Test Bank for Engineering Economics Financial Decision Making for Engineers Canadian 6th edition

Test Bank for Engineering Economics Financial Decision Making for Engineers Canadian 6th edition TEST Bank Engineering Economics 6 th Edition Niall M. Fraser Elizabeth M. Jewkes Mehrdad Pirnia Engineering Economics, 6e (Fraser/Pirnia) Chapter 1 Engineering Decision Making 1.1 Multiple Choice Questions 1) Evaluation of an engineering project involves the following constraints A) financial, environmental, social and political constraints. B) technical and financial constraints. C) technological and social constraints. D) time and money constraints. E) budget and time constraints. Answer: A Diff: 1 Type: MC Page Ref: 3 Topic: 1.1. Engineering decision making Skill: Recall Type: Qualitative 2) Engineering economics is A) a body of knowledge to determine which of several alternative is technically best. B) a collection of techniques for quantitative analysis to select a preferable alternative from several technically viable ones. C) a set of tools to calculate an engineering project's costs. D) a set of rules to evaluate an engineering project. E) a set of methods to determine an engineering project's costs in terms of time value of money. Answer: B Diff: 1 Type: MC Page Ref: 3 Topic: 1.2. What is engineering economics Skill: Recall Type: Qualitative 3) From an economic standpoint, any engineering project can be thought of in terms of A) its costs and benefits over time. B) its constraints. C) its receipts and disbursements. D) its revenues and profits over time. E) its investment and costs over time. Answer: A Diff: 1 Type: MC Page Ref: 3 Topic: 1.2. What is engineering economics Skill: Recall Type: Qualitative 1 © 2017 Pearson Canada Inc. 4) In the context of your textbook, abstraction means A) a study. B) a method. C) a methodology. D) a model. E) an approach. Answer: D Diff: 1 Type: MC Page Ref: 6 Topic: 1.4. Dealing with abstractions Skill: Recall Type: Qualitative 5) When an engineer prepares a feasibility study, what economic information must she possess in order to do it correctly? A) engineering specification B) expert opinion about this project C) macroeconomic situation in the world D) potential future costs and benefits of the project E) the level of uncertainty Answer: D Diff: 2 Type: MC Page Ref: 6 Topic: 1.4. Dealing with abstractions Skill: Applied Type: Qualitative 6) In which of the following problems do you need engineering economics? A) to choose a course in your program B) to chose the right textbook C) to decide whether to borrow money from parents or from a bank D) to decide whether or not to buy a car E) to decide where to spend summer vacation Answer: C Diff: 2 Type: MC Page Ref: 6-8 Topic: 1.4. Dealing with abstractions Skill: Applied Type: Qualitative 2 © 2017 Pearson Canada Inc. 7) Which of the following statements best describes the moral issues faced by engineers while evaluating projects? A) moral issues are clearly defined in engineering design B) moral issues do not matter as long as technical goals are achieved C) your employer is the only person who can define what is ethical or unethical D) there are no general answers to moral questions E) since moral issues are value judgements they must not be taken into consideration Answer: D Diff: 3 Type: MC Page Ref: 9-10 Topic: 1.5. The moral question: Three true stories Skill: Applied Type: Qualitative 8) The best way to find some answers to difficult moral questions in engineering design and project evaluation is A) to ask your friends. B) to consult professional engineering associations. C) to search the web. D) to read newspapers. E) to read professional textbooks. Answer: B Diff: 2 Type: MC Page Ref: 9-10 Topic: 1.5. The moral question: Three true stories Skill: Recall Type: Qualitative 9) Stan borrowed $5 000 one year ago. Now he has to repay $5 100. The interest Stan pays is A) $5 100. B) 102%. C) $100. D) 2%. E) $5 000. Answer: C Diff: 2 Type: MC Page Ref: 6-8 Topic: 1.4. Dealing with abstractions Skill: Applied Type: Quantitative 3 © 2017 Pearson Canada Inc. 10) Joan borrowed $1 000 one year ago. Now she has to repay $1 100. Therefore, the interest rate she pays is A) $1 000. B) $1 100. C) $100. D) 110%. E) 10%. Answer: E Diff: 2 Type: MC Page Ref: 6-8 Topic: 1.4. Dealing with abstractions Skill: Applied Type: Quantitative 11) All but one of the following are economic criteria to evaluate an engineering project. Which one is the non-economic criterion? A) maximum profit B) minimum cost C) minimum pollution D) maximum rate of return E) minimum payback period Answer: C Diff: 2 Type: MC Page Ref: 2-6 Topic: 1.2. What is engineering economics Skill: Applied Type: Qualitative 12) Analyze the following statement: "There is 50% probability of raining." This statement concerns A) extrapolation. B) risk. C) precise description. D) abstraction. E) expected scenario. Answer: B Diff: 2 Type: MC Page Ref: 11 Topic: 1.6. Uncertainty and sensitivity analysis Skill: Applied Type: Qualitative 4 © 2017 Pearson Canada Inc. 13) To resolve uncertainty, engineers apply A) marginal analysis. B) cash-flow analysis. C) sensitivity analysis. D) risk analysis. E) economic impact analysis. Answer: C Diff: 2 Type: MC Page Ref: 11 Topic: 1.6. Uncertainty and sensitivity analysis Skill: Recall Type: Qualitative 14) If you are asked to choose between $100 today and $150 one year from now, you are being asked to A) make a guess. B) reveal your implied interest rate. C) compare two values which are not comparable in principle. D) reveal your private financial information. E) make a choice under uncertainty. Answer: B Diff: 3 Type: MC Page Ref: 6-8 Topic: 1.4. Dealing with abstractions Skill: Applied Type: Qualitative 15) Which of the following items has negligible maintenance costs? A) computer B) building C) ruler D) shoes E) fur hat Answer: C Diff: 2 Type: MC Page Ref: 6-8 Topic: 1.4. Dealing with abstractions Skill: Applied Type: Qualitative 5 © 2017 Pearson Canada Inc. 16) You decide to buy a car. The following are some questions you have to answer with respect to your purchase. Which question is directly associated with engineering economics? A) what colour? B) what size? C) CD player or tape player? D) to lease or to own? E) Ford or Toyota? Answer: D Diff: 2 Type: MC Page Ref: 3 Topic: 1.3. Making decisions Skill: Applied Type: Qualitative 17) Susan is evaluating an engineering project. She assumes zero inflation for the duration of the project. With respect to this situation, which statement is consistent with the subject matter of engineering economics? A) A zero inflation assumption is always a good one. B) A zero inflation assumption is not realistic but it is better than assuming some uncertain inflation rate. C) A zero assumption is not a bad one for the base case, but then the project should be evaluated under different values in some range to see how inflation affects the project. D) Since in Canada inflation is low, it is possible to neglect it. E) The highest historical inflation rate must be chosen instead. Answer: C Diff: 3 Type: MC Page Ref: 3-6 Topic: 1.4. Dealing with abstractions Skill: Applied Type: Qualitative 18) An owner of a small company is deciding to sell her business. She received several options specified bellow. Which one should the company's owner accept? A) $600 000 in cash B) $500 000 in government bonds earning a 5% rate of return over 10 years C) $400 000 in securities earning an 8% rate of return over 8 years D) 15% of the future profits earned by the next owner during first 10 years E) It is impossible to compare these offers due to uncertainty about basic economic variables over time. Answer: E Diff: 3 Type: MC Page Ref: 3-6 Topic: 1.4. Dealing with abstractions Skill: Applied Type: Quantitative 6 © 2017 Pearson Canada Inc. 19) Suppose that you are asked to evaluate a project of building