Test Bank for Fundamentals of Corporate Finance 3rd Edition by Parrino

Fundamentals of Corporate Finance 3e Test Bank

Chapter 6: Discounted Cash Flows and Valuation

Format: True/FalseLearning Objective: LO 1Level of Difficulty: EasyBloomcode: ComprehensionAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

1. Calculating the present and future values of multiple cash flows is relevant only for individual investors.A) TrueB) FalseAns: B

Format: True/FalseLearning Objective: LO 1Level of Difficulty: EasyBloomcode: KnowledgeAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

2. Calculating the present and future values of multiple cash flows is relevant for businesses only.A) TrueB) FalseAns: B


3. In computing the present and future value of multiple cash flows, each cash flow is discounted or compounded at a same rate.A) TrueB) FalseAns: A

Copyright © 2015 John Wiley & Sons, Inc. 6-1



4. The present value of multiple cash flows is greater than the sum of those cash flows.A) TrueB) FalseAns: B

Format: True/FalseLearning Objective: LO 2Level of Difficulty: EasyBloomcode: ApplicationAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

5. Jacob Oram pay the same amount every month as insurance premium for a term life policy for a period of five years, the stream of cash flows is called a perpetuity.A) TrueB) FalseAns: B


6. Allen Bell pay the same amount every month on a car loan for a period of three years, the stream of cash flows is called an annuity.A) TrueB) FalseAns: A




7. In today's financial markets, the best example of a perpetuity is the common stock issued by firms.A) TrueB) FalseAns: B


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) TrueB) FalseAns: A


9. The present value of a perpetuity is the promised constant cash payment divided by the interest rate (i).A) TrueB) FalseAns: A




10. In ordinary annuities, cash flows occur at the beginning of each period.A) TrueB) FalseAns: B


11. In an annuity due, cash flows occur at the beginning of each period.A) TrueB) FalseAns: A

Format: True/FalseLearning Objective: LO 3Level of Difficulty: MediumBloomcode: ComprehensionAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

12. The lease payments by a business of a warehouse rental are an example of an annuity due.A) TrueB) FalseAns: A



Format: True/FalseLearning Objective: LO 2, LO 3Level of Difficulty: MediumBloomcode: ComprehensionAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

13. The present value of an annuity due is less than the present value of an ordinary annuity.A) TrueB) FalseAns: B


14. The present value of an annuity due is equal to the present value of an ordinary annuity.A) TrueB) FalseAns: B


15. The future value of an annuity due is greater than the future value of an ordinary annuity.A) TrueB) FalseAns: A




16. The future value of an annuity due is equal to the future value of an ordinary annuity.A) TrueB) FalseAns: B


17. Cash flow streams that increase at a constant rate over time are called growing annuities or growing perpetuities.A) TrueB) FalseAns: A

Format: True/FalseLearning Objective: LO 4Level of Difficulty: MediumBloomcode: ApplicationAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

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) TrueB) FalseAns: B




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) TrueB) FalseAns: A


20. Natalia Greenberg opened a pizza place last year. She expects to increase her revenue from last year by 7 percent every year for the next 10 years. This is an example of a growing annuity.A) TrueB) FalseAns: A


21. The annual percentage rate (APR) is the annualized interest rate using compound interest.A) TrueB) FalseAns: B



Format: True/FalseLearning Objective: LO 5Level of Difficulty: MediumBloomcode: KnowledgeAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

22. The annual percentage rate (APR) is defined as the simple interest charged per period multiplied by the number of periods per year.A) TrueB) FalseAns: A


23. The correct way to annualize an interest rate is to compute the effective annual interest rate.A) TrueB) FalseAns: A

Format: True/FalseLearning Objective: LO 5Level of Difficulty: MediumBloomcode: KnkowledgeAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

24. The correct way to annualize an interest rate is to compute the annual percentage rate (APR).A) TrueB) FalseAns: B




25. The effective annual interest rate (EAR) is defined as the annual growth rate that takes compounding into account.A) TrueB) FalseAns: A


26. The effective annual interest rate (EAR) is the true cost of borrowing and lending.A) TrueB) FalseAns: A


27. The quoted interest rate is by convention a simple annual interest rate, such as the annual percentage rate (APR).A) TrueB) FalseAns: A




