Chapter 05 - Introduction To Valuation: The Time Value of Money

Chapter 05 - Introduction to Valuation: The Time Value of Money
Chapter 05
Introduction to Valuation: The Time Value of Money

Multiple Choice Questions

1. You are investin !100 today in a savins account at your local "an#. $hich one of the
follo%in terms refers to the value of this investment one year from no%&
'. future value
(. present value
C. principal amounts
). discounted value
*. invested principal

+. Tracy invested !1,000 five years ao and earns - percent interest on her investment. (y
leavin her interest earnins in her account, she increases the amount of interest she earns
each year. The %ay she is handlin her interest income is referred to as %hich one of the
follo%in&
'. simplifyin
(. compoundin
C. areation
). accumulation
*. discountin

.. /teve invested !100 t%o years ao at 10 percent interest. The first year, he earned !10
interest on his !100 investment. 0e reinvested the !10. The second year, he earned !11
interest on his !110 investment. The e1tra !1 he earned in interest the second year is referred
to as:
'. free interest.
(. "onus income.
C. simple interest.
). interest on interest.
*. present value interest.

5-1
-. Interest earned on "oth the initial principal and the interest reinvested from prior periods is
called:
'. free interest.
(. dual interest.
C. simple interest.
*. compound interest.

5. /ara invested !500 si1 years ao at 5 percent interest. /he spends her earnins as soon as
she earns any interest so she only receives interest on her initial !500 investment. $hich type
of interest is /ara earnin&
'. free interest
(. comple1 interest
C. simple interest
). interest on interest
*. compound interest

2. /helley %on a lottery and %ill receive !1,000 a year for the ne1t ten years. The value of her
%innins today discounted at her discount rate is called %hich one of the follo%in&
'. sinle amount
(. future value
C. present value
). simple amount
*. compounded value

3. Terry is calculatin the present value of a "onus he %ill receive ne1t year. The process he is
usin is called:
'. ro%th analysis.
(. discountin.
C. accumulatin.
). compoundin.
*. reducin.

5-+
4. /teve 5ust computed the present value of a !10,000 "onus he %ill receive in the future. The
interest rate he used in this process is referred to as %hich one of the follo%in&
'. current yield
(. effective rate
C. compound rate
). simple rate
*. discount rate

6. The process of determinin the present value of future cash flo%s in order to #no% their
%orth today is called %hich one of the follo%in&
'. compound interest valuation
(. interest on interest computation
C. discounted cash flo% valuation
). present value interest factorin
*. comple1 factorin

10. 'ndy deposited !.,000 this mornin into an account that pays 5 percent interest,
compounded annually. (ar" also deposited !.,000 this mornin into an account that pays 5
percent interest, compounded annually. 'ndy %ill %ithdra% his interest earnins and spend it
as soon as possi"le. (ar" %ill reinvest her interest earnins into her account. 7iven this,
%hich one of the follo%in statements is true&
'. (ar" %ill earn more interest the first year than 'ndy %ill.
(. 'ndy %ill earn more interest in year three than (ar" %ill.
C. (ar" %ill earn interest on interest.
). 'fter five years, 'ndy and (ar" %ill "oth have earned the same amount of interest.
*. 'ndy %ill earn compound interest.

11. /ue and 8eal are t%ins. /ue invests !5,000 at 3 percent %hen she is +5 years old. 8eal
invests !5,000 at 3 percent %hen he is .0 years old. (oth investments compound interest
annually. (oth /ue and 8eal retire at ae 20. $hich one of the follo%in statements is correct
assumin that neither /ue nor 8eal has %ithdra%n any money from their accounts&
'. /ue %ill have less money %hen she retires than 8eal.
(. 8eal %ill earn more interest on interest than /ue.
C. 8eal %ill earn more compound interest than /ue.
). If "oth /ue and 8eal %ait to ae 30 to retire, then they %ill have e9ual amounts of savins.
*. /ue %ill have more money than 8eal as lon as they retire at the same time.

5-.
1+. /amantha opened a savins account this mornin. 0er money %ill earn 5 percent interest,
compounded annually. 'fter five years, her savins account %ill "e %orth !5,200. 'ssume she
%ill not ma#e any %ithdra%als. 7iven this, %hich one of the follo%in statements is true&
'. /amantha deposited more than !5,200 this mornin.
(. The present value of /amantha:s account is !5,200.
C. /amantha could have deposited less money and still had !5,200 in five years if she could
have earned 5.5 percent interest.
). /amantha %ould have had to deposit more money to have !5,200 in five years if she could
have earned 2 percent interest.
*. /amantha %ill earn an e9ual amount of interest every year for the ne1t five years.

1.. This afternoon, you deposited !1,000 into a retirement savins account. The account %ill
compound interest at 2 percent annually. You %ill not %ithdra% any principal or interest until
you retire in forty years. $hich one of the follo%in statements is correct&
'. The interest you earn si1 years from no% %ill e9ual the interest you earn ten years from
no%.
(. The interest amount you earn %ill dou"le in value every year.
C. The total amount of interest you %ill earn %ill e9ual !1,000 .02 -0.
). The present value of this investment is e9ual to !1,000.
*. The future value of this amount is e9ual to !1,000 ;1 < -0=
.02
.

1-. Your randmother has promised to ive you !5,000 %hen you raduate from collee. /he
is e1pectin you to raduate t%o years from no%. $hat happens to the present value of this
ift if you delay your raduation "y one year and raduate three years from no%&
'. remains constant
(. increases
C. decreases
). "ecomes neative
*. cannot "e determined from the information provided

5--
15. >uis is oin to receive !+0,000 si1 years from no%. /oo >ee is oin to receive !+0,000
nine years from no%. $hich one of the follo%in statements is correct if "oth >uis and /oo
>ee apply a 3 percent discount rate to these amounts&
'. The present values of >uis and /oo >ee:s monies are e9ual.
(. In future dollars, /oo >ee:s money is %orth more than >uis: money.
C. In today:s dollars, >uis: money is %orth more than /oo >ee:s.
). T%enty years from no%, the value of >uis: money %ill "e e9ual to the value of /oo >ee:s
money.
*. /oo >ee:s money is %orth more than >uis: money iven the 3 percent discount rate.

12. $hich one of the follo%in varia"les is the e1ponent in the present value formula&
'. present value
(. future value
C. interest rate
). time
*. There is no e1ponent in the present value formula.

13. You %ant to have !1 million in your savins account %hen you retire. You plan on
investin a sinle lump sum today to fund this oal. You are plannin on investin in an
account %hich %ill pay 3.5 percent annual interest. $hich of the follo%in %ill 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 payin a hiher rate of interest.
II. Invest in a different account payin a lo%er rate of interest.
III. ?etire later.
IV. ?etire sooner.
'. I only
(. II only
C. I and III only
). I and IV only
*. II and III only

5-5
14. $hich one of the follo%in %ill produce the hihest present value interest factor&
'. 2 percent interest for five years
(. 2 percent interest for eiht years
C. 2 percent interest for ten years
). 4 percent interest for five years
*. 4 percent interest for ten years

16. $hat is the relationship "et%een present value and future value interest factors&
'. The present value and future value factors are e9ual to each other.
(. The present value factor is the e1ponent of the future value factor.
C. The future value factor is the e1ponent of the present value factor.
). The factors are reciprocals of each other.
*. There is no relationship "et%een these t%o factors.

+0. Martin invested !1,000 si1 years ao and e1pected to have !1,500 today. 0e has not added
or %ithdra%n any money from this account since his initial investment. 'll interest %as
reinvested in the account. 's it turns out, Martin only has !1,-+0 in his account today. $hich
one of the follo%in must "e true&
'. Martin earned simple interest rather than compound interest.
(. Martin earned a lo%er interest rate than he e1pected.
C. Martin did not earn any interest on interest as he e1pected.
). Martin inored the ?ule of 3+ %hich caused his account to decrease in value.
*. The future value interest factor turned out to "e hiher than Martin e1pected.

