Chapter 5 The Time Value of Money

Steve just computed the present value of a $10,000 bonus he will receive in the future. The interest rate he used in this process is referred to as which one of the following?

Discount Rate

The process of determining the present value of future cash flows in order to know their worth today is referred to as

Discounted Cash Flow Valuation

Terry is calculating the present value of a bonus he will receive next year. The process he is using is called

Discounting

Your grandmother has promised to give you $10,000 when you graduate from college. She is expecting you to graduate three years from now. What happens to the present value of this gift if you speed up your graduation by one year and graduate two years from now?

Increases.

Art invested $100 two years ago at 8 percent interest. The first year, he earned $8 interest on his $100 investment. He reinvested the $8. The second year, he earned $8.64 interest on his $108 investment. The extra $.64 he earned in interest the second year is referred to as

Interest on Interest

Which one of the following variables is the exponent in the present value formula?

Number of time periods

Sue and Neal are twins. Sue invests $5,000 at 7 percent when she is 25 years old. Neal invests $5,000 at 7 percent when he is 30 years old. Both investments compound interest annually. Both Sue and Neal retire at age 60. Which one of the following statements is correct assuming neither Sue nor Neal withdraw any money from their accounts prior to retiring?

Sue will have more money than Neal at age 60

What is the relationship between present value and future value interest factors?

The factors are reciprocals of each other.

This afternoon, you deposited $1,000 into a retirement savings account. The account will compound interest at 6 percent annually. You will not withdraw any principal or interest until you retire in 40 years. Which one of the following statements is correct?

The present value of this investment is equal to $1,000

One year ago, you invested $1,800. Today it is worth $1,924.62. What rate of interest did you earn?

6.92 percent

Christina invested $3,000 five years ago and earns 2 percent interest on her investment. By leaving her interest earnings in her account, she increases the amount of interest she earns each year. The way she is handling her interest income is referred to as which one of the following?

Compounding

Interest earned on both the initial principal and the interest reinvested from prior periods is called

Compound Interest

You are investing $100 today in a savings account at your local bank. Which one of the following terms refers to the value of this investment one year from now?

Future Value

You want to have $1 million in your savings account when you retire. You plan on investing a single lump sum today to fund this goal. You will earn 7.5 percent annual interest. Which of the following will reduce the amount that you must deposit today if you are to have your desired $1 million on the day you retire? I. Invest in a different account paying a higher rate of interest. II. Invest in a different account paying a lower rate of interest. III. Retire later. IV. Retire sooner.

I and III only.