A. C. D. E.: Answer Key

Chapter 04 - Introduction to Valuation: The Time Value of Money
Chapter 04 Introduction to Valuation: The Time Value of Money Answer Key

Multiple Choice Questions
1. Martha is investing $5 today at 6 percent interest so she can have $10 later. The $10 is
referred to as the:
A. true value.
B. future value.
C. present value.
D. discounted value.
E. complex value.
2. Tom earned $120 in interest on his savings account last year. Tom has decided to leave the
$120 in his account so that he can earn interest on the $120 this year. This process of earning
interest on prior interest earnings is called:
A. discounting.
B. compounding.
C. duplicating.
D. multiplying.
E. Indexing.
3. Jamie earned $180 in interest on her savings account last year. She has decided to leave the
$180 in her account so that she can earn interest on the $180 this year. The interest Jamie
earns this year on this $180 is referred to as:
A. simple interest.
B. complex interest.
C. accrued interest.
D. interest on interest.
E. discounted interest.
4. Lester had $6,270 in his savings account at the beginning of this year. This amount includes
both the $6,000 he originally invested at the beginning of last year plus the $270 he earned in
interest last year. This year, Lester earned a total of $282.15 in interest even though the
interest rate on the account remained constant. This $282.15 is best described as:
A. simple interest.
B. interest on interest.
C. discounted interest.
D. complex interest.
E. compound interest.
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5. By definition, a bank that pays simple interest on a savings account will pay interest:
A. only at the beginning of the investment period.
B. on interest.
C. only on the principal amount originally invested.
D. on both the principal amount and the reinvested interest.
E. only if all previous interest payments are reinvested.
6. Sue needs to invest $3,626 today in order for her savings account to be worth $5,000 six
years from now. Which one of the following terms refers to the $3,626?
A. Present value
B. Compound value
C. Future value
D. Complex value
E. Factor value
7. Todd will be receiving a $10,000 bonus one year from now. The process of determining
how much that bonus is worth today is called:
A. aggregating.
B. discounting.
C. simplifying.
D. compounding.
E. extrapolating.
8. The interest rate used to compute the present value of a future cash flow is called the:
A. prime rate.
B. current rate.
C. discount rate.
D. compound rate.
E. simple rate.
9. Computing the present value of a future cash flow to determine what that cash flow is
worth today is called:
A. compounding.
B. factoring.
C. time valuation.
D. simple cash flow valuation.
E. discounted cash flow valuation.
10. Sara is investing $1,000 today. Which one of the following will increase the future value
of that amount?
A. Shortening the investment time period
B. Paying interest only on the principal amount
C. Paying simple interest rather than compound interest
D. Paying interest only at the end of the investment period rather than throughout the
investment period
E. Increasing the interest rate
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11. Sam wants to invest $5,000 for 5 years. Which one of the following rates will provide him
with the largest future value?
A. 5 percent simple interest
B. 5 percent interest, compounded annually
C. 6 percent interest, compounded annually
D. 7 percent simple interest
E. 7 percent interest, compounded annually
12. Jenny needs to borrow $16,000 for 3 years. The loan will be repaid in one lump sum at the
end of the loan term. Which one of the following interest rates is best for Jenny?
A. 8 percent simple interest
B. 8 percent interest, compounded annually
C. 8.5 percent simple interest
D. 8.5 percent interest, compounded annually
E. 9 percent interest, compounded annually
13. Which of the following will increase the future value of a lump sum investment?
I. Decreasing the interest rate
II. Increasing the interest rate
III. Increasing the time period
IV. Decreasing the amount of the lump sum investment
A. I and III only
B. I and IV only
C. II and III only
D. II and IV only
E. II, III, and IV only
14. Which one of the following is the correct formula for the future value of $500 invested
today at 7 percent interest for 8 years?
A. FV = $500/[(1 + 0.08) ( 7]
B. FV = $500/[(1 + 0.07) ( 8]
C. FV = $500/(0.07 ( 8)
D. FV = $500 (1 + 0.07)8
E. FV = $500 (1 + 0.08)7
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15. Given an interest rate of zero percent, the future value of a lump sum invested today will
always:
A. remain constant, regardless of the investment time period.
B. decrease if the investment time period is shortened.
C. decrease if the investment time period is lengthened.
D. be equal to $0.
E. be infinite in value.
16. Terry invested $2,000 today in an investment that pays 6.5 percent annual interest. Which