28. The quoted interest rate is by definition a simple annual interest rate, such as the effective annual interest rate (EAR).A) TrueB) FalseAns: B

Format: True/FalseLearning Objective: LO 5Level of Difficulty: EasyBloomcode: KnowledgeAASCB: AnalyticIMA: Corporate FinanceAICPA: Legal/Regulatory Perspective

29. The Truth-in-Lending Act and the Truth-in-Savings Act require by law that the annual percentage rate (APR) be disclosed on all consumer loans and savings plans and that it be prominently displayed on advertising and contractual documents.A) TrueB) FalseAns: A


30. Only the annual percentage rate (APR) or some other quoted rate should be used as the interest rate factor for present or future value calculations.A) TrueB) FalseAns: B




31. A car manufacturer enters into a contract for 25-years lease of warehouse rental that adjusts annually for the expected rate of inflation over the life of the contract. This is an example of growing perpetuity.

A) TrueB) FalseAns: B


32. A growing annuity for an infinite period is called a growing perpetuity.

A) TrueB) FalseAns: A


33. For computation of the present value of growing annuity with n periods, the cash flow for the current period is used and not the cash flow to be received in the next period.

A) TrueB) FalseAns: B




34. Growing perpetuity is widely used in the valuation of common stock of firms that have a policy and history of paying dividends that grow at a constant rate.



35. The present value of growing perpetuity is computed as the cash flow occurring at the end of the first period divided by the difference between interest or discount rate and growth rate.


Format: Multiple ChoiceLearning Objective: LO 1Level of Difficulty: EasyBloomcode: KnowledgeAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

36. Which of the following is used as the denominator while calculating the present value for a growing perpetuity that begins next period (PVP)?A) The difference between i (the discount or interest rate) and g (the constant rate of growth

of the cash flow)B) i (the discount or interest rate)C) g (the constant rate of growth of the cash flow)D) The addition of i (the discount or interest rate) and g (the constant rate of growth of the

cash flow)Ans: A




37. The present value of future cash flows are computed by multiplying future value with the:A) discounting factor.B) compound factor.C) interest rate.D) number of periods.Ans: A

Format: Multiple ChoiceLearning Objective: LO 1Level of Difficulty: EasyBloomcode: ApplicationAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

38. Nick invested $2,000 in a bank savings account today and another $2000 a year from now. If the bank pays interest of 10 percent per year, how much money will Nick have at the end of two years?A) $4,210B) $4,200C) $4,000D) $4,620Ans: DFeedback:Future value of two cash flows = [PV × (1 + i)2]+ [PV × (1 + i)] = [$2,000 × (1 + 0.10)2] + [$2,000 × (1 + 0.10)] = [$2,000 × (1.10)2] + [$2,000 × (1.10)] = [$2,000 × 1.21]+ [$2,000 × 1.10] = $2,420 + $2,200 = $4,620



Format: Multiple ChoiceLearning Objective: LO 1Level of Difficulty: EasyBloomcode: ComprehensionAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

39. Which of the following is true of discounting factor?A) Discounting factor is the reciprocal of compounding factor.B) Discounting factor is the sum of 1 and the rate of interest.C) Discounting factor is period n times the rate of interest.D) Discounting factor is computed by dividing period n by the sum of 1 and the rate of

interest.Ans: A

Format: Multiple ChoiceLearning Objective: LO 1Level of Difficulty: easyBloomcode: ApplicationAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

40. William deposited $25,000 today that would earn an interest at the rate of 3% for a period of 2 years. The amount of $25,000 represents the:A) present value of an annuityB) future value of an annuityC) present valueD) future valueAns: C


41. 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 ChoiceLearning Objective: LO 1Level of Difficulty: EasyBloomcode: ApplicationAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

42. Anna would receive $15,000 from a bank deposit after 2 years which had an interest of 3.5%. The amount of $15,000 represents the:A) present value of an annuityB) future value of an annuityC) present valueD) future valueAns: D


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


44. 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) higher or lower than the cash flows depending on the interest rate.Ans: A




