Financial Decision Making
Case Study Three
Using a Financial Calculator - Valuation
I bet you thought that calculating ratios was simply too much fun. Am I right?? ☺ Well get set,
because this assignment will just be oodles of awesomeness ….
While ratios allow us to compare/contrast what’s going on the business now, the time value of money
lets us see the consequences of decisions. I know you’ve dreamed of winning the lottery, and one of
the questions you’d have to answer is “would I take a lump sum payout now or would I take yearly
payouts?” The answer is typically the lump sum!! You may have heard that a dollar today is worth
more than a dollar tomorrow - this phrase directly relates to the time value of money and the fact that
the dollar today can be invested so it’s worth more by tomorrow. A lump sum lottery payment would
operate the same way. Even though it’s seemingly a lesser amount at first, the fact that it can be
invested promises a larger payoff over the long term.
In Chapter Five, the focus is on determining those long term investments and calculations, i.e. how
much should I invest today to reach my goal, what interest rate should I have, how long should I invest
for, etc. Chapter Six expands on this to determine future cash flows, and also mortgage and/or loan
payments.
Previous classes have struggled a bit with these chapters, so I’m going to tackle them with another
multiple-choice exercise. Please pay particular attention to the examples in the chapters (especially the
calculator entry steps!!), and use these as a guide.
If you don’t have a financial calculator and wish to use one, you can obtain one online at:
http://www.calculator.net/finance-calculator.html
You will see FV (future value), PMT (payment) i/Y (interest), N (number of periods) and Starting
Principal (PV) in the calculation box. WHATEVER YOU ARE SOLVING FOR, click on that
“toggle” to begin. In other words, if you are solving for “N,” click on N - the calculation screen should
be gray, and all other buttons (FV, PMT, etc.) will be in blue. If you don’t have PMT or another figure
to enter into the calcuation, enter “0” - remember there can be no negative numbers. When you’ve
entered the data, press “calculate” for the table of answers - search for what you are looking for.
AGAIN, follow the steps in the textbook chapters so that you get the hang of this!
As a reminder, each chapter has a review with answers - you are welcome to do additional problems as
well! I’m happy to provide answers if requested.
And don’t forget: “Finance is Fun!!!!”
For this next assignment, please:
•
•
Read Chapters Five and Six in the text, and
Complete the attached multiple choice questions.
ASSIGNMENT NOTES:
There are 20 questions on this exercise (ten from Chapter Five and ten from Chapter Six), each worth 5
points. There is also one extra credit question. All questions relate to textbook material, are roughly in
order as the content appears in the text, and this IS an open-book assignment. No question is intended
to be tricky, however please read through all possible responses before answering. IMPORTANT: In
returning your assignment to the instructor, you should list your letter answers in a separate Word
document and forward that document to the instructor for grading. Do not return this assignment
sheet. Be sure to include the Honor Pledge (see syllabus under “Honor Code Policy,” OR in
Blackboard’s Syllabus & Important Policies under “Policy-Honor Code”). Items not returned in the
proper format or without a pledge will face a penalty.
For all students, your FIRM deadline for handing in this case is Sunday, July 1 by 11:59pm.
1. Renee invested $2,000 six years ago at 4.5 percent interest. She spends her earnings as soon as she
earns any interest so she only receives interest on her initial $2,000 investment. Which type of interest
is she earning?
a. Free interest
b. Complex interest
c. Simple interest
d. Interest on interest
e. Compound interest
2. Sue and Neal are twins. Sue invests $5,000 at 7 percent when she is 25 years old. Neal invests
$5,000 at 7 percent when he is 30 years old. Both investments compound interest annually. Both Sue
and Neal retire at age 60. Which one of the following statements is correct assuming neither Sue nor
Neal withdraw any money from their accounts prior to retiring?
a. Sue will have less money when she retires than Neal.
b. Neal will earn more interest on interest than Sue.
c. Neal will earn more compound interest than Sue.
d. If both Sue and Neal wait to age 70 to retire, they will have equal amounts of savings.
e. Sue will have more money than Neal at age 60.
3. This afternoon, you deposited $1,000 into a retirement savings account. The account will
compound interest at 6 percent annually. You will not withdraw any principal or interest until you
retire in 40 years. Which one of the following statements is correct?
a. The interest you earn 6 years from now will equal the interest you earn 10 years from now.
b. The interest amount you earn will double in value every year.
c. The total amount of interest you will earn will equal $1,000 x .06 x 40.
d. The present value of this investment is equal to $1,000.
e. The future value of this amount is equal to $1,000 x (1 + 40)06.
4. Luis is going to receive $20,000 six years from now. Max is going to receive $20,000 nine years
from now. Which one of the following statements is correct is Luis and Max apply a 7 percent
discount rate to these amounts?
a. The present values of Luis and Max’s money are equal.
b. In future dollars, Max’s money is worth more than Luis’s money.
c. In today’s dollars, Luis’s money is worth more than Max’s money.
d. Twenty years from now, the value of Luis’s money will be equal to the value of Max’s
money.
e. Max’s money is worth more than Luis’s money given the 7 percent discount rate.
5. Samuel invested $1,000 10 years ago and expected to have $1,800 today. He has not added or
withdrawn any money from this account since his initial investment. All interest was reinvested in the
account. As it turns out, he only has $1,680 in his account today. Which one of the following must be
true?
a. He earned simple interest rather than compound interest.
b. He earned a lower interest rate than he expected.
c. He did not earn any interest on interest as he expected.
d. He ignored the Rule of 72 which caused his account to decrease in value.
e. The future value interest factor turned out to be higher than he expected.
