Chapter 05 - Introduction to Valuation: The Time Value of Money

Chapter 05
Introduction to Valuation: The Time Value of Money

Chapter 05 Introduction to Valuation: The Time Value of Money Answer Key
Multiple Choice Questions

1 !ou are in"estin# $100 today in a sa"in#s account at your local %an& 'hich one of the
followin# terms refers to the "alue of this in"estment one year from now(
A. future "alue
) present "alue
C principal amounts
* discounted "alue
+ in"ested principal
,efer to section 51

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&o'ic: (uture !alue

- Tracy in"ested $1.000 fi"e years a#o and earns / percent interest on her in"estment )y
lea"in# her interest earnin#s in her account. she increases the amount of interest she earns
each year The way she is handlin# her interest income is referred to as which one of the
followin#(
A simplifyin#
B. compoundin#
C a##re#ation
* accumulation
+ discountin#
,efer to section 51

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&o'ic: Com'ounding

5-1
Chapter 05 - Introduction to Valuation: The Time Value of Money
0 1te"e in"ested $100 two years a#o at 10 percent interest The first year. he earned $10
interest on his $100 in"estment 2e rein"ested the $10 The second year. he earned $11
interest on his $110 in"estment The e3tra $1 he earned in interest the second year is referred
to as:
A free interest
) %onus income
C simple interest
D. interest on interest
+ present "alue interest
,efer to section 51

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&o'ic: )nterest on interest

/ Interest earned on %oth the initial principal and the interest rein"ested from prior periods is
called:
A free interest
) dual interest
C simple interest
* interest on interest
. compound interest
,efer to section 51

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&o'ic: Com'ound interest

5--
Chapter 05 - Introduction to Valuation: The Time Value of Money
5 1ara in"ested $500 si3 years a#o at 5 percent interest 1he spends her earnin#s as soon as
she earns any interest so she only recei"es interest on her initial $500 in"estment 'hich type
of interest is 1ara earnin#(
A free interest
) comple3 interest
C. simple interest
* interest on interest
+ compound interest
,efer to section 51

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&o'ic: Sim'le interest

4 1helley won a lottery and will recei"e $1.000 a year for the ne3t ten years The "alue of her
winnin#s today discounted at her discount rate is called which one of the followin#(
A sin#le amount
) future "alue
C. present "alue
* simple amount
+ compounded "alue
,efer to section 5-

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5-0
Chapter 05 - Introduction to Valuation: The Time Value of Money
5 Terry is calculatin# the present "alue of a %onus he will recei"e ne3t year The process he is
usin# is called:
A #rowth analysis
B. discountin#
C accumulatin#
* compoundin#
+ reducin#
,efer to section 5-

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&o'ic: Discounting

6 1te"e 7ust computed the present "alue of a $10.000 %onus he will recei"e in the future The
interest rate he used in this process is referred to as which one of the followin#(
A current yield
) effecti"e rate
C compound rate
* simple rate
. discount rate
,efer to section 5-

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&o'ic: Discount rate

5-/
Chapter 05 - Introduction to Valuation: The Time Value of Money
8 The process of determinin# the present "alue of future cash flows in order to &now their
worth today is called which one of the followin#(
A compound interest "aluation
) interest on interest computation
C. discounted cash flow "aluation
* present "alue interest factorin#
+ comple3 factorin#
,efer to section 5-

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&o'ic: Discounted cas, flow !aluation

10 Andy deposited $0.000 this mornin# into an account that pays 5 percent interest.
compounded annually )ar% also deposited $0.000 this mornin# into an account that pays 5
percent interest. compounded annually Andy will withdraw his interest earnin#s and spend it
as soon as possi%le )ar% will rein"est her interest earnin#s into her account 9i"en this.
which one of the followin# statements is true(
A )ar% will earn more interest the first year than Andy will
) Andy will earn more interest in year three than )ar% will
C. )ar% will earn interest on interest
* After fi"e years. Andy and )ar% will %oth ha"e earned the same amount of interest
+ Andy will earn compound interest
,efer to section 51

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&o'ic: Com'ound interest

5-5
Chapter 05 - Introduction to Valuation: The Time Value of Money
11 1ue and :eal are twins 1ue in"ests $5.000 at 5 percent when she is -5 years old :eal
in"ests $5.000 at 5 percent when he is 00 years old )oth in"estments compound interest
annually )oth 1ue and :eal retire at a#e 40 'hich one of the followin# statements is correct
assumin# that neither 1ue nor :eal has withdrawn any money from their accounts(
A 1ue will ha"e less money when she retires than :eal
) :eal will earn more interest on interest than 1ue
C :eal will earn more compound interest than 1ue
* If %oth 1ue and :eal wait to a#e 50 to retire. then they will ha"e e;ual amounts of sa"in#s
. 1ue will ha"e more money than :eal as lon# as they retire at the same time
,efer to section 51

