978-0132757089 Chapter 05 Part 1

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Financial Management: Principles and Applications, 11e (Titman)

Chapter 5 Time Value of Money-The Basics

1) Financial managers use the time value of money to:

A) make business decisions.

B) compare cash flows of different projects.

C) determine the price of common stock.

D) both A and B.

E) all of the above.

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: time value of money

Principles: Principle 1: Money Has a Time Value

2) The time value of money is created by:

A) the existence of profitable investment alternatives and interest rates.

B) the fact that the passing of time increases the value of money.

C) the elimination of the opportunity cost as a consideration.

D) the fact that the value of saving money for tomorrow could be more or less than spending it

today.

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: time value of money

Principles: Principle 1: Money Has a Time Value

3) Which of the following statements is FALSE?

A) Quarterly compounding has a higher annual percentage yield than monthly compounding.

B) On monthly compounding loans, the annual percentage yield will be less than the nominal or

quoted rate of interest.

C) Compounding essentially means earning interest on interest on an initial balance.

D) Perpetuities pay an equal payment forever.

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

4) An investment has a nominal interest rate of 12% annually, but interest on the investment is

compounded monthly. Therefore, the annual percentage yield on the investment is:

A) 12%.

B) 12.68%.

C) 13.89%.

D) 12.36%.

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

5) An investment has a nominal interest rate of 12% annually, but interest on the investment is

compounded semiannually. Therefore, the annual percentage yield on the investment is:

A) 12%.

B) 12.68%.

C) 13.89%.

D) 12.36%.

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

6) Which of the following provides the greatest annual interest?

A) 10%, compounded annually

B) 10%, compounded semiannually

C) 10%, compounded quarterly

D) 10%, compounded monthly

E) 10%, compounded daily

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

7) A bank pays a quoted annual (nominal) interest rate of 4.25%, compounded daily (365-day

year). What is the annual percentage yield (APY)?

A) 4.25%

B) 5.56%

C) 4.75%

D) 6.20%

E) 4.34%

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

8) Northwest Bank pays a quoted annual (nominal) interest rate of 4.75%. However, it pays

interest (compounds) daily using a 365-day year. What is the effective annual rate of return

(APY)?

A) 4.75%

B) 5.02%

C) 3.61%

D) 4.86%

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

9) If you are an investor, which of the following would you prefer?

A) Earnings on funds invested would compound annually.

B) Earnings on funds invested would compound daily.

C) Earnings on funds invested would compound monthly.

D) Earnings on funds invested would compound quarterly.

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

10) You have $10,000 to invest. You do not want to take any risk, so you will put the funds in a

savings account at the local bank. Of the following choices, which one will produce the largest

sum at the end of 22 years?

A) An account that compounds interest annually.

B) An account that compounds interest daily.

C) An account that compounds interest quarterly.

D) An account that compounds interest monthly.

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

11) Which of the following statements is true about the time value of money?

A) The future value of a single sum will be greater if funds earn 5% instead of 10%.

B) The future value of a single sum will be unaffected by the rate of return at which funds grow.

C) The future value of a single sum will be greater if funds earn 12% instead of 6%.

D) The future value of a single sum will be unaffected by the length of time funds are invested.

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

12) Which of the following statements is true about the time value of money?

A) The present value of a future amount will be greater if funds earn 5% instead of 10%.

B) The present value of a single sum will be unaffected by the rate of return at which funds grow.

C) The present value of a future amount will be greater if funds earn 12% instead of 6%.

D) The present value of a future amount will be unaffected by how far in the future funds would

be received.

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

13) If you are a borrower, which of the choices would lower your APR?

A) Repay your loan in monthly installments

B) Repay your loan in quarterly installments

C) Repay your loan in semiannual installments

D) Repay your loan in annual installments

E) You would be indifferent to how frequent your loan payments are.

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

14) As the number of compounding periods increases, the ________ increases.

A) quoted

B) annual percentage yield

C) effective annual rate

D) both B and C

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

15) Which of the following statements is FALSE?

A) The effective annual rate (APR) of a loan is always the same as the quoted rate.

B) The payments of an ordinary annuity are made or received at the end of each period.

C) The effective annual rate (APR) of a loan is always equal to or greater than the quoted rate.

D) A perpetuity is a series of equal payments, which are made for an infinite period of time.

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

16) Which of the following provides the lowest return to an investor?

A) 12%, compounded annually

B) 12%, compounded semiannually

C) 12%, compounded quarterly

D) 12%, compounded monthly

E) 12%, compounded daily

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

17) The discount rate for the time value of money should reflect delaying consumption.

