Test Bank, Fundamentals of Corporate Finance, 2e

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Easy

1. Time value of money is based on the belief that people have a positive time preference

for consumption.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Easy

2. Individuals prefer to consume goods in the future rather than right away.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Easy

3. The value of a dollar invested at positive interest rate grows over time.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Medium

4. The value of a dollar invested at positive interest rate grows over time but at an

increasingly slower rate further into the future.

A) True

B)

False

Ans: B

5-1

Test Bank, Fundamentals of Corporate Finance, 2e

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Easy

5. The further in the future you receive a dollar, the more it is worth today.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

6. The higher the rate of interest, the more likely you will elect to invest your funds and

forego current consumption.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

7. Future value focuses on the valuation of cash flows received over time, while present

value focuses on the valuation of cash flows received at a point in time.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Easy

8. The present value technique uses discounting to find the present value of each cash

flow at the beginning of the project.

A) True

B)

False

Ans: A

5-2

Test Bank, Fundamentals of Corporate Finance, 2e

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Easy

9. The present value technique uses compounding to find the present value of each cash

flow at the beginning of the project.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

10. The future value technique uses discounting to find the future value of each cash flow

at the end of the project's life.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

11. The future value technique uses compounding to find the future value of each cash flow

at the end of the project's life.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

12. Compounding is the process by which interest earned on an investment is reinvested so

that in future periods, interest is earned on the interest as well as the principal.

A) True

5-3

Test Bank, Fundamentals of Corporate Finance, 2e

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

13. Compound interest consists of both simple interest and interest-on-interest.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

14. Compound interest consists only of interest-on-interest.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

15. Compounding accelerates the growth of the total interest earned.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

16. The growth rate over time is linear.

A) True

B)

False

5-4

Test Bank, Fundamentals of Corporate Finance, 2e

Ans: B

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

17. The growth rate over time is exponential.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

18. Berrian invested $5,000 in an account earning 10 percent for one year. If he had left his

investment in that account for another two years, he would expect the total interest

earned over the three years to be higher by exactly $1,000.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

19. The higher the interest rate on an investment, the more money that is accumulated for

any time period.

A) True

B)

False

Ans: A

5-5

Test Bank, Fundamentals of Corporate Finance, 2e

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

20. The more frequently the interest payments are compounded, the larger the future value

of $1 for a given time period.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

21. If Bank A pays interest on a monthly basis and Bank B pays the same interest on a

quarterly basis, then investing $1,000 in Bank B will lead to a higher future value than

investing the same amount in Bank A.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

22. The present value can be thought of as the discounted value of a future amount.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

23. The present value is simply the current value of a future cash flow that has been

discounted at the appropriate discount rate.

A) True

B)

False

Ans: A

5-6

Test Bank, Fundamentals of Corporate Finance, 2e

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Easy

24. The Rule of 72 allows one to calculate the return earned on an investment over six

years.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Easy

25. The Rule of 72 allows one to calculate the approximate time needed to double an

investment.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Easy

26. Compound growth occurs when the initial value of a number increases or decreases

each period by the factor (1 + growth rate).

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

27. The future value of an investment of $5,000 earning an annual interest of 10 percent

equals $6,000 at the end of one year.

A) True

5-7

Test Bank, Fundamentals of Corporate Finance, 2e

B)

False

Ans: B

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

28. The present value of an investment of $1,000 to be received in three years at a discount

rate of 10 percent is $751.31.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

29. The present value of an investment of $1,000 to be received in three years at a discount

rate of 10 percent is $1,331.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

30. The future value of an investment of $1,000 to be received in three years at a discount

rate of 10 percent is $1,331.

A) True

B)

False

Ans: A

5-8

Test Bank, Fundamentals of Corporate Finance, 2e

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

31. The higher the discount rate, the lower the present value of a future cash flow.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

32. The lower the discount rate, the lower the present value of a future cash flow.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

33. If you had a choice of choosing a payment of $5,000 to be received in five years being

discounted at 8 percent or at 10 percent, you should always choose the higher rate

because it gives you the higher present value.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

34. Randy has to choose between two cash flows. He could either receive the future value

of an investment of $1,000 at 8 percent annually in three years or in five years. Randy

should always choose the shorter investment term because it is worth more today.

A) True

B)

False

Ans: B

5-9

Test Bank, Fundamentals of Corporate Finance, 2e

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

35. If Laura has to choose between a loan that charges quarterly interest and a loan that

charges monthly interest, she should always choose the one charging quarterly interest.

A) True

B)

False

Ans: A

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

36. 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)

why a dollar received tomorrow is worth the same as a dollar received today.

D)

None of the above.

Ans: A

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

37. Which one of the following statements is NOT true?

A) The time value money refers to what the value of the stream of future cash flows

today is.

