APPENDIX C

TIME VALUE OF MONEY

SUMMARY OF QUESTIONS BY OBJECTIVES AND BLOOMS TAXONOMY
Ite m SO BT Ite m SO BT Ite m SO BT Ite m SO BT Ite m SO BT

True-False Statements
1. 2. 11. 12. 13. 14. 15. 16. 41. 42. 43. 54. 1 1 1 2 2 2 2 3 2 2 2,3 3 K K K C AP K K C AP AP AP K 3. 4. 17. 18. 19. 20. 21. 22. 44. 45. 46. 55. 2 3 3 3 3 3 4 4 3 3 5 3 K C AP K AP K K C AP AP AP K 5. 6. 23. 24. 25. 26. 27. 28. 47. 48. 49. 56. 4 5 4 4 5 5 5 5 5 5 5 4 K K C AP AP AP AP C AP AP AP K 7. 8. 29. 30. 31. 32. 33. 34. 50. 51. 52. 57. 6 6 5 5 5 5 5 5 5 6 6 7 C K AP AP AP C AP AP AN AP AP K 9. 10. 35. 36. 37. 38. 39. 40. 53. 7 7 5 6 6 6 6 6 6 K K AP AP C AP AP AP AN

Multiple Choice Questions

Exercises

Completion Statements

C2
Ite m

Test Bank for Managerial Accounting, Second Edition

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE

Typ e Ite m Typ e Ite m Typ e Ite m Typ e Ite m Typ e Ite m Typ e Ite m Typ e

Study Objective 1 1. 3. 12. 4. 16. 5. 6. 25. 26. 7. 8. 9. TF TF MC TF MC TF TF MC MC TF TF TF 2. 13. 14. 17. 18. 21. 27. 28. 29. 36. 37. 10. TF MC MC MC MC MC MC MC MC MC MC TF 11. 15. 41. 19. 20. 22. 30. 31. 32. 38. 39. 57. MC Study Objective 2 MC 42. Ex Ex 43. Ex Study Objective 3 MC 43. Ex 45. MC 44. Ex 54. Study Objective 4 MC 23. MC 24. Study Objective 5 MC 33. MC 46. MC 34. MC 47. MC 35. MC 48. Study Objective 6 MC 40. MC 52. MC 51. Ex 53. Study Objective 7 C C = Completion Ex = Exercise

Ex C MC Ex Ex Ex Ex Ex

55.

56. 49. 50.

C Ex Ex

Note: TF = True-False MC = Multiple Choice

The chapter also contains one set of five Matching questions.

Time Value of Money

C3

CHAPTER STUDY OBJECTIVES

1. Distinguish between simple and compound interest. Simple interest is computed on the principal only while compound interest is computed on the principal and any interest earned that has not been withdrawn. 2. Solve for future value of a single amount. Prepare a time diagram of the problem. Identify the principal amount, the number of compounding periods, and the interest rate. Using the future value of 1 table, multiply the principal amount by the future value factor specified at the intersection of the number of periods and the interest rate. 3. Solve for future value of an annuity. Prepare a time diagram of the problem. Identify the amount of the periodic payments, the number of compounding periods, and the interest rate. Using the future value of an annuity of 1 table, multiply the amount of the payments by the future value factor specified at the intersection of the number of periods and interest rate. 4. Identify the variables fundamental to solving present value problems. The following three variables are fundamental to solving present value problems: (1) the future amount, (2) the number of periods, and (3) the interest rate (the discount rate). 5. Solve for present value of a single amount. Prepare a time diagram of the problem. Identify the future amount, the number of discounting periods, and the discount (interest) rate. Using the present value of a single amount table, multiply the future amount by the present value factor specified at the intersection of the number of periods and the discount rate. 6. Solve for present value of an annuity. Prepare a time diagram of the problem. Identify the future amounts (annuities), the number of discounting periods, and the discount (interest) rate. Using the present value of an annuity of 1 table, multiply the amount of the annuity by the present value factor specified at the intersection of the number of periods and the interest rate. 7. Compute the present values in capital budgeting situations. Compute the present values of all cash inflows and cash outflows related to the capital budgeting proposal (an investmenttype decision). If the net present value is positive, accept the proposal (make the investment). If the net present value is negative, reject the proposal (do not make the investment).

