FIN 3404 Chapter 5

Which of these will increase the present value of an amount to be received sometime in the future?

Decrease in the interest rate

Steve just computed the present value of a $10,000 bonus he will receive in the future. The interest rate he used in this process is referred to as which one of the following?

Discount Rate

The process of determining the present value of future cash flows in order to know their worth today is referred to as:

Discounted Cash Flow Valuation

Terry is calculating the present value of a bonus he will receive next year. The process he is using is called:

Discounting

Your grandmother has promised to give you $10,000 when you graduate from college. She is expecting you to graduate three years from now. What happens to the present value of this gift if you speed up your graduation by one year and graduate two years from now?

Increases

Art invested $100 two years ago at 8 percent interest. The first year, he earned $8 interest on his $100 investment. He reinvested the $8. The second year, he earned $8.64 interest on his $108 investment. The extra $.64 he earned in interest the second year is referred to as:

Intrest on Interest

Which one of the following variables is the exponent in the present value formula?

Number of time periods

Kurt won a lottery and will receive $1,000 a year for the next 50 years. The value of his winnings today discounted at his discount rate is called which one of the following?

Present Value

Samantha opened a savings account this morning. Her money will earn 3.5 percent interest, compounded annually. After four years, her savings account will be worth $5,000. Assume she will not make any withdrawals. Given this, which one of the following statements is true?

Samantha could have deposited less money today and still had $5,000 in four years if she could have earned a higher rate of interest.

Renee invested $2,000 six years ago at 4.5 percent interest. She spends her earnings as soon as she earns any interest so she only receives interest on her initial $2,000 investment. Which type of interest is she earning?

Simple Interest

Sue and Neal are twins. Sue invests $5,000 at 7 percent when she is 25 years old. Neal invests $5,000 at 7 percent when he is 30 years old. Both investments compound interest annually. Both Sue and Neal retire at age 60. Which one of the following statements is correct assuming neither Sue nor Neal withdraw any money from their accounts prior to retiring?

Sue will have more money than Neal at age 60

What is the relationship between present value and future value interest factors?

The factors are reciprocals of each other.

This afternoon, you deposited $1,000 into a retirement savings account. The account will compound interest at 6 percent annually. You will not withdraw any principal or interest until you retire in 40 years. Which one of the following statements is correct?

The present value of this investment is equal to $1,000.

Which one of the following will produce the lowest present value interest factor?

8 percent interest for 10 years

Andy deposited $3,000 this morning into an account that pays 5 percent interest, compounded annually. Barb also deposited $3,000 this morning into an account that pays 5 percent interest, compounded annually. Andy will withdraw his interest earnings and spend it as soon as possible. Barb will reinvest her interest earnings into her account. Given this, which one of the following statements is true?

Barb will earn more interest the second year than Andy

Christina invested $3,000 five years ago and earns 2 percent interest on her investment. By leaving her interest earnings in her account, she increases the amount of interest she earns each year. The way she is handling her interest income is referred to as which one of the following?

Compounding

Interest earned on both the initial principal and the interest reinvested from prior periods is called:

Compound Interest

You are investing $100 today in a savings account at your local bank. Which one of the following terms refers to the value of this investment one year from now?

Future value

Phillippe invested $1,000 10 years ago and expected to have $1,800 today. He has not added or withdrawn any money from this account since his initial investment. All interest was reinvested in the account. As it turns out, he only has $1,680 in his account today. Which one of the following must be true?

He earned a lower interest rate than he expected.

You want to have $1 million in your savings account when you retire. You plan on investing a single lump sum today to fund this goal. You will earn 7.5 percent annual interest. Which of the following will reduce the amount that you must deposit today if you are to have your desired $1 million on the day you retire? I. Invest in a different account paying a higher rate of interest. II. Invest in a different account paying a lower rate of interest. III. Retire later. IV. Retire sooner.

I and III only

Luis is going to receive $20,000 six years from now. Soo Lee is going to receive $20,000 nine years from now. Which one of the following statements is correct if both Luis and Soo Lee apply a 7 percent discount rate to these amounts?

In today's dollars, Luis's money is worth more than Soo Lee's.