Test Bank for Engineering Economics Financial Decision Making for Engineers, 6th Edition

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Engineering Economics, 5e (Fraser)Chapter 1Engineering Decision Making1.1Multiple Choice Questions1) 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: ADiff: 1Type:MCPage Ref:3Topic: 1.1. Engineering decision makingSkill: RecallUser1: Qualitative2) Engineering economics isA) 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 severaltechnically 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: BDiff: 1Type:MCPage Ref:3Topic: 1.2. What is engineering economicsSkill: RecallUser1: Qualitative3) From an economic standpoint, any engineering project can be thought of in terms ofA) 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: ADiff: 1Type:MCPage Ref:3Topic: 1.2. What is engineering economicsSkill: RecallUser1: Qualitative

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4) In the context of your textbook, abstraction meansA) a study.B) a methodC) a methodologyD) a model.E) an approachAnswer: DDiff: 1Type:MCPage Ref:6Topic: 1.4. Dealing with abstractionsSkill: RecallUser1: Qualitative5) When an engineer prepares a feasibility study, what economic information must she possess in orderto do it correctly?A) engineering specificationB) expert opinion about this projectC) macroeconomic situation in the worldD) potential future costs and benefits of the projectE) the level of uncertaintyAnswer: DDiff: 2Type:MCPage Ref:6Topic: 1.4. Dealing with abstractionsSkill: AppliedUser1: Qualitative6) In which of the following problems do you need engineering economics?A) to choose a course in your programB) to chose the right textbookC) to decide whether to borrow money from parents or from a bankD) to decide whether or not to buy a carE) to decide where to spend summer vacationAnswer: CDiff: 2Type:MCPage Ref:6-8Topic: 1.4. Dealing with abstractionsSkill: AppliedUser1: Qualitative7) Which of the following statements best describes the moral issues faced by engineers whileevaluating projects?A) moral issues are clearly defined in engineering designB) moral issues do not matter as long as technical goals are achievedC) your employer is the only person who can define what is ethical or unethicalD) there are no general answers to moral questionsE) since moral issues are value judgements they must not be taken into considerationAnswer: DDiff: 3Type:MCPage Ref:9-10Topic: 1.5. The moral question: Three true storiesSkill: AppliedUser1: Qualitative8) The best way to find some answers to difficult moral questions in engineering design and project

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evaluation isA) 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: BDiff: 2Type:MCPage Ref:9-10Topic: 1.5. The moral question: Three true storiesSkill: RecallUser1: Qualitative9) Stan borrowed $5 000 one year ago. Now he has to repay $5 100. The interest Stan pays isA) $5 100B) 102%C) $100D) 2%E) $5 000Answer: CDiff: 2Type:MCPage Ref:6-8Topic: 1.4. Dealing with abstractionsSkill: AppliedUser1: Quantitative10) Joan borrowed $1 000 one year ago. Now she has to repay $1 100. Therefore, the interest rate shepays isA) $1 000B) $1 100C) $100D) 110%E) 10%Answer: EDiff: 2Type:MCPage Ref:6-8Topic: 1.4. Dealing with abstractionsSkill: AppliedUser1: Quantitative11) All but one of the following are economic criteria to evaluate an engineering project. Which one isthe non-economic criterion?A) maximum profitB) minimum costC) minimum pollutionD) maximum rate of returnE) minimum payback periodAnswer: CDiff: 2Type:MCPage Ref:2-6Topic: 1.2. What is engineering economicsSkill: AppliedUser1: Qualitative12) Analyze the following statement: "There is 50% probability of raining". This statement concerns

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A) extrapolation.B) risk.C) precise description.D) abstraction.E) expected scenario.Answer: BDiff: 2Type:MCPage Ref:11Topic: 1.6. Uncertainty, sensitivity analysis, and currenciesSkill: AppliedUser1: Qualitative13) To resolve uncertainty, engineers applyA) marginal analysis.B) cash-flow analysis.C) sensitivity analysis.D) risk analysis.E) economic impact analysis.Answer: CDiff: 2Type:MCPage Ref:11Topic: 1.6. Uncertainty, sensitivity analysis, and currenciesSkill: RecallUser1: Qualitative14) If you are asked to choose between $100 today and $150 one year from now, you are being asked toA) 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: BDiff: 3Type:MCPage Ref:6-8Topic: 1.4. Dealing with abstractionsSkill: AppliedUser1: Qualitative15) Which of the following items has negligible maintenance costs?A) computerB) buildingC) rulerD) shoesE) fur hatAnswer: CDiff: 2Type:MCPage Ref:6-8Topic: 1.4. Dealing with abstractionsSkill: AppliedUser1: Qualitative

