Financial Accounting

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Quiz 14 :

Present and Future Value Concepts

Quiz 14 :

Present and Future Value Concepts

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Comparing Options Using Present Value Concepts After hearing a knock at your front door, you are surprised to see the Prize Patrol from a large, well-known magazine subscription company. It has arrived with the good news that you are the big winner, having won "$20 million." You discover that you have three options: (1) you can receive $1 million per year for the next 20 years, (2) you can have $8 million today, or (3) you can have $2 million today and receive $700,000 for each of the next 20 years. Your financial adviser tells you that it is reasonable to expect to earn 10 percent on investments. Which option do you prefer What factors influence your decision TIP : All three scenarios require you to determine today's value of the various payment options. These are present value problems.
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Compare options using present value concepts:
(1) In this option winner receives $1 million per year for next 20 years. Therefore, let us use present value of annuity table C-4 to calculate the value of future receivables today. Let us look into table C-4 for 10% column and 20 period's row to find the factors 8.5136.
img (2) In this option the winner receives $8,000,000 today. Now the present value is $8,000,000 only.
(3) This option involves two receipts of $2,000,000 today and $700,000 for each year for the next 20 years. Now let us add these two receipts to determine the present value of this option.
The present value of $2,000,000 today is $2,000,000 only. Receipt of $700,000 for each year for the next 20 years is calculated as follows.
img img First option yields $8,513,600 second option yields $8,000,000 and third option yields $7,959,520. As first option produces more income, it is preferable to select the same. Generally, more income option would be selected as it influences one's decision.

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Computing Growth in a Savings Account: A Single Amount On January 1, 2013, you deposited $6,000 in a savings account. The account will earn 10 percent annual compound interest, which will be added to the fund balance at the end of each year. Required : (round to the nearest dollar): 1. What will be the balance in the savings account at the end of 10 years 2. What is the interest for the 10 years 3. How much interest revenue did the fund earn in 2013 2014
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(1) Compute the balance in the savings account at the end of 10 years:
In order to calculate the present value of an annuity for $6,000 each year in savings account at 10% at annual compound interest for 10 periods, let us look into table C-3 at 10% column and 10 years row.
img (2) Compute the interest for the 10 years:
img (3) Compute the interest revenue for 2013 and 2014:
For 2013:
img For 2014:
img

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You are saving up for a Mercedes-Benz SLR McLaren, which currently sells for nearly half a million dollars. Your plan is to deposit $15,000 at the end of each year for the next 10 years. You expect to earn 5 percent each year. How much will you have saved after 10 years, rounded to the nearest 10 dollars
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To know the future value of $15,000 deposit for next 10 years to earn 5% each year we have to consider table C.3- future value of annuity of $1. Let us calculate the future value of annuity of deposit of $15,000 of each period is as follows.
img The correct option is (b). Therefore, all the remaining options (a), (c), and (d) are incorrect as they show incorrect value of dollar amounts.

