Ch. 3,4,5,6 - Study Plan

7/2/2019 371-Lama Alqahtani
Course: 371
Student: Lama Alqahtani
Book: Berk/DeMarzo/Harford: Fundamentals of Corporate
Instructor: Aminah Alsalim • 3-1 Finance, 4/e, Global Edition
Date: 7/2/19
Time: 7:32 AM
Honda Motor Company is considering offering a $2,300 rebate on its minivan, lowering the vehicle's price from $32,000 to
$29,700. The marketing group estimates that this rebate will increase sales over the next year from 43,000 to 58,000
vehicles. Suppose Honda's profit margin with the rebate is $7,100 per vehicle. If the change in sales is the only
consequence of this decision, what are its costs and benefits? Is it a good idea? Hint: View this question in terms of
incremental profits.
The cost of the rebate is that Honda will make less on the vehicles it would have sold:
Cost = Loss per Vehicle Vehicles that Would Have Sold Without Rebate
Cost = ($32,000 − $29,700) per vehicle 43,000 vehicles = $98.9 million
The benefit of the rebate is that Honda will sell more vehicles and earn a profit on each additional vehicle sold:
Benefit = Profit per Vehicle Additional Vehicles Sold
Benefit = $7,100 per vehicle (58,000 − 43,000) vehicles = $106.5 million
Is it a good idea?
The difference between benefit and cost is:
Benefit − Cost = $106.5 million − $98.9 million = $7.6 million
Thus, offering the rebate does look attractive.
https://xlitemprod.pearsoncmg.com/api/v1/print/en-us/ﬁnance 1/1
Course: 371
Instructor: Aminah Alsalim
Finance, 4/e, Global Edition
Date: 7/2/19
Time: 7:34 AM
You are an international shrimp trader. A food producer in the Czech Republic offers to pay you 2.6 million Czech koruna
today in exchange for a year's supply of frozen shrimp. Your Thai supplier will provide you with the same supply for 3.3
million Thai baht today. If the current competitive market exchange rates are 26.20 koruna per dollar and 41.60 baht per
dollar, what is the value of this exchange to you?
To compute the cost of the Thai supplier's offer in dollars we use:
Price in THB
Thai Supplier's Offer in Dollars = • 3-2
Exchange Rate THB $
3,300,000 THB
Thai Supplier's Offer in Dollars = = $79,326.92
41.60 THB $
To compute the price of the Czech producer's offer in dollars we use:
Price in CZK
Czech Producer's Offer in Dollars =
Exchange Rate CZK $
2,600,000 CZK
Czech Producer's Offer in Dollars = = $99,236.64
26.20 CZK $
You would buy the shrimp from the Thai supplier at a cost of $79,326.92 and sell the shrimp to the Czech producer at a
price of $99,236.64 , resulting in a profit of $19,909.72 ( = $99,236.64 − $79,326.92 ).
Course: 371
Date: 7/2/19
Time: 7:35 AM
Suppose your employer offers you a choice between a $5,300 bonus and 100 shares of the company's stock. Whichever
one you choose will be awarded today. The stock is currently trading at $65.00 per share.
a. If you receive the stock bonus and you are free to trade it, which form of the bonus should you choose? What is its value?
b. Suppose that if you receive the stock bonus, you are required to hold it for at least one year. What can you say about the
value of the stock bonus now? What will your decision depend on?
a. If you receive the stock bonus and you are free to trade it, which form of the bonus should you choose? What is its value?
If you are free to trade the stock today, to see whether you should choose the cash bonus or the stock bonus you should
compare their values. The value of the stock bonus today is computed as follows:
Value of the Stock Bonus Today = Number of Shares Price per Share
Value of the Stock Bonus Today = 100 shares $65.00 per share = $6,500

