‘CHAPTER 4: TIME VALUE OF MONEY ‘QUESTIONS AND PROBLEMS ‘The time value of money concept can be defined as 'A. The time in your life when you receive an inheritance. 1B. The relationship between money epent versus money received ©. The relationship between a dollar to be received in the future and a dollar today. 1D. Therelationship of interest rate stated and amount paid. E, None of the above c SIMPLE INTEREST AND COMPOUND INTEREST [A firm borrows $1,000 at 8 percent simple Interest with all payments due at the ‘end of four years. What amount must be repaid? A.$1,150, B 81,660. ©. $1470, D $1320, None of the above. D 1 you have a choie to earn simple interest on $10,000 for three years at 8% or ‘compound interest at 7.5% for thre years which one will pay more and by how much? A, Simple interest by $50. BB. Compound intarest by $52. ©. Compound intrest by $23. D. Simple interest by $30. E, None ofthe above ceimple inter- ‘You deposit $1,000 into a bank account. Ifthe bank pays 4 percent ‘et, how much will you accumulate in your account afer 10 years? A. $1,400 B SL40, 81500, D.s1560 . Nove of the above A ‘You deposit $1,000 into a bank sccount. Ifthe bank pays 4 percent compound Interest, how much will you accumulate in your acount after 10 years? A. $1,380. B $1250, © si.so, D. isso, , Note of the above c FUTURE VALUES ‘A creit Union recently advertised an investment certificate tat pays 1.7596 inthe first year, 2.25% inthe second year, 2.75% in the third yea, 8.25% in the fourth year and 5.25% inthe fifth and final year. If you invest $10,000 inthis investment ‘cetiicate and hold it to maturity, how much will you have atthe etd of ive years? A 817,561.94 B. $15,205.85, $13,890.20. D. $11,616.94 None of the above, D Suppose someone invests $1,000 today fora five-year term and rece'ves 10 percent ‘annual compound interest. How much would the investor have ater five years?A. $1,550.42 B. $1,810.51 © s177025, D. $1,980.78. E. None ofthe above. B ‘You have deposited $1,500 in an account thet promises to pay 8% compounded quarterly for the next five years. How much wil you have in the account at the end? A. $1,508.33, B. $2,020.92 ©. $272858, D. $3,303.00 E. None ofthe above. c PRESENT VALUE OF A SINGLE FUTURE CASH FLOW 9. An investor estimates that she needs $1 milion to live comfortably when she re- tires in 40 years. How much does she have to invest today, assuming a 10 percent interest rate on the investment? A. $22,043, B. $22,660.85. © 823,7062. D. $24,980.33. E, None ofthe above. A FINDING THE RATE OF INTEREST 10. An investment of $500 today will grow to $1,500 atthe end of 1D years. What is the effective annual interest rate at which compounding takes place? 4A 10.512%, B. 12.50%, 13.2259 D.11612% E. None ofthe above. D 11, You are considering « one-year investment. If you put up $1,250, you would get back 81,350. What rate is this investment paying? BAS f ofthe above. © ppm # PRESENT VALUE OF A STREAM OF CASH FLOWS 12. You have just graduated and need money to buy a new ear. Your rich Uncle Henry will end you the money so long as you agree to pay him back within four years, and you offer to pay him the rate of interest that he would otherwise get by puting his money in savings account. Based on your earnings and living expenses, you tink you will be able to pay him $5,000 in one year, and then $8,000 each year for the next three years. If Unloe Henry would otherwise earn (6% per yearon his savings, how mich can you borrow fot him? A. $21,550.94 B. $22'66038. ©. $23,770.02, D. s24.980.s, E, None ofthe above D PRESENT VALUE OF AN ANNUITY18. Suppose you are examining an aset that promise to pay $500 at the end ofeach year for the next three years. The cash flows from this asset are in the form of @ three year, $500 annuity. If you wanted to earn 10 percent on your money, how ‘much would you offer for this annuity? A. $1,243.50. B 8187655, ©. $1,485.98, D. $1455.25. E None ofthe above, A 14. An annuity pays $3,000 per year at year end and earns an annual return of 12 percent per year for 30 years. What isthe present value of this annuity? A. $18,165.56. B. $19,865.20. C.