Chapter 02 - How to Calculate Present Values

Chapter 06: How to Calculate Present Values

1. The present value of $100 expected in two years from today at a discount rate of 6% is: 
A. $116.64
B. $108.00
C. $100.00
D. $89.00

PV = 100/(1.06^2) = 89.00

2. Present Value is defined as: 

A. Future cash flows discounted to the present at an appropriate discount rate
B. Inverse of future cash flows
C. Present cash flow compounded into the future
D. None of the above

3. If the interest rate is 12%, what is the 2-year discount factor? 
A. 0.7972
B. 0.8929
C. 1.2544
D. None of the above

DF2 = 1/(1.12^2) = 0.7972

4. If the present value of the cash flow X is $240, and the present value cash flow Y $160,
then the present value of the combined cash flow is: 
A. $240
B. $160
C. $80
D. $400

PV (x + y) = PV (x) + PV (y) = 240 + 160 = 400

5. The rate of return is also called: I) discount rate; II) hurdle rate; III) opportunity cost of
capital 
A. I only
B. I and II only
C. I, II, and III
D. None of the given ones

 6. Presentvalue of $121,000 expected to be received one year from today at an interest rate
(discount rate) of 10% per year is: 
A. $121,000

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B. $100,000
C. $110,000
D. None of the above

PV = (121,000)/(1.1) = 110,000

7. One year discount factor at a discount rate of 25% per year is: 
A. 1.25
B. 1.0
C. 0.8
D. None of the above

Discount Factor = 1/1.25 = 0.8

8. The one-year discount factor at an interest rate of 100% per year is: 
A. 1.5
B. 0.5
C. 0.25
D. None of the above

Discount factor = 1/(1 + 1) = 0.5

9. Present Value of $100,000 that is, expected, to be received at the end of one year at a
discount rate of 25% per year is: 
A. $80,000
B. $125,000
C. $100,000
D. None of the above

PV = (100,000)/(1 + 0.25) = 80,000

10. If the one-year discount factor is 0.8333, what is the discount rate (interest rate) per year? 
A. 10%
B. 20%
C. 30%
D. None of the above

1 + r = 1/(0.8333) = 1.20; r = 20%

11. If the present value of $480 to be paid at the end of one year is $400, what is the one-year
discount factor? 
A. 0.8333
B. 1.20

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C. 0.20
D. None of the above

Discount factor is = 400/480 = 0.8333

12. If the present value of $250 expected to be received one year from today is $200, what is
the discount rate? 
A. 10%
B. 20%
C. 25%
D. None of the above

1 + r = 250 /200 = 1.25; r = 25%

13. If the one-year discount factor is 0.90, what is the present value of $120 to be received one
year from today? 
A. $100
B. $96
C. $108
D. None of the above

PV = (120)(0.90) = 108

14. If the present value of $600 expected to be received one year from today is $400, what is
the one-year discount rate? 
A. 15%
B. 20%
C. 25%
D. 50%

1 + r = (600)/(400) = 1.5; r = 50%

15. The present value formula for one period cash flow is: 
A. PV = C1(1 + r)
B. PV = C1/(1 + r)
C. PV = C1/r
D. None of the above

16. The net present value formula for one period is:

I) NPV = C0 + [C1/(1 + r)]; II) NPV = PV required investment; and III) NPV = C0/C1 
A. I only
B. I and II only
C. III only
D. None of the above

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17. An initial investment of $400,000 will produce an end of year cash flow of $480,000.
What is the NPV of the project at a discount rate of 20%?

 
A. $176,000
B. $80,000
C. $0 (zero)
D. None of the above

NPV = -400,000 + (480,000/1.2) = 0

18. If the present value of a cash flow generated by an initial investment of $200,000 is
$250,000,
what is the NPV of the project? 
A. $250,000
B. $50,000
C. $200,000
D. None of the above

NPV = -200,000 + 250,000 = 50,000

19. What is the present value of the following cash flow at a discount rate of 9%?

    
A. $372,431.81
B. $450,000
C. $405,950.68
D. None of the above

PV = (100,000/1.09) + (150,000/(1.09^2)) + 200,000/(1.09^3) = 372,431.81

20. At an interest rate of 10%, which of the following cash flows should you prefer?

    
A. Option A
B. Option B
C. Option C
D. Option D

PV(A) = 777.61; PV(B) = 714.50; PV(C) = 746.05; A is preferred

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Chapter 02 - How to Calculate Present Values
21. What is the net present value of the following cash flow at a discount rate of 11%

