FBM Chapter 7 - Investment Analysis
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Questions and Answers

What is the future value of $250 after 10 years at a 10% annual interest rate?

  • $1000
  • $1250
  • $648.43 (correct)
  • $250

What is the formula for calculating the future value of a present value with compounding interest?

  • Future Value = Present Value + Interest Rate x Number of Periods
  • Future Value = Present Value x (1 - I)n
  • Future Value = Present Value x (1 + I)n (correct)
  • Future Value = Present Value + Interest Rate

What is the future value of a $1,000 investment after 5 years at a 7% annual interest rate?

  • $1,144.90
  • $1,225.04
  • $1,402.54 (correct)
  • $1,310.79

How is the future value calculated in the provided example with a $1,000 investment, a 7% annual interest rate, and a 5-year time period?

<p>By adding the interest earned each year to the original principal. (A)</p> Signup and view all the answers

What is the significance of the compounding table mentioned in the content?

<p>It provides the factors for compounding $1.00 at different interest rates for various periods of time. (C)</p> Signup and view all the answers

What is the primary reason why individuals prefer to receive a dollar amount today rather than later, according to the text?

<p>Opportunity cost, as the money could be invested and earn interest. (D)</p> Signup and view all the answers

Which of the following is NOT a component necessary for calculating the time value of money?

<p>The investor's risk tolerance (A)</p> Signup and view all the answers

What does the mathematical process of 'compounding' involve?

<p>Calculating the future value of a present sum given an interest rate and time frame (A)</p> Signup and view all the answers

What is simple interest in the context of borrowing?

<p>Interest calculated on the original principal only (B)</p> Signup and view all the answers

What is the future value of $1.00 compounded at 5% for one year, as indicated by the text?

<p>$1.05 (B)</p> Signup and view all the answers

What is the value of $250 invested at a 10% interest rate for 10 years based on the provided information?

<p>$2,593.70 (C)</p> Signup and view all the answers

If you invest $1,000 at 7% simple interest for one year, how much interest would you earn?

<p>$70 (A)</p> Signup and view all the answers

In the context of compound interest, why is the interest earned in the first period added to the original principal?

<p>To calculate interest on the original principal and the accrued interest (C)</p> Signup and view all the answers

What is the primary factor that dictates the viability of an investment?

<p>The amount of capital required for the investment. (A)</p> Signup and view all the answers

What does it mean to analyze investments effectively?

<p>Evaluating and comparing different investment alternatives. (B)</p> Signup and view all the answers

Which of the following is a key factor for determining investment viability, according to the provided text?

<p>The amount of capital required for the investment. (A)</p> Signup and view all the answers

What is the benefit of comparing investment alternatives?

<p>It helps determine if the investment is viable. (B)</p> Signup and view all the answers

What is the MOST important factor in determining the profitability of an investment, according to the provided text?

<p>The overall benefit and cost analysis. (A)</p> Signup and view all the answers

Why is it advisable to choose investments that give you early returns?

<p>To benefit sooner from the investment's growth. (C)</p> Signup and view all the answers

What is the significance of understanding the time value of money when analyzing investments?

<p>It helps estimate the future value of the investment. (D)</p> Signup and view all the answers

What should you consider when choosing between investments with different benefits?

<p>Choose the investment that offers the greatest benefits. (A)</p> Signup and view all the answers

What is the total amount of money William will have if he invests in the four sows?

<p>$1,515 (A)</p> Signup and view all the answers

How much more money will William have if he invests in the four sows compared to putting the money in the bank?

<p>$188 (A)</p> Signup and view all the answers

What is the projected profit for William in year one?

<p>$200 (D)</p> Signup and view all the answers

What is the primary reason why the $200 profit in year one is compounded three years?

<p>It is compounded for three years because it will be received at the end of the first year. (C)</p> Signup and view all the answers

Which of the following is a risk associated with the hog alternative that does not exist in the savings account?

<p>Market fluctuations (C)</p> Signup and view all the answers

What is the purpose of comparing William's opportunity cost with his investment?

