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Exam 6: Time Value of Money Concepts

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Question 21

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Hillsdale is considering two options for comparable computer software. Option A will cost $25,000 plus annual license renewals of $1,000 for three years, which includes technical support. Option B will cost $20,000 with technical support being an add-on charge. The estimated cost of technical support is $4,000 the first year, $3,000 the second year, and $2,000 the third year. Assume the software is purchased and paid for at the beginning of year one, but that technical support is paid for at the end of each year. Interest is at 8%. Ignore income taxes. Required: Determine which option should be chosen based on present value considerations.

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Option A should be ...

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Question 22

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Other things being equal, the present value of an annuity due will be less than the present value of an ordinary annuity.

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Question 23

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Suppose that Healdsburg wants to buy back the 7.75% notes on December 31, 2013, (i.e., five years early) when the going interest rate is 6%, thereby retiring the $345,154,000 in debt. How much would Healdsburg have to pay for the notes (principal only)?

Yamaha Inc. hires a new chief financial officer and promises to pay him a lump-sum bonus four years after he joins the company. The new CFO insists that the company invest an amount of money at the beginning of each year in a 7% fixed rate investment fund to insure the bonus will be available. To determine the amount that must be invested each year, a computation must be made using the formula for:

Two banks each have annual CD rates of 12%. Bank A compounds quarterly and Bank B compounds semiannually. Explain which bank offers the better CD.

Ajax Company purchased a five-year certificate of deposit for its building fund in the amount of $220,000. How much should the certificate of deposit be worth at the end of five years if interest is compounded at an annual rate of 9%?

Compute the present value of the following single amounts to be received at the end of the specified period at the given interest rate.

Shane wants to invest money in a 6% CD account that compounds semiannually. Shane would like the account to have a balance of $100,000 four years from now. How much must Shane deposit to accomplish his goal?

Zulu Corporation hires a new chief executive officer and promises to pay her a signing bonus of $2 million per year for 10 years, starting five years after she joins the company. The liability for this bonus when the CEO is hired:

Monetary assets include only cash and cash equivalents.

Micro Brewery borrows $300,000 to be paid off in three years. The loan payments are semiannual with the first payment due in six months, and interest is at 6%. What is the amount of each payment?

Sandra won $5,000,000 in the state lottery, which she has elected to receive at the end of each month over the next 30 years. She will receive 7% interest on unpaid amounts. To determine the amount of her monthly check, she should use a table for the:

Shelley wants to cash in her winning lottery ticket. She can either receive ten $100,000 semiannual payments starting today, or she can receive a lump-sum payment now based on a 6% annual interest rate. What is the equivalent lump-sum payment?

Touche Manufacturing is considering a rearrangement of its manufacturing operations. A consultant estimates that the rearrangement should result in after-tax cash savings of $6,000 the first year, $10,000 for the next two years, and $12,000 for the next two years. Interest is at 12%. Assume cash flows occur at the end of the year. Required: Calculate the total present value of the cash flows.

A firm leases equipment under a capital lease (analogous to an installment purchase) that calls for 12 semiannual payments of $39,014.40. The first payment is due at the inception of the lease. The annual rate on the lease is 6%. What is the value of the leased asset at inception of the lease?

Koko Company pays $10 million at the beginning of each year for 10 years to Mocha Inc. for a building with a fair value of $75 million. What interest rate is Mocha earning on financing this land sale?

A deferred annuity is one in which interest charges are deferred for a stated time period.

How much must be invested now at 9% interest to accumulate to $10,000 in five years?

The calculation of present value eliminates interest from future cash flows.

Briefly describe the differences between an ordinary annuity, an annuity due, and a deferred annuity.