Parrino/Fundamentals of Corporate Finance, Test Bank, Chapter 6

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Easy

1. Calculating the present and future values of multiple cash flows is relevant only for

individual investors.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Easy

2. Calculating the present and future values of multiple cash flows is relevant for

businesses only.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Easy

3. In computing the present and future value of multiple cash flows, each cash flow is

discounted or compounded at a different rate.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Easy

4. The present value of multiple cash flows is greater than the sum of those cash flows.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Easy

5. When you pay the same amount every month as your insurance premium for a term life

policy for a period of five years, the stream of cash flows is called a perpetuity.

A) True

B) False

Ans: B

Page 1

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

6. When you pay the same amount every month on your car loan for a period of three

years, the stream of cash flows is called an annuity.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Easy

7. In today's financial markets, the best example of a perpetuity is the common stock

issued by firms.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Easy

8. Since the issuers of preferred stock promise to pay investors a fixed dividend, usually

quarterly, forever, these are the most important perpetuities in the financial markets.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Easy

9. The present value of a perpetuity is the promised constant cash payment divided by the

interest rate (i).

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

10. In ordinary annuities, cash flows occur at the beginning of each period.

A) True

B) False

Ans: B

Page 2

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

11. In an annuity due, cash flows occur at the beginning of each period.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

12. The lease payments by a business on a warehouse rental are an example of an annuity

due.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

13. The present value of an annuity due is less than the present value of an ordinary

annuity.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

14. The present value of an annuity due is equal to the present value of an ordinary annuity.

A) True

B) False

Ans: B

Page 3

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

15. The future value of an annuity due is greater than the future value of an ordinary

annuity.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

16. The future value of an annuity due is equal to the future value of an ordinary annuity.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Easy

17. Cash flow streams that increase at a constant rate over time are called growing

annuities or growing perpetuities.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

18. A fertilizer manufacturing company enters into a contract with a county parks and

recreation department that calls for the company to sell 10 percent more of its best lawn

feed every year for the next five years. If they also agree to maintain the total price as

constant over the contract period, this growth in revenue is an example of a growing

perpetuity.

A) True

B) False

Ans: B

Page 4

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

19. You have received news about an inheritance that will pay you $5,000 next year.

Beginning the following year, your inheritance will increase by 5 percent every year

forever. This is a growing perpetuity.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

20. Trey Hughes opened a pizza place last year. He expects to increase his revenue from

last year by 7 percent every year for the next 10 years. This is an example of a growing

annuity.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

21. The APR is the annualized interest rate using compound interest.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

22. The APR is defined as the simple interest charged per period multiplied by the number

of periods per year.

A) True

B) False

Ans: A

Page 5

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

23. The correct way to annualize an interest rate is to compute the effective annual interest

rate.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

24. The correct way to annualize an interest rate is to compute the annual percentage rate

(APR).

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

25. The effective annual interest rate (EAR) is defined as the annual growth rate that takes

compounding into account.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

26. The EAR is the true cost of borrowing and lending.

A) True

B) False

Ans: A

Page 6

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

27. The quoted interest rate is by convention a simple annual interest rate, such as the

APR.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

28. The quoted interest rate is by definition a simple annual interest rate, such as the EAR.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

29. The Truth-in-Lending Act and the Truth-in-Savings Act require by law that the APR

be disclosed on all consumer loans and savings plans and that it be prominently

displayed on advertising and contractual documents.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

30. Only the APR or some other quoted rate should be used as the interest rate factor for

present or future value calculations.

A) True

B) False

Ans: B

Page 7

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

31. To solve future value problems with multiple cash flows involves which of the

following steps?

A) First, draw a time line to make sure that each cash flow is placed in the correct time

period.

B) Second, calculate the future value of each cash flow for its time period.

C) Third, add up the future values.

D) All of the above are necessary steps.

Ans: D

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

32. Which one of the following steps is NOT involved in solving future value problems?

A) First, draw a time line to make sure that each cash flow is placed in the correct time

period.

B) Second, discount each cash flow for its time period.

C) Third, add up the values.

D) All of the above are necessary steps.

Ans: B

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

33. To solve present value problems with multiple cash flows involves which of the

following steps?

A) First, draw a time line to make sure that each cash flow is placed in the correct time

period.

B) Second, calculate the present value of each cash flow for its time period.