$01,88476. D. $24,165.55. None ofthe above D 15. A court settlement awarded an accident victim four payments of $50,000 to be ‘pid at the end of each of the next four years. Which of the fllowing armounts is losest to the current value ofthese payments? The appropriate discount rate is ‘an effective annual rate of 4%, A. $181,390, B. $210,095. $170,495, D. $199,020, E. None ofthe above. A 16. You discover that you are the lucky winner of the $30 milion prize. You can take your prize money in 30 payments of $1 million per year (starting today). If 61, 18, 19. the interes: rate is 8%, what isthe present value of these payments?” A. $10.50 milion, B $1216 nilion ©. $13.25 nilio, D.$1435 nilion, E. None ofthe above FUTURE VALUE OF AN ANNUITY Ellen just turned 35 years old, and she bas decided i i time to plan seriously {or ber retirement. On each birthday, begining in one year and ending when she ‘turns 65, she will sve $10,000 in an RRSP account. If the account earns 10% per ‘year, how much will Ellen have saved at age 657 ‘A. $1.950 million B. 81.764 milion, $1,645 milion, D. $1,850 milion, E. None of the above c ‘A person plans to retire in 10 years and, through annual sevings, wants to build her wealth to $100,000 by that time. Money can be invested to yield interest of 14 percent per year. How much will she have to set aside at :he end ofeach af the ‘ext 10 years in order to achieve her objective? A. $2,866.22. B 83,225.67. $4870.44 D. $5,171.35. E. None ofthe above. D Sappose you plan to contribute $2,000 every year into a Registered Retirement Sevings Pian (RRSP) paying 8 percent. Ifyou retire in 30 years, how much will 7a1. you have? A. $240 879.40. B. $226,367.60 : $308,376.66. D. $206,560.00. E, None ofthe above B How much must be saved annually, begining one year from now, in order to sccumulate $5000 over the next 10 years, earning 9% annually? A. $3,201, B. 83587, ©. $4,500, D.ses87. E. None ofthe above A PRESENT VALUE OF A PERPETUITY ‘A bank wil pay you $100 a year for your lifetime if you deposit $2,500 in the ‘bank today. Ifyou plan to live forever, what interest rate is the bank paying? Aa B 6%, Om, Dink. E None ofthe above, A I the interest is 7 percent, what isthe value of an investment that offers you ‘8100 a year in perpetuity with the payment at the beginning of each yer. A. $1,428.57. B. $1,62857. .$1,72857.D. $1,528.57. E. None ofthe above D PRESENT VALUR OF A GROWING PERPETUITY, ‘Aunt Clarise has promised to leave you $60 a year starting next year and have it Imcreaoe at 4% a year thereafter. The payments are expected to go.on indefinitely. How much has Aunt Clarisse lee you if your opportunity costs 9%. A. $693.33 B. $1,300.00, : $1,200.00. D. 866087. E. None ofthe above, c ‘You own an oi pipeline which will generate a $2 million cash turnover the com- ing yea. The pipeline's operating costs are negligible, and it is expected to last for ‘8 very long time. Unfortunately the volume of oil shipped is delining, and cash flows are expected to decline by 4 percent per year. The discount rates 10 percent, What is the present value (PV) of the pipeline’ cash Rows if its cash flows are assumed to last forever? A. $1745 milion. B.