45. 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) a growing perpetuity.Ans: B


46. 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) a growing perpetuity.Ans: C

Format: Multiple ChoiceLearning Objective: LO 2Level of Difficulty: EasyBloomcode: ComrpehensionAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

47. A preferred stock would be an ideal example of:A) a perpetuity.B) an ordinary annuity.C) an annuity due.D) a growing annuity.Ans: A




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

Format: Multiple ChoiceLearning Objective: LO 1Level of Difficulty: MediumBloomcode: ComprehensionAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

49. Which of the following statements is true of amortization?A) Amortization solely refers to the total value to be paid by the borrower at the end of

maturity.B) The amortization schedule represents only the interest portion of the loan.C) The computation of loan amortization is wholly based on the computation of simple

interest.D) The amortization schedule provides the data of equated monthly payments for which the

classification of principal and interest along with unpaid principal balance is provided.Ans: D




50. Which of the following statements is true of amortization?A) With an amortized loan, a periodical payment of principal portion gradually decreases

over a period.B) Amortization schedule represents only the interest portion of the loan.C) With an amortized loan, a bigger proportion of each month's payment goes toward

interest in the early periods.D) The computation of loan amortization is wholly based on the computation of simple

interest.Ans: C


51. Which of the following statements is true of 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) With an amortized loan, the interest portion of each month’s payment remains

unchanged.Ans: A




52. 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


53. 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


54. 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




55. Which 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 rates that do not

take compounding into account.B) The EAR is the annualized interest rate using simple interest. It ignores the interest

earned on interest associated with compounding periods of less than one year.C) The EAR is the simple interest charged per period multiplied by the number of periods

per year.D) The EAR is the interest rate actually paid (or earned) after accounting for compounding.Ans: D

Format: Multiple ChoiceLearning Objective: LO 5Level of Difficulty: MediumBloomcode: KnowledgeAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

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

Format: Multiple ChoiceLearning Objective: LO 5Level of Difficulty: MediumBloomcode: KnowledgeAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

57. The true cost of lending is the:A) annual percentage rate.B) effective annual rate.C) quoted interest rate.D) interest rate per period.Ans: B




58. Which of the following statements is true of annual percentage rate (APR)?A) The APR is similar to quoted interest rate which is a simple annual rate.B) The APR calculation adjusts for the effects of compounding and, hence, the time value

of money.C) The APR is the true cost of borrowing and lending.D) The APR takes compounding into account.Ans: A


59. Which of the following statements is true of annual percentage rate (APR)?A) The Truth-in-Savings Act was passed by Congress to ensure that the true cost of credit

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

return they would earn on an investment.C) The Truth-in-Savings Act and Truth-in-Lending Act require by law that the APR be

disclosed on all consumer loans and savings plans.D) The annual percentage rate (APR), and not the effective annual interest rate (EAR),

represents the true economic interest rate.Ans: C

Format: Multiple ChoiceLearning Objective: LO 5Level of Difficulty: EasyBloomcode: comprehensionAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

60. What is the appropriate interest rate to use when making future or present value calculations?A) The effective annual interest rate (EAR)B) The annual percentage rate (APR)C) The quoted interest rateD) The simple interestAns: A



Format: Multiple ChoiceLearning Objective: LO 1Level of Difficulty: MediumBloomcode: ApplicationAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

61. Krysel Inc. 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 2 3 4 5$663,547 $698,214 $795,908 $798,326 $755,444

If they can reinvest these cash flows to earn a return of 9.2 percent, what is the future value of this cash flow stream at the end of five years? (Round to the nearest dollar.)A) $4,368,692B) $4,429,046C) $4,468,692D) $4,529,046Ans: BFeedback:0 1 2 3 4 5├─────────┼────────┼─────────┼────────┼────────┤ $663,547 $698,214 $795,908 $798,326 $755,444

n = 5 i = 9.20%

FV5= $663,547(1.092)4 + $698,214(1.092)3 + $795,908(1.092)2 + $798,326(1.092)1 + $755,444 = $943,544.19 + $909,193.80 + $949,091.64 + $871,771.99 + $755,444.00 = $4,429,045.62




