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MULTIPLE CHOICE QUESTIONS

1. The main idea behind the time value of money is that:


A. cash flows received in the distant future are less valuable than cash flows received in the
near-term future.
B. cash received in year 3, say, $80,000, has the same value as $40,000 received in year 3
plus $40,000 received in year 4.
C. cash flows received in different years are treated as equal in value.
D. cash payments made in the future have the same value as payments made today.
E. timing considerations have little value in decision making.
Answer: A LO: 1 Type: RC
2. The procedure used to compute the future value of a series of cash flows is known as:
A. compounding.
B. the annuity method.
C. discounting.
D. the future-cost approach.
E. indexing.
Answer: A LO: 2 Type: RC
3. Norton Company has a 12% interest rate. If the firm invests $60,000 today, how much will
have accumulated by the end of eight years?
A. $117,600.
B. $148,560.
C. $298,080.
D. $738,000.
E. Some other amount.
Answer: B LO: 2 Type: A
4. Lawson Company invests $60,000 today and has $148,560 by the end of eight years. What is
the firm's interest rate?
A. 10.00%.
B. 12.00%.
C. 18.45%.
D. 40.39%.
E. None of the above.
Answer: B LO: 2 Type: A, N

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5. The procedure used to compute the present value of a series of cash flows is known as:
A. compounding.
B. the annuity method.
C. discounting.
D. the present-cost approach.
E. indexing.
Answer: C LO: 2 Type: RC
6. All other things being equal, which of the following would be the most attractive to an
investor?
A. A cash inflow of $10,000 in five years.
B. A cash inflow of $2,000 each year for the next five years.
C. A cash inflow of $5,000 in year 1 and $5,000 in year 5.
D. A cash inflow of $10,000 today.
E. All of the above would be equally attractive to an investor.
Answer: D LO: 2 Type: N
7. All other things being equal, which of the following would be most attractive to an investor?
A. A cash outflow of $60,000 in six years.
B. A cash outflow of $10,000 each year for the next six years.
C. A cash outflow of $30,000 in year 1 and $30,000 in year 6.
D. A cash outflow of $60,000 today.
E. All of the above would be equally attractive to an investor.
Answer: A LO: 2 Type: N
8. A series of equal cash flows is called a(n):
A. ongoing cash flow.
B. payback.
C. accrual.
D. cash accumulation.
E. annuity.
Answer: E LO: 2 Type: RC
9. The sum of the discount factors applicable to individual cash flows in a series of equal cash
flows is called the:
A. single-sum, present-value factor.
B. total discount factor.
C. annuity discount factor.
D. compound discount factor.
E. internal rate discount factor.
Answer: C LO: 2 Type: RC

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10. Consider the following items of information:


I.The target recovery period.
II.The discount rate.
III.The timing (i.e., year) of a cash flow.
Which of the above items would be needed to calculate the present value of a cash flow?
A. I only.
B. II only.
C. I and II.
D. II and III.
E. I, II, and III.
Answer: D LO: 2 Type: RC
11. You desire to invest $3,000 each year for the next five years to accumulate the funds needed
for a down payment on a home. Which table factor(s) should be used to efficiently determine
the amount accumulated by the end of the five-year period?
A. Future value of $1.
B. Future value of a $1 annuity.
C. Present value of $1.
D. Present value of a $1 annuity.
E. Both "A" and "B."
Answer: B LO: 2 Type: A
12. Uncle Roscoe, a wealthy relative, has given you a choice of receiving $10,000 today or $3,000
for each of the next four years. Which table factor(s) should be used to efficiently determine
the "value" of the $3,000 cash-flow stream?
A. Future value of $1.
B. Future value of a $1 annuity.
C. Present value of $1.
D. Present value of a $1 annuity.
E. Both "C" and "D."
Answer: D LO: 2 Type: A
13.

You are a sports agent who is representing Jack Lofton, a star football player, in contract
negotiations with the New York Landmarks. The Landmarks have offered Lofton a four-year
contract, with annual raises and performance bonuses that will result in a growing cash-flow
stream for Lofton each year. Which table factor(s) should you use to efficiently determine the
"value" of the contract?
A. Future value of $1.
B. Future value of a $1 annuity.
C. Present value of $1.
D. Present value of a $1 annuity.
E. Both "C" and "D."
Answer: C LO: 2 Type: A

