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Present Value Factors and Simple versus Compound Interest

1) Suppose you are trying to find the present value of two different cash flows using the same interest rate for each. One cash flow is $1,000 ten years from now, the other $800 seven years from now. Which of the following is true about the discount factors used in these valuations?

a. The discount factor for the cash flow ten years away is always less than or equal to the discount factor for the cash flow that is received seven years from now.
b. Both discount factors are greater than one.
c. Regardless of the interest rate, the discount factors are such that the present value of the $1,000 will always be greater than the present value of the $800.
d. Since the payments are different, no statement can be made regarding the discount factors.
e. You should factor in the time differential and choose the payment that arrives the soonest.

2)You are choosing between investments offered by two different banks. One promises a return of 10% for three years using simple interest while the other offers a return of 10% for three years using compound interest. You should:

a. Choose the simple interest option because both have the same basic interest rate.
b. Choose the compound interest option because it provides a higher return.
c. Choose the compound interest option only if the compounding is for monthly periods.
d. Choose the simple interest option only if compounding occurs more than once a year.
e. Choose the compound interest option only if you are investing less than $5,000.

Solution Preview

1) Suppose you are trying to find the present value of two different cash flows using the same interest rate for each. One cash flow is $1,000 ten years from now, the other $800 seven years from now. Which of the following is true about the discount factors used in these valuations?

a. The discount factor for the cash flow ten years away is always less than or equal to the discount factor for the cash flow that is received seven years from now.
b. Both discount factors are greater than one.
c. Regardless of the ...

Solution Summary

The solution examines the present value factors and simple versus compound interest.

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