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Computing the Present Value of a Single Payment What is the present value of $500,000 to be paid in 10 years, with an interest rate of 8 percent
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Comparing Options Using Present Value Concepts After completing a long and successful career as senior vice president for a large bank, you are preparing for retirement. After visiting the human resources office, you have found that you have several retirement options: (1) you can receive an immediate cash payment of $1 million, (2) you can receive $60,000 per year for life (your remaining life expectancy is 20 years), or (3) you can receive $50,000 per year for 10 years and then $70,000 per year for life (this option is intended to give you some protection against inflation). You have determined that you can earn 8 percent on your investments. Which option do you prefer and why
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Comparing Options Using Present Value Concepts After incurring a serious injury caused by a manufacturing defect, your friend has sued the manufacturer for damages. Your friend received three offers from the manufacturer to settle the lawsuit (1) receive an immediate cash payment of $100,000, (2) receive $6,000 per year for life (your friend's remaining life expectancy is 20 years), or (3) receive $5,000 per year for 10 years and then $7,000 per year for life (this option is intended to compensate your friend for increased aggravation of the injury over time). Your friend can earn 8 percent interest and has asked you for advice. Which option would you recommend and why
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Explain the concept of the time value of money.
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Computing Deposit Required and Accounting for a Single-Sum Savings Account On January 1, 2013, Alan King decided to transfer an amount from his checking account into a savings account that later will provide $80,000 to send his son to college (four years from now). The savings account will earn 8 percent, which will be added to the fund each year-end. Required (show computations and round to the nearest dollar): 1. How much must Alan deposit on January 1, 2013 2. Give the journal entry that Alan should make on January 1, 2013, to record the transfer. 3. What is the interest for the four years 4. Give the journal entry that Alan should make on ( a ) December 31, 2013, and ( b ) December 31, 2014.
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Which of the following is a characteristic of an annuity
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Computing the Present Value of an Annuity What is the present value of 10 equal payments of $15,000, with an interest rate of 10 percent
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Explain the basic difference between future value and present value.
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Recording Growth in a Savings Account with Equal Periodic Payments On each December 31, you plan to transfer $2,000 from your checking account into a savings account. The savings account wilt earn 9 percent annual interest, which will be added, to the savings account balance at each year-end. The first deposit will be made December 31, 2013 (at the end of the period) Required (show computations and Found to the nearest dollar): 1. Give the required journal entry on December 31, 2013. 2. What will be the balance in the savings account at the end of the 10th year (i.e., 10 deposits) 3. What is the total amount of interest earned on the 10 deposits 4. How much interest revenue did the fund earn in 2014 2015 5. Give all required journal entries at the end of 2014 and 2015.
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Which of the following is most likely to be an annuity
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Computing the Present Value of a Complex Contract As a result of a slowdown in operations, Mercantile Stores is offering to employees who have been terminated a severance package of 5100,000 cash; another $100,000 to be paid in one year; and an annuity of $30,000 to be paid each year for 20 years. What is the present value of the package, assuming an interest rate of 8 percent
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If you deposited $10,000 in a savings account that earns 10 percent, how much would you have at the end of 10 years Use a convenient format to display your computations.
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Computing Growth for a Savings Fund with Periodic Deposits On January 1, 2013, you plan to take a trip : around the world upon graduation four years from now. Your grandmother wants to deposit sufficient funds for this trip in a savings' account for you. On the basis of a budget, you estimate that the trip currently would cost $15,000' Being the generous and sweet lady she is, your grandmother decided to deposit $3,500 in; the fund at the end of each of the next four years starting on December 31,2013. The savings account will earn 6 percent annual interest, which will be added to the savings account at each year end. Required (show computations and round to the nearest dollar): 1. How much money will you have for the trip at the end of year 4 (i.e., after four deposits) 2. What is the total amount of interest earned over; the four years 3. How much interest revenue did the fund earn in 2013, 2014, 2015, and 2016
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Assume you bought a state of the art entertainment system, with no payments to be made until two years from now, when you must pay $6,000. If the going rate of interest on most loans is 5 percent, when table in this appendix would you use to calculate the system's equivalent cost if you were to pay for it today
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Computing the Future Value of an Annuity You plan to retire in 20 years. Calculate whether it is better for you to save $25,000 a year for the last 10 years before retirement or $15,000 for each of the 20 years. Assume you are able to earn 10 percent interest on your investments.
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If you hold a valid contract that will pay you $8,000 cash 10 years from now and the going rate of interest is 10 percent, what is its present value Use a convenient format to display your computations.
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Computing Value of an Asset Based on Present Value You have the chance to purchase an oil well. Your best estimate is that the oil well's net royalty income will average $25,000 per year for five years. There will be no residual value at that time, Assume that the cash inflow occurs at each year-end and that considering the uncertainty in your estimates you expect to earn 15 percent per year On the investment. What should' you be willing to pay for this investment right now
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