978-0133507676 chapter 5 Part 5

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23) Suppose the term structure of interest rates is shown below:

Term 1 year 2 years 3 years 5 years 10 years 20 years

Rate

(EAR%) 5.00% 4.80% 4.60% 4.50% 4.25% 4.15%

The present value (PV) of receiving $1100 per year with certainty at the end of the next

three years is closest to ________.

A) $3010

B) $2408

C) $3612

D) $4214

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

24) Suppose the term structure of interest rates is shown below:

Term 1 year 2 years 3 years 5 years 10 years 20 years

Rate

(EAR%) 5.00% 4.80% 4.60% 4.50% 4.25% 4.15%

Consider an investment that pays $1900 certain at the end of each of the next four years. If

the investment costs $6650 and has a net present value (NPV) of $142.31, then the four

year risk-free interest rate is closest to ________.

A) 4.01%

B) 3.51%

C) 5.01%

D) 4.51%

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

25) Suppose the term structure of interest rates is shown below:

Term 1 year 2 years 3 years 5 years 10 years 20 years

Rate

(EAR%) 5.00% 4.80% 4.60% 4.50% 4.25% 4.15%

The net present value (NPV) of an investment that costs $4320 and pays $1600 certain at

the end of one, three, and ive years is closest to ________.

A) $91.37

B) $137.05

C) $114.21

D) -$114.21

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

26) In 2009, U.S. Treasury yielded 0.1%, while inlation was 2.7%. What was the real rate in

2009?

A) -2.6%

B) 2.6%

C) -2.8%

D) 2.8%

AACSB Objective: Analytic Skills

Author: WC

Question Status: New

27) Inlation is calculated as the rate of change in the _______.

A) unemployment rate

B) Gross Domestic Product

C) Consumer Price Index

D) risk-free rate

AACSB Objective: Analytic Skills

Author: WC

Question Status: New

28) The yield curve is typically ________.

A) downward sloping

B) upward sloping

C) lat

D) inverted

AACSB Objective: Analytic Skills

Author: WC

Question Status: Revised

29) Can the nominal interest rate ever be negative? Can the real interest rate ever be

negative? Explain.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

Use the table for the question(s) below.

Suppose the term structure of interest rates is shown below:

Term 1 year 2 years 3 years 5 years 10 years 20 years

Rate (EAR

%) 5.00% 4.80% 4.60% 4.50% 4.25% 4.15%

30) After examining the yield curve, what predictions do you have about interest rates in

the future? About future economic growth and the overall state of the economy?

AACSB Objective: Ethical Understanding and Reasoning Abilities

Author: JN

Question Status: Revised

31) What is the net present value (NPV) of an investment that costs $2,500 and pays

$1,000 at the end of one, three, and ive years?

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

32) What is the implied assumption about interest rates when using the built-in functions of

a inancial calculator to calculate the present value (PV) of an annuity?

AACSB Objective: Analytic Skills

Author: SS

Question Status: Revised

33) What is the implied assumption about interest rates when the equation to calculate the

present value (PV) of perpetuity is used?

AACSB Objective: Analytic Skills

Author: SS

Question Status: Revised

5.4 The Opportunity Cost of Capital

1) The opportunity cost of capital is the best available expected return ofered in the

market on an investment of comparable risk and term to the cash low being discounted.

AACSB Objective: Analytic Skills

Author: DS

Question Status: Previous Edition

2) The term “opportunity” in opportunity cost of capital comes from the fact that any

worthwhile opportunity for investment will have a cost: the risk to the capital invested.

AACSB Objective: Analytic Skills

Author: DS

Question Status: Previous Edition

3) For a free-risk investment, the opportunity cost of capital will generally be more than the

interest rate ofered by U.S. Treasury securities with a similar term.

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

4) What, typically, is used to calculate the opportunity cost of capital on a risk-free

investment?

A) the best expected return ofered in any investment available in the market

B) the interest rate on U.S. Treasury securities with the same term

C) the interest rate of any investments alternatives that are available

D) the best rate of return ofered by U.S. Treasury securities

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

5) Elinore is asked to invest $5100 in a friend’s business with the promise that the friend

will repay $5610 in one year. Elinore inds her best alternative to this investment, with

similar risk, is one that will pay her $5508 in one year. U.S. securities of similar term ofer a

rate of return of 7%. What is the opportunity cost of capital in this case?

A) 7%

B) 8%

C) 9%

D) 10%

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

6) Why, in general, do investment opportunities ofer a rate greater than that ofered by

U.S. Treasury securities for the same horizon?

A) Most investment opportunities bear far greater risk than those ofered by U.S. Treasury

securities.

B) The return from U.S. Treasury securities generally attracts less tax than the returns

from other investments.

C) The opportunity cost of capital for a given horizon is generally based on U.S. Treasury

securities with that same horizon.

D) U.S. Treasury securities are generally considered to be the best alternative to most

investments.

AACSB Objective: Analytic Skills

Author: DS

Question Status: Previous Edition

7) Which of the following statements is FALSE?

A) The opportunity cost of capital is the best available expected return ofered in the

market on an investment of comparable risk and term of the cash lows being discounted.

B) Interest rates we observe in the market will vary based on quoting conventions, the term

of investment, and risk.

C) The opportunity cost of capital is the return the investor forgoes when the investor takes

on a new investment.

D) For a risk-free project, the opportunity cost of capital will typically be greater than the

interest rate of U.S. Treasury securities with a similar term.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

8) Which of the following statements is FALSE?

A) The actual return kept by an investor will depend on how the interest is taxed.

B) The equivalent after-tax interest rate is r(1 – τ).

C) The highest interest rate for a given horizon is the rate paid on U.S. Treasury securities.

D) It is important to use a discount rate that matches both the horizon and the risk of the

cash lows.

AACSB Objective: Ethical Understanding and Reasoning Abilities

Author: JN

Question Status: Previous Edition

9) How do we decide on opportunity cost when we have several opportunities that need to

be foregone?

AACSB Objective: Ethical Understanding and Reasoning Abilities

Author: SS

Question Status: Previous Edition