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16) You decide to buy a car. The following are some questions you have to answer with respect to yourpurchase. 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: DDiff: 2Type:MCPage Ref:3Topic: 1.3. Making decisionsSkill: AppliedUser1: Qualitative17) 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 engineeringeconomics?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 underdifferent 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: CDiff: 3Type:MCPage Ref:3-6Topic: 1.4. Dealing with abstractionsSkill: AppliedUser1: Qualitative18) An owner of a small company is deciding to sell her business. She received several options specifiedbellow. Which one should the company's owner accept?A) $600 000 in cashB) $500 000 in government bonds earning a 5% rate of return over 10 yearsC) $400 000 in securities earning an 8% rate of return over 8 yearsD) 15% of the future profits earned by the next owner during first 10 yearsE) it is impossible to compare these offers due to uncertainty about basic economic variables over timeAnswer: EDiff: 3Type:MCPage Ref:3-6Topic: 1.4. Dealing with abstractionsSkill: AppliedUser1: Quantitative

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19) Suppose that you are asked to evaluate a project of building a new bridge. Which of the followingfactors is the least important in terms of engineering economics?A) service life of the bridgeB) value added by the bridgeC) cost structureD) vehicle stock in your cityE) current interest rateAnswer: DDiff: 3Type:MCPage Ref:3-6Topic: 1.4. Dealing with abstractionsSkill: AppliedUser1: Qualitative20) 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 returnB) $100 invested in a fund with a 10% annual rate of returnC) $200 government bond earning a 5% annual rate of returnD) $200 invested in a fund earning a 10% annual rate of returnE) $150 invested in a fund earning a 7% annual rate of returnAnswer: DDiff: 2Type:MCPage Ref:6-8Topic: 1.4. Dealing with abstractionsSkill: AppliedUser1: Quantitative21) Engineering economics is important becauseA) 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: CDiff: 2Type:MCPage Ref:4Topic: 1.2. What is engineering economicsSkill: RecallUser1: Qualitative22) 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: BDiff: 2Type:MCPage Ref:6Topic: 1.4. Dealing with abstractionsSkill: RecallUser1: Qualitative

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23) In engineering economics, sensitivity analysisA) 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: DDiff: 3Type:MCPage Ref:11-12Topic: 1.6. Uncertainty, sensitivity analysis, and currenciesSkill: RecallUser1: Qualitative24) Most of the economic values we use in our evaluation of engineering projects areA) precise and very descriptive.B) approximate.C) based on robust statistical estimation.D) derived from natural experiments.E) results of precise statistical surveys.Answer: BDiff: 2Type:MCPage Ref:11Topic: 1.6. Uncertainty, sensitivity analysis, and currenciesSkill: RecallUser1: Qualitative25) When we say "let us assume that economic agents are rational", in fact weA) 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: CDiff: 3Type:MCPage Ref:6Topic: 1.3. Making decisionsSkill: AppliedUser1: Qualitative1.2Short Answer Questions1) What is the subject matter of Engineering Economics?Answer: Engineering economics deals with techniques of quantitative analysis useful for selecting apreferable alternative from several technically viable ones. Its major objective is to allow an engineer todetermine which of several alternatives is economically best.Diff: 1Type:SAPage Ref:3Topic: 1.2. What is engineering economicsSkill: RecallUser1: Qualitative

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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 arepreferences, 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, whichmay not be verifiable, contribute to the politics and people, and indirectly to the preferences. At thebottom of the pyramid are the activities that contribute to the facts. These include the history of previoussimilar decisions, statistics of various sorts, and a determination of costs.Diff: 2Type:SAPage Ref:4-5Topic: 1.3. Making decisionsSkill: RecallUser1: Qualitative3) 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 selectsaspects of the real world that are relevant to that purpose. The process of simplifying the complexities ofthe real world is necessary for any engineering analysis. This process of simplification is calledabstraction or a model. Once a model is developed, it is used to analyze a situation, and perhaps makesome predictions about the real world. The analysis and the predictions are then related back to the realworld to make sure that the model is valid. The role of abstractions is to develop a viable mode of thereal world.Diff: 2Type:SAPage Ref:6Topic: 1.4. Dealing with abstractionsSkill: RecallUser1: Qualitative4) How should engineers address moral questions associated with economic evaluation of engineeringprojects?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 oftendifficult to determine what course of action is ethical. There are no general answers to difficult moralquestions. Practicing engineers often have to make choices with an ethical component, and cansometimes rely on no stronger foundation than their own sense of right and wrong. More informationabout ethical issues for engineers can be obtained from provincial professional engineeringorganizations.Diff: 1Type:SAPage Ref:8-10Topic: 1.5. The moral question: Three true storiesSkill: RecallUser1: Qualitative

