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Appendix A

The Time Value of Money

Multiple Choice Questions

1. Flores Company borrowed $10,000 at 10% interest for 5 years. Which statement is true?

a. Regardless of when the note is repaid, total interest over the loan period is the same.

b. Interest expense is the same regardless of the compounding periods.

c. The amount to be repaid is the same regardless of whether the principal is repaid $2,000

per year, or as a sum at the end of five years.

d. Interest is less if simple interest is used than if compound interest is used.

Answer: D

2. How much is interest revenue for 90 days on an 8%, 180-day note receivable with a face

value of $25,000?

a. $1,800

b. $500

c. $300

d. $400

Answer: B

3. How much is interest revenue for 30 days on an 8%, 90-day note receivable with a face

value of $6,000?

a. $40

b. $50

c. $90

d. $60

Answer: A

4. The following computation took place: $20,000 divided by the future value of a 12-year,

4% ordinary annuity What question will this computation answer?

a. How much must be invested now so that equal payments can be withdrawn at the end of

each year for 12 years?

b. How much must be invested now so that $20,000 is accumulated by the end of the 12 th

year?

c. How much will be available at the end of the12th year if a payment of $20,000 is deposted

now?

d. How much must be deposited at the end of every year so that $20,000 is available at the

end of 12 years?

Answer: D

5. Interest is compounded annually. What is the total amount of interest on a $7,000 note

payable at the end of five years at 8%?

a. $3,000

b. $3,285

c. $7,000

d. $3,791

Answer: B

6. Which timing of payments is true for an ordinary annuity?

a. All payments occur at the beginning of the first year.

b. Payments begin immediately and occur once per year on the last day of each year.

c. Payments occur at the end of each period.

d. Payments occur at the beginning of each period.

Answer: C

7. Interest is compounded quarterly on a $10,000 note payable for 1 year at 12%. How much

is total interest on the note?

a. $1,338

b. $1,286

c. $1,255

d. $1,506

Answer: C

8. You need to calculate the present value of an amount at 10% compounded quarterly for 2

years. What interest factor will you use?

a. 10% for 4 periods

b. 2.5% for 8 periods

c. 20% for 2 periods

d. 10% for 8 periods

Answer: B

9. Sierra Capital wants to accumulate $100,000 at the end of 10 years to fund retirement

benefits for its accountant. Annual deposits will be made into a special account earning 6%,

beginning at the end of year 1. To calculate the amount of the equal deposits, use the

a. future value of a annuity due.

b. present value of a single amount.

c. future value of an ordinary annuity.

d. present value of an annuity.

Answer: C

10. Malcom Corp. will deposit $10,000 annually at the end of each year for five years.

Malcom will earn 6%. How much will be accumulated at the end of the 5 years?

a. $65,321

b. $70,399

c. $50,000

d. $56,371

Answer: D

11. Calculate the future value of equal semiannual payments of $9,000 at 12% compounded

semiannually for 4 years. The answer is

a. $43,014.

b. $55,888.

c. $89,077.

d. $114,757.

Answer: C

12. Present value is

a. how much today’s money will be worth in the future.

b. the amount of money that must be invested now to produce a known future value.

c. always larger than the future value.

d. the total cost of interest over several years.

Answer: B

13. How much would you deposit today in a savings account that earns 10%, in order that

you can make equal annual withdrawals of $1,200 each at the end of each of the next 15

years?

a. $5,013

b. $9,127

c. $19,800

d. $18,000

e. $38,127

Answer: B

14. Miracle Corporation wants to withdraw $60,000 from a savings account at the end of

each year for ten years beginning one year from now. The savings earns 10% and is

compounded annually. Which one of the following reflects the correct procedure to determine

the required initial investment at the beginning of the first year?

a. $60,000 times the present value of a 10-year, 10% ordinary annuity.

b. $60,000 divided by the future value of a 10-year, 10% ordinary annuity.

c. $60,000 times the future value of a 10-year, 10% ordinary annuity.

d. $6,000 divided by the present value of a 10-year, 10% ordinary annuity.

Answer: A

15. An annuity due and an ordinary annuity have equal payments, the same interest rates, and

the amount of time between the payments is equal. Which statement is true?

a. The present value of the annuity due is less than the present value of the ordinary annuity.

b. The future value of the annuity due is less than the future value of the ordinary annuity.

c. The future value of the annuity due is equal to the future value of the ordinary annuity.

d. The present value of the annuity due is greater than the present value of the ordinary

annuity.

