Fundamentals of Corporate Finance 3e Test Bank
Chapter 6: Discounted Cash Flows and Valuation
1.
Calculating the present and future values of multiple cash flows is relevant only for individual
investors.
A)
True
B)
False
Ans:
B
2.
Calculating the present and future values of multiple cash flows is relevant for businesses only.
A)
True
B)
False
Ans:
B
3.
In computing the present and future value of multiple cash flows, each cash flow is discounted
or compounded at a same rate.
A)
True
B)
False
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
4.
The present value of multiple cash flows is greater than the sum of those cash flows.
A)
True
B)
False
Ans:
B
5.
Jacob Oram pay the same amount every month as insurance premium for a term life policy for
a period of five years, the stream of cash flows is called a perpetuity.
A)
True
B)
False
Ans:
B
6.
Allen Bell pay the same amount every month on a car loan for a period of three years, the
stream of cash flows is called an annuity.
A)
True
B)
False
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
7.
In today’s financial markets, the best example of a perpetuity is the common stock issued by
firms.
A)
True
B)
False
Ans:
B
8.
Since the issuers of preferred stock promise to pay investors a fixed dividend, usually quarterly,
forever, these are the most important perpetuities in the financial markets.
A)
True
B)
False
Ans:
A
9.
The present value of a perpetuity is the promised constant cash payment divided by the interest
rate (i).
A)
True
B)
False
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
10.
In ordinary annuities, cash flows occur at the beginning of each period.
A)
True
B)
False
Ans:
B
11.
In an annuity due, cash flows occur at the beginning of each period.
A)
True
B)
False
Ans:
A
12.
The lease payments by a business of a warehouse rental are an example of an annuity due.
A)
True
B)
False
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
13.
The present value of an annuity due is less than the present value of an ordinary annuity.
A)
True
B)
False
Ans:
B
14.
The present value of an annuity due is equal to the present value of an ordinary annuity.
A)
True
B)
False
Ans:
B
15.
The future value of an annuity due is greater than the future value of an ordinary annuity.
A)
True
B)
False
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
16.
The future value of an annuity due is equal to the future value of an ordinary annuity.
A)
True
B)
False
Ans:
B
17.
Cash flow streams that increase at a constant rate over time are called growing annuities or
growing perpetuities.
A)
True
B)
False
Ans:
A
18.
A fertilizer manufacturing company enters into a contract with a county parks and recreation
department that calls for the company to sell 10 percent more of its best lawn feed every year
for the next five years. If they also agree to maintain the total price as constant over the contract
period, this growth in revenue is an example of a growing perpetuity.
A)
True
B)
False
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
19.
You have received news about an inheritance that will pay you $5,000 next year. Beginning the
following year, your inheritance will increase by 5 percent every year forever. This is a
growing perpetuity.
A)
True
B)
False
Ans:
A
20.
Natalia Greenberg opened a pizza place last year. She expects to increase her revenue from last
year by 7 percent every year for the next 10 years. This is an example of a growing annuity.
A)
True
B)
False
Ans:
A
21.
The annual percentage rate (APR) is the annualized interest rate using compound interest.
A)
True
B)
False
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
22.
The annual percentage rate (APR) is defined as the simple interest charged per period
multiplied by the number of periods per year.
A)
True
B)
False
Ans:
A
23.
The correct way to annualize an interest rate is to compute the effective annual interest rate.
A)
True
B)
False
Ans:
A
24.
The correct way to annualize an interest rate is to compute the annual percentage rate (APR).
A)
True
B)
False
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
25.
The effective annual interest rate (EAR) is defined as the annual growth rate that takes
compounding into account.
A)
True
B)
False
Ans:
A
26.
The effective annual interest rate (EAR) is the true cost of borrowing and lending.
A)
True
B)
False
Ans:
A
27.
The quoted interest rate is by convention a simple annual interest rate, such as the annual
percentage rate (APR).
A)
True
B)
False
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
28.
