Fundamentals of Corporate Finance 11th Edition Ross Westerfield Jordan Test bank

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Fundamentals of Corporate Finance 11th Edition Ross Westerfield Jordan Test bank

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Chapter 06 Discounted Cash Flow Valuation
Student: ___________________________________________________________________________
1. An ordinary annuity is best defined by which one of the following?

A. Increasing payments paid for a definitive period of time.

B. Increasing payments paid forever.

C. Equal payments paid at the end of regular intervals over a stated time period.

D. Equal payments paid at the beginning of regular intervals for a limited time period.

E. Equal payments that occur at set intervals for an unlimited period of time.

2. Which one of the following accurately defines a perpetuity?

A. A limited number of equal payments paid in even time increments.

B. Payments of equal amounts that are paid irregularly but indefinitely.

C. Varying amounts that are paid at even intervals forever.

D. Unending equal payments paid at equal time intervals.

E. Unending equal payments paid at either equal or unequal time intervals.

3. A Canadian consol is best categorized as:

A. An ordinary annuity.

B. An amortized cash flow.

C. An annuity due.

D. A discounted loan.

E. A perpetuity.

4. The interest rate that is most commonly quoted by a lender is referred to as which one of the following?

A. Annual percentage rate.

B. Compound rate.

C. Effective annual rate.

D. Simple rate.

E. Common rate.

5. An interest rate on a loan that is compounded monthly but expressed as an annual rate would be an example of which one of the following rates?

A. Stated rate.

B. Discounted annual rate.

C. Effective annual rate.

D. Periodic monthly rate.

E. Consolidated monthly rate.

6. Your credit card charges you 1.5 percent interest per month. This rate when multiplied by 12 is called the:

A. Effective annual rate.

B. Annual percentage rate.

C. Periodic interest rate.

D. Compound interest rate.

E. Period interest rate.

7. A loan where the borrower receives money today and repays a single lump sum on a future date is called a(n) _____ loan.

A. Amortized.

B. Continuous.

C. Balloon.

D. Pure discount.

E. Interest-only.

8. Which one of the following terms is used to describe a loan that calls for periodic interest payments and a lump sum principal payment?

A. Amortized loan.

B. Modified loan.

C. Balloon loan.

D. Pure discount loan.

E. Interest-only loan.

9. Amortized loans must have which one of these characteristics?

A. Either equal or unequal principal payments over the life of the loan.

B. One lump-sum principal payment.

C. Increasing payments over the life of the loan.

D. Equal interest payments over the life of the loan.

E. Declining periodic payments.

10. Which one of the following terms is defined as a loan wherein the regular payments, including both interest and principal amounts, are insufficient to retire the entire loan amount, which then must be repaid in one lump sum?

A. Amortized loan.

B. Continuing loan.

C. Balloon loan.

D. Pure discount loan.

E. Interest-only loan.

11. You are comparing two annuities that offer quarterly payments of $2,500 for five years and pay .75 percent interest per month. You will purchase one of these today with a single lump sum payment. Annuity A will pay you monthly, starting today, while annuity B will pay monthly, starting one month from today. Which one of the following statements is correct concerning these two annuities?

A. These annuities have equal present values but unequal future values.

B. These two annuities have both equal present and future values.

C. Annuity B is an annuity due.

D. Annuity A has a smaller future value than annuity B.

E. Annuity B has a smaller present value than annuity A.

12. You are comparing two investment options that each pay 6 percent interest, compounded annually. Both options will provide you with $12,000 of income. Option A pays $2,000 the first year followed by two annual payments of $5,000 each. Option B pays three annual payments of $4,000 each. Which one of the following statements is correct given these two investment options? Assume a positive discount rate.

A. Both options are of equal value since they both provide $12,000 of income.

B. Option A has the higher future value at the end of year three.

C. Option B has a higher present value at time zero.

D. Option B is a perpetuity.

E. Option A is an annuity.

13. You are considering two projects with the following cash flows:
Project X Project Y
Year 1 $8,500 $7,000
Year 2 8,000 7,500
Year 3 7,500 8,000
Year 4 7,000 8,500
Which one of the following statements is true concerning these two projects given a positive discount rate?

A. Both projects have the same future value at the end of Year 4.

B. Both projects have the same value at Time 0.

C. Both projects are ordinary annuities.

D. Project Y has a higher present value than Project X.

E. Project X has both a higher present and a higher future value than Project Y.

14. Which one of the following statements is correct given the following two sets of project cash flows? Assume a positive discount rate.
Project A Project B
Year 1 $4,000 $2,000
Year 2 3,000 3,000
Year 3 0 2,000
Year 4 3,000 3,000

A. The cash flows for Project B are an annuity, but those of Project A are not.

B. Both sets of cash flows have equal present values as of time zero.

C. The present value at time zero of the final cash flow for Project A will be discounted using an exponent of three.

D. Both projects have equal values at any point in time since they both pay the same amount in total.

E. Project B is worth less today than Project A.

15. Which one of the following statements related to annuities and perpetuities is correct?

A. An ordinary annuity is worth more than an annuity due given equal annual cash flows for 10 years at 7 percent interest, compounded annually.

B. A perpetuity composed of $100 monthly payments is worth more than an annuity of $100 monthly payments given equal discount rates.

C. Most loans are a form of a perpetuity.

D. The present value of a perpetuity cannot be computed but the future value can.

E. Perpetuities are finite but annuities are not.

16. Which one of the following statements related to loan interest rates is correct?

A. The annual percentage rate considers the compounding of interest.

B. When comparing loans you should compare the effective annual rates.

C. Lenders are most apt to quote the effective annual rate.

D. Regardless of the compounding period, the effective annual rate will always be higher than the annual percentage rate.

E. The more frequent the compounding period, the lower the effective annual rate given a fixed annual percentage rate.

17. Which one of the following statements concerning interest rates is correct?

A. Savers would prefer annual compounding over monthly compounding given the same annual percentage rate.

B. The effective annual rate decreases as the number of compounding periods per year increases.

C. The effective annual rate equals the annual percentage rate when interest is compounded annually.

D. Borrowers would prefer monthly compounding over annual compounding given the same annual percentage rate.

E. For any positive rate of interest, the annual percentage rate will always exceed the effective annual rate.

18. Which one of these statements related to growing annuities and perpetuities is correct?

A. You can compute the present value of a growing annuity but not a growing perpetuity.

B. In computing the present value of a growing annuity, you discount the cash flows using the growth rate as the discount rate.

