Question 1

You just purchased some furniture from the LB Home Store. The store sold you the furniture under the agreement that you will pay $248 a month for 36 months starting one month from today. Your loan can be described as a(n):

Accepted Answer

An ordinary annuity involves equal payments made at the end of each period over a fixed period of time. Since the payments for the furniture are made at the end of each month for 36 months, it fits the definition of an ordinary annuity.

Question 2

Mason corporation is considering purchasing rental property that provides annual cash flows of $800,000. Rent is expected to increase by 1.8% annually for the foreseeable future. If Mason's return requirement is 12.8% and the rental property is listed at $7,500,000 determine if the property is over or under valued from Mason's perspective.

Accepted Answer

To determine if the property is over or under-valued from Mason's perspective, we need to calculate the present value of the future cash flows using the Gordon Growth Model (a type of Dividend Discount Model for perpetuities with growth) since the rent is expected to increase annually. The formula for the Gordon Growth Model is:$$ PV = \frac{D_1}{r - g} $$Where:- $PV$ = Present Value of the investment- $D_1$ = Cash flow in the first period, which is $800,000 increased by 1.8% for the first year = $800,000 * (1 + 0.018) = $814,400- $r$ = Required rate of return, which is 12.8% or 0.128- $g$ = Growth rate of the cash flow, which is 1.8% or 0.018Plugging the values into the formula gives:$$ PV = \frac{814,400}{0.128 - 0.018} = \frac{814,400}{0.110} = \$7,403,636.36 $$The calculated present value of the property is $7,403,636.36, which is less than the listed price of $7,500,000. Therefore, the property is over-valued from Mason's perspective by the difference:$$ \$7,500,000 - \$7,403,636.36 = \$96,363.64 $$However, none of the provided options exactly match this calculation. Given the options, it seems there might have been a mistake in the calculation or interpretation of the options. Based on the methodology and typical exam questions, the intent might have been to assess understanding of valuation principles rather than exact arithmetic, suggesting a possible error in the setup or interpretation of the provided answer choices.

Question 3

Suppose you are 22 and wish to retire at 65. Which of the following options will result in a greater future value at retirement? Option 1 is to invest $15,000 per year for eight years, and then leave it untouched for 35 years. Option 2 is to deposit $7,500 at the end of each year into an investment for 43 years. Both accounts earn 9% per year.

Accepted Answer

The answer of Suppose you are 22 and wish to...

Question 4

Beatrice has a credit card that applies interest every month to her account balance. In this case, Beatrice is paying an interest rate that:

Accepted Answer

Interest applied monthly results in a higher effective annual rate than the stated APR, due to compounding interest.

Question 5

A pure discount loan is a(n):

Accepted Answer

A pure discount loan involves receiving a sum of money today and repaying a larger amount in the future, which is a classic example of a present value problem, where the future repayment is discounted to determine its present value.

Question 6

A perpetuity differs from an annuity because:

Accepted Answer

Perpetuity payments never cease, continuing indefinitely, whereas annuity payments are for a fixed period.

Question 7

A pure discount loan is one where the borrower receives money today and repays the loan with:

Accepted Answer

A pure discount loan involves the borrower receiving funds upfront and repaying the loan amount in a single lump sum at a future date, without periodic payments in between.

Question 8

Mason corporation is considering purchasing rental property that provides annual cash flows of $800,000. Rent is expected to increase by 1.8% annually for the foreseeable future. If Mason's return requirement is 12.8% and the rental property is listed at $7,000,000 determine if the property is over or under valued from Mason's perspective.

Accepted Answer

To determine if the property is over or under-valued from Mason's perspective, we need to calculate the present value of the future cash flows and compare it to the listed price. The cash flows are growing perpetually at a rate of 1.8%, so we use the Gordon Growth Model (a version of the Dividend Discount Model for perpetuities with growth) to calculate the present value (PV) of the property:$$ PV = \frac{D_1}{r - g} $$Where:- $D_1$ is the cash flow in the first year, which is $800,000.- $r$ is the required rate of return, which is 12.8% or 0.128.- $g$ is the growth rate of the cash flows, which is 1.8% or 0.018.First, we calculate $D_1$, which is already given as $800,000. Then, we plug the values into the formula:$$ PV = \frac{800,000}{0.128 - 0.018} = \frac{800,000}{0.110} = \$7,272,727.27 $$The calculated present value of the property is $7,272,727.27. Since the property is listed at $7,000,000, it is under-valued by the difference:$$ \$7,272,727.27 - \$7,000,000 = \$272,727.27 $$Therefore, from Mason's perspective, the property is under-valued by approximately $272,727.