C4 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Test Bank for Managerial Accounting, Second Edition

TRUE-FALSE STATEMENTS
Interest is the difference between the amount borrowed and the principal. Compound interest is computed on the principal and any interest earned that has not been paid or received. The future value of a single amount is the value at a future date of a given amount invested assuming compound interest. When the periodic payments are not equal in each period, the future value can be computed by using a future value of an annuity table. The process of determining the present value is referred to as discounting the future amount. A higher discount rate produces a higher present value. In computing the present value of an annuity, it is not necessary to know the number of discount periods. Discounting may be done on an annual basis or over shorter periods of time such as semiannually. The decision to make long-term capital investments is best evaluated by future valuing to some future date all the cash flows. When the present value of the cash receipts exceeds the present value of the cash payments, the decision to invest should be accepted.

Answers to True-False Statements

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.

1. 2.

F T

3. 4.

T F

5. 6.

T F

7. 8.

F T

9. 10.

F T

Time Value of Money

C5

MULTIPLE CHOICE QUESTIONS

Note: Students will need future value and present value tables for some questions. 11. Compound interest is the return on principal a. only. b. for one or more periods. c. for two or more periods. d. for one period. The factor 1.0609 is taken from the 3% column and 2 periods row in a certain table. From what table is this factor taken? a. Future value of 1 b. Future value of an annuity c. Present value of 1 d. Present value of an annuity If $10,000 is put in a savings account paying interest of 4% compounded annually, what amount will be in the account at the end of 5 years? a. $8,219.30 b. $12,000.00 c. $12,155.10 d. $12,166.50 The future value of 1 factor will always be a. equal to 1. b. greater than 1. c. less than 1. d. equal to the interest rate. All of the following are necessary to compute the future value of a single amount except the a. interest rate. b. number of periods. c. principal. d. maturity value. Which table has a factor of 1.00000 for 1 period at every interest rate? a. Future value of 1 b. Future value of an annuity c. Present value of 1 d. Present value of an annuity Perez Company deposits $15,000 in a fund at the end of each year for 5 years. The fund pays interest of 4% compounded annually. The balance in the fund at the end of 5 years is computed by multiplying a. $15,000 by the future value of 1 factor. b. $75,000 by 1.04. c. $75,000 by 1.20. d. $15,000 by the future value of an annuity factor.

12.

13.

14.

15.

16.

17.

C6 18.

Test Bank for Managerial Accounting, Second Edition The future value of an annuity factor for 2 periods is equal to a. 1 plus the interest rate. b. 2 plus the interest rate. c. 2 minus the interest rate. d. 2. If $5,000 is deposited in a savings account at the end of each year and the account pays interest of 5% compounded annually, what will be the balance of the account at the end of 10 years? a. $8,144.46 b. $52,500.00 c. $62,889.46 d. $75,000.00 Which of the following is not necessary to know in computing the future value of an annuity? a. Amount of the periodic payments b. Interest rate c. Number of compounding periods d. Year the payments begin In present value calculations, the process of determining the present value is called a. allocating. b. pricing. c. negotiating. d. discounting. Present value is based on a. the dollar amount to be received. b. the length of time until the amount is received. c. the interest rate. d. all of these. Which of the following accounting problems does not involve a present value calculation? a. The determination of the market price of a bond. b. The determination of the declining-balance depreciation expense. c. The determination of the amount to report for long-term notes payable. d. The determination of the amount to report for lease liability. If you are able to earn an 8% rate of return, what amount would you need to invest to have $5,000 one year from now? a. $4,624.45 b. $4,629.65 c. $4,545.45 d. $4,950.00 If you are able to earn a 15% rate of return, what amount would you need to invest to have $2,000 one year from now? a. $1980.20 b. $1,750.00 c. $1,700.00 d. $1,739.16 If the single amount of $1,000 is to be received in 2 years and discounted at 11%, its

19.