• 3-3
The value of the cash bonus is given in the problem statement.
Value of the Cash Bonus Today = $5,300
Since you can sell the stock for $6,500 in cash today, its value is $6,500 which is better than the cash bonus of $5,300
today. You should take the stock bonus.
b. Suppose that if you receive the stock bonus, you are required to hold it for at least one year. What can you say about the
value of the stock bonus now? What will your decision depend on?
Because you could buy the stock today for $6,500 if you wanted to, the value of the stock bonus cannot be more than
$6,500. But if you are not allowed to sell the company's stock for the next year, its value to you could be less than $6,500.
Its value will depend on what you expect the stock to be worth in one year, as well as how you feel about the risk involved.
There is no clearcut answer to which alternative is best, because taking the stock today and having to hold it for a year
involves risk. You might decide that it is better to take the $5,300 in cash than wait for the uncertain value of the stock in one
year. This would be especially true if you believed you could invest the $5,300 today in another equally risky asset that
would be worth more than $6,500 in one year.
Course: 371
Date: 7/2/19
Time: 7:36 AM
4. Suppose Big Bank offers an interest rate of 8.5 % on both savings and loans, and Bank Enn offers an interest rate of
9.0 % on both savings and loans.
a. What profit opportunity is available?
b. Which bank would experience a surge in the demand for loans? Which bank would receive a surge in deposits?
c. What would you expect to happen to the interest rates the two banks are offering?
a. What profit opportunity is available?
A. Take a loan from Big Bank at 9.0 % and save the money in Big Bank at 8.5 %.
B. Take a loan from Big Bank at 8.5 % and save the money in Bank Enn at 9.0 %.
C. Take a loan from Bank Enn at 9.0 % and save the money in Big Bank at 8.5 %.
D. Save at both banks.
b. Which bank would experience a surge in the demand for loans? Which bank would receive a surge in deposits?
A. Big Bank would experience a surge in deposits, while Bank Enn would receive a surge in
loans.
B. Big Bank would experience a surge in the demand for loans, while Bank Enn would • 3-4
receive a surge in deposits.
C. Big Bank would experience a surge in the demand for deposits, as will Bank Enn.
D. Big Bank would experience a surge in the demand for loans, as will Bank Enn.
c. What would you expect to happen to the interest rates the two banks are offering?
A. Both banks would decrease their interest rates.
B. Big Bank would increase its interest rate and Bank Enn would decrease its rate.
C. Big Bank would decrease the interest rate and Bank Enn would increase its rate.
D. Both banks would increase their interest rates.
YOU ANSWERED: D.
Course: 371
Date: 7/2/19
Time: 7:36 AM
5. If the cost of buying a CD and ripping the tracks to your iPod (including your time) is $25 , what is the most Apple could
charge on iTunes for a 15track CD?
(Select the best choice below.)
A. More than $25 , because Apple has more costs and needs to make a profit.
B. Less than $25 , because Apple is more efficient.
C. $25 , the same as the cost of buying the CD and ripping the tracks to your iPod.
D. There is not enough information given to answer this question.
• 3-5
Course: 371
Date: 7/2/19
Time: 7:37 AM
Some companies crosslist their shares, meaning that their stock trades on more than one stock exchange. For example,
BlackBerry Limited, the maker of BlackBerry mobile devices, trades on both the Toronto Stock Exchange and NASDAQ. If
its price in Toronto is 52 Canadian dollars per share and anyone can exchange Canadian dollars for U.S. dollars at the rate
of US$0.99 per C$1.00 , what must BBRY's price be on NASDAQ?
Because of the Law of One Price, BBRY's value in US dollars and Canadian dollars should be the same. To find BBRY's
value in US dollars use the following:
BBRY (US$) = BBRY (C$) Rate of the US$ per C$
US$0.99
BBRY (US$) = C$52 = US$51.48
C$1.00
• 3-6
Course: 371
Date: 7/2/19
Time: 7:38 AM
1. Bubba is a shrimp farmer. In an ironic twist, Bubba is allergic to shellfish, so he cannot eat shrimp. Each day he has a
oneton supply of shrimp. The market price of shrimp is $10,700 per ton.
a. What is the value of a ton of shrimp to him?
b. Would this value change if he were not allergic to shrimp? Why or why not?
a. What is the value of a ton of shrimp to him?
• 3-7
A. The value of a tonne of shrimp to Bubba is less than $10,700 because shrimp is a
perishable item.
B. The value of a tonne of shrimp to Bubba is more than $10,700 because he can wait for
the market price to go up.
C. The value of a tonne of shrimp to Bubba is less than $10,700 because Bubba is allergic
to shellfish.
D. The value of a tonne of shrimp to Bubba is $10,700 because that is the market price.
b. Would this value change if he were not allergic to shrimp? Why or why not?
A. No. Even if he isn't allergic to shrimp, he can't eat a ton of it.
B. Yes. If he is not allergic to shrimp, then he may prefer to eat the shrimp instead of selling
it.
C. Yes. If he is allergic to shrimp, he puts a low value on it, but if he is not allergic to shrimp,
he values it highly.
D. No. As long as he can buy or sell shrimp at $10,700 per ton, his personal preference or
use for shrimp is irrelevant to the value of the shrimp.
Course: 371
Date: 7/2/19
Time: 7:38 AM
Brett has almond orchards, but he is sick of almonds and prefers to eat walnuts instead. The owner of the walnut orchard
next door has offered to swap this year's crop with him. Assume he produces 1,060 tons of almonds and his neighbor
produces 805 tons of walnuts. If the market price of almonds is $111 per ton and the market price of walnuts is $121 per
ton:
a. Should he make the exchange?
b. Does it matter whether he prefers almonds or walnuts? Why or why not?
a. Should he make the exchange?
Brett calculates that the market value of the almond crop is:
Market Value of the Almond Crop = Quantity in Tons Price per Ton
Market Value of the Almond Crop = 1,060 tons $111 per ton = $117,660

• 3-8
The market value of the walnut crop is:
Market Value of the Walnut Crop = Quantity in Tons Price per Ton
Market Value of the Walnut Crop = 805 tons $121 per ton = $97,405
Should he make the exchange?
o, he should not make the exchange. He should not give up an asset worth $117,660 for an asset worth $97,405. If he
N
truly wanted to eat 805 tons of walnuts, he could sell his crop for $117,660 and buy his neighbor's entire crop for $97,405.
Thus, he would have all the walnuts he could eat and have $20,255 remaining from the sale of the almond crop.
b. Does it matter whether he prefers almonds or walnuts? Why or why not?
No. His preference is irrelevant to the value of the crops.

Course: 371
Date: 7/2/19
Time: 7:39 AM
You have $1,300 and a bank is offering 6.5% interest on deposits. If you deposit the money in the bank, how much will you
have in one year?
You can exchange (1 + r) dollars in the future per dollar today, where r
is 6.5%. Use this formula to determine the amount of
money you will have in one year:
FV = PV (1 + r)
FV = $1,300 (1 + 0.065) = $1,384.50

• 3-9
Course: 371
Date: 7/2/19
Time: 7:39 AM
You expect to have $13,000 in one year. A bank is offering loans at 6.5% interest per year. How much can you borrow
today?
You can say 1 (1 + r) is the price today of one dollar in one year, where r is 6.5%. Use this formula to determine how much
you could borrow today:
FV
PV =
1+r
$13,000 • 3-10
PV = = $12,206.57
1 + 0.065
Course: 371
Date: 7/2/19
Time: 7:40 AM
Due to your good credit, your bank reduces the interest rate on your $15,000 loan from 11 % to 8 % per year. Thanks to the
change, how much will you save in interest this year?
To calculate the amount in interest you will save, use the following formula:
Interest saved = Interest paidOriginal − Interest paidNew
To find the amount of interest paid on the loan at the original rate and at the new rate, use the following formula:
Interest paid = Loan amount Interest rate
Therefore, at the original interest rate:
Interest paidOriginal = $15,000 0.11 = $1,650