B) A dollar received today is worth more than a dollar received tomorrow.

C)

A dollar received tomorrow is worth less than a dollar received today.

D)

A dollar received today is worth less than a dollar received tomorrow.

Ans: D

5-10

Test Bank, Fundamentals of Corporate Finance, 2e

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

38. Which one of the following statements is NOT true?

A) The value of a dollar invested at a positive interest rate grows over time.

B)

The further in the future you receive a dollar, the less it is worth today.

C)

A dollar in hand today is worth more than a dollar to be received in the future.

D)

The further in the future you receive a dollar, the more it is worth today.

Ans: D

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

39. Future value measures

A) what one or more cash flows are worth at the end of a specified period.

B)

C)

what one or more cash flows that is to be received in the future will be worth

today.

both a and b

D)

None of the above

Ans: A

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

40. Which one of the following statements is true?

A) Individuals prefer to consume goods right away rather than in the future.

B)

Individuals prefer to consume goods in the future rather than right away.

C)

The time of consumption is irrelevant to individuals.

D)

None of the above.

Ans: A

5-11

Test Bank, Fundamentals of Corporate Finance, 2e

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: easy

41. The process of converting an amount given at the present time into a future value

is called

A) time value of money.

B)

discounting.

C)

compounding.

D)

None of the above.

Ans: C

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

42. The process of converting future cash flows to what its present value is

A) time value of money.

B)

discounting.

C)

compounding.

D)

none of the above.

Ans: B

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

43. Which one of the following statements is NOT true?

A) Present value calculations involve bringing a future amount back to the present.

B)

C)

The present value (PV) is often called the discounted value of future cash

payments.

The present value factor is more commonly called the discount factor.

D)

All of the above are true statements.

Ans: D

5-12

Test Bank, Fundamentals of Corporate Finance, 2e

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

44. Which one of the following statements is NOT true?

A) Present value calculations involve bringing a future amount back to the present.

B)

C)

The future value is often called the discounted value of future cash

payments.

The present value factor is more commonly called the discount factor.

D)

The higher the discount rate, the lower the present value of a dollar.

Ans: B

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Easy

45. The Rule of 72

A) can be used to determine the amount of time it takes to double an investment.

B)

is fairly accurate for interest rates between 25 and 50 percent.

C)

states that the time to double your money (TDM) approximately equals 72/i,

where 72 represents the years it takes to double your investment.

None of the above describe the Rule of 72.

D)

Ans: A

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

46. Using higher discount rates will

A) not affect the present value of the future cash flow.

B)

increase the present value of any future cash flow.

C)

decrease the present value of any future cash flow.

D)

None of the above.

Ans: C

5-13

Test Bank, Fundamentals of Corporate Finance, 2e

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

47. Using higher interest rates will

A) not affect the future value of the investment.

B)

increase the future value of any investment.

C)

decrease the future value of any investment.

D)

None of the above.

Ans: B

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

48. Using lower discount rates will

A) not affect the present value of the future cash flow.

B)

increase the present value of any future cash flow.

C)

decrease the present value of any future cash flow.

D)

None of the above.

Ans: B

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

49. Using lower interest rates will

A) decrease the future value of any investment.

B)

increase the future value of any investment.

C)

not affect the future value of the investment.

D)

None of the above.

Ans: A

5-14

Test Bank, Fundamentals of Corporate Finance, 2e

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

50. Your aunt is looking to invest a certain amount today. Which of the following choices

should she opt for?

A) three-year CD at 6.5% annual rate

B)

three-year CD at 6.75% annual rate

C)

three-year CD at 6.25% annual rate

D)

three-year CD at 7% annual rate

Ans: D

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

51. Future value: You are interested in investing $10,000, a gift from your grandparents,

for the next four years in a mutual fund that will earn an annual return of 8 percent.

What will your investment be worth at the end of four years? (Round to the nearest

dollar.)

A) $10,800

B)

$13,605

C)

$13,200

D)

None of the above

Ans: B

Feedback:

Present value of the investment = PV = $10,000

Return on mutual fund = i = 8%

No. of years = n = 4.

0 1 2 3 4

├───┼───┼───┼────┤

-$10,000

FV=?

FV4 PV �(1 i )n $10,000 �(1.08) 4

$13, 604.89

5-15

Test Bank, Fundamentals of Corporate Finance, 2e

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

52. Future value: Ning Gao is planning to buy a house in five years. She is looking to

invest $25,000 today in an index mutual fund that will provide her a return of 12

percent annually. How much will she have at the end of five years? (Round to the

nearest dollar.)

A) $45,000

B)

$28,000

C)

$44,059

D)

None of the above

Ans: C

Feedback:

Present value of the investment = PV = $25,000

Return on mutual fund = i = 12%

No. of years = n = 5.

