Chapter 6: Discounted Cash Flow Valuation

Consol

A type of perpetuity

Which one of the following statements related to loan interest rates is correct? A. When comparing loans you should compare the effective annual rates. B. The more frequent the compounding period, the lower the effective annual rate given a fixed annual percentage rate. C. Lenders are most apt to quote the effective annual rate. D. The annual percentage rate considers the compounding of interest. E. Regardless of the compounding period, the effective annual rate will always be higher than the annual percentage rate.

A. When comparing loans you should compare the effective annual rates.

Annuity Due

Annuity for which the cash flows occur at the beginning of the period

Perpetuity

Annuity in which the cash flows continue forever

You have your choice of two investment accounts. Investment A is a five-year annuity that features end-of-month $2,500 payments and has an interest rate of 11.5 percent compounded monthly. Investment B is a 10.5 percent continuously compounded lump sum investment, also good for five years. How much would you need to invest in B today for it to be worth as much as investment A five years from now? A. $129,407.17 B. $119,176.06 C. $131,008.15 D. $108,206.67 E. $124,318.08

B. $119,176.06

Theresa adds $1,500 to her savings account on the first day of each year. Marcus adds $1,500 to his savings account on the last day of each year. They both earn 6.5 percent annual interest. What is the difference in their savings account balances at the end of 35 years? A. $12,211 B. $12,093 C. $12,113 D. $12,219 E. $12,127

B. $12,093

You just signed a consulting contract that will pay you $38,000, $52,000, and $85,000 annually at the end of the next three years, respectively. What is the present value of these cash flows given a discount rate of 10.5? A. $154880 B. $139975 C. $157131 D. $148307 E. $162910

B. $139975

Trish receives $450 on the first of each month. Josh receives $450 on the last day of each month. Both Trish and Josh will receive payments for next four years. At a discount rate of 9.5 percent, what is the difference in the present value of these two sets of payments? A. $154.30 B. $141.80 C. $159.08 D. $162.50 E. $151.06

B. $141.80

You are buying a pre-owned car today at a price of $8,500. You are paying $300 down in cash and financing the balance for 36 months at 7.75 percent. What is the amount of each monthly loan payment? A. $312.23 B. $256.01 C. $318.47 D. $284.40 E. $265.37

B. $256.01

Your employer contributes $60 a week to your retirement plan. Assume you work for your employer for another 20 years and the applicable discount rate is 9 percent. Given these assumptions, what is this employee benefit worth to you today? A. $29,211.11 B. $28,927.38 C. $25,987.74 D. $27,618.46 E. $25,306.16

B. $28,927.38

You grandfather invested $20,000 years ago to provide annual payments of $750 a year to his heirs forever. What is the rate of return? A. 4.10% B. 3.75% C. 4.33% D. 4.25% E. 4.75%

B. 3.75%

The interest rate that is most commonly quoted by a lender is referred to as which one of the following? A. Compound rate. B. Annual percentage rate. C. Common rate. D. Simple rate. E. Effective annual rate.

B. Annual percentage rate.

Phil can afford $240 a month for five years for a car loan. If the interest rate is 8.5 percent, how much can he afford to borrow to purchase a car? A. $10,400.00 B. $12,348.03 C. $11,697.88 D. $10,266.67 E. $11,750.00

C. $11,697.88

What is the annual percentage rate on a loan with a stated rate of 2.75 percent per quarter? A. 11.18% B. 11.09% C. 11.00% D. 11.31% E. 11.27%

C. 11.00%

Which one of the following statements correctly defines a time value of money relationship? A. An increase in a positive discount rate increases the present value. B. Time and future values are inversely related, all else held constant. C. Time and present value are inversely related, all else held constant. D. An increase in time increases the future value given a zero rate of interest. E. Interest rates and time are positively related, all else held constant.

C. Time and present value are inversely related, all else held constant.

Travis International has a one-time expense of $2.86 million that must be paid three years from now. Since the firm cannot raise that amount in one day, it wants to save an equal amount each month over the next three years to fund this expense. If the firm can earn 2.1 percent on its savings, how much must it save each month? A. $91,300.05 B. $73,901.15 C. $87,411.08 D. $77,037.69 E. $78,416.20

D. $77,037.69

You have been investing $250 a month for the last 13 years. Today, your investment account is worth $73,262. What is your average rate of return on your investments? A. 9.36% B. 9.78% C. 9.41% D. 8.94% E. 9.23%

D. 8.94%

Which one of the following accurately defines a perpetuity? A. Unending equal payments paid at either equal or unequal time intervals. B. A limited number of equal payments paid in even time increments. C. Varying amounts that are paid at even intervals forever. D. Unending equal payments paid at equal time intervals. E. Payments of equal amounts that are paid irregularly but indefinitely.

D. Unending equal payments paid at equal time intervals.

On June 1, you borrowed $195,000 to buy a house. The mortgage rate is 5.25 percent. The loan is to be repaid in equal monthly payments over 15 years. All taxes and insurance premiums are to be paid separately. The first payment is due on July 1. How much of the first payment applies to the principal balance? A. $756.70 B. $721.14 C. $658.56 D. $743.38 E. $714.43

E. $714.43

You want to buy a new sports coupe for $41,750 and the finance office at the dealership has quoted you an APR of 7.6, compounded monthly for 48 months. What is the effective interest rate on this loan? A. 8.41 percent B. 7.94 percent C. 8.28 percent D. 8.13 percent E. 7.87 percent

E. 7.87 percent

Today, you turn 23. Your birthday wish is that you will be a millionaire by your 40th birthday. In an attempt to reach this goal, you decide to save $75 a day, every day, until you turn 40. You open an investment account and deposit your first $75 today. What rate of return must you earn to achieve your goal? A. 9.9% B. 10.06% C. 10.54% D. 7.67% E. 8.09%

E. 8.09%

Your credit card charges you 1.5 percent interest per month. This rate when multiplied by 12 is called the: A. Periodic interest rate B. Compound interest rate C. Effective interest rate D. Period interest rate E. Annual percentage rate

E. Annual percentage rate

A loan where the borrower receives money today and repays a single lump sum on a future date is called a(n) ________ loan. A. Continuous B. Balloon C. Interest only D. Amortized E. Pure Discount

E. Pure Discount

Interest Only Loans

The borrower pays interest each period and to repay the entire principal (original loan amount) at some point in the future

Annual Percentage Rate (APR)

The interest rate charged per period multiplied by the number of periods per year

Effective Annual Rate (EAR)

The interest rate expressed as if it were compounding once a year

Stated Interest Rate (Also known as the Quoted Interest Rate)

The interest rate expressed in terms of the interest payment made each period

Amortized Loans

The lender may require the borrower to repay parts of the loan amount over time

Pure Discount Loan

The simplest form of a loan in which the buyer receives money today and repays a single lump sum at some time in the future