C) Third, add up the present values.

D) All of the above are necessary steps.

Ans: D

Page 8

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

34. Which one of the following steps is NOT involved in solving present value problems?

A) First, draw a time line to make sure that each cash flow is placed in the correct time

period.

B) Second, compound each cash flow for its time period.

C) Third, add up the values.

D) All of the above are necessary steps.

Ans: B

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: easy

35. Calculating the present and future values of multiple cash flows is relevant

A) for businesses only.

B) for individuals only

C) for both individuals and businesses.

D) none of the above.

Ans: C

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

36. In computing the present and future value of multiple cash flows,

A) each cash flow is discounted or compounded at the same rate.

B) each cash flow is discounted or compounded at a different rate.

C) earlier cash flows are discounted at a higher rate.

D) later cash flows are discounted at a higher rate.

Ans: A

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

37. In computing the present and future value of multiple cash flows,

A) earlier cash flows are discounted at a lower rate.

B) each cash flow is discounted or compounded at the same rate.

C) earlier cash flows are discounted at a higher rate.

D) none of the above.

Ans: B

Page 9

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

38. 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) none of the above.

Ans: C

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

39. The future 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) none of the above.

Ans: A

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

40. If your investment pays the same amount at the end of each year for a period of six

years, the cash flow stream is called

A) a perpetuity.

B) an ordinary annuity.

C) an annuity due.

D) none of the above.

Ans: B

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

41. If your investment pays the same amount at the beginning of each year for a period

of 10 years, the cash flow stream is called

A) a perpetuity.

B) an ordinary annuity.

C) an annuity due.

D) none of the above.

Ans: C

Page 10

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

42. If your investment pays the same amount at the end of each year forever, the cash

flow stream is called

A) a perpetuity.

B) an ordinary annuity.

C) an annuity due.

D) none of the above.

Ans: A

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

43. Cash flows associated with annuities are considered to be

A) an uneven cash flow stream.

B) a cash flow stream of the same amount (a constant cash flow stream).

C) a mix of constant and uneven cash flow streams.

D) none of the above.

Ans: B

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

44. Which ONE of the following statements is true about amortization?

A) Amortization refers to the way the borrowed amount (principal) is paid down over the life

of the loan.

B) With an amortized loan, each loan payment contains some payment of principal and an

interest payment.

C) A loan amortization schedule is just a table that shows the loan balance at the beginning

and end of each period, the payment made during that period, and how much of that

payment represents interest and how much represents repayment of principal.

D) All of the above are true.

Ans: D

Page 11

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

45. Which one of the following statements is NOT true about amortization?

A) Amortization refers to the way the borrowed amount (principal) is paid down over the life

of the loan.

B) With an amortized loan, each loan payment contains some payment of principal and an

interest payment.

C) With an amortized loan, a smaller proportion of each month's payment goes toward

interest in the early periods.

D) A loan amortization schedule is just a table that shows the loan balance at the beginning

and end of each period, the payment made during that period, and how much of that

payment represents interest and how much represents repayment of principal.

Ans: C

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

46. Which one of the following statements is true about amortization?

A) With an amortized loan, a bigger proportion of each month's payment goes toward

interest in the early periods.

B) With an amortized loan, a bigger proportion of each month's payment goes toward

interest in the later periods.

C) With an amortized loan, a smaller proportion of each month's payment goes toward

interest in the early periods.

D) None of the above.

Ans: A

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

47. 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.

Ans: C

Page 12

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

48. A firm receives a cash flow from an investment that will increase by 10 percent

annually for an infinite number of years. This cash flow stream is called

A) an annuity due.

B) a growing perpetuity.

C) an ordinary annuity.

D) a growing annuity.

Ans: B

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

49. Your investment in a small business venture will produce cash flows that increase by 15

percent every year for the next 25 years. This cash flow stream is called

A) an annuity due.

B) a growing perpetuity.

C) an ordinary annuity.

D) a growing annuity.

Ans: D

Format: Multiple Choice

Learning Objective: LO 5

Level of Difficulty: Medium

50. Which one of the following statements is TRUE about the effective annual rate (EAR)?

A) The effective annual interest rate (EAR) is defined as the annual growth rate that takes

compounding into account.

B) The EAR conversion formula accounts for the number of compounding periods and, thus,

effectively adjusts the annualized interest rate for the time value of money.