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&o'ic: (uture !alue

1- 1amantha opened a sa"in#s account this mornin# 2er money will earn 5 percent interest.
compounded annually After fi"e years. her sa"in#s account will %e worth $5.400 Assume she
will not ma&e any withdrawals 9i"en this. which one of the followin# statements is true(
A 1amantha deposited more than $5.400 this mornin#
) The present "alue of 1amantha<s account is $5.400
C. 1amantha could ha"e deposited less money and still had $5.400 in fi"e years if she could
ha"e earned 55 percent interest
* 1amantha would ha"e had to deposit more money to ha"e $5.400 in fi"e years if she could
ha"e earned 4 percent interest
+ 1amantha will earn an e;ual amount of interest e"ery year for the ne3t fi"e years
,efer to section 5-

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5-4
Chapter 05 - Introduction to Valuation: The Time Value of Money
10 This afternoon. you deposited $1.000 into a retirement sa"in#s account The account will
compound interest at 4 percent annually !ou will not withdraw any principal or interest until
you retire in forty years 'hich one of the followin# statements is correct(
A The interest you earn si3 years from now will e;ual the interest you earn ten years from
now
) The interest amount you earn will dou%le in "alue e"ery year
C The total amount of interest you will earn will e;ual $1.000 04 /0
D. The present "alue of this in"estment is e;ual to $1.000
+ The future "alue of this amount is e;ual to $1.000 =1 > /0?
04

,efer to sections 51 and 5-

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&o'ic: +resent and future !alues

1/ !our #randmother has promised to #i"e you $5.000 when you #raduate from colle#e 1he
is e3pectin# you to #raduate two years from now 'hat happens to the present "alue of this
#ift if you delay your #raduation %y one year and #raduate three years from now(
A remains constant
) increases
C. decreases
* %ecomes ne#ati"e
+ cannot %e determined from the information pro"ided
,efer to section 5-

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5-5
Chapter 05 - Introduction to Valuation: The Time Value of Money
15 @uis is #oin# to recei"e $-0.000 si3 years from now 1oo @ee is #oin# to recei"e $-0.000
nine years from now 'hich one of the followin# statements is correct if %oth @uis and 1oo
@ee apply a 5 percent discount rate to these amounts(
A The present "alues of @uis and 1oo @ee<s monies are e;ual
) In future dollars. 1oo @ee<s money is worth more than @uis< money
C. In today<s dollars. @uis< money is worth more than 1oo @ee<s
* Twenty years from now. the "alue of @uis< money will %e e;ual to the "alue of 1oo @ee<s
money
+ 1oo @ee<s money is worth more than @uis< money #i"en the 5 percent discount rate
,efer to sections 51 and 5-

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&o'ic: +resent and future !alues

14 'hich one of the followin# "aria%les is the e3ponent in the present "alue formula(
A present "alue
) future "alue
C interest rate
D. time
+ There is no e3ponent in the present "alue formula
,efer to section 5-

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5-6
Chapter 05 - Introduction to Valuation: The Time Value of Money
15 !ou want to ha"e $1 million in your sa"in#s account when you retire !ou plan on
in"estin# a sin#le lump sum today to fund this #oal !ou are plannin# on in"estin# in an
account which will pay 55 percent annual interest 'hich of the followin# will reduce the
amount that you must deposit today if you are to ha"e your desired $1 million on the day you
retire(
I In"est in a different account payin# a hi#her rate of interest
II In"est in a different account payin# a lower rate of interest
III ,etire later
IV ,etire sooner
A I only
) II only
C. I and III only
* I and IV only
+ II and III only
,efer to section 5-

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&o'ic: +resent !alue

16 'hich one of the followin# will produce the hi#hest present "alue interest factor(
A. 4 percent interest for fi"e years
) 4 percent interest for ei#ht years
C 4 percent interest for ten years
* 6 percent interest for fi"e years
+ 6 percent interest for ten years
,efer to sections 5-

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&o'ic: +resent !alue factor

5-8
Chapter 05 - Introduction to Valuation: The Time Value of Money
18 'hat is the relationship %etween present "alue and future "alue interest factors(
A The present "alue and future "alue factors are e;ual to each other
) The present "alue factor is the e3ponent of the future "alue factor
C The future "alue factor is the e3ponent of the present "alue factor
D. The factors are reciprocals of each other
+ There is no relationship %etween these two factors
,efer to section 50

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&o'ic: +resent and future !alue factors

-0 Martin in"ested $1.000 si3 years a#o and e3pected to ha"e $1.500 today 2e has not added
or withdrawn any money from this account since his initial in"estment All interest was
rein"ested in the account As it turns out. Martin only has $1./-0 in his account today 'hich
one of the followin# must %e true(
A Martin earned simple interest rather than compound interest
B. Martin earned a lower interest rate than he e3pected
C Martin did not earn any interest on interest as he e3pected
* Martin i#nored the ,ule of 5- which caused his account to decrease in "alue
+ The future "alue interest factor turned out to %e hi#her than Martin e3pected
,efer to sections 51 and 50

