Personal Financial Planning 2nd

Edition Altfest Test Bank

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Test Bank Questions, Chapter 8

1. Which of the following best describes financial assets?

a. Assets in which ownership is represented and traded solely through pieces of

paper.
b. Assets that can be sold currently in a public forum for fair value at low transaction
costs.
c. Assets that you can see or touch that have market value.
d. All of the above.
e. None of the above.

Answer: a

2. Which of the following is never used as an alternative name for real assets?

a. Tangible assets.
b. Physical assets.
c. Hard assets.
d. All of the above are alternative names.
e. Only a and c are alternative names.

Answer: d

3. Real assets differ from financial assets as:

a. Real assets generally decline in value over time while financial assets often
maintain or increase in value over time.
b. Financial assets generally decline in value over time while real assets often
maintain or increase in value over time.
c. Real assets are generally used in the household currently while financial assets
may be reserved for future use.
d. Both b and c.
e. Both a and c.

Answer: e

4. What type of human-related assets is personal finance principally interested?

a. Assets that derive their value from particular people.

b. Assets that generate income.
c. Assets in which ownership is represented and traded solely through pieces of
paper.
d. All of the above.

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 e. None of the above.

Answer: b

5. Which of the following household assets are for future use?

a. Real estate.
b. Durable goods.
c. Financial.
d. All of the above.
e. Both a and c.

Answer: c

6. Under which of the following are decisions are made by looking at the investment’s
risk and return characteristics on a stand-alone basis?

a. Individual asset basis.

b. Within activity basis.
c. Fully integrated basis.
d. Both a and b.
e. Both b and c.

Answer: a

7. What are capital expenditures?

a. Outlays for financial assets.

b. Outlays that provide benefits over an extended period of time.
c. Outlays that can be used for purchasing new assets but not improving existing
ones.
d. Both a and b.
e. Both b and c.

Answer: b

8. When calculating the NPV, what discount rate should we use?

a. A discount rate equal to the investment return that could be earned on

nonmarketable securities with similar risk characteristics.
b. A discount rate equal to the investment return that could be earned on marketable
securities with similar risk characteristics.
c. A discount rate equal to the investment return that could be earned on low-risk
marketable securities.
 d. A discount rate equal to the investment return that could be earned on high-risk
nonmarketable securities.
e. None of the above.

Answer: b

9. Which of the following is the NPV?

a. (Sum of Future Cash Flows / Discount Rate) – Cash Outflow in Current Period.
b. Present Value of Future Cash Inflows – Cash Outflow in Current Period.
c. (Sum of Future Cash Flows / Discount Rate) + Cash Outflow in Current Period.
d. Either a and b.
e. Both b and c.

Answer: d.

10. Which of the following would cause the Profitability Index to be higher?

a. Higher NPV.
b. Higher Cost.
c. Lower NPV
d. Both a and b.
e. Both b and c.

Answer: a

11. Project A has NPV of $45 million while project B has NPV of $54.5 million. If the
cost of project A is $33 million and the cost of project B is $22 million, which project
should be chosen if only one can be chosen?

a. Project A.
b. Project B.
c. Neither.
d. Both.
e. Answer varies, depending on inflation.

Answer: b

12. What is the Internal Rate of Return?

a. The Net Present Value.

b. The rate of return that makes the present value of cash inflows greater than that of
cash outflows.
 c. The rate of return that makes the present value of cash inflows equal to that of
cash outflows.
d. Both a and b.
e. None of the above.

Answer: c

13. Which of the following is a major difference between IRR and NPV?

a. NPV assumes that cash flows from projects are invested at the required rate of
return while IRR assumes they are reinvested at the rate of return of that particular
project.
b. IRR assumes that cash flows from projects are invested at the required rate of
return while NPV assumes they are reinvested at the rate of return of that
particular project.
c. NPV also gives multiple answers under some circumstances.
d. Both a and b.
e. Both b and c.

Answer: a

14. Which of the following is true of NPV vs IRR

a. IRR is more accurate
b. NPV has easier to understand answers
c. NPV is more accurate
d. IRR can be done without use of a calculator or computer
e. NPV can done without use of a calculator or computer

Answer: c

15. Which of the following is not a reason to purchase a durable good?

a. To take advantage of a technological improvement with the potential to make

household maintenance more time-efficient.
b. Physical wear and tear that results in an existing durable having reached the end
of its useful life.
c. A change in circumstances.
d. To attempt to minimize risk.
e. All of the above are reasons to purchase a durable good.

Answer: d

16. Which of the following is not a major factor when deciding to change automobiles?
 a. State of current car.
b. Existing finances.
c. Current car promotion.
d. Attractiveness of new car.
e. All of the above are major factors.

Answer: e

17. Which of the following is inapplicable to human assets?

a. It is a resource that reflects the current value of all our future earnings.
b. It is a nonmarketable asset.
c. It is often rented to an employer for a period of time.
d. All of the above are applicable to human assets.
e. A and c are applicable to human assets.

Answer: d

18. Which of the following is the principal purpose of purchasing durable goods?

a. To reap the benefits from the items directly.

b. To benefit from their appreciation in value.
c. To benefit from the tax deduction the government provides.
d. All of the above.
e. None of the above.

Answer: a

19. Which of the following is not an economic reason for leasing?

a. The lessor may absorb the risk of technological or fashion obsolescence or large
unforeseen expenditures on the asset.
b. The lessor is sometimes able to develop efficiencies in specializing in that asset.
c. The business owner may receive tax benefits that the lessor will not.
d. All of the above are economic reasons for leasing.
e. None of the above is an economic reason for leasing.