a new bridge. Which of the following factors is the least important in terms of engineering economics? A) service life of the bridge B) value added by the bridge C) cost structure D) vehicle stock in your city E) current interest rate Answer: D Diff: 3 Type: MC Page Ref: 3-6 Topic: 1.4. Dealing with abstractions Skill: Applied Type: Qualitative 20) Based on your intuition and experience, which of the following options has the highest value? A) $100 government bond earning a 5% annual rate of return B) $100 invested in a fund with a 10% annual rate of return C) $200 government bond earning a 5% annual rate of return D) $200 invested in a fund earning a 10% annual rate of return E) $150 invested in a fund earning a 7% annual rate of return Answer: D Diff: 2 Type: MC Page Ref: 6-8 Topic: 1.4. Dealing with abstractions Skill: Applied Type: Quantitative 21) Engineering economics is important because A) it is a natural science. B) it provides answers to all financial questions. C) it facilitates the establishment of verifiable facts about decisions. D) it uses mathematical models to address engineering issues. E) it is based on objective laws. Answer: C Diff: 2 Type: MC Page Ref: 4 Topic: 1.2. What is engineering economics Skill: Recall Type: Qualitative 7 © 2017 Pearson Canada Inc. 22) What is the best way to describe a mathematical model? A) It is an exact copy of the real world. B) It is a simplification to describe the real world in a reasonable way. C) It is a set of mathematical relationships with assumptions based on natural laws. D) It is a relationship that includes all aspects of a modelling situation. E) It describes all complex processes that occur in the real world. Answer: B Diff: 2 Type: MC Page Ref: 6 Topic: 1.4. Dealing with abstractions Skill: Recall Type: Qualitative 23) In engineering economics, sensitivity analysis A) addresses risk in engineering projects. B) addresses inflation in a country. C) involves random variables with their probabilities. D) assesses the effect of uncertainty on a decision. E) involves cash flows that are known with certainty. Answer: D Diff: 3 Type: MC Page Ref: 11-12 Topic: 1.6. Uncertainty and sensitivity analysis Skill: Recall Type: Qualitative 24) With sensitivity analysis, usually only one parameter is varied at a time A) because the appropriate tools are not available to vary parameters simultaneously. B) because this best emulates "real world" scenarios. C) so as to simplify the procedure. D) so that the effect of each can be observed independently of all other parameters. E) so that the effect can be effectively monitored. Answer: D Diff: 2 Type: MC Page Ref: 12 Topic: 1.6. Uncertainty and sensitivity analysis Skill: Recall Type: Qualitative 25) Most of the economic values we use in our evaluation of engineering projects are A) precise and very descriptive. B) approximate. C) based on robust statistical estimation. D) derived from natural experiments. E) results of precise statistical surveys. Answer: B Diff: 2 Type: MC Page Ref: 11 Topic: 1.6. Uncertainty and sensitivity analysis Skill: Recall Type: Qualitative 8 © 2017 Pearson Canada Inc. 26) When we say "let us assume that economic agents are rational," in fact we A) precisely describe behaviour of economic agents. B) want economic agents to behave that way. C) make an assumption to predict the agents' behaviour. D) impose restrictions on our model. E) introduce uncertainty into our modelling process. Answer: C Diff: 3 Type: MC Page Ref: 6 Topic: 1.3. Making decisions Skill: Applied Type: Qualitative 1.2 Short Answer Questions 1) What is the subject matter of Engineering Economics? Answer: Engineering economics deals with techniques of quantitative analysis useful for selecting a preferable alternative from several technically viable ones. Its major objective is to allow an engineer to determine which of several alternatives is economically best. Diff: 1 Type: ES Page Ref: 3 Topic: 1.2. What is engineering economics Skill: Recall Type: Qualitative 2) Briefly describe the structure of a decision-making process as discussed in your textbook. Answer: The textbook presents this structure in a form of a pyramid. At the top of the pyramid are preferences, which directly control the choices made. The next tier is composed of people and politics. Politics means the use of power in organizations. The next tier is a collection of facts. The facts, which may not be verifiable, contribute to the politics and people, and indirectly to the preferences. At the bottom of the pyramid are the activities that contribute to the facts. These include the history of previous similar decisions, statistics of various sorts, and a determination of costs. Diff: 2 Type: ES Page Ref: 4-5 Topic: 1.3. Making decisions Skill: Recall Type: Qualitative 9 © 2017 Pearson Canada Inc. 3) Explain the role of a mathematical model in engineering economics. Answer: When one describes something, one does so for a purpose. In the description, one selects aspects of the real world that are relevant to that purpose. The process of simplifying the complexities of the real world is necessary for any engineering analysis. This process of simplification is called abstraction or a model. Once a model is developed, it is used to analyze a situation, and perhaps make some predictions about the real world. The analysis and the predictions are then related back to the real world to make sure that the model is valid. The role of abstractions is to develop a viable mode of the real world. Diff: 2 Type: ES Page Ref: 6 Topic: 1.4. Dealing with abstractions Skill: Recall Type: Qualitative 4) How should engineers address moral questions associated with economic evaluation of engineering projects? Answer: Engineers have a responsibility to society to behave ethically and responsibly in all ways. When many different issues must be taken into account in engineering decision making, it is often difficult to determine what course of action is ethical. There are no general answers to difficult moral questions. Practicing engineers often have to make choices with an ethical component, and can sometimes rely on no stronger foundation than their own sense of right and wrong. More information about ethical issues for engineers can be obtained from provincial professional engineering organizations. Diff: 1 Type: ES Page Ref: 8-10 Topic: 1.5. The moral question: Three true stories Skill: Recall Type: Qualitative 5) Suppose that you are about to start a new business: You will provide consulting services for those who want to launch their own web-sites. What major decisions based on the subject matter of engineering economics should be made before you set up your business activities? Answer: You have to evaluate the expected future costs and benefits of your enterprise. In doing so, you have to understand your final product and identify a market for that product. As a result, you will be able to evaluate your expected revenues. This is known as demand-side analysis. On the supply side, you have to understand all materials, efforts and services involved in producing and/or providing your product. This will give you a cost structure. Then you have to define your planning horizon in order to use economic forecasts of major macroeconomic variables such as interest rate, inflation and others. You have to understand the Canadian tax system as well. If you are uncertain about values of some variables involved, you have to use principles of sensitivity analysis. All this is the subject matter of engineering economics. Diff: 3 Type: ES Page Ref: 3-5, 11 Topic: 1.4. Dealing with abstractions Skill: Applied Type: Qualitative 10 © 2017 Pearson Canada Inc. 6) As a University student, when you look for a new apartment, what economic criteria consistent with the subject matter of engineering economics do you apply? Answer: You have to understand your