0 1 2 3 4 5

├───┼───┼───┼────┼───┤

-$25,000

FV = ?

FV5 PV �(1 i )n $25,000 �(1.12)5

$44,058.54

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

53. Future value: Carlos Lopes is looking to invest for the next three years. He is looking

to invest $7,500 today in a bank CD that will earn interest at 5.75 percent annually.

How much will he have at the end of three years? (Round to the nearest dollar.)

A) $8,870

B)

$8,000

C)

$8,681

D)

None of the above

Ans: A

5-16

Test Bank, Fundamentals of Corporate Finance, 2e

Feedback:

Present value of the investment = PV = $7,500

Interest rate on CD = i = 5.75%

No. of years = n = 3.

0 1 2 3

├───┼───┼───┤

-$7,500

FV=?

FV3 PV �(1 i )n $7,500 �(1.0.0575)3

$8,869.57

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

54. Future value: Wes Ottey would like to buy a condo in Florida in six years. He is

looking to invest $75,000 today in a stock that is expected to earn a return of 18.3

percent annually. How much will he have at the end of six years? (Round to the nearest

dollar.)

A) $205,575

B)

$157,350

C)

$184,681

D)

None of the above

Ans: A

Feedback:

Present value of the investment = PV = $75,000

Return on stock = i = 18.3%

No. of years = n = 6.

0 1 2 3 4 5 6

├───┼───┼────┼───┼───┼───┤

-$75,000

FV=?

FV6 PV �(1 i )n $75,000 �(1.183)6

$205,574.73

5-17

Test Bank, Fundamentals of Corporate Finance, 2e

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

55. Future value: Brittany Willis is looking to invest for retirement, which she hopes will

be in 20 years. She is looking to invest $22,500 today in U.S. Treasury bonds that will

earn interest at 6.25 percent annually. How much will she have at the end of 20 years?

(Round to the nearest dollar.)

A) $68,870

B)

$50,625

C)

$75,642

D)

None of the above

Ans: C

Feedback:

Present value of the investment = PV = $22,500

Return on Treasury bonds = i = 6.25%

No. of years = n = 20.

0 1 2 3

19 20

├───┼───┼───┼……………─┼────┤

-$22,500

FV=?

FV20 PV �(1 i )n $22,500 �(1.0.0625) 20

$75,641.70

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

56. Multiple compounding periods (FV): Your brother has asked you to help him with

choosing an investment. He has $5,000 to invest today for a period of two years. You

identify a bank CD that pays an interest rate of 4.25 percent with the interest being paid

quarterly. What will be the value of the investment in two years?

A) $5,434

B)

$5,441

C)

$5,107

D)

$5,216

Ans: B

5-18

Test Bank, Fundamentals of Corporate Finance, 2e

Feedback:

0

2 years

├────────────────────┤

PV = $5,000

FV = ?

Amount invested today = PV = $5,000

Interest rate on CD = i = 4.25%

Duration of investment = n = 2 years

Frequency of compounding = m = 4

Value of investment after 4 years = FV4

4�2

mn

� i �

� 0.0425 �

FV2 PV ��

1 � $5,000 ��

1

�

4 �

� m�

�

$5,000 �(1.010625)8

$5, 441.15

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

57. Multiple compounding periods (FV): Normandy Textiles had a cash inflow of $1

million, which it needs for a long-term investment at the end of one year. It plans to

deposit this money in a bank CD that pays daily interest at 3.75 percent. What will be

the value of the investment at the end of the year? (Round to the nearest dollar.)

A) $1,211,375

B)

$1,000,103

C)

$1,037,500

D)

$1,038,210

Ans: D

5-19

Test Bank, Fundamentals of Corporate Finance, 2e

Feedback:

0

1

├────────────────────┤

PV = $1,000,000

FV = ?

Amount invested today = PV = $1,000,000

Interest rate on CD = i = 3.75%

Duration of investment = n = 1 year

Frequency of compounding = m = 365

Value of investment after 1 year = FV1

365�

1

mn

� i �

� 0.0375 �

FV1 PV ��

1 � $1,000,000 ��

1

�

� m�

� 365 �

$1,000,000 �(1.00010274)365

$1, 038, 210

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

58. Multiple compounding periods (FV): Your mother is trying to choose one of the

following bank CDs to deposit $10,000. Which one will have the highest future value if

she plans to invest for three years?