Answer: d
20. Is leasing presented as a liability on the household’s balance sheet?

a. Yes.
b. No.
c. No, unless the household is attempting to qualify for a new loan.
d. Yes, unless the household is attempting to qualify for a new loan.
e. None of the above.

Answer: b

21. Which of the following factors makes auto leasing less attractive than ownership?

a. Selling an automobile is time-costly.

b. Inspection standards.
c. Mileage charges.
d. Both a and b.
e. Both b and c.

Answer: e

22. Which of the following durable goods is discretionary?

a. Sports.
b. Traveling.
c. Childcare.
d. Both a and b.
e. Both b and c.

Answer: d

Essay Questions

23. Vashti has a suburban home within walking distance of the railroad. She commutes to

work in the city at a cost of $366.50 a month. She also rents a car every weekend,

which costs $450 a month including insurance and fuel. She is considering

purchasing a new car for cash to replace commuting and rental costs. It would cost

$22,000, get 31 miles per gallon, and have an estimated resale value of $8,000 after

five years. After buying this car, Vashti would drive 20,000 miles per year and have
 maintenance and repairs of $1,400 per year, insurance of $1,500 per year, and fuel

costs of $2.5 per gallon. Assume that all costs occur at the end of the year and that she

sells the car at the end of the fifth year. If Vashti’s discount rate is 7 percent after tax,

should she purchase the car?

Yearly maintenance cost

Fuel consumption (20,000/31 mpg) = 645 gallons per year

Fuel cost (645*$2.50) = $1,613

Annual repairs and maintenance = $1,400

Annual insurance = $1,500

Total projected yearly cost = $4,513

Current Annual Cost

Commute ($366.50*12) =$4,398

Car rental ($450*12) =$5,400

Total current annual cost = $9,798

Annual savings = ($9,798 - $4,513) = $5,285

Cost to purchase car = 22,000

Selling price Year 5 = 12,000

General Calculator Approach HP12C TI BA II Plus

CF

Clear the register f FIN 2nd CLR Work

Enter initial cash outflow 22,000 CHS g CFo 22,000 +/− ENTER ↓

Enter cash inflows years 1–4 5,285 g CFj 5,285 ENTER ↓

Enter number of years 5 g Nj 5 ENTER ↓

Enter cash inflow year 5 13,885 g CFj 13,885 ENTER ↓ ↓

Calculate the internal rate of return f IRR IRR CPT

17.5% 17.5%

The return for this capital expenditure is 17.5% much greater than the required 7%

discount rate. The car should be purchased.

24. Adina, age 32, is a married architect with one child. Her salary has reached a plateau

at $85,000 a year. She believes that if she pursues an MBA degree full-time, she

would move into a managerial position and her salary would rise by $60,000 a year.

Adina wants to maintain her current lifestyle, which already generates substantial

yearly cash savings and accumulate the capital to leave to her son. Her MBA course

would take two years to complete and cost $52,000 a year.

Because she plans to pay for the MBA out of existing savings and would be spending the

money to qualify for a new position, she would not be eligible for any tax benefits.

Assume that Adina pays one-third of her salary in taxes and her tax bracket will remain

unchanged after the raise, that she can earn 6 percent after taxes on investments with a

similar risk to her job, and that she plans to retire at age 65. Furthermore, assume that all

salary and schooling payments are made in a lump sum at the beginning of each year.

What is her rate of return on this investment? Should she pursue an MBA? If so, what

will be the value of her human capital, assuming a calculation that incorporates salary

forgone and her extra salary from obtaining her MBA upon graduation.

Her after-tax increase in salary per year is:

After-tax gain = Pretax gain × (1 − t)

= $60,000 × (1 − 0.3333)

= $40,000 per year

Numbers of years of gain = Retirement age – (Current age + Full-time MBA study)

= 65 – (32 + 2)

= 31 years

The cost of attending school is

Schooling cost = $52,000 a year for 2 years

Opportunity cost of time = 2 years of salary forgone

 = $85,000 × (1 – t)

= $85,000 × (1 − 0.33)

= $56,667 a year for 2 years

Combined yearly cost = Schooling cost + Opportunity cost

= $52,000 + $56,667

= $108,667 a year for 2 years

General Calculator Approach HP12C TI BA II Plus

CF

Clear the register f FIN 2nd CLR Work

Enter cash outflow year 1 108,667 CHS g CFo 108,667 +/−

ENTER ↓

Enter cash outflow year 2 108,667 CHSg CFj 108,667 +/−

ENTER ↓ ↓

Enter cash inflows 40,000 g CFj 40,000 ENTER ↓

Enter number of years 31 g Nj 31 ENTER ↓

Calculate the internal rate of return f IRR IRR CPT

16.8% 16.8%

Because that rate exceeds Adina’s rate of return on marketable investments of 6 percent,

she
should pursue the MBA. The value of her human capital would be

New salary = $85,000 + $60,000

= $145,000

After-tax income = $145,000 × (1 − 0.3333)

= $96,667

General Calculator Approach HP12C TI BA II Plus

CF

Clear the register f FIN 2nd CLR Work

Enter cash outflow year 1 108,667 CHS g CFo 108,667 +/−

ENTER ↓

Enter cash outflow year 2 108,667 CHS g CFj 108,667 +/−

ENTER ↓ ↓

Enter cash inflows 96,667 g CFj 96,667

ENTER ↓

Enter number of years 31 g Nj 31

ENTER ↓

Enter the discount rate 6I NPV 6

ENTER ↓

Calculate the net present value f NPV CPT

1,059,084 1,059,084
Value of human capital = $1,059,084