• 3-11
At the new interest rate:
Interest paidNew = $15,000 0.08 = $1,200
Therefore, the amount in interest you will save this year is calculated as:
Interest saved = $1,650 − $1,200 = $450
The amount you will save in interest this year is $450.
Course: 371
Date: 7/2/19
Time: 7:40 AM
A friend asks to borrow $56 from you and in return will pay you $59 in one year. If your bank is offering a 7.0% interest rate
on deposits and loans:
a. How much would you have in one year if you deposited the $56 instead?
b. How much money could you borrow today if you pay the bank $59 in one year?
c. Should you loan the money to your friend or deposit it in the bank?
a. How much would you have in one year if you deposited the $56 instead?
If you deposit the money in the bank today, you can determine how much you will have in one year using the following:
FV = PV (1 + r)
FV = $56 (1 + 0.070) = $59.92
b. How much money could you borrow today if you pay the bank $59 in one year?
You will be able to borrow: • 3-12
FV
PV =
1+r
$59
PV = = $55.14
1 + 0.070
c. Should you loan the money to your friend or deposit it in the bank?
From a financial perspective, you should deposit the money in the bank , as it will result in more money for you at the end of
the year.
Course: 371
Date: 7/2/19
Time: 7:41 AM
What is the discount factor that is equivalent to a 12 % discount rate?
To calculate the discount factor, use the following formula:
1
Discount factor =
1 + Interest rate
Therefore, • 3-13
1
Discount factor = = 0.8929
1.12
The discount factor is 0.8929.
Course: 371
Date: 7/2/19
Time: 7:43 AM
6. You plan to borrow $2,000 from a bank. In exchange for $2,000 today, you promise to pay $2,140 in one year. What
does the cash flow timeline look like from your perspective? What does it look like from the bank's perspective?
What does the cash flow timeline look like from your perspective?
A. 0 1
$2,000 − $2,140
B. 0 1 • 3-15
− $2,140 $2,000
C. 0 1
$2,140 − $2,000
D. 0 1
− $2,000 $2,140
What does it look like from the bank's perspective? (Select the best choice below.)
A. 0 1
− $2,000 $2,140
B. 0 1
$2,140 − $2,000
C. 0 1
$2,000 − $2,140
D. 0 1
− $2,140 $2,000
Course: 371
Date: 7/2/19
Time: 7:43 AM
If your discount factor is 0.9346 , what is your discount rate?
To calculate the discount rate, use the following formula:
1
Discount rate = −1
Discount factor
Therefore,
1 • 3-14
Discount rate = − 1 = 0.07 = 7%
0.9346
The discount rate is 7 %.
Course: 371
Date: 7/2/19
Time: 7:44 AM
The local electronics store is offering a promotion "1year: same as cash," meaning that you can buy a TV now, and wait a
year to pay (with no interest). So, if you take home a $1,150 TV today, you will owe them $1,150 in one year. If your bank is
offering 4.2% interest, what is the true cost of the TV to you today?
The true cost of the TV to you today is:
FV
PV =
1+r
$1,150 • 3-16
PV = = $1,103.65
1 + 0.042
Course: 371
Date: 7/2/19
Time: 7:44 AM
Suppose the interest rate is 5.0%.
a. Having $700 today is equivalent to having what amount in one year?
b. Having $700 in one year is equivalent to having what amount today?
c. Which would you prefer, $700 today or $700 in one year? Does your answer depend on when you need the money? Why
or why not?
a. Having $700 today is equivalent to having what amount in one year?
The future value of the present amount is given by:
FVn = C (1 + r)n • 3-17
Therefore,
FV = $700 (1 + 0.050) = $735.00
b. Having $700 in one year is equivalent to having what amount today?
The present value of the future amount is given by:
C
PV =
(1 + r)n
Therefore,
$700
PV = = $666.67
(1.050)
c. Which would you prefer, $700 today or $700 in one year? Does your answer depend on when you need the money? Why
or why not?
Because money today is worth more than money in the future, $700 today is preferred to $700 in one year. This answer is
correct even if you don't need the money today, because by investing the $700 you receive today at the current interest
rate, you will have more than $700 in one year.rom the dropdown menu.)
Course: 371
Date: 7/2/19
Time: 7:45 AM
You are considering a savings bond that will pay $100 in 12 years. If the interest rate is 2.3% , what should you pay today for
the bond?
The amount that you should pay today for the bond is:
C
PV =
(1 + r)n
$100 • 3-18
PV = = $76.12
(1 + 0.023)12
Course: 371
Date: 7/2/19
Time: 7:45 AM
If your bank pays you 1.7% interest and you deposit $650 today, what will be your balance in six years?
The bank balance will be:
FVn = C (1 + r)n
FVn = $650 (1 + 0.017)6 = $719.18 • 3-19
Course: 371
Date: 7/2/19
Time: 7:46 AM
Consider the following alternatives:
i. $160 received in one year • 3-20
ii. $250 received in five years
iii. $360 received in 10 years
a. Rank the alternatives from most valuable to least valuable if the interest rate is 13% per year.
b. What is your ranking if the interest rate is 7% per year?
c. What is your ranking if the interest rate is 21% per year?
a. Rank the alternatives from most valuable to least valuable if the interest rate is 13% per year.
First calculate the PV of each option using the following formula and rank them by their PV:
C
PV =
(1 + r)n
where PV is the present value, C is the cash flow, r is the interest rate, and n is the number of periods.
The PV of $160 received in one year if the interest rate is 13% per year is:
$160
PV = = $141.59
(1 + 0.13)1
The PV of $250 received in 5 years if the interest rate is 13% per year is:
$250
PV = = $135.69
(1 + 0.13)5
$360
PV = = $106.05
(1 + 0.13)10
For an interest rate of 13% , the ranking of the projects is: option i > option ii > option iii.
b. What is your ranking if the interest rate is only 7% per year?
$160
PV = = $149.53
(1 + 0.07)1
$250
PV = = $178.25
(1 + 0.07)5
$360
PV = = $183.01
(1 + 0.07)10
For an interest rate of 7% per year, the ranking of the projects is: option iii > option ii > option i.
c. What is your ranking if the interest rate is 21% per year?
$160
PV = = $132.23
(1 + 0.21)1
$250
PV = = $96.39
(1 + 0.21)5
$360
PV = = $53.51
(1 + 0.21)10
For an interest rate of 21% per year, the ranking of the projects is: option i > option ii > option iii.
Course: 371
Date: 7/2/19
Time: 7:46 AM
Suppose you invest $1,200 in an account paying 9% interest per year.
a. What is the balance in the account after 5 years? How much of this balance corresponds to "interest on interest"?
b. What is the balance in the account after 36 years? How much of this balance corresponds to "interest on interest"?
a. What is the balance in the account after 5 years?
• 3-21
The balance in the account (compounded interest) is given by:
FV = PV (1 + r)n
where FV is the future value (balance), PV is the present value (investment), r is the interest rate, and n is the number of
periods.
After 5 years the balance in the account (compounded interest) is:
FV = $1,200 (1 + 0.09)5 = $1,846.35
How much of this balance corresponds to "interest on interest"?
The balance in the account (simple interest) is given by:
FV = PV i n + PV
where FV is the future value (balance), PV is the present value (investment), r is the interest rate, and n is the number of
periods.
After 5 years the balance in the account (simple interest) is:
FV = $1,200 9% 5 + $1,200 = $1,740.00
The amount that corresponds to interest on interest is given by:
Interest on interest = FV (compounded interest) − FV (simple interest)
The interest on interest is:
Interest on interest = $1,846.35 − $1,740.00 = $106.35
b. What is the balance in the account after 36 years?
After 36 years the balance in the account (compounded interest) is:
FV = $1,200 (1 + 0.09)36 = $26,701.47
How much of this balance corresponds to "interest on interest"?
After 36 years the balance in the account (simple interest) is:
FV = $1,200 9% 36 + $1,200 = $5,088.00
The interest on interest is:
Interest on interest = $26,701.47 − $5,088.00 = $21,613.47
Course: 371
Date: 7/2/19
Time: 7:47 AM
Calculate the future value of $12,000 in
a. Four years at an interest rate of 11% per year.
b. Eight years at an interest rate of 11% per year.
c. Four years at an interest rate of 22% per year.
d. Why is the amount of interest earned in part (a ) less than half the amount of interest earned in part (b )?
a. Four years at an interest rate of 11% per year.
• 3-22
The timeline for part (a ) is as follows:
Year 0 1 2 3 4
PV $12,000
Using the following formula:
n
FVn = C (1 + r)
At an interest rate of r = 11% per year, the future value of $12,000 in 4 years, FV4 , is below:

