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Principles of Finance > Mid Term #2 > Flashcards

Mid Term #2 Flashcards

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1
Q

In order to determine the future value of some lump sum, we must use the process of _________________.

A

Compounding

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2
Q

If we were to receive some lump sum in the future and we wanted to determine the value of the lump sum in today’s dollars, we must _______________ this future cash flow.

A

Discount

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3
Q

True or False: The discount rate consists of the risk free rate plus the risk premium.

A

True

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4
Q

True or False: A dollar today is worth more than a dollar tomorrow.

A

True

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5
Q

Would you rather have $100,000 today or $100,000 one year from today?

A

I’d rather have $100,000 today.

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6
Q

Holding all else equal, the more discounting periods of a lump sum received in the future, the ______________ the present value of the lump sum.

A

Smaller

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7
Q

The present value of a lump sum that will be received in the future will be ______________ if the interest rate is larger.

A

Smaller

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8
Q

Holding all else equal, the future value of a lump sum will be ______________ if the interest rate is larger.

A

Larger

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9
Q

Holding all else equal, the future value of a lump sum will be ______________ if the number of time periods is larger.

A

Larger

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10
Q

Holding all else equal, the future value of a lump sum will be ______________ if the size of the lump sum is increased.

A

Larger

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11
Q

Suppose you invested $15,000 today into an account that will pay 12% per year. What will the value of the account be in 40 years?

A

Correct Answer: $1,395,765

PV = -15000

PMT = 0
N = 40
I = 12%

Solve for FV = 1,395,764.56

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12
Q

Suppose you invested $3,500 today into an account that will pay 15% per year. What will the value of the account be in 35 years?

A

Correct Answer: $466,114

PV = -3500

PMT = 0
N = 35
I = 15%

Solve for FV = 466,114.33

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13
Q

Suppose you expect to obtain $1,250,000 in 25 years from today. If the discount rate is 12%, then the value of this $1,250,000 will be __________________ in today’s dollars.

A

Correct Answer: $73,529

FV = 1,250,000

N = 25
I = 12%
PMT = 0

Solve for PV = -73,529

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14
Q

(Compound interest) What will be the FV of the following investment? (end mode)

Initial investment of $1,000 for 20 years at 7% compounded annually

A

Correct Answer: $3869.68

PV = -1000

N - 20

PMT = 0

I = 7%

Solve for FV= 3869.68

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15
Q

(Compound value solving for i) At what annual rate would the following have to be invested?

$12,000 to grow to $25,000 in 13 years

A

Correct Answer: 5.81%

PV = -12000

FV = 25000

N = 13

PMT = 0

Solve for I = 5.81%

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16
Q

(Compound value solving for i) At what annual rate would the following have to be invested?

$150,000 to grow to $300,000 in 30 years

A

Correct Answer: 2.34%

PV = -150,000

FV = 300000

N = 30

PMT = 0

Solve for I = 2.34%

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17
Q

(Compound value solving for i) At what annual rate would the following have to be invested?

$1,000 to grow to $2,700 in 5 years

A

Correct Answer: 21.98%

PV = -1000

FV = 2700

N = 5

PMT = 0

Solve for I = 21.98%

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18
Q

(Compound value solving for i) At what annual rate would the following have to be invested?

$25,000 to grow to $2,000,000 in 50 years

A

Correct Answer: 9.16%

PV = -25,000

FV = 2,000,000

N = 50

PMT = 0

Solve for I = 9.16%

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19
Q

(Compound value solving for n) How many years will it take to get the following (round your answer to the nearest year):

$100,000 to become $1,000,000 at 7% compounded annually

A

Correct Answer: 34 years

PV = -100,000
FV = 1,000,000
I = 7%
PMT = 0

Solve for N = 34

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20
Q

(Compound value solving for n) How many years will it take to get the following (round your answer to the nearest year):

$2,100 to become $5,200 at 12% compounded annually

A

Correct Answer: 8 years

PV = -2,100

FV = 5,200

I = 12%

Solve for N = 8

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21
Q

(Present value) What is the present value of the following amount?

$100,000 received 45 years from now discounted at a rate of 3% annually

A

Correct Answer: $26,443.86

FV = 100,000

N = 45

I = 3%

Solve for PV = -26,443.86

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22
Q

(Present value) What is the present value of the following amount?

$250,000 received 15 years from now discounted at a rate of 2.5% annually

A

Correct Answer: $172,616.39

FV = 250,000

N = 15

I = 2.5%

Solve for PV = 172,616.39

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23
Q

(Present value) What is the present value of the following amount?

$1,000,000 received 35 years from now discounted at a rate of 3.5% annually

A

Correct Answer: $299,976.86

FV = 1,000,000

N = 35

I = 3.5%

Solve for PV = -299,976.86

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24
Q

(Present value) What is the present value of the following amount?