+1. 7erold invested !2,+00 in an account that pays 5 percent simple interest. 0o% much
money %ill he have at the end of ten years&
'. !4,310
(. !6,000
C. !6,.00
). !6,234
*. !10,066

5-2
++. 'le1 invested !10,500 in an account that pays 2 percent simple interest. 0o% much
money %ill he have at the end of four years&
'. !1+,250
(. !1+,623
C. !1.,0+0
). !1.,+52
*. !1.,500

+.. You invested !1,250 in an account that pays 5 percent simple interest. 0o% much more
could you have earned over a +0-year period if the interest had compounded annually&
'. !4-6.++
(. !6.0.11
C. !64+.16
). !1,0+1.15
*. !1,033.6-

+-. Travis invested !6,+50 in an account that pays 2 percent simple interest. 0o% much more
could he have earned over a 3-year period if the interest had compounded annually&
'. !3-1.-1
(. !33..54
C. !40+.12
). !4.....
*. !454.06

+5. $hat is the future value of !3,146 invested for +. years at 6.+5 percent compounded
annually&
'. !++,-4..20
(. !+3,460.43
C. !.4,661.03
). !51,006.1.
*. !5-,666.44

5-3
+2. Today, you earn a salary of !.2,000. $hat %ill "e your annual salary t%elve years from
no% if you earn annual raises of ..2 percent&
'. !55,0.+.5-
(. !53,-1-.02
C. !54,+.5.+-
). !56,1++.04
*. !56,.20.-5

+3. You o%n a classic automo"ile that is currently valued at !1-3,600. If the value increases
"y 2.5 percent annually, ho% much %ill the automo"ile "e %orth ten years from no%&
'. !+--,0.5.00
(. !+51,004.13
C. !+30,01...4
). !+33,2+4.2.
*. !+61,-40.14

+4. You hope to "uy your dream car four years from no%. Today, that car costs !4+,500. You
e1pect the price to increase "y an averae of -.4 percent per year over the ne1t four years.
0o% much %ill your dream car cost "y the time you are ready to "uy it&
'. !64,.-0.00
(. !64,222.23
C. !66,513.-1
). !66,414.0+
*. !100,0+..12

+6. This mornin, T> Truc#in invested !40,000 to help fund a company e1pansion pro5ect
planned for - years from no%. 0o% much additional money %ill the firm have - years from
no% if it can earn 5 percent rather than - percent on its savins&
'. !+,6-0.06
(. !.,251.4+
C. !-,004.13
). !-,+16.24
*. !-,311.04

5-4
.0. You 5ust received !++5,000 from an insurance settlement. You have decided to set this
money aside and invest it for your retirement. Currently, your oal is to retire +5 years from
today. 0o% much more %ill you have in your account on the day you retire if you can earn an
averae return of 10.5 percent rather than 5ust 4 percent&
'. !-13,1.3
(. !246,506
C. !1,050,-+.
). !1,146,532
*. !1,414,.-+

.1. You 5ust received a !5,000 ift from your randmother. You have decided to save this
money so that you can ift it to your randchildren 50 years from no%. 0o% much additional
money %ill you have to ift to your randchildren if you can earn an averae of 4.5 percent
instead of 5ust 4 percent on your savins&
'. !-3,.14.06
(. !5+,-2-.36
C. !55,+11.12
). !54,411.66
*. !20,6+..5+

.+. You are depositin !1,500 in a retirement account today and e1pect to earn an averae
return of 3.5 percent on this money. 0o% much additional income %ill you earn if you leave
the money invested for -5 years instead of 5ust -0 years&
'. !10,3+..04
(. !11,360.60
C. !1+,--1.52
). !1+,604.16
*. !1.,560.6.

5-6
... You collect old coins. Today, you have t%o coins each of %hich is valued at !+50. @ne
coin is e1pected to increase in value "y 2 percent annually %hile the other coin is e1pected to
increase in value "y -.5 percent annually. $hat %ill "e the difference in the value of the t%o
coins 15 years from no%&
'. !115..+
(. !+04.0-
C. !+-1.36
). !+5-.+-
*. !+40.15

.-. Your father invested a lump sum +2 years ao at -.+5 percent interest. Today, he ave you
the proceeds of that investment %hich totaled !51,-40.36. 0o% much did your father
oriinally invest&
'. !15,6+6.-3
(. !12,500.00
C. !13,---.42
). !13,500.00
*. !13,666.-5

.5. $hat is the present value of !150,000 to "e received 4 years from today if the discount
rate is 11 percent&
'. !25,044.63
(. !31,1-3.03
C. !3-,1-1.-1
). !36,402.14
*. !4.,+61.02

.2. You %ould li#e to ive your dauhter !35,000 to%ards her collee education 13 years
from no%. 0o% much money must you set aside today for this purpose if you can earn 4
percent on your investments&
'. !14,.44.16
(. !+0,+30.13
C. !+4,-13.23
). !+6,.11.1.
*. !.+,-44..3

5-10
.3. You %ant to have !.5,000 saved 2 years from no% to "uy a house. 0o% much less do you
have to deposit today to reach this oal if you can earn 5.5 percent rather than 5 percent on
your savins& Today:s deposit is the only deposit you %ill ma#e to this savins account.
'. !3...6-
(. !361.14
C. !4+-.20
). !4-5.11
*. !616.0+

.4. Your older sister deposited !5,000 today at 4.5 percent interest for 5 years. You %ould li#e
to have 5ust as much money at the end of the ne1t 5 years as your sister %ill have. 0o%ever,
you can only earn 3 percent interest. 0o% much more money must you deposit today than
your sister did if you are to have the same amount at the end of the 5 years&
'. !.+1.16
(. !.20.-.
C. !.43.34
). !-01.+1
*. !-1...6

.6. ' year ao, you deposited !.0,000 into a retirement savins account at a fi1ed rate of 5.5
percent. Today, you could earn a fi1ed rate of 2.5 percent on a similar type account. 0o%ever,
your rate is fi1ed and cannot "e ad5usted. 0o% much less could you have deposited last year if
you could have earned a fi1ed rate of 2.5 percent and still have the same amount as you
currently %ill %hen you retire .4 years from today&
'. !+,114.-+ less
(. !.,...... less
C. !5,-13.06 less
). !3,+3-.1+ less
*. !6,+.-.63 less

5-11
-0. $hen you retire -0 years from no%, you %ant to have !1.+ million. You thin# you can
earn an averae of 1+ percent on your investments. To meet your oal, you are tryin to
decide %hether to deposit a lump sum today, or to %ait and deposit a lump sum + years from
today. 0o% much more %ill you have to deposit as a lump sum if you %ait for + years "efore
ma#in the deposit&
'. !1,-1-.1-
(. !+,.16.-3
C. !+,461.11
). !.,+40.34
*. !.,-02.34

-1. Theo needs !-0,000 as a do%n payment for a house 2 years from no%. 0e earns ..5
percent on his savins. Theo can either deposit one lump sum today for this purpose or he can
%ait a year and deposit a lump sum. 0o% much additional money must he deposit if he %aits
for one year rather than ma#in the deposit today&
'. !434.64
(. !611.1.
C. !1,1.4.60
). !1,.-4.0.
*. !1,-+0.14

-+. @ne year ao, you invested !1,400. Today it is %orth !1,6+-.2+. $hat rate of interest did
you earn&
'. 2.56 percent
(. 2.23 percent
C. 2.44 percent
). 2.6+ percent
*. 3.01 percent

