Fundamentals of Corporate Finance 9th Canadian Edition By Ross – Test Bank

Complete Test Bank With Answers

 

 

Sample Questions Posted Below

 

Exam

Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) You collect model airplanes. One particular model is currently valued at $275. If this

model increases in value by 5% annually, it will be worth ________ six years from now

and ________ twelve years from now.

A) $368.01; $461.34

B) $368.53; $442.89

C) $368.53; $493.86

D) $368.01; $442.89

E) $368.53; $467.08

Answer: C

Explanation: A)

B)

C)

D)

E)

2) The Smith Co. has $450,000 to invest at 5.5% interest. How much more money will they

have if they invest these funds for eight years instead of five years?

A) $68,851.36

B) $78,408.62

C) $102,476.93

D) $62,948.21

E) $74,250.00

Answer: C

Explanation: A)

B)

C)

D)

E)

3) You deposit $500,000 in a higher risk investment. Three years later, you receive

$711,900 and withdraw your funds. Given this information calculate the balance at the

end of year two.

A) $632,804 B) $636,549 C) $665,202 D) $687,702 E) $693,303

Answer: A

Explanation: A)

B)

C)

D)

E)

1)

2)

3)

14) Jennifer invested $2,000 in an account that pays 3% simple interest. How much more

could she have earned over a six-year period if the interest had compounded annually?

A) $28.10 B) $33.33 C) $29.18 D) $34.67 E) $31.50

Answer: A

Explanation: A)

B)

C)

D)

E)

5) What is the future value of $3,497 invested for 15 years at 7.5% compounded annually? A) $15,267.21

B) $14,911.08

C) $14,289.16

D) $10,347.19

E) $7,431.13

Answer: D

Explanation: A)

B)

C)

D)

E)

6) You would like to give your daughter $40,000 towards her college education thirteen

years from now. How much money must you set aside today for this purpose if you can

earn 6.3% on your funds?

A) $17,989.28

B) $18,213.69

C) $18,077.05

D) $18,395.00

E) $17,750.00

Answer: C

Explanation: A)

B)

C)

D)

E)

4)

5)

6)

27) All else being the same, which of the following statements is correct? A) Present values increase the further away in time the future value.

B) Present values increase as the discount rate increases I only.

C) Present values are always smaller than future values when r is negative and t

positive.

D) Present values decrease as the discount rate decreases.

E) Present values are always smaller than future values when both r and t are positive.

Answer: E

Explanation: A)

B)

C)

D)

E)

8) Jessica invests $3,000 in an account that pays 5% simple interest. How much more could

she have earned over a 7-year period if the interest had compounded annually?

A) $221.30 B) $122.20 C) $171.30 D) $129.20 E) $147.80

Answer: C

Explanation: A)

B)

C)

D)

E)

9) The greater the number of years, the: A) Smaller the future value factor.

B) Greater the compounding effect.

C) Larger the present value factor.

D) Larger the present value of a single sum.

E) Smaller the future value of a single sum.

Answer: B

Explanation: A)

B)

C)

D)

E)

7)

8)

9)

310) Twelve years ago, Jake invested $2,000. Six years ago, Tami invested $4,000. Today,

both Jake’s and Tami’s investments are each worth $9,700. Assume that both Jake and

Tami continue to earn their respective rates of return. Which one of the following

statements is correct concerning these investments?

A) Tami has earned an average annual interest rate of 15.91%.

B) Jake has earned a higher rate of return than Tami.

C) Three years from today, Jake’s investment will be worth more than Tami’s.

D) One year ago, Tami’s investment was worth more than Jake’s.

E) Jake has earned an average annual interest rate of 15.47%.

Answer: A

Explanation: A)

B)

C)

D)

E)

11) Which one of the following interest rates will produce the largest value at the end of ten

years given a lump sum investment of $5,000?

A) 6.0%, compounded semi-annually

B) 5.5%, compounded annually

C) 6.0%, simple interest

D) 6.0%, compounded annually

E) 5.5%, simple interest

Answer: A

Explanation: A)

B)

C)

D)

E)

12) Frank invests $2,500 in an account that pays 6% simple interest. How much money will

he have at the end of four years?

A) $3,163 B) $2,650 C) $3,100 D) $10,600 E) $3,156

Answer: C

Explanation: A)

B)

C)

D)

E)

4

10)

11)

12)13) All County Insurance, Inc. promises to pay Ted $1 million on his 65th birthday in return

for a one-time payment of $75,000 today. (Ted just turned 25) At what rate of interest

would Ted be indifferent between accepting the company’s offer and investing the

premium on his own?

A) 6.1% B) 6.7% C) 7.2% D) 5.5% E) 2.4%

Answer: B

Explanation: A)

B)

C)

D)

E)

14) When you retire forty years from now, you want to have $1 million. You think you can

earn an average of 8.5% on your money. To meet this goal, you are trying to decide

whether to deposit a lump sum today, or to wait and deposit a lump sum five years from

today. How much more will you have to deposit as a lump sum if you wait for five years

before making the deposit?

A) $18,677.78

B) $21,036.83

C) $19,272.81

D) $18,001.06

E) $18,998.03

Answer: C

Explanation: A)

B)

C)

D)

E)

15) The future value factor will decrease: A) The lower the present value factor.

B) The higher the future value.

C) The higher the present value.

D) The longer the period of time.

E) The lower the interest rate.

Answer: E

Explanation: A)

B)

C)

D)

E)

13)

14)

15)

516) One year ago, you invested $2,500. Today it is worth $2,789.50. What rate of interest did

you earn?

Answer: B

Explanation: A)

A) 9.89% B) 11.58% C) 10.67% D) 8.67% E) 11.42%

B)

C)

D)

E)

17) When you retire thirty years from now, you want to have $750,000. You think you can

earn an average of 9% on your money. To meet this goal, you are trying to decide

whether to deposit a lump sum today, or to wait and deposit a lump sum five years from

today. How much more will you have to deposit as a lump sum if you wait for five years

before making the deposit?

A) $30,447.52

B) $29,414.14

C) $28,788.03

D) $38,278.27

E) $36,118.09

Answer: A

Explanation: A)

B)

C)

D)

E)

18) Theresa wants to save $10,000 so that she can surprise her husband with a vacation six

years from now. She can earn 7% on her savings. How much more will she have to

deposit if she waits one more year before investing versus if she deposits one lump sum

today?

A) $466.44 B) $471.08 C) $471.54 D) $470.23 E) $469.15

Answer: A

Explanation: A)

B)

C)

D)

E)

16)

17)

18)

619) Sampson, Inc. invested $1.325 million in a project that earned an 8.25% rate of return.

Sampson sold their investment for $3,713,459. How much sooner could Sampson have

sold the company if they only wanted $3 million from the project?

A) 3.33 years

B) 2.69 years

C) 5.17 years

D) 6.67 years

E) 10.31 years

Answer: B

Explanation: A)

B)

C)

D)

E)

20) The rate used to find the present value of a future payment is called the: A) Discount rate.

B) Simple rate.

C) Future value rate.

D) Loan rate.

E) Compound rate.

Answer: A

Explanation: A)

B)

C)

D)

E)

21) At a 3% rate of interest, you will quadruple your money in approximately ________

years.

Answer: B

Explanation: A)

A) 24 B) 47 C) 6 D) 12 E) 3

B)

C)

D)

E)

19)

20)

21)

722) You invest $1,000 in an account paying 5% simple interest. You do not add nor

withdraw any funds from this account. Every year, your account balance will:

A) Increase at an increasing rate.

