Econ 351 ch 15 Testbank

5) When the interest rate is R, the formula for finding the value of a current amount $M one year from now is A) M (1 + R/100). B) M (1 + R). C) M / (1 + R). D) M / R. E) M / (100R).

Answer: B

3) If the interest rate is 10%, the present value of $1 next year is A) $1.20. B) $1.10 C) 91 cents. D) 10 cents. E) 9 cents.

Answer: C

15.1 Stocks versus Flows 1) The marginal revenue product of capital inputs does not provide complete information about optimal use because capital is: A) money. B) not an input. C) an output as well as an input. D) durable. E) all of the above

Answer: D

3) Which is a stock variable? A) Labor B) Profit C) Income D) Capital E) Price

Answer: D

4) You have won a contest and are allowed to choose between two prizes. One option is to receive $200 today and another $200 one year from now. The second option is $100 today and an additional $325 one year from now. At what interest rate (if any) is the present value of the two prizes identical? A) 0 percent B) 5 percent C) 10 percent D) 25 percent E) none of the above

Answer: D

5) Suppose that many consumers tend to over-state the discount rate that should be used for computing the net present value of education, just as they do when making investments in durable goods like cars and appliances. What would happen if consumers (as a group) started to use lower discount rates when making decisions about their education? A) NPV of a degree declines, demand for eduction declines B) NPV of a degree declines, demand for education increases C) NPV of a degree increases, demand for education declines D) NPV of a degree increases, demand for education increases

Answer: D

15.8 Intertemporal Production Decisions--Depletable Resources Scenario 15.7: Consider the following information: You move to northern California and buy a winery that already holds a stock of some wine in barrels. You are deciding whether to sell the wine now, or keep it until next year. The current price of wine is $20 per bottle, and it costs $2 per bottle to get the wine from barrels to bottles. 1) Based on the information in Scenario 15.7. You should A) keep the wine in barrels. B) sell the wine now, to get $18 per bottle in profit. C) keep the wine unless you expect the price to fall below $18 per bottle. D) keep the wine unless you expect the price to rise above $22 per bottle. E) not do anything until you find out what the interest rate is.

Answer: E

2) The first term in an NPV calculation is usually A) positive, because firms consider only positive returns. B) positive, because interest charges do not accrue until the second period. C) zero, because interest charges do not accrue until the second period. D) negative, because funds for the project have to be borrowed up front before it is begun. E) negative, because the cost of the project is immediate, but revenue streams from the project come later.

Answer: E

4) Which is the best example of a nondiversifiable risk for Stalwart Shoes? A) A project to open a new store in Texas B) A project to open a new factory in Texas C) A project to move into the sock market D) The state of the economy in Texas E) The state of the U.S. economy

Answer: E

3) Another name for diversifiable risk is A) systematic risk. B) nonsystematic risk. C) nominal risk. D) portfolio risk. E) meta-portfolio risk.

Answer: B

3) The authors note that an appropriate discount rate for most U.S. households is near 5%. However, suppose you are considering the decision to attend graduate school, and you already have large credit card balances from your undergraduate years. If you decide to use a higher discount rate (e.g., 10%) to reflect your higher opportunity cost of money, what impact does this change in the discount rate have on the net present value of a graduate degree? A) Increases NPV B) Decreases NPV C) NPV would not change as long as we use nominal costs and returns. D) NPV may increase or decrease, and we cannot determine the direction of change without more information.

Answer: B

4) The real interest rate is A) the nominal rate plus the rate of inflation. B) the nominal rate minus the rate of inflation. C) the nominal rate divided by the rate of inflation. D) the nominal rate multiplied by the rate of inflation. E) the nominal rate.

Answer: B

5) A perpetuity for sale at $100,000 that promises a yearly payment of $5,000 has an effective yield of A) 2%. B) 5%. C) 20%. D) 50%. E) 2,000%.

Answer: B

15.2 Present Discounted Value 1) The present value formula makes it apparent that: A) a decline in the interest rate will cause a decision maker to weigh recent period returns relatively more heavily than before the decline. B) an increase in the interest rate will cause a decision maker to weigh distant (or future) returns relatively more heavily than before the increase. C) the present value of a fixed sum decreases as the time until it is to be paid increases. D) all of the above E) both A and C.

Answer: C

15.9 How Are Interest Rates Determined? 1) Interest rates are determined by the supply and demand for A) money. B) capital goods. C) loanable funds. D) foreign currencies. E) stocks.