-.. 'ccordin to the ?ule of 3+, you can do %hich one of the follo%in&
'. dou"le your money in five years at 3.+ percent interest
(. dou"le your money in 3.+ years at 4 percent interest
C. dou"le your money in 4 years at 6 percent interest
). triple your money in 3.+ years at 5 percent interest
*. triple your money at 10 percent interest in 3.+ years

5-1+
--. Aorty years ao, your mother invested !5,000. Today, that investment is %orth
!-.0,025.11. $hat is the averae annual rate of return she earned on this investment&
'. 11.24 percent
(. 11.31 percent
C. 11.34 percent
). 11.61 percent
*. 1+.0+ percent

-5. /i1teen years ao, 'licia invested !1,000. *iht years ao, Travis invested !+,000. Today,
"oth 'licia:s and Travis: investments are each %orth !+,-00. 'ssume that "oth 'licia and
Travis continue to earn their respective rates of return. $hich one of the follo%in statements
is correct concernin these investments&
'. Three years from today, Travis: investment %ill "e %orth more than 'licia:s.
(. @ne year ao, 'licia:s investment %as %orth less than Travis: investment.
C. Travis earns a hiher rate of return than 'licia.
). Travis has earned an averae annual interest rate of ...3 percent.
*. 'licia has earned an averae annual interest rate of 2.01 percent.

-2. Benn /tation is savin money to "uild a ne% loadin platform. T%o years ao, they set
aside !+-,000 for this purpose. Today, that account is %orth !+4,.66. $hat rate of interest is
Benn /tation earnin on this investment&
'. 2..6 percent
(. 3.-3 percent
C. 4.34 percent
). 6.+. percent
*. 6.23 percent

-3. Aifteen years ao, Cac#son /upply set aside !1.0,000 in case of a financial emerency.
Today, that account has increased in value to !..0,56+. $hat rate of interest is the firm
earnin on this money&
'. 5.40 percent
(. 2.-+ percent
C. 2.35 percent
). 3.+4 percent
*. 3.5. percent

5-1.
-4. Aourteen years ao, your parents set aside !3,500 to help fund your collee education.
Today, that fund is valued at !+2,140. $hat rate of interest is "ein earned on this account&
'. 3.66 percent
(. 4..2 percent
C. 4.51 percent
). 6..- percent
*. 10.02 percent

-6. /ome time ao, Culie purchased eleven acres of land costin !.2,600. Today, that land is
valued at !+1-,400. 0o% lon has she o%ned this land if the price of the land has "een
increasin at 10.5 percent per year&
'. 1.... years
(. 12.64 years
C. 13.2- years
). 16.+6 years
*. +1.04 years

50. @n your ninth "irthday, you received !.00 %hich you invested at -.5 percent interest,
compounded annually. Your investment is no% %orth !352. 0o% old are you today&
'. ae +6
(. ae .0
C. ae .1
). ae .+
*. ae ..

Essay Questions

51. You %ant to deposit sufficient money today into a savins account so that you %ill have
!1,000 in the account three years from today. *1plain %hy you could deposit less money
today if you could earn ..5 percent interest rather than . percent interest.

5-1-
5+. You are considerin t%o separate investments. (oth investments pay 3 percent interest.
Investment ' pays simple interest and Investment ( pays compound interest. $hich
investment should you choose, and %hy, if you plan on investin for a period of 5 years&

5.. $hat lesson does the future value formula provide for youn %or#ers %ho are loo#in
ahead to retirin some day&

5-. You are considerin t%o lottery payment options: @ption ' pays !10,000 today and
@ption ( pays !+0,000 at the end of ten years. 'ssume you can earn 2 percent on your
savins. $hich option %ill you choose if you "ase your decision on present values& $hich
option %ill you choose if you "ase your decision on future values& *1plain %hy your ans%ers
are either the same or different.

5-15
55. 't an interest rate of 10 percent and usin the ?ule of 3+, ho% lon %ill it ta#e to dou"le
the value of a lump sum invested today& 0o% lon %ill it ta#e after that until the account
ro%s to four times the initial investment& 7iven the po%er of compoundin, shouldn:t it ta#e
less time for the money to dou"le the second time&


52. 'ssume the total cost of a collee education %ill "e !.00,000 %hen your child enters
collee in 12 years. You presently have !35,521 to invest. $hat rate of interest must you earn
on your investment to cover the cost of your child:s collee education&
'. 3.35 percent
(. 4.50 percent
C. 6.00 percent
). 6.+5 percent
*. 6.50 percent

53. 't 11 percent interest, ho% lon %ould it ta#e to 9uadruple your money&
'. 2.55 years
(. 2.2- years
C. 1..06 years
). 1..+4 years
*. 1..52 years

54. 'ssume the averae vehicle sellin price in the Dnited /tates last year %as !-1,662. The
averae price 6 years earlier %as !+6,000. $hat %as the annual increase in the sellin price
over this time period&
'. ..46 percent
(. -.+0 percent
C. -.52 percent
). 5.01 percent
*. 5.-0 percent

5-12
56. You:re tryin to save to "uy a ne% !120,000 Aerrari. You have !52,000 today that can "e
invested at your "an#. The "an# pays 2 percent annual interest on its accounts. 0o% many
years %ill it "e "efore you have enouh to "uy the car& 'ssume the price of the car remains
constant.
'. 12.23 years
(. 13.0- years
C. 13.-1 years
). 13.43 years
*. 14.0+ years

20. Imprudential, Inc. has an unfunded pension lia"ility of !450 million that must "e paid in
+5 years. To assess the value of the firm:s stoc#, financial analysts %ant to discount this
lia"ility "ac# to the present. The relevant discount rate is 2.5 percent. $hat is the present
value of this lia"ility&
'. !156,40.,12+
(. !131,-.4,603
C. !132,023,.11
). !14-,516,-4-
*. !161,511,.23

21. You have 5ust received notification that you have %on the !1.- million first priEe in the
Centennial >ottery. 0o%ever, the priEe %ill "e a%arded on your 100
th
"irthday, 30 years from
no%. The appropriate discount rate is 4 percent. $hat is the present value of your %innins&
'. !-,+44.12
(. !2,-0-.+0
C. !15,.06.61
). !+.,......
*. !+5,000.00

2+. Your coin collection contains fifty-four 16-1 silver dollars. Your randparents purchased
them for their face value %hen they %ere ne%. These coins have appreciated at a 10 percent
annual rate. 0o% much %ill your collection "e %orth %hen you retire in +020&
'. !.,211,004
(. !.,643,-52
C. !-,1++,.6-
). !-,-+1,004
*. !-,551,13+

5-13
2.. In 1465, the %inner of a competition %as paid !110. In +002, the %inner:s priEe %as
!30,000. $hat %ill the %inner:s priEe "e in +0-0 if the priEe continues increasin at the same
rate&
'. !.46,-00
(. !-+1,1++
C. !-36,.11
). !505,263
*. !5-4,1+1

2-. /uppose that the first comic "oo# of a classic series %as sold in 165-. In +000, the
estimated price for this comic "oo# in ood condition %as a"out !.-0,000. This represented a
return of +3 percent per year. Aor this to "e true, %hat %as the oriinal price of the comic "oo#
in 165-&
'. !5.00
(. !5.+4
C. !5.50
). !5.31
*. !2.00

25. /uppose you are committed to o%nin a !1-0,000 Aerrari. You "elieve your mutual fund
can achieve an annual rate of return of 6 percent and you %ant to "uy the car in 3 years. 0o%
much must you invest today to fund this purchase assumin the price of the car remains
constant&
'. !3-,+04.12
(. !32,54-.36
C. !33,611.04
). !34,016.4+
*. !36,--2.20

5-14
22. You have 5ust made a !1,500 contri"ution to your individual retirement account. 'ssume
you earn a 1+ percent rate of return and ma#e no additional contri"utions. 0o% much more
%ill your account "e %orth %hen you retire in +5 years than it %ould "e if you %aited another
10 years "efore ma#in this contri"ution&
'. !4,.02.12
(. !6,254.33
C. !12,.11.14
). !12,603.13
*. !13,+46.35

23. You are scheduled to receive !.0,000 in t%o years. $hen you receive it, you %ill invest it
for 5 more years, at 4 percent per year. 0o% much money %ill you have 3 years from no%&
'. !.6,606.16
(. !-1,.41.12
C. !--,036.4-
). !-3,+06.16
*. !51,-1-.3.

