Sample Final Exam Questions

1. Answer each of the following:

(a) (5 marks) Discuss the meaning of the term time value of money.
(b) (5 marks) Use the formulas on the cover page to find the formula for the P/G factor. What is
the interpretation of this factor?
2. Answer each of the following by circling the correct response among the italicized choices and providing a brief explanation in each case. (2.5 marks each)
(a) As n increases, the A/P factor falls / rises because ...
(b) In general, if interest rates decrease, the price of a bond will decrease / increase because...
(c) In general, when choosing among mutually exclusive projects, selecting the project with the
highest rate of return is / need not be optimal because...
(d) The value of the discount factor = 1/(1 + i) can / cannot be negative because...
3. Answer each of the following.
(a) (3 marks) Suppose Tom deposits $2,000 today (i.e., in period 0) in an account which pays
compound interest. What will effective annual interest rate have to be in order for Toms
money to double after 10 years?
(b) (4 marks) Suppose Jerry deposits $10,000 today (i.e., in period 0) in an account which pays
compound interest. He continues to deposit money in this account, increasing his deposit by
5% each year. How many years will it take to accumulate an amount whose present worth is
$1,000,000 (in period 0) if the effective annual rate is 7%?
(c) (3 marks) If the reinvestment rate is 10%, what is the composite rate for return of a project
with net cash flows Ao = 3, 000, A1 = 2, 000, A2 = 5, 000, A3 = 7, 000 (where At denotes
the amount at the end of period t)?

4. Answer each of the following:

(a) (3 marks) If a loan is given out on the terms that the nominal quarterly rate is 4% and interest
is compounded monthly, what is the effective annual interest rate?
(b) (4 marks) A 10-year bond with face value of $ 10,000 has a bond rate of 8% paid quarterly. If a
potential buyer wishes to earn a nominal annual rate of return of 12% on the investment, what
is the maximum price she would be willing to pay? (Use formula to calculate.)
(c) (3 marks) A collateral bond with a face value of $8000 was purchased by an investor for $5900.
The bond was due in 8 years, and it had a bond interest rate of 5% per year, payable semiannually. If the investor kept the bond to maturity, what is the equation that must be solved to
find the investors rate of return per semiannual period?
5. Answer each of the following:
(a) (5 marks) Army Research Laboratory scientists developed a diffusion-enhanced adhesion process
that is expected to significantly improve the performance of multifunction hybrid composites.
NASA engineers estimate that composites made using the new process will result in savings in
many space exploration projects. The cash flows for one project are shown below. State the
equation which must be solved to determine the rate of return per year.
Year(s)
0
1-3
4-8

Cost ($1000)
-300
-100
-

Savings ($1000)
200 + 80(t - 2)

(b) (5 marks) A permanent endowment at the University of Alabama is to award scholarships to

engineering students. The awards are to be made beginning next year. A lump-sum donation
of X dollars is made today. The interest from the endowment is to fund 100 students each year.
A decision has been made to set funding per student to 10,000 in year 1 and then to increase it
each year by %2. If the applicable interest rate is 5%, what must X be to continue funding 100
students per year forever?

6. Two mutually exclusive projects have the estimated cash flows shown below. Using annual worth
analysis, determine which project should be selected at an interest rate of 20% per year. (Factor
values for i = 20% appear below.) What implicit assumption must be made for your analysis to be
valid?
Project A Project B
First cost,
-42,000
-80,000
Annual cost per year -6,000
-7,000 year 1, increasing by 1000 per year
Salvage value,
0
4,000
Life, years
3
5
7. A firm must select among the following three mutually exclusive projects:

Initial Cost (in year 0)

Annual Revenues (in years 1 and 2)
Annual Costs (in years 1 and 2)

Project A
1000
1,000
500

Project B
1500
2,630
1200

Project C
1900
1,900
100

(a) (5 marks) What is the rate of return of each project?

(b) (5 marks) Determine using incremental ROR analysis which project should be chosen by the
firm assuming the M ARR = 5% .
8. (a) (4 marks) State the equation which gives the equivalent annual cost (EAC) of an asset in the
context of replacement analysis and define each of the symbols and terms in the equation.
(b) (3 marks) Using a well defined diagram, illustrate the derivation of EAC of an asset and define
economic service life of an asset in the context of your analysis.
(c) (3 marks) Suppose two (new) machines provide identical services but the economic service life
of machine A is 3 years and that of machine B is 5 years. Under which condition would a firm
requiring the services indefinitely find using machine A to be the better alternative? How will
machine A be used over time?