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5) Suppose that you are about to start a new business: You will provide consulting services for thosewho want to launch their own web-sites. What major decisions based on the subject matter ofengineering 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, youhave to understand your final product and identify a market for that product. As a result, you will be ableto evaluate your expected revenues. This is known as demand-side analysis. On the supply side, youhave to understand all materials, efforts and services involved in producing and/or providing yourproduct. This will give you a cost structure. Then you have to define your planning horizon in order touse 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 somevariables involved, you have to use principles of sensitivity analysis. All this is the subject matter ofengineering economics.Diff: 3Type:SAPage Ref:3-5, 11Topic: 1.4. Dealing with abstractionsSkill: AppliedUser1: Qualitative6) As a University student, when you look for a new apartment, what economic criteria consistent withthe subject matter of engineering economics do you apply?Answer: You have to understand your budget in terms of cash inflows and outflows. Cash inflows mayinclude: a fellowship, a grant, a loan, an allowance provided by parents and others. Cash outflows toconsider are: costs of utilities, transportation cost, cost of textbooks, tuition fee, food expenses, andothers. As well, time should be explicitly introduced into your economic analysis. Therefore, forexample, a more expensive apartment closer to the University can be preferred to a cheaper one faraway, based on transportation costs.Diff: 2Type:SAPage Ref:3-5Topic: 1.3. Making decisionsSkill: AppliedUser1: Qualitative7) Suppose that in order to finance your studies at the University, three options are available to you: (i) astudent loan, (ii) a student line of credit, and (iii) a part-time job at minimum wage. In making yourdecision, 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 associatedwith borrowing and it is necessary to compare them. In general, a student loan is interest-free as long asyou stay in school, while a student line of credit is not interest-free. It means that the costs of borrowingassociated with a student loan are lower. Of course, earning your own money is a good option since youavoid paying costs of borrowing. On the other hand, if you work you forgo opportunity to spend thistime on your studies. There are some costs associated with that opportunity, called opportunity costs. Ifthe opportunity costs of working exceed the costs of borrowing under student loan, then the latter is thebest option. Otherwise, working is a better option.Diff: 3Type:SAPage Ref:3-7Topic: 1.3. Making decisionsSkill: AppliedUser1: Qualitative

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8) List at least three non-economic factors (attributes) that may be used as evaluation criteria in thedecision-making process.Answer: Non-economic factors are mainly associated with social, environmental and politicalconstraints. Examples are:-Results of new elections;-Introduction of a new welfare program;-Introduction of new environmental standards.Diff: 1Type:SAPage Ref:4-6Topic: 1.3. Making decisionsSkill: AppliedUser1: Qualitative9) 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'tearn money at the minimum rate required by the company, it should not be done. The decision makertherefore has to be aware of the financial constraints on the problem. In addition, an engineering projectcan meet all other criteria, but may cause detrimental environmental effects, so we must also considerenvironmental constraints. Finally, any project can be affected by social and political constraints.Diff: 2Type:SAPage Ref:3-6Topic: 1.3. Making decisionsSkill: RecallUser1: Qualitative10) Every year Stan takes a Canada student loan of $5 000 to pay his tuition fees at the University. Theloan 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 $25 000 for five yearsfor free. If this money were invested in a mutual fund or in financial securities, it would earn somereturn. Or if Stan borrowed the money from a commercial bank, he would pay interest payments toservice his debt. Student loan has no borrowing costs.Diff: 2Type:SAPage Ref:3-6Topic: 1.3. Making decisionsSkill: AppliedUser1: Quantitative11) If you decide to buy a home, list basic economic and non-economic factors you have to take intoaccount and rank themAnswer: You need to know the price of a home, current mortgage rate,potential duration of themortgage and your own current and expected income. Those are fundamental economic factors. Non-economic factors may include: location, environmental quality, and safety.Diff: 2Type:SAPage Ref:3-6, 11Topic: 1.6. Uncertainty, sensitivity analysis, and currenciesSkill: AppliedUser1: Qualitative

