FINANCIAL MANAGEMENT

TIME VALUE OF MONEY

I. True or False.

1. (Gitman) Time-value of money is based on the belief that a dollar that will be received at some
future date is worth more than a dollar today. False
2. (Gitman) Since individuals are always confronted with opportunities to earn positive rates of return
on their funds, the timing of cash flows does not have any significant economic consequences. False
3. Future value is the value of a future amount at the present time, found by applying compound
interest over a specified period of time. False
4. (Gitman) Interest earned on a given deposit that has become part of the principal at the end of a
specified period is called compound interest. True
5. (Gitman) Annuity due is an amount that occurs at the beginning of each period. True
6. (Gitman) The nominal (stated) annual rate is the rate of interest actually paid or earned. False
7. (Brigham) The present value of a future sum decreases as either the discount rate or the number of
periods per year increases, other things held constant. True
8. (Brigham) All other things held constant, the present value of a given annual annuity increases as the
number of periods per year increases. True
9. (Brigham) The payment made each period on an amortized loan is constant, and it consists of some
interest and some principal. The closer we are to the end of the loan's life, the greater the
percentage of the payment that will be a repayment of principal. True
10. (Brigham) If a bank compounds savings accounts quarterly, the nominal rate will exceed the
effective annual rate. False

II. Multiple Choice – Theories.

1. (Gitman) The amount of money that would have to be invested today at a given interest rate over a
specified period in order to equal a future amount is called
a. future value.
b. present value.
c. future value interest factor.
d. present value interest factor.

2. (Gitman) The future value of a dollar _________ as the interest rate increases and _________ the
farther in the future an initial deposit is to be received.
a. decreases; decreases
b. decreases; increases
c. increases; increases
d. increases; decreases

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3. For a given interest rate, as the length of time until receipt of the funds increases, the present value
interest factor
a. changes proportionally.
b. increases.
c. decreases.
d. remains unchanged.

4. (Gitman) In comparing an ordinary annuity and an annuity due, which of the following is true?
a. The future value of an annuity due is always greater than the future value of an otherwise
identical ordinary annuity.
b. The future value of an ordinary annuity is always greater than the future value of an otherwise
identical annuity due.
c. The future value of an annuity due is always less than the future value of an otherwise identical
ordinary annuity, since one less payment is received with an annuity due.
d. All things being equal, one would prefer to receive an ordinary annuity compared to an annuity
due.

5. (Brigham) Which of the following statements is CORRECT?

a. A time line is not meaningful unless all cash flows occur annually.
b. Time lines are useful for visualizing complex problems prior to doing actual calculations.
c. Time lines cannot be constructed in situations where some of the cash flows occur annually but
others occur quarterly.
d. Time lines cannot be constructed for annuities where the payments occur at the beginning of
the periods.
e. Some of the cash flows shown on a time line can be in the form of annuity payments, but none
can be uneven amounts.

6. (Brigham) You plan to analyze the value of a potential investment by calculating the sum of the
present values of its expected cash flows. Which of the following would lower the calculated value
of the investment?
a. The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that
the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather
than for $10,000.
b. The discount rate increases.
c. The riskiness of the investment’s cash flows decreases.
d. The total amount of cash flows remains the same, but more of the cash flows are received in the
earlier years and less are received in the later years.
e. The discount rate decreases.

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7. (Brigham) Which of the following investments would have the highest future value at the end of 10
years? Assume that the effective annual rate for all investments is the same and is greater than
zero.
a. Investment A pays P250 at the beginning of every year for the next 10 years (a total of 10
payments).
b. Investment B pays P125 at the end of every 6-month period for the next 10 years (a total of 20
payments).
c. Investment C pays P125 at the beginning of every 6-month period for the next 10 years (a total
of 20 payments).
d. Investment D pays P2,500 at the end of 10 years (just one payment).
e. Investment E pays P250 at the end of every year for the next 10 years (a total of 10 payments).

8. (Brigham) Which of the following investments would have the lowest present value? Assume that
the effective annual rate for all investments is the same and is greater than zero.
a. Investment A pays P250 at the end of every year for the next 10 years (a total of 10 payments).
b. Investment B pays P125 at the end of every 6-month period for the next 10 years (a total of 20
payments).
c. Investment C pays P125 at the beginning of every 6-month period for the next 10 years (a total
of 20 payments).
d. Investment D pays P2,500 at the end of 10 years (just one payment).
e. Investment E pays P250 at the beginning of every year for the next 10 years (a total of 10
payments).