62. Phosfranc Inc., is expecting the following cash flows starting at the end of the year—$133,245, $152,709, $161,554, and $200,760. If their opportunity cost is 9.4 percent, find the future value of these cash flows. (Round to the nearest dollar.)A) $734,731B) $756,525C) $734,231D) $776,252Ans: AFeedback:0 1 2 3 4├─────────┼────────┼─────────┼────────┼ $133,245 $152,709 $161,554 $200,760

n = 4 i = 9.40%

FV4= $133,245(1.094)3 + $152,709(1.094)2 + $161,554(1.094)1 + $200,760 = $174,462.82 + $182,767.63 + $176,740.08 + $200,760.00 = $734,730.53




63. Robert White will receive from his investment cash flows of $4,450, $4,775, and $5,125. If he can earn 7 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) $15,329B) $15,427C) $16,427D) $14,427Ans: AFeedback:

$4,450 $4,775 $5,125

n = 4 i = 7.0%

FV3= $4,450(1.094)2 + $4,775(1.094)1 + $5,125 = $5,094.81 + $5,109.25 + $5,125.00 = $15,329.06




64. Scottie Barnes has invested in an investment that will pay him $6,400, $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) $27,150B) $32,020C) $30,455D) $31,770Ans: DFeedback:

$6,400 $6,450 $7,225 $7,500n = 4; i = 10%

FV4 = $6,400(1.10)3 + $6,450(1.10)2 + $7,225(1.10)1 + $7,500 = $8,518.40 + $7,804.50 + $7,947.50 + $7,500 = $31,770.40




65. Global Shippers Inc. has forecast earnings of $1,233,600, $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) $4,214,360B) 4,551,701C) $3,900,865D) $4,362,428Ans: BFeedback:

1,233,600 1,345,900 1,455,650

FV3 = $1,233,600(1.13)2 + 1,345,900(1.13)1 + $1,455,650 = 1,575,183.84 + $1,520,867.00 + $1,455,650.00 = $4,551,700.84




66. Damien McCoy has loaned money to his brother at an interest rate of 5.85 percent. He expects to receive $987, $1,012, $1,062, and $1,162 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) $3,785B) $3,757C) $3,657D) $3,685Ans: CFeedback:

$987 $1,012 $1,062 $1,162

n = 4 i = 5.85%

$987 $1,012 $1,062 $1,162(1.0585) (1.0585)2 (1.0585)3 (1.0585)4+ ++=

= $932.45 + $903.23 + $895.47 + $925.64 = $3,656.80




67. Newship Inc. has borrowed from its bank at a rate of 8 percent and will repay the loan with interest over the next five years. Its 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) $2,735,200B) $2,989,351C) $2,431,224D) $2,815,885Ans: DFeedback:




68. David Stephens 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) $37,712B) $36,022C) $41,675D) $39,208Ans: BFeedback:




69. Nutech 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) $429,560B) $485,097C) $480,906D) $477,235Ans: AFeedback:




70. Helen Ashley 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) $361,998B) $414,454C) $412,372D) $434,599Ans: AFeedback:

= $45,045.05 + $60,871.68 + $91,398.92 + $164,682.74= $361,998.39




71. Ransport Company has made an investment in another company that will guarantee it a cash flow of $37,250 each year for the next five years. If the company uses a discount rate of 15 percent on its investments, what is the present value of this investment? (Round to the nearest dollar.)A) $101,766B) $124,868C) $251,154D) $186,250Ans: BFeedback:

Annual payment = PMT = $37,250No. of payments = n = 5Required rate of return = 15%Present value of investment = PVA5




72. Ryan Campbell has invested in a fund that will provide him a cash flow of $11,700 for the next 20 years. If his opportunity cost is 8.5 percent, what is the present value of this cash flow stream? (Round to the nearest dollar.)A) $234,000B) $132,455C) $110,721D) $167,884Ans: CFeedback:




73. Moore’s Inc. will be making lease payments of $3,895.50 for a 10-year period, starting at the end of this year. If the firm uses a 9 percent discount rate, what is the present value of this annuity? (Round to the nearest dollar.)A) $23,250B) $29,000C) $25,000D) $20,000Ans: CFeedback:




74. Graciela Treadwell won a lottery. She will have a choice of receiving $25,000 at the end of each year for the next 30 years, or a lump sum today. If she can earn a return of 10 percent on any investment she makes, what is the minimum amount she should be willing to accept today as a lump-sum payment? (Round to the nearest hundred dollars.)A) $750,000B) $334,600C) $212,400D) $235,700Ans: DFeedback:




75. Insulor Inc. is expecting cash flows of $67,000 at the end of each year for the next five years. If the firm's discount rate is 17 percent, what is the present value of this annuity? (Round to the nearest dollar.)A) $214,356B) $241,653C) $278,900D) $197,776Ans: AFeedback:




76. Lloyd Harris is planning to invest $3,500 every year for the next six years in an investment paying 13 percent annually. What will be the amount he will have at the end of the six years? (Round to the nearest dollar.)A) $21,000B) $29,129C) $24,670D) $26,124Ans: BFeedback:

n = 6; i = 13%

= $3,500 × (1.13) 6 – 1 0.13= $3,500 × 8.3227= $29129.47




77. Shaun Barringer has started on his first job. He plans to start saving for retirement. He will invest $5,000 at the end of each year for the next 45 years in a fund that will earn a return of 10 percent. How much will Shaun have at the end of 45 years? (Round to the nearest dollar.)A) $2,667,904B) $3,594,524C) $1,745,600D) $5,233,442Ans: BFeedback:




78. John Mason decided to save $2,250 at the end of each of the next three years to pay for a vacation. If he invests it at 8 percent, how much will he have at the end of three years? (Round to the nearest dollar.)A) $7,304B) $7,403C) $6,297D) $7,010Ans: AFeedback:

$2,250 $2,250 $2,250

n = 3 i = 8.0%

= $2,250 × (1.08) 3 – 1 0.08 = $7,304.40 × 3.2464 = $7,304.40




79. Barbara Lakey is saving to buy a new car in four years. She will save $5,500 at the end of each of the next four years. If she invests her savings at 7.75 percent, how much will she have after four years? (Round to the nearest dollar.)A) $22,000B) $23,345C) $27,556D) $28,692Ans: DFeedback:

=$5,500 × (1.0775) 4 – 1 0.0775 = $5,500 × 4.4895 = $24,692.25




80. Rosalia White will invest $3,000 in an IRA for the next 30 years starting at the end of this year. The investment will earn 13 percent annually. How much will she have at the end of 30 years? (Round to the nearest dollar.)A) $879,598B) $912,334C) $748,212D) $1,233,450Ans: AFeedback:




81. Viviana Carroll needs to have $25,000 in five years. If she can earn 8 percent on any investment, what is the amount that she will have to invest every year at the end of each year for the next five years? (Round to the nearest dollar.)A) $5,000B) $4,261C) $4,640D) $4,445Ans: BFeedback:




82. Cassandra Dawson wants to save for a trip to Australia. She will need $12,000 at the end of four years. She can invest a certain amount at the beginning of each of the next four years in a bank account that will pay her 6.8 percent annually. How much will she have to invest annually to reach her target? (Round to the nearest dollar.)A) $3,000B) $2,980C) $2,538D) $2,711Ans: CFeedback:




83. Dawson Electricals has borrowed $27,850 from its bank at an annual rate of 8.5 percent. It plans to repay the loan in eight equal installments, beginning at the end of next in a year. What is its annual loan payment? (Round to the nearest dollar.)A) $4,708B) $5,134C) $4,939D) $4,748Ans: CFeedback:

PVAn = $27,850 n = 8; i = 8.5%

Present value of annuity = PVA = $27,850Return on investment = i = 8.5%Payment required to meet target = PMTUsing the PVA equation:

Each payment made by Dawson Electricals will be $4,938.66, starting at the end of next year.