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&o'ic: )nterest rate

5-10
Chapter 05 - Introduction to Valuation: The Time Value of Money
-1 9erold in"ested $4.-00 in an account that pays 5 percent simple interest 2ow much
money will he ha"e at the end of ten years(
A $6.510
) $8.000
C. $8.000
* $8.456
+ $10.088
+ndin# "alue A $4.-00 > =$4.-00 05 10? A $8.000

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-- Ale3 in"ested $10.500 in an account that pays 4 percent simple interest 2ow much
money will he ha"e at the end of four years(
A $1-.450
) $1-.845
C. $10.0-0
* $10.-54
+ $10.500
+ndin# "alue A $10.500 > =$10.500 04 /? A $10.0-0

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5-11
Chapter 05 - Introduction to Valuation: The Time Value of Money
-0 !ou in"ested $1.450 in an account that pays 5 percent simple interest 2ow much more
could you ha"e earned o"er a -0-year period if the interest had compounded annually(
A $6/8--
) $80011
C $86-18
* $1.0-115
. $1.0558/
1imple interest A $1.450 > =$1.450 05 -0? A $0.000
Annual compoundin# A $1.450 =105?
-0
A $/.0558/
*ifference A $/.0558/ - $0.000 A $1.0558/

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&o'ic: Sim'le !ersus com'ound interest

5-1-
Chapter 05 - Introduction to Valuation: The Time Value of Money
-/ Tra"is in"ested $8.-50 in an account that pays 4 percent simple interest 2ow much more
could he ha"e earned o"er a 5-year period if the interest had compounded annually(
A $5/1/1
B. $55056
C $60-14
* $60000
+ $65608
1imple interest A $8.-50 > =$8.-50 04 5? A $10.105
Compound interest A $8.-50 =1 > 04?
5
A $10.80656
*ifference A $10.80656 - $10.105 A $55056

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&o'ic: Sim'le !ersus com'ound interest

-5 'hat is the future "alue of $5.168 in"ested for -0 years at 8-5 percent compounded
annually(
A $--./6040
) $-5.68065
C $06.88105
* $51.00810
. $5/.88866
Buture "alue A $5.168 =1 > 08-5?
-0
A $5/.88866

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5-10
Chapter 05 - Introduction to Valuation: The Time Value of Money
-4 Today. you earn a salary of $04.000 'hat will %e your annual salary twel"e years from
now if you earn annual raises of 04 percent(
A. $55.00-5/
) $55./1/04
C $56.-05-/
* $58.1--06
+ $58.040/5
Buture "alue A $04.000 =1 > 004?
1-
A $55.00-5/

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-5 !ou own a classic automo%ile that is currently "alued at $1/5.800 If the "alue increases
%y 45 percent annually. how much will the automo%ile %e worth ten years from now(
A $-//.00500
) $-51.00615
C $-50.01006
D. $-55.4-640
+ $-81./6016
Buture "alue A $1/5.800 =1 > 045?
10
A $-55.4-640

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5-1/
Chapter 05 - Introduction to Valuation: The Time Value of Money
-6 !ou hope to %uy your dream car four years from now Today. that car costs $6-.500 !ou
e3pect the price to increase %y an a"era#e of /6 percent per year o"er the ne3t four years
2ow much will your dream car cost %y the time you are ready to %uy it(
A $86.0/000
) $86.44445
C. $88.515/1
* $88.6160-
+ $100.0-014
Buture "alue A $6-.500 =1 > 0/6?
/
A $88.515/1

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5-15
Chapter 05 - Introduction to Valuation: The Time Value of Money
-8 This mornin#. T@ Truc&in# in"ested $60.000 to help fund a company e3pansion pro7ect
planned for / years from now 2ow much additional money will the firm ha"e / years from
now if it can earn 5 percent rather than / percent on its sa"in#s(
A $-.8/008
B. $0.4516-
C $/.00615
* $/.-1846
+ $/.51106
Buture "alue A $60.000 =1 > 05?
/
A $85.-/050
Buture "alue A $60.000 =1 > 0/?
/
A $80.56646
*ifference A $85.-/050 - $80.56646 A $0.4516-

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5-14
Chapter 05 - Introduction to Valuation: The Time Value of Money
00 !ou 7ust recei"ed $--5.000 from an insurance settlement !ou ha"e decided to set this
money aside and in"est it for your retirement Currently. your #oal is to retire -5 years from
today 2ow much more will you ha"e in your account on the day you retire if you can earn an
a"era#e return of 105 percent rather than 7ust 6 percent(
A $/15.105
) $468.508
C $1.050./-0
D. $1.168.554
+ $1.616.0/-
Buture "alue A $--5.000 =1 > 105?
-5
A $-.500./60
Buture "alue A $--5.000 =1 > 06?
-5
A $1.5/0.805
*ifference A $-.500./60 - $1.5/0.805 A $1.168.554

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5-15
Chapter 05 - Introduction to Valuation: The Time Value of Money
01 !ou 7ust recei"ed a $5.000 #ift from your #randmother !ou ha"e decided to sa"e this
money so that you can #ift it to your #randchildren 50 years from now 2ow much additional
money will you ha"e to #ift to your #randchildren if you can earn an a"era#e of 65 percent
instead of 7ust 6 percent on your sa"in#s(
A $/5.01608
) $5-./4/58
C $55.-1114
* $56.61188
. $40.8-05-
Buture "alue A $5.000 =1 > 065?
50
A $-85./0156
Buture "alue A $5.000 =1 > 06?
50
A $-0/.50604
*ifference A $-85./0156 - $-0/.50604 A $40.8-05-

