Financial Management: Principles and Applications, 11e (Titman)

Chapter 5 Time Value of Money-The Basics

5.1 Using Timelines to Visualize Cash Flows

1) Financial managers use the time value of money to:

A) make business decisions.
B) compare cash flows of different projects.
C) determine the price of common stock.
D) both A and B.
E) all of the above.
Answer: D
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Topic: 5.1 Using Timelines to Visualize Cash Flows
Keywords: time value of money
Principles: Principle 1: Money Has a Time Value

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2) The time value of money is created by:

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A) the existence of profitable investment alternatives and interest rates.
B) the fact that the passing of time increases the value of money.

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C) the elimination of the opportunity cost as a consideration.
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D) the fact that the value of saving money for tomorrow could be more or less than spending it
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today.
Answer: A
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Topic: 5.1 Using Timelines to Visualize Cash Flows

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Keywords: time value of money

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Principles: Principle 1: Money Has a Time Value

3) Which of the following statements is FALSE?

A) Quarterly compounding has a higher annual percentage yield than monthly compounding.
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B) On monthly compounding loans, the annual percentage yield will be less than the nominal or
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quoted rate of interest.

C) Compounding essentially means earning interest on interest on an initial balance.
D) Perpetuities pay an equal payment forever.
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Answer: A
Diff: 2
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Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: compound interest
Principles: Principle 1: Money Has a Time Value
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 4) An investment has a nominal interest rate of 12% annually, but interest on the investment is
compounded monthly. Therefore, the annual percentage yield on the investment is:
A) 12%.
B) 12.68%.
C) 13.89%.
D) 12.36%.
Answer: B
Diff: 2
Topic: 5.1 Using Timelines to Visualize Cash Flows
Keywords: compound interest
Principles: Principle 1: Money Has a Time Value

5) An investment has a nominal interest rate of 12% annually, but interest on the investment is
compounded semiannually. Therefore, the annual percentage yield on the investment is:
A) 12%.
B) 12.68%.

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C) 13.89%.

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D) 12.36%.

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Answer: D

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Diff: 2

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Topic: 5.1 Using Timelines to Visualize Cash Flows
Keywords: compound interest rs e
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Principles: Principle 1: Money Has a Time Value

6) Which of the following provides the greatest annual interest?

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A) 10%, compounded annually

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B) 10%, compounded semiannually

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C) 10%, compounded quarterly

D) 10%, compounded monthly
E) 10%, compounded daily
Answer: E
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Diff: 1
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Topic: 5.1 Using Timelines to Visualize Cash Flows

Keywords: compound interest
Principles: Principle 1: Money Has a Time Value
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7) A bank pays a quoted annual (nominal) interest rate of 4.25%, compounded daily (365-day
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year). What is the annual percentage yield (APY)?

A) 4.25%
B) 5.56%
C) 4.75%
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D) 6.20%
E) 4.34%
Answer: E
Diff: 2
Topic: 5.1 Using Timelines to Visualize Cash Flows
Keywords: compound interest

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 Principles: Principle 1: Money Has a Time Value
8) Northwest Bank pays a quoted annual (nominal) interest rate of 4.75%. However, it pays
interest (compounds) daily using a 365-day year. What is the effective annual rate of return
(APY)?
A) 4.75%
B) 5.02%
C) 3.61%
D) 4.86%
Answer: D
Diff: 2
Topic: 5.1 Using Timelines to Visualize Cash Flows
Keywords: compound interest
Principles: Principle 1: Money Has a Time Value

9) If you are an investor, which of the following would you prefer?

A) Earnings on funds invested would compound annually.

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B) Earnings on funds invested would compound daily.

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C) Earnings on funds invested would compound monthly.

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D) Earnings on funds invested would compound quarterly.

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Answer: B

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Diff: 1
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Topic: 5.1 Using Timelines to Visualize Cash Flows
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Keywords: compound interest
Principles: Principle 1: Money Has a Time Value
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10) You have $10,000 to invest. You do not want to take any risk, so you will put the funds in a
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savings account at the local bank. Of the following choices, which one will produce the largest
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sum at the end of 22 years?