C) The EAR is the true cost of borrowing and lending.

D) All of the above are true.

Ans: D

Format: Multiple Choice

Learning Objective: LO 5

Level of Difficulty: Medium

51. The true cost of borrowing is the

A) annual percentage rate.

B) effective annual rate.

C) quoted interest rate.

D) periodic rate.

Ans: B

Page 13

Format: Multiple Choice

Learning Objective: LO 5

Level of Difficulty: Medium

52. The true cost of lending is the

A) annual percentage rate.

B) effective annual rate.

C) quoted interest rate.

D) none of the above.

Ans: B

Format: Multiple Choice

Learning Objective: LO 5

Level of Difficulty: Medium

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

A) The APR is the appropriate rate to do present and future value calculations.

B) The EAR is the appropriate rate to do present and future value calculations.

C) The EAR is the true cost of borrowing and lending.

D) The EAR takes compounding into account.

Ans: A

Format: Multiple Choice

Learning Objective: LO 5

Level of Difficulty: Medium

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

A) The Truth-in-Lending Act was passed by Congress to ensure that the true cost of credit

was disclosed to consumers.

B) The Truth-in-Savings Act was passed to provide consumers an accurate estimate of the

return they would earn on an investment.

C) The above two pieces of legislation require by law that the APR be disclosed on all

consumer loans and savings plans.

D) All of the above are true statements.

Ans: D

Page 14

Format: Multiple Choice

Learning Objective: LO 5

Level of Difficulty: Medium

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

A) The correct way to annualize an interest rate is to compute the effective annual interest

rate (EAR).

B) The APR is the annualized interest rate using simple interest.

C) The correct way to annualize an interest rate is to compute the annual percentage

rate (APR).

D) You can find the interest rate per period by dividing the quoted annual rate by the number

of compounding periods.

Ans: C

Page 15

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

56. FV of multiple cash flows: Chandler Corp. is expecting a new project to start

producing cash flows, beginning at the end of this year. They expect cash flows to be as

follows:

1

$643,547

2

$678,214

3

$775,908

4

$778,326

5

$735,444

If they can reinvest these cash flows to earn a return of 8.2 percent, what is the future

value of this cash flow stream at the end of five years? (Round to the nearest dollar.)

A) $3,889,256

B) $4,227,118

C) $5,214,690

D) $4, 809,112

Ans: B

Feedback:

FV5 = $643,547(1.082) 4 + $678, 214(1.082)3 + $775,908(1.082)2 + $778,326(1.082)1

+$735, 444

= $882, 042.10 + $859,109.52 + $908,374.12 + $842,148.73 + $735, 444

= $4, 227,118.47

Page 16

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

57. FV of multiple cash flows: Stiglitz, Inc., is expecting the following cash flows

starting at the end of the year—$113,245, $132,709, $141,554, and $180,760. If their

opportunity cost is 9.6 percent, find the future value of these cash flows. (Round to the

nearest dollar.)

A) $644,406.10

B) $732,114

C) $685,312

D) $900,810

Ans: A

Feedback:

Page 17

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

58. FV of multiple cash flows: Tariq Aziz will receive from his investment cash flows of

$3,125, $3,450, and $3, 800. If he can earn 7.5 percent on any investment that he

makes, what is the future value of his investment cash flows at the end of three years?

(Round to the nearest dollar.)

A) $11,120

B) $10,944

C) $10,812

D) $12,770

Ans: A

Feedback:

FV3= $3,125(1.075) 2 + $3, 450(1.075)1 + $3,800

= $3, 611.33 + $3, 708.75 + $3,800

= $11,120.08

Page 18

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

59. FV of multiple cash flows: Shane Matthews has invested in an investment that will

pay him $6,200, $6,450, $7,225, and $7,500 over the next four years. If his opportunity

cost is 10 percent, what is the future value of the cash flows he will receive? (Round to

the nearest dollar.)

A) $27,150

B) $29,900

C) $30,455

D) $31,504

Ans: D

Feedback:

FV4 = $6, 200(1.10)3 + $6, 450(1.10) 2 + $7, 225(1.10)1 + $7,500

= $8, 252.20 + $7,804.50 + $7,947.50 + $7,500

= $31, 504.20

Page 19

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

60. FV of multiple cash flows: International Shippers, Inc., have forecast earnings of $1,

233,400, $1,345,900, and $1,455,650 for the next three years. What is the future value

of these earnings if the firm's opportunity cost is 13 percent? (Round to the nearest

dollar.)

