Corporate Finance Discounted Cash Flow Valuation Answer Key 1

Corporate Finance Discounted Cash Flow Valuation 1) The net present value of a project is equal to the: A) present value of the future cash flows. B) present value of the future cash flows minus the initial cost. C) future value of the future cash flows minus the initial cost. D) future value of the future cash flows minus the present value of the initial cost. E) sum of the project's anticipated cash inflows. Answer: B 2) Which one of these statements is correct concerning the time value of money? A) Increasing the initial cost of a project increases the project's NPV. B) Increasing the discount rate, increases the PV of a project. C) Increasing the FV decreases the PV. D) Decreasing the PV decreases the FV. E) Decreasing the discount rate increases the FV. Answer: D 3) At a discount rate of 5 percent, which one of the following is the correct formula for computing the PV of $1 to be received one year from today? A) $1/1.05 B) $1 C) $1 × 1.05 D) $1 × 1.052 E) $1/1.052 Answer: A 4) What effect will an increase in the discount rate have on the present value of a project that has an initial cash outflow followed by five years of cash inflows? A) There will be no effect on the PV. B) The PV will change but the direction of the change is unknown. C) The PV will remain the same as the timing of the cash flows must change also. D) The PV will increase. E) The PV will decrease. Answer: E 5) You are considering two projects. Project A has projected cash flows of $6,500, $4,500, and $2,500 for the next three years, respectively. Project B has projected cash flows of $2,500, $4,500, and $6,500 for the next three years, respectively. Assuming both projects have the same initial cost, you know that: A) there are no conditions under which the projects can have equal values. B) Project B has a higher net present value than Project A. C) Project A is more valuable than Project B given a positive discount rate. D) both projects offer the same rate of return. E) both projects have equal net present values at any discount rate. Answer: C 6) An interest rate that is compounded monthly, but is expressed as if the rate were compounded annually, is called the ________ rate. A) stated interest B) compound interest C) effective annual D) periodic interest E) daily interest Answer: C 7) The interest rate charged per period multiplied by the number of periods per year is called the ________ rate. A) effective annual B) annual percentage C) periodic interest D) compound interest E) daily interest Answer: B 8) The annual percentage rate: A) considers interest on interest. B) is the actual cost of a loan with monthly payments. C) is higher than the effective annual rate when interest is compounded quarterly. D) is the interest rate charged per period divided by (1 + n), when n is the number of periods per year. E) equals the effective annual rate when the interest on an account is designated as simple interest. Answer: E 9) You would be making a wise decision if you chose to: A) base decisions regarding investments on effective rates and base decisions regarding loans on annual percentage rates. B) assume all loans and investments are based on simple interest. C) accept the loan with the lower effective annual rate rather than the loan with the lower annual percentage rate. D) invest in an account paying 6 percent, compounded quarterly, rather than an account paying 6 percent, compounded monthly. E) ignore the effective rates and concentrate on the annual percentage rates for all transactions. Answer: C 10) The highest effective annual rate that can be derived from an annual percentage rate of 9 percent is computed as: A) (1 + .09/365)(365). B) e.09q. C) 1.09e. D) e.09 − 1. E) (1 + .09/365)365 − 1. Answer: D 11) Given a stated interest rate, which form of compounding will yield the highest effective rate of interest? A) Annual compounding B) Monthly compounding C) Daily compounding D) Continuous compounding E) Semiannual compounding Answer: D 12) A perpetuity differs from an annuity because: A) perpetuity cash flows vary with the rate of inflation. B) perpetuity cash flows vary with the market rate of interest. C) perpetuity cash flows are variable while annuity payments are constant. D) perpetuity cash flows never cease. E) annuity cash flows occur at irregular intervals of time. Answer: D 13) You are comparing two investment options, each of which will provide $15,000 of total income. Option A pays five annual payments starting with $5,000 the first year followed by four annual payments of $2,500 each. Option B pays five annual payments of $3,000 each. Which one of the following statements is correct given these two investment options? A) Both options are of equal value today. B) Given a positive rate of return, Option A is worth more today than Option B. C) Option B has a higher present value than Option A given a positive rate of return. D) Option B has a lower present value than Option A given a zero rate of return. E) Option A is preferable because it is an annuity due. Answer: B 14) An annuity stream of cash flow payments is a set of: A) equal cash flows occurring at equal periods of time over a fixed length of time. B) equal cash flows occurring each time period forever. C) either equal or varying cash flows occurring at set intervals of time for a fixed period. D) increasing cash flows occurring at set intervals of time that go on forever. E) arbitrary cash flows occurring each time period for no more than 10 years. Answer: A 15) Annuities where the payments occur at the end of each time period are called ________, whereas ________ refer to annuity streams with payments occurring at the beginning of each time period. A) ordinary annuities; early annuities B) late annuities; straight annuities C) straight annuities; late annuities D) annuities due; ordinary annuities E) ordinary annuities; annuities due Answer: E 16) A flow of unending annual payments that increase by a set percentage each year and occur at regular intervals of time is called a(n): A) annuity due. B) growing annuity. C) growing perpetuity. D) variable annuity. E) variable perpetuity. Answer: C 17) Ted purchased an annuity today that will pay $1,000 a month for five years. He received his first monthly payment today. Allison purchased an annuity today that will pay $1,000 a month for five years. She will receive her first payment one month from today. Which one of the following statements is correct concerning these two annuities? A) Both annuities are of equal value today. B) Allison's annuity is an annuity due. C) Ted's annuity has a higher present value than Allison's. D) Allison's annuity has a higher present value than Ted's. E) Ted's annuity is an ordinary annuity. Answer: C 18) Assume an annuity will pay $1,000 a year for five years with the first payment occurring in Year 4, that is, four years from today. When you compute the present value of that annuity using the PV formula, the PV will be as of which point in time? A) Today, Year 0 B) Year 1 C) Year 3 D) Year 4 E) Year 2 Answer: C 19) Martha left an inheritance to her grandson that will pay him $1,500 on the first day of every other year. When computing the PV of this inheritance, the grandson should use: A) simple interest. B) a semiannually compounded discount rate. C) an effective annual rate. D) a 2-year discount rate. E) a semiannual discount rate. Answer: D 20) Binder and Sons borrowed $138,000 for three years from their local bank and now they are paying monthly payments that include both principal and interest. Paying off debt by making instalment payments, such as this firm is doing, is referred to as: A) foreclosing on the debt. B) amortizing the debt. C) funding the debt. D) calling the debt. E) refunding the debt. Answer: B