<p>To evaluate the overall financial viability of William's investment. (B)</p> Signup and view all the answers

What is the implied time frame for William's investment analysis?

<p>Four years (B)</p> Signup and view all the answers

Which of the following is NOT a factor considered in William's investment analysis?

<p>The potential impact of interest rate changes on the savings account (A)</p> Signup and view all the answers

What is the defining characteristic of an annuity?

<p>A series of equal payments at equal intervals for a specific period. (B)</p> Signup and view all the answers

Which type of annuity involves payments made at the beginning of each period?

<p>Annuity due (B)</p> Signup and view all the answers

What would classify an automobile loan with payments starting one month after purchase?

<p>Ordinary annuity (B)</p> Signup and view all the answers

If a person deposits $300 per month for five years and the first payment is made today, what type of annuity is this?

<p>Annuity due (D)</p> Signup and view all the answers

How do you determine the future value of an ordinary annuity?

<p>Use the financial factor from a table based on interest rate and time periods. (D)</p> Signup and view all the answers

What future value is achieved with annual deposits of $5,000 for 10 years at a 6% interest rate?

<p>$65,904 (B)</p> Signup and view all the answers

Which of the following is true regarding the timing of annuity payments?

<p>The timing impacts the total future value of the annuity. (B)</p> Signup and view all the answers

What is an example of a situation that constitutes an annuity?

<p>Making monthly payments on a mortgage. (D)</p> Signup and view all the answers

According to the provided content, what is the key factor in choosing the appropriate compounding rate for an investment analysis?

<p>The investor's opportunity cost of capital (A)</p> Signup and view all the answers

What is the primary concern for investors when they borrow funds for an investment?

<p>Ensuring the investment's return is high enough to cover the initial investment (C)</p> Signup and view all the answers

What does the statement "the compounding rate chosen is a matter of judgment, not a fixed fact" suggest about determining the compounding rate?

<p>There is no one correct compounding rate, and the choice depends on the investor's individual circumstances. (D)</p> Signup and view all the answers

What is the most important factor to consider when determining the discount rate for an investment analysis?

<p>The rate of return on competing investments (B)</p> Signup and view all the answers

If an investor is considering borrowing funds for an investment, what is the minimum rate of return required to justify the investment?

<p>The prevailing interest rate on the loan (C)</p> Signup and view all the answers

What is the primary purpose of a full investment analysis?

<p>To determine the profitability of an investment (A)</p> Signup and view all the answers

Which of the following is NOT a technique commonly used in a full investment analysis?

<p>Breakeven analysis (C)</p> Signup and view all the answers

What is the purpose of the Don Smith Cattle Company investing its profits?

<p>To generate additional income (A)</p> Signup and view all the answers

Flashcards

Capital Requirements

The amount of money needed to start an investment.

Investment Analysis

Comparing different investment options to see which is the best fit.

Benefit and Cost Analysis

A method to evaluate investments by comparing expected benefits to the associated costs.

Time Value of Money

The value of money changing over time. A dollar today is worth more than a dollar in the future.

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Early Benefits

The returns from an investment received earlier are generally more valuable than returns received later.

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Investment Return

The overall profit or gain an investment is expected to generate.

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Maximize Returns

Prioritize investments that offer the highest overall return.

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Compare Investments Directly

Comparing investments directly with each other to identify the most suitable option.

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Compounding

The process of calculating the future value of an investment by adding interest earned to the principal amount, and then calculating interest on the new, larger principal.

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Present Value

The amount of money you have at the beginning of an investment.

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Future Value

The amount of money you will have at the end of an investment period, after compounding.

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Interest Rate

The rate at which your investment grows each year.

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Time Periods

The number of periods over which interest is compounded.

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Interest

The reward for waiting to receive money in the future. Typically expressed as a percentage.

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Discounting

The process of calculating the present value of a future sum based on a given interest rate and time frame.

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Simple Interest

A type of interest calculation where only the original principal earns interest. The interest earned is not added to the principal.

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Compound Interest

A type of interest calculation where the earned interest is added to the principal, and future interest is calculated on the combined amount.