A) 3.5% compounded daily

B)

3.25% compounded monthly

C)

3.4% compounded quarterly

D)

3.75% compounded annually

Ans: A

5-20

Test Bank, Fundamentals of Corporate Finance, 2e

Feedback:

A) Interest rate on CD = i = 3.5%

Frequency of compounding = m = 365

Value of investment after 3 years = FV3

365�3

mn

� i �

� 0.035 �

FV1 PV ��

1 � $10,000 ��

1

�

� m�

� 365 �

$10,000 �(1.00009589)1095

$11,107.05

B) Interest rate on CD = i = 3.25%

Frequency of compounding = m = 12

Value of investment after 3 years = FV3

12�3

mn

� i �

� 0.0325 �

FV1 PV ��

1 � $10,000 ��

1

�

12 �

� m�

�

$10,000 �(1.002708333)36

$11, 022.66

C) Interest rate on CD = i = 3.4%

Frequency of compounding = m = 4

Value of investment after 3 years = FV3

4�3

mn

� i �

� 0.034 �

FV1 PV ��

1 � $10,000 ��

1

�

4 �

� m�

�

$10,000 �(1.0085)12

$11,069.06

D) Interest rate on CD = i = 3.75%

Frequency of compounding = m = 1

Value of investment after 3 years = FV3

5-21

Test Bank, Fundamentals of Corporate Finance, 2e

= $10,000 x (1.0375)3

= $11,167.71

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

59. Multiple compounding periods (FV): Carlyn Botti wants to invest $3,500 today in a

money market fund that pays quarterly interest at 5.5 percent. She plans to fund a

scholarship with the proceeds at her alma mater, Towson University. How much will

Carlyn have at the end of seven years? (Round to the nearest dollar.)

A) $5,091

B)

$3,548

C)

$5,130

D)

$5,075

Ans: C

Feedback:

Amount invested today = PV = $3,500

Interest rate on money market account = i = 5.5%

Duration of investment = n = 7 years

Frequency of compounding = m = 4

Value of investment after 7 years = FV7

4�7

mn

� i �

� 0.055 �

FV7 PV ��

1 � $3,500 ��

1

�

4 �

� m�

�

$3,500 �(1.01375)28

$5,130.18

5-22

Test Bank, Fundamentals of Corporate Finance, 2e

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

60. Multiple compounding periods (FV): Hector Cervantes started on his first job last

year and plans to save for a down payment on a house in 10 years. He will be able to

invest $12,000 today in a money market account that will pay him an interest of 6.25

percent on a monthly basis. How much will he have at the end of 10 years?

A) $12,640

B)

$22,383

C)

$24,839

D)

None of the above

Ans: B

Feedback:

Amount invested today = PV = $12,000

Interest rate on money market account = i = 6.25%

Duration of investment = n = 10 years

Frequency of compounding = m = 12

Value of investment after 10 years = FV10

12�

10

mn

� i �

� 0.0625 �

FV10 PV ��

1 � $12,000 ��

1

�

12 �

� m�

�

$12,000 �(1.005208333)120

$22, 382.62

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

61. Compounding: Trish Harris has deposited $2,500 today in an account paying 6 percent

interest annually. What would be the simple interest earned on this investment in five

years? If the account paid compound interest, what would be the interest-on-interest in

five years?

A) $750;

$95.56

5-23

Test Bank, Fundamentals of Corporate Finance, 2e

B)

$150;

$845.56

C)

$150;

$95.56

D)

$95.56; $845.56

Ans: A

Feedback:

Deposit today = PV = $2,500

Interest rate = i = 6%

No. of years = n = 5

Simple interest:

Simple interest per year = $2,500 (0.06) = $150.00

Simple interest for 5 years = $150 x 5 = $750.00

Future value with compound interest:

FV5 = $2,500 (1 + 0.06)5 = $3,345.56

Simple interest = $750

Interest on interest = $3,345.56 – $2,500 – $750 = $95.56

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

62. Compounding: Joachim Noah is investing $5,000 in an account paying 6.75 percent

annually for three years. What is the interest-on-interest if interest is compounded?

A) $1,012.50

B)

$1,082.38

C)

$82.38

D)

$69.88

Ans: D

5-24

Test Bank, Fundamentals of Corporate Finance, 2e

Feedback:

Deposit today = PV = $5,000

Interest rate = i = 6.75%

No. of years = n = 3

Simple interest:

Simple interest per year = $5,000 (0.0675) = $337.50

Simple interest for 3 years = $337.50 x 3 = $1,012.50

Future value with compound interest:

FV3 = $5,000 (1 + 0.0675)3 = $6,082.38

Simple interest = $1,012.50

Interest on interest = $6,082.38 – $5,000 – $1,012.50 = $69.88

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

63. Compounding: Chung Lee wants to invest $3,000 in an account paying 5.25 percent

compounded quarterly. What is the interest on interest after four years?

