Finance chapter 4

True/false: future value is the value of a future amount at the present time, found by applying compound interest over a specified period of time.

false

True/false: the time value of money is based on the belief that a dollar that will be received at some future date is worth more than a dollar today.

false

the present value of an annuity due is always (greater than, equal to, or less than) the present value of an otherwise identical ordinary annuity

greater than

the present value of an annuity is always (greater, equal to, or less) than the future value of an otherwise identical ordinary annuity

greater than

compound interest

interest that is earned on a given deposit and has become part of the principal at the end of a specified period

simple interest

interest that is earned only on an investments original principal and not on interest that accumulates over time

continuous compounding

-compounding of interest, literally, all the time -equivalent to compounding interest an infinite number of times per year

the future value of $100 received today and deposited at 6 percent for four years is closest to _______________ A. $126 B. $79 C. $124 D. $116

A. $126

the present value of a $25,000 perpetuity at a 14 percent discount rate is____________ A. $178,571 B. $285,000 C. $350,000 D. $219,298

A. $178,571

calculate the future value of $4,600 received today if it is deposited at 9 percent for three years. A. $5,957.13 B. $6,457.13 C. $4,957.13 D. $5,457.13

A. $5,957.13

the future value of $2,000 annuity due deposited at 8 percent compounded annually for each of the next 10 years is ___________________. A. $28,973 B. $31,291 C. $14,494 D. $13,420

B. $31,291

you invest a certain amount of money today. the process of determining how much money that investment will produce in the future is called ________________. A. discounting B. compounding C. present value D. annuitizing the cash flow

B. compounding

the present value of $100 to be received 10 years from today, assuming an opportunity cost of 9 percent, is approximately __________________. A. $237 B. $190 C. $42 D. $10

C. $42

which of the following is true of annuities? A. an ordinary annuity is an equal payment paid or received at the beginning of each period B. an annuity due is a payment paid or received at the beginning of each period that increases by an equal amount each period C. an annuity due is an equal stream of cash flows that is paid or received at the beginning of each period D. an ordinary annuity is an equal payment paid or received at the end of each period that increases by an equal amount each period

C. an annuity due is an equal stream of cash flows that is paid or received at the beginning of each period

A certain investment that costs $10,000 today promises to pay you in $10,500 in five years. This investment ____________________ A. is unambiguously a good investment B. is unambiguously a bad investment C. may be a good investment if the rate of return you can earn an alternative investments is very low D. may be a good investment if the rate of return you can earn on alternative investments is very high

C. may be a good investment if the rate of return you can earn an alternative investments is very low

annuity

a level periodic stream of cash flows over a specified time period (inflows or outflows of funds)

single amount

a lump sum amount either currently held or expected at some future date

mixed stream

a stream of cash flows that is not an annuity

interest

amount that is earned on a given deposit at the end of a specified period

annuity due

an annuity for which the cash flow occurs at the beginning of each period

ordinary annuity

an annuity for which the cash flow occurs at the end of each period

perpetuity

an annuity with an infinite life, providing continual annual cash flow

growing perpetuity

an annuity with an infinite life, providing continual annual cash flow, with the cash flow growing at a constant annual rate

Suppose a firm has an opportunity to spend $15,000 today on some investment that will produce $17,000 spread out over the next 5 years as follows: 1: $3,000 2: $5,000 3: $4,000 4: $3,000 5: $2,000 Is this investment a wise one?

it depends on the interest (discount) rate

time value of money

refers to the observation that it is better to receive money sooner than later

basic patterns of cash flow

single amount, annuity, mixed stream

principal

the amount of money on which interest is paid

discounting cash flows

the process of finding present values; the inverse of compounding interest

present value

the value in todays dollars of some future cash flow

future value

the value on some future date of money that you invest today

True/false: everything else being equal, the higher the interest rate, the higher the future value.

true

compounding

used to find the future value of each cash flow at the end of an investments life

discounting

used to find the present value of each cash flow at time zero