4
FV4 = $12,000 (1 + 0.11) = $18,217
b. Eight years at an interest rate of 11% per year.
The timeline for part (b ) is:
Year 0 1 2 3 4 5 6 7 8
PV $12,000

8
FV8 = $12,000 (1 + 0.11) = $27,654
c. Four years at an interest rate of 22% per year.
The timeline for part (c ) is:
Year 0 1 2 3 4
PV $12,000

FV4 = $12,000 (1 + 0.22)4 = $26,584
d. Why is the amount of interest earned in part (a ) less than half the amount of interest earned in part (b )?
This results because you earn interest on past interest. Since more interest has been paid at the end of the time period than
at the beginning, the money grows faster.
Course: 371
Date: 7/2/19
Time: 7:47 AM
What is the present value of $16,000 received:
a. Twenty five years from today when the interest rate is 12% per year?
b. Fifteen years from today when the interest rate is 12% per year?
c. Eight years from today when the interest rate is 12% per year?
a. Twenty five years from today when the interest rate is 12% per year?
The cash flow timeline for part (a ) is as follows:
• 3-23
0 1 2 3 25
PV = ? $16,000
Use the following formula to find the PV of a cash flow:
C
PV =
(1 + r)n
The present value of $16,000 received 25 years from today when the interest rate is 12% per year is below:
$16,000
PV = = $941
(1 + 0.12)25
b. Fifteen years from today when the interest rate is 12% per year?
The cash flow timeline for part (b) is as follows:
0 1 2 3 15
PV = ? $16,000
$16,000
PV = = $2,923
(1 + 0.12)15
c. Eight years from today when the interest rate is 12% per year?
The cash flow timeline for part (c ) is as follows:
0 1 2 3 8
PV = ? $16,000
$16,000
PV = = $6,462
(1 + 0.12)8
Course: 371
Date: 7/2/19
Time: 7:48 AM
Your brother has offered to give you either $80,000 today or $160,000 in 7 years. If the interest rate is 3% per year, which
option is preferable?
Here is the cash flow timeline for this problem:
Years 0 1 2 3 7
• 3-24
Amount offered today $80,000
Future amount $160,000
To solve this problem you need to use the present value of a lump sum formula:
C
PV =
(1 + r)n
where C is the future value, r is the interest rate, and n is the number of periods.
$160,000
PV = = $130,095
(1 + 0.03)7
Which option is preferable?
Take the future amount because its present value is greater than the present amount offered.
c
Course: 371
Date: 7/2/19
Time: 7:48 AM
Your bank pays 2.7% interest per year. You put $1,300 in the bank today and $600 more in the bank in one year. How much
will you have in the bank in two years?
The future value of a cash flow is:
FVn = C (1 + r)n • 3-25
The future value of the first investment is:
FV2 = $1,300 (1 + 0.027)2 = $1,371.15
The future value of the second investment is:
FV1 = $600 (1 + 0.027) = $616.20
In two years, the amount that you will have is:
FV = FV2 + FV1
FV = $1,371.15 + $616.20 = $1,987.35
Course: 371
Date: 7/2/19
Time: 7:48 AM
Your cousin is currently 15 years old. She will be going to college in 3 years. Your aunt and uncle would like to have
$130,000 in a savings account to fund her education at that time. If the account promises to pay a fixed interest rate of
5.0% per year, how much money do they need to put into the account today to ensure that they will have $130,000 in 3
years?
The timeline for this problem is:
Cash flow − PV 0 0 $130,000
Period 0 1 2 3
• 3-26
The present value of a future amount is:
FV
PV =
(1 + r)n
where r is the interest rate and n is the number of periods.
$130,000
PV = = $112,298.89
(1 + 0.050)3
Course: 371
Date: 7/2/19
Time: 7:49 AM
Your mom is thinking of retiring. Her retirement plan will pay her either $275,000 immediately on retirement or $385,000 five
years after the date of her retirement. Which alternative should she choose if the interest rate is:
a. 0% per year?
b. 8% per year?
c. 20% per year?
a. 0% per year?
The cash flow timeline for this problem looks like this: • 3-27
Years 0 1 2 3 4 5
Cash Flow PV = ? $385,000
To find the present value of the amount to be received five years after retirement you use the following formula:

FV
PV =
(1 + r)n
where PV is the present value, FV is the future value, r is the interest rate, and n is the number of periods.
By applying the formula when the interest rate is 0% per year, you should get the following:
$385,000
PV = = $385,000
5
(1 + 0)
When the present value of $385,000 received in five years is greater than $275,000 , your mom should wait the five years
after retirement. If the present value of $385,000 received in five years is less than the $275,000 , your mom should take the
money now.
If the interest rate is zero, an unlikely situation, then your mom should take the $385,000 in five years. If she takes the
$275,000 today and invests it at zero percent for five years, she will have $275,000 in five years. $385,000 is better in five
years than $275,000.
b. 8% per year?
By applying the formula when the interest rate is 8% , you should get the following:
$385,000
PV = = $262,025
5
(1 + 0.08)
money now.
Since the present value of $385,000 is $262,025 , your mom should take the money now.
c. 20% per year?
By applying the formula when the interest rate is 20% , you should get the following:
$385,000
PV = 5
= $154,723
(1 + 0.20)
money now.
Since the present value of $385,000 is $154,723 , your mom should take the money now.
Course: 371
Date: 7/2/19
Time: 7:49 AM
You just won a prize that comes with two payout choices. The first option is to get $105,000 right now and nothing hereafter.
The second option is to get $96,000 right now and $15,000 three years from now (and nothing after that). If your discount
rate is 11 %, which should you take?
In order to choose the best option, compare the present value of the first option to the present value of the second option.
The present value of the second option is equal to the amount that is received now plus the present value of the amount to
be received in three years. To calculate the present value, use the following formula:
FV
PV = n
(1 + r)
Therefore, the present value of the $15,000 to be received in three years is calculated as: • 3-28
$15,000
PV = = $10,967.87
3
(1.11)
The present value of the $15,000 to be received in three years is $10,967.87.
Therefore, the present value of the second option is calculated as:
Value of the second option = $96,000 + $10,967.87 = $106,967.87
After comparing the $105,000 for the first option and the $106,967.87 for the second option, you should take
thesecond option.
Course: 371
Date: 7/2/19
Time: 7:50 AM
You are planning to invest $11,000 in an account earning 15 % per year for retirement.
a. If you put the $11,000 in an account at age 23, and withdraw it 51 years later, how much will you have?
b. If you wait 10 years before making the deposit, so that it stays in the account for only 41 years, how much will you have
at the end?
a. If you put the $11,000 in an account at age 23, and withdraw it 51 years later, how much will you have?
Use the following formula to determine the amount you will have in 51 years for retirement:
n • 3-29
FVn = C (1 + r)
In 51 years you would have:
51
FV51 = $11,000 (1 + 0.15) = $13,708,266.64
b. If you wait 10 years before making the deposit, so that it stays in the account for only 41 years, how much will you have
at the end?
In 41 years you would have:
41
FV41 = $11,000 (1 + 0.15) = $3,388,473.86
Course: 371
Date: 7/2/19
Time: 7:50 AM
Your grandfather put some money into an account for you on the day you were born. You are now 18 years old and are
allowed to withdraw the money. The account currently has $11,000 in it and pays an interest rate of 13%.
a. How much money would be in the account if you left the money there until your 25th birthday?
b. What if you left the money until your 65th birthday?
25 18 7
c. How much money did your grandfather originally put into the account?
a. How much money would be in the account if you left the money there until your 25th birthday?
Here is the cash flow timeline for part (a ): • 3-30
Years (from the day you were born) 18 19 20 25
Years (from now) 0 1 2 7
Cash Flow $11,000 FV = ?

To calculate the amount in the account upon your 25th birthday, use the future value formula.
n
FV = PV (1 + r)
The amount that would be in the account if you left the money there until your 25th birthday would be:
FV = $11,000 (1 + 0.13)7 = $25,879
b. What if you left the money until your 65th birthday?
Here is the cash flow timeline for part (b ):
Years (from the day you were born) 18 19 20 65
Years (from now) 0 1 2 47
If you left the money in the account until your 65th birthday, the future value would be:
FV = $11,000 (1 + 0.13)47 = $3,436,209
c. How much money did your grandfather originally put in the account?
Here is the cash flow timeline for part (c ):
Years 0 1 2 3 18
Cash Flow PV = ? $11,000
To determine how much your grandfather originally put into the account, you must use the present value formula.
FV
PV =
(1 + r)n
The amount of money your grandfather originally put into the account was:
$11,000
PV = = $1,219
(1 + 0.13)18
Course: 371
Date: 7/2/19
Time: 8:14 AM
a. What is the present value of the following set of cash flows, discounted at 9.2% per year?
Year 1 2 3 4 5
CF $12 $21 $30 $39 $48
b. What is the present value of the following set of cash flows, discounted at 9.2% per year?
Year 1 2 3 4 5
CF $48 $39 $30 $21 $12
c. Each set contains the same cash flows ($12 , $21 , $30 , $39 , $48 ), so why is the present value different?
a. What is the present value of the following set of cash flows, discounted at 9.2% per year?
Year 1 2 3 4 5
CF $12 $21 $30 $39 $48
The present value of a cash flow stream is:
C1 C2 CN
PV = C0 + + + • • • +
(1 + r) (1 + r)2 (1 + r)N
The present value of the cash flow stream is:
$12 $21 $30 $39 $48