$2,500,000 received 55 years from now discounted at a rate of 4% annually

A

Correct Answer: $289,138.78

FV = 2,500,000

N = 55

I = 4%

PV = -2,500,000

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25
Q

(Compound value) Amelia just received her annual performance bonus at her job of $15,000. She decides to put it in a savings account at her local bank which pays a 2% annual yield.

How much money will she have accrued after 15 years?

A

Correct Answer: $20,188.03

PV = -15,000
I = 2%
N = 15

Solve for FV = 20,188.03

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26
Q

(Compound value) Amelia just received her annual performance bonus at her job of $15,000. She decides to put it in a Certificate of Deposit (CD) that would receive a yield of 5% annually. How much money will she have accrued after 15 years?

A

Correct Answer: $31,183.92

PV = -15,000
I = 5%
N = 15

Solve for FV = 31,183.92

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27
Q

Suppose that today, you invested $100,000 into a certificate of deposit that pays 5% per year. How much would your investment be worth 4 years from today?

A

Correct Answer: $121,550.63

PV = -100,000
I/Y = 5%
N = 4
PMT = 0

Solve for FV = $121,550.63

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28
Q

How much would your $100,000 investment be worth one year from today? Assume the account the money is invested in has a 5% annual return.

A

Correct Answer: $105,000

PV = -100,000
I/Y = 5%
N = 1
PMT = 0

Solve for FV = $105,000

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29
Q

Suppose you plan to receive $50,000 ten years from today, if the appropriate discount rate is 10%, what is the present value of $50,000?

A

Correct Answer: $19,277.17

FV = -50,000
I/Y = 10%
N = 10
PMT = 0

Solve for PV = $19,277.17

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30
Q

Suppose you plan to receive $50,000 ten years from today, if the appropriate discount rate is 25%, what is the present value of $50,000?

A

Correct Answer: $5,368,71

FV = -50,000
I/Y = 25%
N = 10
PMT = 0

Solve for PV = $5,368.71

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31
Q

Suppose you can afford to invest $1,000 each month into an account that pays 12% per year. How many years will you need to make this monthly investment for your account to be worth $1,000,000? (Assume the first investment will begin one month from today)

A

Correct Answer: 20.08 years

Inputs:
PV = 0
FV = 1,000,000
PMT = -1,000
I = 12%/12 = 1%

The present value is 0 since there is no lump sum. FV is 1,000,000 since that is the amount you will receive at the end of N-year periods as a lump sum. PMT is -1,000 since it is annuity and cash outflow from your hand to the account. I is 1% since the annual rate is 12% and compounded monthly, thus 12%/12 = 1%.

Solve for N = 240.98

As you put PMT and I as monthly rate, you find N as months. In other words, it will take 240.98 months to build up to $1,000,000 if you invest $1,000 a month at the monthly rate of 1%. In order to find the number of years, you divide N by 12, so 240.98/12 = 20.08 years.

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32
Q

Suppose you plan to invest $5,000 each year (beginning at the end of this year) into a retirement account that will pay 12%. What will be the value of the retirement account if you plan to retire in 30 years? (Assume the retirement account has a zero balance currently.)

A

Correct Answer: $1,206,663.42

Inputs:

PV = 0
PMT = -5,000
I/Y = 12%
N = 30

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33
Q

A bank recently quoted you an annual interest rate of 5% on an automobile loan for a new sedan that is currently priced at $28,950. If the length of the loan is 6 years (or 72 months), what will your monthly payment be?

A

Correct Answer: $466.24

PV = $28,950
FV = 0
I/Y = 5%/12 months =
.4167% per month
N = 72

PV is 28,950 because that is how much you borrowed (cash inflow) to purchase a car. FV is 0 since you should be paid back after 6-year payments. I is 0.4167% since 5% is the annual rate and payment is monthly, so you divide 5% by 12. N is 72 since 6 years monthly payment, so 6 times 12.

Compute PMT = -466.24 or $466.24 per month.

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34
Q

If current automobile loans have a 5% annual interest rate on 6 years, and you can only afford a $230 monthly payment, how much of an automobile can you afford?

A

Correct Answer: $14,281.34

FV = 0

PMT = -230

N = 6X12 = 72

I = 5%/12 = 0.4167%

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35
Q

What is the effective yield (as a decimal) on the automobile loans with an annual interest rate of 5% that compounds monthly?

A

Correct Answer: 5.12%

Effective Yield = (1 + (i / m))m - 1, where i is annual rate, m is # of compounding per year.