B) Remain constant.

C) Increase at a decreasing rate.

D) Increase at a constant rate.

E) Increase by a constant amount.

Answer: E

Explanation: A)

B)

C)

D)

E)

23) You wish to have $200,000 at the end of twenty years. In the last five years, you

withdraw $1,000 annually at a rate of 3.8% compounded quarterly. During the middle

ten years, you contribute $500 monthly at a rate of 2.8% compounded semi-annually.

Given this information, determine the initial deposit that has to be made at the start of

the first five years at a rate of 4% compounded monthly.

A) $12,056.65

B) $10,056.65

C) $11,056.65

D) $9,056.65

E) $13,056.65

Answer: D

Explanation: A)

B)

C)

D)

E)

24) Katie is going to receive $1,000 three years from now. Wilt is going to receive $1,000

five years from now. Which one of the following statements is correct if both Katie and

Wilt apply a 5% discount rate to these amounts?

A) The present value of Katie and Wilt’s money is equal.

B) The value of Wilt’s money will be greater than the value of Katie’s money six years

from now.

C) In today’s dollars, Wilt’s money is worth more than Katie’s.

D) Katie’s money is worth more than Wilt’s money today.

E) In five years, the value of Katie’s money will be less than the value of Wilt’s money.

Answer: D

Explanation: A)

B)

C)

D)

E)

22)

23)

24)

825) Betty invests $500 in an account that pays 3% simple interest. How much money will

Betty have at the end of ten years?

A) $633.33 B) $675.00 C) $671.96 D) $650.00 E) $630.00

Answer: D

Explanation: A)

B)

C)

D)

E)

26) Sun Lee has $500 today. Which one of the following statements is correct if she invests

this money at a positive rate of interest for five years?

A) If Sun Lee can earn 7%, she will have to wait about six years to have $1,000 total.

B) At 10% interest Sun Lee should expect to have $1,000 in her account at the end of

the five years.

C) The higher the interest rate she earns, the less money she will have in the future.

D) The higher the interest rate, the longer she has to wait for her money to grow to

$1,000 in value.

E) At the end of the five years Sun Lee will have less money if she invests at 5% rather

than at 7%.

Answer: E

Explanation: A)

B)

C)

D)

E)

27) You have $500 in an account which pays 5% compound interest. How much additional

interest would you earn over four years if you moved the money to an account earning

6%?

A) $21.89 B) $29.94 C) $24.93 D) $23.49 E) $25.88

Answer: D

Explanation: A)

B)

C)

D)

E)

9

25)

26)

27)28) When you retire 36 years from now, you want to have $2 million. You think you can

earn an average of 11.5% on your investments. To meet your goal, you are trying to

decide whether to deposit a lump sum today, or to wait and deposit a lump sum 3 years

from today. How much more will you have to deposit as a lump sum if you wait for 3

years before making the deposit?

A) $17,021.12

B) $19,407.78

C) $16,208.11

D) $15,677.78

E) $15,344.14

Answer: E

Explanation: A)

28)

B)

C)

D)

E)

29) Interest earned on the reinvestment of previous interest payments is called ________. A) Interest on interest.

B) Free interest.

C) Compound interest.

D) Annual interest.

E) Simple interest.

Answer: A

Explanation: A)

29)

B)

C)

D)

E)

30) The discounted value of money is called the: A) Simple value.

B) Complex value.

C) Future value.

D) Present value.

E) Compound value.

Answer: D

Explanation: A)

30)

B)

C)

D)

E)

1031) Andy promises Opie that he will give him $5,000 upon his graduation from college at

Mayberry U. How much must Andy invest today to make good on his promise, if Opie is

expected to graduate in 12 years and Andy can earn 5% on his money?

A) $3,012.88

B) $2,784.19

C) $2,135.32

D) $8,979.28

E) $2,881.11

Answer: B

Explanation: A)

31)

B)

C)

D)

E)

32) Koji invested $3,300 at 7.75% interest. After a period of time he withdrew $9,383.31.

How long did Koji have his money invested?

A) 13 years B) 14 years C) 15 years D) 16 years E) 17 years

Answer: B

Explanation: A)

32)

B)

C)

D)

E)

33) Jeff invests $3,000 in an account that pays 7% simple interest. How much more could he

have earned over a 20-year period if the interest had compounded annually?

A) $4,087.18

B) $4,409.05

C) $3,778.54

D) $3,212.12

E) $2,840.00

Answer: B

Explanation: A)

33)

B)

C)

D)

E)

1134) You want to have $10,000 saved ten years from now. How much less do you have to

deposit today to reach this goal if you can earn 6% rather than 5% on your savings?

A) $615.48

B) $1,046.22

C) $928.73

D) $555.18

E) $609.81

Answer: D

Explanation: A)

B)

C)

D)

E)

35) You collect old model trains. One particular model increases in value at a rate of 6.5%

per year. Today, the model is worth $1,670. How much additional money can you make

if you wait 4 years to sell the model rather than selling it 2 years from now?

A) $280.15 B) $208.04 C) $254.24 D) $241.79 E) $196.67

Answer: C

Explanation: A)

B)

C)

D)

E)

36) Lisa deposited $500 in a savings account this morning. The account pays 2.5% simple

interest. If Lisa leaves this money in the account for five years, how much total interest

will she earn?

A) $12.50 B) $62.50 C) $67.25 D) $10.75 E) $53.75

Answer: B

Explanation: A)

B)

C)

D)

E)

37) At a 6% rate of interest you will double your money in approximately ________ years. A) 24 B) 12 C) 6 D) 48 E) 3

Answer: B

Explanation: A)

B)

C)

D)

E)

34)

35)

36)

37)

1238) You deposit $1,000 in a retirement account today at 8.5% interest. How much more

money will you have if you leave the money invested for 40 years rather than 35 years?

A) $7,714.91

B) $7,846.52

C) $7,839.73

D) $8,753.37

E) $7,799.08

Answer: D

Explanation: A)

B)

C)

D)

E)

39) New Metals, Inc. is planning on expanding their operations when the economy

strengthens in a few years. At that time they will need to purchase additional equipment.

Four years ago, they set aside $300,000 in a special account for this purpose. Today, that

account is worth $383,048.98. What rate of interest is New Metals earning on this

money?

A) 6.35% B) 5.92% C) 6.30% D) 6.26% E) 5.87%

Answer: C

Explanation: A)

B)

C)

D)

E)

40) Neal wants to borrow $2,500 and has received the offers from his local banks. Which

offer should Neal accept if he wants to repay the loan in one single payment two years

from now?

A) Bank A, which offers a simple rate of 4%.

B) Bank B, which offers a simple rate of 5%.

C) Bank C, which offers a rate of 4% compounded annually.

D) Bank D, which offers a rate of 5% compounded annually.

E) Bank E, which offers a rate of 5% compounded monthly.

Answer: A

Explanation: A)

B)

C)

D)

E)

38)

39)

40)

1341) Compound interest means that you earn: A) The same amount of interest each year.

B) Interest only on the initial amount invested.

C) Interest on the initial principal only.

D) A decreasing amount of interest each year.

E) Interest on both the principal and prior reinvested interest.

Answer: E

Explanation: A)

B)

C)

D)

E)

42) An investor deposited $10,500 in an account. At the end of year four, the account had

accumulated $5,728.88. Over the first four years, the account earned ________

compounded annually.