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5-16
Chapter 05 - Introduction to Valuation: The Time Value of Money
0- !ou are depositin# $1.500 in a retirement account today and e3pect to earn an a"era#e
return of 55 percent on this money 2ow much additional income will you earn if you lea"e
the money in"ested for /5 years instead of 7ust /0 years(
A $10.5-006
B. $11.58080
C $1-.//154
* $1-.80618
+ $10.58080
Buture "alue A $1.500 =1 > 055?
/5
A $06.655-4
Buture "alue A $1.500 =1 > 055?
/0
A $-5.04404
*ifference A $06.655-4 - $-5.04404 A $11.58080

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5-18
Chapter 05 - Introduction to Valuation: The Time Value of Money
00 !ou collect old coins Today. you ha"e two coins each of which is "alued at $-50 Cne
coin is e3pected to increase in "alue %y 4 percent annually while the other coin is e3pected to
increase in "alue %y /5 percent annually 'hat will %e the difference in the "alue of the two
coins 15 years from now(
A. $1150-
) $-060/
C $-/158
* $-5/-/
+ $-6015
Buture "alue A $-50 =1 > 04?
15
A $5881/
Buture "alue A $-50 =1 > 0/5?
15
A $/606-
*ifference A $5881/ - $/606- A $1150-

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5--0
Chapter 05 - Introduction to Valuation: The Time Value of Money
0/ !our father in"ested a lump sum -4 years a#o at /-5 percent interest Today. he #a"e you
the proceeds of that in"estment which totaled $51./6058 2ow much did your father
ori#inally in"est(
A $15.8-8/5
) $14.50000
C. $15.///64
* $15.50000
+ $15.888/5
Dresent "alue A $51./6058 E1F=1 > 0/-5?
-4
G A $15.///64

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05 'hat is the present "alue of $150.000 to %e recei"ed 6 years from today if the discount
rate is 11 percent(
A. $45.06685
) $51.1/505
C $5/.1/1/1
* $58.60416
+ $60.-8104
Dresent "alue A $150.000 E1F1 > 11?
6
G A $45.06685

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5--1
Chapter 05 - Introduction to Valuation: The Time Value of Money
04 !ou would li&e to #i"e your dau#hter $55.000 towards her colle#e education 15 years
from now 2ow much money must you set aside today for this purpose if you can earn 6
percent on your in"estments(
A $16.06618
B. $-0.-5015
C $-6./1545
* $-8.01110
+ $0-./6605
Dresent "alue A $55.000 E1F=1 > 06?
15
G A $-0.-5015

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5---
Chapter 05 - Introduction to Valuation: The Time Value of Money
05 !ou want to ha"e $05.000 sa"ed 4 years from now to %uy a house 2ow much less do you
ha"e to deposit today to reach this #oal if you can earn 55 percent rather than 5 percent on
your sa"in#s( Today<s deposit is the only deposit you will ma&e to this sa"in#s account
A. $5008/
) $58116
C $6-/40
* $6/511
+ $8180-
Dresent "alue A $05.000 E1F=1 > 05?
4
G A $-4.1155/
Dresent "alue A $05.000 E1F=1 > 055?
4
G A $-5.06040
*ifference A $-4.1155/ - $-5.06040 A $5008/

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5--0
Chapter 05 - Introduction to Valuation: The Time Value of Money
06 !our older sister deposited $5.000 today at 65 percent interest for 5 years !ou would li&e
to ha"e 7ust as much money at the end of the ne3t 5 years as your sister will ha"e 2owe"er.
you can only earn 5 percent interest 2ow much more money must you deposit today than
your sister did if you are to ha"e the same amount at the end of the 5 years(
A $0-118
B. $040/0
C $06556
* $/01-1
+ $/1008
Buture "alue A $5.000 =1 > 065?
5
A $5.516-6
Dresent "alue A $5.516-6 E1F=1 > 05?
5
G A $5.040/0
*ifference A $5.040/0 - $5.000 A $040/0

AACSB: Analytic
Bloom's: Analysis
Difficulty: )ntermediate
Learning Obecti!e: "#$ and "#*
Section: "%$ and "%*
&o'ic: +resent and future !alues

5--/
Chapter 05 - Introduction to Valuation: The Time Value of Money
08 A year a#o. you deposited $00.000 into a retirement sa"in#s account at a fi3ed rate of 55
percent Today. you could earn a fi3ed rate of 45 percent on a similar type account 2owe"er.
your rate is fi3ed and cannot %e ad7usted 2ow much less could you ha"e deposited last year if
you could ha"e earned a fi3ed rate of 45 percent and still ha"e the same amount as you
currently will when you retire 06 years from today(
A $-.116/- less
) $0.00000 less
C $5./1508 less
* $5.-5/1- less
. $8.-0/85 less
Buture "alue A $00.000 =1 > 055?
06>1
A $-/-.06/41
Dresent "alue A $-/-.06/41 E1F=1 > 045?
06>1
G A $-0.54500
*ifference A $00.000 - $-0.54500 A $8.-0/85