Effective Yield = (1 + (.05 / 12))12 - 1

= (1 + .004167)12 - 1

= .0512 or 5.12%

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36
Q

If you were to begin investing $5,000 each year, beginning one year from today, into an account that paid 15% per year, then how much will the account be worth after 35 years?

A

Correct Answer: $4,405,851

Inputs:
PV = 0
PMT = -5,000
N = 35
I = 15%

Solve for FV = 4,405,851

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37
Q

At what discount rate, will the present value of a $10,000 ordinary annuity payment for 5 years be worth $35,000 today?

A

Correct Answer: 13.20%

Inputs:
PV = -35,000

FV = 0
N = 5
PMT = 10,000

Solve for I = 13.20%

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38
Q

If you were to invest $10,000 each year for the next 20 years, then what rate of return is required for your investment to be worth $1,000,000? (Assume the first payment will begin one year from today)

A

Correct Answer: 14.80%

Input the following values:

PV

FV

PMT

N

0

1000000

-10000

20

After inputting these values, solve for I

I = 14.80%

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39
Q

Suppose you plan to invest $5,000 each year (beginning at the end of this year) into a retirement account that will pay 12%. What will be the value of the retirement account if you plan to retire in 40 years? (Assume the retirement account has a zero balance currently.)

A

Correct Answer: $3,835,457.10

Inputs:

PV = 0
PMT = -5,000
I/Y = 12%
N = 40

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40
Q

Suppose you plan to invest $5,000 each year (beginning at the end of this year) into a retirement account that will pay 15%. What will be the value of the retirement account if you plan to retire in 30 years? (Assume the retirement account has a zero balance currently.)

A

Correct Answer: $2,173,725.73

Inputs:

PV = 0
PMT = -5,000
I/Y = 15%
N = 30

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41
Q

What is the present value of a 10-year $5,000 annuity due if the discount rate is 10%?

A

Correct Answer: $33,795.12

For an annuity due the first payment is made at the beginning of the period or at the beginning of the first year. If we solve this problem using method two from the text we would first put the calculator in BEG MODE. Enter the following entries while solving for the present value.

FV = 0

PMT = 5,000

N = 10

I =10%

FV is 0 since there is no lump sum received or paid. PMT is 5,000 since it is annuity. I is 10% since it is the discount rate. N is 10 since you have payments of 5,000 for 10 years.

Compute PV = -$33,795.12

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42
Q

What is the present value of following streams of future cash flows if the discount rate is 11%?

Year 1 Year 2 Year 3

$14,000 $16,540 $19,889

A

Correct Answer: $40,580

N(Year) 1 2 3FV 14,000 16,540 19,889I 11% 11% 11%PMT 0 0 0PV($12,612.61) ($13,424.24) ($14,542.67)

For this problem, you have to discount future cash flows one by one. Therefore, each cash flow will be FV on your calculator. N is the year(s) you receive the cash flows. I is 11% which is your discount rate. PMT is 0 since there is no annuity. You compute PV’s of each FV.

In order to find the PV of the cash flows, you add the PV’s of each cash flow.

PV = 12,612.61 + 13,424.24 + 14,542.67 = $40,579.52

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43
Q

What is the present value of following streams of future cash flows given at the end of each year if the discount rate is 15%?

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

$0 $0 $0 $21,000 $21,000 $21,000 $21,000

A

Correct Answer: $39,421

Step 1: With the end mode on your calculator:

FV = 0
PMT = 21,000
I = 15%
N = 4

FV is 0 since there is no additional lump sum at the end of Year 7 besides the annuity. PMT is 21,000 since 21,000 is an annuity. N = 4 since there are 4 payments of 21,000. I is 15% which is the discount rate.

PV = -$59,954.5456

The present value you calculated with the first step is the value of the 4-year annuity of $21,000 discounted to at the end of Year 3. When you use End Mode on your calculator, the present value of annuities is a discounted value of the annuity back to one period before the first payment is made. In order to find the real present value (at Year 0), you need to discount the value you found in Step 1 for 3 more years.

FV = 59,954.5456
N = 3
I = 15%
PMT = 0

Solve:
PV = $39,421.09

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44
Q

What is the present value of the following stream of cash flows if the discount rate is 9%?

Year 1 - $0
Year 2 - $0
Year 3 - $19,800
Year 4 - $16,840
Year 5 - $12,120

A

Correct Answer: $35,096.28

N (Year) 3 4 5
FV 19,800 16,840 12,120
I 9% 9% 9%
PMT 0 0 0

PV (15,289.23) (11,929.88)
(7,877.17)

For this problem, you have to discount future cash flows one by one. Therefore, each cash flow will be FV on your calculator. N is the year(s) you receive the cash flows. I is 9% which is your discount rate. PMT is 0 since there is no annuity. You compute PV’s of each FV.

In order to find the PV of the cash flows, you add the PV’s of each cash flow.

