Chapter 5 Questions

What is a perpetuity?

a constant stream of cash flows forever

What is the simplest form of loan?

a pure discount loan

The most common way to repay a loan is to pay _ ______ _____ _______ _____ _______.

a single fixed payment every period

An annuity with payments beginning immediately rather than at the end of the period is called an _______ ___.

annuity due

When calculating annuity present values using a financial calculator, the __ amount is left blank.

FV

An annuity due is a series of payments that are made __ ___ _________ __ ____ ______.

at the beginning of each period

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

end

Spreadsheet functions used to calculate the present value of multiple cash flows assume, by default, that all cash flows occur at the ___ of the period.

end

T/F: If the interest rate is greater than zero, the value of an annuity due is always less than an ordinary annuity.

false

T/F: The annuity due calculation assumes cash flows occur evenly throughout the period.

false

T/F: The annuity present value factor equals one minus the discount rate all divided by the present value factor.

false

T/F: The payment for an annuity can be calculated using the annuity present value, the present value factor, and the interest rate.

false

T/F: To find the annuity future value factor, you only need the cash flows and the discount rate.

false

T/F: When using a financial calculator to find the number of payments, the PMT value should be entered as a positive.

false

T/F: With interest-only loans, the principle is never repaid.

false

What is not a way to amortize a loan?

fixed interest payments only

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

greater than

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

infinite

When finding the present or future value of an annuity using a financial calculator, the ________ ____ should be entered as a percentage.

interest rate

When finding the present or future value of an annuity using a spreadsheet, the ________ ____ should be entered as a decimal.

interest rate

An ordinary annuity consists of a(n) _____ stream of cash flows for a fixed period of time.

level

A simple way to amortize a loan is to have the borrower pay the interest each period plus some fixed amount. This approach is common with ______-term business loans.

medium

The annuity present value factor equals one _____ the present value factor all divided by the discount rate.

minus

You are solving a present value equation using a financial calculator and are given the number of years for compounding. This should be entered as the _ value on the financial calculator.

n

When using a financial calculator to find the number of payments, the PMT value should be entered as a ________.

negative

Using an Excel spreadsheet to solve for the payment in an amortized loan, enter the number of periods as the ____ value.

nper

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

ordinary

The entire principal of an interest-only loan is the:

original loan amount

The _______ for an annuity can be calculated using the annuity present value, the present value factor, and the discount rate.

payment

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

perpetuity

The __________ present value can be found using the perpetual cash flow and the discount rate.

perpetuity

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 formula for the _______ value interest factor of an annuity is: [1- 1/(1+r)τ]/r.

present

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

principal

The original amount of a loan is termed the loan _________.

principal

If you borrow $15,000 today at 5% annual interest to be repaid in one year as a lump sum, this is termed a ____ ________ ____.

pure discount loan

With typical interest-only loans, the entire principal is:

repaid at some point in the future

T/F: A simple way to amortize a loan is to have the borrower pay the interest each period plus a fixed amount.

true

T/F: The annuity present value of an amount C is calculated as C multiplied by {1-[1/(1+r)t]}/r .

true

T/F: The formula for the future value of an annuity factor is [(1+r)t -1]/r.

true

T/F: The perpetuity present value can be found using the perpetual cash flow and the discount rate.

true

T/F: To find the future value of multiple cash flows, calculate the future value of each cash flow first and then sum them.

true

T/F: When calculating the present value of an annuity using the financial calculator, you enter the cash flows of the annuity in the PMT key.

true

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

What is the formula for the future value of an annuity factor?

((1+r)t−1r)

What spreadsheet functions will result in the correct answer for the following annuity problem: You plan to deposit $100 per year for the next 10 years in an account paying 8%. How much will you have in this annuity?

=FV(.08,10,-100,0)

What spreadsheet function will calculate the $614.46 present value of an ordinary annuity of $100 per year for 10 years at 10% per year?

=PV(0.10,10,-100,0,0)

The formula for the present value of an annuity due is:

(1+r)×(PV of an ordinary annuity)

What processes can be used to calculate the future value of multiple cash flows?

- compound the accumulated balance forward one year at a time - calculate the future value of each cash flow first and then sum them

What could not be evaluated as annuities or annuities due?

- monthly electric bills - tips to a waiter

What are real-world examples of annuities?

- mortgages - pensions - leases

What are the following are ways to amortize a loan?

- pay principal and interest every period in a fixed payment - pay the interest each period plus some fixed amount of the principal

When entering variables in a spreadsheet function (or in a financial calculator) the "sign convention" can be critical to achieving a correct answer. The sign convention says that outflows are negative values; inflows are positive values. For which variables is this a consideration?

- payment - present value - future value

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

- to find the principal payment each month, you subtract the dollar interest payment from the fixed payment - the payment is found with = PMT(rate, nper, -pv, fv)

The cash flows of an annuity due are the same as those of an ordinary annuity except that there is an extra cash flow at Time _.

0

To find the present value of an annuity of $100 per year for 10 years at 10% per year using the tables, find a present value factor of 6.1446 and multiply it by $___.

100