A) 23.1% B) 11.5% C) 15.6% D) 12.8% E) 14.6%

Answer: B

Explanation: A)

B)

C)

D)

E)

43) The formula for a present value calculation using Excel is: A) PV (rate, nper, pmt, fv).

B) PV (nper, pmt, fv).

C) PV (rate, nper, pmt).

D) PV (rate, pmt, pv, fv).

E) PV (rate, nper, pmt, pv).

Answer: A

Explanation: A)

B)

C)

D)

E)

14

41)

42)

43)44) An account was opened with $1,000 three years ago. Today, the account balance is

$1,157.63. If the account earns simple interest, how long will it take until the account has

earned a total of $225 in interest?

A) Less than one more year.

B) Between one and two more years.

C) Between two and three more years.

D) Between three and four more years.

E) Between four and five more years.

Answer: B

Explanation: A)

B)

C)

D)

E)

45) Robin invested $10,000 in an account that pays 5% simple interest. How much more

could she have earned over a 40-year period if the interest had compounded annually?

A) $50,399.89

B) $48,414.14

C) $38,207.16

D) $38,414.14

E) $40,399.89

Answer: E

Explanation: A)

B)

C)

D)

E)

46) You wish to have $400,000 at the end of twenty-five years. In the last ten years, you

contribute $1,000 semi-annually at a rate of 5.8% compounded monthly. During the

middle ten years, you withdraw $750 quarterly at a rate of 4.5% compounded annually.

Given this information, determine the initial deposit that has to be made at the start of the

first five years at a rate of 4% compounded monthly.

A) $135,150.00

B) $125,150.00

C) $130,150.00

D) $115,150.00

E) $120,150.00

Answer: C

Explanation: A)

B)

C)

D)

E)

44)

45)

46)

1547) Alpha, Inc. is saving money to build a new factory. Six years ago they set aside $250,000

for this purpose. Today, that account is worth $306,958. What rate of interest is Alpha

earning on this money?

A) 3.55% B) 3.43% C) 3.48% D) 3.52% E) 3.45%

Answer: C

Explanation: A)

B)

C)

D)

E)

48) Last year, you deposited $25,000 into a retirement savings account at a fixed rate of

7.5%. Today, you could earn a fixed rate of 8% on a similar type account. However, your

rate is fixed and cannot be adjusted. How much less could you have deposited last year if

you could have earned a fixed rate of 8% and still have the same amount as you currently

will when you retire 40 years from today?

A) $1,666.67 less

B) $3,628.09 less

C) $2,408.28 less

D) $1,218.46 less

E) $4,331.30 less

Answer: E

Explanation: A)

B)

C)

D)

E)

49) You would like to invest some money today such that your investment will be worth

$100,000 fifteen years from now. Your broker gives you two options. First, you can

invest at a guaranteed annual rate of 4%. Or, you can invest in stocks and hopefully earn

an average of 7% per year. How much more will you have to invest today if you opt for

the fixed rate rather than the stocks?

A) $18,623.18

B) $19,281.85

C) $18,419.02

D) $18,145.45

E) $18,904.21

Answer: B

Explanation: A)

B)

C)

D)

E)

47)

48)

49)

1650) A deposit of $10,000 increased to $12,500 in 5 years. Determine the annual rate of

interest used and calculate the balance at the end of year four.

A) $15,954 B) $11,954 C) $12,254 D) $14,254 E) $13,954

Answer: B

Explanation: A)

B)

C)

D)

E)

51) Your parents agree to pay half of the purchase price of a new car when you graduate

from college. You will graduate and buy the car two years from now. You have $6,000

to invest today and can earn 10% on invested funds. If your parents match the amount of

money you have in two years, what is the maximum you can spend on the new car?

A) $12,000 B) $11,948 C) $13,250 D) $14,520 E) $7,260

Answer: D

Explanation: A)

B)

C)

D)

E)

52) The amount an investment is worth after one or more periods of time is the ________. A) Principal value.

B) Compound interest rate.

C) Present value.

D) Simple interest rate.

E) Future value.

Answer: E

Explanation: A)

B)

C)

D)

E)

53) Your older sister deposited $5,000 today at 8% interest for five years. You would like to

have just as much money at the end of the next five years as your sister. However, you

can only earn 6% interest. How much more money must you deposit today than your

sister if you are to have the same amount at the end of five years?

A) $201.80 B) $489.84 C) $399.05 D) $367.32 E) $423.81

Answer: B

Explanation: A)

B)

C)

D)

E)

50)

51)

52)

53)

1754) The present value factor will decrease: A) The slower the rate of growth.

B) The longer the period of time.

C) The lower the interest rate.

D) The higher the present value.

E) The higher the future value.

Answer: B

Explanation: A)

B)

C)

D)

E)

55) Many economists view a 3% annual inflation rate as “acceptable”. Assuming a 3%

annual increase in the price of automobiles, how much will a new Suburban cost you five

years from now, if today’s price is $48,000?

A) $55,200 B) $54,024 C) $48,000 D) $55,645 E) $41,405

Answer: D

Explanation: A)

B)

C)

D)

E)

56) Omar has an investment valued at $12,345 today. He made a one-time investment at

6.5% four years ago. Leon has an investment that is also valued at $12,345 today. Leon

invested four years ago at 7.5%. Omar originally invested ________ and Leon invested

________.

A) $9,633.33; $9,304.06

B) $9,652.18; $9,389.00

C) $9,568.24; $9,199.16

D) $9,596.05; $9,243.94

E) $9,608.14; $9,267.67

Answer: D

Explanation: A)

B)

C)

D)

E)

54)

55)

56)

1857) As the discount rate increases, the present value of $500 to be received six years from

now:

A) Remains constant.

B) Becomes negative.

C) Decreases.

D) Also increases.

E) Will vary but the direction of the change is unknown.

Answer: C

Explanation: A)

B)

C)

D)

E)

58) Which one of the following statements is correct if you invest $100 in an account at a

simple interest rate of 4% for five years?

A) The amount of interest you earn in year five will equal the interest you earn in year

one, whether or not you reinvest your earnings.

B) For every $1 you earn in interest in the first year, you will earn ($1.04) interest in

the second year.

C) You will earn more interest than if you invested in an account which compounded

the interest.

D) The total interest you will earn over five years will be equal to $100 x (1 + .04)5.

E) You will earn interest on interest for four of the five years.

Answer: A

Explanation: A)

B)

C)

D)

E)

59) An account paying annual compound interest was opened with $1,000 ten years ago.

Today, the account balance is $1,500. If the same interest rate is offered on an account

paying simple interest, how much income would be earned each year over the same time

period?

A) $50.00 B) $36.97 C) $40.75 D) $40.41 E) $41.38

Answer: E

Explanation: A)

B)

C)

D)

E)

57)

58)

59)

1960) Thirty years ago, your father invested $6,000. Today that investment is worth

$67,270.98. What is the average rate of return your father earned on this investment?

A) 8.44% B) 10.23% C) 11.67% D) 10.34% E) 8.39%

Answer: E

Explanation: A)

B)

C)

D)

E)

61) Calculating the present value of a future cash flow to determine its value today is called: A) Present value compounding.

B) Discounted cash flow valuation.

C) The discount rate.

D) Future value compounding.

E) Timing the cash flow.

Answer: B

Explanation: A)

B)

C)

D)

E)

62) The future value interest factor is calculated as: A) (1 + rt) B) (1 + r)t C) (1 + r)(2) Answer: B

Explanation: A)

D) 1 + r – t E) (1 + r)(t)

B)

C)

D)

E)

63) You own a stamp collection that is currently valued at $24,500. If the value increases by

5.5% annually, how much will the collection be worth when you retire 40 years from

now?