    
A. $69,108.03
B. $231,432.51
C. $80,000
D. None of the above

NPV = -120,000 + (300,000/1.11) -(100,000/(1.11^2)) = 69,108.03

22. What is the present value of the following cash flow at a discount rate of 16% APR?

  
A. $136,741.97
B. $122,948.87
C. $158,620.69
D. None of the above

PV = (-100,000/1.16) + (300,000/(1.16^2)) = 136,741.97

23. What is the net present value (NPV) of the following cash flows at a discount rate of 9%?

    
A. $122,431.81
B. $200,000
C. $155,950.68
D. None of the above

NPV = -250,000 + (100,000/1.09) + (150,000/(1.09^2)) + (200,000/(1.09^3))

NPV = 122,431.81

24. The following statements regarding the NPV rule and the rate of return rule are true
except: 
A. Accept a project if its NPV > 0
B. Reject a project if the NPV < 0
C. Accept a project if its rate of return > 0
D. Accept a project if its rate of return > opportunity cost of capital

25. An initial investment of $500 produces a cash flow $550 one year from today. Calculate
the rate of return on the project 
A. 10%

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B. 15%

C. 25%
D. none of the above

Rate of return = (550 - 500)/500 = 10%

26. According to the net present value rule, an investment in a project should be made if the: 
A. Net present value is greater than the cost of investment
B. Net present value is greater than the present value of cash flows
C. Net present value is positive
D. Net present value is negative

27. Which of the following statements regarding the net present value rule and the rate of
return rule is not true? 
A. Accept a project if NPV > cost of investment
B. Accept a project if NPV is positive
C. Accept a project if return on investment exceeds the rate of return on an equivalent
investment in the financial market
D. Reject a project if NPV is negative

28. The opportunity cost of capital for a risky project is 

A. The expected rate of return on a government security having the same maturity as the
project
B. The expected rate of return on a well-diversified portfolio of common stocks
C. The expected rate of return on a portfolio of securities of similar risks as the project
D. None of the above

29. A perpetuity is defined as: 

A. Equal cash flows at equal intervals of time for a specific number of periods
B. Equal cash flows at equal intervals of time forever
C. Unequal cash flows at equal intervals of time forever
D. None of the above

30. Which of the following is generally considered an example of a perpetuity: 

A. Interest payments on a 10-year bond
B. Interest payments on a 30-year bond
C. Consols
D. None of the above

31. You would like to have enough money saved to receive $100,000 per year perpetuity after
retirement so that you and your family can lead a good life. How much would you need to
save in your retirement fund to achieve this goal (assume that the perpetuity payments start
one year from the date of your retirement. The interest rate is 12.5%)?

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A. $1,000,000
B. $10,000,000
C. $800,000
D. None of the above

PV = (100,000/0.125) = 800,000

32. What is the present value of $10,000 per year perpetuity at an interest rate of 10%? 
A. $10,000
B. $100,000
C. $200,000
D. None of the above

PV = (10,000/0.1) = 100,000

33. You would like to have enough money saved to receive $80,000 per year perpetuity after
retirement so that you and your family can lead a good life. How much would you need to
save in your retirement fund to achieve this goal (assume that the perpetuity payments start
one year from the date of your retirement. The interest rate is 8%)? 
A. $7,500,000
B. $750,000
C. $1,000,000
D. None of the above

PV = (80,000/0.08) = 1,000,000

34. You would like to have enough money saved to receive a $50,000 per year perpetuity
after retirement so that you and your family can lead a good life. How much would you need
to save in your retirement fund to achieve this goal (assume that the perpetuity payments
starts on the day of retirement. The interest rate is 8%)? 
A. $1,000,000
B. $675,000
C. $625,000
D. None of the above

PV = [(50,000/0.08)](1.08) = 675,000

35. You would like to have enough money saved to receive an $80,000 per year perpetuity
after retirement so that you and your family can lead a good life. How much would you need
to save in your retirement fund to achieve this goal (assume that the perpetuity payments
starts on the day of retirement. The interest rate is 10%)? 

