Time Value of Money - Problem and Answer

CHAPTER 4

DISCOUNTED CASH FLOW

VALUATION

Answers to Concepts Review and Critical Thinking Questions

1.

Assuming positive cash flows and interest rates, the future value increases and the present

value decreases.

2.

Assuming positive cash flows and interest rates, the present value will fall and the future

value will rise.

3.

The better deal is the one with equal installments.

4.

Yes, they should. APRs generally don’t provide the relevant rate. The only advantage is that

they are easier to compute, but, with modern computing equipment, that advantage is not

very important.

5.

A freshman does. The reason is that the freshman gets to use the money for much longer

before interest starts to accrue.

6.

It’s a reflection of the time value of money. TMCC gets to use the $24,099 immediately. If

TMCC uses it wisely, it will be worth more than $100,000 in thirty years.

7.

This will probably make the security less desirable. TMCC will only repurchase the security

prior to maturity if it is to its advantage, i.e. interest rates decline. Given the drop in interest

rates needed to make this viable for TMCC, it is unlikely the company will repurchase the

security. This is an example of a “call” feature. Such features are discussed at length in a

later chapter.

8.

The key considerations would be: (1) Is the rate of return implicit in the offer attractive

relative to other, similar risk investments? and (2) How risky is the investment; i.e., how

certain are we that we will actually get the $100,000? Thus, our answer does depend on who

is making the promise to repay.

9.

The Treasury security would have a somewhat higher price because the Treasury is the

strongest of all borrowers.

10. The price would be higher because, as time passes, the price of the security will tend to rise

toward $100,000. This rise is just a reflection of the time value of money. As time passes,

the time until receipt of the $100,000...