A) $204,981.16

B) $205,155.45

C) $208,576.07

D) $206,666.67

E) $204,113.07

Answer: C

Explanation: A)

B)

C)

D)

E)

20

60)

61)

62)

63)64) Alpo, Inc. invested $500,000 to help fund a company expansion project scheduled for

eight years from now. How much additional money will they have eight years from now

if they can earn 9% rather than 7% on this money?

A) $86,991.91

B) $58,829.69

C) $118,009.42

D) $137,188.23

E) $126,745.19

Answer: D

Explanation: A)

B)

C)

D)

E)

65) Today Richard is investing $1,000 at 5% interest for five years. One year ago, Richard

invested $1,000 at 6.25% for six years. How much money will Richard have saved in

total five years from now if both investments compound interest annually?

A) $2,678.81

B) $2,543.77

C) $2,630.36

D) $2,714.99

E) $2,641.98

Answer: D

Explanation: A)

B)

C)

D)

E)

66) Lakeside Inc. invested $735,000 at an 11.25% rate of return. The company sold their

investment for $1,067,425. How much longer would Lakeside have had to wait if they

had wanted to sell their investment for $1.25 million?

A) .98 year

B) 2.31 years

C) 1.98 years

D) 1.48 years

E) 3.50 years

Answer: D

Explanation: A)

B)

C)

D)

E)

64)

65)

66)

2167) How much would you have to invest today at 8% compounded annually to have $25,000

available for the purchase of a car four years from now?

A) $19,147.25

B) $21,370.10

C) $22,149.57

D) $18,375.75

E) $18,267.26

Answer: D

Explanation: A)

B)

C)

D)

E)

68) As long as the interest rate is greater than zero, the present value of a single sum will

always:

A) Increase as the number of periods increases.

B) Decrease as the period of time decreases.

C) Increase as the interest rate increases.

D) Be less than the future value.

E) Equal the future value if the time period is one year.

Answer: D

Explanation: A)

B)

C)

D)

E)

69) What is the present value of $2,800 to be received three years from now if the discount

rate is 9.5%?

A) $2,361.48

B) $3,676.21

C) $2,734.54

D) $2,132.63

E) $2,114.48

Answer: D

Explanation: A)

B)

C)

D)

E)

67)

68)

69)

2270) Chia Burgers began operations by opening 115 restaurants in Western Canada at the end

of its first year of operations. By the end of year 2, an additional 5 restaurants were

opened. By the end of year 3, there were 130 restaurants operational. At the end of year 5,

there were 138 total restaurants.

Between the end of year 2 and the end of year 3, the number of eating establishments

grew at a rate of ________ compounded annually.

A) 4.2% B) 4.7% C) 9.3% D) 8.3% E) 5.6%

Answer: D

Explanation: A)

B)

C)

D)

E)

71) You just received $278,000 from an insurance settlement. You have decided to set this

money aside and invest it for your retirement. Currently, your goal is to retire 38 years

from today. How much more will you have in your account on the day you retire if you

can earn an average return of 9.5% rather than just 9.0%?

A) $794,014

B) $2,033,333

C) $1,396,036

D) $1,818,342

E) $1,611,408

Answer: C

Explanation: A)

B)

C)

D)

E)

72) You just won the lottery and want to put some money away for your child’s college

education. College will cost $65,000 in 18 years. You can earn 8% compounded

annually. How much do you need to invest today?

A) $11,763.07

B) $13,690.82

C) $16,266.19

D) $15,258.17

E) $9,828.18

Answer: C

Explanation: A)

B)

C)

D)

E)

70)

71)

72)

2373) Chia Burgers began operations by opening 115 restaurants in Western Canada at the end

of its first year of operations. By the end of year 2, an additional 5 restaurants were

opened. By the end of year 3, there were 130 restaurants operational. At the end of year 5,

there were 138 total restaurants.

If the number of eating establishments is expected to grow in year 6 at the same rate as the

percentage increase in year 5, how many new eating establishments will be added in year

6?

A) 5 B) 6 C) 7 D) 8 E) 9

Answer: B

Explanation: A)

B)

C)

D)

E)

74) You are choosing between investments offered by two different banks. One promises a

return of 10% for three years using simple interest while the other offers a return of 10%

for three years using compound interest. You should:

A) Choose the compound interest option because it provides a higher return.

B) Choose the simple interest option only if compounding occurs more than once a

year.

C) Choose the compound interest option only if the compounding is for monthly

periods.

D) Choose the compound interest option only if you are investing less than $5,000.

E) Choose the simple interest option because both have the same basic interest rate.

Answer: A

Explanation: A)

B)

C)

D)

E)

75) The term to convert a future value amount into its present value is: A) Multiply

B) Annuitize

C) Amortize

D) Compound

E) Discount

Answer: E

Explanation: A)

B)

C)

D)

E)

24

73)

74)

75)76) The term “interest-on-interest” refers to: A) Earning interest on an investment for a period greater than one year.

B) The process of accumulating interest on an investment over time to earn more

interest.

C) Earning interest only on the principal amount invested.

D) The payment of interest more than once per year.

E) The interest earned on previous interest earnings which were reinvested.

Answer: E

Explanation: A)

B)

C)

D)

E)

77) Six years ago, Marti invested $3,500 in an account. No other investments or withdrawals

have been made. Today the account is worth $7,403.16. What rate of return has Marti

earned thus far?

A) 12.86% B) 19.20% C) 15.96% D) 13.30% E) 18.58%

Answer: D

Explanation: A)

B)

C)

D)

E)

78) Stephen invests $2,500 in an account that pays 6% simple interest. How much money

will Stephen have at the end of three years?

A) $3,000 B) $2,650 C) $2,978 D) $2,809 E) $2,950

Answer: E

Explanation: A)

B)

C)

D)

E)

76)

77)

78)

2579) Ito invested $4,350. After seven years he had an account value of $6,980.58. Maria

invested $5,920. After six years she had an account value of $8,834.62. Which one of the

following statements is correct?

A) Both Ito and Maria earned the same rate of interest.

B) Ito earned a rate of interest that was 0.09% higher than Maria’s rate.

C) Maria earned a rate of interest that was 0.9% higher than Ito’s rate.

D) Ito earned a rate of interest of 6.90%.

E) Maria earned a rate of interest of 5.89%.

Answer: B

Explanation: A)

B)

C)

D)

E)

80) Interest earned only on the original principal amount invested is called ________. A) Annual interest.

B) Interest on interest.

C) Free interest.

D) Simple interest.

E) Compound interest.

Answer: D

Explanation: A)

B)

C)

D)

E)

81) You will receive a $100,000 inheritance in 20 years. You can invest that money today at

6% compounded annually. What is the present value of your inheritance?

A) $35,492.34

B) $100,000.00

C) $27,491.53

D) $31,180.47

E) $29,767.15

Answer: D

Explanation: A)

B)

C)

D)

E)

79)

80)

81)

2682) In which year did the account earn its highest annually compounded return? A) Year 1 at 10%

B) Year 2 at 5.45%

C) Year 3 at 13.8%

D) Year 4 at 17.0%

E) Year 5 at 15.6%

Answer: D

Explanation: A)

B)

C)

D)

E)

83) You are scheduled to receive $18,000 in five years. When you receive it, you will invest

it for five more years at 8.6% per year. How much will you have at the end of this time?

What would be an equivalent Present Value?