A) $4,214,360

B) $4,551,446

C) $3,900,865

D) $4,875,212

Ans: B

Feedback:

FV3 = $1, 233, 400(1.13) 2 + $1,345, 900(1.13)1 + $1, 455, 650

= $1,574,928.46 + $1,520,867 + $1, 455, 650

= $4, 551, 445.46

Page 20

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

61. PV of multiple cash flows: Jack Stuart has loaned money to his brother at an interest

rate of 5.75 percent. He expects to receive $625, $650, $700, and $800 at the end of the

next four years as complete repayment of the loan with interest. How much did he loan

out to his brother? (Round to the nearest dollar.)

A) $2,713

B) $2,250

C) $2,404

D) $2,545

Ans: C

Feedback:

0

1

2

3

4

$625

$650

$700

$800

n = 4;

i=5.75%

$625

$650

$700

$800

+

+

+

2

3

(1.0575) (1.0575) (1.0575) (1.0575)4

= $591.02 + $581.24 + $591.91 + $639.69

PV =

= $2, 403.85

Page 21

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

62. PV of multiple cash flows: Ferris, Inc., has borrowed from their bank at a rate of 8

percent and will repay the loan with interest over the next five years. Their scheduled

payments, starting at the end of the year are as follows—$450,000, $560,000,

$750,000, $875,000, and $1,000,000. What is the present value of these payments?

(Round to the nearest dollar.)

A) $2,735,200

B) $2,615,432

C) $2431,224

D) $2,815,885

Ans: D

Feedback:

$450, 000 $560, 000 $750, 000 $875, 000 $1, 000, 000

+

+

+

+

(1.08)

(1.08) 2

(1.08)3

(1.08) 4

(1.08)5

= $416, 666.67 + $480,109.74 + $595,374.18 + $643,151.12 + $680,583.20

= $2, 815, 884.91

PV =

Page 22

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

63. PV of multiple cash flows: Hassan Ali has made an investment that will pay him

$11,455, $16,376, and $19,812 at the end of the next three years. His investment was to

fetch him a return of 14 percent. What is the present value of these cash flows? (Round

to the nearest dollar.)

A) $33,124

B) $36,022

C) $41,675

D) $39,208

Ans: B

Feedback:

$11, 455 $16,376 $19,812

+

+

(1.14)

(1.14) 2

(1.14)3

= $10, 048.25 + $12, 600.80 + $13,372.54

PV =

= $36, 021.58

Page 23

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

64. PV of multiple cash flows: Ajax Corp. is expecting the following cash flows—

$79,000, $112,000, $164,000, $84,000, and $242,000—over the next five years. If the

company’s opportunity cost is 15 percent, what is the present value of these cash flows?

(Round to the nearest dollar.)

A) $429,560

B) $414,322

C) $480,906

D) $477,235

Ans: A

Feedback:

$79, 000 $112, 000 $164, 000 $84, 000 $242, 000

+

+

+

+

(1.15)

(1.15) 2

(1.15)3

(1.15) 4

(1.15)5

= $68, 695.65 + $84, 688.09 + $107,832.66 + $48, 027.27 + $120,316.77

= $429, 560.45

PV =

Page 24

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

65. PV of multiple cash flows: Pam Gregg is expecting cash flows of $50,000, $75,000,

$125,000, and $250,000 from an inheritance over the next four years. If she can earn 11

percent on any investment that she makes, what is the present value of her inheritance?

(Round to the nearest dollar.)

A) $361,998

B) $309,432

C) $412,372

D) $434,599

Ans: A

Feedback:

$50, 000 $75, 000 $125, 000 $250, 000

+

+

+

(1.11)

(1.11) 2

(1.11)3

(1.11) 4

= $45, 045.05 + 60,871.68 + $91,398.92 + $164, 682.74

PV =

= $361, 998.39

Page 25

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Easy

1. Calculating the present and future values of multiple cash flows is relevant only for

individual investors.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Easy

2. Calculating the present and future values of multiple cash flows is relevant for

businesses only.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Easy

3. In computing the present and future value of multiple cash flows, each cash flow is

discounted or compounded at a different rate.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 1

Level of Difficulty: Easy

4. The present value of multiple cash flows is greater than the sum of those cash flows.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Easy

5. When you pay the same amount every month as your insurance premium for a term life

policy for a period of five years, the stream of cash flows is called a perpetuity.

