Business Finance Ch. 6 Discounted Cash Flow Valuation

Most investments involve _____ cash flows.

multiple

The loan balance on ___ amortization loans declines so slowly because the payments are mostly interest.

partial or partially

When using the spreadsheet (Excel) function for finding the PV of an annuity, it's a good idea to enter the ______ as a negative value.

payment

The present value formula for a(n) ______ is PV = C/r, where C is the constant and regularly timed cash flow to infinity, and r is the interest rate.

perpetuity

The APR is also called the Blank______ rate and it differs from the EAR.

stated

True or false: The APR is always the same as the EAR.

False

When valuing cash flows, you can either value multiple cash flows or a single sum, also known as a(n) _____ sum.

lump

True or false: There is only one way to quote interest rates.

False

Which of the following payment methods amortizes a loan?

Interest plus fixed amount Fixed payments that result in a zero loan balance

Which of the following are real-world examples of annuities?

Mortgages Pensions

_____ loans are short-term loans made to consumers which require you to write a check today that is postdated.

Payday

True or false: A fixed payment loan is most common for consumers.

True

Assuming the same interest rate, the future value of an amount compounded semiannually is ______ the future value of that amount compounded annually.

greater than

If the interest rate is greater than zero, the value of an annuity due is always ______ an ordinary annuity.

greater than

The future value of $100 at 10 percent compounded semiannually is ______ the future value of $100 at 10 percent compounded annually.

greater than

A traditional (non-growing) annuity consists of a(n) ________ stream of cash flows for a fixed period of time.

level

The loan balance on partial amortization loans declines so slowly because the ___.

payments are mostly interest

Amortization is the process of paying off loans by regularly reducing the _________.

principal

To use a present value of an annuity table to find the present value of an annuity factor, search the ______ for the number of periods and the ______ for the rate.

row; column

An effective annual rate of 7.12 percent is equal to 7 percent compounded ______.

semiannually

Semiannual compounding means that interest is paid ______ per year.

two times

Ralph has $1,000 in an account that pays 10 percent per year. Ralph wants to give this money to his favorite charity by making three equal donations at the end of the next 3 years. How much will Ralph give to the charity each year?

$402.11 Reason: Correct. Calculate the payment using the PV of an annuity at 10 percent for 3 years. $1,000/[(1 − 1/1.103)/0.10] = $402.11.

What is the formula to calculate the future value of an annuity due of $100 per year for 10 years at 10 percent per year?

$100[(1.1010 − 1)/0.10][1.10]

Which of the following are annuities?

-Installment loan payments -Monthly rent payments in a lease

Which of the following is equal to an effective annual rate of 12.36 percent?

12%, compounded semiannually

To find the present value of an annuity of $100 per year for 5 years at 10 percent per year using the tables, look up the present value interest factor which is Blank______ and multiply that by Blank______.

3.7908; $100

Which compounding interval will result in the lowest future value assuming everything else is held constant?

Annual

Which of the following processes can be used to calculate future value for multiple cash flows?

Compound the accumulated balance forward one year at a time Calculate the future value of each cash flow first and then add them up

Which of the following are ways to amortize a loan?

Pay the interest each period plus some fixed amount of the principal. Pay principal and interest every period in a fixed payment.

Which of the following are true about the amortization of a fixed payment loan?

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

Which of the following is true about a growing annuity?

The cash flows grow at a constant rate. The cash flows grow for a finite period.

In the Excel setup of a loan amortization problem, which of the following occurs?

The payment is found using PMT(rate, nper,-pv, fv). To find the principal payment each month, you subtract the interest payment from the total payment.

The formula for the present value interest factor for annuities is: Annuity present value factor = {1-[1/(1+r)t]}/r.

True

When using a financial calculator to find the interest rate, you may use the inputs N, PMT, and PV to find I/ ___.

Y

Which of the following is the formula for the EAR?

[1 + (Quoted rate/m)]m − 1

The formula for the annuity present value factor for a 30-year annuity with an interest rate of 10 percent per year is ______.

[1 − (1/1.1030)]/.10]

The ___ percentage rate is the interest rate charged per period multiplied by the number of periods in a year.

annual

Payday loans allow you to ___.

borrow now and repay later

When calculating the future value of multiple cash flows using a spreadsheet, you must:

calculate the future value of each cash flow then add the compounded values together.

When calculating the present value of multiple cash flows using a spreadsheet, you must:

calculate the present value of each cash flow then add the discounted values together

An annuity ___ is an annuity for which the cash flows occur at the beginning of each period.

due

Assume interest is compounded monthly. The ______ annual rate will express this rate as though it were compounded annually.

effective

In almost all multiple cash flow calculations, it is implicitly assumed that the cash flows occur at the _____ of each period.

end

The present value of a series of future cash flows is the amount you would need today to _____.

exactly duplicate those future cash flows

A single cash flow is also known as a:

lump sum

One method of calculating future values for multiple cash flows is to compound the accumulated balance forward _____ at a time.

one year

A typical investment has a large cash ___ (inflow/outflow) at the beginning and then a cash ___ (inflows/outflows) for many years.

outflow, inflow

C/r is the formula for the present value of a(n) ____.

perpetuity

The formula for the ______ value interest factor of an annuity is {1-[1/(1+r)t]/r} .

present

With interest-only loans that are not perpetuities, the entire principal is _____.

repaid at some point in the future

Interest paid twice a year is known as ______ compounding.

semiannual

Because of __________ and _________, interest rates are often quoted in many different ways.

tradition; legislation

What is formula to calculate the present value of an annuity that makes payments of $100 per year for 10 years if the first payment is made immediately and the discount rate is 10 percent per year?