20.

21.

22.

23.

24.

25.

26.

Time Value of Money present value is a. $909.10. b. $811.63. c. $900.90. d. $826.45. 27.

C7

If the single amount of $1,500 is to be received in 3 years and discounted at 6%, its present value is a. $1,259.45. b. $1,415.10. c. $1,300.05. d. $1,410.00. Which of the following discount rates will produce the smallest present value? a. 8% b. 9% c. 10% d. 4% Suppose you have a winning sweepstakes ticket and you are given the option of accepting $600,000 three years from now or taking the present value of the $600,000 now. The sponsor of the prize uses a 6% discount rate. If you elect to receive the present value of the prize now, the amount you will receive is a. $503,772. b. $518,304. c. $534,000. d. $600,000. The amount you must deposit now in your savings account, paying 6% interest, in order to accumulate $2,000 for a down payment 5 years from now on a new Toyota Corolla is a. $400.00. b. $1,494.52. c. $1,492.44. d. $1,400.00. The amount you must deposit now in your savings account, paying 5% interest, in order to accumulate $9,000 for your first tuition payment when you start college in 3 years is a. $7,650.00. b. $7,047.00. c. $7,774.56. d. $7,973.64. The present value of $10,000 to be received in 5 years will be smaller if the discount rate is a. increased. b. decreased. c. not changed. d. equal to the stated rate of interest.

28.

29.

30.

31.

32.

33.

Flynn Company is considering purchasing equipment. The equipment will produce the following cash flows:

C8

Test Bank for Managerial Accounting, Second Edition Year 1 Year 2 $20,000 $30,000

Flynn requires a minimum rate of return of 10%. What is the maximum price Flynn should pay for this equipment? a. $42,975.30 b. $21,487.65 c. $50,000.00 d. $25,000.00 34. If Susan Metro invests $17,524.68 now and she will receive $50,000 at the end of 11 years, what annual rate of interest will she be earning on her investment? a. 8% b. 8.5% c. 9% d. 10% Kim Davis has been offered the opportunity of investing $73,540 now. The investment will earn 8% per year and at the end of its life will return $200,000 to Kim. How many years must Kim wait to receive the $200,000? a. 10 b. 11 c. 12 d. 13 Rita Bonner invests $21,310.08 now for a series of $3,000 annual returns beginning one year from now. Rita will earn 10% on the initial investment. How many annual payments will Rita receive? a. 10 b. 12 c. 13 d. 15 In order to compute the present value of an annuity, it is necessary to know the 1. discount rate. 2. number of discount periods and the amount of the periodic payments or receipts. a. 1 b. 2 c. both 1 and 2 d. something in addition to 1 and 2 A $10,000, 8%, 5-year note payable that pays interest quarterly would be discounted back to its present value by using tables that would indicate which one of the following periodinterest combinations? a. 5 interest periods, 8% interest b. 20 interest periods, 8% interest c. 20 interest periods, 2% interest d. 5 interest periods, 2% interest Hazlett Company has just purchased equipment that requires annual payments of $20,000 to be paid at the end of each of the next 4 years. The appropriate discount rate is 15%. What is the present value of the payments? a. $57,099.60

35.

36.

37.

38.

39.

Time Value of Money b. $80,000.00 c. $23,487.28 d. $75,374.12 40.

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Belltone Company has purchased equipment that requires annual payments of $25,000 to be paid at the end of each of the next 6 years. The appropriate discount rate is 12%. What amount will be used to record the equipment? a. $150,000.00 b. $102,785.25 c. $138,143.40 d. $96,374.50

Answers to Multiple Choice Questions

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.