A) $695.98

B)

$65.98

C)

$630.00

D)

None of the above

Ans: B

5-25

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Easy

1. Time value of money is based on the belief that people have a positive time preference

for consumption.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Easy

2. Individuals prefer to consume goods in the future rather than right away.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Easy

3. The value of a dollar invested at positive interest rate grows over time.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Medium

4. The value of a dollar invested at positive interest rate grows over time but at an

increasingly slower rate further into the future.

A) True

B)

False

Ans: B

5-1

Test Bank, Fundamentals of Corporate Finance, 2e

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Easy

5. The further in the future you receive a dollar, the more it is worth today.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

6. The higher the rate of interest, the more likely you will elect to invest your funds and

forego current consumption.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

7. Future value focuses on the valuation of cash flows received over time, while present

value focuses on the valuation of cash flows received at a point in time.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Easy

8. The present value technique uses discounting to find the present value of each cash

flow at the beginning of the project.

A) True

B)

False

Ans: A

5-2

Test Bank, Fundamentals of Corporate Finance, 2e

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Easy

9. The present value technique uses compounding to find the present value of each cash

flow at the beginning of the project.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

10. The future value technique uses discounting to find the future value of each cash flow

at the end of the project's life.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

11. The future value technique uses compounding to find the future value of each cash flow

at the end of the project's life.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

12. Compounding is the process by which interest earned on an investment is reinvested so

that in future periods, interest is earned on the interest as well as the principal.

A) True

5-3

Test Bank, Fundamentals of Corporate Finance, 2e

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

13. Compound interest consists of both simple interest and interest-on-interest.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

14. Compound interest consists only of interest-on-interest.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

15. Compounding accelerates the growth of the total interest earned.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

16. The growth rate over time is linear.

A) True

B)

False

5-4

Test Bank, Fundamentals of Corporate Finance, 2e

Ans: B

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

17. The growth rate over time is exponential.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

18. Berrian invested $5,000 in an account earning 10 percent for one year. If he had left his

investment in that account for another two years, he would expect the total interest

earned over the three years to be higher by exactly $1,000.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

19. The higher the interest rate on an investment, the more money that is accumulated for

any time period.

A) True

B)

False

Ans: A

5-5

Test Bank, Fundamentals of Corporate Finance, 2e

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

20. The more frequently the interest payments are compounded, the larger the future value

of $1 for a given time period.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

21. If Bank A pays interest on a monthly basis and Bank B pays the same interest on a

quarterly basis, then investing $1,000 in Bank B will lead to a higher future value than

investing the same amount in Bank A.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

22. The present value can be thought of as the discounted value of a future amount.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

23. The present value is simply the current value of a future cash flow that has been

discounted at the appropriate discount rate.

A) True

B)

False

Ans: A

5-6

Test Bank, Fundamentals of Corporate Finance, 2e

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Easy

24. The Rule of 72 allows one to calculate the return earned on an investment over six

years.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Easy

25. The Rule of 72 allows one to calculate the approximate time needed to double an

investment.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Easy

26. Compound growth occurs when the initial value of a number increases or decreases

each period by the factor (1 + growth rate).

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

27. The future value of an investment of $5,000 earning an annual interest of 10 percent

equals $6,000 at the end of one year.

A) True

5-7

Test Bank, Fundamentals of Corporate Finance, 2e

B)

False

Ans: B

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

28. The present value of an investment of $1,000 to be received in three years at a discount

rate of 10 percent is $751.31.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

29. The present value of an investment of $1,000 to be received in three years at a discount

rate of 10 percent is $1,331.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

30. The future value of an investment of $1,000 to be received in three years at a discount

rate of 10 percent is $1,331.

A) True

B)

False

Ans: A

5-8

Test Bank, Fundamentals of Corporate Finance, 2e

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

31. The higher the discount rate, the lower the present value of a future cash flow.

A) True

B)

False

Ans: A

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

32. The lower the discount rate, the lower the present value of a future cash flow.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Medium

33. If you had a choice of choosing a payment of $5,000 to be received in five years being

discounted at 8 percent or at 10 percent, you should always choose the higher rate

because it gives you the higher present value.

A) True

B)

False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

34. Randy has to choose between two cash flows. He could either receive the future value

of an investment of $1,000 at 8 percent annually in three years or in five years. Randy

should always choose the shorter investment term because it is worth more today.

A) True

B)

False

Ans: B

5-9

Test Bank, Fundamentals of Corporate Finance, 2e

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

35. If Laura has to choose between a loan that charges quarterly interest and a loan that

charges monthly interest, she should always choose the one charging quarterly interest.

A) True

B)

False

Ans: A

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

36. 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)

why a dollar received tomorrow is worth the same as a dollar received today.

D)

None of the above.

Ans: A

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

37. Which one of the following statements is NOT true?

A) The time value money refers to what the value of the stream of future cash flows

today is.