A. $1,500,000
B. $880,000

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C. $800,000
D. None of the above

PV = [(80,000/0.1)] * (1.1) = 880,000

36. An annuity is defined as 

A. Equal cash flows at equal intervals of time for a specified period of time
B. Equal cash flows at equal intervals of time forever
C. Unequal cash flows at equal intervals of time forever
D. None of the above

37. If you receive $1,000 payment at the end each year for the next five years, what type of
cash flow do you have? 
A. Uneven cash flow stream
B. An annuity
C. An annuity due
D. None of the above

38. If the three-year present value annuity factor is 2.673 and two-year present value annuity
factor is 1.833, what is the present value of $1 received at the end of the 3 years? 
A. $1.1905
B. $0.84
C. $0.89
D. None of the above

PV = (2.673 - 1.833) * (1) = 0.84

39. If the five-year present value annuity factor is 3.60478 and four-year present value annuity
factor is 3.03735, what is the present value at the $1 received at the end of five years? 
A. $0.63552
B. $1.76233
C. $0.56743
D. None of the above

PV = (3.60478 - 3.03735) * (1) = 0.56743

40. What is the present value annuity factor at a discount rate of 11% for 8 years? 
A. 5.7122
B. 11.8594
C. 5.1461
D. None of the above

PV annuity factor = (1/0.11) - (1/((0.11)(1.11^8))) = 5.1461

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41. What is the present value annuity factor at an interest rate of 9% for 6 years? 
A. 7.5233
B. 4.4859
C. 1.6771
D. None of the above

PV annuity factor = (1/0.09) - (1/((0.09)(1.09^6))) = 4.4859

42. What is the present value of $1000 per year annuity for five years at an interest rate of
12%? 
A. $6,352.85
B. $3,604.78
C. $567.43
D. None of the above

PV annuity factor = [(1/0.12) - (1/((0.12)(1.12^ 5)))] * 1000 = 3,604.78

43. What is the present value of $5000 per year annuity at a discount rate of 10% for 6 years? 
A. $21,776.30
B. $3,371.91
C. $16,760.78
D. None of the above

PV = [(1/0.10) - (1/((0.10)(1.10^6)))] * 5000 = 16,760.78

44. After retirement, you expect to live for 25 years. You would like to have $75,000 income
each year. How much should you have saved in the retirement to receive this income, if the
interest is 9% per year (assume that the payments start on the day of retirement)? 
A. $736,693.47
B. $802,995.88
C. $2,043,750
D. None of the above

PV = [[(1/0.09) - (1/((0.09)(1.09^25)))] * 75,000] * (1.09) = 802,995.88

 45. After retirement, you expect to live for 25 years. You would like to have $75,000 income
each year. How much should you have saved in the retirement to receive this income, if the
interest is 9% per year (assume that the payments start one year after the retirement)? 
A. $736,693.47
B. $6,352,567.22
C. $1,875,000
D. None of the above

PV = [(1/0.09) - (1/((0.09)(1.09^25)))] * 75,000 = 736,693.47

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46. For $10,000 you can purchase a 5-year annuity that will pay $2504.57 per year for five
years. The payments are made at the end of each year. Calculate the effective annual interest
rate implied by this arrangement: (approximately) 
A. 8%
B. 9%
C. 10%
D. None of the above

Using a financial calculator: N = 5; PV = -10,000; PMT = 2504.57; FV = 0

Compute: I = 8.0% [calculator setting: END]

47. If the present value annuity factor for 10 years at 10% interest rate is 6.1446, what is the
present value annuity factor for an equivalent annuity due? 
A. 6.1446
B. 7.38
C. 6.759
D. None of the above

Annuity due: 6.1446 * 1.1 = 6.759

48. If the present annuity factor is 3.8896, what is the present value annuity factor for an
equivalent annuity due if the interest rate is 9%? 
A. 3.5684
B. 4.2397
C. 3.8896
D. None of the above.

annuity due factor = 3.8896 * 1.09 = 4.2397

49. For $10,000 you can purchase a 5-year annuity that will pay $2358.65 per year for five
years. The payments are made at the beginning of each year. Calculate the effective annual
interest rate implied by this arrangement: (approximately) 
A. 8%
B. 9%
C. 10%
D. none of the above

Using a financial calculator: N = 5; PV = -10,000; PMT = 2358.65; FV = 0

Compute: I = 9.0% [Calculator setting: BEGIN (BGN)]

50. John House has taken a $250,000 mortgage on his house at an interest rate of 6% per year.
If the mortgage calls for twenty equal annual payments, what is the amount of each payment? 