A) $12,916 B) $14,916 C) $11,916 D) $13,916 E) $15,916

Answer: C

Explanation: A)

B)

C)

D)

E)

84) The James Co. plans on saving money to buy some new equipment. The company is

opening an account today with a deposit of $15,000 and expects to earn 4% interest.

After 3 years, the firm wants to add an additional $50,000 to the account. If the account

continues to earn 4%, how much money will the James Co. have in their account five

years from now?

A) $70,952.96

B) $81,361.18

C) $68,249.79

D) $72,329.79

E) $66,872.96

Answer: D

Explanation: A)

B)

C)

D)

E)

27

82)

83)

84)85) You deposit $500,000 in a higher risk investment. Three years later, you receive

$711,900 and withdraw your funds. Given this information, calculate the interest earned

at the end of year 3.

A) $81,096 B) $80,806 C) $78,806 D) $79,096 E) $77,096

Answer: D

Explanation: A)

B)

C)

D)

E)

86) Interest earned on both the initial principal and the interest reinvested from prior periods

is called ________.

A) Compound interest.

B) Free interest.

C) Interest on interest.

D) Annual interest.

E) Simple interest.

Answer: A

Explanation: A)

B)

C)

D)

E)

87) Six years ago, Home Health Industries (HHI) adopted a plan to expand its services next

year. At the time the plan was adopted, HHI set aside $125,000 in excess funds to be

held for this purpose. As of today, that money has increased in value to $186,408. What

rate of interest is the firm earning on these funds?

A) 7.27% B) 6.89% C) 7.43% D) 7.10% E) 7.18%

Answer: B

Explanation: A)

B)

C)

D)

E)

28

85)

86)

87)88) When you were 26 years old, you received an inheritance of $1,500 from your

grandfather. You invested that amount in Nu-Wave stock and have not touched the

investment since then. Today, this investment is worth $109,533.59. Nu-Wave stock has

earned an average rate of return of 11.3% per year over this time period. How old are you

today?

A) age 57 B) age 59 C) age 62 D) age 64 E) age 66

Answer: E

Explanation: A)

B)

C)

D)

E)

89) One year ago, you invested $5,000. Today, your investment is worth $6,178.40. What

rate of interest did you earn?

A) 16.45% B) 23.57% C) 16.23% D) 24.09% E) 22.18%

Answer: B

Explanation: A)

B)

C)

D)

E)

90) You own a classic automobile that is currently valued at $67,900. If the value increases

by 8% annually, how much will the automobile be worth 15 years from now?

A) $214,740.01

B) $215,390.28

C) $212,524.67

D) $199,801.33

E) $218,887.79

Answer: B

Explanation: A)

B)

C)

D)

E)

88)

89)

90)

2991) Today, your grandmother gave you a gift of $25,000 to help pay for your college

education. She told you that this amount was the result of a one-time investment at 8%

interest 13 years ago. How much did your grandmother originally invest?

A) $9,225.00

B) $9,419.25

C) $9,350.00

D) $9,504.55

E) $9,192.45

Answer: E

Explanation: A)

B)

C)

D)

E)

92) In 1889, Vincent Van Gogh’s painting, “Sunflowers,” sold for $125. One hundred years

later it sold for $36 million. Had the painting been purchased by your great-grandfather

and passed on to you, what annual return on investment would your family have earned

on the painting?

A) 13.40% B) 11.88% C) 9.11% D) 11.99% E) 10.09%

Answer: A

Explanation: A)

B)

C)

D)

E)

93) Chia Burgers began operations by opening 115 restaurants in Western Canada at the end

of its first year of operations. By the end of year 2, an additional 5 restaurants were

opened. By the end of year 3, there were 130 restaurants operational. At the end of year 5,

there were 138 total restaurants.

91)

92)

93)

From the end of year 1 to the end of year 5, the number of eating establishments grew at a

rate of ________ compounded annually.

A) 4.2% B) 5.6% C) 4.7% D) 9.3% E) 8.7%

Answer: C

Explanation: A)

B)

C)

D)

E)

3094) The interest rate used to calculate the present value of future cash flows is called the

________ rate.

A) Annual.

B) Discount.

C) Compound.

D) Simple.

E) Free.

Answer: B

Explanation: A)

B)

C)

D)

E)

95) You hope to buy your dream house six years from now. Today your dream house costs

$189,900. You expect housing prices to rise by an average of 4.5% per year over the next

six years. How much will your dream house cost by the time you are ready to buy it?

A) $246,396.67

B) $246,019.67

C) $240,284.08

D) $247,299.20

E) $246,831.94

Answer: D

Explanation: A)

B)

C)

D)

E)

96) You would like to give your daughter $50,000 towards her college education 15 years

from now. How much money must you set aside today for this purpose if you can earn

9% on your investments?

A) $12,250.00

B) $12,989.47

C) $14,211.11

D) $14,008.50

E) $13,726.90

Answer: E

Explanation: A)

B)

C)

D)

E)

31

94)

95)

96)97) The value today of future cash flows discounted at the appropriate discount rate is called

the ________ value.

A) Future

B) Principal

C) Compound

D) Present

E) Simple

Answer: D

Explanation: A)

97)

B)

C)

D)

E)

98) You need $2,000 to buy a new stereo for your car. If you have $800 to invest at 5%

compounded annually, how long will you have to wait to buy the stereo?

A) 14.58 years

B) 18.78 years

C) 6.58 years

D) 15.75 years

E) 8.42 years

Answer: B

Explanation: A)

B)

C)

D)

E)

99) Today, you earn a salary of $37,800. What will your annual salary be twelve years from

now if you receive annual raises of 3.6%?

A) $56,324.17

B) $56,907.08

C) $57,784.17

D) $55,981.03

E) $58,213.46

Answer: C

Explanation: A)

B)

C)

D)

E)

98)

99)

32100) You just won the lottery and want to put some money away for your child’s college

education. College will cost $65,000 in 18 years. You can earn 8% compounded

annually. How much do you need to invest today?

A) $15,258.17

B) $9,828.18

C) $13,690.82

D) $11,763.07

E) $16,266.19

Answer: E

Explanation: A)

B)

C)

D)

E)

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.

101) Provide a definition of “simple interest.” Answer: Interest earned only on the original principal amount invested.

Explanation:

101)

102) Present value is used extensively by managers who are reviewing proposed

projects. How does the present value of a cash flow assist management in making

these business decisions?

102)

Answer: By converting cash flows into present values, management can compare

and contrast various alternative opportunities and determine which course

of action is best for the firm. The present value allows management to view

projects on an equivalent basis. Also, by knowing the present value of the

future cash flows of a project, management can determine if those cash

inflows are sufficient to offset the required investment in the project. While

students may have various answers, this question starts them thinking about

financial decision-making, which is covered later in the text.

Explanation:

103) Provide a definition of “present value” (PV). Answer: The current value of future cash flows discounted at the appropriate

discount rate.

103)

Explanation:

104) How long will it take for money to double at a rate of 6% compounded monthly? Answer: At the given rate, money will double in 11 years and 7 months.

Explanation:

104)

100)

33105) Write a sentence explaining why present values decrease as the discount rate

increases.

Answer: Student answers will vary. Here is one example. When you can earn more

interest, you need less of your own money to reach the same future dollar

amount.

Explanation:

106) Explain what compounding is and the relationship between compound interest

earned and the number of years over which an investment is compounded.

Answer: Compounding is earning interest on interest. Compounding is not very

significant over short time periods, but greatly increases in importance over

a longer time period.