11. 12. 13. 14. 15.

c a d b d

16. 17. 18. 19. 20.

b d b c d

21. 22. 23. 24. 25.

d d b b d

26. 27. 28. 29. 30.

b a c a b

31. 32. 33. 34. 35.

c a a d d

36. 37. 38. 39. 40.

c c c a b

C10 Ex. 41

Test Bank for Managerial Accounting, Second Edition

EXERCISES
Joe Walsh deposited $4,000 in an account paying interest of 4% compounded annually. What amount would be in the account at the end of 4 years? Solution 41 (5 min.)

Use Table 1. $4,000 1.16986 (4 periods and 4%) = $4,679.44

Ex. 42 Taylor Company borrowed $30,000 on January 2, 2002. This amount plus accrued interest of 6% compounded annually will be repaid at the end of 3 years. What amount will Taylor repay at the end of the third year? Solution 42 (5 min.)

Use Table 1. $30,000 1.19102 (3 periods and 6%) = $35,730.60

Ex. 43 Ding Company has decided to begin accumulating a fund for plant expansion. The company deposited $20,000 in a fund on January 2, 2002. Ding will also deposit $10,000 annually at the end of each year, starting in 2002. The fund pays interest at 4% compounded annually. What is the balance of the fund at the end of 2006 (after the 2006 deposit)? Solution 43 (8 min.)

Use Tables 1 and 2. $20,000 1.21665 (5 periods and 4%; Table 1) = $24,333.00 $10,000 5.41632 (5 periods and 4%; Table 2) = 54,163.20 Fund Balance at 12-31-06 $78,496.20

Ex. 44 Sutton Company deposited $10,000 annually for 6 years in an account paying 5% interest compounded annually. What is the balance of the account at the end of the 6th year? Solution 44 (5 min.)

Use Table 2. $10,000 6.80191 (6 periods and 5%) = $68,019.10

Time Value of Money Ex. 45

C11

Pippen Company wants to purchase a $400,000 building in 10 years and decides to make annual plant sinking fund deposits of $32,000. The deposits are made at the end of each year to a fund paying 5% interest compounded annually. What amount will be in the sinking fund at the end of the 10 years? Solution 45 (5 min.)

Use Table 2. $32,000 12.57789 (10 periods and 5%) = $402,492.48

Ex. 46 (a) (b) What is the present value of $60,000 due 7 years from now, discounted at 9%? What is the present value of $100,000 due 5 years from now, discounted at 12%?

Solution 46

(8 min.)

Use Table 3. (a) $60,000 .54703 (7 periods and 9%) = $32,821.80 (b) $100,000 .56743 (5 periods and 12%) = $56,743

Ex. 47 Milner Company is considering an investment which will return a lump sum of $1,000,000 six years from now. What amount should Milner Company pay for this investment to earn an 11% return?

Solution 47

(5 min.)

Use Table 3. $1,000,000 .53464 (6 periods and 11%) = $534,640 Ex. 48 Singer Company earns 15% on an investment that will return $600,000 eleven years from now. What is the amount that Singer Company should invest now to earn this rate of return? Solution 48 (5 min.)

Use Table 3. $600,000 .21494 (11 periods and 15%) = $128,964

C12 Ex. 49

Test Bank for Managerial Accounting, Second Edition

If Logan Cornell invests $8,977.50 now, she will receive $30,000 at the end of 14 years. What annual rate of return will Logan earn on her investment? Solution 49 (5 min.)

Use Table 3. Answer: 9% $8,977.50 $30,000 = .29925 Read across the 14-period row in Table 3 to find .29925 in the 9% column.

Ex. 50 Your younger sister, a philosophy major at a nearby liberal arts college, has just learned that she has just won the state lottery. Knowing that you are taking an accounting class, she has called for your advice. She has an option of receiving $50,000,000 immediately or $5,000,000 each year for ten years, at which time she would receive an additional lump sum of $10,000,000. Instructions Assuming she can invest money at 10% rate of return, which option will you suggest your sister should choose? Show computations to support your answer.