A) True

B) False

Ans: B

Page 1

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

6. When you pay the same amount every month on your car loan for a period of three

years, the stream of cash flows is called an annuity.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Easy

7. In today's financial markets, the best example of a perpetuity is the common stock

issued by firms.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Easy

8. Since the issuers of preferred stock promise to pay investors a fixed dividend, usually

quarterly, forever, these are the most important perpetuities in the financial markets.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 3

Level of Difficulty: Easy

9. The present value of a perpetuity is the promised constant cash payment divided by the

interest rate (i).

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

10. In ordinary annuities, cash flows occur at the beginning of each period.

A) True

B) False

Ans: B

Page 2

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Easy

11. In an annuity due, cash flows occur at the beginning of each period.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

12. The lease payments by a business on a warehouse rental are an example of an annuity

due.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

13. The present value of an annuity due is less than the present value of an ordinary

annuity.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

14. The present value of an annuity due is equal to the present value of an ordinary annuity.

A) True

B) False

Ans: B

Page 3

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

15. The future value of an annuity due is greater than the future value of an ordinary

annuity.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 2

Level of Difficulty: Medium

16. The future value of an annuity due is equal to the future value of an ordinary annuity.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Easy

17. Cash flow streams that increase at a constant rate over time are called growing

annuities or growing perpetuities.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

18. A fertilizer manufacturing company enters into a contract with a county parks and

recreation department that calls for the company to sell 10 percent more of its best lawn

feed every year for the next five years. If they also agree to maintain the total price as

constant over the contract period, this growth in revenue is an example of a growing

perpetuity.

A) True

B) False

Ans: B

Page 4

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

19. You have received news about an inheritance that will pay you $5,000 next year.

Beginning the following year, your inheritance will increase by 5 percent every year

forever. This is a growing perpetuity.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 4

Level of Difficulty: Medium

20. Trey Hughes opened a pizza place last year. He expects to increase his revenue from

last year by 7 percent every year for the next 10 years. This is an example of a growing

annuity.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

21. The APR is the annualized interest rate using compound interest.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

22. The APR is defined as the simple interest charged per period multiplied by the number

of periods per year.

A) True

B) False

Ans: A

Page 5

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

23. The correct way to annualize an interest rate is to compute the effective annual interest

rate.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

24. The correct way to annualize an interest rate is to compute the annual percentage rate

(APR).

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

25. The effective annual interest rate (EAR) is defined as the annual growth rate that takes

compounding into account.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

26. The EAR is the true cost of borrowing and lending.

A) True

B) False

Ans: A

Page 6

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

27. The quoted interest rate is by convention a simple annual interest rate, such as the

APR.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

28. The quoted interest rate is by definition a simple annual interest rate, such as the EAR.

A) True

B) False

Ans: B

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Easy

29. The Truth-in-Lending Act and the Truth-in-Savings Act require by law that the APR

be disclosed on all consumer loans and savings plans and that it be prominently

displayed on advertising and contractual documents.

A) True

B) False

Ans: A

Format: True/False

Learning Objective: LO 5

Level of Difficulty: Medium

30. Only the APR or some other quoted rate should be used as the interest rate factor for

present or future value calculations.

A) True

B) False

Ans: B

Page 7

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

31. To solve future value problems with multiple cash flows involves which of the

following steps?

A) First, draw a time line to make sure that each cash flow is placed in the correct time

period.

B) Second, calculate the future value of each cash flow for its time period.

C) Third, add up the future values.

D) All of the above are necessary steps.

Ans: D

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

32. Which one of the following steps is NOT involved in solving future value problems?

A) First, draw a time line to make sure that each cash flow is placed in the correct time

period.

B) Second, discount each cash flow for its time period.

C) Third, add up the values.

D) All of the above are necessary steps.

Ans: B

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

33. To solve present value problems with multiple cash flows involves which of the

following steps?

A) First, draw a time line to make sure that each cash flow is placed in the correct time

period.

B) Second, calculate the present value of each cash flow for its time period.