24. You e1pect to receive !6,000 at raduation in + years. You plan on investin this money at
10 percent until you have !20,000. 0o% many years %ill it "e until this occurs&
'. 14.34 years
(. 16.62 years
C. +1.60 years
). +..04 years
*. +5.00 years

5-16
Chapter 05 Introduction to Valuation: The Time Value of Money 'ns%er Fey


1. You are investin !100 today in a savins account at your local "an#. $hich one of the
follo%in terms refers to the value of this investment one year from no%&
A. future value
(. present value
C. principal amounts
). discounted value
*. invested principal
?efer to section 5.1

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Obecti!e: "#$
Section: "%$
&o'ic: (uture !alue

+. Tracy invested !1,000 five years ao and earns - percent interest on her investment. (y
leavin her interest earnins in her account, she increases the amount of interest she earns
each year. The %ay she is handlin her interest income is referred to as %hich one of the
follo%in&
'. simplifyin
B. compoundin
C. areation
). accumulation
*. discountin

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%$
&o'ic: Com'ounding

5-+0
.. /teve invested !100 t%o years ao at 10 percent interest. The first year, he earned !10
interest on his !100 investment. 0e reinvested the !10. The second year, he earned !11
interest on his !110 investment. The e1tra !1 he earned in interest the second year is referred
to as:
'. free interest.
(. "onus income.
C. simple interest.
. interest on interest.
*. present value interest.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%$
&o'ic: )nterest on interest

-. Interest earned on "oth the initial principal and the interest reinvested from prior periods is
called:
'. free interest.
(. dual interest.
C. simple interest.
E. compound interest.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%$
&o'ic: Com'ound interest

5-+1
5. /ara invested !500 si1 years ao at 5 percent interest. /he spends her earnins as soon as
she earns any interest so she only receives interest on her initial !500 investment. $hich type
of interest is /ara earnin&
'. free interest
(. comple1 interest
C. simple interest
). interest on interest
*. compound interest

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%$
&o'ic: Sim'le interest

2. /helley %on a lottery and %ill receive !1,000 a year for the ne1t ten years. The value of her
%innins today discounted at her discount rate is called %hich one of the follo%in&
'. sinle amount
(. future value
C. present value
). simple amount
*. compounded value
?efer to section 5.+

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Obecti!e: "#*
Section: "%*
&o'ic: +resent !alue

5-++
3. Terry is calculatin the present value of a "onus he %ill receive ne1t year. The process he is
usin is called:
'. ro%th analysis.
B. discountin.
C. accumulatin.
). compoundin.
*. reducin.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%*
&o'ic: Discounting

4. /teve 5ust computed the present value of a !10,000 "onus he %ill receive in the future. The
interest rate he used in this process is referred to as %hich one of the follo%in&
'. current yield
(. effective rate
C. compound rate
). simple rate
E. discount rate

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%*
&o'ic: Discount rate

5-+.
6. The process of determinin the present value of future cash flo%s in order to #no% their
%orth today is called %hich one of the follo%in&
'. compound interest valuation
(. interest on interest computation
C. discounted cash flo% valuation
). present value interest factorin
*. comple1 factorin

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%*
&o'ic: Discounted cas, flow !aluation

10. 'ndy deposited !.,000 this mornin into an account that pays 5 percent interest,
compounded annually. (ar" also deposited !.,000 this mornin into an account that pays 5
percent interest, compounded annually. 'ndy %ill %ithdra% his interest earnins and spend it
as soon as possi"le. (ar" %ill reinvest her interest earnins into her account. 7iven this,
%hich one of the follo%in statements is true&
'. (ar" %ill earn more interest the first year than 'ndy %ill.
(. 'ndy %ill earn more interest in year three than (ar" %ill.
C. (ar" %ill earn interest on interest.
). 'fter five years, 'ndy and (ar" %ill "oth have earned the same amount of interest.
*. 'ndy %ill earn compound interest.

AACSB: N/A
Bloom's: Com're,ension
Difficulty: Basic
Section: "%$
&o'ic: Com'ound interest

5-+-
11. /ue and 8eal are t%ins. /ue invests !5,000 at 3 percent %hen she is +5 years old. 8eal
invests !5,000 at 3 percent %hen he is .0 years old. (oth investments compound interest
annually. (oth /ue and 8eal retire at ae 20. $hich one of the follo%in statements is correct
assumin that neither /ue nor 8eal has %ithdra%n any money from their accounts&
'. /ue %ill have less money %hen she retires than 8eal.
(. 8eal %ill earn more interest on interest than /ue.
C. 8eal %ill earn more compound interest than /ue.
). If "oth /ue and 8eal %ait to ae 30 to retire, then they %ill have e9ual amounts of savins.
E. /ue %ill have more money than 8eal as lon as they retire at the same time.

AACSB: N/A
Difficulty: Basic
Section: "%$
&o'ic: (uture !alue

1+. /amantha opened a savins account this mornin. 0er money %ill earn 5 percent interest,
compounded annually. 'fter five years, her savins account %ill "e %orth !5,200. 'ssume she
%ill not ma#e any %ithdra%als. 7iven this, %hich one of the follo%in statements is true&
'. /amantha deposited more than !5,200 this mornin.
(. The present value of /amantha:s account is !5,200.
C. /amantha could have deposited less money and still had !5,200 in five years if she could
have earned 5.5 percent interest.
). /amantha %ould have had to deposit more money to have !5,200 in five years if she could
have earned 2 percent interest.
*. /amantha %ill earn an e9ual amount of interest every year for the ne1t five years.

AACSB: N/A
Difficulty: )ntermediate
Section: "%*

5-+5
1.. This afternoon, you deposited !1,000 into a retirement savins account. The account %ill
compound interest at 2 percent annually. You %ill not %ithdra% any principal or interest until
you retire in forty years. $hich one of the follo%in statements is correct&
'. The interest you earn si1 years from no% %ill e9ual the interest you earn ten years from
no%.
(. The interest amount you earn %ill dou"le in value every year.
C. The total amount of interest you %ill earn %ill e9ual !1,000 .02 -0.
. The present value of this investment is e9ual to !1,000.
*. The future value of this amount is e9ual to !1,000 ;1 < -0=
.02
.
?efer to sections 5.1 and 5.+

AACSB: N/A
Learning Obecti!e: "#$ and "#*
Section: "%$ and "%*
&o'ic: +resent and future !alues

1-. Your randmother has promised to ive you !5,000 %hen you raduate from collee. /he
is e1pectin you to raduate t%o years from no%. $hat happens to the present value of this
ift if you delay your raduation "y one year and raduate three years from no%&
'. remains constant
(. increases
C. decreases
). "ecomes neative
*. cannot "e determined from the information provided

AACSB: N/A
Difficulty: Basic
Section: "%*

5-+2
15. >uis is oin to receive !+0,000 si1 years from no%. /oo >ee is oin to receive !+0,000
nine years from no%. $hich one of the follo%in statements is correct if "oth >uis and /oo
>ee apply a 3 percent discount rate to these amounts&
'. The present values of >uis and /oo >ee:s monies are e9ual.
(. In future dollars, /oo >ee:s money is %orth more than >uis: money.
C. In today:s dollars, >uis: money is %orth more than /oo >ee:s.
). T%enty years from no%, the value of >uis: money %ill "e e9ual to the value of /oo >ee:s
money.
*. /oo >ee:s money is %orth more than >uis: money iven the 3 percent discount rate.
?efer to sections 5.1 and 5.+