A. $21,796.14

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B. $10,500.00
C. $16,882.43
D. None of the above

(Use a financial calculator) PV = 250,000; I - = 6%; N = 20; FV = 0;

Compute PMT = $21,796.14

51. John House has taken a 20-year, $250,000 mortgage on his house at an interest rate of 6%
per year. What is the value of the mortgage after the payment of the fifth annual installment? 
A. $128,958.41
B. $211,689.53
C. $141,019.50
D. None of the above

Step 1: I = 6%; N = 20; PV = 250,000; FV = 0; Compute PMT = 21,796.14

Step 2: I = 6%; N = 15; PMT = 21,796.14; Compute PV = 211,689. 53

52. If the present value of $1.00 received n years from today at an interest rate of r is 0.3855,
then what is the future value of $1.00 invested today at an interest rate of r% for n years? 
A. $1.3855
B. $2.594
C. $1.70
D. Not enough information to solve the problem

FV = 1/(0.3855) = 2.594

53. If the present value of $1.00 received n years from today at an interest rate of r is 0.621,
then what is the future value of $1.00 invested today at an interest rate of r% for n years? 
A. $1.00
B. $1.61
C. $1.621
D. Not enough information to solve the problem

FV = 1/(0.621) = 1.61

54. If the future value of $1 invested today at an interest rate of r% for n years is 9.6463, what
is the present value of $1 to be received in n years at r% interest rate? 
A. $9.6463
B. $1.00
C. $0.1037
D. None of the above

PV = 1/9.6463 = 0.1037

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55. If the future value annuity factor at 10% and 5 years is 6.1051, calculate the equivalent
present value annuity factor 
A. 6.1051
B. 3.7908
C. 6.7156
D. None of the given ones

PV = 6.1051/(1.1)^5 = 3.7908

56. If the present value annuity factor at 10% APR for 10 years is 6.1446, what is the
equivalent future value annuity factor? 
A. 3.108
B. 15.9374
C. 2.5937
D. None of the above

FV annuity factor = 6.1446 * (1.1^10) = 15.9374

57. If the present value annuity factor at 12% APR for 5 years is 3.6048, what is the
equivalent future value annuity factor? 
A. 2.0455
B. 6.3529
C. 1.7623
D. None of the above

FV annuity factor = 3.6048 * (1.12^5) = 6.3529

58. If the present value annuity factor at 8% APR for 10 years is 6.71, what is the equivalent
future value annuity factor? 
A. 3.108
B. 14.487
C. 2.159
D. None of the above

FV annuity factor = 6.71 * (1.08^10) = 14.487

59. You are considering investing in a retirement fund that requires you to deposit $5,000 per
year, and you want to know how much the fund will be worth when you retire. What financial
technique should you use to calculate this value? 
A. Future value of a single payment
B. Future value of an annuity
C. Present value of an annuity
D. None of the above

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60. Mr. Hopper is expected to retire in 25 years and he wishes accumulate $750,000 in his
retirement fund by that time. If the interest rate is 10% per year, how much should Mr.
Hopper put into the retirement fund each year in order to achieve this goal? [Assume that the
payments are made at the end of each year] 
A. $4,559.44
B. $2,500
C. $7,626.05
D. None of the above

Future value annuity factor = [(1.1^25) - 1]/(0.1) = 98.347;

payment = 750,000/98.347 = 7626.05

61. Mr. Hopper is expected to retire in 30 years and he wishes accumulate $1,000,000 in his
retirement fund by that time. If the interest rate is 12% per year, how much should Mr.
Hopper put into the retirement fund each year in order to achieve this goal? 
A. $4,143.66
B. $8,287.32
C. $4,000
D. None of the above

Future value annuity factor = [(1.12^30 - 1]/(0.12) = 241.3327;

payment = 1,000,000/241.3327 = 4143.66

62. You would like to have enough money saved to receive a growing annuity for 20 years,
growing at a rate of 5% per year, the first payment being $50,000 after retirement. That way,
you hope that you and your family can lead a good life after retirement. How much would you
need to save in your retirement fund to achieve this goal.(assume that the growing annuity
payments start one year from the date of your retirement. The interest rate is 10%)? 
A. $1,000,000
B. $425,678.19
C. $605,604.20
D. None of the above