Answer: C

2) A bond has a current market value of $800. The holder of the bond will receive a single payment of $1,000 one year from now. The interest rate is 10 percent. The effective yield on the bond is: A) $200. B) 10 percent. C) 25 percent. D) negative. E) The yield cannot be determined with the information provided.

Answer: C

2) Based on the information in Scenario 15.7, if you expect the price to be $21 next year, you should A) keep the wine in barrels until next year no matter what the interest rate. B) keep the wine if interest rates are above 5%. C) keep the wine if interest rates are below 5%. D) sell the wine now. E) do nothing until you know what the interest rate is going to be for the following year.

Answer: C

2) In the consumer's NPV decision, the correct value for the interest rate R is A) the interest rate that could be earned in a savings account when the consumer must borrow to finance the purchase. B) the interest rate that would have to be paid on a loan when the consumer could pay for the purchase with funds in a savings account. C) the interest rate charged for the loan when the consumer must borrow to finance the purchase. D) the prime rate, irrespective of whether when the consumer must borrow to finance the purchase. E) the prime rate plus the rate of inflation as measured by the CPI, irrespective of whether when the consumer must borrow to finance the purchase.

Answer: C

3) Len is putting in a new swimming pool. He can either heat his pool with natural gas or with solar power. If he chooses solar power it will cost him more today, but he will recover these costs over the next 7 years in savings on his natural gas bill. The solar heater is expected to last 12 years. Len: A) will put in the solar heater regardless of the discount rate because the savings in natural gas outweigh the initial cost of the solar heater. B) is more likely to install the solar heater as the discount rate increases. C) is more likely to install the solar heater as the discount rate declines. D) will not put in the solar heater unless he is an environmentalist.

Answer: C

3) What is the "Hotelling rule" for situations in which a producer can determine when a good is sold? A) Price must rise at exactly the rate of interest. B) Marginal cost must rise at exactly the rate of interest. C) Price minus marginal cost must rise at exactly the rate of interest. D) Price plus marginal cost must rise at exactly the rate of interest. E) Price and marginal cost must be independent of the rate of interest.

Answer: C

4) If a firm can earn a profit stream of $50,000 per year for 10 years, that profit stream is worth A) more than $500,000 today. B) $500,000 today. C) less than $500,000 today, but a positive amount. D) nothing today E) some amount, but whether it is more, less or the same as $500,000 cannot be determined.

Answer: C

4) What is the "Hotelling rule" for a monopolist? A) Price minus marginal cost must rise at exactly the rate of interest. B) Price plus marginal cost must rise at exactly the rate of interest. C) Marginal revenue minus marginal cost must rise at exactly the rate of interest. D) Marginal revenue and marginal cost must be independent of the rate of interest.

Answer: C

4) When the government runs a large deficit, A) the supply of loanable funds will shift rightward. B) the supply of loanable funds will shift leftward. C) the demand for loanable funds will shift rightward. D) the demand for loanable funds will shift leftward. E) taxes must rise.

Answer: C

5) Of the following endeavors of Happy Home Insurance Company of California, which involves the most nondiversifiable risk? A) Fire insurance B) Home burglary insurance C) Earthquake insurance D) Personal accident insurance E) Home office insurance

Answer: C

5) To avoid the stock versus flow issue in production, some economists discuss capital usage in terms of rented capital. For example, your firm may not directly own some of the capital inputs to your production operation, and these capital inputs are employed on an hourly or daily basis. Which of the following inputs is a good example of a capital input that acts like a flow? A) Land and buildings that are owned by the firm B) A long-term licensing agreements that allow you to use a patented idea owned by another firm C) A forklift that is rented on an hourly basis D) all of the above

Answer: C

15.6 Investment Decisions by Consumers 1) The decision firms make about new capital projects is most like the decision consumers make when they decide A) whether to take a new job. B) which of two new jobs to take. C) what brand of coffee to buy. D) whether to buy a new house. E) whether to go on vacation.

Answer: D

3) As firms' expected profit from new capital projects falls, A) the supply of loanable funds will shift rightward. B) the supply of loanable funds will shift leftward. C) the demand for loanable funds will shift rightward. D) the demand for loanable funds will shift leftward. E) projects must become more profitable

Answer: D

4) The PDV of a perpetuity with a yearly payment of $500 at an interest rate of 5% is A) $100. B) $5,000. C) $25,000. D) $10,000. E) $100,000.

