.00%Annual effective rate = 8.24% vs. nominal rate = 8.00%

57.Suppose a bank offers to lend you $10,000 for 1 year on a loan contract that calls for you to make interest payments of $250.00 at the end of each quarter and then pay off the principal amount at the end of the year. What is the effective annual rate on the loan?

a.8.46%b.8.90%c.9.37%d.9.86%e.10.38%Answer: eInterest payment: $250.00

01234CFs:10,000-250-250-250-250-10,00010,000-250-250-250-10,250

IRR (quarterly) = 2.50%Annual effective rate = 10.38% vs. nominal rate = 10.00%

58.Charter Bank pays a 4.50% nominal rate on deposits, with monthly compounding. What effective annual rate (EFF%) does the bank pay?

a.3.72%b.4.13%c.4.59%d.5.05%e.5.56%Answer: cNominal I/YR4.50%Periods/yr12Periodic rate0.38%EFF% = (1+(rNOM/N))N 1 =4.59%

59.Suppose your credit card issuer states that it charges a 15.00% nominal annual rate, but you must make monthly payments, which amounts to monthly compounding. What is the effective annual rate?

a.15.27%b.16.08%c.16.88%d.17.72%e.18.61%Answer: bNominal I/YR = APR15.00%Periods/yr12EFF% = (1+(rNOM/N))N 1 =16.08%

60.Pace Co. borrowed $20,000 at a rate of 7.25%, simple interest, with interest paid at the end of each month. The bank uses a 360-day year. How much interest would Pace have to pay in a 30-day month?

a.$120.83b.$126.88c.$133.22d.$139.88e.$146.87Answer: aNominal I/YR7.25%Days in month30Days/yr360Daily rate0.020139%Amount borrowed$20,000Interest per day$4.02778Interest per month = Interest/day 30 =$120.83

61.Suppose you deposited $5,000 in a bank account that pays 5.25% with daily compounding based on a 360-day year. How much would be in the account after 8 months, assuming each month has 30 days?

a.$5,178.09b.$5,436.99c.$5,708.84d.$5,994.28e.$6,294.00Answer: aNominal I/YR5.25%Rate/day = rNOM/360 =0.0146%Number of months8Days = Months 30 =240Days in year360Days in month30Amount deposited$5,000Ending amount$5,178.09

62.Suppose you borrowed $12,000 at a rate of 9.0% and must repay it in 4 equal installments at the end of each of the next 4 years. How large would your payments be?

a.$3,704.02b.$3,889.23c.$4,083.69d.$4,287.87e.$4,502.26Answer: aYears = N4I/YR9.0%FV$0Amount borrowed = PV$12,000Payments = PMT$3,704.02Found with a calculator, as the PMT.

63.Suppose you are buying your first condo for $145,000, and you will make a $15,000 down payment. You have arranged to finance the remainder with a 30-year, monthly payment, amortized mortgage at a 6.5% nominal interest rate, with the first payment due in one month. What will your monthly payments be?

a.$741.57b.$780.60c.$821.69d.$862.77e.$905.91Answer: cYears30N360Payments/year12Periodic rate0.54%Nominal rate6.50%PV$130,000Purchase price$145,000FV$0.00Down payment$15,000PMT$821.69

64.Your uncle will sell you his bicycle shop for $250,000, with "seller financing," at a 6.0% nominal annual rate. The terms of the loan would require you to make 12 equal end-of-month payments per year for 4 years, and then make an additional final (balloon) payment of $50,000 at the end of the last month. What would your equal monthly payments be?

a.$4,029.37b.$4,241.44c.$4,464.67d.$4,699.66e.$4,947.01Answer: eMonthly annuity, so interest must be calculated on a monthly basis.Years4Payments/year12N48Nominal rate6.0%PV$250,000I/period0.5%FV$50,000PMT$4,947.01

65.Suppose you borrowed $14,000 at a rate of 10.0% and must repay it in 5 equal installments at the end of each of the next 5 years. How much interest would you have to pay in the first year?

a.$1,200.33b.$1,263.50c.$1,330.00d.$1,400.00e.$1,470.00Answer: dI/YR10.0%Years5Amount borrowed$14,000Interest in Year 1$1,400.00Simply multiply the rate times the amount borrowed.

66.You plan to borrow $35,000 at a 7.5% annual interest rate. The terms require you to amortize the loan with 7 equal end-of-year payments. How much interest would you be paying in Year 2?

a.$1,994.49b.$2,099.46c.$2,209.96d.$2,326.27e.$2,442.59Answer: dFind the required payment:N7I7.5%PV$35,000FV$0PMT$6,608.01Found with a calculator or Excel.

Amortization schedule (first 2 years)YearBeg. BalancePaymentInterestPrincipalEnd. Balance135,000.006,608.012,625.003,983.0131,016.99231,016.996,608.012,326.274,281.7426,735.25

67.Your bank offers to lend you $100,000 at an 8.5% annual interest rate to start your new business. The terms require you to amortize the loan with 10 equal end-of-year payments. How much interest would you be paying in Year 2?

a.$7,531b.$7,927c.$8,323d.$8,740e.$9,177Answer: bFind the required payment:N10I8.5%PV$100,000FV$0PMT$15,241Found with a calculator or Excel.

Amortization schedule (first 2 years)YearBeg. BalancePaymentInterestPrincipalEnd. Balance1100,00015,2418,5006,74193,259293,25915,2417,9277,31485,945

68.You are considering an investment in a Third World bank account that pays a nominal annual rate of 18%, compounded monthly. If you invest $5,000 at the beginning of each month, how many months would it take for your account to grow to $250,000? Round fractional months up.

a.23b.27c.32d.38e.44Answer: dBEGIN ModeI/YR18.0%I/MO1.5%Monthly annuity due, so interest must be calculated on monthly basis. rNOM/12.PV$0PMT$5,000FV$250,000N37.16Rounded up: 38

69.You are considering investing in a bank account that pays a nominal annual rate of 7%, compounded monthly. If you invest $3,000 at the end of each month, how many months will it take for your account to grow to $150,000?

a.39.60b.44.00c.48.40d.53.24e.58.57Answer: bI/YR7.0%I/MO0.583333%Monthly annuity, so interest must be calculated on monthly basisPV$0PMT$3,000FV$150,000N44.0021

70.Your childs orthodontist offers you two alternative payment plans. The first plan requires a $4,000 immediate up-front payment. The second plan requires you to make monthly payments of $137.41, payable at the end of each month for 3 years. What nominal annual interest rate is built into the monthly payment plan?

a.12.31%b.12.96%c.13.64%d.14.36%e.15.08%Answer: dN36PV$4,000PMT$137.41FV$0I/MO1.20%Monthly annuity, so interest must be calculated on monthly basisI/YR = I/MO 12 = 14.36%

Page 150Conceptual M/CChapter 5: Time Value of Money