AACSB: N/A

12. $hich one of the follo%in varia"les is the e1ponent in the present value formula&
'. present value
(. future value
C. interest rate
. time
*. There is no e1ponent in the present value formula.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: "%*

5-+3
13. You %ant to have !1 million in your savins account %hen you retire. You plan on
investin a sinle lump sum today to fund this oal. You are plannin on investin in an
account %hich %ill pay 3.5 percent annual interest. $hich of the follo%in %ill 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 payin a hiher rate of interest.
II. Invest in a different account payin a lo%er rate of interest.
III. ?etire later.
IV. ?etire sooner.
'. I only
(. II only
C. I and III only
). I and IV only
*. II and III only

AACSB: N/A
Section: "%*

14. $hich one of the follo%in %ill produce the hihest present value interest factor&
A. 2 percent interest for five years
(. 2 percent interest for eiht years
C. 2 percent interest for ten years
). 4 percent interest for five years
*. 4 percent interest for ten years
?efer to sections 5.+

AACSB: N/A
Section: "%*
&o'ic: +resent !alue factor

5-+4
16. $hat is the relationship "et%een present value and future value interest factors&
'. The present value and future value factors are e9ual to each other.
(. The present value factor is the e1ponent of the future value factor.
C. The future value factor is the e1ponent of the present value factor.
. The factors are reciprocals of each other.
*. There is no relationship "et%een these t%o factors.
?efer to section 5..

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Obecti!e: "#-
Section: "%-
&o'ic: +resent and future !alue factors

+0. Martin invested !1,000 si1 years ao and e1pected to have !1,500 today. 0e has not added
or %ithdra%n any money from this account since his initial investment. 'll interest %as
reinvested in the account. 's it turns out, Martin only has !1,-+0 in his account today. $hich
one of the follo%in must "e true&
'. Martin earned simple interest rather than compound interest.
B. Martin earned a lo%er interest rate than he e1pected.
C. Martin did not earn any interest on interest as he e1pected.
). Martin inored the ?ule of 3+ %hich caused his account to decrease in value.
*. The future value interest factor turned out to "e hiher than Martin e1pected.
?efer to sections 5.1 and 5..

AACSB: N/A
Learning Obecti!e: "#$ and "#-
Section: "%$ and "%-
&o'ic: )nterest rate

5-+6
+1. 7erold invested !2,+00 in an account that pays 5 percent simple interest. 0o% much
money %ill he have at the end of ten years&
'. !4,310
(. !6,000
C. !6,.00
). !6,234
*. !10,066
*ndin value G !2,+00 < ;!2,+00 .05 10= G !6,.00

AACSB: Analytic
Bloom's: A''lication
Difficulty: Basic
Section: "%$
&o'ic: (uture !alue

++. 'le1 invested !10,500 in an account that pays 2 percent simple interest. 0o% much
money %ill he have at the end of four years&
'. !1+,250
(. !1+,623
C. !1.,0+0
). !1.,+52
*. !1.,500
*ndin value G !10,500 < ;!10,500 .02 -= G !1.,0+0

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: (uture !alue

5-.0
+.. You invested !1,250 in an account that pays 5 percent simple interest. 0o% much more
could you have earned over a +0-year period if the interest had compounded annually&
'. !4-6.++
(. !6.0.11
C. !64+.16
). !1,0+1.15
E. !1,033.6-
/imple interest G !1,250 < ;!1,250 .05 +0= G !.,.00
'nnual compoundin G !1,250 ;1.05=
+0
G !-,.33.6-
)ifference G !-,.33.6- - !.,.00 G !1,033.6-

AACSB: Analytic
Section: "%$
&o'ic: Sim'le !ersus com'ound interest

5-.1
+-. Travis invested !6,+50 in an account that pays 2 percent simple interest. 0o% much more
could he have earned over a 3-year period if the interest had compounded annually&
'. !3-1.-1
B. !33..54
C. !40+.12
). !4.....
*. !454.06
/imple interest G !6,+50 < ;!6,+50 .02 3= G !1.,1.5
Compound interest G !6,+50 ;1 < .02=
3
G !1.,604.54
)ifference G !1.,604.54 - !1.,1.5 G !33..54

AACSB: Analytic
Section: "%$
&o'ic: Sim'le !ersus com'ound interest

+5. $hat is the future value of !3,146 invested for +. years at 6.+5 percent compounded
annually&
'. !++,-4..20
(. !+3,460.43
C. !.4,661.03
). !51,006.1.
E. !5-,666.44
Auture value G !3,146 ;1 < .06+5=
+.
G !5-,666.44

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: (uture !alue

5-.+
+2. Today, you earn a salary of !.2,000. $hat %ill "e your annual salary t%elve years from
no% if you earn annual raises of ..2 percent&
A. !55,0.+.5-
(. !53,-1-.02
C. !54,+.5.+-
). !56,1++.04
*. !56,.20.-5
Auture value G !.2,000 ;1 < .0.2=
1+
G !55,0.+.5-

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: (uture !alue

+3. You o%n a classic automo"ile that is currently valued at !1-3,600. If the value increases
"y 2.5 percent annually, ho% much %ill the automo"ile "e %orth ten years from no%&
'. !+--,0.5.00
(. !+51,004.13
C. !+30,01...4
. !+33,2+4.2.
*. !+61,-40.14
Auture value G !1-3,600 ;1 < .025=
10
G !+33,2+4.2.

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: (uture !alue

5-..
+4. You hope to "uy your dream car four years from no%. Today, that car costs !4+,500. You
e1pect the price to increase "y an averae of -.4 percent per year over the ne1t four years.
0o% much %ill your dream car cost "y the time you are ready to "uy it&
'. !64,.-0.00
(. !64,222.23
C. !66,513.-1
). !66,414.0+
*. !100,0+..12
Auture value G !4+,500 ;1 < .0-4=
-
G !66,513.-1

AACSB: Analytic
Difficulty: Basic
Section: "%$
&o'ic: (uture !alue

5-.-
+6. This mornin, T> Truc#in invested !40,000 to help fund a company e1pansion pro5ect
planned for - years from no%. 0o% much additional money %ill the firm have - years from
no% if it can earn 5 percent rather than - percent on its savins&
'. !+,6-0.06
B. !.,251.4+
C. !-,004.13
). !-,+16.24
*. !-,311.04
Auture value G !40,000 ;1 < .05=
-
G !63,+-0.50
Auture value G !40,000 ;1 < .0-=
-
G !6.,544.24
)ifference G !63,+-0.50 - !6.,544.24 G !.,251.4+

AACSB: Analytic
Bloom's: Analysis
Section: "%$
&o'ic: (uture !alue

5-.5
.0. You 5ust received !++5,000 from an insurance settlement. You have decided to set this
money aside and invest it for your retirement. Currently, your oal is to retire +5 years from
today. 0o% much more %ill you have in your account on the day you retire if you can earn an
averae return of 10.5 percent rather than 5ust 4 percent&
'. !-13,1.3
(. !246,506
C. !1,050,-+.
. !1,146,532
*. !1,414,.-+
Auture value G !++5,000 ;1 < .105=
+5
G !+,3.0,-4.
Auture value G !++5,000 ;1 < .04=
+5
G !1,5-0,603
)ifference G !+,3.0,-4. - !1,5-0,603 G !1,146,532