9. (Brigham) A Philippine Treasury bond will pay a lump sum of P1,000 exactly 3 years from today. The
nominal interest rate is 6%, semiannual compounding. Which of the following statements is
CORRECT?
a. The periodic interest rate is greater than 3%.
b. The periodic rate is less than 3%.
c. The present value would be greater if the lump sum were discounted back for more periods.
d. The present value of the P1,000 would be smaller if interest were compounded monthly rather
than semiannually.
e. The PV of the P1,000 lump sum has a higher present value than the PV of a 3-year, P333.33
ordinary annuity.

10. (Brigham) Which of the following bank accounts has the highest effective annual return?
a. An account that pays 8% nominal interest with monthly compounding.
b. An account that pays 8% nominal interest with annual compounding.
c. An account that pays 7% nominal interest with daily (365-day) compounding.
d. An account that pays 7% nominal interest with monthly compounding.
e. An account that pays 8% nominal interest with daily (365-day) compounding

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III. PROBLEM-SOLVING.

1. You deposit P10,000 today in a savings account that pays 3.5% interest, compounded annually. How
much will your account be worth at the end of 25 years? P23,632.45

2. Suppose BSP offers to sell you a bond for P747.25. No payments will be made until the bond
matures 5 years from now, at which time it will be redeemed for P1,000. What interest rate would
you earn if you bought this bond at the offer price? 6.%

3. Wendy has P5,000 invested in a bank that pays 3.8% annually. How long will it take for her funds to
triple? P29.46

4. You want to buy a new sports car 3 years from now, and you plan to save P42,000 per year,
beginning one year from today. You will deposit your savings in an account that pays 5.2% interest.
How much will you have just after you make the 3rd deposit, 3 years from now? P132,665.57

5. You want to quit your job and go back to school for a law degree 4 years from now, and you plan to
save P35,000 per year, beginning immediately. You will make 4 deposits in an account that pays
5.7% interest. Under these assumptions, how much will you have 4 years from today? P161,119.93

6. What is the PV of an ordinary annuity with 10 payments of P2,700 if the appropriate interest rate is
5.5%? P20,351.59

7. What is the PV of an annuity due with 5 payments of P2,500 at an interest rate of 5.5%? P11,262.88

8. What’s the present value of a perpetuity that pays P250 per year if the appropriate interest rate is
5%? P5,000

9. Your uncle is about to retire, and he wants to buy an annuity that will provide him with P75,000 of
income a year for 20 years, with the first payment coming immediately. The going rate on such
annuities is 5.25%. How much would it cost him to buy the annuity today? P963,212.94

10. What’s the present value of a 4-year ordinary annuity of P2,250 per year plus an additional P3,000
at the end of Year 4 if the interest rate is 5%? P10,446.50

11. Suppose you inherited P275,000 and invested it at 8.25% per year. How much could you withdraw
at the end of each of the next 20 years? P28,532.45

12. Your grandmother just died and left you P100,000 in a trust fund that pays 6.5% interest. You must
spend the money on your college education, and you must withdraw the money in 4 equal
installments, beginning immediately. How much could you withdraw today and at the beginning of
each of the next 3 years and end up with zero in the account? P27,408.71

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13. Your father's employer was just acquired, and he was given a severance payment of P375,000,
which he invested at a 7.5% annual rate. He now plans to retire, and he wants to withdraw P35,000
at the end of each year, starting at the end of this year. What is the maximum number of whole
payments that can be withdrawn before the account is exhausted; i.e., before the account balance
would become negative? (Hint: Round down to the nearest whole number.) 22

14. Your Aunt Elsa has P500,000 invested at 6.5%, and she plans to retire. She wants to withdraw
P40,000 at the beginning of each year, starting immediately. What is the maximum number of
whole payments that can be withdrawn before the account is exhausted; i.e., before the account
balance would become negative? (Hint: Round down to the nearest whole number.) 22

15. What is the present value of the following cash flow stream at a rate of 12.0%? P10,746.29
Years: 0 1 2 3 4
| | | | |
CFs: P0 P1,500 P3,000 P4,500 P6,000

16. What is the present value of the following cash flow stream at a rate of 8.0%? P9,233.43
Years: 0 1 2 3
| | | |
CFs: P750 P2,450 P3,175 P4,400

17. At a rate of 6.5%, what is the future value of the following cash flow streams? 645.80
Years: 0 1 2 3 4
| | | | |
CFs: P0 P75 P225 P0 P300

18. What’s the future value of P1,500 after 5 years if the appropriate interest rate is 6%, compounded
semiannually? P2,015.8

19. What’s the present value of P1,525 discounted back 5 years if the appropriate interest rate is 6%,
compounded monthly? P1,130.59

20. Master Card and other credit card issuers must by law print the Annual Percentage Rate (APR) on
their monthly statements. If the APR is stated to be 18.00%, with interest paid monthly, what is the
card's EFF%? 19.56%