budget in terms of cash inflows and outflows. Cash inflows may include: a fellowship, a grant, a loan, an allowance provided by parents and others. Cash outflows to consider are: costs of utilities, transportation cost, cost of textbooks, tuition fee, food expenses, and others. As well, time should be explicitly introduced into your economic analysis. Therefore, for example, a more expensive apartment closer to the University can be preferred to a cheaper one far away, based on transportation costs. Diff: 2 Type: ES Page Ref: 3-5 Topic: 1.3. Making decisions Skill: Applied Type: Qualitative 7) Suppose that in order to finance your studies at the University, three options are available to you: (i) a student loan, (ii) a student line of credit, and (iii) a part-time job at minimum wage. In making your decision, what factors should be taken into account and why? Answer: Both a student loan and a student line of credit represent borrowing. There are costs associated with borrowing and it is necessary to compare them. In general, a student loan is interest-free as long as you stay in school, while a student line of credit is not interest-free. It means that the costs of borrowing associated with a student loan are lower. Of course, earning your own money is a good option since you avoid paying costs of borrowing. On the other hand, if you work you forgo opportunity to spend this time on your studies. There are some costs associated with that opportunity, called opportunity costs. If the opportunity costs of working exceed the costs of borrowing under student loan, then the latter is the best option. Otherwise, working is a better option. Diff: 3 Type: ES Page Ref: 3-7 Topic: 1.3. Making decisions Skill: Applied Type: Qualitative 8) List at least three non-economic factors (attributes) that may be used as evaluation criteria in the decision-making process. Answer: Non-economic factors are mainly associated with social, environmental and political constraints. Examples are: - Results of new elections; - Introduction of a new welfare program; - Introduction of new environmental standards. Diff: 1 Type: ES Page Ref: 4-6 Topic: 1.3. Making decisions Skill: Applied Type: Qualitative 11 © 2017 Pearson Canada Inc. 9) When evaluating an engineering project, what types of constraints does a decision maker face? Answer: A project might be technically feasible and the cheapest solution to a problem, but if it doesn't earn money at the minimum rate required by the company, it should not be done. The decision maker therefore has to be aware of the financial constraints on the problem. In addition, an engineering project can meet all other criteria, but may cause detrimental environmental effects, so we must also consider environmental constraints. Finally, any project can be affected by social and political constraints. Diff: 2 Type: ES Page Ref: 3-6 Topic: 1.3. Making decisions Skill: Recall Type: Qualitative 10) Every year Stan takes a Canada student loan of $5 000 to pay his tuition fees at the University. The loan is interest-free for as long as Stan is a full-time student. After graduation, he will have to start re-paying the loan within 6 months including interest. Is this a good decision? Why? Answer: Yes, this is a good decision. Stan can borrow $20 000 for four years or for five years for free. If this money were invested in a mutual fund or in financial securities, it would earn some return. Or if Stan borrowed the money from a commercial bank, he would pay interest payments to service his debt. Student loan has no borrowing costs. Diff: 2 Type: ES Page Ref: 3-6 Topic: 1.3. Making decisions Skill: Applied Type: Quantitative 11) If you decide to buy a home, list basic economic and non-economic factors you have to take into account and rank them Answer: You need to know the price of a home, current mortgage rate,potential duration of the mortgage and your own current and expected income. Those are fundamental economic factors. Non-economic factors may include: location, environmental quality, and safety. Diff: 2 Type: ES Page Ref: 3-6, 11 Topic: 1.6. Uncertainty and sensitivity analysis Skill: Applied Type: Qualitative 12) Suppose that a local government decides to build a bridge. In order to justify this project, economists want to ask people directly about their willingness to pay for the bridge. Using the discussion in your textbook, list at least three problems with this economic measure. Answer: The following three problems can be mentioned in this regard: (i) willingness to pay for a non-market good is very difficult to define; (ii) willingness to pay for non-market good is very subjective measure; (ii) it will require a lot of data and comprehensive statistical analysis to evaluate total willingness to pay for the bridge Diff: 3 Type: ES Page Ref: 6-7 Topic: 1.4. Dealing with abstractions Skill: Applied Type: Qualitative 12 © 2017 Pearson Canada Inc. 13) You were notified by an economics expert that the total costs of a project you are about to start are approximately $50 000. In order to justify this project, what additional economic information do you need? Answer: First of all, it is necessary to understand what this value includes. Usually costs are divided into capital costs and operating costs and those are two different types of costs. Second, it is necessary to understand whether or not the value of total costs is given as of today or at some other time. Finally, the benefits of the project should be evaluated to compare them with total costs. Diff: 1 Type: ES Page Ref: 3-4 Topic: 1.3. Making decisions Skill: Recall Type: Qualitative 14) Maintenance costs are an important component of the total costs of many engineering projects. Normally in engineering projects these costs are added to the purchase price of a piece of engineering equipment. For the following items, describe how important the maintenance costs are compared to the item's price: (i) A tractor (ii) A desk (iii) A computer (iv) An oil pump Answer: The maintenance costs of a tractor, computer and oil pump are important. Particularly maintenance costs of a tractor are very important since the quantity and quality of the services, produced by the tractor, depend on these costs. To lesser extent maintenance costs are important in case of oil pump and computer. Maintenance costs of a desk are not important because they are very low, and have little effect on the services provided by the desk. Diff: 1 Type: ES Page Ref: 3-6 Topic: 1.3. Making decisions Skill: Applied Type: Qualitative 15) Suppose that you want to buy a used car for $3 000, but you don't have enough cash. List some of the (legal) strategies that you might consider. Answer: Possible alternatives for financing the purchase of a used car are: - Not to buy (a "do nothing" alternative); - To borrow money from your parents; - To take a loan from a commercial bank; - To finance through a car dealer; - To postpone the purchase and earn money working extra hours. Diff: 2 Type: ES Page Ref: 3-6 Topic: 1.3. Making decisions Skill: Applied Type: Qualitative 13 © 2017 Pearson Canada Inc. 16) Sensitivity Analysis has sometimes been referred to as "what if" analysis. Explain why. Answer: Sensitivity Analysis begins with a base situation, which is developed using the most likely values for each input. We then vary the variable of interest by specified percentage points above and below the most likely value, while holding the other variables steady and observing the output. Sensitivity analysis is providing information on the "what if I vary this input"? What will be the effect on the output? For instance, "what if" our annual sales were only 2 million units instead of 2.5 million units? What effect would that have on overall earnings? Diff: 3 Type: ES Page Ref: 11 Topic: 1.6. Uncertainty and sensitivity analysis Skill: Applied Type: Qualitative 14 © 2017 