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12) Suppose that a local government decides to build a bridge. In order to justify this project, economistswant to ask people directly about their willingness to pay for the bridge. Using the discussion in yourtextbook, 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 subjectivemeasure; (ii) it will require a lot of data and comprehensive statistical analysis to evaluate totalwillingness to pay for the bridgeDiff: 3Type:SAPage Ref:6-7Topic: 1.4. Dealing with abstractionsSkill: AppliedUser1: Qualitative13) You were notified by an economics expert that the total costs of a project you are about to start areapproximately $50 000. In order to justify this project, what additional economic information do youneed?Answer: First of all, it is necessary to understand what this value includes. Usually costs are dividedinto capital costs and operating costs and those are two different types of costs. Second, it is necessary tounderstand whether or not the value of total costs is given as of today or at some other time. Finally, thebenefits of the project should be evaluated to compare them with total costs.Diff: 1Type:SAPage Ref:3-4Topic: 1.3. Making decisionsSkill: RecallUser1: Qualitative14) 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 engineeringequipment. For the following items, describe how important the maintenance costs are compared to theitem's price:(i)A tractor(ii)A desk(iii)A computer(iv)An oil pumpAnswer: The maintenance costs of a tractor, computer and oil pump are important. Particularlymaintenance costs of a tractor are very important since the quantity and quality of the services, producedby the tractor, depend on these costs. To lesser extent maintenance costs are important in case of oilpump and computer. Maintenance costs of a desk are not important because they are very low, and havelittle effect on the services provided by the desk.Diff: 1Type:SAPage Ref:3-6Topic: 1.3. Making decisionsSkill: AppliedUser1: Qualitative

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15) Suppose that you want to buy a used car for $3 000, but you don't have enough cash. List some ofthe (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: 2Type:SAPage Ref:3-6Topic: 1.3. Making decisionsSkill: AppliedUser1: Qualitative

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Engineering Economics, 5e (Fraser)Chapter 2Time Value of Money2.1Multiple Choice Questions1) The price of money can be captured throughA) the difference between benefits and costs that occur at different times.B) the future worth of an investment.C) the present worth of an investment.D) the interest rate.E) the consumer price index.Answer: DDiff: 1Type:MCPage Ref:19Topic: 2.2 Interest and Interest RatesSkill: RecallUser1: Qualitative2) What makes one dollar in the future less desirable than one dollar today?A) variable interest rateB) a forgone opportunity of investmentC) a diminishing purchasing power of money over timeD) a growing inflationE) accumulated welfare of peopleAnswer: BDiff: 1Type:MCPage Ref:20Topic: 2.2 Interest and Interest RatesSkill: RecallUser1: Qualitative3) The principal amount isA) 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: ADiff: 1Type:MCPage Ref:20Topic: 2.3 Compound and Simple InterestSkill: RecallUser1: Qualitative

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4) Bill wants to buy a new car in three years from now. He expects that the price of a car will be $15 000in three years. How much money should Bill put in his savings account now if a bank pays 5% interestrate on this account?A) $11 629B) $12 104C) $12 958D) $13 465E) $14 286Answer: CDiff: 2Type:MCPage Ref:21Topic: 2.3 Compound and Simple InterestSkill: AppliedUser1: Quantitative5) 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 ofthe financial problems at the time. Milo calculated that the interest rate thebank would pay on hisinvestment certificate would allow him to accumulate the $7 600 he would need over 4 years. Whatinterest rate does the bank pay?A) 2.0B) 2.5C) 3.0D) 3.5E) 4.0Answer: EDiff: 2Type:MCPage Ref:21Topic: 2.3 Compound and Simple InterestSkill: AppliedUser1: Qualitative6) It is known that the total interest paid over a 5-year period is $2 081.13. What was the principalamount borrowed at a 6% nominal interest rate compounded quarterly?A) $3 000B) $4 000C) $5 000D) $6 000E) $7 000Answer: DDiff: 3Type:MCPage Ref:26-27Topic: 2.3 Compound and Simple InterestSkill: AppliedUser1: Quantitative

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7) Nominal interest rate is calculated byA) 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 peryear.Answer: EDiff: 2Type:MCPage Ref:26Topic: 2.4 Effective and Nominal Interest RatesSkill: RecallUser1: Qualitative8) Your credit card statement says that your card charges 0.0562% interest per day. What is the actualinterest rate per year?A) 11.6%B) 14.5%C) 18.3%D) 20.1%E) 22.8%Answer: EDiff: 2Type:MCPage Ref:26Topic: 2.4 Effective and Nominal Interest RatesSkill: AppliedUser1: Quantitative9) 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: BDiff: 2Type:MCPage Ref:25Topic: 2.4 Effective and Nominal Interest RatesSkill: AppliedUser1: Quantitative

