Which of the following will result in a lower present value for a given future cash flow?

More risk
A higher interest rate
More time

Why is a dollar received today worth more than a dollar received in the future?
Multiple choice question.

Inflation will increase the value of today's dollar over the next year
Reason: 
Inflation decreases the value of today's dollar. We generally assume the interest rate earned is
higher than the rate of inflation.

Today's dollar can be invested, yielding a greater amount in the future

The difference between _______ interest and compound interest is that compound interest (increases or
decreases) ___________ with time.
simple; increases

The idea behind ______ is that interest is earned on interest.

compounding

The value of a future cash flow stated in today's dollars is referred to as the _____.
present value

True or false: Small changes in the interest rate do not really matter when dealing with millions or billions
of dollars over 30 or 40 years.
False
Reason: 
Small rate differences can be worth thousands of dollars, especially when either the amount or
the time period is large.

Another name for the rate of return is the ______ rate.

discount
The __________ annual interest rate is usually calculated as the total annual payment divided by
the number of payments in the year.
quoted

Suppose you invest $1,000 and the PV of your future cash flows is $1,100. If the investment
becomes riskier, what will happen?
Multiple choice question.

The NPV will remain constant.

Reason: 
The question implies that the future cash flows will not change. Therefore their PV will decrease,
making the NPV lower and possibly negative.

The NPV will decrease.

The NPV will increase.

Reason: 
The question implies that the future cash flows will not change. Therefore their PV will decrease,
making the NPV lower and possibly negative.

If you invest $1,000 and the present value of the incoming cash flows over the following year is
$800, then the NPV is ____.
Reason: 
NPV = -$1,000 + 800 = -$200
Correct Answer
-$200

Another name for the rate of return is the ______ rate.

Discount

What is the NPV of a project with an initial investment of $90, a cash flow in one year of $100,
and a discount rate of 6%? (Be sure to record the initial investment as a negative number.)
Multiple choice question.
$6.17
Reason: 
NPV = -$90 + ($100/1.06) = $4.34

$4.34

If you increase the risk level of a project, the discount rate should ______ which will _____ the project's
present value.
increase; decrease

How is net present value (NPV) computed?

NPV = PV – investment

If you invest $1,000 and the present value of the expected cash inflows is $1,300, then the NPV
is ______.
Multiple choice question.

+$300

A positive NPV will ______ wealth.

increase

According to the basic investment rule for NPV, a firm should ____.
accept a project if the NPV is greater than zero.
reject a project if NPV is less than zero.

What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a
discount rate of 6%? (Be sure to record the initial investment as a negative number.)
When trying to find the total present value of a stream of cash flows over a number of years, you
should add the __________ of the individual cash flows.
present values

The formula for the present value of a perpetuity is ____________.

PV = C/r

The present value formula for a(n) ______ is PV = C/r, where C is the constant and regularly
timed cash flow to infinity, and r is the interest rate.
perpetuity

When trying to find the total present value of a stream of cash flows over a number of years, you should
___________ the present values of the individual cash flows.
add

If interest rates go down, the present value of a perpetuity will ______. (Enter only one word per
blank.)
Increase

$200 at the end of each year forever at 10% per year is worth how much today?
Reason: 
$200/0.10 = $2,000

One example of a perpetuity is a British _____.

consol

If interest rates go up, the present value of a perpetuity will ______.

decrease

If the interest rate is greater than zero, the value of an annuity due is always ______ an ordinary
annuity.
greater than
Which of the following are true about the growing perpetuity model assumptions?
The cash flows occur at regular intervals.
The interest rate must exceed the growth rate.
The cash flow used is that for next year.

Find the future value of an annuity of $200 per year for 10 years at 10 percent per year.

Reason: 
First, find the PV by using the 10 year annuity factor: PV = $200 x 10 year annuity factor = $200
x [1/.1 - 1/.1x(1.1)10]= $1,228.92
To find the future value, multiply $1,228.92 x (1.1)10= $3,187.49.

