Chapter 4: Discounted Cash Valuation

Amortization is the process of paying off loans by regularly reducing the _________. -Principal -Payment Frequency -Life of the loan -Interest rate

-Answer: Principal

The _____________ ___________________ allows for a borrowed amount to be paid off with payment that regularly reduce the principal

Amortized Loan

A growing annuity has a(n) ____. -Finite number of growing cash flows -infinite number of growing cash flows -infinite number of constant cash flows -finite number of level cash flows

Answer: Finite number of growing cash flows

Assume $10 invested today will be worth $64 in 25 years. Which one of these is the correct formula for computing the interest rate on this investment?

r = ($64/$10)1/25 - 1

Present value represents what an amount of money promised or expected in the future is worth ______. -today -next year -next month -last year

today

Suppose you paid off a $1,200 loan by paying $400 in principal each year plus 10 percent annual interest over a 3-year period. What is the total payment (interest plus principal) in Year 3?

$440

What is the present value of $100 each year for 20 years at 10 percent per year?

$851.36 Reason: $100{[1 - (1/(1.10)20)]/0.10}= $851.36

A borrower receives $7,500 today and repays a single lump sum in nine months. This simple form of loan is called _________. -Pure discount loan -The delayed payback loan -The interest only loan -A collateral loan

Answer: The pure discount loan

An annuity due is a series of payments that are made ____.

At the beginning of each period

Which one of the following constitutes an infrequent annuity? -$100 once every 2 years -$100 every month -$100 dollars every years -$100 dollars

Answer: $100 once every 2 years Reason: In an infrequent annuity, the payments occur less than once a year, so this is not an infrequent annuity.

If you invest $50 at a stated annual rate of 10 percent compounded monthly, how much more money will you have in 10 years than if the rate was compounded annually?

Answer: 1.43 Reason: $50 × (1 + .10/12)120 - $50 × (1.10)10 = $5.66

The most common way to repay a loan is to pay _________ -interest plus a fixed principal amount every period -just interest every period -a lump sum of interest and principal at the end of the loan -a single fixed payment every period

Answer: A single fixed payment every period Such as a car or mortgage loan

A fixed payment loan has a fixed payments but the interest amount paid ______ over the life of the loan.

Decreases

A perpetuity is a constant stream of cash flows for a(n) ______ period of time.

Infinite

To find the present value of an annuity of $500 per year for 5 years at 7 percent per year using the tables, look up the present value interest factor which is ______ and multiply that by ______.

4.10020; $500

To find the present value of an annuity of $100 per year for 10 years at 10 percent per year using the tables, look up the present value interest factor which is ______ and multiply that by ______.

6.1446; $100

An annuity in which the first payment or receipt occurs immediately is known as an ______.

Annuity Due

What is the annual percentage rate?

It is the annual interest rate without consideration of compounding

For a positive annual percentage rate (APR) and multiple (more than one) compounding periods per year, the EAR is always ______ the APR.

Larger than

Which of the following are true about the amortization of a fixed payment loan? (choose 2) -The amount of interest paid decreases each period. -The payment amount decreases each period. -The amount of interest and principal paid increases each period. -The principal amount paid increases each period.

The amount of interest paid decreases each period. The principal amount paid increases each period.

The first cash flow at the end of week 1 is $100, the second cash flow at the end of month 2 is $100, and the third cash flow at the end of year 3 is $100. This cash flow pattern is a(n) ______ type of cash flow.

Answer: Uneven Reason: The cash flows for an annuity must happen at regular intervals. These do not (week, month, year).

The annual percentage rate is the annual interest rate without consideration of _____.

Compounding

If reinvestment of interest or dividends does not occur, then the future value of an investment will be _____ and the realized yield will be ____ than if reinvestment had occurred. -lower; lower -higher; higher -lower;higher -higher;lower

lower; lower

Discounting is the process of converting ______ dollars into a ______ value. 1. Future; zero 2. Future; present 3. Current; Future 4. Current; Present

Answer: Future; Present Reason: Discounting is the process of converting future dollars into a present value.

In an infrequent annuity, the payments occur ____. -Exactly once per year -More than once per year -Less than once per year -More than twice per year

Answer: Less than once per year

The interest rate (r) used in the general compounding formula is the ______ interest rate. 1. Periodic 2. Quoted 3. Effective 4. Prime

Answer: Quoted Reason: The interest rate (r) used in the general compounding formula is the quoted interest rate.

An increase in the interest rate/discount rate will result in _____ in the NPV.

Decrease Reason: The NPV decreases when the interest rate increases.

A stream of cash flows that grows at a constant rate for a finite period is called a(n) _____.

Growing annuity