Pearson Canada Inc. Engineering Economics, 6e (Fraser/Pirnia) Chapter 2 Time Value of Money 2.1 Multiple Choice Questions 1) What makes one dollar in the future less desirable than one dollar today? A) variable interest rate B) a forgone opportunity of investment C) a diminishing purchasing power of money over time D) a growing inflation E) accumulated welfare of people Answer: B Diff: 1 Type: MC Page Ref: 20 Topic: 2.2. Interest and Interest Rates Skill: Recall Type: Qualitative 2) The principal amount is A) the present value of money. B) the future value of money. C) the amount of money invested at the prime interest rate. D) the annual equivalent value of money. E) the difference between the amount of money lent and the amount of money later repaid. Answer: A Diff: 1 Type: MC Page Ref: 20 Topic: 2.3. Compound and Simple Interest Skill: Recall Type: Qualitative 3) Bill wants to buy a new car in three years from now. He expects that the price of a car will be $15 000 in three years. How much money should Bill put in his savings account now if a bank pays 5% interest rate on this account? A) $11 629 B) $12 104 C) $12 958 D) $13 465 E) $14 286 Answer: C Diff: 2 Type: MC Page Ref: 21 Topic: 2.3. Compound and Simple Interest Skill: Applied Type: Quantitative 1 © 2017 Pearson Canada Inc. 4) Milo has just inherited $6 500 and immediately spent the money purchasing an investment certificate. He decided to use the investment certificate to finance his return to the university that he left because of the financial problems at the time. Milo calculated that the interest rate the bank would pay on his investment certificate would allow him to accumulate the $7 600 he would need over 4 years. What interest rate does the bank pay? A) 2.0 B) 2.5 C) 3.0 D) 3.5 E) 4.0 Answer: E Diff: 2 Type: MC Page Ref: 21 Topic: 2.3. Compound and Simple Interest Skill: Applied Type: Qualitative 5) It is known that the total interest paid over a 5-year period is $2 081.13. What was the principal amount borrowed at a 6% nominal interest rate compounded quarterly? A) $3 000 B) $4 000 C) $5 000 D) $6 000 E) $7 000 Answer: D Diff: 3 Type: MC Page Ref: 26-27 Topic: 2.3. Compound and Simple Interest Skill: Applied Type: Quantitative 6) Nominal interest rate is calculated by A) summing up all interest rates for all compounding periods. B) converting a given interest rate with a compounding period to an equivalent interest rate with a one-year compounding period. C) dividing the interest rate per compounding period by the number of compounding periods per year. D) multiplying the simple interest rate by the number of years. E) multiplying the interest rate per compounding period by the number of compounding periods per year. Answer: E Diff: 2 Type: MC Page Ref: 26 Topic: 2.4. Effective and Nominal Interest Rates Skill: Recall Type: Qualitative 2 © 2017 Pearson Canada Inc. 7) Your credit card statement says that your card charges 0.0562% interest per day. What is the actual interest rate per year? A) 11.6% B) 14.5% C) 18.3% D) 20.1% E) 22.8% Answer: E Diff: 2 Type: MC Page Ref: 26 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 8) If an interest rate is 18% per year, what is the equivalent interest rate per quarter? A) 3.8% B) 4.5% C) 4.8% D) 6.2% E) 8.6% Answer: B Diff: 2 Type: MC Page Ref: 25 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 9) How many compounding periods are needed to obtain an effective interest rate of 25% if the interest rate per sub-compounding period is 1.88%? A) 13 B) 12 C) 11 D) 10 E) 9 Answer: B Diff: 2 Type: MC Page Ref: 26 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 3 © 2017 Pearson Canada Inc. 10) Bill deposits $100 to his savings account biweekly. His savings account pays a nominal interest rate of 5% per year, compounded every six months. What is his savings account's effective interest rate for a 6-month period? A) 2.1% B) 2.5% C) 3.2% D) 4.2% E) 5.1% Answer: B Diff: 2 Type: MC Page Ref: 64 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 11) What does a cash flow diagram of a project represent? A) summary of benefits and costs of a project B) summary of the timing and magnitude of payments and receipts as they occur over time C) magnitude of cash flows at a given period of time D) summary of present, future, and annual worths of a project E) change in value of money at different interest rates at various compounding periods Answer: B Diff: 2 Type: MC Page Ref: 29-31 Topic: 2.6. Cash Flow Diagrams Skill: Recall Type: Qualitative 4 © 2017 Pearson Canada Inc. 12) J.D.Irving Ltd. is considering a construction project with $2 million initial investment that will last for 10 years. The duration of the construction phase is one year. Once the construction is over, the project starts yielding a constant annual revenue of $1.0 million. By the end of the fifth year the project generates $0.5 million extra revenue. The annual operation and maintenance expenses of $0.5 million will start at year four and last till the end of the project's life. At the very end of the 10-year project the used equipment can be sold for $1.5 million. What cash flow diagram represents this project? A) B) C) 5 © 2017 Pearson Canada Inc. D) E) Answer: B Diff: 3 Type: MC Page Ref: 29-31 Topic: 2.6. Cash Flow Diagrams Skill: Applied Type: Quantitative 13) What does the term "market equivalence" imply? A) indifference on the part of a decision maker among available choices B) the existence of a mathematical relationship between time and money C) the ability to exchange one cash flow for another at minimum cost D) the ability to exchange one cash flow for another at no cost E) the ability to obtain a zero net cash flow Answer: A Diff: 2 Type: MC Page Ref: 32 Topic: 2.8. Equivalence Skill: Recall Type: Qualitative 6 © 2017 Pearson Canada Inc. 14) You invest $10 000 at 5% interest rate compounded monthly, what is your accumulated interest at the end of year 2? A) $511.62 B) $537.79 C) $1 025.00 D) $1 049.41 E) $1 089.41 Answer: D Diff: 2 Type: MC Page Ref: 26-27 Topic: 2.3. Compound and Simple Interest Skill: Applied Type: Quantitative 15) You would like to have $8 500 for future spending in three years from now. How much should you deposit in your bank account now if the account pays you 0.4% interest per month? A) $2 071 B) $7 362 C) $8 102 D) $8 399 E) $8 429 Answer: B Diff: 3 Type: MC Page Ref: 35 Topic: 2.3. Compound and Simple Interest Skill: Applied Type: Quantitative 16) The nominal interest rate is 6% per year compounded quarterly. What is the effective annual rate? A) 5.74% B) 5.84% C) 5.94% D) 6.04% E) 6.14% Answer: E Diff: 1 Type: MC Page Ref: 27 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 7 © 2017 Pearson Canada Inc. 17) Emily is considering two mutually exclusive financial options: (i) to deposit $4 000 in her bank's savings account that pays 4.6% annual interest, or (ii) to purchase a $4 000 one-year guaranteed investment certificate with a monthly interest rate of 0.3%. From an opportunity cost standpoint, by making the decision to deposit $4 000 in the bank account, Emily will A) gain $37.6 by the end of the year. B) lose $37.6 by the end of the year. C) gain $57.6 by the end of the year. D) lose $57.6 by the end of the year. E) make zero economic profit. Answer: A Diff: 3 Type: MC Page Ref: 32-34 Topic: 2.1. Introduction Skill: Applied Type: Quantitative 18) If you borrow $2 000 today at 20% interest rate for 5 years, what is your simple interest in this case? A) $2 000 B) $4 000 C) $4 976.64 D) $976.64 E) $2 976.64 Answer: A Diff: 1 Type: MC Page Ref: 24 Topic: 2.3. Compound and Simple Interest Skill: Applied Type: Quantitative 19) COSCO invested $5.5 million in a project ten years ago. As of today the worth of this project is $24.9 million. What annual interest rate has the project been earning if interest is compounded monthly? A) 14.2% B) 14.8% C) 15.2% D) 