AACSB: Analytic
Bloom's: Analysis
Difficulty: )ntermediate
Learning Obecti!e: "#$ and "#*
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&o'ic: +resent and future !alues

5--5
Chapter 05 - Introduction to Valuation: The Time Value of Money
/0 'hen you retire /0 years from now. you want to ha"e $1- million !ou thin& you can
earn an a"era#e of 1- percent on your in"estments To meet your #oal. you are tryin# to
decide whether to deposit a lump sum today. or to wait and deposit a lump sum - years from
today 2ow much more will you ha"e to deposit as a lump sum if you wait for - years %efore
ma&in# the deposit(
A $1./1/1/
) $-.018/5
C $-.68111
D. $0.-6056
+ $0./0456
Dresent "alue A $1.-00.000 E1F=1 > 1-?
/0
G A $1-.68414
Dresent "alue A $1.-00.000 E1F=1 > 1-?
06
G A $14.1548/
*ifference A $14.1548/ - $1-.68414 A $0.-6056

AACSB: Analytic
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&o'ic: +resent !alue

5--4
Chapter 05 - Introduction to Valuation: The Time Value of Money
/1 Theo needs $/0.000 as a down payment for a house 4 years from now 2e earns 05
percent on his sa"in#s Theo can either deposit one lump sum today for this purpose or he can
wait a year and deposit a lump sum 2ow much additional money must he deposit if he waits
for one year rather than ma&in# the deposit today(
A $65686
) $81110
C. $1.10680
* $1.0/600
+ $1./-016
Dresent "alue A $/0.000 E1F=1 > 005?
4
G A $0-.5/000
Dresent "alue A $-4.000 E1F=1 > 005?
5
G A $00.45680
*ifference A $00.45680 - $0-.5/000 A $1.10680

AACSB: Analytic
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5--5
Chapter 05 - Introduction to Valuation: The Time Value of Money
/- Cne year a#o. you in"ested $1.600 Today it is worth $1.8-/4- 'hat rate of interest did
you earn(
A 458 percent
) 445 percent
C 466 percent
D. 48- percent
+ 501 percent
$1.8-/4- A $1.600 =1 > r?
1
H r A 48- percent

AACSB: Analytic
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Difficulty: Basic
Learning Obecti!e: "#-
Section: "%-
&o'ic: )nterest rate

/0 Accordin# to the ,ule of 5-. you can do which one of the followin#(
A dou%le your money in fi"e years at 5- percent interest
) dou%le your money in 5- years at 6 percent interest
C. dou%le your money in 6 years at 8 percent interest
* triple your money in 5- years at 5 percent interest
+ triple your money at 10 percent interest in 5- years
,ule of 5- A 5-F6 years A 8 percent interest

AACSB: Analytic
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Difficulty: Basic
Learning Obecti!e: "#-
Section: "%-
&o'ic: )nterest rate

5--6
Chapter 05 - Introduction to Valuation: The Time Value of Money
// Borty years a#o. your mother in"ested $5.000 Today. that in"estment is worth
$/00.04511 'hat is the a"era#e annual rate of return she earned on this in"estment(
A 1146 percent
) 1151 percent
C. 1156 percent
* 1181 percent
+ 1-0- percent
$/00.04511 A $5.000 =1 > r?
/0
H r A 1156 percent

AACSB: Analytic
Bloom's: A''lication
Difficulty: Basic
Learning Obecti!e: "#-
Section: "%-
&o'ic: )nterest rate

5--8
Chapter 05 - Introduction to Valuation: The Time Value of Money
/5 1i3teen years a#o. Alicia in"ested $1.000 +i#ht years a#o. Tra"is in"ested $-.000 Today.
%oth Alicia<s and Tra"is< in"estments are each worth $-./00 Assume that %oth Alicia and
Tra"is continue to earn their respecti"e rates of return 'hich one of the followin# statements
is correct concernin# these in"estments(
A Three years from today. Tra"is< in"estment will %e worth more than Alicia<s
B. Cne year a#o. Alicia<s in"estment was worth less than Tra"is< in"estment
C Tra"is earns a hi#her rate of return than Alicia
* Tra"is has earned an a"era#e annual interest rate of 005 percent
+ Alicia has earned an a"era#e annual interest rate of 401 percent
Alicia: $-./00 A $1.000 =1 > r?
14
H r A 54- percent
Tra"is: $-./00 A $-.000 =1 > r?
6
H r A -01 percent
1ince %oth Alicia and Tra"is ha"e e;ual account "alues today and since Alicia earns the hi#her
rate of return. her account had to %e worth less than Tra"is< account one year a#o

AACSB: Analytic
Bloom's: Synt,esis
Difficulty: )ntermediate
Learning Obecti!e: "#-
Section: "%-
&o'ic: )nterest rate

