Finance Flashcards Chapter 5
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You are investing $100 today in a savings account at your local bank. Which one of the following terms refers to the value of this investment one year from now?
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future value
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Tracy invested $1,000 five years ago and earns 4 percent interest on her investment. By leaving her interest earnings in her account, she increases the amount of interest she earns each year. The way she is handling her interest income is referred to as which one of the following?
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compounding
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Steve invested $100 two years ago at 10 percent interest. The first year, he earned $10 interest on his $100 investment. He reinvested the $10. The second year, he earned $11 interest on his $110 investment. The extra $1 he earned in interest the second year is referred to as
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interest on interest.
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Interest earned on both the initial principal and the interest reinvested from prior periods is called:
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compound interest
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Sara invested $500 six years ago at 5 percent interest. She spends her earnings as soon as she earns any interest so she only receives interest on her initial $500 investment. Which type of interest is Sara earning?
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simple interest
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Shelley won a lottery and will receive $1,000 a year for the next ten years. The value of her winnings today discounted at her discount rate is called which one of the following?
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present value
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Terry is calculating the present value of a bonus he will receive next year. The process he is using is called:
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discounting.
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Steve just computed the present value of a $10,000 bonus he will receive in the future. The interest rate he used in this process is referred to as which one of the following?
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discount rate
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The process of determining the present value of future cash flows in order to know their worth today is called which one of the following?
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discounted cash flow valuation
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Andy deposited $3,000 this morning into an account that pays 5 percent interest, compounded annually. Barb also deposited $3,000 this morning into an account that pays 5 percent interest, compounded annually. Andy will withdraw his interest earnings and spend it as soon as possible. Barb will reinvest her interest earnings into her account. Given this, which one of the following statements is true?
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Barb will earn interest on interest.
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Sue and Neal are twins. Sue invests $5,000 at 7 percent when she is 25 years old. Neal invests $5,000 at 7 percent when he is 30 years old. Both investments compound interest annually. Both Sue and Neal retire at age 60. Which one of the following statements is correct assuming that neither Sue nor Neal has withdrawn any money from their accounts?
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Sue will have more money than Neal as long as they retire at the same time.
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Samantha opened a savings account this morning. Her money will earn 5 percent interest, compounded annually. After five years, her savings account will be worth $5,600. Assume she will not make any withdrawals. Given this, which one of the following statements is true?
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Samantha could have deposited less money and still had $5,600 in five years if she could have earned 5.5 percent interest.
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This afternoon, you deposited $1,000 into a retirement savings account. The account will compound interest at 6 percent annually. You will not withdraw any principal or interest until you retire in forty years. Which one of the following statements is correct?
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The present value of this investment is equal to $1,000.
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Your grandmother has promised to give you $5,000 when you graduate from college. She is expecting you to graduate two years from now. What happens to the present value of this gift if you delay your graduation by one year and graduate three years from now?
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decreases
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Luis is going to receive $20,000 six years from now. Soo Lee is going to receive $20,000 nine years from now. Which one of the following statements is correct if both Luis and Soo Lee apply a 7 percent discount rate to these amounts?
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In today's dollars, Luis' money is worth more than Soo Lee's
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Which one of the following variables is the exponent in the present value formula?
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time
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You want to have $1 million in your savings account when you retire. You plan on investing a single lump sum today to fund this goal. You are planning on investing in an account which will pay 7.5 percent annual interest. Which of the following will reduce the amount that you must deposit today if you are to have your desired $1 million on the day you retire? I. Invest in a different account paying a higher rate of interest. II. Invest in a different account paying a lower rate of interest. III. Retire later. IV. Retire sooner.
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I and III only
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Which one of the following will produce the highest present value interest factor?
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6 percent interest for five years
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What is the relationship between present value and future value interest factors?
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The factors are reciprocals of each other.
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Martin invested $1,000 six years ago and expected to have $1,500 today. He has not added or withdrawn any money from this account since his initial investment. All interest was reinvested in the account. As it turns out, Martin only has $1,420 in his account today. Which one of the following must be true?
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Martin earned a lower interest rate than he expected.
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Gerold invested $6,200 in an account that pays 5 percent simple interest. How much money will he have at the end of ten years?
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$9,300 Ending value = $6,200 + ($6,200 .05 10) = $9,300
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Alex invested $10,500 in an account that pays 6 percent simple interest. How much money will he have at the end of four years?
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$13,020 Ending value = $10,500 + ($10,500 .06 4) = $13,020
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You invested $1,650 in an account that pays 5 percent simple interest. How much more could you have earned over a 20-year period if the interest had compounded annually?
