CHAPTER 6

TIME VALUE OF MONEY

(Difficulty: E = Easy, M = Medium, and T = Tough)

Multiple Choice: Conceptual

Easy:
PV and discount rate Answer: a Diff: E
1. You have determined the profitability of a planned project by finding
the present value of all the cash flows from that project. Which of the
following would cause the project to look more appealing in terms of the
present value of those cash flows?

a. The discount rate decreases.

b. The cash flows are extended over a longer period of time, but the
total amount of the cash flows remains the same.
c. The discount rate increases.
d. Statements b and c are correct.
e. Statements a and b are correct.

Time value concepts Answer: e Diff: E

2. Which of the following statements is most correct?

a. A 5-year $100 annuity due will have a higher present value than a 5-
year $100 ordinary annuity.
b. A 15-year mortgage will have larger monthly payments than a 30-year
mortgage of the same amount and same interest rate.
c. If an investment pays 10 percent interest compounded annually, its
effective rate will also be 10 percent.
d. Statements a and c are correct.
e. All of the statements above are correct.

Time value concepts Answer: d Diff: E

3. The future value of a lump sum at the end of five years is $1,000. The
nominal interest rate is 10 percent and interest is compounded
semiannually. Which of the following statements is most correct?

a. The present value of the $1,000 is greater if interest is compounded

monthly rather than semiannually.
b. The effective annual rate is greater than 10 percent.
c. The periodic interest rate is 5 percent.
d. Statements b and c are correct.
e. All of the statements above are correct.

Chapter 6 - Page 1
Time value concepts Answer: d Diff: E
4. Which of the following statements is most correct?

a. The present value of an annuity due will exceed the present value of
an ordinary annuity (assuming all else equal).
b. The future value of an annuity due will exceed the future value of an
ordinary annuity (assuming all else equal).
c. The nominal interest rate will always be greater than or equal to the
effective annual interest rate.
d. Statements a and b are correct.
e. All of the statements above are correct.

Time value concepts Answer: e Diff: E

5. Which of the following investments will have the highest future value at
the end of 5 years? Assume that the effective annual rate for all
investments is the same.

a. A pays $50 at the end of every 6-month period for the next 5 years (a
total of 10 payments).
b. B pays $50 at the beginning of every 6-month period for the next
5 years (a total of 10 payments).
c. C pays $500 at the end of 5 years (a total of one payment).
d. D pays $100 at the end of every year for the next 5 years (a total of
5 payments).
e. E pays $100 at the beginning of every year for the next 5 years (a
total of 5 payments).

Effective annual rate Answer: b Diff: E

6. Which of the following bank accounts has the highest effective annual
return?

a. An account that pays 10 percent nominal interest with monthly com-

pounding.
b. An account that pays 10 percent nominal interest with daily com-
pounding.
c. An account that pays 10 percent nominal interest with annual com-
pounding.
d. An account that pays 9 percent nominal interest with daily com-
pounding.
e. All of the investments above have the same effective annual return.

Effective annual rate Answer: d Diff: E

7. You are interested in investing your money in a bank account. Which of
the following banks provides you with the highest effective rate of
interest?

a. Bank 1; 8 percent with monthly compounding.

b. Bank 2; 8 percent with annual compounding.
c. Bank 3; 8 percent with quarterly compounding.
d. Bank 4; 8 percent with daily (365-day) compounding.
e. Bank 5; 7.8 percent with annual compounding.

Chapter 6 - Page 2