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: time value of money

Principles: Principle 1: Money Has a Time Value

18) Why is the concept of the time value of money so important to financial managers?

Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: cash flow

Principles: Principle 1: Money Has a Time Value

1) Which of the following is the formula for compound value?

A) FVn = P(1 + i)n

B) FVn = (1 + i)/P

C) FVn = P/(1 + i)n

D) FVn = P(1 + i)-n

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

2) At 8% compounded annually, how long will it take $750 to double?

A) 6.5 years

B) 48 months

C) 9 years

D) 12 years

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

3) At what rate must $400 be compounded annually for it to grow to $716.40 in 10 years?

A) 6%

B) 5%

C) 7%

D) 8%

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

4) An increase in future value can be caused by an increase in the:

A) annual interest rate.

B) number of compounding periods.

C) original amount invested.

D) both A and B.

E) all of the above.

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

5) A friend plans to buy a big-screen TV/entertainment system and can afford to set aside $1,320

toward the purchase today. If your friend can earn 5.0%, compounded yearly, how much can

your friend spend in four years on the purchase? Round off to the nearest $1.

A) $1,444

B) $1,604

C) $1,764

D) $1,283

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

6) You just purchased a parcel of land for $10,000. If you expect a 12% annual rate of return on

your investment, how much will you sell the land for in 10 years?

A) $25,000

B) $31,060

C) $38,720

D) $34,310

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

7) If you place $50 in a savings account with an interest rate of 7% compounded weekly, what

will the investment be worth at the end of five years (round to the nearest dollar)?

A) $72

B) $70

C) $71

D) $57

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

8) If you put $700 in a savings account with a 10% nominal rate of interest compounded

monthly, what will the investment be worth in 21 months (round to the nearest dollar)?

A) $827

B) $833

C) $828

D) $1,176

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

9) If you put $600 in a savings account that yields an 8% rate of interest compounded weekly,

what will the investment be worth in 37 weeks (round to the nearest dollar)?

A) $648

B) $635

C) $634

D) $645

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

10) Which of the following formulas represents the future value of $500 invested at 8%

compounded quarterly for five years?

A) 500(1 + .08)5

B) 500(1 + .08)20

C) 500(1 + .02)5

D) 500(1 + .02)20

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

11) What is the value of $750 invested at 7.5% compounded quarterly for 4.5 years (round to the

nearest $1)?

A) $1,048

B) $1,010

C) $1,038

D) $808

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

12) Shorty Jones wants to buy a one-way bus ticket to Mule-Snort, Pennsylvania. The ticket

costs $142, but Mr. Jones has only $80. If Shorty puts the money in an account that pays 9%

interest compounded monthly, how many months must Shorty wait until he has $142 (round to

the nearest month)?

A) 73 months

B) 75 months

C) 77 months

D) 79 months

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

13) If you want to have $10,000 in 10 years, which of the following formulas represents how

much money you must put in a savings account today? Assume that the savings account pays 6%

and it is compounded monthly.

A) 10,000/(1 + .05)10

B) 10,000/(1 + .005)120

C) 10,000/(1 + .06)10

D) 10,000/(1 + .006)120

Topic: 5.2 Compounding and Future Value

Keywords: future value

Principles: Principle 1: Money Has a Time Value

14) Dawn Swift discovered that 20 years ago, the average tuition for one year at an Ivy League

school was $4,500. Today, the average cost is $29,000. What is the growth rate in tuition cost

over this 20-year period? Round off to the nearest 0.1%.

A) 15.5%

B) 4.2%

C) 9.8%

D) 10.6%

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

15) If you want to have $1,700 in seven years, how much money must you put in a savings

account today? Assume that the savings account pays 6% and it is compounded quarterly (round

to the nearest $10).

A) $1,120

B) $1,130

C) $1,110

D) $1,140

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

16) If you want to have $90 in four years, how much money must you put in a savings account

today? Assume that the savings account pays 8.5% and it is compounded monthly (round to the

nearest $1).

A) $64

B) $65

C) $66

D) $71

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

17) How much money must be put into a bank account yielding 5.5% (compounded annually) in

order to have $250 at the end of five years (round to nearest $1)?

A) $237

B) $191

C) $187

D) $179

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value

18) If you want to have $1,200 in 27 months, how much money must you put in a savings

account today? Assume that the savings account pays 14% and it is compounded monthly (round

to the nearest $10).

A) $910

B) $890

C) $880

D) $860

Topic: 5.2 Compounding and Future Value

Keywords: compound interest

Principles: Principle 1: Money Has a Time Value