PV = 15,289.23+11,929.88+7,877.17 = $35,096.28

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45
Q

If you are going to receive $70,000 for 20 years starting 5 years from now, what is the present value of the cash flows discounted at 12%?

A

Correct Answer: $332,288

Step 1:
End Mode
N = 20
I = 12%
PMT = $70000
FV = 0
PV = ? = $522,861.05

N is 20 since you have 20 payments, I is 12% which is the discount rate, PMT is $70,000 since that is the annuity, FV is 0 since there is no lump sum. Then solve for PV which is $522,861.05. Now if you use End mode, then PV you calculate on your calculator is one year before the first payment of the annuity is given. Since the annuity starts in 5 years, PV you calculate is in 4 years; thus you have to discount 4 more years with the PV you calculated as the FV.

Step 2:
FV = $522,861.05
N = 4
I = 12%
PMT = 0
PV = ? = $332,287.65

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46
Q

What is the today’s value of a $5,000 annual perpetuity starting in 40 years discounted at 8%?

A

Correct Answer: $3,107.09

Step 1:
Value of Perpetuity at the beginning of year 40 = PMT/I = 5,000/0.08 = 62500

The perpetuity formula calculates discounted perpetuity back to a year before the first payment is given. Therefore, you have to discount what you find in the first step back by 39 years not 40 years.

Step 2:
FV = 62500
I = 8%
N = 39
PMT = 0
PV = 3,107.09

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47
Q

Suppose today is January 1st, and you have planned to invest $12,000 at the end of this year, $14,220 at the end of the second year, and $15,600 at the end of the third year. If you can earn a 14% rate of return in each year, what is the future value of this stream of cash flows at the end of 4 years?

A

FV = PV × (1 + i)n

Year

CFs

FV

1

$12,000

$17,778.53

*Compound 3 years

2

$14,220

$18,480.31

*Compound 2 years

3

$15,600

$17,784.00

*Compound 1 year

Sum of FVs

$54,042.84

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48
Q

What is the present value of an annual payment of $10,000 that is received in perpetuity if the discount rate is 13%?

A

Correct Answer: $76,923

When solving for the present value of a regular perpetuity we would use the formula

PV = PMT/I

10,000/0.13 = $76,923

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49
Q

Suppose that an investment product pays an investor $10,000 in perpetuity. If the appropriate discount rate is 12%, what should the price (or present value) of this product be?

A

Correct Answer: $83,333.33

PV (of a perpetuity) = CF/discount rate

= $10,000/.12

= $83,333.33

50
Q

A particular investment product pays an investor 5 equal payments of $15,000 in each year, however the first payment starts immediately. If the appropriate discount rate is 10%, what is the price (or present value) of this annuity due?

A

Correct Answer: $62,547.98

The investor will receive an immediate cash flow of $15,000 (in time 0), and then $15,000 1 year from today, 2 years from today, 3 years from today, and 4 years from today. First, let’s calculate the present value of the future cash flows:

FV = 0
I/Y = 10%
N = 4
PMT = -$15,000
Compute PV = $47,547.98
Now add the present value of the $15,000 (which is $15,000 ) that will be received immediately to the present value of the future cash flows: $15,000+$47,547.98 = $62,547.98

Alternative method:

Change calculator from end mode to beg. mode. Now, your calculator assumes the first payment is immediately received.

Solve for PV

FV = 0
I/Y = 10%
N = 5
PMT = -15,000
Compute PV = 62,547.98

51
Q

What is the present value of the following stream of cash flows if the discount rate is 9%?

Year 1 - $15,500
Year 2 - $17,250
Year 3 - $19,800
Year 4 - $16,840
Year 5 - $12,120

A

PV = (15,500 / 1.091) + (17,250 / 1.092) + (19,800 / 1.093) + (16,840 / 1.094) + (12,120 / 1.095)

= 14,220.18 + 14,518.98 + 15,289.23 + 11,929.88 + 7,877.17

= $63,835.44

52
Q

MINI-CASE

Name: April
Current age: 25
Tax rate: 20%
Assumed portfolio return: 8% annually
Projected retirement age: 65
April nest-egg goal: $3,000,000

Calculate the required monthly savings that April needs to have in order to reach her goal to accumulate $3,000,000 when she retires if she makes payment at the end of each month until she retires?

A

Correct Answer: $859.35

First, find the number of years April has to save.
Age of retirement - Current age = 65 - 25 = 40

FV = 3,000,000
N= 40 X 12 = 480
I = 8/12 = .6667
Solve for PMT = (859.35)

N is going to be 40 years X 12 months. I is going to be 8/12 = .6667

53
Q

MINI-CASE

Name: April
Current age: 25
Tax rate: 20%
Assumed portfolio return: 8% annually
Projected retirement age: 65
April nest-egg goal: $3,000,000
Calculate the required monthly savings April needs to have to reach her goal if she starts saving at age 35?