Explanation:

107) State the future value formula and explain the effect that time has on the future

value of an investment.

Answer: FV = PV(1 + r)t

Time is the exponential function. Thus, time has a significant bearing on the

future value of an investment because the future value rises exponentially in

response to time. The longer the time period, the greater this effect will be.

Explanation:

108) Provide a definition of “discount.” Answer: To calculate the present value of some future amount.

Explanation:

109) An investor is considering depositing $10,000 and making $400 semi-annual

contributions for the next five years. If one investment provides 5% compounded

monthly and another investment provides 5.2% compounded semi-annually,

determine the difference between the two investments.

Answer: The investment earning 5% will have a future value of $17,320.33, while

the investment earning 5.2% will have a future value of $17,428.25, for a

difference of $107.92.

Explanation:

105)

106)

107)

108)

109)

34110) At an interest rate of 10% and using the Rule of 72, how long will it take to

double the value of a lump sum invested today? How long will it take after that

until the account grows to four times the initial investment? Given the power of

compounding, shouldn’t it take less time for the money to double the second

time?

Answer: It will take 7.2 years to double the initial investment, then another 7.2 years

to double it again. That is, it takes 14.4 years for the value to reach four

times the initial investment. Compounding doesn’t affect the amount of

time it takes for an investment to double the second time, but note that

during the first 7.2 years, the interest earned is equal to 100% of the initial

investment. During the second 7.2 years, the interest earned is equal to

200% of the initial investment. That is the power of compounding.

Explanation:

111) What is the rate needed (compounded monthly) for $10,000 to mature to $25,000

in 15 years?

Answer: The required rate of return is 6.12% compounded quarterly.

Explanation:

112) You wish to have $200,000 at the end of twenty years. In the last five years, you

withdraw $1,000 annually at a rate of 3.8% compounded quarterly. During the

middle ten years, you contribute $500 monthly at a rate of 2.8% compounded

semi-annually. Given this information, determine the initial deposit that has to be

made at the start of the first five years at a rate of 4% compounded monthly.

Answer: The initial deposit will be $9,056.50.

Explanation:

113) An investor is considering depositing $20,000 in an account earning 5%

compounded quarterly for the next three years. Afterwards, he will take this

amount and contribute $200 quarterly for the next four years at a rate of 4%

compounded semi-annually. Finally, over the next two years, he will withdraw

$1,000 annually at a rate of 3.5% compounded monthly. Determine the future

value at the end of this time period.

Answer: The future value will be $30,833.94.

Explanation:

114) Provide a definition of “compounding.” Answer: The process of reinvesting interest earned on the investment such that it

accumulates interest.

Explanation:

35

110)

111)

112)

113)

114)115) If $10,000 was invested at 4% over ten years, determine the difference if this

investment was based on simple interest versus interest that was compounded

annually.

Answer: Simple interest provides a future value of $14,800, while compounded

annually provides $14,802.44.

Explanation:

116) Define and explain the relationship between the present value and the discount

rate. Graphically illustrate this relationship.

Answer: The present value is inversely related to the discount rate. If you can earn

more interest, then it takes less of an initial investment to reach a

predetermined future value. Students should draw a graph depicting an

inverse relationship.

Explanation:

117) Explain intuitively why it is that present values decrease as the discount rate

increases.

Answer: Intuitively, a dollar today is worth more than a dollar tomorrow. As a

practical matter, the discount rate is an opportunity cost, and the higher the

rate, the higher the cost.

Explanation:

118) How long will it take for money to tripe at a rate of 4.5% compounded quarterly? Answer: At the given rate, money will triple in 24.55 years.

Explanation:

119) Why do you think the concept known as the “time value of money” plays such a

critical role in finance?

Answer: Student answers will vary. However, each response should demonstrate (1)

an understanding that $1 today is worth more than $1 tomorrow and (2) that

all investment decisions should consider the impact of this concept.

Explanation:

120) Provide a definition of “future value” (FV). Answer: The amount an investment is worth after one or more periods. Also

compound value.

Explanation:

121) Provide a definition of “time value of money.” Answer: Refers to the fact that a dollar today is worth more than a dollar at a future

point in time, given positive rates of interest.

Explanation:

115)

116)

117)

118)

119)

120)

121)

36122) What is the difference in future value if $40,000 is invested at 5% over twenty

years, with one option compounding interest annually, while the other is based on

monthly compounding?

Answer: Annual compounding provides a return of $106,131.91, while monthly

compounding provides a return of $108,505.61 for a difference of

$2,373.70.

Explanation:

123) An investor is considering depositing $10,000 in an account earning 3%

compounded monthly for the next two years. Afterwards, he will take this

amount and contribute $500 monthly for the next three years at a rate of 5%

compounded annually. Finally, over the next three years, he will withdraw $500

annually at a rate of 4.5% compounded semi-annually. Determine the future value

at the end of this time period.

Answer: The future value will be $34,584.92

Explanation:

124) The notion that money has “time-value” is based on the existence of a nonzero

“opportunity rate”, i.e., a rate of return at which it is possible to invest. Why is the

opportunity rate so important?

Answer: We have found that, while they are able to perform compounding and

discounting computations successfully, some students never really grasp

the “why” of the computation. This question is designed to probe the issue

of “why time value procedures work” more deeply. An adequate answer

will indicate that the opportunity rate is the rate of return that equates two

different dollar values at two different points in time. That is, a rational

investor will be indifferent to $.9091 today and $1.00 in one year.

Explanation:

125) An investor is considering depositing $20,000 and making monthly contributions

of $250 per month into investment. If the investor wants to have a future value of

$50,000, what will be the rate of interest if he wishes to have this amount in 5

years? Assume interest is compounded monthly.

Answer: The rate of interest will have to be 8.92%.

Explanation:

126) If $20,000 was invested at 5% over five years, determine the difference if this

investment was based on simple interest versus interest that was compounded

annually.

Answer: Simple interest provides a future value of $25,000, while compounded

annually provides $25,525.63.

Explanation:

122)

123)

124)

125)

126)

37127) You are considering two lottery payment streams. Choice A pays $1,000 today

and choice B pays $1,750 at the end of five years from now. Using a discount rate

of 5%, based on present values, which would you choose? Using the same

discount rate of 5%, based on future values, which would you choose? What do

your results suggest as a general rule for approaching such problems? (Make your

choices based purely on the time value of money.)

Answer: PV of A = $1,000; PV of B = $1,371; FV of A = $1,276; FV of B = $1,500.

Based on both present values and future values, B is the better choice. The

student should recognize that finding present values and finding future

values are simply reverse processes of one another, and that choosing

between two lump sums based on PV will always give the same result as

choosing between the same two lump sums based on FV.

Explanation:

128) Provide a definition of “discount rate.” Answer: The rate used to calculate the present value of future cash flows.

Explanation:

129) Susie and Tim are twins. Susie invests $5,000 at age 20 and earns 5% compound

interest. Tim invests $10,000 at age 40 and earns 5% compound interest. No

matter how long they live, Tim will never have as much money as Susie. Explain

why.

127)

128)

129)

Answer: By age 40, Susie’s funds had grown to $13,266.49, which is more than the

amount of money Tim is investing at that point in time. The key here is

time. Time is the exponential function and therefore has a tremendous

impact on the value of money. Even though Tim invests twice as much

money, he will always have less than Susie.

Explanation:

130) Explain what compounding is and the relationship between compound interest

earned and the number of years over which an investment is compounded.