5-00
Chapter 05 - Introduction to Valuation: The Time Value of Money
/4 Denn 1tation is sa"in# money to %uild a new loadin# platform Two years a#o. they set
aside $-/.000 for this purpose Today. that account is worth $-6.088 'hat rate of interest is
Denn 1tation earnin# on this in"estment(
A 408 percent
) 5/5 percent
C. 656 percent
* 8-0 percent
+ 845 percent
$-6.088 A $-/.000 =1 > r?
-
H r A 656 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Obecti!e: "#-
Section: "%-
&o'ic: )nterest rate

/5 Bifteen years a#o. Iac&son 1upply set aside $100.000 in case of a financial emer#ency
Today. that account has increased in "alue to $000.58- 'hat rate of interest is the firm
earnin# on this money(
A 560 percent
B. 4/- percent
C 455 percent
* 5-6 percent
+ 550 percent
$000.58- A $100.000 =1 > r?
15
H r A 4/- percent

AACSB: Analytic
Bloom's: A''lication
Difficulty: Basic
Learning Obecti!e: "#-
Section: "%-
&o'ic: )nterest rate

5-01
Chapter 05 - Introduction to Valuation: The Time Value of Money
/6 Bourteen years a#o. your parents set aside $5.500 to help fund your colle#e education
Today. that fund is "alued at $-4.160 'hat rate of interest is %ein# earned on this account(
A 588 percent
) 604 percent
C 651 percent
D. 80/ percent
+ 1004 percent
$-4.160 A $5.500 =1 > r?
1/
H r A 80/ percent

AACSB: Analytic
Bloom's: A''lication
Difficulty: Basic
Learning Obecti!e: "#-
Section: "%-
&o'ic: )nterest rate

/8 1ome time a#o. Iulie purchased ele"en acres of land costin# $04.800 Today. that land is
"alued at $-1/.600 2ow lon# has she owned this land if the price of the land has %een
increasin# at 105 percent per year(
A 1000 years
) 1486 years
C. 154/ years
* 18-8 years
+ -106 years
$-1/.600 A $04.800 =1 > 105?
t
H t A 154/ years

AACSB: Analytic
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Learning Obecti!e: "#.
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&o'ic: &ime 'eriod

5-0-
Chapter 05 - Introduction to Valuation: The Time Value of Money
50 Cn your ninth %irthday. you recei"ed $000 which you in"ested at /5 percent interest.
compounded annually !our in"estment is now worth $554 2ow old are you today(
A a#e -8
B. a#e 00
C a#e 01
* a#e 0-
+ a#e 00
$554 A $000 =1 > 0/5?
t
H t A -1 yearsH A#e today A 8 > -1 A 00

AACSB: Analytic
Bloom's: A''lication
Difficulty: Basic
Learning Obecti!e: "#.
Section: "%-
&o'ic: &ime 'eriod


ssay Questions

51 !ou want to deposit sufficient money today into a sa"in#s account so that you will ha"e
$1.000 in the account three years from today +3plain why you could deposit less money
today if you could earn 05 percent interest rather than 0 percent interest
1tudent answers will "ary %ut should present the idea that when you can earn more interest.
you need less of your own money to reach the same future dollar amount They can also %ase
their answer on the present "alue formula
Beed%ac&: ,efer to section 5-

AACSB: /eflecti!e t,in0ing
Bloom's: Analysis
Difficulty: Basic
Learning Obecti!e: "#*
Section: "%*
&o'ic: +resent !alue

5-00
Chapter 05 - Introduction to Valuation: The Time Value of Money
5- !ou are considerin# two separate in"estments )oth in"estments pay 5 percent interest
In"estment A pays simple interest and In"estment ) pays compound interest 'hich
in"estment should you choose. and why. if you plan on in"estin# for a period of 5 years(
1imple interest is interest earned on the initial principal amount only Compound interest is
interest earned on %oth the initial principal and all prior interest earnin#s that ha"e %een
rein"ested !ou should choose In"estment ) which pays compound interest as you will earn
more interest income o"er the 5 years %y doin# so
Beed%ac&: ,efer to section 51

AACSB: /eflecti!e t,in0ing
Bloom's: Analysis
Difficulty: Basic
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Section: "%$
&o'ic: Sim'le and com'ound interest

50 'hat lesson does the future "alue formula pro"ide for youn# wor&ers who are loo&in#
ahead to retirin# some day(
The future "alue formula is: BV A DV =1 > r?
t
Time is the e3ponent 'hile the rate of return is
important and has a direct affect on the #rowth of an in"estment account. time is critical To
ma3imiJe retirement income. wor&ers need to commence sa"in# when they are youn# so that
rein"ested earnin#s ha"e time to compound
Beed%ac&: ,efer to section 51

AACSB: /eflecti!e t,in0ing
Bloom's: 1!aluation
Difficulty: )ntermediate
Learning Obecti!e: "#$
Section: "%$
&o'ic: (uture !alue