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$1,077.94 Simple interest = $1,650 + ($1,650 x .05 x 20) = $3,300 Annual compounding = $1,650 x (1.05)^20 = $4,377.94 Difference = $4,377.94 - $3,300 = $1,077.94 CALCULATOR: Enter [20 for N, 5 for I/Y, -1650 for PV, CPT FV --> 4377.94]
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Travis invested $9,250 in an account that pays 6 percent simple interest. How much more could he have earned over a 7-year period if the interest had compounded annually?
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$773.58 Simple interest = $9,250 + ($9,250 x .06 x 7) = $13,135 Compound interest = $9,250 x (1 + .06)^7 = $13,908.58 Difference = $13,908.58 - $13,135 = $773.5 CALCULATOR: Enter [7 for N, 6 for I/Y, -9250 for PV, CPT FV-->13,908.58]
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What is the future value of $7,189 invested for 23 years at 9.25 percent compounded annually?
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$54,999.88 Future value = $7,189 x (1 + .0925)^23 = $54,999.88 CALCULATOR: Enter [23 for N, 9.25 for I/Y, -7,189 for PV, CPT FV --> 54,999.88]
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Today, you earn a salary of $36,000. What will be your annual salary twelve years from now if you earn annual raises of 3.6 percent?
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$55,032.54 Future value = $36,000 x (1 + .036)^12 = $55,032.54 CALCULATOR: Enter N: 12, I/Y: 3.6, PV: -36,000, CPT FV --> 55,032.54
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You own a classic automobile that is currently valued at $147,900. If the value increases by 6.5 percent annually, how much will the automobile be worth ten years from now?
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$277,628.63 Future value = $147,900 x (1 + .065)^10 = $277,628.63 CALCULATOR: Enter N: 10, I/Y: 6.5, PV: -147,900, CPT FV --> 277,628.63
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You hope to buy your dream car four years from now. Today, that car costs $82,500. You expect the price to increase by an average of 4.8 percent per year over the next four years. How much will your dream car cost by the time you are ready to buy it?
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$99,517.41 Future value = $82,500 x (1 + .048)^4 = $99,517.41 CALCULATOR: Enter N: 4, I.Y: 4.8, PV: -82,000, CPT FV --> 99,517.41
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This morning, TL Trucking invested $80,000 to help fund a company expansion project planned for 4 years from now. How much additional money will the firm have 4 years from now if it can earn 5 percent rather than 4 percent on its savings?
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$3,651.82 Future value = $80,000 x (1 + .05)^4 = $97,240.50 Future value = $80,000 x (1 + .04)^4 = $93,588.68 Difference = $97,240.50 - $93,588.68 = $3,651.82 CALCULATOR: Enter N: 4, I/Y: 5, PV: -80,000, CPT FV --> 97,240.50 Enter N: 4, I/Y: 4, PV: -80,000 CPT FV --> 93,588.68 Find difference.
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You just received $225,000 from an insurance settlement. You have decided to set this money aside and invest it for your retirement. Currently, your goal is to retire 25 years from today. How much more will you have in your account on the day you retire if you can earn an average return of 10.5 percent rather than just 8 percent?
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$1,189,576 Future value = $225,000 x (1 + .105)^25 = $2,730,483 Future value = $225,000 x (1 + .08)^25 = $1,540,907 Difference = $2,730,483 - $1,540,907 = $1,189,576 CALCULATOR: Enter N: 25, I/Y 10.5, PV: -225,000, CPT FV --> 2,730,483 Enter N: 25, I/Y: 8, PV: -225,000, CPT FV --> 1,540,907
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You just received a $5,000 gift from your grandmother. You have decided to save this money so that you can gift it to your grandchildren 50 years from now. How much additional money will you have to gift to your grandchildren if you can earn an average of 8.5 percent instead of just 8 percent on your savings?
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$60,923.52 Future value = $5,000 x (1 + .085)^50 = $295,431.58 Future value = $5,000 x (1 + .08^)50 = $234,508.06 Difference = $295,431.58 - $234,508.06 = $60,923.52 CALCULATOR: Enter N: 50, I/Y: 8.5, PV: -5,000, CPT FV --> 295,431.58 Enter N: 50, I/Y: 8, PV: -5,000, CPT FV --> 234,508.06
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You are depositing $1,500 in a retirement account today and expect to earn an average return of 7.5 percent on this money. How much additional income will you earn if you leave the money invested for 45 years instead of just 40 years?