AACSB: Analytic
Bloom's: Analysis
Section: "%$
&o'ic: (uture !alue

5-.2
.1. You 5ust received a !5,000 ift from your randmother. You have decided to save this
money so that you can ift it to your randchildren 50 years from no%. 0o% much additional
money %ill you have to ift to your randchildren if you can earn an averae of 4.5 percent
instead of 5ust 4 percent on your savins&
'. !-3,.14.06
(. !5+,-2-.36
C. !55,+11.12
). !54,411.66
E. !20,6+..5+
Auture value G !5,000 ;1 < .045=
50
G !+65,-.1.54
Auture value G !5,000 ;1 < .04=
50
G !+.-,504.02
)ifference G !+65,-.1.54 - !+.-,504.02 G !20,6+..5+

AACSB: Analytic
Bloom's: Analysis
Section: "%$
&o'ic: (uture !alue

5-.3
.+. You are depositin !1,500 in a retirement account today and e1pect to earn an averae
return of 3.5 percent on this money. 0o% much additional income %ill you earn if you leave
the money invested for -5 years instead of 5ust -0 years&
'. !10,3+..04
B. !11,360.60
C. !1+,--1.52
). !1+,604.16
*. !1.,560.6.
Auture value G !1,500 ;1 < .035=
-5
G !.4,453.+2
Auture value G !1,500 ;1 < .035=
-0
G !+3,022..2
)ifference G !.4,453.+2 - !+3,022..2 G !11,360.60

AACSB: Analytic
Bloom's: Analysis
Section: "%$
&o'ic: (uture !alue

5-.4
... You collect old coins. Today, you have t%o coins each of %hich is valued at !+50. @ne
coin is e1pected to increase in value "y 2 percent annually %hile the other coin is e1pected to
increase in value "y -.5 percent annually. $hat %ill "e the difference in the value of the t%o
coins 15 years from no%&
A. !115..+
(. !+04.0-
C. !+-1.36
). !+5-.+-
*. !+40.15
Auture value G !+50 ;1 < .02=
15
G !566.1-
Auture value G !+50 ;1 < .0-5=
15
G !-4..4+
)ifference G !566.1- - !-4..4+ G !115..+

AACSB: Analytic
Bloom's: Analysis
Section: "%$
&o'ic: (uture !alue

5-.6
.-. Your father invested a lump sum +2 years ao at -.+5 percent interest. Today, he ave you
the proceeds of that investment %hich totaled !51,-40.36. 0o% much did your father
oriinally invest&
'. !15,6+6.-3
(. !12,500.00
C. !13,---.42
). !13,500.00
*. !13,666.-5
Bresent value G !51,-40.36 H1I;1 < .0-+5=
+2
J G !13,---.42

AACSB: Analytic
Difficulty: Basic
Section: "%*

.5. $hat is the present value of !150,000 to "e received 4 years from today if the discount
rate is 11 percent&
A. !25,044.63
(. !31,1-3.03
C. !3-,1-1.-1
). !36,402.14
*. !4.,+61.02
Bresent value G !150,000 H1I1 < .11=
4
J G !25,044.63

AACSB: Analytic
Difficulty: Basic
Section: "%*

5--0
.2. You %ould li#e to ive your dauhter !35,000 to%ards her collee education 13 years
from no%. 0o% much money must you set aside today for this purpose if you can earn 4
percent on your investments&
'. !14,.44.16
B. !+0,+30.13
C. !+4,-13.23
). !+6,.11.1.
*. !.+,-44..3
Bresent value G !35,000 H1I;1 < .04=
13
J G !+0,+30.13

AACSB: Analytic
Difficulty: Basic
Section: "%*

5--1
.3. You %ant to have !.5,000 saved 2 years from no% to "uy a house. 0o% much less do you
have to deposit today to reach this oal if you can earn 5.5 percent rather than 5 percent on
your savins& Today:s deposit is the only deposit you %ill ma#e to this savins account.
A. !3...6-
(. !361.14
C. !4+-.20
). !4-5.11
*. !616.0+
Bresent value G !.5,000 H1I;1 < .05=
2
J G !+2,113.5-
Bresent value G !.5,000 H1I;1 < .055=
2
J G !+5,.4..20
)ifference G !+2,113.5- - !+5,.4..20 G !3...6-

AACSB: Analytic
Section: "%*

5--+
.4. Your older sister deposited !5,000 today at 4.5 percent interest for 5 years. You %ould li#e
to have 5ust as much money at the end of the ne1t 5 years as your sister %ill have. 0o%ever,
you can only earn 3 percent interest. 0o% much more money must you deposit today than
your sister did if you are to have the same amount at the end of the 5 years&
'. !.+1.16
B. !.20.-.
C. !.43.34
). !-01.+1
*. !-1...6
Auture value G !5,000 ;1 < .045=
5
G !3,514.+4
Bresent value G !3,514.+4 H1I;1 < .03=
5
J G !5,.20.-.
)ifference G !5,.20.-. - !5,000 G !.20.-.

AACSB: Analytic
Bloom's: Analysis

5--.
.6. ' year ao, you deposited !.0,000 into a retirement savins account at a fi1ed rate of 5.5
percent. Today, you could earn a fi1ed rate of 2.5 percent on a similar type account. 0o%ever,
your rate is fi1ed and cannot "e ad5usted. 0o% much less could you have deposited last year if
you could have earned a fi1ed rate of 2.5 percent and still have the same amount as you
currently %ill %hen you retire .4 years from today&
'. !+,114.-+ less
(. !.,...... less
C. !5,-13.06 less
). !3,+3-.1+ less
E. !6,+.-.63 less
Auture value G !.0,000 ;1 < .055=
.4<1
G !+-+,04-.21
Bresent value G !+-+,04-.21 H1I;1 < .025=
.4<1
J G !+0,325.0.
)ifference G !.0,000 - !+0,325.0. G !6,+.-.63

AACSB: Analytic
Bloom's: Analysis

5---
-0. $hen you retire -0 years from no%, you %ant to have !1.+ million. You thin# you can
earn an averae of 1+ percent on your investments. To meet your oal, you are tryin to
decide %hether to deposit a lump sum today, or to %ait and deposit a lump sum + years from
today. 0o% much more %ill you have to deposit as a lump sum if you %ait for + years "efore
ma#in the deposit&
'. !1,-1-.1-
(. !+,.16.-3
C. !+,461.11
. !.,+40.34
*. !.,-02.34
Bresent value G !1,+00,000 H1I;1 < .1+=
-0
J G !1+,462.12
Bresent value G !1,+00,000 H1I;1 < .1+=
.4
J G !12,132.6-
)ifference G !12,132.6- - !1+,462.12 G !.,+40.34

AACSB: Analytic
Bloom's: Analysis
Section: "%*

5--5
-1. Theo needs !-0,000 as a do%n payment for a house 2 years from no%. 0e earns ..5
percent on his savins. Theo can either deposit one lump sum today for this purpose or he can
%ait a year and deposit a lump sum. 0o% much additional money must he deposit if he %aits
for one year rather than ma#in the deposit today&
'. !434.64
(. !611.1.
C. !1,1.4.60
). !1,.-4.0.
*. !1,-+0.14
Bresent value G !-0,000 H1I;1 < .0.5=
2
J G !.+,5-0.0.
Bresent value G !+2,000 H1I;1 < .0.5=
5
J G !..,234.6.
)ifference G !..,234.6. - !.+,5-0.0. G !1,1.4.60

AACSB: Analytic
Bloom's: Analysis
Section: "%*

5--2
-+. @ne year ao, you invested !1,400. Today it is %orth !1,6+-.2+. $hat rate of interest did
you earn&
'. 2.56 percent
(. 2.23 percent
C. 2.44 percent
. 2.6+ percent
*. 3.01 percent
!1,6+-.2+ G !1,400 ;1 < r=
1
K r G 2.6+ percent