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10) How many compounding periods are needed to obtain an effective interest rate of 25% if the interestrate per sub-compounding period is 1.88%?A) 13B) 12C) 11D) 10E) 9Answer: BDiff: 2Type:MCPage Ref:26Topic: 2.4 Effective and Nominal Interest RatesSkill: AppliedUser1: Quantitative11) What does a cash flow diagram of a project represent?A) summary of benefits and costs of a projectB) summary of the timing and magnitude of payments and receipts as they occur over timeC) magnitude of cash flows at a given period of timeD) summary of present, future,and annual worths of a projectE) change in value of money at different interest rates at various compounding periodsAnswer: BDiff: 2Type:MCPage Ref:29-31Topic: 2.6 Cash Flow DiagramsSkill: RecallUser1: Qualitative12) A project is represented by the following cash flow diagram:What are the project's cash flows?A) receipts = $45 000; disbursements = $25 000; project life = 6 yearsB) receipts = $35 000; disbursements = $45 000; project life = 6 yearsC) receipts = $45 000; disbursements = $35 000; project life = 6 yearsD) receipts = $45 000; disbursements = $35 000; project life = 7 yearsE) receipts = $35 000; disbursements = $45 000; project life = 7 yearsAnswer: CDiff: 2Type:MCPage Ref:29-31Topic: 2.6 Cash Flow DiagramsSkill: AppliedUser1: Quantitative

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13) J.D.Irving Ltd. is considering a construction project with $2 million initial investment that will lastfor 10 years. The duration of the construction phase is one year. Once the construction is over, theproject starts yielding a constant annual revenue of $1.0 million. By the end of the fifth year the projectgenerates $0.5 million extra revenue. The annual operation and maintenance expenses of $0.5 millionwill start at year four and last till the end of the project's life. At the very end of the 10-yearproject theused equipment can be sold for $1.5 million. What cash flow diagram represents this project?A)B)C)D)

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E)Answer: BDiff: 3Type:MCPage Ref:29-31Topic: 2.6 Cash Flow DiagramsSkill: AppliedUser1: Quantitative14) What does the term "market equivalence" imply?A) indifference on the part of a decision maker among available choicesB) the existence of a mathematical relationship between time and moneyC) the ability to exchange one cash flow for another at minimum costD) the ability to exchange one cash flow for another at no costE) the ability to obtain a zero net cash flowAnswer: ADiff: 2Type:MCPage Ref:32Topic: 2.7 EquivalenceSkill: RecallUser1: Qualitative15) You invest $10 000 at 5% interest rate compounded monthly, what is your accumulated interest atthe end of year 2?A) $511.62B) $537.79C) $1 025.00D) $1 049.41E) $1 089.41Answer: DDiff: 2Type:MCPage Ref:26-27Topic: 2.3 Compound and Simple InterestSkill: AppliedUser1: Quantitative

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16) You would like to have $8 500 for future spending in three years from now. How much should youdeposit in your bank account now if the account pays you 0.4% interest per month?A) $2 071B) $7 362C) $8 102D) $8 399E) $8 429Answer: BDiff: 3Type:MCPage Ref:35Topic: 2.3 Compound and Simple InterestSkill: AppliedUser1: Quantitative17) 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: EDiff: 1Type:MCPage Ref:27Topic: 2.4 Effective and Nominal Interest RatesSkill: AppliedUser1: Quantitative18) Emily is considering two mutually exclusive financial options: (i) to deposit $4 000 in her bank'ssavings account that pays 4.6% annual interest, or (ii) to purchase a $4 000 one-year guaranteedinvestment certificate with a monthly interest rate of 0.3%. From an opportunity cost standpoint, bymaking the decision to deposit $4 000 in the bank account, Emily willA) 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: ADiff: 3Type:MCPage Ref:32-34Topic: 2.1 IntroductionSkill: AppliedUser1: Quantitative