PV = + + + + = $109.98
(1 + 0.092) (1 + 0.092)2 (1 + 0.092)3 (1 + 0.092)4 (1 + 0.092)5
b. What is the present value of the following set of cash flows, discounted at 9.2% per year?
Year 1 2 3 4 5
CF $48 $39 $30 $21 $12
$48 $39 $30 $21 $12

PV = + + + + = $122.20
(1 + 0.092) (1 + 0.092)2 (1 + 0.092)3 (1 + 0.092)4 (1 + 0.092)5
c. Each set contains the same cash flows ($12 , $21 , $30 , $39 , $48 ), so why is the present value different?
The present value in part (b ) is higher because the larger cash flows occur sooner.
Course: 371
Date: 7/2/19
Time: 8:14 AM
What is the present value of the following set of cash flows, discounted at 14.7% per year?
Year 1 2 3 4
CF $95 − $95 $206 − $206
C1 C2 CN
PV = C0 + + +•• •+
(1 + r) (1 + r)2 (1 + r)N • 4-2
$95 − $95 $206 − $206

PV = + + + = $28.11
(1 + 0.147) (1 + 0.147)2 (1 + 0.147)3 (1 + 0.147)4
Course: 371
Instructor: Aminah Alsalim • 4-3
Date: 7/2/19
Time: 8:15 AM
You want to borrow $10,000. You figure that you can make the following payments. If the interest rate on the loan is 8.9%
per year, will your payments be enough to pay off the $10,000 loan?
Year 1 2 3 4
CF $2,130 $2,970 $3,540 $3,860
You need to find the present value of your payments. The present value of a cash flow stream is:
C1 C2 CN
PV = C0 + + +•• •+
(1 + r) (1 + r)2 (1 + r)N
$2,130 $2,970 $3,540 $3,860

PV = + + + = $9,946
(1 + 0.089) (1 + 0.089)2 (1 + 0.089)3 (1 + 0.089)4
If the present value of your payments is equal to or larger than the amount of the loan, you will be able to pay off your loan
as planned.
The present value of your payments is smaller than the amount of the loan, so you will not be able to pay off the loan.
Course: 371
Date: 7/2/19
Time: 8:16 AM
You have a balance of $5,000 on your credit card, which charges an interest rate of 1.4% per month. Looking at your
budget, you figure you can make the following payments. Will they be enough to pay off your credit card?
Month 1 2 3 4 5 6 7 8
CF $495 $550 $605 $660 $715 $770 $825 $880
C1 C2 CN
PV = C0 + + +•• •+
(1 + r) (1 + r)2 (1 + r)N
$495 $550 $825 $880

PV = + +•••+ + = $5,139
(1 + 0.014) (1 + 0.014)2 (1 + 0.014)7 (1 + 0.014)8
as planned.
The present value of your payments is larger than the amount of the loan, so you will be able to pay off the loan.
• 4-4
Course: 371
Date: 7/2/19
Time: 8:14 AM
What is the present value of the following set of cash flows, discounted at 14.7% per year?
Year 1 2 3 4
CF $95 − $95 $206 − $206
C1 C2 CN
PV = C0 + + +•• •+
(1 + r) (1 + r)2 (1 + r)N
$95 − $95 $206 − $206

PV = + + + = $28.11
(1 + 0.147) (1 + 0.147)2 (1 + 0.147)3 (1 + 0.147)4
Course: 371
Date: 7/2/19
Time: 8:15 AM
You want to borrow $10,000. You figure that you can make the following payments. If the interest rate on the loan is 8.9%
per year, will your payments be enough to pay off the $10,000 loan?
Year 1 2 3 4
CF $2,130 $2,970 $3,540 $3,860
C1 C2 CN
PV = C0 + + +•• •+
(1 + r) (1 + r)2 (1 + r)N
$2,130 $2,970 $3,540 $3,860

PV = + + + = $9,946
(1 + 0.089) (1 + 0.089)2 (1 + 0.089)3 (1 + 0.089)4
as planned.
The present value of your payments is smaller than the amount of the loan, so you will not be able to pay off the loan.
Course: 371
Date: 7/2/19
Time: 8:16 AM
You have a balance of $5,000 on your credit card, which charges an interest rate of 1.4% per month. Looking at your
budget, you figure you can make the following payments. Will they be enough to pay off your credit card?
Month 1 2 3 4 5 6 7 8
CF $495 $550 $605 $660 $715 $770 $825 $880
C1 C2 CN
PV = C0 + + +•• •+
(1 + r) (1 + r)2 (1 + r)N
$495 $550 $825 $880

PV = + +•••+ + = $5,139
(1 + 0.014) (1 + 0.014)2 (1 + 0.014)7 (1 + 0.014)8
as planned.
The present value of your payments is larger than the amount of the loan, so you will be able to pay off the loan.
Course: 371
Date: 7/2/19
Time: 8:17 AM
5. You have just taken out a fiveyear loan from a bank to buy an engagement ring. The ring costs $6,500. You plan to put
down $1,200 and borrow $5,300. You will need to make annual payments of $1,150 at the end of each year. Show the
timeline of the loan from your perspective. How would the timeline differ if you created it from the bank's perspective?
Show the timeline of the loan from your perspective. (Select the best choice below.)
A. Year 0 1 2 3 4 5
Cash Flow $6,500 − $1,150 − $1,150 − $1,150 − $1,150 − $1,150

