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

Page 2

B)
Ans:

False
B

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
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

Page 3

B)
Ans:

False
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
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

Page 4

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
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).

Page 5

A)
B)
Ans:

True
False
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
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

Page 6

A)
B)
Ans:

be disclosed on all consumer loans and savings plans and that it be prominently
displayed on advertising and contractual documents.
True
False
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
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

Page 7

A)
B)
C)
D)
Ans:

following steps?
First, draw a time line to make sure that each cash flow is placed in the correct
time period.
Second, calculate the present value of each cash flow for its time period.
Third, add up the present values.
All of the above are necessary steps.
D

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

Page 8

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
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

Page 9

A)
B)
C)
D)
Ans:

years, the cash flow stream is called

a perpetuity.
an ordinary annuity.
an annuity due.
none of the above.
C

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 10

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
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Easy

Page 11

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 12

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
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

Page 13

Ans:

number of compounding periods.

C

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

A)
B)
C)
D)
Ans:

2
$678,214

3
$775,908

4
5
$778,326 $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.)
$3,889,256
$4,227,118
$5,214,690
$4, 809,112
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
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.)

Page 14

A)
B)
C)
D)
Ans:

$644,406.10
$732,114
$685,312
$900,810
A
Feedback:

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:

Page 15

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

$3, 611.33 $3, 708.75 $3,800
$11,120.08
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
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

Page 16

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
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

n = 4;

$625

$650

$700

$800

i=5.75%

Page 17

$625
$650
$700
$800

2
3
(1.0575) (1.0575) (1.0575) (1.0575) 4
$591.02 $581.24 $591.91 $639.69
$2, 403.85

PV

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

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
Page 18

C)
D)
Ans:

$41,675
$39,208
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
$36, 021.58

PV

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 $242,000over the next five years. If the companys
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:

Page 19

$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

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
$361, 998.39

PV

Format: Multiple Choice

Learning Objective: LO 2
Level of Difficulty: Medium
66.Present value of an annuity: Transit Insurance 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)
$101,766
B)
$124,868

Page 20

C)
D)
Ans:

$251,154
$186,250
B
Feedback:

Annual payment = PMT = $37,250

No. of payments = n = 5
Required rate of return = 15%
Present value of investment = PVA5
1

1 (1 i ) n
PVAn PMT

1 (1.15)5
$37, 250
$37, 250 3.3522
0.15

$124, 867.78
Format: Multiple Choice
Learning Objective: LO 2
Level of Difficulty: Medium
67.Present value of an annuity: Herm Mueller 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)
$234,000
B)
$132,455
C)
$110,721
D)
$167,884
Ans:
C
Feedback:

Page 21

1
1 (1 i ) n
PVAn PMT

1
1 (1.085) 20
$11, 700
$11, 700 9.4633
0.085

$110, 721.04
Format: Multiple Choice
Learning Objective: LO 2
Level of Difficulty: Medium
68.Present value of an annuity: Myers, 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)
$23,250
B)
$29,000
C)
$25,000
D)
$20,000
Ans:
C
Feedback:

Page 22

1
1 (1 i ) n
PVAn PMT

1 (1.09)10
$3,895.50
$3,895.50 6.4177
0.09

$24, 999.99
Format: Multiple Choice
Learning Objective: LO 2
Level of Difficulty: Medium
69.Present value of an annuity: Lorraine Jackson 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)
$750,000
B)
$334,600
C)
$212,400
D)
$235,700
Ans:
D
Feedback:

Page 23

Format: Multiple Choice

Learning Objective: LO 2
Level of Difficulty: Medium
70.Present value of an annuity: Craymore Tech 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)
$214,356
B)
$241,653
C)
$278,900
D)
$197,776
Ans:
A
Feedback:

Page 24

Format: Multiple Choice

Learning Objective: LO 2
Level of Difficulty: Medium
71.Future value of an annuity: Carlos Menendez is planning to invest $3,500 every year
for the next six years in an investment paying 12 percent annually. What will be the
amount he will have at the end of the six years? (Round to the nearest dollar.)
A)
$21,000
B)
$28,403
C)
$24,670
D)
$26,124
Ans:
B
Feedback:

Page 25

Format: Multiple Choice

Learning Objective: LO 2
Level of Difficulty: Medium
72.Future value of an annuity: Jayadev Athreya has started on his first job. He plans to
start saving for retirement early. 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 Jayadev
have at the end of 45 years? (Round to the nearest dollar.)
A)
$2,667,904
B)
$3,594,524
C)
$1,745,600
D)
$5,233,442
Ans:
B
Feedback:

