Question

1. You put $2,500 into an account earning interest at a rate of 8% per year. How much money will you have after 8 years, assuming simple interest and assuming no withdrawals? How much money will you have assuming compound interest and no withdrawals? (4 pts.)

2. Suppose you have an investment that pays 8% per year, compounded quarterly. What interest rate are you actually getting per year? (2 pts.)

3. What is the present value of $2,500 received in 7 years with monthly compounding at a 6% annual percentage rate (APR)? (2 pts.)

4. You are a financial manager for ABC Corp. trying to figure out which of three mutually exclusive projects to choose from, all of which are within the budget of the company. According to your projections, Project A will require an initial cash outlay of $2 million and promises to pay out $2 million after one year and $3 million after two years. Project B will require an initial cash outlay of $3 million and promises to pay out $3 million after one year and another $2.5 million after two years. Project C will require a cash outlay of $500,000 and will generate $1.2 million every year for the next five years. Which of the projects (A, B or C) should you choose to pursue, and why? (5 pts.)

5. You have a choice between a corporate bond paying out 7% per year and a municipal bond paying out 8% per year. If you’re in a 20% tax bracket, which bond should you invest in? Show your work. (3 pts.)

6. You plan on buying a boat in the future that costs $20,000 today. If inflation is 3% per year and you can earn 8% per year in your investment account, how much money should you invest in the account today to be able to buy the boat four years from now?
   1. $15,141.61
   2. $16,545.65
   3. $15,684.57
   4. $16,182.38

7. An investment should be undertaken so long as it has a positive:
   1. Return on Investment (ROI)
   2. Net Present Value (NPV)
   3. Internal Rate of Return (IRR)
   4. Interest Rate after Taxes
8. A person borrowing $100,000 at an interest rate of 8% compounded semi-annually who is able to and does turn around and lend the same $100,000 at an interest rate of 12% compounded semi-annually while incurring negligible costs in doing so may have engaged in interest rate ______________.
   1. Compounding
   2. Arbitrage
   3. Manipulation
   4. Amortization
9. Suppose US government bonds have an interest rate of 7% per year. If you invest $6,000 in the US government bond for one year, the exchange rate today is 20 South African rands (currency) to one U.S. dollar, and the dollar depreciates 8% with respect to the rand over the next year, what is the rate of return in terms of rands at the end of that year? (3 pts.)

10. Which of the following is true about the Internal Rate of Return (IRR)?
    1. The IRR rule says to accept a project only if the present values of its cash inflows exceeds the present value of its cash outflows; also, the IRR is the discount rate which makes the present value of the future cash inflows equal to the present value of the future cash outflows.
    2. The IRR rule says to accept a project if its rate of return is greater than the opportunity cost of capital; also, the IRR is the discount rate which makes the present value of the future cash inflows equal to the present value of the future cash outflows.
    3. The IRR rule says to accept a project only if the present value of its cash inflows exceeds the present value of its cash outflows; also, the IRR is the rate of return determined by subtracting the cash outflows from the cash inflows and then dividing by the cash outflows.
    4. The IRR rule says to accept a project if its rate of return is greater than the opportunity cost of capital; also, the IRR is the rate of return determined by subtracting the cash outflows from the cash inflows and then dividing by the cash outflows.

Answer 1

Q. You put $2,500 into an account earning interest at a rate of 8% per year. How much money will you have after 8 years, assuming simple interest and assuming no withdrawals?

A. Money after 8 years = $2,500 + ($2,500 *(0.08*8)) = $4,100

Q. How much money will you have assuming compound interest and no withdrawals?

A. Money after 8 years = $2,500 * (1+0.08)8 = $4,627.33

Q. Suppose you have an investment that pays 8% per year, compounded quarterly. What interest rate are you actually getting per year?

A. Interest rate per quarter = 0.08 / 4 = 0.02 or 2%

Effective Annual interest rate = (1 + 0.02)4 - 1 = 0.0824 or 8.24%

Q. What is the present value of $2,500 received in 7 years with monthly compounding at a 6% annual percentage rate (APR)?

A. Interest rate per month = 0.06 / 12 = 0.005 or 0.5%

Number of compounding periods = 12 * 7 = 84 periods

Present Value = $2,500 * (1 / (1+0.005)84) = $1,644.34