Answer: D

16. An amount is deposited for five years at 6% and is compounded semi-annually. Which

interest rate and periods will be used to determine the present value?

a. 8% for 5 periods

b. 3% for 10 periods

c. 3% for 2.5 periods

d. 8% for 10 periods

Answer: B

17. To determine how much must be deposited in the bank today so that you can withdraw 6

annual payments beginning one year from now, which interest factor will you need?

a. Future value of an ordinary annuity of 1

b. Future value of an annuity due of 1

c. Present value of an ordinary annuity of 1

d. Present value of an annuity due of 1

Answer: C

18. On July 1, 2009, Roseland Inc. purchased land for a new manufacturing facility at a price

of $750,000. However, the seller is financing the transaction and equal quarterly payments

will be made starting today, July 1, 2009. The last semi-annual payment will be made on

December 31, 2028. The applicable interest rate is 8%. How much is each semi-annual

payment?

a. $35,365

b. $36,435

c. $37,893

d. None of the above

Answer: B

Calculations: n = 40; I = 4% [$750,000/20.58448 (table 6)] = $36,435

19. Carter Holding Co. intends to purchase a new accounting system, including hardware,

software and a complete package of services needed to get the new system up and running.

Carter has four options for paying for the new system. Which of the four options is the least

costly if the applicable interest rate is 12%?

a. Make a lump sum payment of $100,000 today

b. Make 10 annual payments of $16,000, starting today

c. Make 40 quarterly payments of $4,000, starting today

d. Make one lump sum payment of $150,000 four years from today

Answer: C

Calculations: a. (no calculations required) $100,000

b. n = 10; I = 12% [$16,000 * 6.32825 (table 6)] = $101,252

c. n = 40; I = 3% [$4,000 * 23.80822 (table 6)] = $95,233

d. n = 4; I = 12% [$150,000 * .63552 (table 4)] = $95,328

20. Jim Hall invested $12,000 at 8% annual interest and left the money invested without

withdrawing any of the interest for 15 years. At the end of the 15 years, Jim withdrew the

accumulated amount of money. What amount did Jim withdraw, assuming the investment

earns compounded interest?

a. $14,400

b. $38,066

c. $26,400

d. $15,783

Answer: B

Calculations: n = 15; I = 8% $12,000 x 3.17217 (table 1) = $38,066

21. Karla Simpson invested $15,000 at 10% annual interest and left the money invested

without withdrawing any of the interest for 15 years. At the end of the 15 years, Karla

decided to withdraw the accumulated amount of money. Karla has found the following values

in various tables related to the time value of money.

Which factor would she use to compute the amount she would withdraw, assuming that the

investment earns interest compounded annually?

a. 0.23939

b. 4.17725

c. 7.60608

d. 31.77248

Answer: B

22. Thomas Young invested $15,000 at 10% annual interest and left the money invested

without withdrawing any of the interest for 15 years. At the end of the 15 years, Thomas

decided to withdraw the accumulated amount of money. Thomas has found the following

values in various tables related to the time value of money.

To the closest dollar, which amount would he withdraw, assuming that the investment earns

interest compounded annually?

a. $18,591

b. $114,091

c. $47,659

d. $62,659

Answer: D

23. Rowan and Lisa Sharp invested $10,000 in a savings account paying 5% annual interest

when their son, Jeremy, was born. They also deposited $500 on each of his birthdays until he

was 20 (including his 20th birthday). Rowan and Lisa have obtained the following values

related to the time value of money to help them with their planning process for their

compounded interest decisions.

To the closest dollar, how much was in the savings account on his 20th birthday (after the last

deposit)?

a. $53,066

b. $43,066

c. $30,000

d. $26,533

Answer: B

24. Harrison Marshall borrowed $65,000 on June 1, 2009. This amount plus accrued interest

at 8% compounded annually is to be repaid on June 1, 2022. Harrison has obtained the

following values related to the time value of money to help him with his financing process

and compounded interest decisions.

To the closest dollar, how much will Harrison have to repay on June 1, 2022?

a. $132,600

b. $310,707

c. $116,375

d. $176,775

Answer: D

25. Stranton Company is considering investing in an annuity contract that will return $40,000

annually at the end of each year for 12 years. Stranton has obtained the following values

related to the time value of money to help in its planning process and compounded interest

decisions.