Answer: Compounding is earning interest on interest. Compounding is not

significant over short time periods, but increases in importance the longer

the time period considered.

Explanation:

130)

38131) Some financial advisors recommend you increase the amount of federal income

taxes withheld from your paycheque each month so that you will get a larger

refund come April. That is, you take home less today but get a bigger lump sum

when you get your refund. Based on your knowledge of the time value of money,

what do you think of this idea? Explain.

Answer: Some students may slip in a discussion about the benefits of forced savings,

etc., but these issues are based on preferences, not the time value of money.

Based on the time value of money, the students should recommend the

opposite tack, that is, withhold as little as possible and pay the tax bill when

it comes the following year. This is the usual dollar today versus a dollar

tomorrow argument. Of course, the astute student will note the potential tax

complications of this strategy, namely the CRA penalty for insufficient

withholding, but the basic argument still applies.

Explanation:

132) $15,000 is invested into a plan earning 5% compounded quarterly for the first ten

years. What will the rate of interest have to be for the next ten years

(compounded monthly) for the value to reach $40,000?

Answer: The rate of interest will have to be 4.85%.

Explanation:

133) Provide a definition of “interest on interest.” Answer: Interest earned on the reinvestment of previous interest payments.

Explanation:

134) Provide a graphical illustration of present value over a twenty year time span

given rates of return of 0%, 5%, 10%, 15% and 20%.

Answer:

131)

132)

133)

134)

Explanation:

39135) Provide a definition of “compound interest.” Answer: Interest earned on both the initial principal and the interest reinvested from

prior periods.

Explanation:

136) You wish to have $400,000 at the end of twenty-five years. In the last ten years,

you contribute $1,000 semi-annually at a rate of 5.8% compounded monthly.

During the middle ten years, you withdraw $750 quarterly at a rate of 4.5%

compounded annually. Given this information, determine the initial deposit that

has to be made at the start of the first five years at a rate of 4% compounded

monthly.

Answer: The initial deposit will be $130,150.00.

Explanation:

137) What is the rate needed (compounded annually) for $95,000 to mature to

$250,000 in 25 years?

Answer: The required rate of return is 3.95% compounded monthly.

Explanation:

138) What is the difference in future value if $20,000 is invested at 5% over ten years,

with one option compounding interest semi-annually, while the other is based on

quarterly compounding?

Answer: Semi-annual compounding provides a return of $32,772.33, while quarterly

compounding provides a return of $32,872.39, for a difference of $100.06.

Explanation:

135)

136)

137)

138)

40139) Provide a graphical illustration of future value over a ten year time span given

rates of return of 0%, 5%, 10%, 15% and 20%.

Answer:

139)

Explanation:

TRUE/FALSE. Write ‘T’ if the statement is true and ‘F’ if the statement is false.

140) Tom and Antonio both want to open savings accounts today. Tom wants to have $1,000

in his savings account six years from now. Antonio wants to have $1,000 in his savings

account three years from now. Antonio needs to deposit twice the amount of money

today as Tom.

Answer: True False

Explanation:

141) The I.C. James Co. invested $10,000 six years ago at 5% simple interest. The I.M. Smart

Co. invested $10,000 six years ago at 5% interest which is compounded annually. The

I.M Smart Co. will earn $525 interest in the second year.

Answer: True False

Explanation:

142) The future value of a single sum will increase more rapidly when the frequency of

compounding increases.

Answer: True False

Explanation:

140)

141)

142)

41143) Jamie deposits $1,000 into an account that pays 4% interest compounded annually. Chris

deposits $1,000 into an account that pays 4% simple interest. Both deposits were made

today. At the end of one year, both Jamie and Chris will have the same amount in their

accounts.

Answer: True False

Explanation:

144) The future value will increase the higher the rate of interest. Answer: True False

Explanation:

145) Discount rate is the interest rate used to calculate the present value of future cash flows. Answer: True False

Explanation:

146) The I.C. James Co. invested $10,000 six years ago at 5% simple interest. The I.M. Smart

Co. invested $10,000 six years ago at 5% interest which is compounded annually. The

I.C. James Co. will have an account value of $13,400.96 six years from now.

Answer: True False

Explanation:

147) Jamie deposits $1,000 into an account that pays 4% interest compounded annually. Chris

deposits $1,000 into an account that pays 4% simple interest. Both deposits were made

today. All else equal, Jamie made the better investment.

Answer: True False

Explanation:

148) The present value will increase the higher the rate of interest. Answer: True False

Explanation:

149) Present value is the value today of future cash flows discounted at the appropriate

discount rate.

Answer: True False

Explanation:

150) The future value of a single sum will increase more rapidly when the frequency of

compounding decreases.

Answer: True False

Explanation:

151) The present value will increase the lower the rate of interest. Answer: True False

Explanation:

143)

144)

145)

146)

147)

148)

149)

150)

151)

42152) Future value can be lower than present value. Answer: True False

Explanation:

153) Present values are always smaller than future values when both r and t are positive. Answer: True False

Explanation:

154) The future value of a single sum will increase more rapidly when the interest rate

decreases.

Answer: True False

Explanation:

155) If the rate at which you can invest is 0%, the value today of $1 to be received in the

future is less than $1.

Answer: True False

Explanation:

156) Present values increase as the discount rate increases. Answer: True False

Explanation:

157) The larger the present value factor, the larger the present value. Answer: True False

Explanation:

158) The I.C. James Co. invested $10,000 six years ago at 5% simple interest. The I.M. Smart

Co. invested $10,000 six years ago at 5% interest which is compounded annually. Both

the I.C. James Co. and the I.M. Smart Co. will earn $500 interest in the first year.

Answer: True False

Explanation:

159) The future value will increase the longer the period of time. Answer: True False

Explanation:

160) Present values increase the further away in time the future value. Answer: True False

Explanation:

161) Tom and Antonio both want to open savings accounts today. Tom wants to have $1,000

in his savings account six years from now. Antonio wants to have $1,000 in his savings

account three years from now. Tom needs to deposit more money into his account today

than does Antonio.

Answer: True False

Explanation:

152)

153)

154)

155)

156)

157)

158)

159)

160)

161)

43162) The larger the future value, the larger the present value. Answer: True False

Explanation:

163) The future value will increase the shorter the period of time. Answer: True False

Explanation:

164) Future value is always higher than present value. Answer: True False

Explanation:

165) Jamie deposits $1,000 into an account that pays 4% interest compounded annually. Chris

deposits $1,000 into an account that pays 4% simple interest. Both deposits were made

today. Chris will never earn any interest on interest.

Answer: True False

Explanation:

166) As the discount rate increases, the future value of $500 to be received four years from

now will decrease.

Answer: True False

Explanation:

167) Discounting is the process of finding the present value of some future amount. Answer: True False

Explanation:

168) Jamie deposits $1,000 into an account that pays 4% interest compounded annually. Chris

deposits $1,000 into an account that pays 4% simple interest. Both deposits were made

today. At the end of five years, Chris will have more money in his account than Jamie

has in hers.

Answer: True False

Explanation:

169) Tom and Antonio both want to open savings accounts today. Tom wants to have $1,000

in his savings account six years from now. Antonio wants to have $1,000 in his savings

account three years from now. Antonio needs to deposit more money into his account

today than does Tom.

Answer: True False

Explanation:

170) Compounding is the process of finding the present value of some future amount. Answer: True False

Explanation:

162)

163)

164)

165)

166)

167)

168)

169)

170)

44171) The longer the time period, the higher the present value. Answer: True False

Explanation:

172) Interest earned on the reinvestment of previous interest payments is called simple

interest.