A

Correct Answer: $2,012.94

Number of years April will save = 65 - 35 = 30

Calculator:
FV = 3,000,000
I = 8/12 = .667
N = 30 X 12 = 360
Solve for PMT = (2,012.94)

54
Q

MINI-CASE

Name: April
Current age: 25
Tax rate: 20%
Assumed portfolio return: 8% annually
Projected retirement age: 65
April nest-egg goal: $3,000,000

Calculate the required monthly savings April needs to have to reach her goal if she starts saving at age 50?

A

Correct Answer: $8,669.56

Years of saving = Retirement Age - Age she will start saving
Years of saving = 65 - 50 = 15

FV = 3,000,000
N = 15 X 12 = 180
I = 8/12 = .667
Solve for PMT = (8,669.56)

55
Q

Lisa is putting together a retirement plan and is scheduled to retire in 32 years. She is planning to open a retirement account and invest an equal amount each month into the retirement account. If she expects to earn 9% per year in the account and is planning to have $2,000,000 in the account at retirement, what is the amount of the monthly investment?

A

Correct Answer: $902.32

PV = 0
FV = 2000000
N = 32 X 12 = 384
I = 9/12 = .75
Solve for PMT = ($902.32)

56
Q

Blake is planning to retire in 38 years. He is thinking about opening a retirement account and plans to invest an equal amount each year into the account. He expects to earn 13% per year in the account and is planning to have $1,750,000 in the account at retirement, what is the amount of Blake’s annual investment?

A

Correct Answer: $2,209

PV = 0
FV = 1750000
N = 38
I = 13
Solve for PMT = ($2,209.01)

57
Q

(Loan amortization) The Jones family recently purchased a new home for $2,300,000. The family paid $250,000 down at signing and decided to pay the rest over 15 years in equal monthly payments that include principal payments plus 4.5% interest on the unpaid balance. Determine the amount of the equal monthly payments the Jones family will have to make over the life of the loan?

A

Correct Answer: $15,682.36

PV = 2,300,000 - 250,000 = 2,050,000

N = 15 X 12 = 180

I = 4.5/12 = .375

Solve for PMT = (15,682.36)

58
Q

(Solving for Annuity) Mary and John had their first child a week ago. They decide to set up a savings account for their child’s college education in 18 years. Mary figures that tuition costs for her child to get a 4-year degree at the local university at the end of 18 years will be $40,000. At their local bank, they can offer an account with 3% annual yield. How much will Mary and John have to pay at the end of each month to attain their goal?

A

Correct Answer: $139.89

FV = 40,000

PV = 0

I = 3/12 = .25

N = 18 X 12 = 216

Solve for PMT = (139.89)

59
Q

(Present value of an ordinary annuity) In the month of December, you receive a job offer from Credit Suisse. The letter tells you that you will be starting on January 1st, and you will receive an annual salary to be paid at the end of each year of $70,000. The letter also says that this is a 4-year contract after which you will be expected to do an MBA. Before accepting you decide to calculate the present value of your 4-year contract with Credit Suisse as of your starting date. What is your contract worth at that time given a 15% discount rate?

A

Correct Answer: $199,848.48

PMT = 70,000
N = 4
I = 15%
Solve for PV = (199,848.49)

60
Q

If you are compounding a cash flow, you are:

A

Finding a future value

61
Q

Today, a round-trip plane ticket from Los Angeles to New York costs $350. If the average annual inflation rate is 2.5%, who much will the ticket cost 30 years from now?

A

$734.15

62
Q

You want $15,000, fifteen years from now. If you can earn 8% per year in your savings account, how much do you have to deposit in today?

A

$4,729

63
Q

Which of the following best describes the difference between an annuity due and an ordinary annuity?

A

An ordinary annuity pays at the end of the period, but an annuity due pays at the beginning.

64
Q

You are planning to retire 40 years from now. If your retirement account pays an annual rate of 6% compounded monthly and you start making a monthly contribution of $400 a month today, how much will you have when you retire in 40 years?

A

$800,579

65
Q

If you deposit $10,000 in an account with annual rate of 9% compounded semi-annually, how long will it take for you to have $2,000,000 in the account?

A

60.18 years

66
Q

Suppose you deposit $10,000 in an account today that pays an interest rate which is compounding monthly. If your goal is to have $2,000,000 in 40 years, the stated annual rate must be at least:

A

13.32%

67
Q

Which of the following gives the smallest effective yield? Assume that 1 year is 365 days.

A

18.65% APR compounded monthly

68
Q

How does a perpetuity differ from an ordinary annuity?