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19) If you borrow $2 000 today at 20% interest rate for 5 years, what is your simple interest in this case?A) $2 000B) $4 000C) $4 976.64D) $976.64E) $2 976.64Answer: ADiff: 1Type:MCPage Ref:24Topic: 2.3 Compound and Simple InterestSkill: AppliedUser1: Quantitative20) 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: CDiff: 3Type:MCPage Ref:27Topic: 2.4 Effective and Nominal Interest RatesSkill: AppliedUser1: Quantitative21) Equivalence is a condition that exists whenA) the value of a cost at one time is numerically equal to the value of the related benefits received at adifferent 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 anypoint 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: EDiff: 1Type:MCPage Ref:32Topic: 2.7 EquivalenceSkill: RecallUser1: Qualitative

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22) A project has the timing illustrated by the following cash flow diagram:Which of the following statements about this cash flow diagram is correct?A) Year 1 ends at point A and year 2 begins at point B.B) Year 1 ends at point 2 and year 2 begins at point B.C) Year 1 ends at point 2 and year 2 begins at point 2.D) A project has four periods.E) First cost should be put at point 1.Answer: CDiff: 1Type:MCPage Ref:29-31Topic: 2.6 Cash Flow DiagramsSkill: AppliedUser1: Quantitative23) An effective interest rate hasA) an arbitrary compounding period.B) a compounding period that is normally less than a year.C) an exogenously given compounding period.D) a one-year compounding period.E) no compounding periods.Answer: ADiff: 1Type:MCPage Ref:26Topic: 2.4 Effective and Nominal Interest RatesSkill: RecallUser1: Qualitative24) Jennifer lends $2 000 to her friend who is launching a small business. Her friend promises to pay her9% per year compounding interest. How much interest would Jennifer get at the end of four years?A) $823B) $1 284C) $1 892D) $2 324E) $2 823Answer: ADiff: 2Type:MCPage Ref:24Topic: 2.3 Compound and Simple InterestSkill: AppliedUser1: Quantitative

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25) At some point in time Peter had $3 000 inspare cash. He deposited this money in his bank accountthat pays a 1.1% annual interest rate. After one year he was approached by his friend who said that hecould offer Peter an investment deal for a two-year period. What would the market equivalence be ofPeter's money?A) $3 000B) $3 033C) $3 066D) $3 100E) $3 133Answer: DDiff: 3Type:MCPage Ref:32-33Topic: 2.3 Compound and Simple InterestSkill: AppliedUser1: Quantitative26) In general, an interest rate isA) the difference between the amount of money lent and the amount of money repaid later.B) a percentage change in the time value of money.C) the ratio of the amount of money lent to the amount of money repaid later.D) the future worth of the money.E) the rate of return on direct investment.Answer: ADiff: 1Type:MCPage Ref:20-21Topic: 2.2 Interest and Interest RatesSkill: RecallUser1: Qualitative27) Nominal interest rate isA) 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: CDiff: 1Type:MCPage Ref:26Topic: 2.4 Effective and Nominal Interest RatesSkill: RecallUser1: Qualitative

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28) If the effective equivalent annual interest rate is 16.2%, and interest is compounded daily, what isthe corresponding nominal annual interest rate?A) 11%B) 13%C) 15%D) 17%E) 19%Answer: CDiff: 3Type:MCPage Ref:26Topic: 2.4 Effective and Nominal Interest RatesSkill: AppliedUser1: Quantitative29) If you borrow $1 000 now at 10% interest for 5 years, what is the compound interest owed at the endof the fifth year?A) $1 000B) $1 100C) $1 610.51D) $610.51E) $500Answer: DDiff: 2Type:MCPage Ref:24-25Topic: 2.3 Compound and Simple InterestSkill: AppliedUser1: Quantitative30) Suppose that you just paid $9.91 monthly interest compounded daily on an outstanding balance of$1 000 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: DDiff: 3Type:MCPage Ref:26Topic: 2.4 Effective and Nominal Interest RatesSkill: AppliedUser1: Quantitative

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31) Suppose the nominal rate is 10% per year and interest is compounded every two years. Use Equation2.4 to calculate the effective annual rate.A) 4.88%B) 9.54%C) 10.25%D) 21%E) 44%,Answer: BDiff: 3Type:MCPage Ref:26Topic: 2.4 Effective and Nominal Interest RatesSkill: AppliedUser1: Quantitative32) If the nominal annual interest rate is 10% and interest is continuously compounded, what is theeffective annual interest rate?A) 9%B) 9.52%C) 10.52%D) 11%E) 11.52%Answer: CDiff: 2Type:MCPage Ref:28Topic: 2.5 Continuous CompoundingSkill: AppliedUser1: Quantitative33) If the effective annual interest rate is 10% and interest is continuously compounded, what is thenominal annual interest rate?A) 9.00%B) 9.53%C) 10.53%D) 11.53%E) 12.53%Answer: BDiff: 3Type:MCPage Ref:28Topic: 2.5 Continuous CompoundingSkill: AppliedUser1: Quantitative