B) A dollar received today is worth more than a dollar received tomorrow.

C)

A dollar received tomorrow is worth less than a dollar received today.

D)

A dollar received today is worth less than a dollar received tomorrow.

Ans: D

5-10

Test Bank, Fundamentals of Corporate Finance, 2e

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

38. Which one of the following statements is NOT true?

A) The value of a dollar invested at a positive interest rate grows over time.

B)

The further in the future you receive a dollar, the less it is worth today.

C)

A dollar in hand today is worth more than a dollar to be received in the future.

D)

The further in the future you receive a dollar, the more it is worth today.

Ans: D

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

39. Future value measures

A) what one or more cash flows are worth at the end of a specified period.

B)

C)

what one or more cash flows that is to be received in the future will be worth

today.

both a and b

D)

None of the above

Ans: A

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

40. Which one of the following statements is true?

A) Individuals prefer to consume goods right away rather than in the future.

B)

Individuals prefer to consume goods in the future rather than right away.

C)

The time of consumption is irrelevant to individuals.

D)

None of the above.

Ans: A

5-11

Test Bank, Fundamentals of Corporate Finance, 2e

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: easy

41. The process of converting an amount given at the present time into a future value

is called

A) time value of money.

B)

discounting.

C)

compounding.

D)

None of the above.

Ans: C

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

42. The process of converting future cash flows to what its present value is

A) time value of money.

B)

discounting.

C)

compounding.

D)

none of the above.

Ans: B

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

43. Which one of the following statements is NOT true?

A) Present value calculations involve bringing a future amount back to the present.

B)

C)

The present value (PV) is often called the discounted value of future cash

payments.

The present value factor is more commonly called the discount factor.

D)

All of the above are true statements.

Ans: D

5-12

Test Bank, Fundamentals of Corporate Finance, 2e

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

44. Which one of the following statements is NOT true?

A) Present value calculations involve bringing a future amount back to the present.

B)

C)

The future value is often called the discounted value of future cash

payments.

The present value factor is more commonly called the discount factor.

D)

The higher the discount rate, the lower the present value of a dollar.

Ans: B

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Easy

45. The Rule of 72

A) can be used to determine the amount of time it takes to double an investment.

B)

is fairly accurate for interest rates between 25 and 50 percent.

C)

states that the time to double your money (TDM) approximately equals 72/i,

where 72 represents the years it takes to double your investment.

None of the above describe the Rule of 72.

D)

Ans: A

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

46. Using higher discount rates will

A) not affect the present value of the future cash flow.

B)

increase the present value of any future cash flow.

C)

decrease the present value of any future cash flow.

D)

None of the above.

Ans: C

5-13

Test Bank, Fundamentals of Corporate Finance, 2e

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

47. Using higher interest rates will

A) not affect the future value of the investment.

B)

increase the future value of any investment.

C)

decrease the future value of any investment.

D)

None of the above.

Ans: B

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Medium

48. Using lower discount rates will

A) not affect the present value of the future cash flow.

B)

increase the present value of any future cash flow.

C)

decrease the present value of any future cash flow.

D)

None of the above.

Ans: B

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

49. Using lower interest rates will

A) decrease the future value of any investment.

B)

increase the future value of any investment.

C)

not affect the future value of the investment.

D)

None of the above.

Ans: A

5-14

Test Bank, Fundamentals of Corporate Finance, 2e

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

50. Your aunt is looking to invest a certain amount today. Which of the following choices

should she opt for?

A) three-year CD at 6.5% annual rate

B)

three-year CD at 6.75% annual rate

C)

three-year CD at 6.25% annual rate

D)

three-year CD at 7% annual rate

Ans: D

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

51. Future value: You are interested in investing $10,000, a gift from your grandparents,

for the next four years in a mutual fund that will earn an annual return of 8 percent.

What will your investment be worth at the end of four years? (Round to the nearest

dollar.)

A) $10,800

B)

$13,605

C)

$13,200

D)

None of the above

Ans: B

Feedback:

Present value of the investment = PV = $10,000

Return on mutual fund = i = 8%

No. of years = n = 4.

0 1 2 3 4

├───┼───┼───┼────┤

-$10,000

FV=?

FV4 PV �(1 i )n $10,000 �(1.08) 4

$13, 604.89

5-15

Test Bank, Fundamentals of Corporate Finance, 2e

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

52. Future value: Ning Gao is planning to buy a house in five years. She is looking to

invest $25,000 today in an index mutual fund that will provide her a return of 12

percent annually. How much will she have at the end of five years? (Round to the

nearest dollar.)

A) $45,000

B)

$28,000

C)

$44,059

D)

None of the above

Ans: C

Feedback:

Present value of the investment = PV = $25,000

Return on mutual fund = i = 12%

No. of years = n = 5.

