Chapter 5

Question 1

What does the Time Value of Money (TVM) principle state?

Answer 1

A dollar today is worth more than a dollar in the future due to its potential earning capacity.

Question 2

True or False: The Time Value of Money assumes that money can earn interest.

Answer 2

True

Question 3

Fill in the blank: The formula for calculating future value is FV = PV × (1 + r)^n, where PV stands for _____ and r stands for _____ and n stands for _____.

Answer 3

Present Value, interest rate, number of periods

Question 4

What is the present value (PV) of an investment?

Answer 4

The current worth of a future sum of money or stream of cash flows given a specified rate of return.

Question 5

Which of the following is true about compounding?

Answer 5

Compounding refers to the process of earning interest on both the initial principal and the accumulated interest from previous periods.

Question 6

True or False: The longer the time period, the greater the impact of compounding.

Answer 6

True

Question 7

What is the formula for calculating present value?

Answer 7

PV = FV / (1 + r)^n

Question 8

What does ‘r’ represent in the time value of money formulas?

Answer 8

The interest rate or rate of return.

Question 9

How does inflation affect the time value of money?

Answer 9

Inflation decreases the purchasing power of money over time, affecting the real value of future sums.

Question 10

Fill in the blank: The net present value (NPV) is the _____ of all future cash flows discounted back to the present.

Answer 10

sum

Question 11

What is the primary purpose of discounting cash flows?

Answer 11

To determine the present value of future cash flows.

Question 12

True or False: A higher interest rate will result in a lower present value of future cash flows.

Answer 12

True

Question 13

What is an annuity?

Answer 13

A series of equal payments made at regular intervals over a period of time.

Question 14

Which type of annuity pays at the end of each period?

Answer 14

Ordinary annuity

Question 15

What is the difference between an ordinary annuity and an annuity due?

Answer 15

An ordinary annuity pays at the end of each period, while an annuity due pays at the beginning of each period.

Question 16

What is the future value of an annuity formula?

Answer 16

FV = PMT × (((1 + r)^n - 1) / r)

Question 17

What does PMT represent in annuity formulas?

Answer 17

The amount of each annuity payment.

Question 18

Fill in the blank: The effective annual rate (EAR) accounts for _____ in the calculation of interest.

Answer 18

compounding

Question 19

What is the formula for calculating the effective annual rate (EAR)?

Answer 19

EAR = (1 + i/n)^(n) - 1

Question 20

True or False: The time value of money is only applicable to financial investments.

Answer 20

False

Question 21

What is the importance of understanding the time value of money in finance?

Answer 21

It helps in evaluating investment opportunities and making informed financial decisions.

Question 22

What is a perpetuity?

Answer 22

A financial instrument that pays a constant amount indefinitely.

Question 23

What is the formula for calculating the present value of a perpetuity?

Answer 23

PV = PMT / r

Question 24

Fill in the blank: The term ‘discount rate’ refers to the _____ used to determine the present value of future cash flows.

Answer 24

interest rate

Question 25

What does the term 'risk-adjusted discount rate' mean?

Answer 25

A discount rate that accounts for the risk of the investment or cash flow.

Question 26

True or False: The time value of money concept applies only to investments with fixed cash flows.

Answer 26

False

Question 27

What is the purpose of a financial calculator in relation to the time value of money?

Answer 27

To perform complex calculations involving present value, future value, interest rates, and annuities.

Question 28

Fill in the blank: The term 'future value interest factor' (FVIF) is used to calculate _____ in the future.

Answer 28

future value

Question 29

What is the relationship between present value and future value?

Answer 29

Present value is the discounted value of future cash flows, while future value is the accumulated value of present cash flows.

Question 30

What does 'n' represent in the time value of money equations?

Answer 30

The number of compounding periods.

Question 31

What is the key to understanding the time value of money?

Answer 31

Recognizing that money has the potential to earn returns over time.

Question 32

True or False: The time value of money can be ignored when assessing short-term investments.

Answer 32

False

Question 33

What is a cash flow diagram?

Answer 33

A visual representation of cash inflows and outflows over time.

Question 34

What is the primary benefit of using the time value of money concepts in financial planning?

Answer 34

To maximize the value of investments and savings over time.

Question 35

Fill in the blank: The term 'discounting' refers to the process of determining the _____ of future cash flows.

Answer 35

present value

Question 36

What does the term 'interest compounding frequency' refer to?

Answer 36

The number of times interest is calculated and added to the principal balance in a given time period.

Question 37

What is the formula for calculating the future value of a single sum?

Answer 37

FV = PV × (1 + r)^n

Question 38

True or False: The time value of money concept only applies to individual investors.

Answer 38

False

Question 39

What is the primary purpose of calculating the internal rate of return (IRR)?

Answer 39

To determine the profitability of potential investments.

Question 40

Fill in the blank: The term 'real interest rate' refers to the nominal interest rate adjusted for _____.

Answer 40

inflation

Question 41

What is the significance of the time value of money in loan agreements?

Answer 41

It affects the total cost of borrowing and the payment structure.

Question 42

What is the implication of a higher discount rate?

Answer 42

It decreases the present value of future cash flows.