15.8% E) 16.2% Answer: C Diff: 3 Type: MC Page Ref: 27 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 8 © 2017 Pearson Canada Inc. 20) Equivalence is a condition that exists when A) the value of a cost at one time is numerically equal to the value of the related benefits received at a different time. B) the present worth of a cost equals the future worth of a cost at any point in time. C) the present worth of all costs and benefits equals the future worth of these costs and benefits at any point in time. D) the project breaks even, meaning costs equal benefits at a certain point in time. E) a decision-maker assesses two sets of cashflows as equally attractive. Answer: E Diff: 1 Type: MC Page Ref: 32 Topic: 2.8. Equivalence Skill: Recall Type: Qualitative 21) Jennifer lends $2 000 to her friend who is launching a small business. Her friend promises to pay her 9% per year compounding interest. How much interest would Jennifer get at the end of four years? A) $823 B) $1 284 C) $1 892 D) $2 324 E) $2 823 Answer: A Diff: 2 Type: MC Page Ref: 24 Topic: 2.3. Compound and Simple Interest Skill: Applied Type: Quantitative 22) Nominal interest rate is A) the actual but not usually stated interest rate. B) the actual and usually stated interest rate. C) the conventional method of stating the annual interest rate. D) the key interest rate in an economy. E) the overnight interest rate. Answer: C Diff: 1 Type: MC Page Ref: 26 Topic: 2.4. Effective and Nominal Interest Rates Skill: Recall Type: Qualitative 9 © 2017 Pearson Canada Inc. 23) If the effective equivalent annual interest rate is 16.2%, and interest is compounded daily, what is the corresponding nominal annual interest rate? A) 11% B) 13% C) 15% D) 17% E) 19% Answer: C Diff: 3 Type: MC Page Ref: 26 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 24) If you borrow $1 000 now at 10% interest for 5 years, what is the compound interest owed at the end of the fifth year? A) $1 000 B) $1 100 C) $1 610.51 D) $610.51 E) $500 Answer: D Diff: 2 Type: MC Page Ref: 24-25 Topic: 2.3. Compound and Simple Interest Skill: Applied Type: Quantitative 25) Suppose the nominal rate is 10% per year and interest is compounded every two years. What is the effective annual rate? A) 4.88% B) 9.54% C) 10.25% D) 21% E) 44%, Answer: B Diff: 3 Type: MC Page Ref: 26 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 10 © 2017 Pearson Canada Inc. 26) If the effective annual interest rate is 10% and interest is continuously compounded, what is the nominal annual interest rate? A) 9.00% B) 9.53% C) 10.53% D) 11.53% E) 12.53% Answer: B Diff: 3 Type: MC Page Ref: 28 Topic: 2.5. Continuous Compounding Skill: Applied Type: Quantitative 27) You have $100 to deposit. Bank A offers 20% simple interest, Bank B offers 15% interest compounded annually. How many years would you have to keep your money in the bank for Bank B to be a better choice than Bank A? A) Bank B is always better. B) 4 years C) 5 years D) 6 years E) Bank B will never be better. Answer: C Diff: 2 Type: MC Page Ref: 22 Topic: 2.3. Compound and Simple Interest Skill: Applied Type: Quantitative 28) You have $100 to deposit. Bank A offers 16% interest, compounded annually, Bank B offers 15% interest, compounded monthly. How many years would you have to keep your money in the bank for Bank B to be a better choice? A) Bank B is always better. B) 4 years C) 5 years D) 6 years E) Bank B is never better. Answer: A Diff: 2 Type: MC Page Ref: 27 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 11 © 2017 Pearson Canada Inc. 29) You need to borrow $1 000 for a period of 10 years. Bank A will lend you the money at 10% interest, compounded annually, whereas Bank B will lend you the money at 10% interest, compounded monthly. At the end of ten years, how much more interest will you owe if you borrow from Bank B instead of Bank A? A) $74.59 B) $92.50 C) $113.30 D) $137.39 E) $148.12 Answer: B Diff: 2 Type: MC Page Ref: 22-24 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 30) Suppose that you just paid $9.91 monthly interest compounded daily on an outstanding balance of on your credit card. What is the nominal annual interest rate in this case? A) 9% B) 10% C) 11% D) 12% E) 13% Answer: D Diff: 3 Type: MC Page Ref: 26 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 31) If the nominal annual interest rate is 10% and interest is continuously compounded, what is the effective annual interest rate? A) 9% B) 9.52% C) 10.52% D) 11% E) 11.52% Answer: C Diff: 2 Type: MC Page Ref: 28 Topic: 2.5. Continuous Compounding Skill: Applied Type: Quantitative 12 © 2017 Pearson Canada Inc. 32) You need to borrow $1 000. Bank A will lend you the money at 5% interest, compounded annually, whereas Bank B will lend you the money at 5% interest, compounded monthly. Bank B also offers you a free cell phone, valued at $100, if you do business with them. What is the longest duration of the loan for which Bank B would be a better choice? A) 10 years B) 15 years C) 20 Years D) 25 years E) 30 years Answer: D Diff: 2 Type: MC Page Ref: 22-24 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 33) What is the depreciation rate of a physical asset with the purchase price of $150 000 and salvage value of $16 100 after 10 years of service? A) 16.40% B) 16.66% C) 20.00% D) 25.00% E) 59.20% Answer: C Diff: 2 Type: MC Page Ref: 169 Topic: 2.7. Depreciation Skill: Applied Type: Quantitative 34) A computer was bought for $2 000. After three years of service it can be sold for $500. If straight line depreciation is assumed, what was the computer's book value at the end of year 2? A) $2 000 B) $1 500 C) $1 000 D) $500 E) $0 Answer: C Diff: 2 Type: MC Page Ref: 166-167 Topic: 2.7. Depreciation Skill: Applied Type: Quantitative 13 © 2017 Pearson Canada Inc. 35) The most popular depreciation method for physical assets in Canada is A) 150%-declining-balance depreciation. B) declining-balance depreciation. C) sum-of-the-years'-digits depreciation. D) double-declining-balance depreciation. E) units-of-production depreciation. Answer: B Diff: 1 Type: MC Page Ref: 169-170 Topic: 2.7. Depreciation Skill: Recall Type: Qualitative 36) Two assets, A and B, are purchased for the same price. Each loses 10% of its value in the first year. Subsequently, the value of A continues to decline in the same way by decliningbalance depreciation, while the value of B continues to decline in the same way by straight-line depreciation. Which will have the greater book value in five years time? A) A B) B C) Their book values will always be equal. D) Their book values will generally be different, but they are exactly equal at the end of the fifth year. E) It is impossible to say without knowing the MARR. Answer: A Diff: 3 Type: MC Page Ref: 166-171 Topic: 2.7. Depreciation Skill: Recall Type: Quantitative 37) What is depreciation? A) the decline in value of a future good due to the time we have to wait to receive that good B) the decline in value of expected future income, due to inflation C) the tendency of money in a bank account to lose value over time D) the loss in an asset's value over time E) the accumulation of money in an interest-bearing account over time Answer: D Diff: 1 Type: MC Page Ref: 165 Topic: 2.7. Depreciation Skill: Recall Type: Qualitative 14 © 2017 Pearson Canada Inc. 38) What is functional loss? A) Functional loss occurs when the asset can still perform its function despite a loss in its market value. B) Functional loss occurs when the asset becomes unusable to to misuse. C) Functional loss occurs when the asset wears out due to being used for its intended function. D) Functional loss occurs when the asset wears out due to the passage of time, whether or not it is used. E) Functional loss occurs when the asset can still perform its original function, but that function is no longer valued. Answer: E Diff: 1 Type: MC Page Ref: 