Page 26

Format: Multiple Choice

Learning Objective: LO 2
Level of Difficulty: Medium
73.Future value of an annuity: You plan to save $1,250 at the end of each of the next three
years to pay for a vacation. If you can invest it at 7 percent, how much will you have at
the end of three years? (Round to the nearest dollar.)
A)
$3,750
B)
$3,918
C)
$4,019
D)
$4,589
Ans:
C
Feedback:

Page 27

Format: Multiple Choice

Learning Objective: LO 2
Level of Difficulty: Medium
74.Future value of an annuity: Zhijie Jiang 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
6.75 percent, how much will she have after four years? (Round to the nearest dollar.)
A)
$22,000
B)
$23,345
C)
$27,556
D)
$24,329
Ans:
D
Feedback:

Page 28

Format: Multiple Choice

Learning Objective: LO 2
Level of Difficulty: Medium
75.Future value of an annuity: Terri Garner 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)
$897,598
B)
$912,334
C)
$748,212
D)
$1,233,450
Ans:
A
Feedback:

Page 29

Format: Multiple Choice

Learning Objective: LO 2
Level of Difficulty: Medium
76.Computing annuity payment: Maricela Sanchez 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)
$5,000
B)
$4,261
C)
$4,640
D)
$4,445
Ans:
B
Feedback:

Page 30

Format: Multiple Choice

Learning Objective: LO 2
Level of Difficulty: Medium
77.Computing annuity payment: Jane Ogden 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)
$3,000
B)
$2,980
C)
$2,538
D)
$2,711
Ans:
C
Feedback:

Page 31

Format: Multiple Choice

Learning Objective: LO 2
Level of Difficulty: Medium
78.Computing annuity payment: Jackson 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 in a year. What is its annual loan payment? (Round to the nearest dollar.)
A)
$4,708
B)
$5,134
C)
$4,939
D)
$4,748
Ans:
C
Feedback:

PVAn = $27,850

n = 8;

i = 8.5%

Present value of annuity = PVA = $27,850

Return on investment = i = 8.5%
Payment required to meet target = PMT
Page 32

Using the PVA equation:

1

1 (1 i ) n
PVAn PMT

$27,850
$27,850
PMT

1
5.6392

1 (1.085)8

0.085

$4, 938.66
Each payment made by Jackson Electricals will be $4,938.66, starting at the end of next
year.
Format: Multiple Choice
Learning Objective: LO 2
Level of Difficulty: Medium
79.Computing annuity payment: John Harper has borrowed $17,400 to pay for his new
truck. 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)
$5,229
B)
$5,450
C)
$4,850
D)
$4,953
Ans:
D
Feedback:

PVAn = $17,400

n = 4;

i = 9.4%

Present value of annuity = PVA = $17,400

Return on investment = i = 9.4%
Payment required to meet target = PMT
Type of annuity = Annuity due
Using the PVA equation:

Page 33

= $4,952.53
Each payment made by John Harper will be $4,952.53, starting today.

Format: Multiple Choice

Learning Objective: LO 2
Level of Difficulty: Medium
80.Computing annuity payment: Trevor Smith 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)
$13,464
B)
$14,273
C)
$10,900
D)
$16,110
Ans:
A
Feedback:
Retirement investment target in 15 years = $1,000,000
Amount invested in IRA account now = PV = $200,000
Return earned by investment = i = 8%
Value of current investment in 15 years = FV15
FV15 PV (1 i )15 $200, 000(1.08)15
$634, 433.82
Balance of money needed to buy car = $1,000,000 -$634,433.82 =$365,566.18 = FVA
Payment needed to reach target = PMT

Page 34

 (1 i ) n 1

FVA PMT

FVA
$365,566.18 $365,566.18

n
27.1521
1 (1 i ) (1.08)15 1

i
0.08

$13, 463.64

PMT

Format: Multiple Choice

Learning Objective: LO 3
Level of Difficulty: Medium
81.Perpetuity: Your father is 60 years old and wants to set up a cash flow stream that
would be forever. He would like to receive $20,000 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)
$222,222
B)
$200,000
C)
$189,000
D)
$235,200
Ans:
A
Feedback:
Annual payment needed = PMT = $20,000
Investment rate of return = i = 9%
Term of payment = Perpetuity
Present value of investment needed = PV
PMT $20, 000
PV of Perpetuity

i
0.09
$222, 222.22
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Medium
82.Perpetuity: A lottery winner was given a perpetual payment of $11, 444. She could
invest the cash flows at 7 percent. What is the present value of this perpetuity? (Round to
the nearest dollar.)
A)
$112,344
B)
$163,486
C)
$191,708
D)
$201,356
Ans:
B
Feedback:
Annual payment needed = PMT = $11,444
Investment rate of return = i = 7%

