FIN 331 Chapter Notes - Chapter Chapter 5: Effective Interest Rate, Annual Percentage Rate, Amortization Schedule

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16 Sep 2016

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*of all financial concepts, time value of money is the single most important concept. Concepts can be applied to anything that grows (i. e. sales, population, earnings per share, or future salary. Time value analysis steps: set up a time line *each tick mark corresponds to both the end of one period and the beginning of the next one. *a dollar in hand today is worth more than a dollar to be received in the future because if you had it now, you could invest it, earn interest, and own more than a dollar in the future. The process of going to future value (fv) from present value (pv) is called compounding. Future value- the amount to which a cash flow or series of cash flows will grow over a given period of time when compounded at a given interest rate. Present value- the value today of future cash flow or series of cash flows.

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QUESTION 1 The time value of money refers to the issue of: A. what the value of the stream of future cash flows is today. B. why a dollar received tomorrow is worth more than a dollar received today. C. what the time required to double an amount of money. D. why people prefer to consume things at some time in the future rather than today.

QUESTION 2 The process of converting an amount given at the present time into a future value is called: A. annualizing. B. discounting. C. compounding. D. capital budgeting. 2 points

QUESTION 3 Juan Vinson is planning to buy a house in five years. He is looking to invest $25,000 today in an index mutual fund that will provide him a return of 12 percent annually. How much will he have at the end of five years? (Round to the nearest dollar.) A. $45,000 B. $28,000 C. $44,059 D. $28,530 2 points

QUESTION 4 Which of the following statements is true with respect to the present value of a future amount? A. The higher the discount rate, the higher the present value of a single sum for a given time period. B. The relation between present value and time is exponential. C. The greater the time period, the higher the present value of a single sum for a given interest rate. D. The lower the discount rate, the lower the present value of a single sum for a given time period. 2 points

QUESTION 5 Which of the following statements is true of the rule of 72? A. It can be used to determine the amount of time it takes to double an investment. B. It is fairly accurate for interest rates between 25 and 50 percent. C. It states that the time to double your money (TDM) approximately equals 72/i, where i represents the years it takes to double your investment. D. It can be used to estimate approximate compound interest earned for a period of 72 days. 2 points

QUESTION 6 The present value of future cash flows are computed by multiplying future value with the: A. discounting factor. B. compound factor. C. interest rate. D. number of periods. 2 points

QUESTION 7 The present value of multiple cash flows is: A. greater than the sum of the cash flows. B. equal to the sum of all the cash flows. C. less than the sum of the cash flows. D. higher or lower than the cash flows depending on the interest rate. 2 points

QUESTION 8 Cash flows associated with annuities are considered to be: A. an uneven cash flow stream. B. a constant cash flow stream. C. a mix of constant and uneven cash flow streams. D. a cash flow stream with decreasing trend. 2 points

QUESTION 9 The annuity transformation method is used to transform: A. a present value annuity to a future value annuity. B. a present value annuity to an annuity due. C. an ordinary annuity to an annuity due. D. a perpetuity to an annuity. 2 points

QUESTION 10 The true cost of borrowing is the: A. annual percentage rate. B. effective annual rate. C. quoted interest rate. D. periodic rate.

Read each statement below indicate if it true or false, and give a brief explanation of your answer.

1. When a bond is sold at a discount, the cash received is less than the present value of the future cash flows from the bond, based on the market rate of interest on the date of issue.

A the discount amount equals to the difference between the cash received and the present value of the future cash flows.

B. the cash received is more than the present value of the future cash flows.

C. the cash received is equal to the present value of the future cash flows.

D. because the market rate of interest is used when calculating the present value of the future cash flows.

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a. What does it mean when a company's free cash flow is negative in one or more years?

b. Do negative values of free cash flow in any way alter or invalidate the notion that a company's fair market value equals the present value of its free cash flows discounted at the company's weighted average cost of capital?

c. Suppose a company's free cash flows were expected to be negative in all future periods. Can you conceive of any reasons for buying the company's stock?

FIN 331 Chapter Notes - Chapter Chapter 5: Effective Interest Rate, Annual Percentage Rate, Amortization Schedule

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