C. The future value of an annuity will decrease if the growth rate is increased.

D. An increase in the rate of growth will decrease the present value of an annuity.

E. The present value of a growing perpetuity will decrease if the discount rate is increased.

19. Which one of the following statements correctly defines a time value of money relationship?

A. Time and future values are inversely related, all else held constant.

B. Interest rates and time are positively related, all else held constant.

C. An increase in a positive discount rate increases the present value.

D. An increase in time increases the future value given a zero rate of interest.

E. Time and present value are inversely related, all else held constant.

20. Which one of the following compounding periods will yield the lowest effective annual rate given a stated future value at year 5 and an annual percentage rate of 10 percent?

A. Annual.

B. Semiannual.

C. Monthly.

D. Daily.

E. Continuous.

21. The entire repayment of which one of the following loans is computed simply by computing one single future value?

A. Interest-only loan.

B. Balloon loan.

C. Amortized loan.

D. Pure discount loan.

E. Bullet loan.

22. How is the principal amount of an interest-only loan repaid?

A. The principal is forgiven over the loan period; thus it does not have to be repaid.

B. The principal is repaid in decreasing increments and included in each loan payment.

C. The principal is repaid in one lump sum at the end of the loan period.

D. The principal is repaid in equal annual payments.

E. The principal is repaid in increasing increments through regular monthly payments.

23. An amortized loan:

A. Requires the principal amount to be repaid in even increments over the life of the loan.

B. May have equal or increasing amounts applied to the principal from each loan payment.

C. Requires that all interest be repaid on a monthly basis while the principal is repaid at the end of the loan term.

D. Requires that all payments be equal in amount and include both principal and interest.

E. Repays both the principal and the interest in one lump sum at the end of the loan term.

24. You need $25,000 today and have decided to take out a loan at 7 percent for five years. Which one of the following loans would be the least expensive? Assume all loans require monthly payments and that interest is compounded on a monthly basis.

A. Interest-only loan.

B. Amortized loan with equal principal payments.

C. Amortized loan with equal loan payments.

D. Discount loan.

E. Balloon loan where 50 percent of the principal is repaid as a balloon payment.

25. Your grandmother is gifting you $150 a month for four years while you attend college to earn your bachelors degree. At a 4.8 percent discount rate, what are these payments worth to you on the day you enter college?

A. $6,201.16

B. $6,539.14

C. $5,589.19

D. $6,608.87

E. $6,870.23

26. You just won the grand prize in a national writing contest! As your prize, you will receive $1,000 a month for 10 years. If you can earn 7 percent on your money, what is this prize worth to you today?

A. $86,126.35

B. $78,411.06

C. $81,338.40

D. $85,333.33

E. $90,450.25

27. Phil can afford $240 a month for five years for a car loan. If the interest rate is 8.5 percent, how much can he afford to borrow to purchase a car?

A. $11,750.00

B. $12,348.03

C. $11,697.88

D. $10,266.67

E. $10,400.00

28. As the beneficiary of a life insurance policy, you have two options for receiving the insurance proceeds. You can receive a lump sum of $200,000 today or receive payments of $1,400 a month for 20 years. If you can earn 6 percent on your money, which option should you take and why?

A. You should accept the payments because they are worth $209,414 to you today.

B. You should accept the payments because they are worth $247,800 to you today.

C. You should accept the payments because they are worth $336,000 to you today.

D. You should accept the $200,000 because the payments are only worth $189,311 to you today.

E. You should accept the $200,000 because the payments are only worth $195,413 to you today.

29. Your employer contributes $60 a week to your retirement plan. Assume you work for your employer for another 20 years and the applicable discount rate is 9 percent. Given these assumptions, what is this employee benefit worth to you today?

A. $28,927.38

B. $27,618.46

C. $29,211.11

D. $25,306.16

E. $25,987.74

30. The Distribution Point plans to save $2,000 a month for the next 3 years for future emergencies. The interest rate is 4.5 percent compounded monthly. The first monthly deposit will be made today. What would todays deposit amount have to be if the firm opted for one lump sum deposit that would yield the same amount of savings as the monthly deposits after 3 years?

A. $70,459.07

B. $67,485.97

C. $69,068.18

D. $69,333.33

E. $67,233.84

31. You need some money today and the only friend you have that has any is your miserly friend. He agrees to loan you the money you need, if you make payments of $30 a month for the next six months. In keeping with his reputation, he requires that the first payment be paid today. He also charges you 2 percent interest per month. How much money are you borrowing?

A. $164.09

B. $168.22

C. $169.50

D. $170.68

E. $171.40

32. You just purchased an annuity that will pay you $24,000 a year for 25 years, starting today. What was the purchase price if the discount rate is 8.5 percent?

A. $241,309

B. $245,621

C. $251,409

D. $258,319

E. $266,498

33. You are scheduled to receive annual payments of $3,600 for each of the next 12 years. The discount rate is 8 percent. What is the difference in the present value if you receive these payments at the beginning of each year rather than at the end of each year?

A. $2,170.39

B. $2,511.07

C. $2,021.18

D. $2,027.94

E. $2,304.96

34. You are comparing two annuities with equal present values. The applicable discount rate is 7.25 percent. One annuity pays $2,500 on the first day of each year for 15 years. How much does the second annuity pay each year for 15 years if it pays at the end of each year?

A. $2,331.00

B. $2,266.67

C. $2,500.00

D. $2,390.50

E. $2,681.25

35. Trish receives $450 on the first of each month. Josh receives $450 on the last day of each month. Both Trish and Josh will receive payments for next four years. At a discount rate of 9.5 percent, what is the difference in the present value of these two sets of payments?

A. $141.80

B. $151.06

C. $154.30

D. $159.08

E. $162.50

36. What is the future value of $1,400 a year for 35 years at 6 percent interest? Assume annual compounding.

A. $164,200

B. $138,714

C. $156,009

D. $142,908

E. $147,267

37. What is the future value of $12,000 a year for 40 years at 11.5 percent interest?

A. $8,278,406

B. $8,014,195

C. $7,711,414

D. $7,989,476

E. $8,021,223

38. Rosina plans on saving $2,000 a year and expects to earn an annual rate of 8.8 percent. How much will she have in her account at the end of 43 years?

A. $806,429

B. $838,369

C. $997,407

D. $831,532

E. $908,316

39. Theresa adds $1,500 to her savings account on the first day of each year. Marcus adds $1,500 to his savings account on the last day of each year. They both earn 6.5 percent annual interest. What is the difference in their savings account balances at the end of 35 years?