B. Year 0 1 2 3 4 5 • 4-5
Cash Flow $5,300 − $1,150 − $1,150 − $1,150 − $1,150 − $1,150

C. Year 0 1 2 3 4 5
Cash Flow − $1,200 $1,150 $1,150 $1,150 $1,150 $1,150

D. Year 0 1 2 3 4 5
Cash Flow − $5,300 $1,150 $1,150 $1,150 $1,150 $1,150
How would the timeline differ if you created it from the bank's perspective? (Select the best choice below.)
A. Year 0 1 2 3 4 5
Cash Flow $6,500 − $1,150 − $1,150 − $1,150 − $1,150 − $1,150

B. Year 0 1 2 3 4 5
Cash Flow $5,300 − $1,150 − $1,150 − $1,150 − $1,150 − $1,150

C. Year 0 1 2 3 4 5
Cash Flow − $1,200 $1,150 $1,150 $1,150 $1,150 $1,150

D. Year 0 1 2 3 4 5
Cash Flow − $5,300 $1,150 $1,150 $1,150 $1,150 $1,150
Course: 371
• 4-6 Book: Berk/DeMarzo/Harford: Fundamentals of Corporate
Date: 7/2/19
Time: 8:17 AM
6. You currently have a oneyearold loan outstanding on your car. You make monthly payments of $200. You have just
made a payment. The loan has four years to go (i.e., it had an original term of five years). Show the timeline from your
perspective. How would the timeline differ if you created it from the bank's perspective?
Show the timeline from your perspective. (Select the best choice below.)
A. Month 0 1 2 3 4 48
Cash Flow $200 $200 $200 $200 $200

B. Month 0 1 2 3 4 60
Cash Flow − $200 − $200 − $200 − $200 − $200 − $200

C. Month 0 1 2 3 4 48
Cash Flow − $200 − $200 − $200 − $200 − $200

D. Month 0 1 2 3 4 60
Cash Flow $200 $200 $200 $200 $200 $200
Which of the following loan timelines is from the bank's perspective? (Select the best choice below.)
A. Month 0 1 2 3 4 48
Cash Flow − $200 − $200 − $200 − $200 − $200

B. Month 0 1 2 3 4 60
Cash Flow $200 $200 $200 $200 $200 $200

C. Month 0 1 2 3 4 48
Cash Flow $200 $200 $200 $200 $200

D. Month 0 1 2 3 4 60
Cash Flow − $200 − $200 − $200 − $200 − $200 − $200
Course: 371
Date: 7/2/19
Time: 8:18 AM
You plan to deposit $900 in a bank account now and $700 at the end of one year. If the account earns 8% interest per year,
what will be the balance in the account right after you make the second deposit?
Here is the timeline for the cash flows from the perspective of the bank account:
Time 0 1
Cash Flows $900 $700

• 4-7
To compute the future value of the cash flows, use the following formula:
FV1 = C0 ( 1 + r ) + C1
FV1 = $900 (1 + 0.08) + $700 = $1,672
Course: 371
Date: 7/2/19
Time: 8:18 AM
You have just received a windfall from an investment you made in a friend's business. She will be paying you $60,000 at the
end of this year, $120,000 at the end of next year, and $180,000 at the end of the year after that (three years from today).
The interest rate is 16.0% per year.
a. What is the present value of your windfall?
b. What is the future value of your windfall in three years (on the date of the last payment)?
a. What is the present value of your windfall?
Here is the cash flow timeline:
Years 0 1 2 3 • 4-8
Cash Flow PV = ? $60,000 $120,000 $180,000
The present value of your windfall is found by using this formula:
C1 C2 C3
PV = + +
(1 + r) (1 + r)2 (1 + r)3
where C1 , C2 , C3 are the annual cash flows and r is the interest rate.
The present value of your windfall is:
$60,000 $120,000 $180,000

PV = + + = $256,222
(1 + 0.160) (1 + 0.160)2 (1 + 0.160)3
Or using the financial calculator:
Data and Key Input Display
CF ; 2ND ; CE C CF0 = 0. (this clears out any past
cash flows)
0 ; ENTER CF0 = 0
; 60,000 ; ENTER C01 = 60,000
; 1; ENTER F01 = 1
; 120,000 ; ENTER C02 = 120,000
; 1; ENTER F02 = 1
; 180,000 ; ENTER C03 = 180,000
; 1; ENTER F03 = 1
NPV
I = 0
16.0 ; ENTER
I = 16.0
NPV = 0
CPT NPV = 256,222
Or using Excel:
A B C D
1 NET PRESENT VALUE
2
3 The investment examined has the following cash flows:
4
5 rate (i) = 16.0 %
6
7 Year Cash Flow
8 Initial Outlay 0
9 1 60,000
10 2 120,000
11 3 180,000
12
13 NPV = 256,222
14
15 Excel formula: =NPV(rate, value1:valuen) − Initial Outlay
16 Entered value in Cell C13: =NPV(C5, C9:C11) C8
b. What is the future value of your windfall in three years (on the date of the last payment)?
Here is the cash flow timeline for part (b):
Years 0 1 2 3
The future value of your windfall is found by using this formula:
FVn = PV (1 + r)n
where PV is the present value found above, r is the interest rate, and n is the number of periods.
The future value of your windfall in three years (on the date of the last payment) is found by finding the future value of the
answer in part (a ):
FV = $256,222 (1 + 0.160)3 = $399,936
Or using a financial calculator or Excel:
N I /Y PV PMT FV
iven:
G 3 16.0 256,222 0
Solve for: − 399,936
Excel Formula: =FV(RATE,NPER,PMT,PV) = FV(0.160 ,3 ,0,256222 ) = − 399,936
Course: 371
Date: 7/2/19
Time: 8:19 AM
Suppose you receive $210 at the end of each year for the next three years.
a. If the interest rate is 11% , what is the present value of these cash flows?
b. What is the future value in three years of the present value you computed in (a )?
c. Suppose you deposit the cash flows in a bank account that pays 11% interest per year. What is the balance in the
account at the end of each of the next three years (after your deposit is made)? How does the final bank balance compare
with your answer in (b )?
a. If the interest rate is 11% , what is the present value of these cash flows?
The timeline for this question is:
• 4-9
Time 0 1 2 3
Cash Flows ? $210 $210 $210
Present value of a cash flow stream is:
C1 C2 Cn
PV = + 2
+•• •+ n
(1 + r) (1 + r) (1 + r)
$210 $210 $210