A

A perpetuity has payments that go on forever while an ordinary annuity has a limited numbers of cash flows.

69
Q

Suppose you want to establish a fund that will pay $5,000 a year forever to your favorite charity. If the discount rate is 8%, how much do you have to set a side today?

A

$62,500

70
Q

You have a son who is 5 years old. You want to provide financial help when he goes to college in exactly 13 years. You are planning to give him $20,000 a year at the beginning of each year for 4 years to pay his educational expenses. How much do you have to set aside today if you can earn an annual rate of 5% on all invested funds?

A

$39,490

71
Q

What is the value of an asset that pays $5,000 at the end of each of the next three years, $7,500 at the end of each of the following three years, and $10,000 at the end of each of the final three years? Assume a discount rate of 7%.

A

$46,675

72
Q

What should you be willing to pay now in order to receive $12,000 annually forever starting 40 years from now if you require 8.5% on the investment?

A

$5,861

73
Q

You bought a new car today which cost you $20,000. You financed the entire cost with a 5-year loan at 4.00%. If you make payments at the end of each month starting a month from now, how much is your monthly payment?

A

$368.33

74
Q

4 years ago you took out a student loan of $20,000 with the annual interest rate of 8% compounded monthly. Because it is a student loan, you did not make any payments while you were in school but interest was still accruing on the amount borrowed. You just graduated. As such, you must now start paying back your loan by making equal, monthly, end of the month payments. If you plan to pay back the loan over the next 10 years, how much is your monthly payment?

A

$333.81

75
Q

You just started a full-time job today and received information on the firm’s retirement savings program. Your employer will match all your contributions on a 1-to-1 basis and you expect an average annual return of 6%. You decided to make a monthly contribution to your retirement account of $315 at the beginning of each month starting today. How much will you have in 40 years?

A

$1,260,912

76
Q

You are considering buying a house. Your current annual salary is $100,000 and you want the monthly payment to be no more than 25% of your monthly income. You can get 25-year mortgage at 4.2% APR. Insurance and taxes will be $300 per month and must be included when calculating your maximum loan amount. If you can make a down payment of $30,000, what is the maximum amount you can spend on a house?

A

$360,895

77
Q

You just welcomed a new baby girl to your family today. You want your daughter to go to Harvard in 18 years for her college education. This year, tuition and fee are $60,000 if she were attending today. You expect the cost to increase by 4% each year. Assume the full amount is payable at the beginning of each year. Your savings account earns an annual rate of 6% but is compounded monthly.

What will be the cost of attending for one year when she starts college in 18 years?

A

$121,549

78
Q

You just welcomed a new baby girl to your family today. You want your daughter to go to Harvard in 18 years for her college education (assumed to be 4 years in length). This year, tuition and fees are $60,000 IF she were attending today. You expect the cost to increase by 4% each year. Assume the full amount is payable at the beginning of each year. Your savings account earns an annual rate of 6% but is compounded monthly.

(Challenge Problem) If you are going to make a monthly deposit at the beginning of each month starting a month from today until the first month your daughter starts college in 18 years, how much do you have to put in every month?

A

$1,217

79
Q

True or False: Bonds are the backbone of the world’s pension funds.

A

True

80
Q

True or false: The two main reasons the text states for the importance of understanding bonds are the bond market is an important source of financing and bonds play a role in most personal investment plans.

A

True

81
Q

True or false: Bonds are also known as “fixed income.”

A

True

82
Q

In the bond market, firms raise debt financing directly from ________.

A

Investors

83
Q

Bookmark question for later
What is the written agreement between the bond issuer and its bondholders called?

A

Indenture

84
Q

The period of time for which a bond remains outstanding is called:

A

Maturity

85
Q

The stated interest payment made on a bond is the:

A

Coupon

86
Q

Which of the following types of loans are always classified as a secured loan?

A

Credit Card and Mortgage

87
Q

BLU-DAY Co. is currently issuing a $1,000 face-value bond that has an annual coupon of 6% and matures in 10 years. Interest payments are made annually. If the yield to maturity is 8%, then what is the current price of the bond?

A

Correct Answer: $865.80

PV

FV

PMT

N

I

($865.80)

1000

60

10

8%

88
Q

LLY Corporation is planning to issue a $1,000 face value bond with a maturity of 30 years. The annual coupon rate is expected to be 7.25% and interest payments are expected to be paid semi-annually. If the market is requiring a return of 10% annually on similar bonds, then what should LLY expect to receive for each bond they issue?

A

Correct Answer: $739.72

PV

FV

PMT

N

I

($739.72)

1000

36.25

60

5%

89
Q

The Diamond Co. just issued some new bonds with a maturity of 15 years and a face value of $1,000. Similar bonds have an annual coupon rate of 8.5%, and a yield to maturity of 7.2%. What is the current price of these bonds?