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Compounding Factor

A factor that represents the future value of a dollar compounded at a certain interest rate for a specific time period.

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What is an annuity?

A series of equal payments at equal intervals for a specific period of time.

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What is an annuity due?

Annuities with payments made at the beginning of each period.

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What is an ordinary annuity?

Annuities with payments made at the end of each period.

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What is compounding an annuity?

The process of calculating the future value of an annuity by considering interest earned over time.

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What is discounting an annuity?

The process of calculating the present value of an annuity by considering the time value of money.

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What is a Future Value of Ordinary Annuity Table?

A table that shows the future value factor for different interest rates and time periods.

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What is the future value factor?

The factor in the Future Value of Ordinary Annuity Table that you multiply by the periodic payment.

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What is the future value of an annuity?

The total amount of money you will have at the end of the annuity period, taking into account the interest earned.

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Opportunity Cost

The potential return you miss out on by choosing one investment over another.

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Investment Risk

The risk that an investment might not perform as expected.

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Opportunity Cost of Capital

The rate of return you could earn on your best alternative use of capital.

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Payback Period

The length of time it takes for an investment to generate enough cash flow to recover the initial investment.

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Net Present Value (NPV)

A method to calculate the present value of future cash flows, considering the time value of money.

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Internal Rate of Return (IRR)

The discount rate that makes the net present value of an investment equal to zero.

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Compounded Interest Rate

The rate at which the value of an investment grows each year, based on the compounding effect.

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Study Notes

Investment Analysis Introduction

  • Surplus funds should be invested to grow
  • Investors need to determine the best investment strategies

Benefit and Cost Analysis

  • Choose investments with earlier returns
  • Favor investments with higher overall returns
  • Consider the time value of money when evaluating benefits and costs

Time Value of Money

  • The concept of calculating the value of money now or in the future, given an interest rate and timeframe
  • Individuals generally prefer money today over money in the future without interest.
  • Interest acts as a reward for waiting
  • Compounding: Calculating future value from a present sum
  • Discounting: Calculating present value from a future sum
  • Simple Interest: Calculated based on principal x interest rate
  • Compound Interest: Calculated including accumulated interest

Simple Interest vs. Compounding

  • Simple interest is the interest paid only on the original principal
  • Compound interest is interest earned on both the principal and previously earned interest
  • Illustrative annual compounding example given

Discounting - Computing Present Value

  • Discounting is the opposite of compounding
  • Used to determine current worth of a future sum
  • Discounting table (Table 2) provides factors for discounting a $1
  • Use provided information to calculate present value example given

Compounding Annuities

  • Annuity: Series of equal payments at regular intervals
  • Ordinary annuity: Payments at the end of the time period
  • Annuity Due: Payments at the beginning of the time period
  • Future value of an ordinary annuity example given (Table 3)

Amortization

  • Amortization is the application of time value of money to loans.
  • Most loans are based on the present value of an ordinary annuity.
  • Loan amounts are the present value of payments

Partial Investment Analysis

  • Decision-making scenario involving a $1,000 investment for college
  • William Larson could invest in an FFA hog enterprise
  • Calculation of potential investment earnings compared to a savings account
  • Opportunity cost of capital: The rate of return on the best alternative use of the money

Full Investment Analysis

  • Three methods for analyzing investments (payback, net present value, and internal rate of return)
  • Using Don Smith Cattle Company example, demonstrates analysis method
  • Payback Period Analysis: Calculate time to recover initial investment
  • Net Present Value (NPV): Calculate difference in present value of projected cash inflows and outflows
  • Internal Rate of Return (IRR): The discount rate that makes NPV zero

Final Note

  • Investment analysis should consider factors like
  • Taxes
  • Inflation
  • Risk
  • Consult with a financial advisor when analyzing complex investment alternatives

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Investment Analysis PDF

Description

Explore the fundamentals of investment strategies, including the concepts of benefit-cost analysis and the time value of money. Understand the differences between simple and compound interest, and learn how to evaluate investments for maximum returns. This quiz will enhance your knowledge of financial decision-making.

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