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Term of payment = Perpetuity

Present value of investment needed = PV
PMT $11, 444
PV of Perpetuity

i
0.07
$163, 485.71
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Medium
83.Perpetuity: Roger Barkley wants to set up a scholarship at his alma mater. He is willing
to invest $500,000 in an account earning 10 percent. What will be the annual scholarship
that can be given from this investment? (Round to the nearest dollar.)
A)
$5,000
B)
$500,000
C)
$50,000
D)
None of the above
Ans:
C
Feedback:
Annual payment needed = PMT
Present value of investment = PVA = $500,000
Investment rate of return = i = 10%
Term of payment = Perpetuity

= $50,000
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Medium
84.Perpetuity: Chris Collinge has funded a retirement investment with $250,000 earning a
return of 5.75 percent. What is the value of the payment that he can receive in
perpetuity? (Round to the nearest dollar.)
A)
$12,150
B)
$15,250
C)
$14,375
D)
$14,900
Ans:
C
Feedback:
Annual payment needed = PMT
Present value of investment = PVA = $250,000
Investment rate of return = i = 5.75%

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Term of payment = Perpetuity

PMT
PV of Perpetuity
i
PMT PV of Perpetuity i
$250, 000 0.0575
$14, 375
Format: Multiple Choice
Learning Objective: LO 3
Level of Difficulty: Medium
85.Perpetuity: Jeff Conway wants to receive $25,000 in perpetuity and will invest his
money in an investment that will earn a return of 13.5 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)
$640,225
B)
$252,325
C)
$144,350
D)
$185,185
Ans:
D
Feedback:
Annual Payment needed = PMT = $25,000
Investment rate of return = i = 13.5%
Term of payment = Perpetuity
Present value of investment needed = PV
PMT $25, 000
PV of Perpetuity

i
0.135
$185,185.19
Format: Multiple Choice
Learning Objective: LO 2
Level of Difficulty: Medium
86.Annuity due: 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)
B)
C)
D)
Ans:

$6,124
$5,618
$4,019
$6,492
D

Page 37

Feedback:
0
1
2
3
4

$1,400
$1,400
$1,400
$1,400
n = 4;

i = 6%

(1 i ) n
(1 i )
i

FVA PMT

(1.06) 4 1
$1, 400
(1.06)
0.06

$1, 400 4.3746 1.06

$6, 491.93

Format: Multiple Choice

Learning Objective: LO 2
Level of Difficulty: Medium
87.Annuity due: Mark Holcomb 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)
$9,588
B)
$8,854
C)
$8,612
D)
$9,122
Ans:
A
Feedback:
0
1
2
3
4
5

Page 38


$2,235
$2,235
$2,235
$2,235
$2,235
n = 5;

i = 8.3%

Annual payment = PMT = $2,235

No. of payments = n = 5
Required rate of return = 8.3%
Present value of investment = PVA5
1

1 (1 i ) n
PVA PMT
(1 i )
i

1 (1.083)5
$2, 235
(1.083)
0.083

$2, 235 3.9613 1.083

$9, 588.44
Format: Multiple Choice
Learning Objective: LO 2
Level of Difficulty: Medium
88.Annuity due: Jenny Abel 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)
$25,223
B)
$28,249
C)
$31,127
D)
$29,460
Ans:
B
Feedback:
0
1
2
3
6
7

PMT
PMT
PMT
PMT
PMT
n = 7;

i = 12%

Present value of annuity = PVA Return on investment = i = 9.4%

Payment required to meet target = $2,500
Type of annuity = Annuity due

Page 39

 (1 i ) n
(1 i )
i

FVA PMT

(1.12) 7 1
(1.12)
0.12

$2,500

$2,500 10.0890 1.12

$28, 249.23
Format: Multiple Choice
Learning Objective: LO 2
Level of Difficulty: Medium
89.Annuity due: 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)
$399,356
B)
$401,916
C)
$433,064
D)
$467,812
Ans:
C
Feedback:
0
1
2
3
4
5

$100,000 $100,000 $100,000 $100,000

$100,000
n = 5;
i = 7.75%
Annual payment = PMT = $100,000
No. of payments = n = 5
Required rate of return = 7.75%
Present value of investment = PVA5
1