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34) You have $100 to deposit. Bank A offers 20% simple interest, Bank B offers 15% interestcompounded annually. How many years would you have to keep your money in the bank for Bank B tobe a better choice than Bank A?A) Bank B is always better.B) 4 yearsC) 5 yearsD) 6 yearsE) Bank B will never be better.Answer: CDiff: 2Type:MCPage Ref:22Topic: 2.3 Compound and Simple InterestSkill: AppliedUser1: Quantitative35) 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 forBank B to be a better choice?A) Bank B is always better.B) 4 yearsC) 5 yearsD) 6 yearsE) Bank B is never better.Answer: ADiff: 2Type:MCPage Ref:27Topic: 2.4 Effective and Nominal Interest RatesSkill: AppliedUser1: Quantitative36) 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, compoundedmonthly. At the end of ten years, how much more interest will you owe if you borrow from Bank Binstead of Bank A?A) $74.59B) $92.50C) $113.30D) $137.39E) $148.12Answer:CDiff: 2Type:MCPage Ref:22-24Topic: 2.4 Effective and Nominal Interest RatesSkill: AppliedUser1: Quantitative

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37) 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 youa free cell phone, valued at $100, if you do business with them. What is the longest duration of the loanfor which Bank B would be a better choice?A) 10 yearsB) 15 yearsC) 20 YearsD) 25 yearsE) 30 yearsAnswer: DDiff: 2Type:MCPage Ref:22-24Topic: 2.4 Effective and Nominal Interest RatesSkill: AppliedUser1: Quantitative2.2Short Answer Questions1) 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 x (1 +i)2= 2 000 andi= 15.5%.Diff: 1Type:SAPage Ref:32-33Topic: 2.7 EquivalenceSkill: AppliedUser1: Quantitative2) When you borrow money from your bank, you paya higher interest rate on that money comparedwith the interest rate offered on money in your savings account. How is this circumstance consistentwith principles of engineering economics?Answer: This situation means that the interest rate associated with borrowing is higher than the oneassociated with saving. When you borrow, you convert future worth into present worth. However, whenyou save you convert present worth into future worth. As this example shows, conversion from presentto future worth and vice versa in real life is not the same. This is inconsistent with market equivalence inengineering economics. Market equivalence is based on the idea that there is a market for money thatpermits cash flows in the future to be exchanged for cash flows in the present and vice versa at the sameinterest rate.Diff: 1Type:SAPage Ref:32-33Topic: 2.7 EquivalenceSkill: RecallUser1: Qualitative

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3) Stan has invested $1 000 into mutual fund at a 5% annual rate of return, compounded daily. What arethe nominal and effective interest rates in this case? Discuss how these two interest rates affect Stan'sinvestment?Answer: The 5% annual rate of return is a nominal interest rate. The effective interest rate is the actualrate used in financial calculations. In order to convert the 5% nominal interest rate into effective interestrate, we have to use the following formula:ie== 0.05127 or 5.127%.Therefore, when calculating the real return on his investment, Stan should use 5.127% interest rateinstead of 5%.Diff: 2Type:SAPage Ref:26Topic: 2.4 Effective and Nominal Interest RatesSkill: AppliedUser1: Qualitative4) Mary just earned $1 000 and wants to invest the money in Canada Savings Bonds. These bonds pay a3% annual interest rate and have a ten-year maturity period. How much interest will Mary receive at thebonds' maturity? In addition, compute simple interest and compare with actual interest.Answer:By the end of tenth year, $1 000 at 3% annual interest rate will become1 000 x (1 + 0.03)10= $1 343.92 and therefore, the accumulated interest is$1 343.92-1 000 = $343.92.It is also possible to directly apply the formula (2.2) on page 23 for compound interest rateIc= P(1 +i)N-P = 1 000 x (1 + 0.03)10-1 000 = $343.92Simple interest can be defined asIs= PiN = 1 000 x 0.03 x 10 = $300 (formula on page 24)Real interest is larger by $43.93Diff: 2Type:SAPage Ref:24Topic: 2.3 Compound and Simple InterestSkill: AppliedUser1: Qualitative