165 Topic: 2.7. Depreciation Skill: Recall Type: Qualitative 39) What is the difference between market value and book value? A) The market value represents the price for which an asset could be sold at the end of its physical life whereas the book value represents the depreciated value of the asset for accounting purposes. B) The market value represents the price for which an asset could be sold at any point in its life, whereas the book value represents the depreciated value of the asset for accounting purposes. C) The market value represents the price for which an asset could be sold at any point in its life whereas the book value represents the actual value of an asset at the end of its useful life. D) The market value represents the price for which an asset could be sold at the end of its physical life whereas the book value represents the price for which an asset could be sold at the end of its useful life. E) The market value represents the price for which an asset could be sold at the end of its useful life whereas the book value represents the depreciated value of an asset for accounting purposes. Answer: B Diff: 2 Type: MC Page Ref: 165 Topic: 2.7. Depreciation Skill: Recall Type: Qualitative 40) The only depreciation models needed for corporate tax calculations in Canada are A) straight-line and declining balance. B) declining balance and double-declining balance. C) straight-line and Sum-of-year's digits. D) straight-line and units-of-production. E) declining-balance and 150%-declining-balance. Answer: A Diff: 2 Type: MC Page Ref: 166 Topic: 2.7. Depreciation Skill: Recall Type: Qualitative 15 © 2017 Pearson Canada Inc. 41) Calculate the depreciation rate of a vehicle if it was bought 5 years ago for $25 000 and can be sold now for $8 200. A) 20% B) 32% C) 48% D) 68% E) 80% Answer: A Diff: 2 Type: MC Page Ref: 168-169 Topic: 2.7. Depreciation Skill: Applied Type: Quantitative 42) A company buys a corrugated-metal building to store fertiliser. Because of a change in plans, no fertiliser is ever stored in the building, but it rusts away due to exposure to the rain. What kind of depreciation is this? A) a functional loss B) a time-related physical loss C) a use-related physical loss D) a technological loss E) a social loss Answer: B Diff: 1 Type: MC Page Ref: 165 Topic: 2.7. Depreciation Skill: Recall Type: Qualitative 43) Your accounting records show that an asset in use has book value of $7 119.14. The asset cost $30 000 when it was purchased and has been depreciated under the declining balance depreciation method with a 25% depreciation rate. How many years has the asset been in service? A) 1 year B) 2 years C) 3 years D) 4 years E) 5 years Answer: E Diff: 2 Type: MC Page Ref: 168-171 Topic: 2.7. Depreciation Skill: Applied Type: Quantitative 16 © 2017 Pearson Canada Inc. 44) Calculate the salvage value of equipment with a service life of 15 years if it was purchased 5 years ago for and depreciates at the rate of 10% per year. A) $5 400 B) $12 000 C) $24 707 D) $60 000 E) $70 859 Answer: C Diff: 2 Type: MC Page Ref: 168-171 Topic: 2.7. Depreciation Skill: Applied Type: Quantitative 45) Charles has just purchased a car for $9 520. He expects that the value of this car will decline by 5% each year. Eventually Charles wants to sell this car for at least $6 000 and buy a new one. How many years should Charles use this car before he can sell it? A) 12 B) 10 C) 8 D) 6 E) 4 Answer: C Diff: 2 Type: MC Page Ref: 168-169 Topic: 2.7. Depreciation Skill: Applied Type: Quantitative 46) Two assets, A and B, are purchased for the same price. Each loses 10% of its value in the first year. Subsequently, the value of A continues to decline in the same way by decliningbalance depreciation, while the value of B continues to decline in the same way by straight-line depreciation. Which will have the greater book value in five years time? A) A B) B C) Their book values will always be equal. D) Their book values will generally be different, but they are exactly equal at the end of the fifth year. E) It is impossible to say without knowing the MARR. Answer: A Diff: 3 Type: MC Page Ref: 166-171 Topic: 2.7. Depreciation Skill: Recall Type: Quantitative 17 © 2017 Pearson Canada Inc. 2.2 Short Answer Questions 1) Michael is indifferent about paying $1 500 for a new computer now and $2 000 two years from now. Define Michael's implied interest rate. Answer: The implied interest rate can be defined from the following mathematical equivalence: 1 500 × (1 + i)2 = 2 000 and i = 15.5%. Diff: 1 Type: ES Page Ref: 32-33 Topic: 2.8. Equivalence Skill: Applied Type: Quantitative 2) A credit card quotes its annual interest rate as 21%. If the interest rate is compounded monthly, what is the effective interest rate for this credit card? Answer: ie = - 1 = 0.2314 or 23.14% Diff: 1 Type: ES Page Ref: 26 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 3) Stan has invested $1 000 into mutual fund at a 5% annual rate of return, compounded daily. What are the nominal and effective interest rates in this case? Discuss how these two interest rates affect Stan's investment? Answer: The 5% annual rate of return is a nominal interest rate. The effective interest rate is the actual rate used in financial calculations. In order to convert the 5% nominal interest rate into effective interest rate, we have to use the following formula: ie = - 1 = 0.05127 or 5.127%. Therefore, when calculating the real return on his investment, Stan should use 5.127% interest rate instead of 5%. Diff: 2 Type: ES Page Ref: 26 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Qualitative 18 © 2017 Pearson Canada Inc. 4) Suppose that the effective interest rate associated with a VISA credit card is 20.9% while the nominal interest rate is 18.9%. What are the card's terms with respect to compounding? Answer: The following relationship between effective interest rate ie and nominal interest rate r should be used in this case: ie = - 1 where m is the number of compounding periods per year. Plugging in values of ie and r 0.213 = - 1 and solving for m by trial and error: Trying m = 2(semiannual), 4 (quarterly), 12 (monthly) and 365 (daily) compounding, it turns out that m = 365 or nominal interest rate of 18.9% is compounded daily. Diff: 3 Type: ES Page Ref: 25-27 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 5) Paul just bought a car for $15 000 and paid in cash. Calculate Paul's opportunity cost as "funds tied up in the car" if you know that otherwise it was possible to invest the money at a 5% annual interest rate compounded monthly for five years. Answer: Opportunity cost in this case is the money forgone as a result of the car purchase, which is forgone interest. If this sum of money was invested under the specified conditions, it would earn the following interest in five years: Ic = P(1 + ie)N - P where ie is the effective interest rate. In this case, the effective interest rate is ie = - 1 = 0.05116 or 5.116%. Therefore, interest forgone is Ic = 15 000 × (1+0.05116)5 - 15 000 = $4 250.21 Diff: 3 Type: ES Page Ref: 23-24 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 6) Suppose you invested $1 000 in a new savings account with an annual interest rate of 3% compounded daily. What is your accumulated interest at the end of the first year? Answer: First, calculate the effective interest rate since 3% is nominal interest rate: or it is 3.045%. Interest is given by the difference between future worth of the investment and its present worth which is . Diff: 2 Type: ES Page Ref: 25-27 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 19 © 2017 Pearson Canada Inc. 7) Explain why equivalences are just convenient assumptions. Give examples of two real world financial situations in which these equivalences do not hold Answer: Equivalences are needed to calculate and compare different costs and benefits over time. They