A. $12,093

B. $12,113

C. $12,127

D. $12,211

E. $12,219

40. You are borrowing $21,800 to buy a car. The terms of the loan call for monthly payments for five years at 8.25 percent interest. What is the amount of each payment?

A. $387.71

B. $391.40

C. $401.12

D. $439.76

E. $444.64

41. You borrow $230,000 to buy a house. The mortgage rate is 4.5 percent and the loan period is 25 years. Payments are made monthly. If you pay the mortgage according to the loan agreement, how much total interest will you pay?

A. $160,408

B. $147,027

C. $153,524

D. $164,319

E. $141,406

42. Travis International has a one-time expense of $2.86 million that must be paid three years from now. Since the firm cannot raise that amount in one day, it wants to save an equal amount each month over the next three years to fund this expense. If the firm can earn 2.1 percent on its savings, how much must it save each month?

A. $78,416.20

B. $77,037.69

C. $91,300.05

D. $87,411.08

E. $73,901.15

43. Nadine is retiring today at age 66 and expects to live to age 82. She has $136,000 in her retirement savings account. She is somewhat conservative with her money and expects to earn 6 percent during her retirement years. How much can she withdraw from her retirement savings each month if she plans to spend her last penny on the morning of her death?

A. $909.92

B. $847.78

C. $919.46

D. $1,416.08

E. $1,103.56

44. Island News purchased a piece of property for $1.36 million. The firm paid a down payment of 12 percent in cash and financed the balance. The loan terms require monthly payments for 10 years at an annual percentage rate of 4.75 percent, compounded monthly. What is the amount of each mortgage payment?

A. $12,548.18

B. $13,419.97

C. $13,607.11

D. $14,878.15

E. $12,301.16

45. You estimate that you will owe $39,950 in student loans by the time you graduate. The interest rate is 3.75 percent. If you want to have this debt paid in full within 10 years, how much must you pay each month?

A. $411.09

B. $399.74

C. $414.28

D. $436.05

E. $442.50

46. You are buying a pre-owned car today at a price of $8,500. You are paying $300 down in cash and financing the balance for 36 months at 7.75 percent. What is the amount of each monthly loan payment?

A. $256.01

B. $312.23

C. $318.47

D. $265.37

E. $284.40

47. An insurance annuity offers to pay you $1,000 per quarter for 20 years. If you want to earn a rate of return of 6.5 percent, what is the most you are willing to pay as a lump sum today to buy this annuity?

A. $32,008.24

B. $34,208.16

C. $44,591.11

D. $43,008.80

E. $38,927.59

48. Your car dealer is willing to lease you a new car for $190 a month for 36 months. Payments are due on the first day of each month starting with the day you sign the lease contract. If your cost of money is 6.5 percent, what is the current value of the lease?

A. $10,331.03

B. $6,232.80

C. $9,197.74

D. $7,203.14

E. $11,008.31

49. Your great aunt left you an inheritance in the form of a trust. The trust agreement states that you are to receive $2,400 on the first day of each year, starting immediately and continuing for 20 years. What is the value of this inheritance today if the applicable discount rate is 6.75 percent?

A. $24,890.88

B. $26,311.16

C. $27,677.34

D. $28,909.29

E. $29,333.33

50. You just received an insurance settlement offer related to an accident you had three years ago. The offer provides you with three choices:

Option A: $1,500 a month for 6 years
Option B: $1,025 a month for 10 years
Option C: $85,000 as a lump sum payment today

You can earn 7.5 percent on your investments and do not care if you personally receive the funds or if they are paid to your heirs should you die within the settlement period. Which option should you select and why is that option justified?

A. Option A: It provides the largest monthly payment.

B. Option B: It pays the largest total amount.

C. Option C: It is all paid today.

D. Option B: It pays the greatest number of payments.

E. Option A: It has the greatest value today.

51. Racing Engines wants to save $750,000 to buy some new equipment four years from now. The plan is to set aside an equal amount of money on the first day of each quarter starting today. The firm can earn 4.75 percent on its savings. How much does the firm have to save each quarter to achieve its goal?

A. $42,337.00

B. $42,969.70

C. $43,192.05

D. $43,419.29

E. $43,911.08

52. Stephanie is going to contribute $250 on the first of each month, starting today, to her retirement account. Her employer will provide a 50 percent match. In other words, her employer will add $125 to the amount Stephanie saves. If both Stephanie and her employer continue to do this and she can earn a monthly interest rate of .5 percent, how much will she have in her retirement account 25 years from now?

A. $336,264

B. $204,286

C. $199,312

D. $268,418

E. $261,172

53. You are considering an annuity that costs $160,000 today. The annuity pays $17,500 a year at an annual interest rate of 7.5 percent. What is the length of the annuity time period?

A. 13 years

B. 14 years

C. 15 years

D. 16 years

E. 17 years

54. Today, you borrowed $6,200 on your credit card to purchase some furniture. The interest rate is 14.9 percent, compounded monthly. How long will it take you to pay off this debt assuming that you do not charge anything else and make regular monthly payments of $120?

A. 5.87 years

B. 6.40 years

C. 6.93 years

D. 7.23 years

E. 7.31 years

55. MBM estimates its expansion cost at $18.63 million and wants it fully funded upfront. Management has decided to save $1.1 million a quarter for this purpose. The firm earns 6.25 percent, compounded quarterly, on its savings. How long does the firm have to wait before expanding its operations?

A. 3.09 years

B. 3.79 years

C. 4.46 years

D. 4.82 years

E. 4.91 years

56. Today, you are retiring. You have a total of $289,416 in your retirement savings. You want to withdraw $2,500 at the beginning of every month, starting today and expect to earn 4.6 percent, compounded monthly. How long will it be until you run out of money?

A. 29.97 years

B. 8.56 years

C. 22.03 years

D. 12.71 years

E. 18.99 years

57. The Art Gallery is notoriously known as a slow-payer. The firm currently needs to borrow $25,000 and only one company will loan to them. The terms of the loan call for weekly payments of $500 at a weekly interest rate of .45 percent. What is the loan term?

A. 42.5 weeks

B. 45.00 weeks

C. 56.77 weeks

D. 31.65 weeks

E. 43.33 weeks

58. Jogging Gear is considering a project with an initial cash requirement of $238,400. The project will yield cash flows of $4,930 monthly for 65 months. What is the rate of return on this project?