one of the following statements is correct, assuming all interest is reinvested?
A. Terry will earn the same amount of interest each year.
B. Terry could have the same future value and invest less than $2,000 initially if he could earn
more than 6.5 percent interest.
C. Terry will earn an increasing amount of interest each and every year even if he should
decide to withdraw the interest annually rather than reinvesting the interest.
D. Terry's interest for year two will be equal to $2,000 ( 0.065 ( 2.
E. Terry will be earning simple interest.
17. Which of the following will decrease the future value of a lump sum investment made
today assuming that all interest is reinvested? Assume the interest rate is a positive value.
I. Increase in the interest rate
II. Decrease in the lump sum amount
III. Increase in the investment time period
IV. Decrease in the investment time period
A. I and III only
B. I and IV only
C. I, II, and III only
D. II and III only
E. II and IV only
18. Which one of the following will increase the present value of a lump sum future amount?
Assume the interest rate is a positive value and all interest is reinvested.
A. Increase in the time period
B. Increase in the interest rate
C. Decrease in the future value
D. Decrease in the interest rate
E. None of the above
19. Jeff deposits $3,000 into an account which pays 2.5 percent interest, compounded
annually. At the same time, Kurt deposits $3,000 into an account paying 5 percent interest,
compounded annually. At the end of three years:
A. Both Jeff and Kurt will have accounts of equal value.
B. Kurt will have twice the money saved that Jeff does.
C. Kurt will earn exactly twice the amount of interest that Jeff earns.
D. Kurt will have a larger account value than Jeff will.
E. Jeff will have more money saved than Kurt.
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20. Lisa has $1,000 in cash today. Which one of the following investment options is most apt
to double her money?
A. 6 percent interest for 3 years
B. 12 percent interest for 5 years
C. 7 percent interest for 9 years
D. 8 percent interest for 9 years
E. 6 percent interest for 10 years
21. Which one of the following is the correct formula for computing the present value of $600
to be received in 6 years? The discount rate is 7 percent.
A. PV = $600 (1 + 6)7
B. PV = $600 (1 + 0.07)6
C. PV = $600 ( (0.07 ( 6)
D. PV = $600/(1 + 0.07)6
E. PV = $600/(1 + 6)0.07
22. Centre Bank pays 2.5 percent interest, compounded annually, on its savings accounts.
Country Bank pays 2.5 percent simple interest on its savings accounts. You want to deposit
sufficient funds today so that you will have $1,500 in your account 2 years from today. The
amount you must deposit today:
A. is the same regardless of which bank you choose because they both pay compound interest.
B. is the same regardless of which bank you choose because they both pay simple interest.
C. is the same regardless of which bank you choose because the time period is the same for
both banks.
D. will be greater if you invest with Centre Bank.
E. will be greater if you invest with Country Bank.
4-5
23. The present value of a lump sum future amount:
A. increases as the interest rate decreases.
B. decreases as the time period decreases.
C. is inversely related to the future value.
D. is directly related to the interest rate.
E. is directly related to the time period.
24. The relationship between the present value and the time period is best described as:
A. direct.
B. inverse.
C. unrelated.
D. ambiguous.
E. parallel.
25. Today, Courtney wants to invest less than $5,000 with the goal of receiving $5,000 back
some time in the future. Which one of the following statements is correct?
A. The period of time she has to wait until she reaches her goal is unaffected by the
compounding of interest.
B. The lower the rate of interest she earns, the shorter the time she will have to wait to reach
her goal.
C. She will have to wait longer if she earns 6 percent compound interest instead of 6 percent
simple interest.
D. The length of time she has to wait to reach her goal is directly related to the interest rate
she earns.
E. The period of time she has to wait decreases as the amount she invests today increases.
26. Which one of the following is a correct statement, all else held constant?
A. The present value is inversely related to the future value.
B. The future value is inversely related to the period of time.
C. The period of time is directly related to the interest rate.
D. The present value is directly related to the interest rate.
E. The future value is directly related to the interest rate.
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Chapter 04 - Introduction to Valuation: The Time Value of Money

Chapter 04 Introduction to Valuation: The Time Value of Money Answer Key

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