0 1 2 3 4 5

├───┼───┼───┼────┼───┤

-$25,000

FV = ?

FV5 PV �(1 i )n $25,000 �(1.12)5

$44,058.54

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

53. Future value: Carlos Lopes is looking to invest for the next three years. He is looking

to invest $7,500 today in a bank CD that will earn interest at 5.75 percent annually.

How much will he have at the end of three years? (Round to the nearest dollar.)

A) $8,870

B)

$8,000

C)

$8,681

D)

None of the above

Ans: A

5-16

Test Bank, Fundamentals of Corporate Finance, 2e

Feedback:

Present value of the investment = PV = $7,500

Interest rate on CD = i = 5.75%

No. of years = n = 3.

0 1 2 3

├───┼───┼───┤

-$7,500

FV=?

FV3 PV �(1 i )n $7,500 �(1.0.0575)3

$8,869.57

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

54. Future value: Wes Ottey would like to buy a condo in Florida in six years. He is

looking to invest $75,000 today in a stock that is expected to earn a return of 18.3

percent annually. How much will he have at the end of six years? (Round to the nearest

dollar.)

A) $205,575

B)

$157,350

C)

$184,681

D)

None of the above

Ans: A

Feedback:

Present value of the investment = PV = $75,000

Return on stock = i = 18.3%

No. of years = n = 6.

0 1 2 3 4 5 6

├───┼───┼────┼───┼───┼───┤

-$75,000

FV=?

FV6 PV �(1 i )n $75,000 �(1.183)6

$205,574.73

5-17

Test Bank, Fundamentals of Corporate Finance, 2e

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

55. Future value: Brittany Willis is looking to invest for retirement, which she hopes will

be in 20 years. She is looking to invest $22,500 today in U.S. Treasury bonds that will

earn interest at 6.25 percent annually. How much will she have at the end of 20 years?

(Round to the nearest dollar.)

A) $68,870

B)

$50,625

C)

$75,642

D)

None of the above

Ans: C

Feedback:

Present value of the investment = PV = $22,500

Return on Treasury bonds = i = 6.25%

No. of years = n = 20.

0 1 2 3

19 20

├───┼───┼───┼……………─┼────┤

-$22,500

FV=?

FV20 PV �(1 i )n $22,500 �(1.0.0625) 20

$75,641.70

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

56. Multiple compounding periods (FV): Your brother has asked you to help him with

choosing an investment. He has $5,000 to invest today for a period of two years. You

identify a bank CD that pays an interest rate of 4.25 percent with the interest being paid

quarterly. What will be the value of the investment in two years?

A) $5,434

B)

$5,441

C)

$5,107

D)

$5,216

Ans: B

5-18

Test Bank, Fundamentals of Corporate Finance, 2e

Feedback:

0

2 years

├────────────────────┤

PV = $5,000

FV = ?

Amount invested today = PV = $5,000

Interest rate on CD = i = 4.25%

Duration of investment = n = 2 years

Frequency of compounding = m = 4

Value of investment after 4 years = FV4

4�2

mn

� i �

� 0.0425 �

FV2 PV ��

1 � $5,000 ��

1

�

4 �

� m�

�

$5,000 �(1.010625)8

$5, 441.15

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

57. Multiple compounding periods (FV): Normandy Textiles had a cash inflow of $1

million, which it needs for a long-term investment at the end of one year. It plans to

deposit this money in a bank CD that pays daily interest at 3.75 percent. What will be

the value of the investment at the end of the year? (Round to the nearest dollar.)

A) $1,211,375

B)

$1,000,103

C)

$1,037,500

D)

$1,038,210

Ans: D

5-19

Test Bank, Fundamentals of Corporate Finance, 2e

Feedback:

0

1

├────────────────────┤

PV = $1,000,000

FV = ?

Amount invested today = PV = $1,000,000

Interest rate on CD = i = 3.75%

Duration of investment = n = 1 year

Frequency of compounding = m = 365

Value of investment after 1 year = FV1

365�

1

mn

� i �

� 0.0375 �

FV1 PV ��

1 � $1,000,000 ��

1

�

� m�

� 365 �

$1,000,000 �(1.00010274)365

$1, 038, 210

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

58. Multiple compounding periods (FV): Your mother is trying to choose one of the

following bank CDs to deposit $10,000. Which one will have the highest future value if

she plans to invest for three years?