A. 9.97 percent

B. 11.38 percent

C. 14.28 percent
D. 13.41 percent
E. 10.56 percent

59. Your insurance agent is trying to sell you an annuity that costs $50,000 today. By buying this annuity, your agent promises that you will receive payments of $250 a month for the next 20 years. What is the rate of return on this investment?

A. 3.75 percent

B. 2.47 percent

C. 1.88 percent

D. 2.45 percent

E. 3.67 percent

60. You have been investing $250 a month for the last 13 years. Today, your investment account is worth $73,262. What is your average rate of return on your investments?

A. 8.94 percent

B. 9.23 percent

C. 9.36 percent

D. 9.41 percent

E. 9.78 percent

61. You have been purchasing $9,000 worth of stock annually for the past 5 years and now have a portfolio valued at $45,881. What is your annual rate of return?

A. 13.13 percent

B. 6.24 percent

C. 1.29 percent

D. 9.32 percent

E. .97 percent

62. Your father helped you start saving $20 a month beginning on your fifth birthday. He always made you deposit the money into your savings account on the first day of each month just to start the month out right. Today completes your 17th year of saving and you now have $6,528.91 in this account. What is the rate of return on your savings?

A. 5.15 percent

B. 5.30 percent

C. 5.47 percent

D. 5.98 percent

E. 6.12 percent

63. Today, you turn 23. Your birthday wish is that you will be a millionaire by your 40th birthday. In an attempt to reach this goal, you decide to save $75 a day, every day, until you turn 40. You open an investment account and deposit your first $75 today. What rate of return must you earn to achieve your goal?

A. 7.67 percent

B. 8.09 percent

C. 9.90 percent

D. 10.06 percent

E. 10.54 percent

64. You just settled an insurance claim. The settlement calls for increasing payments over a five-year period. The first payment will be paid one year from now in the amount of $7,000. The following payments will increase by 3.5 percent annually. What is the value of this settlement to you today if you can earn 6.5 percent on your investments?

A. $36,408.28

B. $31,063.79

C. $42,023.05

D. $34,141.14

E. $28,008.16

65. Your grandfather left you an inheritance that will provide an annual income for the next 20 years. You will receive the first payment one year from now in the amount of $16,500. Every year after that, the payment amount will increase by 5 percent. What is your inheritance worth to you today if you can earn 7.5 percent on your investments?

A. $247,750

B. $286,667

C. $231,211

D. $354,612

E. $308,974

66. You just won the magazine sweepstakes and opted to take unending payments. The first payment will be $21,500 and will be paid one year from today. Every year thereafter, the payments will increase by 2.5 percent annually. What is the present value of your prize at a discount rate of 7.9 percent?

A. $350,000

B. $348,409

C. $398,148

D. $291,006

E. $346,900

67. A wealthy benefactor just contributed to your colleges scholarship program. This gift will provide $20,000 in scholarships next year with that amount increasing by 2 percent annually thereafter.. If the discount rate is 6.5 percent, what is the current value of this perpetual gift?

A. $307,700

B. $350,000

C. $525,000

D. $444,444

E. $550,750

68. Southern Tours is considering acquiring Holiday Vacations. Management believes Holiday Vacations can generate cash flows of $187,000, $220,000, and $245,000 over the next three years, respectively. After that time, they feel the business will be worthless. If the desired rate of return is 13.5 percent, what is the maximum Southern Tours should pay today to acquire Holiday Vacations?

A. $503,098

B. $538,615

C. $545,920

D. $601,226

E. $638,407

69. You are considering two savings options. Both options offer a rate of return of 11 percent. The first option is to save $2,500, $1,500, and $3,000 at the end of each year for the next three years, respectively. The other option is to save one lump sum amount today. You want to have the same balance in your savings account at the end of the three years, regardless of the savings method you select. If you select the lump sum method, how much do you need to save today?

A. $5,405.41

B. $6,289.74

C. $6,660.00

D. $5,663.26

E. $4,784.20

70. Your parents have made you two offers. The first offer includes annual gifts of $10,000, $11,000, and $12,000 at the end of each of the next three years, respectively. The other offer is the payment of one lump sum amount today. You are trying to decide which offer to accept given the fact that your discount rate is 8 percent. What is the minimum amount that you will accept today if you are to select the lump sum offer?

A. $28,216

B. $29,407

C. $29,367

D. $30,439

E. $30,691

71. You want to start your own consulting business and believe it could produce cash flows of $5,600, $48,200, and $125,000 at the end of each of the next three years, respectively. At the end of three years you think you can sell the business for $450,000. At a 14 percent discount rate, what is this business idea worth today?

A. $311,406

B. $514,545

C. $430,109

D. $345,738

E. $478,901

72. You are considering a project that will provide annual cash inflows of $16,500, $25,700, and $18,000 at the end of each year for the next three years, respectively. What is the present value of these cash flows, given a discount rate of 12.5 percent?

A. $54,877

B. $47,615

C. $55,429

D. $46,388

E. $53,567

73. You just signed a consulting contract that will pay you $38,000, $52,000, and $85,000 annually at the end of the next three years, respectively. What is the present value of these cash flows given a discount rate of 10.5?

A. $139,975

B. $148,307

C. $154,880

D. $157,131

E. $162,910

74. You have some property for sale and have received two offers. The first offer is for $89,500 today in cash. The second offer is the payment of $35,000 today and an additional guaranteed $70,000 two years from today. If the applicable discount rate is 11.5 percent, which offer should you accept and why?

A. You should accept the $89,500 today because it has the higher net present value.

B. You should accept the $89,500 today because it has the lower future value.

C. You should accept the first offer as it is a lump sum payment.

D. You should accept the second offer because it has the larger net present value.

E. It does not matter which offer you accept as they are equally valuable.

75. You are planning a special wedding three years from today. You dont know who your spouse will be but you do know that you are saving $25,000 today and $35,000 one year from today for this purpose. You also plan to pay the final $45,000 of costs on your wedding day. At a discount rate of 7 percent, what is the current cost of your special wedding?

A. $94,444

B. $88, 800

C. $105,000

D. $85,711

E. $101,667

76. One year ago, JK Mfg. deposited $20,500 in an investment account for the purpose of buying new equipment four years from today. Today, it is adding another $15,000 to this account. The company plans on making a final deposit of $10,000 to the account one year from today. How much will be available when it is ready to buy the equipment, assuming the account pays 3.5 interest?

A. $53,408

B. $53,919

C. $56,211

D. $52,648

E. $58,021

77. Troy will receive $7,500 at the end of year 2. At the end of the following two years, he will receive $9,000 and $12,500, respectively. What is the future value of these cash flows at the end of year 5 if the interest rate is 8 percent?