$1429 milion ©. $18.78 million D. $15.64 million E. None of the above B ‘You planned to donate money to your university to fund an ancual $90,000 grad uation party. Before accepting the money, however, the president of the student association bas asked that you increase the donation to accoust forthe effect of inflation on the cost ofthe party in future years. Although $3,000 inadequate for next year’s party, the president estimates that the party's cont wil rise by 4% °ber year thereafter. To satisfy the president's request, how much do you need to donate now ifthe interest rate is 8% per year? ‘A. $750,000. B. $864,000 ©. s710,000. D. $650,000. E. None ofthe above, A PRESENT VALUE OF A GROWING ANNUITY 26. You have jst been offered a job at $50,000 a year. You anticipate your salary. Increasing by 5 percent a year until retirement in 40 years. Given an interest rate (f 8 percent, what is the present value of your lifetime salary? ‘A. $1,126,60567 B. 83.245 80030. ©. $4356,67576 D. $1,459,998 95, E. None ofthe above A ‘A sports team in an effort to solve the salary cap problem has offered a player 8 contract of $1 million dollars a year forthe next season withthe payments growing at 7% per year for the next 25 years. The player believes the discount rate for such payments is 13%. What is the value today of taking this contict? ‘A. $12,405,955.40. B, $16,606,665.67. : $884,956.00, D. $5,824,965 76. None of the above. A EFFECTIVE ANNUAL RATES AND MORTGAGES 1028, Lenny Loanshark charges 1 percent per week on his loans. Astume there are cexectly 52 weeks ina year. What isthe effective annual rate? A. 225%, B 38955, c.6777% D. 720%, B. None ofthe above, c 29, I you take out a 4-year $8,000 car loan that calls for monthly payments at an ‘annual percentage rate (APR) of 10 percent, compounded monty, what is your ‘monthly payment? A. $170.05 B. $180.20 ©. $240.40, D. $202.90, E. None ofthe above. D ‘30. Charles Carr borrowed $3,500 to consolidate his debts. Since Charles had an ex- cellent credit rating, he was able to borrow at a 12% effective annual rate. Charles {is required to make monthly payments. Charles will make equal payments for the next 36 months, Which one of the following values is closest to his monthly payments? A 812134 B si2255. c.$5.24 D. $118.98, . None ofthe above, c 31. As a lender, you know you want to actually earn 18% effective annual rate on ‘particular Ioan. You want to quote arate that features monthly compounding, uWhat rate would you quote? A. 15.4% Blas2%, C.17.38%, D. 16.63% None ofthe aboe. D ‘What effective annual interest rate (EAR) is being earned on a deposit of $5,000, ‘made ten years ago today if the deposit is worth $9,948.94 today? The deposit ayes interest semi-annually. A 356%. B.6.76%, 7.008% D. 8.00% B. None ofthe above. c If the compound period is greater than one: ‘AT efctivn anal nae te a loa oul tothe annual pecntage B Toe tev ann te nye aha he ann percentage ae The afcive anal stress aby rater han thea peretage Dae etctive nm iter ae nvr reer han the anual perentage None fie aon. c EFFECTIVE ANNUAL RATES WITH CONTINUOUS COMPOUND- ING Investing $2,000 at «continuously compounded rate of 15 percent for 2 years is equivalent to an annually compounded rate of 2an A.1428%, B. 16.18%. ©.1745%, D. 18.36%, E. None of the above. ‘The following situation concerns questions 36-96. ‘A firm borrows $1,000 at 8 percent compounded continuously with all payments due at the end of thee years. ‘What isthe equivalent effective annual interest rate? A 942%, B. 833%, 733%. D. 6.88%. B. None ofthe above. ‘What isthe amount due at the end of three years? AS17136. B.§1.271.29. ©. $1,165.24 D. $1051.48 E. None ofthe above B INFLATION AND INTEREST RATES IE Tobll rates are presetly 6.0 perwent and the expected rate of inflation is 2.0 percent, the real rate of return is expected to be 13E, None of the above D INFLATION AND THE TIME VALUE OF MONEY ‘An engineer in 1950 was earning $6,000 a year. Today, in 206, she earns $60,000 ‘year. However, on average, goods today cost 8.2 times what they did in 1980. ‘What is her real income today in terms of constant 1950 dollars?” A. 88,405.22. B $7,31707, C. $6,456.96 D. $9,046.45 E. None of the above, B 4“THE Time URWE of MONEY SOLUTIONS TO RQUETONS W PROBLEMSop Eons = ood +4 lyoao «4 < 0-98 \ro =&)\j3203 - Semele miererh = IQ 0 + 3 « (13000 noose ) = 190004 2us0 A 12,480 3 lorooo Ga + oot) Compound a Wik eQip = Eerabaes (12423) = lb, 423 IAWN23-V2,4e0 = bag ComPound interest al aes3 oy Wie simple Imterest \Ooo% (S00 */0 x Oey = (S00 +Qsod = 4,490y 84 wut Compound iw eves t \S \\ovo x Ci\.04) Eas (900 x (.4 9d = &),470s 6 A, ist (10,000)G- 0175) (1.8225) Qa 0235) (1.0325 (19525) = BU BIGoF Fre = kooe x (1+ O-9) o00 « C1. 