Chapter 2

An annuity is defined as a set of:

A. equal cash flows occurring at equal intervals of time for a specified period.

Present value is defined as:

A. future cash flows discounted to the present by an appropriate discount rate.

You are considering investing in a retirement fund that requires you to deposit $5,000 per year, and you want to know how much the fund will be worth when you retire. What financial technique should you use to calculate this value?

B. Future value of an annuity

A. equal cash flows occurring at equal intervals of time for a specified period.

B. an annuity

A perpetuity is defined as a sequence of:

B. equal cash flows occurring at equal intervals of time forever.

The present value formula for a cash flow expected one period from now is

B. PV = C1/(1 + r).

Which of the following statements regarding the net present value rule and the rate of return rule is false? A. Accept a project if NPV > cost of investment. B. Accept a project if NPV is positive. C. Accept a project if return on investment exceeds the rate of return on an equivalent-risk investment in the financial market. D. Reject a project if NPV is negative.

A. Accept a project if NPV > cost of investment.

The net present value formula for one period is:

A. NPV = C0 + [C1/(1 + r)].

Which of the following statements is true? A. The process of discounting is the inverse of the process of compounding. B. Ending balances using simple interest are always greater than ending balances using compound interest at positive interest rates. C. The present value of an annuity due is always less than the present value of an equivalent ordinary annuity at positive interest rates. D. The future value of an annuity due is always less than the present value of an equivalent ordinary annuity at positive interest rates.

A. The process of discounting is the inverse of the process of compounding.

The managers of a firm can maximize stockholder wealth by:

A. taking all projects with positive NPVs.

Which of the following statements regarding the NPV rule and the rate of return rule is false? A. Accept a project if its NPV > 0. B. Reject a project if the NPV < 0. C. Accept a project if its rate of return > 0. D. Accept a project if its rate of return > opportunity cost of capital.

C. Accept a project if its rate of return > 0.

The rate of return is also called the: I) discount rate; II) hurdle rate; III) opportunity cost of capital

C. I, II, and III.

Which of the following is generally considered an example of a perpetuity?

C. Interest payments on a consol

The concept of compound interest is best described as:

C. interest earned on interest.

According to the net present value rule, an investment in a project should be made if the:

C. net present value is positive.

The opportunity cost of capital for a risky project is:

C. the expected rate of return on a security of similar risk as the project.