C) Third, add up the present values.

D) All of the above are necessary steps.

Ans: D

Page 8

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

34. Which one of the following steps is NOT involved in solving present value problems?

A) First, draw a time line to make sure that each cash flow is placed in the correct time

period.

B) Second, compound each cash flow for its time period.

C) Third, add up the values.

D) All of the above are necessary steps.

Ans: B

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: easy

35. Calculating the present and future values of multiple cash flows is relevant

A) for businesses only.

B) for individuals only

C) for both individuals and businesses.

D) none of the above.

Ans: C

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

36. In computing the present and future value of multiple cash flows,

A) each cash flow is discounted or compounded at the same rate.

B) each cash flow is discounted or compounded at a different rate.

C) earlier cash flows are discounted at a higher rate.

D) later cash flows are discounted at a higher rate.

Ans: A

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

37. In computing the present and future value of multiple cash flows,

A) earlier cash flows are discounted at a lower rate.

B) each cash flow is discounted or compounded at the same rate.

C) earlier cash flows are discounted at a higher rate.

D) none of the above.

Ans: B

Page 9

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

38. 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) none of the above.

Ans: C

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Easy

39. The future 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) none of the above.

Ans: A

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

40. If your investment pays the same amount at the end of each year for a period of six

years, the cash flow stream is called

A) a perpetuity.

B) an ordinary annuity.

C) an annuity due.

D) none of the above.

Ans: B

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

41. If your investment pays the same amount at the beginning of each year for a period

of 10 years, the cash flow stream is called

A) a perpetuity.

B) an ordinary annuity.

C) an annuity due.

D) none of the above.

Ans: C

Page 10

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

42. If your investment pays the same amount at the end of each year forever, the cash

flow stream is called

A) a perpetuity.

B) an ordinary annuity.

C) an annuity due.

D) none of the above.

Ans: A

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

43. Cash flows associated with annuities are considered to be

A) an uneven cash flow stream.

B) a cash flow stream of the same amount (a constant cash flow stream).

C) a mix of constant and uneven cash flow streams.

D) none of the above.

Ans: B

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

44. Which ONE of the following statements is true about amortization?

A) Amortization refers to the way the borrowed amount (principal) is paid down over the life

of the loan.

B) With an amortized loan, each loan payment contains some payment of principal and an

interest payment.

C) A loan amortization schedule is just a table that shows the loan balance at the beginning

and end of each period, the payment made during that period, and how much of that

payment represents interest and how much represents repayment of principal.

D) All of the above are true.

Ans: D

Page 11

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

45. Which one of the following statements is NOT true about amortization?

A) Amortization refers to the way the borrowed amount (principal) is paid down over the life

of the loan.

B) With an amortized loan, each loan payment contains some payment of principal and an

interest payment.

C) With an amortized loan, a smaller proportion of each month's payment goes toward

interest in the early periods.

D) A loan amortization schedule is just a table that shows the loan balance at the beginning

and end of each period, the payment made during that period, and how much of that

payment represents interest and how much represents repayment of principal.

Ans: C

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

46. Which one of the following statements is true about amortization?

A) With an amortized loan, a bigger proportion of each month's payment goes toward

interest in the early periods.

B) With an amortized loan, a bigger proportion of each month's payment goes toward

interest in the later periods.

C) With an amortized loan, a smaller proportion of each month's payment goes toward

interest in the early periods.

D) None of the above.

Ans: A

Format: Multiple Choice

Learning Objective: LO 2

Level of Difficulty: Easy

47. 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.

Ans: C

Page 12

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

48. A firm receives a cash flow from an investment that will increase by 10 percent

annually for an infinite number of years. This cash flow stream is called

A) an annuity due.

B) a growing perpetuity.

C) an ordinary annuity.

D) a growing annuity.

Ans: B

Format: Multiple Choice

Learning Objective: LO 3

Level of Difficulty: Easy

49. Your investment in a small business venture will produce cash flows that increase by 15

percent every year for the next 25 years. This cash flow stream is called

A) an annuity due.

B) a growing perpetuity.

C) an ordinary annuity.

D) a growing annuity.

Ans: D

Format: Multiple Choice

Learning Objective: LO 5

Level of Difficulty: Medium

50. Which one of the following statements is TRUE about the effective annual rate (EAR)?

A) The effective annual interest rate (EAR) is defined as the annual growth rate that takes

compounding into account.