are simplifications which capture the basic properties of cash flows without overcomplicating the problem. They may not hold precisely true in the real world. For example, we borrow at a higher interest rate compared to savings. It means that in real life when we move along a time line in a cash flow diagram we might see different rates moving in two different directions; however, equivalences assume that the rate is the same. Another example is the cost of information. We assume (until Chapter 12 in the text) that information is free, while in real life information is costly. Diff: 3 Type: ES Page Ref: 32-34 Topic: 2.8. Equivalence Skill: Applied Type: Qualitative 8) A transportation company just bought a new truck for $25 000. The service life of the truck is seven years. The company has to pay a $100 registration fee at the beginning of every year plus maintenance costs of $1 000 in the first year and$200 at the beginning of the second year. At the end of the truck's service life, it will be sold at 10% of its purchase price. Construct a cash flow diagram from the company's perspective. Answer: Diff: 2 Type: ES Page Ref: 29-31 Topic: 2.6. Cash Flow Diagrams Skill: Applied Type: Quantitative 20 © 2017 Pearson Canada Inc. 9) Consider the following statement: "Financial data are collected based on discrete time periods. However, in real life time is continuous. The error when using discrete compounding instead of continuous compounding is smaller the briefer the discrete compounding period is." Do you agree or disagree with this statement and why? Answer: This statement is correct. With an increase in the number of discrete time periods, the error decreases. This can be seen by comparing two effective interest rates—compounded daily and continuously compounded—using the same nominal interest rate. In this case, the error is negligible. Diff: 2 Type: ES Page Ref: 28-29 Topic: 2.5. Continuous Compounding Skill: Applied Type: Qualitative 10) Joan is deciding whether she should remodel her house now or one year from now. If she does it now, the cost will be $1 500. If she waits one year, the cost is expected to be $1 600. At current interest rate of 5.6%, should Joan remodel her house now or one year from now? Answer: To compare the two alternatives, the concept of mathematical equivalence must be applied. According to the concept, $1 500 now is equivalent to 1 500 × (1 + 0.056) = $1 584 one year from now. This is less than $1 600 and therefore Joan should remodel her house now. Diff: 1 Type: ES Page Ref: 32 Topic: 2.3. Compound and Simple Interest Skill: Applied Type: Quantitative 11) Suppose that a power plant project requires $10 million in period zero, has operating costs of $1 million per year over 10 years, and brings revenue of $2 million per year over that period of time. Based on this information and the concept of time value of money, comment on whether this is a profit generating project or not? Answer: If we forget about time value of money, then each year we have $2 million - $1 million = $1 million in net savings. Over 10 years it comes to $10 million. So, we invest $10 million now, and we will get $10 million in net savings over 10 years. However, if we take into account time value of money, net savings each year should be divided by some discount factor which means that net savings are less than $10 million. This project is not a good investment Diff: 3 Type: ES Page Ref: 25-27 Topic: 2.1. Introduction Skill: Applied Type: Quantitative 21 © 2017 Pearson Canada Inc. 12) Suppose that the nominal interest rate is 18%. Calculate the effective interest rate when interest is compounded: (i) Annually (ii) Semiannually (iii) Quarterly (iv) Monthly (v) Biweekly (vi) Weekly (vii) Daily (viii) Continuously Answer: Basic formula for (i) - (vii) is ie = - 1 where r is nominal interest rate and m is the number of sub-periods in the whole compounding period. Therefore: (i) Annually (m = 1): is = r = 0.18 or 18% (ii) Semiannually (m = 2): ie = - 1 = 0.1881 or 18.81% (iii) Quarterly (m = 4): ie = - 1 = 0.1925 or 19.25% (iv) Monthly (m = 12): ie = - 1 = 0.1956 or 19.56% (v) Biweekly (m = 26): ie = - 1 = 0.1965 or 19.65% (vi) Weekly (m = 52): ie = - 1 = 0.1968 or 19.68% (vii) Continuously: ie = er - 1 = 2.71820.18 - 1 = 0.1925 or 19.72% Diff: 2 Type: ES Page Ref: 25-27 Topic: 2.4. Effective and Nominal Interest Rates Skill: Applied Type: Quantitative 22 © 2017 Pearson Canada Inc. 13) A hydraulic press has just been purchased. It will have a book value of $6 465 in year 5. The present worth of its salvage value at the end of year 10 is $700, assuming a MARR of 7%. What is the purchase price of the press? Answer: We can set the following equations: P * (1 - d)5 = 6 465 P * (1 - d)10/1.0710 = 700 The second equation can be re-written as P * (1 - d)5 * (1 - d)5/1.0710 = 700 Substituting the first one into the last expression: 6 465 * (1 - d)5/1.0710 = 700 and solving for d, we find that d = 0.266 or 26.6% P can be found from the first equation as follows: P * (1 - 0.266)5 = 6 465 So P = $30 353 Diff: 3 Type: ES Page Ref: 168-171 Topic: 2.7. Depreciation Skill: Applied Type: Quantitative 14) If a new technology comes into existence which partially replaces some old technology, how will the loss in the value of the old technology be classified? Answer: This is an example of functional loss. The value of the old technology decreases because there is a better and cheaper way of producing services via the new technology. Diff: 1 Type: ES Page Ref: 165 Topic: 2.7. Depreciation Skill: Recall Type: Qualitative 15) Explain the difference between scrap value and salvage value. Answer: Scrap value is the value of an asset at the end of its physical life while salvage value is the value of an asset at the end of its useful life. Useful life can be shorter than or equal to, but never longer than an asset's physical life. Diff: 1 Type: ES Page Ref: 165 Topic: 2.7. Depreciation Skill: Applied Type: Qualitative 23 © 2017 Pearson Canada Inc. 16) It is known that the book value of an asset depreciated through declining balance depreciation is $3 000 in year 3. Purchase price of the asset was $3 800. What is the asset's salvage value at the end of its useful life, which is 10 years? Answer: First we can find the depreciation rate from d = 1 - = 0.0758 or 7.58% Salvage value at the end of the asset's life is its book value in year 10 or BV(10) = P * (1 - d)10 = $3 800 * (1 - 0.0758)10 = $1 727.60 Diff: 2 Type: ES Page Ref: 169 Topic: 2.7. Depreciation Skill: Applied Type: Quantitative 17) What is the major advantage and the major drawback of the straight line depreciation method? Answer: The straight-line depreciation method has the great advantage of being easy to calculate. It also is easy to understand and is in common use. The main problem with the method is that its assumption of a constant rate of loss in asset value is often not valid. Diff: 1 Type: ES Page Ref: 168 Topic: 2.7. Depreciation Skill: Recall Type: Qualitative 24 © 2017 Pearson Canada Inc. 18) Suppose that the purchase price of a piece of equipment is $1 million. Its salvage value at the end of its 5-year service life is $500 000. Depreciate this asset using straight line depreciation and declining balance depreciation. Answer: For Straight Line depreciation (SLD), we need to find the depreciation amount per year: = $100 000 Under SLD, the asset's value loses this amount per year. For Declining Balance Depreciation (DBD), we need to calculate the depreciation rate: d = 1 - = 0.129 For DBD, the asset loses 12.9% of its value per year. Now we can calculate the book value in each year under both methods. The results are summarized in the following table: SLD DBD BV(0) 000 BV(1) BV(2) BV(3) BV(4) BV(5) Diff: 2 Type: ES Page Ref: 166-171 Topic: 2.7. Depreciation Skill: Applied Type: Quantitative 25 © 2017 Pearson Canada Inc. 19) A