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14. How much money must be invested today in order to have $25,000 at the end of four years if
the rate of return is 12%?
A. $15,900.
B. $17,100.
C. $19,900.
D. $22,300.
E. Some other amount.
Answer: A LO: 2 Type: A
15. You estimate that it will take five years to complete your college education. Your parents want
to invest enough money today at 8% to allow you to withdraw $8,000 each year for the next
five years, with nothing left at the end. The amount of money to invest today is:
A. $11,752.
B. $27,240.
C. $31,944.
D. $40,000.
E. None of the above.
Answer: C LO: 2 Type: A
16. Green Company owes White Company money for the purchase of equipment. White has
given Green the following payment options:
I.Immediate payment in full of $38,000.
II.Annual payments of $15,000 made at the end of each of the next three years.
III.A single payment of $48,000 made at the end of three years.
Green uses a 10% interest rate and will choose the option with the lowest present value.
Which option should Green choose, and what is the present value of that option?
A. Option I, $34,542.
B. Option I, $38,000.
C. Option II, $37,305.
D. Option III, $34,164.
E. Option III, $36,048.
Answer: E LO: 2 Type: A

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17. Nelson Company owes money to Nash Company for the purchase of equipment. Nash
Company has given Nelson the following payment options:
I.Immediate payment in full of $38,000.
II.Annual payments of $15,000 made at the end of each of the next three years.
III.A single payment of $48,000 made at the end of three years.
Assume that both Nelson and Nash use a 10% interest rate. What option would Nash prefer,
and what is the present value of that option?
A. Option I, $34,542.
B. Option I, $38,000.
C. Option II, $37,305.
D. Option III, $34,164.
E. Option III, $36,048.
Answer: B LO: 2 Type: A
EXERCISES
Future Value and Present Value
18. Future value and present value are two key business tools.
Required:
Ignoring income taxes, answer the following independent questions:
A. Suppose that you invest $4,000 today in an account that bears interest at the rate of 8%.
What will your investment grow to in five years?
B. Your best friend won the state lottery and has offered to give you $5,000 in seven years,
after he has made his first million. You figure that if you had the money now, you could
invest it at 10% annual interest. What is the value today of your friend's future gift?
C. Suppose that you invest $1,200 per year in an investment that provides a 6% return. What
will be the value of your investment in four years?
D. Suppose that your best friend won the state lottery and promised to give you $5,000 per
year for eight years. The first payment will be made at the end of 20x1. Using a 10%
discount rate, what is the value of these payments at the beginning of 20x1?
LO: 2 Type: A
Answer:
A. Future value: $4,000 x 1.469 = $5,876
B. Present value: $5,000 x 0.513 = $2,565
C. Future value: $1,200 x 4.375 = $5,250
D. Present value: $5,000 x 5.335 = $26,675

Appendix II

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Present Value and Time Value: Emphasis on Concepts


19. Your Uncle Otto has struck it rich by investing in racehorses and desires to share some of his
newfound wealth with you. Assume that you must choose from among the following three
options:
1. Receive a lump sum of $400,000 in 20 years.
2. Receive $20,000 at the end of each year for the next 10 years.
3. Receive $90,000 now.
Required:
A. Why is it inappropriate to compare $400,000 (no. 1) vs. $200,000 (no. 2) vs. $90,000 (no.
3) and conclude that no. 1 is the best option? Explain.
B. What should you do to determine which option is the best? What does this process do?
C. If Uncle Otto agreed to revise option no. 1 so that you could receive $200,000 in 10 years
and the remaining $200,000 in another 10 years, would you likely prefer the revision or
the option as originally stated? Why?
D. What is an annuity? Do any of the options involve an annuity?
LO: 1, 2 Type: N
Answer:
A. The cash flows do not occur at the same points in time, and such an analysis disregards
the time value of money. Dollars received in earlier years are worth more than dollars
received in the future.
B. The cash flows should be discounted, and the option with the highest present value should
be selected. Such a process integrates the time value of money into the decision process.
C. The revision should be preferred. Both options involve the same total dollars; however,
because significant inflows occur sooner with the revision, this option would have a
higher present value.
D. An annuity is a series of uniform cash inflows or outflows over a period of years. Option
no. 2 involves an annuity.

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DISCUSSION QUESTIONS
The Time Value of Money
20. The time value of money and present value are important business concepts.
Required:
Briefly explain these concepts to someone with a limited business background.
LO: 1 Type: RC
Answer:
The time value of money recognizes that a dollar received today is worth more than a dollar
received in the future. Such monies can be invested to earn additional returns for the
individual and/or firm. Present value, an approach that is based on time values, weights
dollars in earlier years of an investment more heavily than dollars of later years. The result is
present value, namely, the amount that a company (or individual) should be willing to pay
today to secure a future cash flow at a given rate of return.

Appendix II

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