A. $38,418

B. $32,907

C. $33,445

D. $36,411

E. $35,255

78. Sue plans to save $4,500, $0, and $5,500 at the end of each of the next three years, respectively. What will her investment account be worth at the end of the third year if she earns an annual rate of 4.15 percent?

A. $10,528.12

B. $10,381.25

C. $9,907.11

D. $11,526.50

E. $10,812.07

79. Waldo expects to receive the following payments: year 1 = $50,000; year 2 = $28,000; year 3 = $12,000. All of this money will be saved for his retirement. If he can earn an average annual return of 10.5 percent, how much will he have in his account 25 years after making the first deposit?

A. $1,172,373

B. $935,334

C. $806,311

D. $947,509

E. $1,033,545

80. Jones Stoneware has a $65,000 liability it must pay four years from today. The company is opening a savings account so that the entire amount will be available when this debt comes due. The plan is to make an initial deposit today and then deposit an additional $10,000 at the end of each of the four years. The account pays a 4.5 percent rate of return. How much does the firm need to deposit today?

A. $18,299.95

B. $19,469.64

C. $21,400.33

D. $18,631.23

E. $22,218.09

81. The government has imposed a fine on JJs Place. The fine calls for annual payments of $60,000, $70,000, $75,000, and $50,000, respectively, over the next four years. The first payment is due one year from today. The government plans to invest the funds until the final payment is collected and then donate the entire amount, including the investment earnings, to help the local community shelter. The government will earn 5.5 percent on the funds held. How much will the community shelter receive four years from today?

A. $263,025

B. $236,875

C. $277,491

D. $328,572

E. $285,737

82. Goods Guys Foods established a trust fund that provides $125,000 in scholarships each year for needy students. The trust fund earns a fixed 7.25 percent rate of return. How much money did the firm contribute to the fund assuming that only the interest income is distributed?

A. $1,687,450

B. $1,478,023

C. $1,333,333

D. $1,724,138

E. $1,600,000

83. A preferred stock pays an annual dividend of $4.10. What is one share of this stock worth today if the rate of return is 9.68 percent?

A. $41.48

B. $41.18

C. $42.36

D. $39.87

E. $42.90

84. You would like to establish a trust fund to provide $140,000 a year forever for your heirs. The expected rate of return is 5.45 percent. How much money must you deposit today to fund this gift?

A. $2,568,807

B. $2,521,212

C. $2,600,000

D. $2,458,122

E. $2,500,000

85. You just paid $750,000 for an annuity that will pay you and your heirs $36,000 a year forever. What rate of return are you earning on this policy?

A. 4.75 percent

B. 5.10 percent

C. 5.33 percent

D. 4.80 percent

E. 4.72 percent

86. You grandfather invested $20,000 years ago to provide annual payments of $750 a year to his heirs forever. What is the rate of return?

A. 4.75 percent

B. 3.75 percent

C. 4.10 percent

D. 4.25 percent

E. 4.33 percent

87. DLM preferred stock has a 5.8 percent dividend yield. The stock is currently priced at $36.20 per share. What is the amount of the annual dividend?

A. $2.30

B. $2.35

C. $2.40

D. $2.10

E. $1.90

88. Your credit card company charges you 1.65 percent interest per month. What is the annual percentage rate on your account?

A. 18.95 percent

B. 19.80 percent

C. 20.90 percent

D. 21.25 percent

E. 21.70 percent

89. What is the annual percentage rate on a loan with a stated rate of 2.75 percent per quarter?

A. 11.00 percent

B. 11.09 percent

C. 11.18 percent

D. 11.27 percent

E. 11.31 percent

90. You are paying an effective annual rate of 15.33 percent on your credit card. The interest is compounded monthly. What is the annual percentage rate on this account?

A. 14.35 percent

B. 13.90 percent

C. 14.10 percent

D. 13.75 percent

E. 14.00 percent

91. What is the effective annual rate if a bank charges you an APR of 8.25 percent, compounded quarterly?

A. 8.32 percent

B. 8.38 percent

C. 8.42 percent

D. 8.51 percent

E. 8.61 percent

92. Your credit card company quotes you an interest rate of 21.9 percent based on annual compounding. Interest is billed monthly. What is the actual rate of interest you are paying?

A. 21.90 percent

B. 19.21 percent

C. 24.24 percent

D. 22.57 percent

E. 23.72 percent

93. Your local pawn shop loans money at an annual rate of 23 percent and compounds interest weekly. What is the actual rate being charged on these loans?

A. 25.16 percent

B. 25.80 percent

C. 26.49 percent

D. 26.56 percent

E. 26.64 percent

94. You are considering five loan offers. The only significant difference between them is their interest rates. Given the following information, which offer should you accept? (Assume a 365-day year.)

Offer A: 6.75 percent APR with daily compounding.
Offer B: 6.8 percent APR with monthly compounding.
Offer C: 7 percent APR with annual compounding.
Offer D: 6.825 percent APR with quarterly compounding.
Offer E: 6.85 percent APR with semiannual compounding.

A. Offer A

B. Offer B

C. Offer C

D. Offer D

E. Offer E

95. The banks in your area offer the following rates of interest on their savings accounts. If you want to open one of these accounts, which bank should you select?

Bank A: .75 percent APR with daily compounding.
Bank B: .85 percent APR with monthly compounding.
Bank C: .8725 percent APR with annual compounding.
Bank D: .87 percent APR with quarterly compounding.
Bank E: .775 percent APR with semiannual compounding.

A. Bank A

B. Bank B

C. Bank C

D. Bank D

E. Bank E

96. What is the effective annual rate of 14.9 percent compounded continuously?

A. 15.59 percent

B. 15.62 percent

C. 15.69 percent

D. 15.84 percent

E. 16.07 percent

97. What is the effective annual rate of 11.9 percent compounded continuously?

A. 12.72 percent

B. 12.64 percent

C. 13.43 percent

D. 12.89 percent

E. 12.68 percent

98. First City Bank wants to appear competitive based on quoted loan rates and thus must offer a 7.65 percent annual percentage rate on its loans. What is the maximum rate the bank can actually earn based on the quoted rate?

A. 7.95 percent

B. 8.14 percent

C. 8.21 percent

D. 7.78 percent

E. 7.87 percent

99. You are going to loan a friend $6,000 for one year at an interest rate of 4.5 percent, compounded annually. How much additional interest could you have earned if you had compounded the rate continuously rather than annually?