A) An account that compounds interest annually.
B) An account that compounds interest daily.
C) An account that compounds interest quarterly.
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D) An account that compounds interest monthly.

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Answer: B
Diff: 1
Topic: 5.1 Using Timelines to Visualize Cash Flows
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Keywords: compound interest

Principles: Principle 1: Money Has a Time Value
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11) Which of the following statements is true about the time value of money?
A) The future value of a single sum will be greater if funds earn 5% instead of 10%.
B) The future value of a single sum will be unaffected by the rate of return at which funds grow.
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C) The future value of a single sum will be greater if funds earn 12% instead of 6%.
D) The future value of a single sum will be unaffected by the length of time funds are invested.
Answer: C
Diff: 1
Topic: 5.1 Using Timelines to Visualize Cash Flows
Keywords: compound interest

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 Principles: Principle 1: Money Has a Time Value

12) Which of the following statements is true about the time value of money?
A) The present value of a future amount will be greater if funds earn 5% instead of 10%.
B) The present value of a single sum will be unaffected by the rate of return at which funds grow.
C) The present value of a future amount will be greater if funds earn 12% instead of 6%.
D) The present value of a future amount will be unaffected by how far in the future funds would
be received.
Answer: A
Diff: 2
Topic: 5.1 Using Timelines to Visualize Cash Flows
Keywords: compound interest
Principles: Principle 1: Money Has a Time Value

13) If you are a borrower, which of the choices would lower your APR?
A) Repay your loan in monthly installments

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B) Repay your loan in quarterly installments

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C) Repay your loan in semiannual installments

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D) Repay your loan in annual installments

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E) You would be indifferent to how frequent your loan payments are.

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Answer: D
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Topic: 5.1 Using Timelines to Visualize Cash Flows
Keywords: compound interest
Principles: Principle 1: Money Has a Time Value
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14) As the number of compounding periods increases, the ________ increases.

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A) quoted
B) annual percentage yield
C) effective annual rate
D) both B and C
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Answer: D
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Diff: 2
Topic: 5.1 Using Timelines to Visualize Cash Flows
Keywords: compound interest
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Principles: Principle 1: Money Has a Time Value

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15) Which of the following statements is FALSE?

A) The effective annual rate (APR) of a loan is always the same as the quoted rate.
B) The payments of an ordinary annuity are made or received at the end of each period.
C) The effective annual rate (APR) of a loan is always equal to or greater than the quoted rate.
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D) A perpetuity is a series of equal payments, which are made for an infinite period of time.
Answer: A
Diff: 2
Topic: 5.1 Using Timelines to Visualize Cash Flows
Keywords: compound interest
Principles: Principle 1: Money Has a Time Value

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 16) Which of the following provides the lowest return to an investor?
A) 12%, compounded annually
B) 12%, compounded semiannually
C) 12%, compounded quarterly
D) 12%, compounded monthly
E) 12%, compounded daily
Answer: A
Diff: 1
Topic: 5.1 Using Timelines to Visualize Cash Flows
Keywords: compound interest
Principles: Principle 1: Money Has a Time Value

17) The discount rate for the time value of money should reflect delaying consumption.
Answer: TRUE
Diff: 2

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Topic: 5.1 Using Timelines to Visualize Cash Flows
Keywords: time value of money

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Principles: Principle 1: Money Has a Time Value

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18) Why is the concept of the time value of money so important to financial managers?
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Answer: The concept of the time value of money is important to financial managers because it is
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this concept that drives managerial decision making. Management decisions are driven by cash
flow and these cash flows must be adjusted for the time value of money. This would be most
closely reflected in the project evaluation. In addition, the value of a firm's common stock is
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driven by discounted cash flows. Management pays close attention as to how their decisions
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affect the value of ownership in their firm.

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Diff: 2
Topic: 5.1 Using Timelines to Visualize Cash Flows
Keywords: cash flow
Principles: Principle 1: Money Has a Time Value
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