5-0/
Chapter 05 - Introduction to Valuation: The Time Value of Money
5/ !ou are considerin# two lottery payment options: Cption A pays $10.000 today and
Cption ) pays $-0.000 at the end of ten years Assume you can earn 4 percent on your
sa"in#s 'hich option will you choose if you %ase your decision on present "alues( 'hich
option will you choose if you %ase your decision on future "alues( +3plain why your answers
are either the same or different
DV of A A $10.000H DV of ) A $11.14580H BV of A A $15.806/6H BV of ) A $-0.000 )ased
on %oth present "alues and future "alues. ) is the %etter choice 1tudents should e3plain that
computin# present "alues and computin# future "alues are simply in"erse processes of one
another. and that choosin# %etween two lump sums %ased on present "alues will always #i"e
the same result as choosin# %etween the same two lump sums %ased on future "alues
Beed%ac&: ,efer to sections 51 and 5-

AACSB: /eflecti!e t,in0ing
Bloom's: 1!aluation
Difficulty: )ntermediate
Learning Obecti!e: "#$ and "#*
Section: "%$ and "%*
&o'ic: +resent and future !alues

55 At an interest rate of 10 percent and usin# the ,ule of 5-. how lon# will it ta&e to dou%le
the "alue of a lump sum in"ested today( 2ow lon# will it ta&e after that until the account
#rows to four times the initial in"estment( 9i"en the power of compoundin#. shouldn<t it ta&e
less time for the money to dou%le the second time(
It will ta&e 5- years to dou%le the initial in"estment. then another 5- years to dou%le it a#ain
That is. it ta&es 1// years for the "alue to reach four times the initial in"estment
Compoundin# doesn<t affect the amount of time it ta&es for an in"estment to dou%le in "alue
2owe"er. you should note that durin# the first 5- years. the interest earned is e;ual to 100
percent of the initial in"estment *urin# the second 5- years. the interest earned is e;ual to
-00 percent of the initial in"estment That is the power of compoundin#
Beed%ac&: ,efer to section 50

AACSB: /eflecti!e t,in0ing
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5-05
Chapter 05 - Introduction to Valuation: The Time Value of Money
Multiple Choice Questions

54 Assume the total cost of a colle#e education will %e $000.000 when your child enters
colle#e in 14 years !ou presently ha"e $55.541 to in"est 'hat rate of interest must you earn
on your in"estment to co"er the cost of your child<s colle#e education(
A 555 percent
) 650 percent
C. 800 percent
* 8-5 percent
+ 850 percent
$000.000 A $55.541 =1 > r?
14
H r A 8 percent

AACSB: Analytic
Bloom's: A''lication
Difficulty: Basic
1OC 3: "#4
Learning Obecti!e: "#-
Section: "%-
&o'ic: )nterest rate

55 At 11 percent interest. how lon# would it ta&e to ;uadruple your money(
A 455 years
) 44/ years
C 1008 years
D. 10-6 years
+ 1054 years
$/ A $1 =1 > 11?
t
H t A 10-6 years

AACSB: Analytic
Bloom's: A''lication
Difficulty: Basic
Learning Obecti!e: "#.
Section: "%-
&o'ic: &ime 'eriod

5-04
Chapter 05 - Introduction to Valuation: The Time Value of Money
56 Assume the a"era#e "ehicle sellin# price in the Knited 1tates last year was $/1.884 The
a"era#e price 8 years earlier was $-8.000 'hat was the annual increase in the sellin# price
o"er this time period(
A 068 percent
B. /-0 percent
C /54 percent
* 501 percent
+ 5/0 percent
$/1.884 A $-8.000 =1 > r?
8
H r A /-0 percent

AACSB: Analytic
Bloom's: A''lication
Difficulty: Basic
1OC 3: "#5
Learning Obecti!e: "#-
Section: "%-
&o'ic: )nterest rate

5-05
Chapter 05 - Introduction to Valuation: The Time Value of Money
58 !ou<re tryin# to sa"e to %uy a new $140.000 Berrari !ou ha"e $54.000 today that can %e
in"ested at your %an& The %an& pays 4 percent annual interest on its accounts 2ow many
years will it %e %efore you ha"e enou#h to %uy the car( Assume the price of the car remains
constant
A 1445 years
) 150/ years
C 15/1 years
* 1565 years
. 160- years
$140.000 A $54.000 =1 > 04?
t
H t A 160- years

AACSB: Analytic
Bloom's: A''lication
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1OC 3: "#6
Learning Obecti!e: "#.
Section: "%-
&o'ic: &ime 'eriod

5-06
Chapter 05 - Introduction to Valuation: The Time Value of Money
40 Imprudential. Inc has an unfunded pension lia%ility of $650 million that must %e paid in
-5 years To assess the "alue of the firm<s stoc&. financial analysts want to discount this
lia%ility %ac& to the present The rele"ant discount rate is 45 percent 'hat is the present
"alue of this lia%ility(
A $158.600.14-
) $151./06.805
C. $154.045.011
* $16/.518./6/
+ $181.511.045
DV A $650.000.000 E1F=1045?
-5
G A $154.045.011