84. Tim Dodson has borrowed $8,600 to pay for his new car. The annual interest rate on the loan is 9.4 percent, and the loan needs to be repaid in four payments. What will be his annual payment if he begins his payment beginning now? (Round to the nearest dollar.)A) $2,229B) $2,304C) $2,850D) $2,448Ans: DFeedback:

PVAn = $8,600 n = 4; i = 9.4%

Present value of annuity = PVA = $8,600Return on investment = i = 9.4%Payment required to meet target = PMTType of annuity = Annuity dueUsing the PVA equation:

PMT = $8,600

= $8,600 3.2115×1.094 = $2,447.80Each payment made by Tim Dodson will be $2,447.80, starting today.




85. James Perkins wants to have a million dollars at retirement, which is 15 years away. He already has $200,000 in an IRA earning 8 percent annually. How much does he need to save each year, beginning at the end of this year to reach his target? Assume he could earn 8 percent on any investment he makes. (Round to the nearest dollar.)A) $13,464B) $14,273C) $10,900D) $16,110Ans: AFeedback:Retirement investment target in 15 years = $1,000,000Amount invested in IRA account now = PV = $200,000Return earned by investment = i = 8%Value of current investment in 15 years = FV15

Balance of money needed to reach his target of having million dollars = $1,000,000 – $634,433.82 = $365,566.18 = FVAPayment needed to reach target = PMT




86. Stuart Weddle’s father is 55 years old and wants to set up a cash flow stream that would be forever. He would like to receive $15,000 every year, beginning at the end of this year. If he could invest in account earning 9 percent, how much would he have to invest today to receive his perpetual cash flow? (Round to the nearest dollar.)A) $166,667B) $200,000C) $222,222D) $135,200Ans: AFeedback:Annual payment needed = PMT = $15,000Investment rate of return = i = 9%Term of payment = PerpetuityPresent value of investment needed = PV

= $15,000 0.09 = $166,666.67




87. A lottery winner was given a perpetual payment of $25,362. She could invest the cash flows at 7.5 percent. What is the present value of this perpetuity? (Round to the nearest dollar.)A) $338,160B) $390,215C) $238,160D) $201,356Ans: AFeedback:Annual payment needed = PMT = $25,362Investment rate of return = i = 7.5%Term of payment = PerpetuityPresent value of investment needed = PV

= $25,362 0.075 = $338,160




88. Brandon Ramirez wants to set up a scholarship at his alma mater. He is willing to invest $320,000 in an account earning 11 percent. What will be the annual scholarship that can be given from this investment? (Round to the nearest dollar.)A) $50,000B) $32,600C) $35,200D) $40,300Ans: CFeedback:Annual payment needed = PMT Present value of investment = PVA = $320,000Investment rate of return = i = 11%Term of payment = Perpetuity

PMT = PV of Perpetuity × i = $320,000 × 0.11 = $35,200


89. Sid Phillips has funded a retirement investment with $250,000 earning a return of 6.75 percent. What is the value of the payment that he can receive in perpetuity? (Round to the nearest dollar.)A) $12,150B) $15,250C) $16,875D) $14,900Ans: CFeedback:Annual payment needed = PMT Present value of investment = PVA = $250,000Investment rate of return = i = 6.75%Term of payment = Perpetuity



= $250,000 × 0.0675 = $16,875


90. Ralf Wilson wants to receive $25,000 in perpetuity and will invest his money in an investment that will earn a return of 14 percent annually. What is the value of the investment that he needs to make today to receive his perpetual cash flow stream? (Round to the nearest dollar.)A) $640,225B) $252,325C) $144,350D) $178,571Ans: DFeedback:Annual Payment needed = PMT = $25,000Investment rate of return = i = 14%Term of payment = PerpetuityPresent value of investment needed = PV

= $25,0000.14

= $178,571.43




91. You plan to save $1,400 for the next four years, beginning now, to pay for a vacation. If you can invest it at 6 percent, how much will you have at the end of four years? Round to the nearest dollar.A) $6,124B) $5,618C) $4,019D) $6,492Ans: DFeedback:0 1 2 3 4├───────┼────────┼───────┼────────┤$1,400 $1,400 $1,400 $1,400n = 4; i = 6%




