Muskan Valbani PGP/24/456

Muskan Valbani
PGP/24/456
Note: For all the MCQs the final answer has been highlighted with calculations shown wherever
necessary
Formulae frequently used:
i) PVIFAr%,n periods (deferred) = {(1+r)^n}-1}/{r*(1+r)^n}
ii) FVIFA r%,n periods (deferred) = {(1+r)^n}-1}/(r)}
iii) PVIF = 1/(1+r)^n
Question1
1. An annuity stream of cash flow payments is a set of:
A. equal cash flows occurring each time period over a fixed length of time.
B. equal cash flows occurring each time period forever.
C. either equal or varying cash flows occurring at set intervals of time for a fixed period.
D. increasing cash flows occurring at set intervals of time that go on forever.
E. arbitrary cash flows occurring each time period for no more than 10 years.
Answer: Option A
Explanation: As mentioned in BM Chapter 2 ‘How to Calculate Present Values’, annuities are
fixed sum of payments received each time period (typically each year) for a specified period of time
Question 2
11. The annual percentage rate:
A. considers interest on interest.
B. is the actual cost of a loan with monthly payments.
C. is higher than the effective annual rate when interest is compounded quarterly.
D. is the interest rate charged per period divided by (1 + n), when n is the number of periods
per year.
E. equals the effective annual rate when the interest on an account is designated as simple
interest.
Answer: Option E
Explanation: all the other options are false as APR is simply calculated by multiplying the
periodic rate to the number of periods vs EAR which is calculated as ((1+i/n)^n)-1 where I is
the annual compounding rate. For example, periodic rate be 1% monthly, APR = 12% and
EAR = 12.68%; more the number of periods, more will be the difference between EAR and
APR where EAR>APR which rules out option C and other options are ruled out by definition
Thus option E as simple interest ignores compounding effect and so EAR = APR
Muskan Valbani
PGP/24/456
Question 3
21. Olivia is willing to pay $185 a month for four years for a car payment. If the interest rate
is 4.9 percent, compounded monthly, and she has a cash down payment of $2,500, what price
car can she afford to purchase?
A. $10,961.36
B. $10,549.07
C. $8,533.84
D. $8,686.82
E. $8,342.05
Answer: Option B
Solution:
Price of the car ( a present value) = Down Payment of $2500(already a PV) + PV of an
Annuity of $185 per month @ 4.9% compounded mothly
Now PV of the annuity:
A = $185
No of periods (n) = 4*12 =48
Rate = 4.9/12 = 0.40833%
PV= 185*PVIFA 0.4083%,48years
= 185*43.50852
=$8049.0762
Total price of car = 2500 +8049.0762
=$1059.07
Question 4
31. What is the future value of $845 a year for seven years at an interest rate of 11.3 percent?
A. $6,683.95
B. $6,075.69
C. $8,343.51
D. $8,001.38
E. $8,801.91
Answer: Option C
Solution:
This can be done in two ways:
Muskan Valbani
PGP/24/456
i. Calculating FV of an annuity using FVIFA

ii. Calculating PV of the annuity and then compounding it for 7 years
i) FV of the annuity = $845 * FVIFA 11.3%,7years

= 845 * 9.87397
= $8343.5058
ii) PV of the annuity = 845* PVIFA11.3%,7YEARS
= 845 * 4.66687
=3943.505
FV = 3943.505*(1.113)^7
= $8343.5058
Question 5
41. You are buying a car for $7,500, paying $900 down in cash, and financing the balance for
24 months at 6.5 percent, compounded monthly. What is the amount of each monthly loan?
A. $318.64
B. $294.01
C. $302.02
D. $264.78
E. $245.09
Answer: Option B
Solution: PV of the loan to be taken (shortage/balance amount) = Price of the car (already a
PV) – Down payment made in cash (already a PV)
= $7500 - $900
=$6600
EMI is an annuity and thus the amount of EMI can be found out by using the PV of a loan
formula as we already know it
6600 = EMI * PVIFA 0.54167%, 24
6600 = EMI * 22.44856
EMI = $ 294.01
Question 6
51. A project is expected to produce cash flows of $48,000, $39,000, and $15,000 over the
next three years, respectively. After three years, the project will be worthless. What is the
present value of this project if the applicable discount rate is 15.25 percent?
Muskan Valbani
PGP/24/456
A. $89,201.76
B. $80,809.09
C. $73,457.96
D. $97,808.17
E. $93,132.48
Answer: Option b
Solution: Following is a table showing calculations of PV of each cash flow with Discount
rate 15.25%
Year Cash Flow($) PVIF PV($)
1 48000 0.8676 41645.8
2 39000 0.752867 29363.813
3 15000 0.65324 9798.6999
Total of the PV column = $80807.3
Question 7
61. Leo received $7,500 today and will receive another $5,000 two years from today. He will
invest these funds when he receives them and expects to earn a rate of return of 11.5 percent.
What value does he expect his investments to have five years from today?
A. $18,758.04
B. $18,806.39
C. $19,856.13
D. $20,314.00
E. $19,904.36
Answer: Option C
Solution : Timeline
T - $7500 T+2 - $5000 + T+5
Invested at 11.5%
i) FV of $7500 as at T+5 = 7500*(1+0.115)^5

= $12925.15
ii) FV of $ 5000 as at T+5 = 5000*(1+0.115)^3 = $ 6930.98
iii) Total value as at T+5 = $12925.15+ 6930.98
= $ 19856.13
Muskan Valbani
PGP/24/456
Question 8
71. Your credit card company charges you 1.35 percent per month. What is the annual
percentage rate on your account?
A. 16.45%
B. 16.30%
C. 16.39%
D. 16.20%
E. 16.56%
Answer: Option D
Explanation: If a bank offers a loan at 12% APR (annual percentage rate) with interest to be
paid monthly, the bank means that we pay 1/12th of the rate of the loan monthly.
Thus for a rate of 1.35% monthly the APR will be 1.35*12 = 16.2%
Of course because the interest increases as period of compounding reduces the effective
interest rate will be higher than APR (17.4% approx.)
Question 9
81. Thirty-five years ago, your father invested $2,000. Today that investment is worth
$98,407. What rate of return has your father earned on his investment?
A. 10.94%
B. 11.33%
C. 10.50%
D. 11.77%
E. 9.99%
Answer: Option D
Solution: n= 35 years , Amount invested (P) = $2000, FV = $98,407, r =?
FV = P * (1+r)^n
98407 = 2000 * (1+r) ^35
r = 0.117745 or 11.77%
Question 10
91. Scott has been offered a 10-year job at a starting salary of $65,000 and guaranteed annual
raises of 5 percent. What is the current value of this offer at a discount rate of 7 percent?
A. $638,724.17
B. $602,409.91
Muskan Valbani
PGP/24/456
C. $558,845.85
D. $630,500.00
E. $525,000.00
This is an example of a declining annuity

(since raise(g) @5% < discount rate(r)@7%)
Formula = > C * (1/r-g) * (1- ((1+g)^t / (1+r)^t)))
65000 * (1/0.02) * (1- (1.05^10)/(1.07)^10))
65000 * (50) * (0.17195256) = 558845.82

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Muskan Valbani

i. Calculating FV of an annuity using FVIFA

i) FV of the annuity = $845 * FVIFA 11.3%,7years

T - $7500 T+2 - $5000 + T+5

i) FV of $7500 as at T+5 = 7500*(1+0.115)^5

This is an example of a declining annuity

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