AACSB: Analytic
Difficulty: Basic
Section: "%-

-.. 'ccordin to the ?ule of 3+, you can do %hich one of the follo%in&
'. dou"le your money in five years at 3.+ percent interest
(. dou"le your money in 3.+ years at 4 percent interest
C. dou"le your money in 4 years at 6 percent interest
). triple your money in 3.+ years at 5 percent interest
*. triple your money at 10 percent interest in 3.+ years
?ule of 3+ G 3+I4 years G 6 percent interest

AACSB: Analytic
Difficulty: Basic
Section: "%-

5--3
--. Aorty years ao, your mother invested !5,000. Today, that investment is %orth
!-.0,025.11. $hat is the averae annual rate of return she earned on this investment&
'. 11.24 percent
(. 11.31 percent
C. 11.34 percent
). 11.61 percent
*. 1+.0+ percent
!-.0,025.11 G !5,000 ;1 < r=
-0
K r G 11.34 percent

AACSB: Analytic
Difficulty: Basic
Section: "%-

5--4
-5. /i1teen years ao, 'licia invested !1,000. *iht years ao, Travis invested !+,000. Today,
"oth 'licia:s and Travis: investments are each %orth !+,-00. 'ssume that "oth 'licia and
Travis continue to earn their respective rates of return. $hich one of the follo%in statements
is correct concernin these investments&
'. Three years from today, Travis: investment %ill "e %orth more than 'licia:s.
B. @ne year ao, 'licia:s investment %as %orth less than Travis: investment.
C. Travis earns a hiher rate of return than 'licia.
). Travis has earned an averae annual interest rate of ...3 percent.
*. 'licia has earned an averae annual interest rate of 2.01 percent.
'licia: !+,-00 G !1,000 ;1 < r=
12
K r G 5.2+ percent
Travis: !+,-00 G !+,000 ;1 < r=
4
K r G +..1 percent
/ince "oth 'licia and Travis have e9ual account values today and since 'licia earns the hiher
rate of return, her account had to "e %orth less than Travis: account one year ao.

AACSB: Analytic
Bloom's: Synt,esis
Section: "%-

5--6
-2. Benn /tation is savin money to "uild a ne% loadin platform. T%o years ao, they set
aside !+-,000 for this purpose. Today, that account is %orth !+4,.66. $hat rate of interest is
Benn /tation earnin on this investment&
'. 2..6 percent
(. 3.-3 percent
C. 4.34 percent
). 6.+. percent
*. 6.23 percent
!+4,.66 G !+-,000 ;1 < r=
+
K r G 4.34 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Section: "%-

-3. Aifteen years ao, Cac#son /upply set aside !1.0,000 in case of a financial emerency.
Today, that account has increased in value to !..0,56+. $hat rate of interest is the firm
earnin on this money&
'. 5.40 percent
B. 2.-+ percent
C. 2.35 percent
). 3.+4 percent
*. 3.5. percent
!..0,56+ G !1.0,000 ;1 < r=
15
K r G 2.-+ percent

AACSB: Analytic
Difficulty: Basic
Section: "%-

5-50
-4. Aourteen years ao, your parents set aside !3,500 to help fund your collee education.
Today, that fund is valued at !+2,140. $hat rate of interest is "ein earned on this account&
'. 3.66 percent
(. 4..2 percent
C. 4.51 percent
. 6..- percent
*. 10.02 percent
!+2,140 G !3,500 ;1 < r=
1-
K r G 6..- percent

AACSB: Analytic
Difficulty: Basic
Section: "%-

-6. /ome time ao, Culie purchased eleven acres of land costin !.2,600. Today, that land is
valued at !+1-,400. 0o% lon has she o%ned this land if the price of the land has "een
increasin at 10.5 percent per year&
'. 1.... years
(. 12.64 years
C. 13.2- years
). 16.+6 years
*. +1.04 years
!+1-,400 G !.2,600 ;1 < .105=
t
K t G 13.2- years

AACSB: Analytic
Difficulty: Basic
Learning Obecti!e: "#.
Section: "%-
&o'ic: &ime 'eriod

5-51
50. @n your ninth "irthday, you received !.00 %hich you invested at -.5 percent interest,
compounded annually. Your investment is no% %orth !352. 0o% old are you today&
'. ae +6
B. ae .0
C. ae .1
). ae .+
*. ae ..
!352 G !.00 ;1 < .0-5=
t
K t G +1 yearsK 'e today G 6 < +1 G .0

AACSB: Analytic
Difficulty: Basic
Section: "%-
&o'ic: &ime 'eriod

Essay Questions

51. You %ant to deposit sufficient money today into a savins account so that you %ill have
!1,000 in the account three years from today. *1plain %hy you could deposit less money
today if you could earn ..5 percent interest rather than . percent interest.
/tudent ans%ers %ill vary "ut should present the idea that %hen you can earn more interest,
you need less of your o%n money to reach the same future dollar amount. They can also "ase
their ans%er on the present value formula.
Aeed"ac#: ?efer to section 5.+

AACSB: /eflecti!e t,in0ing
Bloom's: Analysis
Difficulty: Basic
Section: "%*

5-5+
5+. You are considerin t%o separate investments. (oth investments pay 3 percent interest.
Investment ' pays simple interest and Investment ( pays compound interest. $hich
investment should you choose, and %hy, if you plan on investin for a period of 5 years&
/imple interest is interest earned on the initial principal amount only. Compound interest is
interest earned on "oth the initial principal and all prior interest earnins that have "een
reinvested. You should choose Investment ( %hich pays compound interest as you %ill earn
more interest income over the 5 years "y doin so.
Aeed"ac#: ?efer to section 5.1

Bloom's: Analysis
Difficulty: Basic
Section: "%$
&o'ic: Sim'le and com'ound interest

5.. $hat lesson does the future value formula provide for youn %or#ers %ho are loo#in
ahead to retirin some day&
The future value formula is: AV G BV ;1 < r=
t
. Time is the e1ponent. $hile the rate of return is
important and has a direct affect on the ro%th of an investment account, time is critical. To
ma1imiEe retirement income, %or#ers need to commence savin %hen they are youn so that
reinvested earnins have time to compound.
Aeed"ac#: ?efer to section 5.1

Bloom's: 1!aluation
Section: "%$
&o'ic: (uture !alue

5-5.
5-. You are considerin t%o lottery payment options: @ption ' pays !10,000 today and
@ption ( pays !+0,000 at the end of ten years. 'ssume you can earn 2 percent on your
savins. $hich option %ill you choose if you "ase your decision on present values& $hich
option %ill you choose if you "ase your decision on future values& *1plain %hy your ans%ers
are either the same or different.
BV of ' G !10,000K BV of ( G !11,123.60K AV of ' G !13,604.-4K AV of ( G !+0,000. (ased
on "oth present values and future values, ( is the "etter choice. /tudents should e1plain that
computin present values and computin future values are simply inverse processes of one
another, and that choosin "et%een t%o lump sums "ased on present values %ill al%ays ive
the same result as choosin "et%een the same t%o lump sums "ased on future values.
Aeed"ac#: ?efer to sections 5.1 and 5.+

Bloom's: 1!aluation

55. 't an interest rate of 10 percent and usin the ?ule of 3+, ho% lon %ill it ta#e to dou"le
the value of a lump sum invested today& 0o% lon %ill it ta#e after that until the account
ro%s to four times the initial investment& 7iven the po%er of compoundin, shouldn:t it ta#e
less time for the money to dou"le the second time&
It %ill ta#e 3.+ years to dou"le the initial investment, then another 3.+ years to dou"le it aain.
That is, it ta#es 1-.- years for the value to reach four times the initial investment.
Compoundin doesn:t affect the amount of time it ta#es for an investment to dou"le in value.
0o%ever, you should note that durin the first 3.+ years, the interest earned is e9ual to 100
percent of the initial investment. )urin the second 3.+ years, the interest earned is e9ual to
+00 percent of the initial investment. That is the po%er of compoundin.
Aeed"ac#: ?efer to section 5..