Using the present value of an annuity formula, the present value of $100 received each year for
20 years at 10% per year is:
Reason: 
100[(1/.10)-(1/(.10(1.10)20))] = 851.36

PV = C1/(r - g) is the formula for the present value of a:

growing perpetuity.

Find the future value of an annuity of $100 per year for 10 years at 10 percent per year.
Reason: 
First, find the PV by using the 10 year annuity factor: PV = $100 x 10 year annuity factor = $100
x [1/.1 - 1/.1x(1.1)10]= $614.46
To find the future value, multiply $614.46 x (1.1)10= $1,593.75.

What is the present value of a perpetuity of $100 per year if the annual interest rate is 10% and
the growth rate is 6% per year?
Reason: 
$100/(.10 - .06) = $2,500

A company pays a $5 dividend with annual dividend increases of 3 percent. If the discount rate is 12
percent, what is present value of this growing perpetuity?
Reason: 
$5/(.12-.03) = $55.56

The effective annual rate (EAR) takes into account the ______ of interest that occurs within a
year.
Compounding

At an annual interest rate of 10 percent, what is the present value of a perpetuity growing at 4
percent per year if next year's cash flow is $6?
Reason: 
$6/(.10 - .04)= $100

Assume 12 percent annual interest is compounded semiannually on a $500 investment. What will
that investment be worth after 1 year?
Reason: 
$500 × (1.06)2 = $561.80

An effective annual rate of 7.12 percent is equal to 7 percent compounded ______.

Semiannually (correct):
EAR = (1 + .07/2)2 – 1 = 7.12%

What is the difference in the future value of $100 at 7 percent interest for 5 years if the interest is
compounded semiannually rather than annually?
Reason: 
($100 × 1.03510) - ($100 × 1.075) = $.80

Another common name for the stated annual interest rate is _____.
annual percentage rate (APR)

Your bank quotes a 9% annual percentage rate on your car loan, which is equal to .75% monthly
interest. What is the effective annual rate?
Reason: 
1.007512 - 1 = 9.38%

Assume interest is compounded monthly. The ______ annual rate will express this rate as though
it were compounded annually.
Effective
What is the general compounding formula for calculating the annual return on an investment
when there is more than one compounding period in a year?

What is the general compounding formula for calculating the annual return on an investment
when there is more than one compounding period in a year?
(1 + r/m)m

The annual percentage rate is the annual interest rate without consideration of _____.
compounding

Which of the following gives an effective annual yield of 12.36 percent?

EAR = (1 + 0.12/2)2 -1 = 12.36%

Which term refers to the stated annual interest rate?

APR

The general formula for the ______ is (1+r/m)m - 1.

EAR

Which compounding interval will result in the highest future value, assuming everything else is
held constant?
Continuous

Which compounding interval will result in the lowest future value, assuming everything else is
held constant?
Annual

There is no limit to how frequently interest could be paid. Where payments are spread evenly
and continuously throughout the year we say the interest rate is ____________ compounded.
continuously

If the stated interest rate is 12 percent, what is the EAR if interest is compounded monthly?
Reason: 
(1 +.12/12)12 - 1 = 12.68%

What is the formula for computing future value with continuous compounding?
C0 × erT

If the stated interest rate is 10 percent, what is the EAR if interest is compounded monthly?
10.47%

What is the future value of $100 compounded continuously for 2 years at a stated annual interest
rate of 10 percent per year?
Reason: 
$100 × e.10 x 2 = $122.14

What is the present value of $100 in 10 years at a continuously compounded rate of 10 percent?
Reason: 
$100/e.1 × 10 = $36.79

What is the future value of $100 compounded continuously at a stated annual rate of 10 percent
for 10 years?
$100 × e.10 × 10 = $271.83

What is the present value of $50 in 10 years at a continuously compounded rate of 10 percent?
Reason: 
$50/e.1 × 10 = $18.39