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MULTIPLE CHOICE QUESTIONS The main idea behind the time value of money is that: A cash flows received in the distant future are less valuable than cash flows received in the near-term future B cash received in year 3, say, $80,000, has the same value as $40,000 received in year plus $40,000 received in year C cash flows received in different years are treated as equal in value D cash payments made in the future have the same value as payments made today E timing considerations have little value in decision making Answer: A LO: Type: RC The procedure used to compute the future value of a series of cash flows is known as: A compounding B the annuity method C discounting D the future-cost approach E indexing Answer: A LO: Type: RC Norton Company has a 12% interest rate If the firm invests $60,000 today, how much will have accumulated by the end of eight years? A $117,600 B $148,560 C $298,080 D $738,000 E Some other amount Answer: B LO: Type: A Lawson Company invests $60,000 today and has $148,560 by the end of eight years What is the firm's interest rate? A 10.00% B 12.00% C 18.45% D 40.39% E None of the above Answer: B LO: Type: A, N Appendix II 81 The procedure used to compute the present value of a series of cash flows is known as: A compounding B the annuity method C discounting D the present-cost approach E indexing Answer: C LO: Type: RC All other things being equal, which of the following would be the most attractive to an investor? A A cash inflow of $10,000 in five years B A cash inflow of $2,000 each year for the next five years C A cash inflow of $5,000 in year and $5,000 in year D A cash inflow of $10,000 today E All of the above would be equally attractive to an investor Answer: D LO: Type: N All other things being equal, which of the following would be most attractive to an investor? A A cash outflow of $60,000 in six years B A cash outflow of $10,000 each year for the next six years C A cash outflow of $30,000 in year and $30,000 in year D A cash outflow of $60,000 today E All of the above would be equally attractive to an investor Answer: A LO: Type: N A series of equal cash flows is called a(n): A ongoing cash flow B payback C accrual D cash accumulation E annuity Answer: E LO: Type: RC The sum of the discount factors applicable to individual cash flows in a series of equal cash flows is called the: A single-sum, present-value factor B total discount factor C annuity discount factor D compound discount factor E internal rate discount factor Answer: C LO: Type: RC 82 Hilton, Managerial Accounting, Seventh Edition 10 Consider the following items of information: I.The target recovery period II.The discount rate III.The timing (i.e., year) of a cash flow Which of the above items would be needed to calculate the present value of a cash flow? A I only B II only C I and II D II and III E I, II, and III Answer: D LO: Type: RC 11 You desire to invest $3,000 each year for the next five years to accumulate the funds needed for a down payment on a home Which table factor(s) should be used to efficiently determine the amount accumulated by the end of the five-year period? A Future value of $1 B Future value of a $1 annuity C Present value of $1 D Present value of a $1 annuity E Both "A" and "B." Answer: B LO: Type: A 12 Uncle Roscoe, a wealthy relative, has given you a choice of receiving $10,000 today or $3,000 for each of the next four years Which table factor(s) should be used to efficiently determine the "value" of the $3,000 cash-flow stream? A Future value of $1 B Future value of a $1 annuity C Present value of $1 D Present value of a $1 annuity E Both "C" and "D." Answer: D LO: Type: A 13 You are a sports agent who is representing Jack Lofton, a star football player, in contract negotiations with the New York Landmarks The Landmarks have offered Lofton a four-year contract, with annual raises and performance bonuses that will result in a growing cash-flow stream for Lofton each year Which table factor(s) should you use to efficiently determine the "value" of the contract? A Future value of $1 B Future value of a $1 annuity C Present value of $1 D Present value of a $1 annuity E Both "C" and "D." Answer: C LO: Type: A Appendix II 83 14 How much money must be invested today in order to have $25,000 at the end of four years if the rate of return is 12%? A $15,900 B $17,100 C $19,900 D $22,300 E Some other amount Answer: A LO: Type: A 15 You estimate that it will take five years to complete your college education Your parents want to invest enough money today at 8% to allow you to withdraw $8,000 each year for the next five years, with nothing left at the end The amount of money to invest today is: A $11,752 B $27,240 C $31,944 D $40,000 E None of the above Answer: C LO: Type: A 16 Green Company owes White Company money for the purchase of equipment White has given Green the following payment options: I.Immediate payment in full of $38,000 II.Annual payments of $15,000 made at the end of each of the next three years III.A single payment of $48,000 made at the end of three years Green uses