92. Jeff Lovett has a five-year loan on which he will make annual payments of $2,235, beginning now. If the interest rate on the loan is 8.3 percent, what is the present value of this annuity? (Round to the nearest dollar.)A) $9,588B) $8,854C) $8,612D) $9,122Ans: AFeedback:0 1 2 3 4 5├───────┼────────┼───────┼────────┼───────┤$2,235 $2,235 $2,235 $2,235 $2,235n = 5; i = 8.3%

Annual payment = PMT = $2,235No. of payments = n = 5Required rate of return = 8.3%Present value of investment = PVA5




93. : Ann Chang is investing $2,500 today and will do so at the beginning of each of the next six years for a total of seven payments. If her investment can earn 12 percent, how much will she have at the end of seven years? (Round to the nearest dollar.)A) $25,223B) $28,249C) $31,127D) $29,460Ans: BFeedback:0 1 2 3 6 7 ├───────┼────────┼───────┼………………┼───────┤PMT PMT PMT PMT PMT n = 7; i = 12%

Present value of annuity = PVA Return on investment = i = 12%Payment required to meet target = $2,500Type of annuity = Annuity due




94. Your inheritance will pay you $100,000 a year for five years beginning now. You can invest it in a CD that will pay 7.75 percent annually. What is the present value of your inheritance? (Round to the nearest dollar.)A) $399,356B) $401,916C) $433,064D) $467,812Ans: CFeedback:0 1 2 3 4 5├───────┼────────┼───────┼────────┼───────┤$100,000 $100,000 $100,000 $100,000 $100,000n = 5; i = 7.75%

Annual payment = PMT = $100,000No. of payments = n = 5Required rate of return = 7.75%Present value of investment = PVA5




95. Noel Klinger is planning to invest in an insurance company product. The product will pay $12,500 at the end of this year. Thereafter, the payments will grow annually at a 2.5 percent rate forever. Jack will be able to invest his cash flows at a rate of 5.5 percent. What is the present value of this investment cash flow stream? (Round to the nearest dollar.)A) $326,908 B) $312,766C) $416,667D) $446,667Ans: CFeedback:Cash flow at t=1 = CF1 = $12,500Annual growth rate = g = 2.5%Discount rate = i = 5.5%Present value of growing perpetuity = PVPPVA∞ = CF1 = $12,500 (i – g) (0.055 – 0.03) = $416,666.67




96. Bryant Investments is putting out a new product. The product will pay out $32,000 in the first year, and after that the payouts will grow by an annual rate of 2.75 percent forever. If you can invest the cash flows at 7.25 percent, how much will you be willing to pay for this perpetuity? (Round to the nearest dollar.)A) $721,111B) $633,111C) $531,111D) $711,111Ans: DFeedback:Cash flow at t = 1 = CF1 = $32,000Annual growth rate = g = 2.75%Discount rate = i = 7.25%Present value of growing perpetuity = PVPPVA∞ = CF1 = $12,500 (i – g) (0.0725 – 0.0275) = $711,111.11




97. Shelton Enterprises is expecting tremendous growth from its newest boutique store. Next year the store is expected to bring in net cash flows of $675,000. The company expects its earnings to grow annually at a rate of 13 percent for the next 15 years. What is the present value of this growing annuity if the firm uses a discount rate of 18 percent on its investments? (Round to the nearest dollar.)A) $6,448,519B) $6,750,000C) $7,115,449D) $5,478,320Ans: AFeedback:Time of growth = n = 15 yearsNext year's expected net cash flow = CF1 = $675,000Expected annual growth rate = g = 13%Firm's required rate of return = i = 18%Present value of growing annuity = PVAn

= $13,500,000 × 0.477668109 = $6,448,519.47




98. Foodelicious Corp. is evaluating whether it should take over the lease of an ethnic restaurant in Manhattan. The current owner had originally signed a 25-year lease, of which 16 years still remain. The restaurant has been growing steadily at a 7 percent growth for the last several years. Foodelicious Corp. expects the restaurant to continue to grow at the same rate for the remaining lease term. Last year, the restaurant brought in net cash flows of $310,000. If the firm evaluates similar investments at 15 percent, what is the present value of this investment? (Round to the nearest dollar.)A) $2,966,350B) $2,838,182C) $3,109,460D) $2,709,124Ans: BFeedback:Time for lease to expire = n = 16 yearsLast year's net cash flow = CF0 = $310,000Expected annual growth rate = g = 7%Firm's required rate of return = i = 15%Expected cash flow next year = CF1 = $310,000(1 + g) = $310,000(1.07) = $331,700Present value of growing annuity = PVAn