AACSB: Analytic
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1OC 3: "#$7
Learning Obecti!e: "#*
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&o'ic: +resent !alue

5-08
Chapter 05 - Introduction to Valuation: The Time Value of Money
41 !ou ha"e 7ust recei"ed notification that you ha"e won the $1/ million first priJe in the
Centennial @ottery 2owe"er. the priJe will %e awarded on your 100
th
%irthday. 50 years from
now The appropriate discount rate is 6 percent 'hat is the present "alue of your winnin#s(
A $/.-6614
B. $4./0/-0
C $15.00881
* $-0.00000
+ $-5.00000
DV A $1./00.000 E1F=106?
50
G A $4./0/-0

AACSB: Analytic
Bloom's: A''lication
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1OC 3: "#$$
Learning Obecti!e: "#*
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5-/0
Chapter 05 - Introduction to Valuation: The Time Value of Money
4- !our coin collection contains fifty-four 18/1 sil"er dollars !our #randparents purchased
them for their face "alue when they were new These coins ha"e appreciated at a 10 percent
annual rate 2ow much will your collection %e worth when you retire in -040(
A $0.411.006
) $0.865./54
C $/.1--.08/
* $/./-1.006
. $/.551.15-
BV A $5/ =110?
118
A $/.551.15-

AACSB: Analytic
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5-/1
Chapter 05 - Introduction to Valuation: The Time Value of Money
40 In 1685. the winner of a competition was paid $110 In -004. the winner<s priJe was
$50.000 'hat will the winner<s priJe %e in -0/0 if the priJe continues increasin# at the same
rate(
A $068./00
) $/-1.1--
C $/58.011
D. $505.485
+ $5/6.1-1
$50.000 A $110 =1 A r?
111
H r A 5866/44 percent
BV A $50.000 =1 > 05866/44?
0/
A $505.485

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
1OC 3: "#$-
Learning Obecti!e: "#$ and "#-
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&o'ic: )nterest rate and future !alue

5-/-
Chapter 05 - Introduction to Valuation: The Time Value of Money
4/ 1uppose that the first comic %oo& of a classic series was sold in 185/ In -000. the
estimated price for this comic %oo& in #ood condition was a%out $0/0.000 This represented a
return of -5 percent per year Bor this to %e true. what was the ori#inal price of the comic %oo&
in 185/(
A $500
) $5-6
C $550
D. $551
+ $400
DV A $0/0.000 E1F=1 > -5?
/4
H DV A $551

AACSB: Analytic
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5-/0
Chapter 05 - Introduction to Valuation: The Time Value of Money
45 1uppose you are committed to ownin# a $1/0.000 Berrari !ou %elie"e your mutual fund
can achie"e an annual rate of return of 8 percent and you want to %uy the car in 5 years 2ow
much must you in"est today to fund this purchase assumin# the price of the car remains
constant(
A $5/.-0614
B. $54.56/58
C $55.81106
* $56.0186-
+ $58.//440
DV A $1/0.000 E1F=1 > 08?
5
H DV A $54.56/58

AACSB: Analytic
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1OC 3: "#$2
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5-//
Chapter 05 - Introduction to Valuation: The Time Value of Money
44 !ou ha"e 7ust made a $1.500 contri%ution to your indi"idual retirement account Assume
you earn a 1- percent rate of return and ma&e no additional contri%utions 2ow much more
will your account %e worth when you retire in -5 years than it would %e if you waited another
10 years %efore ma&in# this contri%ution(
A $6.00414
) $8.45655
C $14.01116
* $14.80515
. $15.-6855
BV A $1.500 =1 > 1-?
-5
A $-5.50010
BV A $1.500 =1 > 1-?
15
A $6.-1005
*ifference A $15.-6855

AACSB: Analytic
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&o'ic: (uture !alue

5-/5
Chapter 05 - Introduction to Valuation: The Time Value of Money
45 !ou are scheduled to recei"e $00.000 in two years 'hen you recei"e it. you will in"est it
for 5 more years. at 6 percent per year 2ow much money will you ha"e 5 years from now(
A $08.80818
) $/1.06114
C. $//.0586/
* $/5.-0818
+ $51./1/50
BV A $00.000 =1 > 06?
=5--?
A $//.0586/

AACSB: Analytic
Bloom's: A''lication
Difficulty: )ntermediate
1OC 3: "#$6
Learning Obecti!e: "#$
Section: "%$
&o'ic: (uture !alue

46 !ou e3pect to recei"e $8.000 at #raduation in - years !ou plan on in"estin# this money at
10 percent until you ha"e $40.000 2ow many years will it %e until this occurs(
A 1656 years
) 1884 years
C. -180 years
* -006 years
+ -500 years
$40.000 A $8.000 =1 > 10?
t
H t A 1880 years
Total time A - > 1880 A -180 years

AACSB: Analytic
Bloom's: A''lication
Difficulty: )ntermediate
1OC 3: "#*7
Learning Obecti!e: "#.
Section: "%-
&o'ic: &ime 'eriod

5-/4