6. Sarah invested $10,500 in an account that pays 6 percent simple interest. How much money will
she have at the end of four years?
a. $12,650
b. $12,967
c. $13,020
d. $13,256
e. $13,500
7. Today, you earn a salary of $28,000. What will your annual salary be 12 years from now if you
earn annual raises of 2.6 percent?
a. $38,100.12
b. $37,414.06
c. $38,235.24
d. $36,122.08
e. $36,738.00
8. You just received $25,000 from an insurance settlement and have decided to invest it for your
retirement. Currently, your goal is to retire 40 years from today. How much more will you have in your
account on the day you retire if you can earn an average return of 8.2 percent rather than just 8
percent?
a. $41,137.07
b. $38,509.16
c. $40,423.33
d. $41,718.03
e. $38,342.91
9. Towne Station is saving money to build a new loading platform. Three years ago, they set aside
$23,000 for this purpose. Today, that account is worth $31,406. What rate of interest is Towne
Station earning on this investment?
a. 8.39 percent
b. 9.47 percent
c. 10.94 percent
d. 8.23 percent
e. 9.01 percent
10. You're trying to save to buy a new $72,000 sports car. You have $38,000 today that can be
invested at your bank. The bank pays 1.26 percent annual interest on its accounts. How many years
will it be before you have enough to buy the car assuming the price of the car remains constant?
a. 46.67 years
b. 47.18 years
c. 51.04 years
d. 46.91 years
e. 55.84 years
11. Which one of the following accurately defines a perpetuity?
a. A limited number of equal payments paid in even time increments.
b. Payments of equal amounts that are paid irregularly but indefinitely.
c. Varying amounts that are paid at even intervals forever.
d. Unending equal payments paid at equal time intervals.
e. Unending equal payments paid at either equal or unequal time intervals.
12. Your credit card charges you 1.5 percent interest per month. This rate when multiplied by 12 is
called the:
a. Effective annual rate.
b. Annual percentage rate.
c. Periodic interest rate.
d. Compound interest rate.
e. Period interest rate.
13. You are comparing two annuities that offer quarterly payments of $2,500 for five years and pay
.75 percent interest per month. You will purchase one of these today with a single lump sum payment.
Annuity A will pay you monthly, starting today, while Annuity B will pay monthly, starting one month
from today. Which one of the following statements is correct concerning these two annuities?
a. These annuities have equal present values but unequal future values.
b. These two annuities have both equal present and future values.
c. Annuity B is an annuity due.
d. Annuity A has a smaller future value than Annuity B.
e. Annuity B has a smaller present value than Annuity A.
14. You are considering two projects with the following cash flows (see chart below). Which one of
the statements is true concerning these two projects given a positive discount rate?
Year 1
Year 2
Year 3
Year 4
Project X
$8,500
8,000
7,500
7,000
Project Y
$7,000
7,500
8,000
8,500
a. Both projects have the same future value at the end of Year 4.
b. Both projects have the same value at Time 0.
c. Both projects are ordinary annuities.
d. Project Y has a higher present value than Project X.
e. Project X has both a higher present value and a higher future value than Project Y.
15. Which one of the following statements related to loan interest rates is correct?
a. The annual percentage rate considers the compounding of interest.
b. When comparing loans you should compare the effective annual rates.
c. Lenders are most apt to quote the effective annual rate.
d. Regardless of the compounding period, the effective annual rate will always be higher than
the
annual percentage rate.
e. The more frequent the compounding period, the lower the effective annual rate given a fixed
annual \
percentage rate.
16. Which one of the following statements correctly defines a time value of money relationship?
a. Time and future values are inversely related, all else held constant.
b. Interest rates and time are positively related, all else held constant.
c. An increase in a positive discount rate increases the present value.
d. An increase in time increases the future value given a zero rate of interest.
e. Time and present value are inversely related, all else held constant.
17. Your grandmother is gifting you $150 a month for four years while you attend college to earn your
bachelor’s degree. At a 4.8 percent discount rate, what are these payments worth to you on the day
you enter college?
a. $6,201.16
b. $6,539.14
c. $5,589.19
d. $6,608.87
e. $6,870.23
18. Phil can afford $240 a month for five years for a car loan. If the interest rate is 8.5 percent, how
much can he afford to borrow to purchase a car?
a. $11,750.00
b. $12,348.03
c. $11,697.88
d. $10,266.67
e. $10,400.00
19. Patrick plans on saving $2,000 a year and expects to earn an annual rate of 8.8 percent. How
much will she have in her account at the end of 43 years?
a. $806,429
b. $838,369
c. $997,407
d. $831,532
e. $908,316
20. Today, you borrowed $6,200 on your credit card to purchase some furniture. The interest rate is
14.9 percent, compounded monthly. How long will it take you to pay off this debt assuming that you
do not charge anything else and make regular monthly payments of $120?
a. 5.87 years
b. 6.40 years
c. 6.93 years
d. 7.23 years
e. 7.31 years
Extra Credit: You have been investing $250 a month for the last 13 years. Today, your investment
account is worth $73,262. What is your average rate of return on your investments?
a. 8.94 percent
b. 9.23 percent
c. 9.36 percent
d. 9.41 percent
e. 9.78 percent
Remember to submit your document as requested. ☺