A. $5.84

B. $.6.17

C. $6.10

D. $5.93

E. $6.28

100. You are borrowing money today at 8.48 percent, compounded annually. You will repay the principal plus all the interest in one lump sum of $12,800 two years from today. How much are you borrowing?

A. $9,900.00

B. $10,211.16

C. $10,877.04

D. $11,401.16

E. $11,250.00

101. This morning, you borrowed $13,400 at a 6.9 percent annual interest rate. You are to repay the loan principal plus all of the loan interest in one lump sum three years from today. How much will you have to repay?

A. $16,369.59

B. $17,808.13

C. $15,313.00

D. $15,324.60

E. $16,441.20

102. On this date last year, you borrowed $3,400. You have to repay the loan principal plus all of the interest six years from today. The payment that is required at that time is $6,000. What is the interest rate on this loan?

A. 8.01 percent

B. 8.45 percent

C. 8.78 percent

D. 9.47 percent

E. 9.93 percent

103. Johns Auto Repair just took out a $52,000, 10-year, 8 percent, interest-only loan from the bank. Payments are made annually. What is the amount of the loan payment in year 10?

A. $7,750

B. $41,600

C. $4,160

D. $52,000

E. $56,160

104. On the day you entered college, you borrowed $25,000 on an interest-only, four-year loan at 4.75 percent from your local bank. Payments are to be paid annually. What is the amount of your loan payment in year 2?

A. $1,187.50

B. $1,890.00

C. $7,009.40

D. $5,106.67

E. $6,250.00

105. On the day you entered college, you borrowed $30,000 from your local bank. The terms of the loan include an interest rate of 4.75 percent. The terms stipulate that the principal is due in full one year after you graduate. Interest is to be paid annually at the end of each year. Assume that you complete college in four years. How much total interest will you pay on this loan assuming you paid as agreed?

A. $7,267

B. $7,400

C. $7,125

D. $1,500

E. $1,425

106. You just acquired a 30-year mortgage in the amount of $179,500 at 4.75 percent interest, compounded monthly. Payments will be equal over the life of the loan with the first payment due one month after the date of the loan. How much of the first payment will be interest?

A. $925.20

B. $806.16

C. $710.52

D. $936.36

E. $548.60

107. On June 1, you borrowed $195,000 to buy a house. The mortgage rate is 5.25 percent. The loan is to be repaid in equal monthly payments over 15 years. All taxes and insurance premiums are to be paid separately. The first payment is due on July 1. How much of the first payment applies to the principal balance?

A. $714.43

B. $721.14

C. $658.56

D. $743.38

E. $756.70

108. This morning, you borrowed $162,000 to buy a house. The mortgage rate is 4.35 percent. The loan is to be repaid in equal monthly payments over 20 years with the first payment due one month from today. Assume each month is equal to 1/12 of a year and all taxes and insurance premiums are paid separately. How much of the second payment applies to the principal balance?

A. $568.84

B. $426.11

C. $424.57

D. $587.25

E. $585.71

109. Western Bank offers you a $10,000, 6-year term loan at 7 percent annual interest. What is the amount of your annual loan payment?

A. $1,883.33

B. $2,097.96

C. $2,066.67

D. $1,901.18

E. $1,811.07

110. The Friendly Bank wants to earn an effective annual return on its consumer loans of 12 percent per year. The bank uses daily compounding. What rate is the bank most apt to quote on these loans?

A. 11.76 percent

B. 11.38 percent

C. 11.33 percent

D. 12.12 percent

E. 12.00 percent

111. Your broker is offering 1.2 percent compounded daily on its money market account. If you deposit $7,500 today, how much will you have in your account 15 years from now?

A. $8,979.10

B. $9,714.06

C. $8,204.50

D. $9,336.81

E. $9,414.14

112. You want to buy a new sports coupe for $41,750 and the finance office at the dealership has quoted you an APR of 7.6, compounded monthly for 48 months. What is the effective interest rate on this loan?

A. 8.28 percent

B. 8.41 percent

C. 7.94 percent

D. 8.13 percent

E. 7.87 percent

113. Beginning three months from now, you want to be able to withdraw $1,700 each quarter from your bank account to cover college expenses. The account pays .45 percent interest per quarter. How much do you need to have in your account today to meet your expense needs over the next four years?

A. $26,187.10

B. $26,847.15

C. $25,068.00

D. $27,319.54

E. $26,069.79

114. You are planning to save for retirement over the next 15 years. To do this, you will invest $1,100 a month in a stock account and $500 a month in a bond account. The return on the stock account is expected to be 7 percent, and the bond account will pay 4 percent. When you retire, you will combine your money into an account with a 5 percent return. How much can you withdraw each month during retirement assuming a 20-year withdrawal period?

A. $2,636.19

B. $2,904.11

C. $3,008.21

D. $3,113.04

E. $3,406.97

115. You want to be a millionaire when you retire in 40 years and can earn an annual return of 12.5 percent. How much more will you have to save each month if you wait 15 years to start saving versus if you start saving at the end of this month?

A. $489.22

B. $354.13

C. $308.47

D. $441.15

E. $414.34

116. You are the recipient of a gift that will pay you $25,000 one year from now and every year thereafter for the following 24 years. The payments will increase in value by 2.5 percent each year. If the appropriate discount rate is 8.5 percent, what is the present value of this gift?

A. $416,667

B. $316,172

C. $409,613

D. $311,406

E. $386,101

117. You are preparing to make monthly payments of $75, beginning at the end of this month, into an account that pays 6 percent interest compounded monthly. How many payments will you have made when your account balance reaches $10,000?

A. 97

B. 102

C. 89

D. 102

E. 91

118. You want to borrow $38,400 and can afford monthly payments of $960 for 48 months, but no more. Assume monthly compounding. What is the highest APR rate you can afford?

A. 9.24 percent

B. 8.67 percent

C. 8.82 percent

D. 9.01 percent

E. 9.18 percent

119. You need a 30-year, fixed-rate mortgage to buy a new home for $225,000. Your bank will lend you the money at an APR of 5.5 percent with monthly compounding. You can only afford monthly payments of $1,000 for principal and interest, so you offer to pay off any remaining loan balance at the end of the loan term in the form of a single balloon payment. What will be the amount of the balloon payment?