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5) Suppose that the effective interest rate associated with a VISA credit card is 20.9% whilethe nominalinterest 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 ratershouldbe used in this case:ie=-1 wheremis the number of compounding periods per year.Plugging in values ofieandr0.213 =-1 and solving formby trial and error:Tryingm= 2(semiannual), 4 (quarterly), 12 (monthly) and 365 (daily) compounding, it turns out thatm= 365 or nominal interest rate of 18.9% is compounded daily.Diff: 3Type:SAPage Ref:25-27Topic: 2.4 Effective and Nominal Interest RatesSkill: AppliedUser1: Quantitative6) Paul just bought a car for $15 000 and paid in cash. Calculate Paul's opportunity cost as "funds tied upin the car" if you know that otherwise it was possible to invest the money at a 5% annual interest ratecompounded monthly for five years.Answer: Opportunity cost in this case is the money forgone as a result of the car purchase, which isforgone interest. If this sum of money was invested under the specified conditions, it would earn thefollowing interest in five yearsIc= P(1 +ie)N-Pwhere ie is the effective interest rate. In this case, the effective interest rate isie== 0.05116 or 5.116%.Therefore, interest forgone isIc= 15 000 x (1+0.05116)5-15 000 = $4 250.21Diff: 3Type:SAPage Ref:23-24Topic: 2.4 Effective and Nominal Interest RatesSkill: AppliedUser1: Quantitative7) 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:ie=(1 +0.03/365)365-1 = 0.03045 or it is 3.045%. Interest is given by the difference between future worth ofthe investment and its present worth which is $1 000 * (1 + 0.003045)-$1 000 = $30.45.Diff: 2Type:SAPage Ref:25-27Topic: 2.4 Effective and Nominal Interest RatesSkill: AppliedUser1: Quantitative

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8) Maria borrowed $2 000 for five years at a simple interest rate of 6% per year. How much money willMaria repay at the end of five years?Answer: Simple interest rate is a method of computing interest where interest earned during an interestperiod is not added to the principal amount used to calculate interest in the next period (p. 23).Therefore, the interest for each of five years isInterest per year = 2, 000 x 0.06 = $120/yearTotal interest = 120 x 5 = $600The amount due after five years = 2 000 + 600 = $2 600.Diff: 1Type:SAPage Ref:24Topic: 2.3 Compound and Simple InterestSkill: AppliedUser1: Quantitative9) Explain why equivalences are just convenient assumptions. Give examples of two real world financialsituations in which these equivalences do not holdAnswer: Equivalences are needed to calculate and compare different costs and benefits over time. Theyare simplifications which capture the basic properties of cash flows without over-complicating theproblem. They may not hold precisely true in the real world. For example, we borrow at a higher interestrate compared to savings. It means that in real life when we move along a time line in a cash flowdiagram we might see different rates moving in two different directions; however, equivalences assumethat the rate is the same. Another example is the cost of information. We assume (until Chapter 12) thatinformation is free, while in real life information is costly.Diff: 3Type:SAPage Ref:32-34Topic: 2.7 EquivalenceSkill: AppliedUser1: Qualitative

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10) A transportation company just bought a new truck for $25 000. The service life of the truck is sevenyears. The company has to pay a $100 registration fee at the beginning of every year plus maintenancecosts of $1 000 in the first year and$200 at the beginning of the second year. At the end of the truck'sservice life, it will be sold at 10% of its purchase price. Construct a cash flow diagram from thecompany's perspective.Answer:Diff: 2Type:SAPage Ref:29-31Topic: 2.6 Cash Flow DiagramsSkill: AppliedUser1: Quantitative11) 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 ofcontinuous compounding is smaller the briefer the discrete compounding period is". Do you agree ordisagree with this statement and why?Answer: This statement is correct. With an increase in the number of discrete time periods, the errordecreases. This can be seen by comparing two effective interest rates—compounded daily andcontinuously compounded—using the same nominal interest rate. In this case, the error is negligible.Diff: 2Type:SAPage Ref:28-29Topic: 2.5 Continuous CompoundingSkill: AppliedUser1: Qualitative12) Joan is deciding whether she should remodel her house now or one year from now. If she does itnow, the cost will be $1 500. If she waits one year, the cost is expected to be $1 600. At current interestrate 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 x (1+0.056) = $1 584 one year from now.This is less than $1 600 and therefore Joan should remodel her house now.Diff: 1Type:SAPage Ref:32Topic: 2.3 Compound and Simple InterestSkill: AppliedUser1: Quantitative

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