Managerial Finance – Problem Review Set – Time Value of Money

1.)

Suppose an investor plans to invest a given sum of money. She can earn an effective annual rate of 5% on Security A, while Security B will provide an effective annual rate of 12%. Within 11 years' time, the compounded value of Security B will be more than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.)

a.
True

b.
False

2.)

The present value of a future sum decreases as either the discount rate or the number of periods per year increases.

a.
True

b.
False

3.)

When a loan is amortized, a relatively high percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment's percentage declines in the loan's later years.

a.
True

b.
False

4.)

Midway through the life of an amortized loan, the percentage of the payment that represents interest is equal to the percentage that represents principal repayment. This is true regardless of the original life of the loan.

a.
True

b.
False

5.)

You are analyzing the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would lower the calculated value of the investment?

a.
The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000.
b.
The discount rate increases.
c.
The riskiness of the investment’s cash flows decreases.
d.
The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years.
e.
The discount rate decreases.
6.)

Which of the following statements is CORRECT?

a.
If you have a series of cash flows, all of which are positive, you can solve for I, where the solution value of I causes the PV of the cash flows to equal the cash flow at Time 0.
b.
If you have a series of cash flows, and CF0 is negative but all of the other CFs are positive, you can solve for I, but only if the sum of the undiscounted cash flows exceeds the cost.
c.
To solve for I, one must identify the value of I that causes the PV of the positive CFs to equal the absolute value of the PV of the negative CFs. This is, essentially, a trial-and-error procedure that is easy with a computer or financial calculator but quite difficult otherwise.
d.
If you solve for I and get a negative number, then you must have made a mistake.
e.
If CF0 is positive and all the other CFs are negative, then you cannot solve for I.

7.)

Which of the following bank accounts has the highest effective annual return?

a.
An account that pays 8% nominal interest with monthly compounding.
b.
An account that pays 8% nominal interest with annual compounding.
c.
An account that pays 7% nominal interest with daily (365-day) compounding.
d.
An account that pays 7% nominal interest with monthly compounding.
e.
An account that pays 8% nominal interest with daily (365-day) compounding.

8.)

A $50,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT?

a.
The annual payments would be larger if the interest rate were lower.
b.
If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 7-year amortization plan.
c.
The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower.
d.
The last payment would have a higher proportion of interest than the first payment.
e.
The proportion of interest versus principal repayment would be the same for each of the 7 payments.

9.)

Which of the