Question 9

An amortized loan:

Accepted Answer

The answer of An amortized loan:
...

Question 10

The interest rate charged per period multiplied by the number of periods per year is called the _____ rate.

Accepted Answer

The annual percentage rate (APR) is the interest rate charged per period multiplied by the number of periods per year. This rate reflects the cost of borrowing on an annual basis and includes any fees or additional costs associated with the transaction.

Question 11

Price corporation is considering purchasing rental property that provides annual cash flows of $600,000. Rent is expected to increase by 2.5% annually for the foreseeable future. If Mason's return requirement is 12.5% and the rental property is listed at $6,000,000 determine if the property is over or under valued from Mason's perspective.

Accepted Answer

The answer of Price corporation is considering purchasing rental property...

Question 12

You just received an insurance settlement offer related to an accident you had four years ago. The offer gives you a choice of one of the following three offers:

Option A: $6,500 on the first day of each year for 40 years
Option B: $610 on the first day of each month for 25 years
Option C: $75,000 as a lump sum payment today

You can earn 8.75% on your investments. You do not care if you personally receive the funds or if they are paid to your heirs should you die within the settlement period. Which one of the following statements is correct given this information?

Accepted Answer

Option A has the largest present value when discounted at the given interest rate of 8.75%, making it the most valuable option over time.

Question 13

You are comparing two investment options. The cost to invest in either option is the same today. Both options will provide you with $20,000 of income. Option A pays five annual payments starting with $8,000 the first year followed by four annual payments of $3,000 each. Option B pays five annual payments of $4,000 each. Which one of the following statement is correct given these two investment options?

Accepted Answer

Option A is the better choice because it provides a larger sum of money earlier than Option B. In terms of present value, receiving money earlier is more valuable than receiving the same amount later, assuming a positive rate of return. This is because the earlier payments can be reinvested to earn additional returns.

Question 14

You recently filed suit against a company. Today, you received three settlement options as follows:

Option A: $10,000 on the first day of each year for 25 years
Option B: $880 on the first day of each month for 25 years
Option C: $119,830 as a lump sum payment today
You can earn 7.5% on your investments. You do not care if you personally receive the funds or if they are paid to your heirs should you die within the next 25 years. Which one of the following statements is correct given this information?

Accepted Answer

The present value of all three options is approximately equal when discounted at a 7.5% rate, making you relatively indifferent to the choice.

Question 15

An annuity stream where the payments occur forever is called a(n):

Accepted Answer

A perpetuity is a type of annuity that continues indefinitely, or forever, making choice C the correct answer.

Question 16

Which of the following is correct concerning perpetuities?

Accepted Answer

Perpetuities are financial instruments that consist of a stream of equal payments that continue indefinitely. Unlike annuities, which have a fixed term, perpetuities go on forever.

Question 17

If you are investing money, you should prefer an ______ and if you are borrowing money you should prefer an _____.

Accepted Answer

When investing money, an annuity due is preferred because payments are made at the beginning of each period, allowing the investment to grow for a longer period. When borrowing, an ordinary annuity is preferred because payments are made at the end of each period, delaying outflows.

Question 18

Price corporation is considering purchasing rental property that provides annual cash flows of $600,000. Rent is expected to increase by 2.5% annually for the foreseeable future. If Mason's return requirement is 12.5% and the rental property is listed at $6,500,000 determine if the property is over or under valued from Mason's perspective.

Accepted Answer

The listed property is over-valued by $500,000 because the present value of the future cash flows is only $6,000,000.

Question 19

Which one of the following terms would best describe the type of compounding that occurs when interest is compounded continuously?

Accepted Answer

Instantaneous compounding refers to the theoretical concept of interest being compounded at every possible instant, which aligns with the concept of continuous compounding in finance and mathematics.

Question 20

The difference between an annuity and a perpetuity is the:

Accepted Answer

An annuity consists of a series of payments made at equal intervals for a fixed period of time, whereas a perpetuity involves payments that continue indefinitely. The key difference is the number of time periods over which the payments are made.

Quiz 6: Discounted Cash Flow Valuation

You just purchased some furniture from the LB Home Store. The store sold you the furniture under the agreement that you will pay $248 a month for 36 months starting one month from today. Your loan can be described as a(n) :