A. $232,191

B. $213,316

C. $254,480

D. $253,550

E. $226,315

120. The present value of the following cash flow stream is $5,933.86 when discounted at 11 percent annually. What is the value of the missing cash flow?
Year Cash Flow
1 $2,000
2 ?
3 1,750
4 1,250

A. $1,500

B. $1,750

C. $2,250

D. $2,250
E. $2,500

121. You have just purchased a new warehouse. To finance the purchase, you arranged for a 30-year mortgage loan for 65 percent of the $2.5 million purchase price. The monthly payment on this loan will be $10,400. What is the effective annual rate on this loan?

A. 6.82 percent

B. 6.25 percent

C. 6.46 percent

D. 7.01 percent

E. 7.27 percent

122. Als obtained a discount loan of $71,000 today that requires a repayment of $90,000, 3 years from today. What is the APR on this loan?

A. 7.87 percent

B. 8.01 percent

C. 8.23 percent

D. 8.57 percent

E. 8.90 percent

123. What is the present value of $1,400 a year at a discount rate of 8 percent if the first payment is received 7 years from now and you receive a total of 23 annual payments?

A. $9,149.74

B. $9,238.87

C. $9,333.33

D. $9,420.12

E. $9,881.72

124. You have your choice of two investment accounts. Investment A is a five-year annuity that features end-of-month $2,500 payments and has an interest rate of 11.5 percent compounded monthly. Investment B is a 10.5 percent continuously compounded lump sum investment, also good for five years. How much would you need to invest in B today for it to be worth as much as investment A five years from now?

A. $108,206.67

B. $119,176.06

C. $124,318.08

D. $129,407.17

E. $131,008.15

125. You want to buy a new sports car for $55,000. The contract is in the form of a 60-month annuity due at an APR of 6 percent, compounded monthly. What will be your monthly payment?

A. $1,047.90

B. $1,053.87

C. $1,058.01

D. $1,063.30

E. $1,072.11

126. You are considering a one-year discount loan of $16,000. The interest rate is quoted as 7 percent plus 4 points. What is the actual rate you are paying on this loan?

A. 11.00 percent

B. 11.67 percent

C. 12.55 percent

D. 11.46 percent

E. 10.84 percent

127. You just received an offer in the mail to transfer your $5,000 balance from your current credit card, which charges an annual rate of 18.7 percent, to a new credit card charging a rate of 5.9 percent. You plan to make payments of $250 a month on this debt. How many fewer payments will you have to make to pay off this debt if you transfer the balance to the new card?

A. 2.36 payments

B. 3.05 payments

C. 3.10 payments

D. 2.79 payments

E. 2.86 payments

Chapter 06 Discounted Cash Flow Valuation Key

1. An ordinary annuity is best defined by which one of the following?

A. Increasing payments paid for a definitive period of time.

B. Increasing payments paid forever.

C. Equal payments paid at the end of regular intervals over a stated time period.

D. Equal payments paid at the beginning of regular intervals for a limited time period.

E. Equal payments that occur at set intervals for an unlimited period of time.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Basic
Learning Objective: 06-01 How to determine the future and present value of investments with multiple cash flows.
Section: 6.2 Valuing Level Cash Flows: Annuities and Perpetuities
Topic: Annuities

2. Which one of the following accurately defines a perpetuity?

A. A limited number of equal payments paid in even time increments.

B. Payments of equal amounts that are paid irregularly but indefinitely.

C. Varying amounts that are paid at even intervals forever.

D. Unending equal payments paid at equal time intervals.

E. Unending equal payments paid at either equal or unequal time intervals.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Basic
Learning Objective: 06-01 How to determine the future and present value of investments with multiple cash flows.
Section: 6.2 Valuing Level Cash Flows: Annuities and Perpetuities
Topic: Perpetuities

3. A Canadian consol is best categorized as:

A. An ordinary annuity.

B. An amortized cash flow.

C. An annuity due.

D. A discounted loan.

E. A perpetuity.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Basic
Learning Objective: 06-01 How to determine the future and present value of investments with multiple cash flows.
Section: 6.2 Valuing Level Cash Flows: Annuities and Perpetuities
Topic: Perpetuities

4. The interest rate that is most commonly quoted by a lender is referred to as which one of the following?

A. Annual percentage rate.

B. Compound rate.

C. Effective annual rate.

D. Simple rate.

E. Common rate.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Basic
Learning Objective: 06-04 How interest rates are quoted (and misquoted).
Section: 6.3 Comparing Rates: The Effect of Compounding
Topic: Loan interest and rates

5. An interest rate on a loan that is compounded monthly but expressed as an annual rate would be an example of which one of the following rates?

A. Stated rate.

B. Discounted annual rate.

C. Effective annual rate.

D. Periodic monthly rate.

E. Consolidated monthly rate.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Basic
Learning Objective: 06-04 How interest rates are quoted (and misquoted).
Section: 6.3 Comparing Rates: The Effect of Compounding
Topic: Loan interest and rates

6. Your credit card charges you 1.5 percent interest per month. This rate when multiplied by 12 is called the:

A. Effective annual rate.

B. Annual percentage rate.

C. Periodic interest rate.

D. Compound interest rate.

E. Period interest rate.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Basic
Learning Objective: 06-04 How interest rates are quoted (and misquoted).
Section: 6.3 Comparing Rates: The Effect of Compounding
Topic: Loan interest and rates

7. A loan where the borrower receives money today and repays a single lump sum on a future date is called a(n) _____ loan.

A. Amortized.

B. Continuous.

C. Balloon.

D. Pure discount.

E. Interest-only.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Basic
Learning Objective: 06-03 How loans are amortized or paid off.
Section: 6.4 Loan Types and Loan Amortization
Topic: Types of loans

8. Which one of the following terms is used to describe a loan that calls for periodic interest payments and a lump sum principal payment?

A. Amortized loan.

B. Modified loan.

C. Balloon loan.

D. Pure discount loan.

E. Interest-only loan.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Basic
Learning Objective: 06-03 How loans are amortized or paid off.
Section: 6.4 Loan Types and Loan Amortization
Topic: Types of loans

9. Amortized loans must have which one of these characteristics?

A. Either equal or unequal principal payments over the life of the loan.

B. One lump-sum principal payment.

C. Increasing payments over the life of the loan.

D. Equal interest payments over the life of the loan.

E. Declining periodic payments.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Basic
Learning Objective: 06-03 How loans are amortized or paid off.
Section: 6.4 Loan Types and Loan Amortization
Topic: Amortization

10. Which one of the following terms is defined as a loan wherein the regular payments, including both interest and principal amounts, are insufficient to retire the entire loan amount, which then must be repaid in one lump sum?