To the closest dollar, what amount should Stranton Company pay for this investment if it

earns a 9% return?

a. $497,066

b. $592,507

c. $805,629

d. $286,429

Answer: D

26. Everett Corporation issues a 8%, 9-year mortgage note on January 1, 2009, to obtain

financing for new equipment. Land is used as collateral for the note. The terms provide for

semiannual installment payments of $131,600. The following values related to the time value

of money were available to Everett to help them with their planning process and compounded

interest decisions.

To the closest dollar, what were the cash proceeds received from the issuance of the note?

a. $822,091

b. $947,520

c. $1,665,964

d. $1,643,363

Answer: C

27. Gaynor Company is considering purchasing equipment. The equipment will produce the

following cash flows: Year 1, $25,000; Year 2, $45,000; Year 3, $60,000. Below is some of

the time value of money information that Gaynor has compiled that might help them in their

planning and compounded interest decisions.

Gaynor requires a minimum rate of return of 11%. To the closest dollar, what is the maximum

price Gaynor should pay for the equipment?

a. $117,117

b. $102,917

c. $165,253

d. $246,209

Answer: B

28. Clarkson Corporation earns 12% on an investment that will return $900,000, 7 years from

now. Below is some of the time value of money information that Clarkson has compiled that

might help in planning compounded interest decisions.

To the closest dollar, what is the amount Clarkson should invest now to earn this rate of

return?

a. $198,961

b. $407,115

c. $756,000

d. $410,738

Answer: B

29. Turner Company is considering an investment, which will return a lump sum of $450,000

four years from now. Below is some of the time value of money information that Turner has

compiled that might help in planning compounded interest decisions.

To the closest dollar, what amount should Turner Company pay for this investment to earn a

10% return?

a. $270,000

b. $180,000

c. $307,355

d. $356,609

Answer: C

30. Mitch has been offered three different contracts for a service he provides.

Contract 1: $9,000 received at the beginning of each year for ten years, compounded at a 6

percent annual rate.

Contract 2: $9,000 received today and $20,000 received ten years from today. The relevant

interest rate is 12 percent.

Contract 3: $9,000 received at the end of Years 4, 5, and 6. The relevant annual interest rate is

10 percent.

What is the present value of Contract 1?

a. $66,240.81

b. $118,627.11

c. $70,215.21

d. $125,744.76

Answer: C

Contract 1

31. Mitch has been offered three different contracts for a service he provides.

Contract 1: $9,000 received at the beginning of each year for ten years, compounded at a 6

percent annual rate.

Contract 2: $9,000 received today and $20,000 received ten years from today. The relevant

interest rate is 12 percent.

Contract 3: $9,000 received at the end of Years 4, 5, and 6. The relevant annual interest rate is

10 percent.

What is the present value of Contract 2?

a. $9,337.13

b. $71,117.00

c. $29,000.00

d. $15,439.40

Answer: D

Contract 2

32. Mitch has been offered three different contracts for a service he provides.

Contract 1: $9,000 received at the beginning of each year for ten years, compounded at a 6

percent annual rate.

Contract 2: $9,000 received today and $20,000 received ten years from today. The relevant

interest rate is 12 percent.

Contract 3: $9,000 received at the end of Years 4, 5, and 6. The relevant annual interest rate is

10 percent.

What is the present value of Contract 3?

a. $18,497.15

b. $16,815.56

c. $24,619.68

d. $22,381.52

Answer: B

Contract 3

33. Morgan is considering entering into a contract to sell a building on January 1 in exchange

for a note. The note pays a lump sum payment of $300,000 in ten years and ten annual

payments of $2,500 beginning on the date of sale (January 1). If the annual interest rate is 10

percent, what is the total present value of the contract?

a. $159,489.92

b. $132,559.55

c. $131,023.42

d. $155,505.55

Answer: B

34. Kaitlin is contemplating investing in Cocoa Beach Tans. She estimates that the company

will pay the following dividends per share at the end of the next four years and that the

current price of the company’s common stock, which is $100 per share, will remain

unchanged.

If Kaitlin wants to earn 12 percent on her investment and plans to sell the investment at the

end of the fourth year, how much would she be willing to pay for one share of common

stock? (Round all calculations to the nearest cent.)

a. $130.00

b. $119.07

c. $85.90

d. $82.00

Answer: C

Matching Questions

1. For each of the following situations in A through D, indicate the abbreviation of the table

that should be used to solve for the solution requested. Place the abbreviation of the

respective table in the space provided. You may use each table more than once or not at all.