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$11,790.90 Future value = $1,500 x (1 + .075)^45 = $38,857.26 Future value = $1,500 x (1 + .075)^40 = $27,066.36 Difference = $38,857.26 - $27,066.36 = $11,790.90 CALCULATOR: Enter N: 45, I/Y: 7.5, PV: -1500, CPT FV --> 38,857.26 Enter N: 40, I/Y: 7.5, PV: -1500, CPT FV --> 27,066.36
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You collect old coins. Today, you have two coins each of which is valued at $250. One coin is expected to increase in value by 6 percent annually while the other coin is expected to increase in value by 4.5 percent annually. What will be the difference in the value of the two coins 15 years from now?
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$115.32 Future value = $250 x (1 + .06)^15 = $599.14 Future value = $250 x (1 + .045)^15 = $483.82 Difference = $599.14 - $483.82 = $115.32 CALCULATOR: Enter N: 15, I/Y: 6, PV: -250, CPT FV --> 599.14 Enter N: 15, I/Y: 4.5, PV: -250, CPT FV --> 483.82
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Your father invested a lump sum 26 years ago at 4.25 percent interest. Today, he gave you the proceeds of that investment which totaled $51,480.79. How much did your father originally invest?
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$17,444.86 Present value = $51,480.79 x [1/(1 + .0425)^26] = $17,444.86 CALCULATOR: Enter N: 26, I/Y: 4.25, FV: 51,480.79, CPT PV --> -17,444.86
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What is the present value of $150,000 to be received 8 years from today if the discount rate is 11 percent?
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$65,088.97 Present value = $150,000 x [1/1 + .11)^8] = $65,088.97 CALCULATOR Enter N:8, I.Y: 11, FV: 150,000, CPT PV --> -65,088.97
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You would like to give your daughter $75,000 towards her college education 17 years from now. How much money must you set aside today for this purpose if you can earn 8 percent on your investments?
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$20,270.17 Present value = $75,000 x [1/(1 + .08)^17] = $20,270.17 CALCULATOR Enter N: 17, I/Y: 8, FV: 75,000, CPT PV --> -20,270.17
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You want to have $35,000 saved 6 years from now to buy a house. How much less do you have to deposit today to reach this goal if you can earn 5.5 percent rather than 5 percent on your savings? Today's deposit is the only deposit you will make to this savings account.
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$733.94 Present value = $35,000 x [1/(1 + .05)^6] = $26,117.54 Present value = $35,000 x [1/(1 + .055)^6] = $25,383.60 Difference = $26,117.54 - $25,383.60 = $733.94 CALCULATOR Enter N:6, I/Y: 5, FV: 35,000, CPT PV --> -26,117.54 Enter N: 6, I/Y: 5.5, FV: 35,000, CPT PV --> -25,383.60
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Your older sister deposited $5,000 today at 8.5 percent interest for 5 years. You would like to have just as much money at the end of the next 5 years as your sister will have. However, you can only earn 7 percent interest. How much more money must you deposit today than your sister did if you are to have the same amount at the end of the 5 years?
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$360.43 Future value = $5,000 x (1 + .085)^5 = $7,518.28 Present value = $7,518.28 x [1/(1 + .07)^5] = $5,360.43 Difference = $5,360.43 - $5,000 = $360.43 CALCULATOR Enter N: 5, I/Y: 8.5, PV: -5000, CPT FV --> 7518.28 Enter N: 5, I/Y: 7, FV: 7518.28, CPT PV --> -5,360.43
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A year ago, you deposited $30,000 into a retirement savings account at a fixed rate of 5.5 percent. Today, you could earn a fixed rate of 6.5 percent on a similar type account. However, your rate is fixed and cannot be adjusted. How much less could you have deposited last year if you could have earned a fixed rate of 6.5 percent and still have the same amount as you currently will when you retire 38 years from today?
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$9,234.97 less Future value = $30,000 x (1 + .055)^38+1 = $242,084.61 Present value = $242,084.61 x [1/(1 + .065)^38+1] = $20,765.03 Difference = $30,000 - $20,765.03 = $9,234.97 CALCULATOR Enter N: 39, I/Y: 5.5, PV: -30,000, CPT FV --> 242,084.61 Enter N: 39, I/Y: 6.5, FV: 242,084.61, CPT PV --> -20,765.03
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When you retire 40 years from now, you want to have $1.2 million. You think you can earn an average of 12 percent on your investments. To meet your goal, you are trying to decide whether to deposit a lump sum today, or to wait and deposit a lump sum 2 years from today. How much more will you have to deposit as a lump sum if you wait for 2 years before making the deposit?