Answer: D

15.4 The Net Present Value Criterion for Capital Investment Decisions 1) The "NPV Criterion" is that a firm should invest in a new capital project if A) the present value of the expected future cash flows is larger than the present value of the cost of the investment. B) the future value of the expected future cash flows is larger than the cost of the investment. C) financing can be secured on the basis of new bonds. D) financing can be secured on the basis of new stocks. E) financing is not necessary because there are enough liquid assets in the company's portfolio to afford the investment.

Answer: A

15.5 Adjustments for Risk 1) Which kind of risk affects the opportunity cost of capital? A) Nondiversifiable risk B) Diversifiable risk C) Both nondiversifiable and diversifiable risk D) The risk inherent in "riskless" assets such as U.S. Treasury bills E) The risk inherent in "riskless" portfolios such as broad stock market holdings

Answer: A

2) Which of the following questions is addressed when hiring capital, but not addressed when hiring labor? A) How much are future profits worth today? B) How much are today's profits worth in the future? C) How much are the future's profits worth in the future? D) How much are today's profits worth today? E) All questions present when capital is purchased are present when labor is purchased.

Answer: A

3) As interest rates fall, A) the values of bonds rise. B) the values of bonds fall. C) the values of bonds are unchanged. D) the value of perpetuities are unchanged, but the value of other bonds change in value. E) the value of all bonds except perpetuities change.

Answer: A

3) The interest rate R in an NPV calculation should always A) be the return that the firm could earn on a similar investment. B) be the riskless interest rate (e.g., U.S. Treasury bills). C) be the rate on corporate bonds. D) be the rate of return available in the stock market. E) be the interest rate at which the firm has to borrow.

Answer: A

4) The authors cite a recent study of MBA programs that compares pre-MBA salaries with post-MBA salaries. For some of the highest ranked schools, the salary difference was roughly $100,000 per year, and the difference was roughly $60,000 for some schools ranked near the bottom of the top 20. Is it possible that the financial returns from an MBA earned at a lower ranked school may actually exceed the returns from a top ranked school? A) Yes, the lower ranked schools may provide a higher net present value for the degree if their tuition is low enough. B) Yes, but the potential gains depend on the discount rate and not the tuition. C) No, the salary advantages of the top ranked schools always payoff in the long run. D) We do not have enough information to answer the question.

Answer: A

5) From the Hotelling rule, we would expect that a perfectly competitive industry selling an exhaustible resource would A) sell more of it than a monopolist would in each period. B) sell it all at once. C) sell less of it than a monopolist would in each period. D) not sell it. E) not sell it unless interest rates were low.

Answer: A

5) If individuals decide to save more for retirement, A) the supply of loanable funds will shift rightward. B) the supply of loanable funds will shift leftward. C) the demand for loanable funds will shift rightward. D) the demand for loanable funds will shift leftward. E) an excess supply of loanable funds emerges and persists.

Answer: A

15.3 The Value of a Bond 1) Two bonds of equal risk are for sale on the secondary bond market. The two bonds have the same face value, and both mature in 10 years. Bond A pays $10 per year and bond B pay $15 per year. Which bond will sell for a higher price? A) Bond A B) Bond B C) They will sell for the same price. D) The relative prices will depend on the expected interest rate over the next 10 years.

Answer: B

15.7 Investments in Human Capital 1) Knowledge, skills, and experience that make an individual more productive and able to earn a higher income are known as: A) mental capital. B) human capital. C) sweat equity. D) intangible capital.

Answer: B

2) A "risky" asset will earn a rate of return close to that of "riskless" assets if its risk is A) nondiversifiable. B) diversifiable. C) nominal, as opposed to real. D) related to the rate of inflation. E) no greater than the risk of similar assets.

Answer: B

2) If the interest rate is 5%, in one period the future value of $1 today is A) $1.20. B) $1.05. C) 95 cents. D) 20 cents. E) 5 cents.

Answer: B

2) Suppose you plan to retire in eight years, but your boss would like you to earn an online MBA in order to take on a new managerial position. The firm will continue to pay your salary while you are working through the online courses, and the new position pays an additional $15,000 per year. The online MBA tuition is $35,000 per year, and your discount rate is 5%. Should you complete the degree? A) No, the net present value of the degree is negative. B) Yes, the net present value of the degree is about $4,300 C) Yes, the net present value of the degree is about $20,000 D) We do not have enough information to answer this question.

Answer: B

2) The demand for loanable funds slopes A) downward because NPV falls as interest rates fall. B) downward because NPV falls as interest rates rise. C) downward because NPV falls as money enters the economy. D) upward because at higher interest rates people are more willing to save. E) upward because at higher interest rates the stock market is a less attractive investment.

Answer: B