Bloom's: Analysis
Section: "%-
&o'ic: /ule of 2*

5-5-

52. 'ssume the total cost of a collee education %ill "e !.00,000 %hen your child enters
collee in 12 years. You presently have !35,521 to invest. $hat rate of interest must you earn
on your investment to cover the cost of your child:s collee education&
'. 3.35 percent
(. 4.50 percent
C. 6.00 percent
). 6.+5 percent
*. 6.50 percent
!.00,000 G !35,521 ;1 < r=
12
K r G 6 percent

AACSB: Analytic
Difficulty: Basic
1OC 3: "#4
Section: "%-

53. 't 11 percent interest, ho% lon %ould it ta#e to 9uadruple your money&
'. 2.55 years
(. 2.2- years
C. 1..06 years
. 1..+4 years
*. 1..52 years
!- G !1 ;1 < .11=
t
K t G 1..+4 years

AACSB: Analytic
Difficulty: Basic
Section: "%-
&o'ic: &ime 'eriod

5-55
54. 'ssume the averae vehicle sellin price in the Dnited /tates last year %as !-1,662. The
averae price 6 years earlier %as !+6,000. $hat %as the annual increase in the sellin price
over this time period&
'. ..46 percent
B. -.+0 percent
C. -.52 percent
). 5.01 percent
*. 5.-0 percent
!-1,662 G !+6,000 ;1 < r=
6
K r G -.+0 percent

AACSB: Analytic
Difficulty: Basic
1OC 3: "#5
Section: "%-

5-52
56. You:re tryin to save to "uy a ne% !120,000 Aerrari. You have !52,000 today that can "e
invested at your "an#. The "an# pays 2 percent annual interest on its accounts. 0o% many
years %ill it "e "efore you have enouh to "uy the car& 'ssume the price of the car remains
constant.
'. 12.23 years
(. 13.0- years
C. 13.-1 years
). 13.43 years
E. 14.0+ years
!120,000 G !52,000 ;1 < .02=
t
K t G 14.0+ years

AACSB: Analytic
Difficulty: Basic
1OC 3: "#6
Section: "%-
&o'ic: &ime 'eriod

5-53
20. Imprudential, Inc. has an unfunded pension lia"ility of !450 million that must "e paid in
+5 years. To assess the value of the firm:s stoc#, financial analysts %ant to discount this
lia"ility "ac# to the present. The relevant discount rate is 2.5 percent. $hat is the present
value of this lia"ility&
'. !156,40.,12+
(. !131,-.4,603
C. !132,023,.11
). !14-,516,-4-
*. !161,511,.23
BV G !450,000,000 H1I;1.025=
+5
J G !132,023,.11

AACSB: Analytic
Difficulty: Basic
1OC 3: "#$7
Section: "%*

5-54
21. You have 5ust received notification that you have %on the !1.- million first priEe in the
Centennial >ottery. 0o%ever, the priEe %ill "e a%arded on your 100
th
"irthday, 30 years from
no%. The appropriate discount rate is 4 percent. $hat is the present value of your %innins&
'. !-,+44.12
B. !2,-0-.+0
C. !15,.06.61
). !+.,......
*. !+5,000.00
BV G !1,-00,000 H1I;1.04=
30
J G !2,-0-.+0

AACSB: Analytic
Difficulty: Basic
1OC 3: "#$$
Section: "%*

5-56
2+. Your coin collection contains fifty-four 16-1 silver dollars. Your randparents purchased
them for their face value %hen they %ere ne%. These coins have appreciated at a 10 percent
annual rate. 0o% much %ill your collection "e %orth %hen you retire in +020&
'. !.,211,004
(. !.,643,-52
C. !-,1++,.6-
). !-,-+1,004
E. !-,551,13+
AV G !5- ;1.10=
116
G !-,551,13+

AACSB: Analytic
Difficulty: Basic
1OC 3: "#$*
Section: "%$
&o'ic: (uture !alue

5-20
2.. In 1465, the %inner of a competition %as paid !110. In +002, the %inner:s priEe %as
!30,000. $hat %ill the %inner:s priEe "e in +0-0 if the priEe continues increasin at the same
rate&
'. !.46,-00
(. !-+1,1++
C. !-36,.11
. !505,263
*. !5-4,1+1
!30,000 G !110 ;1 G r=
111
K r G 5.644-22 percent
AV G !30,000 ;1 < .05644-22=
.-
G !505,263

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
1OC 3: "#$-
Learning Obecti!e: "#$ and "#-
Section: "%$ and "%-
&o'ic: )nterest rate and future !alue

5-21
2-. /uppose that the first comic "oo# of a classic series %as sold in 165-. In +000, the
estimated price for this comic "oo# in ood condition %as a"out !.-0,000. This represented a
return of +3 percent per year. Aor this to "e true, %hat %as the oriinal price of the comic "oo#
in 165-&
'. !5.00
(. !5.+4
C. !5.50
. !5.31
*. !2.00
BV G !.-0,000 H1I;1 < .+3=
-2
K BV G !5.31

AACSB: Analytic
1OC 3: "#$.
Section: "%*

5-2+
25. /uppose you are committed to o%nin a !1-0,000 Aerrari. You "elieve your mutual fund
can achieve an annual rate of return of 6 percent and you %ant to "uy the car in 3 years. 0o%
much must you invest today to fund this purchase assumin the price of the car remains
constant&
'. !3-,+04.12
B. !32,54-.36
C. !33,611.04
). !34,016.4+
*. !36,--2.20
BV G !1-0,000 H1I;1 < .06=
3
K BV G !32,54-.36

AACSB: Analytic
1OC 3: "#$2
Section: "%*

5-2.
22. You have 5ust made a !1,500 contri"ution to your individual retirement account. 'ssume
you earn a 1+ percent rate of return and ma#e no additional contri"utions. 0o% much more
%ill your account "e %orth %hen you retire in +5 years than it %ould "e if you %aited another
10 years "efore ma#in this contri"ution&
'. !4,.02.12
(. !6,254.33
C. !12,.11.14
). !12,603.13
E. !13,+46.35
AV G !1,500 ;1 < .1+=
+5
G !+5,500.10
AV G !1,500 ;1 < .1+=
15
G !4,+10..5
)ifference G !13,+46.35

AACSB: Analytic
1OC 3: "#$5
Section: "%$
&o'ic: (uture !alue

5-2-
23. You are scheduled to receive !.0,000 in t%o years. $hen you receive it, you %ill invest it
for 5 more years, at 4 percent per year. 0o% much money %ill you have 3 years from no%&
'. !.6,606.16
(. !-1,.41.12
C. !--,036.4-
). !-3,+06.16
*. !51,-1-.3.
AV G !.0,000 ;1 < .04=
;3-+=
G !--,036.4-

AACSB: Analytic
1OC 3: "#$6
Section: "%$
&o'ic: (uture !alue

24. You e1pect to receive !6,000 at raduation in + years. You plan on investin this money at
10 percent until you have !20,000. 0o% many years %ill it "e until this occurs&
'. 14.34 years
(. 16.62 years
C. +1.60 years
). +..04 years
*. +5.00 years
!20,000 G !6,000 ;1 < .10=
t
K t G 16.60 years
Total time G + < 16.60 G +1.60 years

AACSB: Analytic
1OC 3: "#*7
Section: "%-
&o'ic: &ime 'eriod

5-25

Chapter 05 - Introduction To Valuation: The Time Value of Money

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