A

Correct Answer: $1,116.92

FV = $1,000
PMT = $85
N = 15
I/Y = 7.2%
Compute PV = -$1,116.92

90
Q

(Bond valuation) Tonic Juice Corp.’s 15-year, $1,000 par value bonds pay 12% interest annually. The market price of the bonds is $1,062.20 and your required rate of return is 10%. Determine the value of the bond to you given your required rate of return. Should you purchase this bond?

A

Correct Answer: You should buy the bond since the actual price of the bond is lower than the price with your required rate.

Price of the bond with the required rate of return:
PV FV PMT N I
($1,152.12) $1,000.00 120 15 10%

Given your required rate of return, you would value the bond to be worth $1,152.12 today. Since the market price of this bond is below this price, this means the bond is traded cheaper than you believe it should; therefore you should buy it to get a higher return than you require.

91
Q

Current Government Treasury bills (i.e. short-term bonds) are priced at 96.8% of par, where par is $1,000. If these bonds do not pay a coupon and mature in one year from today, then what is the yield to maturity on these bonds?

A

PV

FV

PMT

N

I

-968

1000

0

1

3.31%

92
Q

A 7.5 percent semi-annual coupon bond is priced at $1,055.33. The bond has a $1,000 face value and an annual yield to maturity of 6.5 percent. How many years until this bond’s maturity?

A

Correct Answer: 6.97 years

FV = $1,000
PMT = $75/2 = $37.50
PV = -$1,055.33
I/Y = 6.5%/2 = 3.25%
Compute N = 13.94 (this is in semi-annual time periods) = 13.94/2 = 6.97 years

93
Q

A bond for AJB Co. has a yield to maturity of 13.90 percent, a 9.5 percent annual coupon, a $1,000 face value, and a maturity date 5 years from today. What is the current yield?

A

Correct Answer: 11.20%

First, let’s find that price of the bond:

FV = $1,000
PMT = $95
I/Y = 13.9%
N = 5
Compute PV = -$848.58

With the current price of $848.58, we can now solve for the current yield.

Recall that: Current Yield = Annual Coupon/Current Market Price of Bond.
= 95/848.58 = 0.112 or 11.2%

94
Q

(Bondholder’s expected rate of return) Jobby McJobberton’s Inc. is selling bonds for $700. It has an 8% coupon rate and makes payments semi-annually. The bond matures in 25 years. What is the bond’s expected rate of return?

A

Correct Answer: 11.74%

PV FV PMT N I
($700.00) $1,000.00 40 50 5.87%
5.87% X 2 = 11.74%

95
Q

(Bond valuation) Tonic Juice Corp.’s 15-year, $1,000 par value bonds pay 12% interest annually. The market price of the bonds is $1,062.20 and your required rate of return is 10%. Compute the bond’s market expected rate of return.

A

Correct Answer: 11.13%

PV FV PMT N I
$ (1,062.20) $ 1,000.00 120 15 11.13%

96
Q

What are bonds issued by cities, counties, or states called?

A

Municipal Bonds

97
Q

What is a bond called that has no coupon payments?

A

Zero Bonds

98
Q

A zero-coupon bond that is currently priced at $456, has a face value of $1,000, and matures in 10 years. What is the yield to maturity of this bond?

A

Correct Answer: 8.17%

FV = -1,000, PV = $456, PMT = 0, N = 10, Compute I/Y = 8.17%

99
Q

What is a bond that is unsecured called?

A

Debentures

100
Q

Suppose you bought a 10-year $1,000 face-value bond for $925 one year ago. The annual coupon rate is 7% and interest payments are paid annually. If the price today is $1,004, the yield to maturity must have changed from _____________ to ______________.

A

Correct Answer: 8.12%; 6.94%

PV

FV

PMT

N

I

-925

1000

70

10

8.12%

-1004

1000

70

9

6.94%

101
Q

If returns required by bondholders have increased 1.5% from last year, we should expect bond prices to have _______________.

A

Decreased

102
Q

The relation between bond prices and yields to maturity can best be described as:

A

Inverse

103
Q

Stockholders have a __________ claim on firm earnings and assets.

A

Residual

104
Q

True or False: A right that common stock shareholders have is the right to vote on company management and policy.

A

True

105
Q

True or false: Knowing about equity is only important if you want to become a Wall Street banker.

A

False

106
Q

True or false: Equity often is a big part of individual investment portfolios.

A

True

107
Q

Which of the following securities is considered a hybrid security?

A

Preferred stock

108
Q

If a company skips a dividend payment to preferred shareholders, then the company _____________.