B) The EAR conversion formula accounts for the number of compounding periods and, thus,

effectively adjusts the annualized interest rate for the time value of money.

C) The EAR is the true cost of borrowing and lending.

D) All of the above are true.

Ans: D

Format: Multiple Choice

Learning Objective: LO 5

Level of Difficulty: Medium

51. The true cost of borrowing is the

A) annual percentage rate.

B) effective annual rate.

C) quoted interest rate.

D) periodic rate.

Ans: B

Page 13

Format: Multiple Choice

Learning Objective: LO 5

Level of Difficulty: Medium

52. The true cost of lending is the

A) annual percentage rate.

B) effective annual rate.

C) quoted interest rate.

D) none of the above.

Ans: B

Format: Multiple Choice

Learning Objective: LO 5

Level of Difficulty: Medium

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

A) The APR is the appropriate rate to do present and future value calculations.

B) The EAR is the appropriate rate to do present and future value calculations.

C) The EAR is the true cost of borrowing and lending.

D) The EAR takes compounding into account.

Ans: A

Format: Multiple Choice

Learning Objective: LO 5

Level of Difficulty: Medium

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

A) The Truth-in-Lending Act was passed by Congress to ensure that the true cost of credit

was disclosed to consumers.

B) The Truth-in-Savings Act was passed to provide consumers an accurate estimate of the

return they would earn on an investment.

C) The above two pieces of legislation require by law that the APR be disclosed on all

consumer loans and savings plans.

D) All of the above are true statements.

Ans: D

Page 14

Format: Multiple Choice

Learning Objective: LO 5

Level of Difficulty: Medium

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

A) The correct way to annualize an interest rate is to compute the effective annual interest

rate (EAR).

B) The APR is the annualized interest rate using simple interest.

C) The correct way to annualize an interest rate is to compute the annual percentage

rate (APR).

D) You can find the interest rate per period by dividing the quoted annual rate by the number

of compounding periods.

Ans: C

Page 15

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

56. FV of multiple cash flows: Chandler Corp. is expecting a new project to start

producing cash flows, beginning at the end of this year. They expect cash flows to be as

follows:

1

$643,547

2

$678,214

3

$775,908

4

$778,326

5

$735,444

If they can reinvest these cash flows to earn a return of 8.2 percent, what is the future

value of this cash flow stream at the end of five years? (Round to the nearest dollar.)

A) $3,889,256

B) $4,227,118

C) $5,214,690

D) $4, 809,112

Ans: B

Feedback:

FV5 = $643,547(1.082) 4 + $678, 214(1.082)3 + $775,908(1.082)2 + $778,326(1.082)1

+$735, 444

= $882, 042.10 + $859,109.52 + $908,374.12 + $842,148.73 + $735, 444

= $4, 227,118.47

Page 16

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

57. FV of multiple cash flows: Stiglitz, Inc., is expecting the following cash flows

starting at the end of the year—$113,245, $132,709, $141,554, and $180,760. If their

opportunity cost is 9.6 percent, find the future value of these cash flows. (Round to the

nearest dollar.)

A) $644,406.10

B) $732,114

C) $685,312

D) $900,810

Ans: A

Feedback:

Page 17

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

58. FV of multiple cash flows: Tariq Aziz will receive from his investment cash flows of

$3,125, $3,450, and $3, 800. If he can earn 7.5 percent on any investment that he

makes, what is the future value of his investment cash flows at the end of three years?

(Round to the nearest dollar.)

A) $11,120

B) $10,944

C) $10,812

D) $12,770

Ans: A

Feedback:

FV3= $3,125(1.075) 2 + $3, 450(1.075)1 + $3,800

= $3, 611.33 + $3, 708.75 + $3,800

= $11,120.08

Page 18

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

59. FV of multiple cash flows: Shane Matthews has invested in an investment that will

pay him $6,200, $6,450, $7,225, and $7,500 over the next four years. If his opportunity

cost is 10 percent, what is the future value of the cash flows he will receive? (Round to

the nearest dollar.)