$100[(1 − 1/1.1010)/0.10][1.10]

You will receive a bonus of $5,000 in one year's time, and would like to take a loan against it now. What is the formula that shows how much you can borrow if you plan to use the entire amount to pay back the loan and your interest rate is 3%?

$5,000/1.03

The formula for the present value of an annuity due is _____.

(1 + r) × (PV of an ordinary annuity)

Which of the following spreadsheet (Excel) functions will calculate the $614.46 present value of an ordinary annuity of $100 per year for 10 years at 10 percent per year?

=PV(.10,10,-100,0,)

Which of the following should be valued using a perpetuity formula?

A consol (bond that pays interest only and does not mature) Preferred stock Cash flows from a product whose sales are expected to remain constant forever

Which of the following is the simplest form of loan?

A pure discount loan

Match the type of rate with its definition. APR EAR

APR The interest rate per period multiplied by the number of periods in the year. EAR The interest rate stated as though it were compounded once per year.

Another common term for the effective annual rate (EAR) is the:

APY

Which of the following show the steps you would apply using a financial calculator to find the future value of an annuity of $400 per year for 10 years at 5%?

Enter 400 for PMT, 10 for N, and 5 for I/Y. Solve for FV.

You are planning to buy a CD for $1,352. You will receive $1,500 in 2 years. Which inputs will you use in a financial calculator to find the interest rate you will receive on that investment, assuming annual compounding?

Enter −1,352 for PV, 2 for N, and 1,500 for FV. Solve for I/Y.

You owe $1,200 on your credit card, which charges 1.5% per month. If you pay $50 per month starting at the end of this month, which of the following show the steps you will apply using a financial calculator to solve for the number of months will it take to pay off your credit card?

Enter −50 for PMT, 1,200 for PV, and 1.5 for I/Y. Solve for N.

When using a financial calculator to determine the number of payments on a loan, you may use the inputs I/Y, PMT, and PV to solve for _____.

N

You may use which of the following sets of inputs together to solve for the present value of an annuity using a financial calculator?

N, I/Y, PMT, PV

The present value interest factor for an annuity with an interest rate of 8 percent per year over 20 years is ____.

[1 − (1/1.0820)]/.08

The future value factor for a(n) ___ is found by taking the future value factor and subtracting one, then dividing this number by the interest rate.

annuity

The present value of a(n) ___ of C dollars per period for t periods when the rate of return or interest rate, r, is given by: C × (1 − [1/(1 + r)t]r/)

annuity

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

at the beginning of each period

A lump sum payment to pay off the balance of a partially amortized loan is called a ___, or bullet, payment.

balloon

The effective annual rate (EAR) takes into account the ______ of interest that occurs within a year.

compounding

One example of a perpetuity is a British _____.

consol

The name for a perpetuity in Canada and the United Kingdom is a ___ .

consols

With a fixed payment loan, the amount of interest paid (decreases/increases) each period.

decreases

In the standard present and future value tables, and in all the default settings on a financial calculator, the assumption is that cash flows occur at the ___ (beginning/end) of each period.

end

How frequently does continuous compounding occur?

every instant

A growing annuity has a(n) ____.

finite number of growing cash flows

The present value of a series of ___ cash flows is the amount you would need today to exactly duplicate those future cash flows.

future

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

infinite

In a spreadsheet loan amortization schedule, to find the principal payment each month, you subtract the ___ from the total payment.

interest

For a positive stated annual interest rate and multiple (more than one) compounding periods per year, the EAR is always ___ (smaller/larger) than the APR.

larger

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

larger than

Compared to a comparable fixed payment loan, the total interest on a fixed principal loan is:

less.

The present value of an annuity due is equal to the present value of a(an) ______ annuity multiplied by (1 + r).

ordinary

Payments in a partial amortization loan are based on the amortization period, not the loan period. The remaining balance is then:

paid off in a lump sum bullet payment.

The payments in a Blank______ amortization loan are NOT based on the life of the loan.

partial

The original loan amount is called the _____.

principal

Versus a similar fixed payment loan, the total interest on a fixed ___ loan is less.

principal

The _____ rate is used to find the EAR.

quoted

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.

uneven

Another common name for the effective annual rate is the annual percentage ______.

yield

If the interest rate is greater than ___, the value of an annuity due is always greater than an ordinary annuity.

zero or 0

What is the present value of an ordinary annuity that pays $100 per year for 20 years if the interest rate is 10 percent per year?

$100{[1 - (1/(1.10)20)]/0.10}

Which formula shows the present value of an ordinary annuity that pays $100 per year for three years if the interest rate is 10 percent per year?

$100{[1 − (1/(1.10)3)]/0.10}

___ is the process of paying off loans by regularly reducing the principal.

Amortization

Which of the following show the steps you would apply using a financial calculator to find the future value of an annuity of $100 per year for 10 years at 15%?

Enter 100 for PMT, 10 for N, and 15 for I/Y. Solve for FV.

Which of the following is the formula for the future value of an annuity?

FV = C((1+r)t−1/r))

What are two ways to calculate a balloon payment?

Find the present value of the payments remaining after the loan term. Amortize the loan over the loan life to find the ending balance.

Which type of amortization is most commonly used in the real world for mortgages and car loans?

Fixed payment

Which of the following show the inputs you would use in a financial calculator to compute the present value of $100 per year for 30 years if the discount rate is 5%?

In your financial calculator, enter 100 for PMT, 30 for N, and 5 for I/Y. Solve for PV.