A

Cannot pay any dividends to common shareholders until the preferred dividend is paid

109
Q

Which of the following securities represents ownership in the firm?

A

Any sort of stock like common or preferred

110
Q

Which of the following statements is correct regarding preferred stock and the common stock?

A

Both preferred and common stocks do not have fixed maturities like bonds.

111
Q

Corporate Governance can be defined as:

A

The rules and regulations for managers of the firm

112
Q

A preferred stock pays a dividend of $1.79 in perpetuity. If the return required by shareholders is 8%, then the price per share for this preferred stock is:

A

Correct Answer: $22.38

Price = 1.79/0.08 = $22.38

113
Q

If a preferred stock pays a constant dividend of 5% of par, which is $50, and investors require a rate of return of 9%, what is the price of this preferred stock?

A

Correct Answer: $27.78

D = 5% of $50 = .05×$50 = $2.50

Vps = (D / kps)
= 2.50 / 0.09
= 27.78

114
Q

(Preferred stockholder expected return) Spaceman Corp’s preferred stock is selling at $35.29 a share and pays a $2.26 dividend. What is the expected rate of return of Spaceman’s stock?

A

Correct Answer: 6.40%

kps = D / Vcs = 2.26 / 35.29 = 6.40%

115
Q

(Preferred stockholder expected return) You own 252 shares of Global Services’ preferred stock, which currently sell for $18.12 and pay annual dividends of $1.19 per share. If you require a 10% return, given the current price, would you be interested in selling or buying more stock?

A

Correct Answer: You should sell the stock since it is overvalued by $6.22.

Vps = D / kps = 1.19 / 0.10 = $11.90, so you should sell the stock since it is overvalued

116
Q

Some Co. is planning to pay a dividend of $5.60 in the next year and expects to grow the dividend at a constant rate of 4% per year, indefinitely. If the required rate of return by shareholders is 13%, then the price of this stock should be:

A

Correct Answer: $62.22

Price = 5.60/(0.13 – 0.04) = $62.22

117
Q

UHFD has just paid a dividend of $2.56 and is expected to increase the future dividends at a rate of 5% per year indefinitely. If you, as a share holder, require 15% per year, what is the current price per share?

A

Correct Answer: $26.88

Price = (2.56 X 1.05)/(0.15 - 0.05) = $26.88

118
Q

BlackHawk.com anticipates paying a dividend of $4.25 next year and is expected to grow the dividend at a constant rate of 7% per year, indefinitely. If the required rate of return by shares holders is 13%, then, according to the Gordon Model, what should the price of the stock be today?

A

Correct Answer: $70.83

V0 = $4.25 / (.13 - .07)
= $4.25 / .06
= $70.83

119
Q

Liquid Systems Inc. has a unique dividend policy. This recent start up is expecting to pay a dividend of $2.00 in the next year, a dividend of $2.50 in year 2, and a dividend of $3.00 in the third year. After year 3, the company is anticipating increasing its dividend by 2.5% per year indefinitely. If the required return by shareholders is currently 12%, what is the price of the stock?

A

Correct Answer: $28.96

Year

1

2

3

4

Div

2

2.5

3

3.075*

GGM

32.36842105**

PV

$1.79

$1.99

$2.14

$23.04

$28.95

*3 X (1 + .025) = 3.075

**V at 3 = 3.075/(0.12 – 0.025) = 32.3684

120
Q

Yukat Inc. is expecting to pay a dividend of $4.50 next year and then retain all of earnings thereafter. The expected price of the Yukat’s common stock is $45.60 next year. If the return required by share holders is 17%, what is the price of Yukat’s stock today?

A

Correct Answer: $42.82

P = (45.60 + 4.50)/1.17 = $42.82

121
Q

Another Co. just paid a dividend of $1.75. The company is expected to grow their dividend at a rate equal to their sustainable growth rate. The company recently reported a Return on Equity of 15% and paid out 25% of their net income in dividends. If the required rate of return by shareholders is 20% and the annual growth rate is 11.25%, what is the price of the stock today?

A

Correct Answer: $22.25

V0 = ($1.75 x 1.1125) / (0.20 - .1125)
= $1.95 / .0875
= $22.25

122
Q

(Common shareholder expected return) Kiwi Pro’s common stock currently sells for $8.78 per share. The company executives anticipate a growth rate of 4% forever and a dividend of $1.05 next year. If you require a 15% rate of return, should you purchase the stock?

A

Correct Answer: You should buy because it is undervalued by $0.77.

Vcs = D1 / (kcs – g) = 1.05/(0.15 – 0.04) = $9.55; The current price of the stock is only $8.78, which is less that the value of the stock, according to your analysis. Therefore, you should buy the stock (i.e. it is undervalued).

Principles of Finance (1 decks)

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