Answer: True False

Explanation:

173) The higher the discount rate, the higher the present value. Answer: True False

Explanation:

174) The future value will increase the lower the rate of interest. Answer: True False

Explanation:

175) The future value will increase the longer the period of time. Answer: True False

Explanation:

176) The future value of a single sum will increase more rapidly when the interest rate

increases.

Answer: True False

Explanation:

177) Tom and Antonio both want to open savings accounts today. Tom wants to have $1,000

in his savings account six years from now. Antonio wants to have $1,000 in his savings

account three years from now. Tom will need to deposit twice the amount of money

today as Antonio.

Answer: True False

Explanation:

171)

172)

173)

174)

175)

176)

177)

45Answer Key

Testname: C5

1) C

2) C

3) A

4) A

5) D

6) C

7) E

8) C

9) B

10) A

11) A

12) C

13) B

14) C

15) E

16) B

17) A

18) A

19) B

20) A

21) B

22) E

23) D

24) D

25) D

26) E

27) D

28) E

29) A

30) D

31) B

32) B

33) B

34) D

35) C

36) B

37) B

38) D

39) C

40) A

41) E

42) B

43) A

44) B

45) E

46) C

47) C

48) E

49) B

50) B

46Answer Key

Testname: C5

51) D

52) E

53) B

54) B

55) D

56) D

57) C

58) A

59) E

60) E

61) B

62) B

63) C

64) D

65) D

66) D

67) D

68) D

69) D

70) D

71) C

72) C

73) B

74) A

75) E

76) E

77) D

78) E

79) B

80) D

81) D

82) D

83) C

84) D

85) D

86) A

87) B

88) E

89) B

90) B

91) E

92) A

93) C

94) B

95) D

96) E

97) D

98) B

99) C

100) E

47Answer Key

Testname: C5

101) Interest earned only on the original principal amount invested.

102) By converting cash flows into present values, management can compare and contrast various alternative

opportunities and determine which course of action is best for the firm. The present value allows

management to view projects on an equivalent basis. Also, by knowing the present value of the future cash

flows of a project, management can determine if those cash inflows are sufficient to offset the required

investment in the project. While students may have various answers, this question starts them thinking

about financial decision-making, which is covered later in the text.

103) The current value of future cash flows discounted at the appropriate discount rate.

104) At the given rate, money will double in 11 years and 7 months.

105) Student answers will vary. Here is one example. When you can earn more interest, you need less of your

own money to reach the same future dollar amount.

106) Compounding is earning interest on interest. Compounding is not very significant over short time periods,

but greatly increases in importance over a longer time period.

107) FV = PV(1 + r)t

Time is the exponential function. Thus, time has a significant bearing on the future value of an investment

because the future value rises exponentially in response to time. The longer the time period, the greater this

effect will be.

108) To calculate the present value of some future amount.

109) The investment earning 5% will have a future value of $17,320.33, while the investment earning 5.2% will

have a future value of $17,428.25, for a difference of $107.92.

110) It will take 7.2 years to double the initial investment, then another 7.2 years to double it again. That is, it

takes 14.4 years for the value to reach four times the initial investment. Compounding doesn’t affect the

amount of time it takes for an investment to double the second time, but note that during the first 7.2 years,

the interest earned is equal to 100% of the initial investment. During the second 7.2 years, the interest

earned is equal to 200% of the initial investment. That is the power of compounding.

111) The required rate of return is 6.12% compounded quarterly.

112) The initial deposit will be $9,056.50.

113) The future value will be $30,833.94.

114) The process of reinvesting interest earned on the investment such that it accumulates interest.

115) Simple interest provides a future value of $14,800, while compounded annually provides $14,802.44.

116) The present value is inversely related to the discount rate. If you can earn more interest, then it takes less

of an initial investment to reach a predetermined future value. Students should draw a graph depicting an

inverse relationship.

117) Intuitively, a dollar today is worth more than a dollar tomorrow. As a practical matter, the discount rate is

an opportunity cost, and the higher the rate, the higher the cost.

118) At the given rate, money will triple in 24.55 years.

119) Student answers will vary. However, each response should demonstrate (1) an understanding that $1 today

is worth more than $1 tomorrow and (2) that all investment decisions should consider the impact of this

concept.

120) The amount an investment is worth after one or more periods. Also compound value.

121) Refers to the fact that a dollar today is worth more than a dollar at a future point in time, given positive

rates of interest.

48Answer Key

Testname: C5

122) Annual compounding provides a return of $106,131.91, while monthly compounding provides a return of

$108,505.61 for a difference of $2,373.70.

123) The future value will be $34,584.92

124) We have found that, while they are able to perform compounding and discounting computations

successfully, some students never really grasp the “why” of the computation. This question is designed to

probe the issue of “why time value procedures work” more deeply. An adequate answer will indicate that

the opportunity rate is the rate of return that equates two different dollar values at two different points in

time. That is, a rational investor will be indifferent to $.9091 today and $1.00 in one year.

125) The rate of interest will have to be 8.92%.

126) Simple interest provides a future value of $25,000, while compounded annually provides $25,525.63.

127) PV of A = $1,000; PV of B = $1,371; FV of A = $1,276; FV of B = $1,500. Based on both present values

and future values, B is the better choice. The student should recognize that finding present values and

finding future values are simply reverse processes of one another, and that choosing between two lump

sums based on PV will always give the same result as choosing between the same two lump sums based

on FV.

128) The rate used to calculate the present value of future cash flows.

129) By age 40, Susie’s funds had grown to $13,266.49, which is more than the amount of money Tim is

investing at that point in time. The key here is time. Time is the exponential function and therefore has a

tremendous impact on the value of money. Even though Tim invests twice as much money, he will always

have less than Susie.

130) Compounding is earning interest on interest. Compounding is not significant over short time periods, but

increases in importance the longer the time period considered.

131) Some students may slip in a discussion about the benefits of forced savings, etc., but these issues are based

on preferences, not the time value of money. Based on the time value of money, the students should

recommend the opposite tack, that is, withhold as little as possible and pay the tax bill when it comes the

following year. This is the usual dollar today versus a dollar tomorrow argument. Of course, the astute

student will note the potential tax complications of this strategy, namely the CRA penalty for insufficient

withholding, but the basic argument still applies.

132) The rate of interest will have to be 4.85%.

133) Interest earned on the reinvestment of previous interest payments.

49Answer Key

Testname: C5

134)

135) Interest earned on both the initial principal and the interest reinvested from prior periods.

136) The initial deposit will be $130,150.00.

137) The required rate of return is 3.95% compounded monthly.

138) Semi-annual compounding provides a return of $32,772.33, while quarterly compounding provides a

return of $32,872.39, for a difference of $100.06.

139)

140) FALSE

141) TRUE

142) TRUE

143) TRUE

50Answer Key

Testname: C5

144) TRUE

145) TRUE

146) FALSE

147) TRUE

148) FALSE

149) TRUE

150) FALSE

151) TRUE

152) TRUE

153) TRUE

154) FALSE

155) FALSE

156) FALSE

157) TRUE

158) TRUE

159) TRUE

160) FALSE

161) FALSE

162) FALSE

163) FALSE

164) FALSE

165) TRUE

166) FALSE

167) TRUE

168) FALSE

169) TRUE

170) FALSE

171) FALSE

172) FALSE

173) TRUE

174) FALSE

175) TRUE

176) TRUE

177) FALSE

51