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$3,280.78 Present value = $1,200,000 x [1/(1 + .12)^40] = $12,896.16 Present value = $1,200,000 x [1/(1 + .12)^38] = $16,176.94 Difference = $16,176.94 - $12,896.16 = $3,280.78 CALCULATOR Enter N: 40, I/Y: 12, FV: 1,200,000, CPT PV --> -12896.16 Enter N: 38, I/Y: 12, FV: 1200000, CPT PV --> -16,176.94
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Theo needs $40,000 as a down payment for a house 6 years from now. He earns 3.5 percent on his savings. Theo can either deposit one lump sum today for this purpose or he can wait a year and deposit a lump sum. How much additional money must he deposit if he waits for one year rather than making the deposit today?
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$1,138.90 Present value = $40,000 x [1/(1 + .035)^6] = $32,540.03 Present value = $26,000 x [1/(1 + .035)^5] = $33,678.93 Difference = $33,678.93 - $32,540.03 = $1,138.90 CALCULATOR Enter N: 6, I/Y:3.5, FV: 40,000, CPT PV --> -32,540.03 Enter N: 5, I/Y: 3.5, FV: 40,000, CPT PV --> -33,678.93
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One year ago, you invested $1,800. Today it is worth $1,924.62. What rate of interest did you earn?
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6.92 percent $1,924.62 = $1,800 x (1 + r)^1; r = 6.92 percent CALCULATOR Enter N: 1, PV: -1800, FV: 1,924.64, CPT I/Y --> 6.92
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According to the Rule of 72, you can do which one of the following?
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double your money in 8 years at 9 percent interest Rule of 72 = 72/8 years = 9 percent interest
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Forty years ago, your mother invested $5,000. Today, that investment is worth $430,065.11. What is the average annual rate of return she earned on this investment?
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11.78 percent $430,065.11 = $5,000 (1 + r)40; r = 11.78 percent CALCULATOR Enter N: 40, PV: -5000, FV: 430,065.11, CPT I/Y -->11.78
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Sixteen years ago, Alicia invested $1,000. Eight years ago, Travis invested $2,000. Today, both Alicia's and Travis' investments are each worth $2,400. Assume that both Alicia and Travis continue to earn their respective rates of return. Which one of the following statements is correct concerning these investments?
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One year ago, Alicia's investment was worth less than Travis' investment. Alicia: $2,400 = $1,000 x (1 + r)^16; r = 5.62 percent Travis: $2,400 = $2,000 x (1 + r)^8; r = 2.31 percent CALCULATOR Alicia: Enter N: 16, PV: -1000, FV: 2400, CPT I/Y --> 5.62 Travis: Enter N: 8, PV: -2000, FV: 2400, CPT I/Y --> 2.31 Since both Alicia and Travis have equal account values today and since Alicia earns the higher rate of return, her account had to be worth less than Travis' account one year ago.
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Penn Station is saving money to build a new loading platform. Two years ago, they set aside $24,000 for this purpose. Today, that account is worth $28,399. What rate of interest is Penn Station earning on this investment?
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8.78 percent $28,399 = $24,000 (1 + r)2; r = 8.78 percent CALCULATOR Enter N: 2, PV: -24000, FV: 28399, CPT I/Y --> 8.78
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Fifteen years ago, Jackson Supply set aside $130,000 in case of a financial emergency. Today, that account has increased in value to $330,592. What rate of interest is the firm earning on this money?
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6.42 percent $330,592 = $130,000 x (1 + r)^15; r = 6.42 percent CALCULATOR Enter N: 15, PV: -130,000, FV: 330,592, CPT I/Y --> 6.42
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Fourteen years ago, your parents set aside $7,500 to help fund your college education. Today, that fund is valued at $26,180. What rate of interest is being earned on this account?
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9.34 percent $26,180 = $7,500 x (1 + r)^14; r = 9.34 percent CALCULATOR Enter N: 14, PV: -7500, FV: 26180, CPT I/Y --> 9.34
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Some time ago, Julie purchased eleven acres of land costing $36,900. Today, that land is valued at $214,800. How long has she owned this land if the price of the land has been increasing at 10.5 percent per year?
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17.64 years $214,800 = $36,900 x (1 + .105)^t; t = 17.64 years CALCULATOR Enter I/Y: 10.5, PV: -36900, FV: 214,800, CPT N --> 17.64
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On your ninth birthday, you received $300 which you invested at 4.5 percent interest, compounded annually. Your investment is now worth $756. How old are you today?
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age 30 $756 = $300 (1 + .045)t; t = 21 years; Age today = 9 + 21 = 30 CALCULATOR Enter I/Y: 4.5, PV: -300, FV: 756, CPT N --> 21
