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The principal of the time value of money is probably the single most important concept in financial management. One of the most frequently encountered applications
The principal of the time value of money is probably the single most important concept in financial management. One of the most frequently encountered applications involves the calculation of a future value. occurs when interest is not earned on prior periods' interest. Which of the following is not one of these variables? The inflation rate indicating the change in average prices O The present value (PV) of the amount invested O The interest rate (r) that could be earned by invested funds O The duration of the investment (n) All other things being equal, the numerical difference between a present and a future value corresponds to the amount of interest earned during the deposit or investment period. Each line on the following graph corresponds to an interest rate: 0%, 11%, or 22%. Identify the interest rate that corresponds with each line. A 20000 15000 DOLLARS (PV) B 10000 5000 0 0 1 2 3 6 7 8 9 10 5 TIME (periods) Line A corresponds to while Line B is consistent with Line C corresponds to Investments and loans base their interest calculations on one of two possible methods: the interest and the interest methods. Both methods apply three variables-the amount of principal, the interest rate, and the investment or deposit period-to the amount deposited or invested in order to compute the amount of interest. However, the two methods differ in their relationship between the variables. Assume that the variables r, n, and PV represent the interest rate, investment or deposit period, and present value of the amount deposited or invested, respectively. Which equation best represents the calculation of a future value (FV) using simple interest? FV = PV + (PV XrXn) FV = PV X (PV XrXn) FV = PV XIXn FV = PV - (PV Xrxn) Which equation best represents the calculation of a future value (FV) using compound interest? PV FV = O FV = (1+r)" $40,000.00 O FV = PV x (1 + r)" FV = PV + (PV XrXn) Identify whether the following statements about the simple and compound interest methods are true or false. True False All other variables held constant, investments paying simple interest have to pay significantly higher interest rates to earn the same amount of interest as an account earning compound interest. O future value based on compound interest will After the end of the second year and all other factors remaining equal, never exceed the future value based on simple interest. o Everything else held constant, an account that earns compound interest will grow more quickly than an otherwise identical account that earns simple interest. o Tim is willing to invest $40,000.00 for two years, and is an economically rational investor. He has identified three investment alternatives (X, Y, and z) that vary in their method of calculating interest and in the annual interest rate offered. Since he can only make one investment during the two-year investment period, complete the following table and indicate whether Tim should invest in each of the investments. Note: When calculating each investment's future value, assume that all interest is compounded annually. The final value should be rounded to the nearest whole dollar. Investment Interest rate and Method Expected future value Make this investment? X 9% compound interest 12% compound interest Y 11. Z 12% simple interest
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