1 (1 i ) n
PVA PMT
(1 i )
i

1 (1.0775)5
$100, 000
(1.0775)
0.0775

$100, 000 4.0192 1.0775

$433, 064.19
Format: Multiple Choice

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Learning Objective: LO 4
Level of Difficulty: Medium
90.Growing perpetuity: Jack Benny is planning to invest in an insurance company
product. The product will pay $10,000 at the end of this year. Thereafter, the payments
will grow annually at a 3 percent rate forever. Jack will be able to invest his cash flows at
a rate of 6.5 percent. What is the present value of this investment cash flow stream?
(Round to the nearest dollar.)
A)
$326,908
B)
$312,766
C)
$285,714
D)
$258,133
Ans:
C
Feedback:
Cash flow at t=1 = CF1 = $10,000
Annual growth rate = g = 3%
Discount rate = i = 6.5%
Present value of growing perpetuity = PVA
CF1
$10, 000
PVA

(i g ) (0.065 0.03)
$285, 714.29

Format: Multiple Choice

Learning Objective: LO 4
Level of Difficulty: Medium
91.Growing perpetuity: Norwood Investments is putting out a new product. The product
will pay out $25,000 in the first year, and after that the payouts will grow by an annual
rate of 2.5 percent forever. If you can invest the cash flows at 7.5 percent, how much will
you be willing to pay for this perpetuity? (Round to the nearest dollar.)
A)
$312,000
B)
$233,000
C)
$250,000
D)
$500,000
Ans:
D
Feedback:
Cash flow at t=1 = CF1 = $25,000
Annual growth rate = g = 2.5%
Discount rate = i = 7.5%
Present value of growing perpetuity = PVA
CF1
$25, 000
PVA

(i g ) (0.075 0.025)
$500, 000

Format: Multiple Choice

Page 41

Learning Objective: LO 4
Level of Difficulty: Medium
92.Growing annuity: Hill 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)
$6,448,519
B)
$6,750,000
C)
$7,115,449
D)
$5,478,320
Ans:
A
Feedback:
Time of growth = n = 15 years
Next year's expected net cash flow = CF1 = $675,000
Expected annual growth rate = g = 13%
Firm's required rate of return = i = 18%
Present value of growing annuity = PVAn

=$13,500,000 x .477668
= $6,448,519.47

Format: Multiple Choice

Learning Objective: LO 4
Level of Difficulty: Medium
93.Growing annuity: Wilbon 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. Wilbon 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)
$2,966.350
B)
$2,838,182
C)
$3,109,460
D)
$2,709,124
Ans:
B
Feedback:
Time for lease to expire = n = 16 years
Last year's net cash flow = CF0 = $310,000

Page 42

Expected 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) = $331,700
Present value of growing annuity = PVAn
n
16
CF1
$331, 700
1 g
1.07

PVAn
1

(i g )
(0.15 0.07)
1 i
1.15

$4,146, 250 0.684518

$2, 838,181.52
Format: Multiple Choice
Learning Objective: LO 5
Level of Difficulty: Medium
94.Effective annual rate: Desire 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)
11.75%
B)
14.3%
C)
12.5%
D)
11.6%
Ans:
C
Feedback:
Loan amount = PV = $152,300
Interest rate on loan = i = 11.75%
Frequency of compounding = m = 365
Effective annual rate = EAR
m1
365
i
0.1175

EAR 1
1
1

m
365

1.12455 1 12.46%
Format: Multiple Choice
Learning Objective: LO 5
Level of Difficulty: Medium
95.Effective annual rate: Largent Supplies Corp. has borrowed to invest in a project. The
loan calls for a payment of $17,384 every month for three years. The lender quoted
Largent a rate of 8.40 percent with monthly compounding. At what rate would you
discount the payments to find amount borrowed by Largent? (Round to two decimal
places.)
A)
8.40%
B)
8.73%
C)
8.95%
D)
None of the above.
Ans:
B

Page 43

Feedback:
Loan amount = PV
Interest rate on loan = i = 8.4%
Frequency of compounding = m = 12
Effective annual rate = EAR
m1
12
i
0.084

EAR 1
1
1

m
12

1.0873 1 8.73%
To discount present or future value of cash flows, the most appropriate rate is the EAR,
that is, 8.73 percent.
Format: Essay
Learning Objective: LO 2
96.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: Essay
Learning Objective: LO 5
97.The annual percentage rate (APR) is not the appropriate rate to do 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: Essay
Learning Objective: LO 5
98.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
Page 44

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.

Page 45