Module 2-DAVIS, MICHAELS, AND CO-Questions

1. Consider a 1-year, $10,000 CD.

a. What is its value at maturity (future value) if it pays 10.0 percent (annual) interest?
FV=10000*(1+0.1)= $11,000

b. What would be the future value if the CD pays 5.0 percent? If it pays 15.0 percent?
FV= 10000*(1+0.05)= $10,500
FV= 10000*(1+0.15)= $11,500

c. The First National Bank of San Francisco offers CDs with a 10.0 percent nominal (stated) interest rate but
compounded semiannually. What is the effective annual rate on such a CD? What would its future value
be?
r = (1+0.1/2)^2-1 = 10.25% annual effective rate
FV = 10000*(1+0.1025) = $11,025

d. Pacific Trust offers 10.0 percent CDs with daily compounding. What is such a CD’s effective annual rate
and its value at maturity?
r= (1+.1/365)^365-1 = 10.52%
FV= 10000*(1+10.52%) = $11,052

e. What nominal rate would the First National Bank have to offer to make its semiannual compounding CD
competitive with Pacific’s daily-compounding CD?
Pacific is 10.52%
(1+X/2)^2 = 1.052
(1+X/2) = 1.0513 X/2 = 1.0513-1
X/2=.0513 X=0.513(2)
x=.1026
Would need a 10.26% rate to be competitive with Pacific’s daily compounding CD

2. Now consider a 5-year CD. Rework Parts a through d of Question 1 using a 5-year ending date.
A) FV=10000*(1+0.1)^5= $16,105.10

B) FV= 10000*(1+0.05)^5= $12,762.82

FV= 10000*(1+0.15)^5= $20,113.57
C) r = (1+0.1/2)^2-1 = 10.25% annual effective rate
FV = 10000*(1+0.1025)^5 = $16,288.95

D) r= (1+.1/365)^365-1 = 10.52%
FV= 10000*(1+10.52%)^5 = $16,496.08

3. It is estimated that in 5 years the total cost for one year of college will be $20,000.
a. How much must be invested today in a CD paying 10.0 percent annual interest in order to accumulate the
needed $20,000?
20000/(1+10%)^5 = $12,418.43

b. If only $10,000 is invested, what annual interest rate is needed to produce $20,000 after 5 years?
10000=20000/(1+r)^5
(1=r)^5=2 1+r=2^(1/5) = 1.14869 r= 0.14869
r=14.87%

c. If only $10,000 is invested, what stated rate must the First National Bank offer on its semiannual
compounding CD to accumulate the required $20,000?
1.14869((1+(r/2))^2)
1.0717734 = (1+(r/2))
r/2= 0.0717734 r=0.143546
r=14.35%

4. Now consider the second alternative—5 annual payments of $2,000 each. Assume that the payments are made at
the end of each year.

a. What type of annuity is this?

Ordinary annuity
b. What is the future value of this annuity if the payments are invested in an account paying 10.0 percent
interest annually?
2000 (1.10^5-1)/.10
2000(6.1051) = $12,210.20
c. What is the future value if the payments are invested with the First National Bank which offers semiannual
compounding?
= (1+0.05)*2,000 (1.05)^10-1)/0.05
= (1.05)*2,000 (12.57789)
=2100(12.57)= 26,413.80
d.What size payment would be needed to accumulate $20,000 under annual compounding at a 10.0 percent interest
rate?
=(1.01)^5-1)/0.1=20,000
=0.05101/0.1
=5.101=20,000
=$3,920.79

e.What lump sum, if deposited today, would produce the same ending value as in Part b?
(1+.10)^5=20,000
1.61051=20,000
=12,418.42

f.Suppose the payments are only $1,000 each, but are made every 6 months, starting 6 months from now. What would
be the future value if the 10 payments were invested at 10.0 percent annual interest? If they were invested at
the First National Bank which offers semiannual compounding?
=(1.05^10-1)/.05) (1+0.05)*1000
=12.577(1+0.05)1000
=1050(12.577)= 13,205.85
5. Assume now that the payments are made at the beginning of each period. Repeat the analysis in Question 4.
A) Annuity due
B) 2000 (1+.10)*(1+.10^5)/.10
2200(1.6105-1)/1
2200(6.1051)
= 13,431.22

c)2,000(1+.05)(1+.05)^10)-1)/.05
2100(.62889)/.05
2100(12.57789)
26,413.57
D) (1+.10)(1+.10)^5-1)/.10=20,000
(1+.10)(6.1051)=20,000
(.6105)+(6.1051)
20,000/(6.7156)= 2,978.14
E)13,431.22=PV (1+.10)^5
13,431.22/1.6105 = 8339.73
F) 1000(1+.5)(1+.5^10)-1)/.5
1050 ( .62.89)/.5
1050(12.578) = 13,206.79
 6. Now consider the following schedule of payments:

End of Year Payment

0 $2,000
1 2,000
2 0
3 1,500
4 2,500
5 4,000

a. What is the value of this payment stream at the end of Year 5 if the payments are invested at 10.0 percent
annually?
Year Payment Future value
0 2000 2000(1+.10)^5 3221.02
1 2000 2000(1+.10)^4 2928.2
2 0
3 1500 1500(1+.10)^2 1815
4 2500 2500(1+.10)^1 2750
5 4000 4000 4000

=14,714.22

b. What payment today (Year 0) would be needed to accumulate the needed $20,000? (Assume that the
payments for Years 1 through 5 remain the same.)
FV= 14714.22 PV-= 5285.78/(1+.10)^5 = 3282.05
Needed = 20,000 3282.05+2,000 = 5282.05
=5,285.78
7. Consider Bay City Savings Bank, which pays 10.0 percent interest compounded continuously.
a. What is the effective annual rate under these terms?
Effective rate 10.52%
=EXP(C32)-C34

b.What is the future value of a $10,000 lump sum after 5 years?

Future value $16,487.21
=C30*(C34+C108)^(C33)

c. What is the future value of a 5year ordinary annuity with payments of $2,000 each?
Present value $12,130.61
=C31/(C34+C108)^C33
 8. The client is also considering borrowing the $20,000 for his daughter’s first year of college and repaying the
loan over a fouryear period. Assuming that he can borrow the funds at a 10 percent interest rate, what
amount of interest and principal will be repaid at the end of each year?
Year Beginning Balance Annual Interest (10%) Principal b- Ending
c=d
1 20,000 6309.42 2000 4309.42 15690.58
2 15960.58 6309.42 1569.06 4740.36 10950.22
3 10,950.22 6309.42 1095.02 5214.40 5735.82
4 5735.82 6,309.42 573.58 5735.84 (.02)

9. Assume that you are given a set of cash flows on a time line and asked to find their present value. How would
you choose the discount rate to apply to these flows?
The discount rate is the rate of return, we should use it because it can be applied to show cash flow on projects and
help calculate the present value

10. If you are using the Lotus 1-2-3 model, first examine the model closely to see how it works and then complete
the model. Don’t hesitate to change input values to obtain a better grasp of the model. Also, don’t forget to
look at the graphs. After you are thoroughly familiar with the model, write a short summary of Lotus’s DCF
capabilities. Include not only what spreadsheets can do, but how they can be used in financial management
decision making.
The lotus model is like excel but it does not need to remember formulas, so it can assist people who are not used to
using excel or know how to use excel formulas. It also helps do calculations with no paper or pen and the
graphs give great visualizations that can benefit non-financial excel users. Overall it gives a advantage for
financial decision management and has lots of capabilities to perform those duties