a 10% interest rate and will choose the option with the lowest present value Which option should Green choose, and what is the present value of that option? A Option I, $34,542 B Option I, $38,000 C Option II, $37,305 D Option III, $34,164 E Option III, $36,048 Answer: E LO: Type: A 84 Hilton, Managerial Accounting, Seventh Edition 17 Nelson Company owes money to Nash Company for the purchase of equipment Nash Company has given Nelson the following payment options: I.Immediate payment in full of $38,000 II.Annual payments of $15,000 made at the end of each of the next three years III.A single payment of $48,000 made at the end of three years Assume that both Nelson and Nash use a 10% interest rate What option would Nash prefer, and what is the present value of that option? A Option I, $34,542 B Option I, $38,000 C Option II, $37,305 D Option III, $34,164 E Option III, $36,048 Answer: B LO: Type: A EXERCISES Future Value and Present Value 18 Future value and present value are two key business tools Required: Ignoring income taxes, answer the following independent questions: A Suppose that you invest $4,000 today in an account that bears interest at the rate of 8% What will your investment grow to in five years? B Your best friend won the state lottery and has offered to give you $5,000 in seven years, after he has made his first million You figure that if you had the money now, you could invest it at 10% annual interest What is the value today of your friend's future gift? C Suppose that you invest $1,200 per year in an investment that provides a 6% return What will be the value of your investment in four years? D Suppose that your best friend won the state lottery and promised to give you $5,000 per year for eight years The first payment will be made at the end of 20x1 Using a 10% discount rate, what is the value of these payments at the beginning of 20x1? LO: Type: A Answer: A Future value: $4,000 x 1.469 = $5,876 B Present value: $5,000 x 0.513 = $2,565 C Future value: $1,200 x 4.375 = $5,250 D Present value: $5,000 x 5.335 = $26,675 Appendix II 85 Present Value and Time Value: Emphasis on Concepts 19 Your Uncle Otto has struck it rich by investing in racehorses and desires to share some of his newfound wealth with you Assume that you must choose from among the following three options: Receive a lump sum of $400,000 in 20 years Receive $20,000 at the end of each year for the next 10 years Receive $90,000 now Required: A Why is it inappropriate to compare $400,000 (no 1) vs $200,000 (no 2) vs $90,000 (no 3) and conclude that no is the best option? Explain B What should you to determine which option is the best? What does this process do? C If Uncle Otto agreed to revise option no so that you could receive $200,000 in 10 years and the remaining $200,000 in another 10 years, would you likely prefer the revision or the option as originally stated? Why? D What is an annuity? Do any of the options involve an annuity? LO: 1, Type: N Answer: A The cash flows not occur at the same points in time, and such an analysis disregards the time value of money Dollars received in earlier years are worth more than dollars received in the future B The cash flows should be discounted, and the option with the highest present value should be selected Such a process integrates the time value of money into the decision process C The revision should be preferred Both options involve the same total dollars; however, because significant inflows occur sooner with the revision, this option would have a higher present value D An annuity is a series of uniform cash inflows or outflows over a period of years Option no involves an annuity 86 Hilton, Managerial Accounting, Seventh Edition DISCUSSION QUESTIONS The Time Value of Money 20 The time value of money and present value are important business concepts Required: Briefly explain these concepts to someone with a limited business background LO: Type: RC Answer: The time value of money recognizes that a dollar received today is worth more than a dollar received in the future Such monies can be invested to earn additional returns for the individual and/or firm Present value, an approach that is based on time values, weights dollars in earlier years of an investment more heavily than dollars of later years The result is present value, namely, the amount that a company (or individual) should be willing to pay today to secure a future cash flow at a given rate of return Appendix II 87 ... factor D compound discount factor E internal rate discount factor Answer: C LO: Type: RC 82 Hilton, Managerial Accounting, Seventh Edition 10 Consider the following items of information: I.The target... Option II, $37,305 D Option III, $34,164 E Option III, $36,048 Answer: E LO: Type: A 84 Hilton, Managerial Accounting, Seventh Edition 17 Nelson Company owes money to Nash Company for the purchase... uniform cash inflows or outflows over a period of years Option no involves an annuity 86 Hilton, Managerial Accounting, Seventh Edition DISCUSSION QUESTIONS The Time Value of Money 20 The time value
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