_______ A. How much would an investor deposit today in order to withdraw $12,000 at the

beginning of each of the next four years, assuming that the first payment is withdrawn one

year from today?

_______ B. If interest rates are compounded semi-annually, how much will a company

accumulate in three years after making six equal semi-annual payments of $15,000 each? The

first payment will be made today.

_______ C. If interest rates are compounded monthly, how much can a company withdraw

per month for 6 months beginning one month from now if $100,000 is deposited today?

_______ D. You want to buy a house for $200,000 and finance it with interest compounded

monthly. If it is financed over a 12-year period, what will be the amount of each annual

payment, the first of which will be due at the beginning of the first year?

Answer:

A. PVOA

B. FVAD

C. PVOA

D. PVAD

Short Problems

1. How much must be invested now to receive $10,000 per year for ten years if the first

$10,000 is received today and the rate is 10%?

Answer: n = 10; I = 10; $10,000 6.75902 [table 6] = $67,590.

2. Ocean Corporation purchased a machine with a cash price of $35,000. Payments will be

made at the end of every quarter for 30 payments beginning at the end of each quarter. The

machine was financed at 12%. How much is each payment?

Answer: n = 30; I = 3% ($35,000/19.60044) [table 5] = $1,786

3. You deposited $4,000 per year annually starting on January 1, 2008 in a bank account

which earns 10%. How much will accumulate by December 31, 2011, the date of the final

payment?

Answer: n = 4; I = 10% ($4,000 5.105) [table 3] = $20,420

4. Middlesex Enterprises plans to issue $120,000 of 10-year, 6% bonds. The effective yield at

the time of issuance is 8%.

A. How much will the bonds sell for in the market if interest is paid annually?

B. How much will the bonds sell for in the market if interest is paid semi-annually?

Answer:

5. The phone rings. You answer, “Hello.” Is this Billy Bob?” “Yes, it is.” “This is Ed

McMahon. Congratulations! You have just won the Just Kidding Clearing House

sweepstakes! How would you like us to pay you?”

You ponder over the best choice of accepting your winnings:

1. Equal payments of $250,000 at the end of each year for twenty years

2. A lump-sum payment of $2,400,000 today

3. A lump-sum payment of $100,000 today and payments of $400,000 at the end of every

year for 10 years

All earnings can be invested at 10 percent. Make a choice of one of the three options. Show

calculations.

Answer:

6. Calculate the contract price of equipment that requires 20 annual payments of $5,000 at the

end of each year, beginning one year after the purchase contract is signed. The interest rate

expressed in the loan is 7%.

Answer:

Present value of $5,000 annuity for 20 periods at 7%

$5,000 x 10.59401 [table 5] = $52,970

Short Essay Questions

1. Explain the concept of the "time value of money."

Answer: The time value of money concept states than a dollar in the future is worth less than

a dollar at present. This concept assigns value to money over time. Cash flows received are

worth more if received now, rather than later. Cash flows paid are best if deferred for as long

as possible.

2. How does inflation affect the value of money over time?

Answer: Today's dollar will buy more goods than a future dollar will buy. In periods of rising

prices (inflation) prices of today's goods are less than the prices for the same goods in the

future. Inflation is the secondary reason why one would prefer a dollar today to a dollar in the

future.

3. How does an annuity due differ from an ordinary annuity?

Answer: An ordinary annuity assumes the first payment, or cash flow occurs at the end of the

first period. An annuity due assumes the first payment occurs at the beginning of the first

period. When determining the amount of interest on debt, the cost of interest is more for an

annuity due because the balance accumulated is larger.

4. Why is present value not used more liberally on financial statements?

Answer: Present value calculations require that both future cash flows and future interest

rates be predicted. Predicting the future cash flows associated with an asset or liability with

any degree of confidence is almost impossible. Likewise, the development of interest rate

assumptions can vary widely and result in significant differences between present value

calculations. Therefore, financial statement presentations typically avoid the subjectivity of

present values and opt for historical cost, fair market value, replacement costs, and net

realizable values.

Test Bank for Financial Accounting: In an Economic Context

Jamie Pratt

9780470635292, 9781119537571, 9781119444367