A) 3.5% compounded daily

B)

3.25% compounded monthly

C)

3.4% compounded quarterly

D)

3.75% compounded annually

Ans: A

5-20

Test Bank, Fundamentals of Corporate Finance, 2e

Feedback:

A) Interest rate on CD = i = 3.5%

Frequency of compounding = m = 365

Value of investment after 3 years = FV3

365�3

mn

� i �

� 0.035 �

FV1 PV ��

1 � $10,000 ��

1

�

� m�

� 365 �

$10,000 �(1.00009589)1095

$11,107.05

B) Interest rate on CD = i = 3.25%

Frequency of compounding = m = 12

Value of investment after 3 years = FV3

12�3

mn

� i �

� 0.0325 �

FV1 PV ��

1 � $10,000 ��

1

�

12 �

� m�

�

$10,000 �(1.002708333)36

$11, 022.66

C) Interest rate on CD = i = 3.4%

Frequency of compounding = m = 4

Value of investment after 3 years = FV3

4�3

mn

� i �

� 0.034 �

FV1 PV ��

1 � $10,000 ��

1

�

4 �

� m�

�

$10,000 �(1.0085)12

$11,069.06

D) Interest rate on CD = i = 3.75%

Frequency of compounding = m = 1

Value of investment after 3 years = FV3

5-21

Test Bank, Fundamentals of Corporate Finance, 2e

= $10,000 x (1.0375)3

= $11,167.71

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

59. Multiple compounding periods (FV): Carlyn Botti wants to invest $3,500 today in a

money market fund that pays quarterly interest at 5.5 percent. She plans to fund a

scholarship with the proceeds at her alma mater, Towson University. How much will

Carlyn have at the end of seven years? (Round to the nearest dollar.)

A) $5,091

B)

$3,548

C)

$5,130

D)

$5,075

Ans: C

Feedback:

Amount invested today = PV = $3,500

Interest rate on money market account = i = 5.5%

Duration of investment = n = 7 years

Frequency of compounding = m = 4

Value of investment after 7 years = FV7

4�7

mn

� i �

� 0.055 �

FV7 PV ��

1 � $3,500 ��

1

�

4 �

� m�

�

$3,500 �(1.01375)28

$5,130.18

5-22

Test Bank, Fundamentals of Corporate Finance, 2e

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Medium

60. Multiple compounding periods (FV): Hector Cervantes started on his first job last

year and plans to save for a down payment on a house in 10 years. He will be able to

invest $12,000 today in a money market account that will pay him an interest of 6.25

percent on a monthly basis. How much will he have at the end of 10 years?

A) $12,640

B)

$22,383

C)

$24,839

D)

None of the above

Ans: B

Feedback:

Amount invested today = PV = $12,000

Interest rate on money market account = i = 6.25%

Duration of investment = n = 10 years

Frequency of compounding = m = 12

Value of investment after 10 years = FV10

12�

10

mn

� i �

� 0.0625 �

FV10 PV ��

1 � $12,000 ��

1

�

12 �

� m�

�

$12,000 �(1.005208333)120

$22, 382.62

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

61. Compounding: Trish Harris has deposited $2,500 today in an account paying 6 percent

interest annually. What would be the simple interest earned on this investment in five

years? If the account paid compound interest, what would be the interest-on-interest in

five years?

A) $750;

$95.56

5-23

Test Bank, Fundamentals of Corporate Finance, 2e

B)

$150;

$845.56

C)

$150;

$95.56

D)

$95.56; $845.56

Ans: A

Feedback:

Deposit today = PV = $2,500

Interest rate = i = 6%

No. of years = n = 5

Simple interest:

Simple interest per year = $2,500 (0.06) = $150.00

Simple interest for 5 years = $150 x 5 = $750.00

Future value with compound interest:

FV5 = $2,500 (1 + 0.06)5 = $3,345.56

Simple interest = $750

Interest on interest = $3,345.56 – $2,500 – $750 = $95.56

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

62. Compounding: Joachim Noah is investing $5,000 in an account paying 6.75 percent

annually for three years. What is the interest-on-interest if interest is compounded?

A) $1,012.50

B)

$1,082.38

C)

$82.38

D)

$69.88

Ans: D

5-24

Test Bank, Fundamentals of Corporate Finance, 2e

Feedback:

Deposit today = PV = $5,000

Interest rate = i = 6.75%

No. of years = n = 3

Simple interest:

Simple interest per year = $5,000 (0.0675) = $337.50

Simple interest for 3 years = $337.50 x 3 = $1,012.50

Future value with compound interest:

FV3 = $5,000 (1 + 0.0675)3 = $6,082.38

Simple interest = $1,012.50

Interest on interest = $6,082.38 – $5,000 – $1,012.50 = $69.88

Format: Multiple Choice

Learning Objective: LO 4

Level of Difficulty: Medium

63. Compounding: Chung Lee wants to invest $3,000 in an account paying 5.25 percent

compounded quarterly. What is the interest on interest after four years?

A) $695.98

B)

$65.98

C)

$630.00

D)

None of the above

Ans: B

5-25

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