A) $27,150

B) $29,900

C) $30,455

D) $31,504

Ans: D

Feedback:

FV4 = $6, 200(1.10)3 + $6, 450(1.10) 2 + $7, 225(1.10)1 + $7,500

= $8, 252.20 + $7,804.50 + $7,947.50 + $7,500

= $31, 504.20

Page 19

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

60. FV of multiple cash flows: International Shippers, Inc., have forecast earnings of $1,

233,400, $1,345,900, and $1,455,650 for the next three years. What is the future value

of these earnings if the firm's opportunity cost is 13 percent? (Round to the nearest

dollar.)

A) $4,214,360

B) $4,551,446

C) $3,900,865

D) $4,875,212

Ans: B

Feedback:

FV3 = $1, 233, 400(1.13) 2 + $1,345, 900(1.13)1 + $1, 455, 650

= $1,574,928.46 + $1,520,867 + $1, 455, 650

= $4, 551, 445.46

Page 20

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

61. PV of multiple cash flows: Jack Stuart has loaned money to his brother at an interest

rate of 5.75 percent. He expects to receive $625, $650, $700, and $800 at the end of the

next four years as complete repayment of the loan with interest. How much did he loan

out to his brother? (Round to the nearest dollar.)

A) $2,713

B) $2,250

C) $2,404

D) $2,545

Ans: C

Feedback:

0

1

2

3

4

$625

$650

$700

$800

n = 4;

i=5.75%

$625

$650

$700

$800

+

+

+

2

3

(1.0575) (1.0575) (1.0575) (1.0575)4

= $591.02 + $581.24 + $591.91 + $639.69

PV =

= $2, 403.85

Page 21

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

62. PV of multiple cash flows: Ferris, Inc., has borrowed from their bank at a rate of 8

percent and will repay the loan with interest over the next five years. Their scheduled

payments, starting at the end of the year are as follows—$450,000, $560,000,

$750,000, $875,000, and $1,000,000. What is the present value of these payments?

(Round to the nearest dollar.)

A) $2,735,200

B) $2,615,432

C) $2431,224

D) $2,815,885

Ans: D

Feedback:

$450, 000 $560, 000 $750, 000 $875, 000 $1, 000, 000

+

+

+

+

(1.08)

(1.08) 2

(1.08)3

(1.08) 4

(1.08)5

= $416, 666.67 + $480,109.74 + $595,374.18 + $643,151.12 + $680,583.20

= $2, 815, 884.91

PV =

Page 22

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

63. PV of multiple cash flows: Hassan Ali has made an investment that will pay him

$11,455, $16,376, and $19,812 at the end of the next three years. His investment was to

fetch him a return of 14 percent. What is the present value of these cash flows? (Round

to the nearest dollar.)

A) $33,124

B) $36,022

C) $41,675

D) $39,208

Ans: B

Feedback:

$11, 455 $16,376 $19,812

+

+

(1.14)

(1.14) 2

(1.14)3

= $10, 048.25 + $12, 600.80 + $13,372.54

PV =

= $36, 021.58

Page 23

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

64. PV of multiple cash flows: Ajax Corp. is expecting the following cash flows—

$79,000, $112,000, $164,000, $84,000, and $242,000—over the next five years. If the

company’s opportunity cost is 15 percent, what is the present value of these cash flows?

(Round to the nearest dollar.)

A) $429,560

B) $414,322

C) $480,906

D) $477,235

Ans: A

Feedback:

$79, 000 $112, 000 $164, 000 $84, 000 $242, 000

+

+

+

+

(1.15)

(1.15) 2

(1.15)3

(1.15) 4

(1.15)5

= $68, 695.65 + $84, 688.09 + $107,832.66 + $48, 027.27 + $120,316.77

= $429, 560.45

PV =

Page 24

Format: Multiple Choice

Learning Objective: LO 1

Level of Difficulty: Medium

65. PV of multiple cash flows: Pam Gregg is expecting cash flows of $50,000, $75,000,

$125,000, and $250,000 from an inheritance over the next four years. If she can earn 11

percent on any investment that she makes, what is the present value of her inheritance?

(Round to the nearest dollar.)

A) $361,998

B) $309,432

C) $412,372

D) $434,599

Ans: A

Feedback:

$50, 000 $75, 000 $125, 000 $250, 000

+

+

+

(1.11)

(1.11) 2

(1.11)3

(1.11) 4

= $45, 045.05 + 60,871.68 + $91,398.92 + $164, 682.74

PV =

= $361, 998.39

Page 25

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