The quoted interest rate is by definition a simple annual interest rate, such as the effective
annual interest rate (EAR).
A)
True
B)
False
Ans:
B
29.
The Truth-in-Lending Act and the Truth-in-Savings Act require by law that the annual
percentage rate (APR) be disclosed on all consumer loans and savings plans and that it be
prominently displayed on advertising and contractual documents.
A)
True
B)
False
Ans:
A
30.
Only the annual percentage rate (APR) or some other quoted rate should be used as the interest
rate factor for present or future value calculations.
A)
True
B)
False
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
31.
A car manufacturer enters into a contract for 25-years lease of warehouse rental that adjusts
annually for the expected rate of inflation over the life of the contract. This is an example of
growing perpetuity.
A)
True
B)
False
Ans:
B
32.
A growing annuity for an infinite period is called a growing perpetuity.
A)
True
B)
False
Ans:
A
33.
For computation of the present value of growing annuity with n periods, the cash flow for the
current period is used and not the cash flow to be received in the next period.
A)
True
B)
False
Ans:
B
Fundamentals of Corporate Finance 3e Test Bank
34.
Growing perpetuity is widely used in the valuation of common stock of firms that have a policy
and history of paying dividends that grow at a constant rate.
A)
True
B)
False
Ans:
A
35.
The present value of growing perpetuity is computed as the cash flow occurring at the end of
the first period divided by the difference between interest or discount rate and growth rate.
A)
True
B)
False
Ans:
A
36.
Which of the following is used as the denominator while calculating the present value for a
growing perpetuity that begins next period (PVP)?
A)
The difference between i (the discount or interest rate) and g (the constant rate of growth
of the cash flow)
B)
i (the discount or interest rate)
C)
g (the constant rate of growth of the cash flow)
D)
The addition of i (the discount or interest rate) and g (the constant rate of growth of the
cash flow)
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
37.
The present value of future cash flows are computed by multiplying future value with the:
A)
discounting factor.
B)
compound factor.
C)
interest rate.
D)
number of periods.
Ans:
A
38.
Nick invested $2,000 in a bank savings account today and another $2000 a year from now. If
the bank pays interest of 10 percent per year, how much money will Nick have at the end of
two years?
A)
$4,210
B)
$4,200
C)
$4,000
D)
$4,620
Ans:
D
Fundamentals of Corporate Finance 3e Test Bank
39.
Which of the following is true of discounting factor?
A)
Discounting factor is the reciprocal of compounding factor.
B)
Discounting factor is the sum of 1 and the rate of interest.
C)
Discounting factor is period n times the rate of interest.
D)
Discounting factor is computed by dividing period n by the sum of 1 and the rate of
interest.
Ans:
A
AICPA: Measurement
40.
William deposited $25,000 today that would earn an interest at the rate of 3% for a period of 2
years. The amount of $25,000 represents the:
A)
present value of an annuity
B)
future value of an annuity
C)
present value
D)
future value
Ans:
C
AICPA: Measurement
41.
In computing the present and future value of multiple cash flows:
A)
each cash flow is discounted or compounded at the same rate.
B)
each cash flow is discounted or compounded at a different rate.
C)
earlier cash flows are discounted at a higher rate.
D)
later cash flows are discounted at a higher rate.
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
42.
Anna would receive $15,000 from a bank deposit after 2 years which had an interest of 3.5%.
The amount of $15,000 represents the:
A)
present value of an annuity
B)
future value of an annuity
C)
present value
D)
future value
Ans:
D
AICPA: Measurement
43.
The present value of multiple cash flows is:
A)
greater than the sum of the cash flows.
B)
equal to the sum of all the cash flows.
C)
less than the sum of the cash flows.
D)
higher or lower than the cash flows depending on the interest rate.
Ans:
C
44.
The future value of multiple cash flows is:
A)
greater than the sum of the cash flows.
B)
equal to the sum of all the cash flows.
C)
less than the sum of the cash flows.