PV = (50,000)[(1/(0.1 - 0.05)) - {(1/(0.1 - 0.05)}{(1.05^20)/(1.10^20)}] = 605,604.20

63. You would like to have enough money saved to receive a growing annuity for 25 years,
growing at a rate of 4% per year, the first payment being $60,000 after retirement, so that you
and your family can lead a good life. How much would you need to save in your retirement
fund to achieve this goal? (assume that the growing perpetuity payments start one year from
the date of your retirement. The interest rate is 12%)? 
A. $1,500,000
B. $632,390
C. $452,165
D. None of the above

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PV = (60,000) [(1/(0.12 - 0.04)) - {(1/(0.12 - 0.04)}{(1.04^25)/(1.12^25)}] = 632,390

64. The discount rate is used for calculating the NPV is: 

A. Determined by the financial markets
B. Found by the government
C. Found by the CEO
D. None of the above

65. The managers of a firm can maximize stockholder wealth by: 

A. Taking all projects with positive NPVs
B. Taking all projects with NPVs greater than the cost of investment
C. Taking all projects with NPVs greater than present value of cash flow
D. All of the above

66. If you invest $100 at 12% APR for three years, how much would you have at the end of 3
years using simple interest? 
A. $136
B. $140.49
C. $240.18
D. None of the above

FV = 100 + (100 * 0.12 * 3) = $136

67. If you invest $100 at 12% APR for three years, how much would you have at the end of 3
years using compound interest? 
A. $136
B. $140.49
C. $240.18
D. None of the above

FV = 100 * (1.12^3) = $140.49

68. Which of the following statements is true? 

A. The process of discounting is the inverse of the process of compounding.
B. Ending balances using simple interest is always greater than the ending balance using
compound interest at positive interest rates.
C. Present value of an annuity due is always less than the present value of an equivalent
annuity at positive interest rates.
D. All of the above are true.

69. The concept of compound interest is most appropriately described as: 

A. Interest earned on an investment
B. The total amount of interest earned over the life of an investment

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C. Interest earned on interest
D. None of the above

70. Ms. Colonial has just taken out a $150,000 mortgage at an interest rate of 6% per year. If
the mortgage calls for equal monthly payments for twenty years, what is the amount of each
payment? (Assume monthly compounding or discounting.) 
A. $1254.70
B. $1625.00
C. $1263.06
D. None of the above are true

PMT = 150,000/[(1/0.005) - 1/((0.005 * ((1 + 0.005)^240)))] = $1254.70

71. An investment at 10.47% effective rate compounded monthly is equal to a nominal

(annual) rate of: 
A. 10.99%
B. 9.57%
C. 10%
D. None of the above

NOM = [(1.1047)^(1/12) - 1] * 12 = 0.1 = 10.00%

72. An investment at 12% nominal rate compounded monthly is equal to an annual rate of: 
A. 12.68%
B. 12.36%
C. 12%
D. None of the above

EAR = ((1.01)^12) - 1 = 0.12681 = 12.68%

 73. Mr. William expects to retire in 30 years and would like to accumulate $1 million in the
pension fund. If the annual interest rate is 12% per year, how much should Mr. Williams put
into the pension fund each month in order to achieve his goal? Assume that Mr. Williams will
deposit the same amount each month into his pension fund and also use monthly
compounding. 
A. $286.13
B. $771.60
C. $345.30
D. None of the above

PMT = 1,000,000/{[(1/0.01) - (1/(0.01 * (1.01^360)))] * (1.01^360)} = $286.13

74. An investment at 10% nominal rate compounded continuously is equal to an equivalent

annual rate of: 

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A. 10.250%
B. 10.517%
C. 10.381%
D. None of the above

(e^(0.1)) - 1 = 0.10517 = 10.517%

75. The present value of a $100 per year perpetuity at 10% per year interest rate is $1000.
What would be the present value if the payments were compounded continuously? 
A. $1000.00
B. $1049.21
C. $1024.40
D. None of the above