Solution 50

(10 min.)

Your sister should take the $50,000,000 immediately. That option has a present value of $50,000,000. The other option is worth $34,578,250, calculated as follows: $ 5,000,000 6.14457 $30,722,850 $10,000,000 .38554 $ 3,855,400 (factor for present value of an annuity of $1, 10 periods and 10%)

(factor for present value of $1, 10 periods and 10%)

The total of the two income streams is $30,722,850 + $3,855,400 = $34,578,250 (less than $50,000,000).

Ex. 51 Howe Company is considering investing in an annuity contract that will return $25,000 annually at the end of each year for 20 years. What amount should Howe Company pay for this investment if it earns an 8% return?

Time Value of Money Solution 51 (5 min.)

C13

Use Table 4. $25,000 9.81815 (20 periods and 8%) = $245,454 Ex. 52 Kelly Passmore purchased an investment for $19,636.30. From this investment, she will receive $2,000 annually for the next 20 years starting one year from now. What rate of interest will Kelly be earning on her investment? Solution 52 (5 min.)

Use Table 4. Answer: 8% (20 periods and 8%) = 9.81815 Read across the 20-period row in Table 4 to find 9.81815 in the 8% column. Ex. 53 Your uncle Howard has promised to give you money for an investment, provided you can choose the best investment alternative. Both Investment A and Investment B earn an annual rate of 13% and require the same initial investment. Listed below is information concerning the cash flows associated with each: Year Investment A Investment B 1 $ 6,000 $10,000 2 7,000 9,000 3 8,000 8,000 4 9,000 7,000 5 10,000 6,000 $40,000 $40,000 Your best friend insists that Investment A and Investment B are equal in value because both will earn a total of $40,000. As a student of accounting, you understand the time value of money and realize that one of the investments is superior. Instructions (a) Which investments will you choose? Show calculations to support your answer. (b) Why is your investment choice worth more than the alternative?

Solution 53 (a) Year 1 2 3 4 5

(15 min.) Investment A $ 6,000 7,000 8,000 9,000 10,000 $40,000 12% Present Factor Value .89286 = $ 5,357.16 .79719 = 5,580.33 .71178 = 5,694.24 .63552 = 5,719.68 .56743 = 5,674.30 $28,025.71 Investment B $10,000 9,000 8,000 7,000 6,000 $40,000 12% Present Factor Value .89286 = $ 8,928.60 .79719 = 7,174.71 .71178 = 5,694.24 .63552 = 4,448.64 .56743 = 3,404.58 $29,650.77

CTest Bank for Managerial Accounting, Second Edition 14 Solution 53 (cont.) You should choose Investment B. The net present value of Investment B exceeds the net present value of Investment A by $1,625.06 ($29,650,77 $28,025,71). (b) Investment B is worth more because the cash flows are larger in the early years, which produces a higher present value. The present value of Investment Bs cash flows is $16,103.31 for the first two years versus $10,937.49 for Investment A.

Time Value of Money

C15

COMPLETION STATEMENTS
54. 55. 56. 57. Payments or receipts of equal dollar amounts are referred to as __________________. The _____________________ of an annuity is the sum of all the payments plus the accumulated compound interest on them. The process of determining the present value is referred to as _________________ the future amount. If the present value of the cash payments exceeds the present value of the cash receipts, the investment should be _________________.

Answers to Completion Statements 54. 55. 56. 57. annuities future value discounting rejected

MATCHING
58. Match the items below by entering the appropriate code letter in the space provided. A. Compound interest B. Future value of a single amount C. Future value of an annuity D. Present value of a single amount E. Present value of an annuity

_____ 1. The value today of a future amount to be received or paid. _____ 2. The value at a future date of a given amount invested. _____ 3. Return on principal for two or more periods. _____ 4. Value today of a series of future amounts to be received or paid. _____ 5. The sum of all the payments or receipts plus the accumulated compound interest on them. Answers to Matching 1. D 2. B 3. A 4. E 5. C