A. Amortized loan.

B. Continuing loan.

C. Balloon loan.

D. Pure discount loan.

E. Interest-only loan.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: Basic
Learning Objective: 06-03 How loans are amortized or paid off.
Section: 6.4 Loan Types and Loan Amortization
Topic: Types of loans

11. You are comparing two annuities that offer quarterly payments of $2,500 for five years and pay .75 percent interest per month. You will purchase one of these today with a single lump sum payment. Annuity A will pay you monthly, starting today, while annuity B will pay monthly, starting one month from today. Which one of the following statements is correct concerning these two annuities?

A. These annuities have equal present values but unequal future values.

B. These two annuities have both equal present and future values.

C. Annuity B is an annuity due.

D. Annuity A has a smaller future value than annuity B.

E. Annuity B has a smaller present value than annuity A.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Basic
Learning Objective: 06-01 How to determine the future and present value of investments with multiple cash flows.
Section: 6.2 Valuing Level Cash Flows: Annuities and Perpetuities
Topic: Annuities

12. You are comparing two investment options that each pay 6 percent interest, compounded annually. Both options will provide you with $12,000 of income. Option A pays $2,000 the first year followed by two annual payments of $5,000 each. Option B pays three annual payments of $4,000 each. Which one of the following statements is correct given these two investment options? Assume a positive discount rate.

A. Both options are of equal value since they both provide $12,000 of income.

B. Option A has the higher future value at the end of year three.

C. Option B has a higher present value at time zero.

D. Option B is a perpetuity.

E. Option A is an annuity.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Basic
Learning Objective: 06-01 How to determine the future and present value of investments with multiple cash flows.
Section: 6.1 Future and Present Values of Multiple Cash Flows
Section: 6.2 Valuing Level Cash Flows: Annuities and Perpetuities
Topic: Present value multiple cash flows

13. You are considering two projects with the following cash flows:
Project X Project Y
Year 1 $8,500 $7,000
Year 2 8,000 7,500
Year 3 7,500 8,000
Year 4 7,000 8,500
Which one of the following statements is true concerning these two projects given a positive discount rate?

A. Both projects have the same future value at the end of Year 4.

B. Both projects have the same value at Time 0.

C. Both projects are ordinary annuities.

D. Project Y has a higher present value than Project X.

E. Project X has both a higher present and a higher future value than Project Y.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Basic
Learning Objective: 06-01 How to determine the future and present value of investments with multiple cash flows.
Section: 6.1 Future and Present Values of Multiple Cash Flows
Topic: Time value of money

14. Which one of the following statements is correct given the following two sets of project cash flows? Assume a positive discount rate.
Project A Project B
Year 1 $4,000 $2,000
Year 2 3,000 3,000
Year 3 0 2,000
Year 4 3,000 3,000

A. The cash flows for Project B are an annuity, but those of Project A are not.

B. Both sets of cash flows have equal present values as of time zero.

C. The present value at time zero of the final cash flow for Project A will be discounted using an exponent of three.

D. Both projects have equal values at any point in time since they both pay the same amount in total.

E. Project B is worth less today than Project A.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Basic
Learning Objective: 06-01 How to determine the future and present value of investments with multiple cash flows.
Section: 6.1 Future and Present Values of Multiple Cash Flows
Topic: Present value multiple cash flows

15. Which one of the following statements related to annuities and perpetuities is correct?

A. An ordinary annuity is worth more than an annuity due given equal annual cash flows for 10 years at 7 percent interest, compounded annually.

B. A perpetuity composed of $100 monthly payments is worth more than an annuity of $100 monthly payments given equal discount rates.

C. Most loans are a form of a perpetuity.

D. The present value of a perpetuity cannot be computed but the future value can.

E. Perpetuities are finite but annuities are not.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Basic
Learning Objective: 06-01 How to determine the future and present value of investments with multiple cash flows.
Section: 6.2 Valuing Level Cash Flows: Annuities and Perpetuities
Topic: Perpetuities

16. Which one of the following statements related to loan interest rates is correct?

A. The annual percentage rate considers the compounding of interest.

B. When comparing loans you should compare the effective annual rates.

C. Lenders are most apt to quote the effective annual rate.

D. Regardless of the compounding period, the effective annual rate will always be higher than the annual percentage rate.

E. The more frequent the compounding period, the lower the effective annual rate given a fixed annual percentage rate.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Basic
Learning Objective: 06-04 How interest rates are quoted (and misquoted).
Section: 6.3 Comparing Rates: The Effect of Compounding
Topic: Loan interest and rates

17. Which one of the following statements concerning interest rates is correct?

A. Savers would prefer annual compounding over monthly compounding given the same annual percentage rate.

B. The effective annual rate decreases as the number of compounding periods per year increases.

C. The effective annual rate equals the annual percentage rate when interest is compounded annually.

D. Borrowers would prefer monthly compounding over annual compounding given the same annual percentage rate.

E. For any positive rate of interest, the annual percentage rate will always exceed the effective annual rate.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Basic
Learning Objective: 06-04 How interest rates are quoted (and misquoted).
Section: 6.3 Comparing Rates: The Effect of Compounding
Topic: Interest rates

18. Which one of these statements related to growing annuities and perpetuities is correct?

A. You can compute the present value of a growing annuity but not a growing perpetuity.

B. In computing the present value of a growing annuity, you discount the cash flows using the growth rate as the discount rate.

C. The future value of an annuity will decrease if the growth rate is increased.

D. An increase in the rate of growth will decrease the present value of an annuity.

E. The present value of a growing perpetuity will decrease if the discount rate is increased.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-01 How to determine the future and present value of investments with multiple cash flows.
Section: 6.2 Valuing Level Cash Flows: Annuities and Perpetuities
Topic: Annuities

19. Which one of the following statements correctly defines a time value of money relationship?

A. Time and future values are inversely related, all else held constant.

B. Interest rates and time are positively related, all else held constant.

C. An increase in a positive discount rate increases the present value.

D. An increase in time increases the future value given a zero rate of interest.

E. Time and present value are inversely related, all else held constant.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-01 How to determine the future and present value of investments with multiple cash flows.
Section: 6.1 Future and Present Values of Multiple Cash Flows
Topic: Time value of money

20. Which one of the following compounding periods will yield the lowest effective annual rate given a stated future value at year 5 and an annual percentage rate of 10 percent?

A. Annual.

B. Semiannual.

C. Monthly.

D. Daily.

E. Continuous.

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