Chapter 4 Practice Quiz

If the current rate of interest is 8%, then the future value 20 years from now of an investment that pays $1000 per year and lasts 20 years is closest to: a. $45,762. b. $36,725. c. $9818. d. $93,219.

a; Explanation: FV = C/r((1 + r)N - 1) = $1000/0.08((1 + 0.08)20 - 1)FV = $45,762

You are considering investing in a security that will pay you $80 in interest-only at the end of each of the next 10 years. If this security is currently selling for $588.81, then the IRR for investing in this security is closest to: a. 6.0%. b. 7.0% c. 6.5% d. 5.0%

a; Explanation: PV = -588.81 PMT = 80 N = 10 FV = 0 Compute I = 5.99989

Which of the following formulas is INCORRECT? a. PV of a growing annuity = C × (1/(r-g))(1-((1+r)/(1+g))^N) b. PV of an annuity = C × (1/r)*((1-(1/((1+r)^N))) c. PV of a growing perpetuity = C/(r-g) d. PV of a perpetuity = C/r

a; Explanation: PV of a growing annuity = C × (1/(r-g))(1-((1+g)/(1+r))^N)

The British government has a consol bond outstanding that pays ₤100 in interest each year. Assuming that the current interest rate in Great Britain is 5% and that you will receive your first interest payment immediately upon purchasing the consol bond, then the value of the consol bond is closest to: a. ₤2000. b. ₤2100. c. ₤1000. d. ₤1100.

b

Your son is about to start kindergarten in a private school. Currently, the tuition is $12,000 per year, payable at the start of the school year. You expect annual tuition increases to average 6% per year over the next 13 years. Assuming that your son remains in this private school through high school and that your current interest rate is 7%, then the present value of your son's private school education is closest to: a. $332,300. b. $147,546. c. $155,800. d. $156,000.

b

Suppose that a young couple has just had their first baby and they wish to ensure that enough money will be available to pay for their child's college education. They decide to make deposits into an educational savings account on each of their daughter's birthdays, starting with her first birthday. Assume that the educational savings account will return a constant 7%. The parents deposit $2000 on their daughter's first birthday and plan to increase the size of their deposits by 5% each year. Assuming that the parents have already made the deposit for their daughter's 18th birthday, then the amount available for the daughter's college expenses on her 18th birthday is closest to: a. $42,825. b. $97,331. c. $67,998. d. $103,063.

b; Explanation: FV of a growing annuity $2000 × (1/(0.07 - 0.05))*(1-((1 + 0.05)/(1 + 0.07))^18)*(1.07)^18

Use the following timeline to answer the question(s) below. 0 ---- 1 ---- 2 ---- 3 ---- --- $600 $1200 $1800 At an annual interest rate of 7%, the future value of the cash flows in this timeline in year 2 is closest to: a. $3080. b. $3525. c. $3771. d. $4035.

b; Explanation: FV year 2 = $600(1.07)1 + $1200 + $1800/(1.07)1 = $3524.24

Which of the following is NOT a valid time value of money function in Excel? a. PMT b. NPER c. I d. FV

c

Use the figure for the question(s) below. Date: ------ 0 -------------- 1 -------------- 2 Cash Flow: $0 ---------- $5000 --------- $5000 Which of the following statements regarding the timeline is TRUE? a. Date 1 is the beginning of the first year. b. Date 2 is the beginning of the second year. c. Date 1 is the beginning of the second year. d. Date 0 is the end of the first year.

c; Explanation:

Dagny Taggart is a graduating college senior and she is considering the costs of going to medical school. Beginning next fall, Dagny expects medical school tuition to run $45,000 for the first year (paid at the end of each year) and she estimates that tuition will increase by 6% each year. If Dagny is able to invest her money in an account paying 8% interest per year, then the present value to Dagny of four years of medical school tuition is closest to: a. $149,045. b. $155,930. c. $162,095. d. $180,000.

c; Explanation: PVAgrow = PMT(((1/(i-g))-(1/(i-g))*((1+g)/(1+i))^N) = $45,000 $45,000 × ((1/(0.08-0.06))-(1/(0.08-0.06)*((1+0.06)/(1+0.08))^4)) = $162,093.03