(e^r) = 1.1 r = ln(1.1) = 0.09531; PV = 100/0.09531 = $1049.21

76. The rate of return, discount rate, hurdle rate or opportunity cost of capital all means the
same. TRUE

77. A dollar today is worth more than a dollar tomorrow if the interest rate is positive. TRUE

78. The present value of a future cash flow can be found by dividing it by an appropriate
discount factor. FALSE

79. Net present value is found by subtracting the required investment from the present value
of future cash flows. TRUE

80. The opportunity cost of capital is higher for safe investments than for risky ones. FALSE

81. A safe dollar is always worth less than a risky dollar because the rate of return on a safe
investment is generally low and the rate of return on a risky investment is generally
high. FALSE

82. "Accept investments that have positive net present values" is called the net present value
rule. TRUE

83. "Accept investments that offer rates of return in excess of opportunity cost of

capital". TRUE

 84. The rate of return on any perpetuity is equal to the cash flow multiplied by the
price. FALSE

85. An annuity is an asset that pays a fixed sum each year for a specified number of
years. TRUE

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86. The value of a five-year annuity is equal to the sum of two perpetuities. One makes its
first
payment in year 1, and the other makes its first payment in year 6. FALSE

87. An equal-payment home mortgage is an example of an annuity. TRUE

88. In the amortization of a mortgage loan with equal payments, the fraction of each payment
devoted to interest steadily increases over time and the fraction devoted to reducing the loan
decreases steadily. TRUE

89. In the case of a growing perpetuity, the present value of the cash flow is given by:
[C1/(r - g)] where r > g. TRUE

90. Compound interest assumes that you are reinvesting the interest payments at the rate of
return. TRUE

91. Briefly explain the term "discount rate." 

Discount rate is the rate of return used for discounting future cash flows to obtain the present
value. The discount rate can be obtained by looking at the rate of return, an equivalent
investment opportunity in the capital market.

92. Intuitively explain the concept of the present value. 

If you have $100 today, you can invest it and start earning interest on it. On the other hand, if
you have to make a payment of $100 one year from today, you do not need to invest $100
today but a lesser amount. The lesser amount invested today plus the interest earned on it
should add up to $100. The present value of $100 one year from today at an interest rate of
10% is $90.91. [PV = 100/1.1 = 90.91]

93. State the "net present value rule." 

Invest in projects with positive net present values. Net present value is the difference between
the present value of future cash flows from the project and the initial investment.

94. Briefly explain the concept of risk. 

If the future cash flows from an investment are not certain then we call it a risky cash flow.
That means there is an uncertainty about the future cash flows or future cash flows could be
different from expected cash flows. The degree of uncertainty varies from investment to
investment. Generally, uncertain cash flows are discounted using a higher discount rate than
certain cash flows. This is only one method of dealing with risk. There are many ways to take
risk into consideration while making financial decisions.

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95. State the "rate of return rule." 

Invest as long as the rate of return on the investment exceeds the rate of return on equivalent
investments in the capital market.

96. Discuss why a dollar tomorrow cannot be worth less than a dollar the day after tomorrow. 

If a dollar tomorrow is worth less than a dollar a day after tomorrow, it would be possible to
earn a very large amount of money through "money machine" effect. This is only possible, if
someone else is losing a very large amount of money. These conditions can only exist for a
short period of time, and cannot exist in equilibrium as the source of money is quickly
exhausted. Thus a dollar tomorrow cannot be worth less than a dollar the day after tomorrow.

97. Define the term "perpetuity." 

A perpetuity is defined as the same cash flow occurring each year forever.

98. Describe how you would go about finding the present value of any annuity given the
formula for
the present value of a perpetuity. 

The present value of any annuity can be thought of as the difference between two
perpetuities one payment stating in year-1 (immediate) and one starting in year (n + 1)
(delayed). By calculating difference between the present values of these two perpetuities
today we can find the present value of an annuity.

99. What is the difference between simple interest and compound interest? 

When money is invested at compound interest, each interest payment is reinvested to earn
more interest in subsequent periods. In the simple interest case, the interest is paid only on the
initial investment.

100. Briefly explain, "continuous compounding." 

As frequency of compounding increases, the effective rate on an investment also increases. In

case of continuous compounding the frequency of compounding is infinity. In this case, the
nature of the function also changes. The effective interest rate is given by (er - 1), where the
value of e = 2.718. e is the base for natural logarithms.

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