99. Beautinator Cosmetics borrowed $152,300 from a bank for three years. If the quoted rate (APR) is 11.75 percent, and the compounding is daily, what is the effective annual rate (EAR)? (Round to one decimal place.)A) 11.7%B) 14.3%C) 12.5%D) 11.6%Ans: CFeedback:Loan amount = PV = $152,300Interest rate on loan = i = 11.75%Frequency of compounding = m = 365Effective annual rate = EAR




100. Surreal Corp. has borrowed to invest in a project. The loan calls for a payment of $17,500 every month for three years. The lender quoted Surreal a rate of 8.40 percent with monthly compounding. At what rate would you discount the payments to find amount borrowed by Surreal Corp.? (Round to two decimal places.)A) 8.40%B) 8.73%C) 8.95%D) 8.44%Ans: BFeedback:Loan amount = PVInterest rate on loan = i = 8.4%Frequency of compounding = m = 12Effective annual rate = EAR

To discount present or future value of cash flows, the most appropriate rate is the EAR, that is, 8.73 percent.

Format: EssayLearning Objective: LO 2Level of Difficulty: MediumBloomcode: AnalysisAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

101. How is an annuity due different from the ordinary annuity?Ans: When constant cash flows are received or paid at the end of each period for a length of

time, we have an ordinary annuity. If the same cash flows happen at the beginning of each period, we call it an annuity due. Cash flows received at the beginning of each period earn interest for an extra period compared to cash flows received at the end of each period for an investment of the same time frame. Thus, annuity dues have higher values than ordinary annuities.



Format: EssayLearning Objective: LO 5Level of Difficulty: HardBloomcode: ApplicationAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

102. The annual percentage rate (APR) is not the appropriate rate to perform present or future value calculations. Explain this statement.Ans: The APR is the annualized interest rate using simple interest. In other words, the APR is

the simple interest charged per period multiplied by the number of periods per year. However, the APR ignores the impact of compounding on cash flows. This makes it an inappropriate discount rate for doing present and future value calculations. An appropriate rate for such calculations is the effective annual rate (EAR).

Format: EssayLearning Objective: LO 5Level of Difficulty: MediumBloomcode: ComprehensionAASCB: AnalyticIMA: Corporate FinanceAICPA: Legal/Regulatory Perspective

103. What was the purpose behind the passage of the two consumer protection acts discussed in this chapter?Ans: In 1968, Congress passed the Truth-in-Lending Act to ensure that all borrowers receive

meaningful information about the cost of credit so they can make intelligent economic decisions. The act applies to all lenders that extend credit to consumers, and it covers credit card loans, auto loans, home mortgage loans, home equity loans, home improvement loans, and some small business loans. Similar legislation, the so-called Truth-in-Savings Act, applies to consumer savings vehicles such as consumer certificates of deposits (CDs). These two pieces of legislation 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.



Format: EssayLearning Objective: LO 5Level of Difficulty: MediumBloomcode: ComprehensionAASCB: AnalyticIMA: Corporate FinanceAICPA: Measurement

104. What are the three ways of interest rate quoted in the market place?Ans: The interest rates in the marketplace are quoted in three ways.

1. The quoted interest rate. This is an interest rate that has been annualized by multiplying the rate per period by the number of compounding periods. The annual percentage rate (APR) is an example. All consumer borrowing and lending rates are annualized in this manner.2. The interest rate per period. The bank credit card rate of 1 percent per month is an example of this kind of rate. You can find the interest rate per period by dividing the quoted interest rate by the number of compounding periods.3. The effective annual interest rate (EAR). This is the interest rate actually paid (or earned) after accounting for compounding. Sometimes it is difficult to distinguish a quoted rate from an EAR. Generally, however, an annualized consumer rate is an APR rather than an EAR.


Economy & Finance

Test Bank for Fundamentals of Corporate Finance 3rd Edition by Parrino