D)
higher or lower than the cash flows depending on the interest rate.
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
45.
If your investment pays the same amount at the end of each year for a period of six years, the
cash flow stream is called:
A)
a perpetuity.
B)
an ordinary annuity.
C)
an annuity due.
D)
a growing perpetuity.
Ans:
B
AICPA: Measurement
46.
If your investment pays the same amount at the beginning of each year for a period of 10 years,
the cash flow stream is called:
A)
a perpetuity.
B)
an ordinary annuity.
C)
an annuity due.
D)
a growing perpetuity.
Ans:
C
AICPA: Measurement
47.
A preferred stock would be an ideal example of:
A)
a perpetuity.
B)
an ordinary annuity.
C)
an annuity due.
D)
a growing annuity.
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
48.
Cash flows associated with annuities are considered to be:
A)
an uneven cash flow stream.
B)
a constant cash flow stream.
C)
a mix of constant and uneven cash flow streams.
D)
a cash flow stream with decreasing trend.
Ans:
B
49.
Which of the following statements is true of amortization?
A)
Amortization solely refers to the total value to be paid by the borrower at the end of
maturity.
B)
The amortization schedule represents only the interest portion of the loan.
C)
The computation of loan amortization is wholly based on the computation of simple
interest.
D)
The amortization schedule provides the data of equated monthly payments for which the
classification of principal and interest along with unpaid principal balance is provided.
Ans:
D
Fundamentals of Corporate Finance 3e Test Bank
50.
Which of the following statements is true of amortization?
A)
With an amortized loan, a periodical payment of principal portion gradually decreases
over a period.
B)
Amortization schedule represents only the interest portion of the loan.
C)
With an amortized loan, a bigger proportion of each month’s payment goes toward
interest in the early periods.
D)
The computation of loan amortization is wholly based on the computation of simple
interest.
Ans:
C
51.
Which of the following statements is true of amortization?
A)
With an amortized loan, a bigger proportion of each month’s payment goes toward
interest in the early periods.
B)
With an amortized loan, a bigger proportion of each month’s payment goes toward
interest in the later periods.
C)
With an amortized loan, a smaller proportion of each month’s payment goes toward
interest in the early periods.
D)
With an amortized loan, the interest portion of each month’s payment remains
unchanged.
Ans:
A
Fundamentals of Corporate Finance 3e Test Bank
52.
The annuity transformation method is used to transform:
A)
a present value annuity to a future value annuity.
B)
a present value annuity to an annuity due.
C)
an ordinary annuity to an annuity due.
D)
a perpetuity to an annuity.
Ans:
C
53.
A firm receives a cash flow from an investment that will increase by 10 percent annually for an
infinite number of years. This cash flow stream is called:
A)
an annuity due.
B)
a growing perpetuity.
C)
an ordinary annuity.
D)
a growing annuity.
Ans:
B
54.
Your investment in a small business venture will produce cash flows that increase by 15
percent every year for the next 25 years. This cash flow stream is called:
A)
an annuity due.
B)
a growing perpetuity.
C)
an ordinary annuity.
D)
a growing annuity.
Ans:
D
Fundamentals of Corporate Finance 3e Test Bank
55.
Which of the following statements is true about the effective annual rate (EAR)?
A)
The effective annual interest rate (EAR) is defined as the annual growth rates that do not
take compounding into account.
B)
The EAR is the annualized interest rate using simple interest. It ignores the interest
earned on interest associated with compounding periods of less than one year.
C)
The EAR is the simple interest charged per period multiplied by the number of periods
per year.
D)
The EAR is the interest rate actually paid (or earned) after accounting for compounding.
Ans:
D
56.
The true cost of borrowing is the:
A)
annual percentage rate.
B)
effective annual rate.
C)
quoted interest rate.
D)
periodic rate.
Ans:
B
57.
The true cost of lending is the:
A)
annual percentage rate.
B)
effective annual rate.
C)
quoted interest rate.
D)
interest rate per period.
Ans:
B