Question

5.  An ordinaryannuity is

      A)        an infinte series of equal payments

      B)        an infinite series of unequal payments

C)        a finite series of equal payments where the first cash flow comes at the beginning of the first year.

D)        a finite series of equal payments where the first cash flow comes at the end of the first year.

6. How much will you have in seven years if you invest $150 today if you can earn 3%?

1. $184.48
2. $154.50
3. $ 153
4. $ 121.96

7. If the cash flows for a project change signs more than once, then the IRR criterion

1. Will give you a correct decision.
2. Will not give you the same decision as Profitability Index.
3. Cannot be used as the criteria does not make sense in these circumstances.
4. Will always give you the same decision as NPV.

8. What is the Payback Period for the following cash flows (CFFA): today, -$7,200; end of year one, + $3,000; end of year two, + $4,200; end of year three, + $200; and end of year four, $1,000.

      A)  3 years

      B)  2 years      

      C)   2.34 years

      D)  2.9 years  

      E)  3.2 years

Answer 1

Annuities are finite and paid each year.
Annuity due is where payment is made at beginning of the year
Ordinary annuity is where payment are received at end of year
Ordinary annuity is therefore finite series of cash flow paid at end of the year
Thus, option (D) is correct
Future value	Amount invested*((1+r)^n)
Interest rate is r and number of payments is n
Future value	150*(1.03^7)
Future value	$184.48
Thus, at end of seven years you would have $184.48
If cash flows of projects changes sign more than one then there is possibility of multiple internal rate of return
These multiple interest rate of return does not help in making correct decision
PI and NPV are not impacted if cash flow changes sign in project
Thus, option (A), (B) and (D) are incorrect
Option (C ) is correct answer
Payback period indicates number of years it would take for company to get back its cash flow invested and thus lower payback period is preferable
Year	Cash flow	Cumulative cash flow
0	-$7,200	-$7,200
1	$3,000	-$4,200
2	$4,200	$0
3	$200	$200
4	$1,000	$1,200
In year 2 the cumulative cash flow is zero which mean the investment of $7,200 is recovered by year 2
Thus, payback period is 2 years