8B)? tT. A ave =tec0 * |. 61051 =), 610.5)me O€ v Pye ivox (i+ vet) 7 = \Soo peu Acces i = 1,09 (1.4854) = 2,228.5%OA ie Pye & : aas* \ Gis 4® \ YS.2592254 = #22, 094.93 = \,009,600 ~ = 1,990,000= L.we\e-\ = oO. (tS)e =z WGAOo; I-B8at -4 Bel = a+] _ OTH . Bol = asze4y °2 Ad = Gt)Iz AN > Syo00 _, ¥,000 | YDCo Kp0D 2 Se Saeed o6 1-06 [o6= Log We Sod Bee 4 ¥e00 _ fie00 + \-06 \y\236 \yiQlO— Ly2¢257 au NG EEF UGA + 6 71G.95+6,33635 rs By B9O<6SOns 0 Runway reent vali Pv=e ec CL- eels = oc Cie eo. =Se0 (1 - aT fare = Soo (\ ~ sees os = Seo Cl-0 F813 ae sive C0897 fore = (243.503 uy a | Pv = Zoos | 1 intl has = 3000 (8.05518 ) = #2 lenseois “ me eLi- cd /p a = Sd,000 (1 - eel ee Ley" = L16ee | > 50,000 C3. 6308] = 181,530ee ‘S PV aHear Penne ity of H Millon ) = HL rallean se Ct- tax) ee 1-089. gq 3/927 = BLM ralleoy bly Va Aohal Prebent vale ef Cosh Dlows oc RH wilco $ UG Mal (lon, = Bate atteny The Bea paynent ic We Ckivel toad Es aud it shauld nod be Aes countedOtt ‘eS oe cL one ceed Fas {9,080 « —— a =) = 19,0 see cox de “(ue.a4ave) = 10,000% 64.4% = Rl4yus million OA OAR 6SOB Se Tudawre va lar Bwnuity & T ct+ry—t ots lo 100,000 = C civen) —\ | ae is Qagy i 00,900 NE ce Ole \@ghQ09 = c £19.3373] LOO SOC = HH GLST Ce \Q.33%3BAA hyp Pom Pudare volar t Fvre G+ty eet i i U c a 2 2,000 (ees peer ] O.0g o-97 Leog ’= (0.062% Be assis 125, 7 sy roy eee = (2.5 OOK = 2,000 Ces.tg39_ 12. 5] = 226567. Cobabi st lbeSH= ae =a) ( brb1-51) D sanclog bovo He we [rsZp——] > = ores pkg See =o bp) Love H oe S eihoce " oN coo: b, Ley ey ON aevat otewv@2zL 2 Aa veuo| pespetehy a Ag nme dt $2 pay ment of loo P= Heo + = = lon + 12S. = \s0 + 428. SHY =4 1,528 SRG Te Creek PA YRent Le wok ALS ConteOWS Ye au6os ee oq — 2 OY GO o-eS Vw (\ + i200S24 The Soy Pecpe tus Re Reomula with «& mega we goth rade i eo: = 2 rrullion PV = Sad ©-1o-(-0-0¥ ) S Ze eullvoy ong F \t.2es 9 Mill oyois pea aq Pye _4 20,000 ~ Oo. 0K 2024 ot Be, 00 e020 ‘Oot = qN0,000 Fo" “Fre — Cane sare (- G28) | ©. OR 6. 880.0 = 32/000 (\ thet 3240 | O03, es 5,000 LbRE = — Ce J Firs, COF- GRG2, & Ca iy ) = Lasene_ jeer Fr (122 ) “= | 2 AR, Ys, 97 Ho, wwUx 2% - pe Aer cine ARE ee) S2 = Ci + 0-01) —! ERR = = 09997 = 64.49%Iv 1% QA The nunbor of. paynent P2wiod NaH eye C+ “) a, > (+ 22) = O04 o¢ . Reeth © (14 eftome yh Rate soe oe = | + 0-104) Tr_, =0.0 @332F = See go0e= Cx ee a 08329 | oO wef ong) | C= PMT = trer.90SSO zu te Ps i he «hechve Emp= (i+ cess Le 2 heck vit i - , \Z%, we onl = (v2) wave Steen (cee Se eealie so cee Joni 3,500 = e(t- ae), 6G Soa tow) 3 [oes ee rues 3500 = OC (30.3674 ) c= (5.244563\ 3S 4 a Epes Cee ts ose (ele ree fia. > 118 : - OOB32 ee 5 VW te wm Pitt so vO {2 T= 1.9139 -) = 013 2 = 99134 5 q 1 a re ARN Cooreg ) V=16.6e 7% oH 16-68 & ye 6 4 “astersesr fv = oe, Gre pal Waa. T4 => Sevo Gee t= sae WASqg = - ee ) \.a9qg/2° oe i = 1.4348 = f os (i+ = ) es3s- oF ce &) lo os) ee eeav O34 WEAR Continuous Hime SG te eet oA5 (2) 2,000 x & WA Ascrete Hmede - t ey Gre) = 2000 Ger)" | sed then BRAK \ O45 (2) ~~ 2Zoevdx @ = 2,000 (1+ ) 5.30 5 Es 7 2 = Cvae y ez 24 ze rs Ci4ar)> Wyuqg se Cte) Gels yisuae = iggy Cee) = Weis ee leleig~l TOAGIE = (GZ4% SS are, Caserta ca 2 2.%8 -! ae \.08337\ ef «9.0882 0© 839 A” Fve ev (is) ~\,000( (8839) = \,000 (y. 27124 = Alen. 2ok Ost (wr Saeat ke ta Tek cee vw fever ~ vt tn £1 Octron vote Bote = \ 40.06 = \+0.0n —~ Les = 93QD ~ \on real wwderes = 1 O3q2—! pole = 0.03 quG- be EIS = . Eescom sms\s \deD ass Sysxah [waa &SO