piece of equipment has just been purchased. It is expected to have a 5-year service life and to depreciate via the declining balance method. The present worth of its salvage value is $1 000. If the depreciation rate is 10%,and the MARR is also 10%, what was the purchase price of this equipment? Answer: The following equation captures this P*(1 - 0.1 )5/1.15 = 1 000 where P is the purchase price of the equipment. Solving for P: P = 1 000 * = $2 727.41 Diff: 3 Type: ES Page Ref: 169 Topic: 2.7. Depreciation Skill: Applied Type: Quantitative 20) A machinist's lathe was purchased five years ago and, with installation and setup, has an initial cost of $250 000. It will have a salvage value of $20 000 three years from now. Assuming straight-line depreciation is a reasonable model, determine the current book value. Answer: BV(S) = BV(5) = 250 000 - 5[()/8] = 106 250 Diff: 2 Type: ES Page Ref: 19 Topic: 2.7. Depreciation Skill: Applied Type: Quantitative 21) If the book value of an item at the beginning of the first year is $20,000 and its useful life is 5 years, tabulate the depreciation deduction over the course of the first four years. After four years, what is the total of the interest that Jennifer will have received during that period? Assume a salvage value of $2000 and use the Single Declining Balance method. Answer: Note that the salvage value does not enter into the table: Year Bn-1 Dn Bn 16 000 12 800 10 240 8 192 Diff: 2 Type: ES Page Ref: 19 Topic: 2.7. Depreciation Skill: Applied Type: Quantitative 26 © 2017 Pearson Canada Inc. Engineering Economics, 6e (Fraser/Pirnia) Chapter 3 Cash Flow Analysis 3.1 Multiple Choice Questions 1) What is an annuity? A) a series of payments that changes by the same proportion from one period to the next B) a series of equal payments over a sequence of equal periods C) a series of payments that changes by a constant amount from one period to the next D) a single payment E) present worth of a series of equal payments Answer: B Diff: 1 Type: MC Page Ref: 51 Topic: 3.3. Compound Interest Factors for discrete compounding Skill: Recall Type: Qualitative 2) The present worth factor A) converts an annuity into the equivalent present amount. B) gives the future value equivalent to a series of equal payments. C) converts a series of repeated equal payments into the equivalent future amount. D) gives the present amount that is equivalent to some future amount. E) gives the future amount that is equivalent to a present amount. Answer: D Diff: 1 Type: MC Page Ref: 49 Topic: 3.4. Compound interest factors for single disbursements and receipts Skill: Recall Type: Qualitative 3) If the growth rate of a series is equal to 5% and annual interest rate is equal to 10%, what is the growth adjusted interest rate? A) +5.00% B) -5.00% C) +4.76% D) -4.76% E) +4.16% Answer: C Diff: 2 Type: MC Page Ref: 63 Topic: 3.7. Conversion factor for geometric gradient series Skill: Applied Type: Quantitative 1 © 2017 Pearson Canada Inc. 4) Five years ago John invested $10 000 at 5% nominal interest rate compounded daily. What is his investment worth today? A) $10 513 B) $11 763 C) $12 763 D) $12 840 E) $13 763 Answer: D Diff: 2 Type: MC Page Ref: 48 Topic: 3.4. Compound interest factors for single disbursements and receipts Skill: Applied Type: Quantitative 5) An arithmetic gradient series A) starts at zero at the end of the first period and then increases by a constant amount each period. B) starts at zero at the beginning of the first period and then increases by a constant amount each period. C) starts at zero at the end of the second period and then increases by a constant amount each period. D) starts at zero at the beginning of the second period and then increases by a constant amount each period. E) starts at zero at the end of the first period and then increases by an increasing amount each period. Answer: A Diff: 2 Type: MC Page Ref: 58 Topic: 3.6. Conversion factor for arithmetic gradient series Skill: Recall Type: Qualitative 6) Natalie received a gift of $1 000 from her grandmother. She decides to invest the money into a trip she wants to take when she graduates from college three years from now. What annual rate of return does she have to have to accumulate $1 250 by the time of her graduation? A) 7.7% B) 7.9% C) 8.4% D) 9.2% E) 12.5% Answer: A Diff: 2 Type: MC Page Ref: 49 Topic: 3.4. Compound interest factors for single disbursements and receipts Skill: Applied Type: Quantitative 2 © 2017 Pearson Canada Inc. 7) How much money will you accumulate in a bank account by the end of a 5-year period if you deposit $1 200 today at an interest rate of 2% per year, compounded quarterly? A) $1 230 B) $1 326 C) $1 514 D) $1 783 E) $1 849 Answer: B Diff: 3 Type: MC Page Ref: 49 Topic: 3.4. Compound interest factors for single disbursements and receipts Skill: Applied Type: Quantitative 8) One standard assumption for annuities and gradients is A) each payment occurs at the beginning of the period. B) annuities and gradients coincide with the beginning of sequential periods. C) annuities and gradients coincide with the end of preceding periods. D) payment period and compounding period differ. E) payment period and compounding period are the same. Answer: E Diff: 2 Type: MC Page Ref: 51, 58, 61 Topic: 3.5. Compound interest factors for annuities Skill: Recall Type: Qualitative 9) The compound amount factor produces A) the present amount, P, that is equivalent to a future amount, F. B) the future amount, F, that is equivalent to a present amount, P. C) the annuity, A, that is equivalent to a future amount, F. D) the annuity, A, that is equivalent to a present amount, P. E) the future amount of arithmetic gradient series. Answer: B Diff: 1 Type: MC Page Ref: 49 Topic: 3.4. Compound interest factors for single disbursements and receipts Skill: Recall Type: Qualitative 3 © 2017 Pearson Canada Inc. 10) If Emily deposits $500 every other year into her bank account that pays 1.5% annual interest, compounded yearly, how much will she accumulate over a 10-year period? A) $2 500 B) $2 568 C) $2 576 D) $2 656 E) $5 738 Answer: D Diff: 3 Type: MC Page Ref: 51-52 Topic: 3.8. Non-standard annuities and gradients Skill: Applied Type: Quantitative 11) The present worth of an infinitely long uniform series of cash flows is called A) capitalized value. B) salvage value. C) sinking value. D) compound value. E) continuous value. Answer: A Diff: 2 Type: MC Page Ref: 67 Topic: 3.9. Present worth of infinite annuity Skill: Recall Type: Qualitative 12) When is the growth-adjusted interest rate for a geometric series equal to zero? A) Growth is positive, but less than the interest rate. B) Growth is positive and greater than the interest rate. C) Growth is positive and equal to the interest rate. D) Growth is negative. E) Growth is positive. Answer: C Diff: 2 Type: MC Page Ref: 63 Topic: 3.7. Conversion factor for geometric gradient series Skill: Recall Type: Quantitative 4 © 2017 Pearson Canada Inc. 13) Suppose that you want to evaluate the following non-standard cash flow: $1 000 paid at the end of every third year in a 12-year period with annual interest rate of 10%. What is the best method? A) Convert the non-standard cash flow into standard annuity by changing the interest rate. B) Convert the non-standard cash flow into standard annuity by changing the compounding period. C) Convert the non-standard cash flow into arithmetic gradient series. D) Treat each payment as a separate payment. E) Convert the non-standard cash flow into a geometric gradient series. Answer: B Diff: 3 Type: MC Page Ref: 65 Topic: 3.8. Non-standard annuities and gradients Skill: Recall Type: Qualitative 14) A municipality has just completed the construction of a bridge. It was calculated that operating and maintenance (O&M) costs of this bridge will be $20 000 in the first year with a 5% increase each year ther