Computing Cash Flows

Interest and Equivalence

Computing Cash Flows

One way we model financial processes is with cash flow diagrams.

These are horizontal lines that represent time. At various points we place arrows pointing up or down
to represent cash going out (payments) or coming in (revenues). Usually, payments are represented
as negative, down-pointing, and revenues as positive, up-pointing. However, you will see other
representations; within a single financial process you must be consistent. (Remember that EOY means
End-Of-Year.)

Consider several cash flows; do not be concerned with why they are occurring:

At time 0 (beginning of the first year) $50,000 is paid out

At EOY 3 $23,000 is paid out
At EOY 6 $15,000 is received
Every year starting at EOY 1 $2,000 is received

Here is the way the Cash Flow Diagram will look:

We can see that in some years the cash flow is simple: At EOY 1 the cash flow is positive — that is,
revenue — and equals $2,000. In other years, there may be more than one contributor to the cash
flow: At EPY 3, the cash flow is composed of the $2,000 annual amount minus the $23,000 one-time
expense. Thus, the total cash flow at EOY 3 is $21,000 negative.

What is the cash flow at EOY 6?

Scroll down to check your answer.

Did you get $17,000? Note that at EOY 6, there is the annual received amount of $2000 plus the one-
time receipt of $15,000.

Interest and Equivalence

Computing Cash Flows

Question 1.

The Huge Sheet Printing Company is considering purchasing a new web printing press, and they have
determined the following cash items:

Initial Cost: $530,000

Annual Revenue 210,000
Annual Maintenance 80,000
Rebuild Expenses EOY 4 330,000
Salvage Value EOY 7 70,000

Here is a possible cash-flow diagram. Select the answer below that describes this diagram.

Choose the statement which best describes the diagram by clicking on one of the letters below, or
click on "Review topic" if needed.

A The $210,000 is shown in the wrong year.

B The $70,000 should be pointing down.

C The $210,000 must be shown for years 1 through 7.

D The $80,000 arrows must point up.

Review topic

Question 2.

This is the same situation as in Question 1.

The Huge Sheet Printing Company is considering purchasing a new web printing press, and they have
determined the following cash items:

Initial Cost: $530,000

Annual Revenue 210,000
Annual Maintenance 80,000
Rebuild Expenses EOY 4 330,000
Salvage Value EOY 7 70,000

Here is another possible cash flow diagram. Select the answer below that describes this diagram.
Choose the statement which best describes the diagram by clicking on one of the letters below, or
click on "Review topic" if needed.

A The $210,000 is shown in the wrong year.

B The rebuild expense is missing.

C The $70,000 should be pointing down.

D The $80,000 arrows must point up.

Review topic

Question 3.

This is the same situation as in Question 1.

The Huge Sheet Printing Company is considering purchasing a new web printing press, and they have
determined the following cash items:

Initial Cost: $530,000

Annual Revenue 210,000
Annual Maintenance 80,000
Rebuild Expenses EOY 4 330,000
Salvage value EOY 7 70,000

Here is another possible cash flow diagram. Select the answer below that describes this diagram.
Choose the statement which best describes the diagram by clicking on one of the letters below, or
click on "Review topic" if needed.

A The $80,000 arrows must point up.

B The rebuild expense is missing.

C The $70,000 should be pointing down.

D The $210,000 should not be shown at time 0.

Chapter 3 Interest and Equivalence

A company borrows $25,000 for 3 years at an interest rate of 7%. How much must it repay in a lump
sum at the end of the third year?

a. $26,750

b. $30,625

c. $32,000

d. $75,000

A loan of $12,500 for six months yields $1,200 in interest. What is the approximate annual interest rate?

a. 9.6%

b. 10.2%

c. 19.2%

d. 20.3%

A student loan with a simple annual interest rate of 3% is to be repaid in 5 years. The total interest paid
on a student loan is calculated to be $500. How much was originally borrowed?

a. $500

b. $1,667

c. $3,333

d. Cannot be determined from the information given

At an interest rate of 1.75% per month, money will double in value in how many months?

a. 32 months

b. 40 months

c. 43 months

d. It will never double in value

You wish to deposit a certain quantity of money now so that you will have $500 at the end of 5 years.
Assume interest is at 8% per year compounded quarterly. The amount you need to deposit now is
approximately

a. $325.12

b. $336.50

c. $340.20

d. $540.00

A developer wants to purchase three acres of commercial property that will be worth $150,000 in 5
years. It is estimated that the value of the land increases at 9% per year. How much should the
developer be willing to pay now for this property?

a. $13,500

b. $30,000

c. $50,000

d. $97,485

At an interest rate of 1.5% per month, money will double in value in how many months?

a. 22 months

b. 40 months

c. 47 months

d. It will never double in value

A municipal bond is being offered for sale for $250,000. The bond pays no interest (as is the case for
many municipal bonds) during its 20 year life. At the end of 20 years, the owner of the bond will receive
a lump sum payment of $600,000. The bond yield is approximately

a. 4.47%

b. 8.94%

c. 41.67%

d. None of the above

You have just inherited $200,000 and wisely decide to invest your money in a diversified portfolio with
your investment firm. You financial advisor tells you that you can earn an average of 8% interest per
year on your investment. You tell your advisor that you want to retire as soon as your account balance
reaches $1,000,000. If you do not add or take money out of your account and interest does not
fluctuate, how long, rounded to the nearest year, will it take before you have a $1,000,000 balance?

a. 5 years
 b. 7 years

c. 21 years

d. 22 years

What is the interest earned on an investment of $10,000 for five years at 8% simple interest per year?

a. $800

b. $4,000

c. $40,000

d. $400,000