PV = + + = $513.18
(1 + 0.11) (1 + 0.11)2 (1 + 0.11)3
N I /Y PV PMT FV
iven:
G 3 11 210 0
Solve for: − 513.18
Excel Formula: =PV(RATE,NPER,PMT,FV) = PV(0.11 ,3 ,210 ,0)= − 513.18
b. What is the future value in three years of the present value you computed in (a )?
The timeline for this question is:
Time 0 1 2 3
Cash Flows $513.18 ?
The future value of a cash flow is:
FVn = C (1 + r)n
FV3 = $513.18 (1 + 0.11)3 = $701.84
N I /Y PV PMT FV
iven:
G 3 11 513.18 0
Solve for FV: − 701.84
Excel Formula: =FV(RATE,NPER,PMT,PV) =FV(0.11 ,3 ,0,513.18 )= − 701.84
c. Suppose you deposit the cash flows in a bank account that pays 11% interest per year. What is the balance in the
account at the end of each of the next three years (after each deposit is made)?
The timeline for year one is:
Time 0 1 2 3
Cash Flows $210
?
The balance in the account at the end of year one is:
FV1 = $210 (1) = $210
N I /Y PV PMT FV
iven:
G 1 11 0 210
Excel Formula: =FV(RATE,NPER,PMT,PV) =FV(0.11 ,1,210 ,0)= − 210.00
The timeline for year two is:
Time 0 1 2 3
Cash flow $210 $210

?
The future value of a cash flow for year two is:
FV2 = C1 ( 1 + r ) + C2
FV2 = $210 (1 + 0.11) + $210 = $443.10
N I /Y PV PMT FV
iven:
G 2 11 0 210
Excel Formula: =FV(RATE,NPER,PMT,PV) =FV(0.11 ,2,210 ,0)= − 443.10
The timeline for year three is:
Time 0 1 2 3
Cash flow $443.10 $210

?
The future value of a cash flow for year three is:
FV3 = FV2 ( 1 + r ) + C3
FV3 = $443.10 (1 + 0.11) + $210 = $701.84
N I /Y PV PMT FV
iven:
G 3 11 0 210
Excel Formula: =FV(RATE,NPER,PMT,PV) =FV(0.11 ,3 ,210 ,0)= − 701.84
How does the final bank balance compare with your answer in (b )?
The final bank balance in (c ) is equal to the bank balance from part (b ).
Course: 371
Date: 7/2/19
Time: 8:19 AM
You have a loan outstanding. It requires making nine annual payments of $10,000 each at the end of the next nine years.
Your bank has offered to restructure the loan so that instead of making the nine payments as originally agreed, you will
make only one final payment in nine years. If the interest rate on the loan is 11% , what final payment will the bank require
you to make so that it is indifferent to the two forms of payment?
First, the timeline for the cash flows is:
Years 0 1 2 3 4 5 6 7 8 9
Cash Flows $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000
Second, compute the present value of the cash flows using the following formula:
• 4-10
C1 C2 Cn
PV = + 2
+•• •+ n
(1 + r) (1 + r) (1 + r)
The present value of the cash flows is:
$10,000 $10,000 $10,000

PV = + +•••+ = $55,370
2 9
1 + 0.11 (1 + 0.11) (1 + 0.11)
N I/Y PV PMT FV
iven:
G 9 11 10,000 0
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.11 ,9 ,10000 ,0) = − 55,370
Once you know the present value of the cash flows, compute the future value (of this present value) using the following
formula:
n
FVn = PV (1 + r)
The future value of the cash flows is:
9
FV = $55,370 (1 + 0.11) = $141,639
N I/Y PV PMT FV
iven:
G 9 11 55,370 0
Excel Formula: = FV(RATE,NPER,PMT,PV) = FV(0.11 ,9 ,0,55370 ) = − 141,639
Course: 371
• 4-11 Finance, 4/e, Global Edition
Date: 7/2/19
Time: 8:20 AM
Assume you can earn 8.8% per year on your investments.
a. If you invest $140,000 for retirement at age 30, how much will you have 35 years later for retirement?
b. If you wait until age 40 to invest the $140,000 , how much will you have 25 years later for retirement?
c. Why is the difference so large?
a. If you invest $140,000 for retirement at age 30, how much will you have 35 years later for retirement?
The future value is:
n
FVn = C (1 + r)
FV35 = $140,000 (1 + 0.088)35 = $2,680,028
b. If you wait until age 40 to invest the $140,000 , how much will you have 25 years later for retirement?
The future value is:
FV25 = $140,000 (1 + 0.088)25 = $1,153,056
c. Why is the difference so large?
The difference is large because the compounding effect is accentuated the longer the time of investment.
Course: 371
Date: 7/2/19
Time: 8:22 AM
The British government has a consol bond outstanding paying 500 per year forever. Assume the current interest rate is
16% per year.
a. What is the value of the bond immediately after a payment is made?
b. What is the value of the bond immediately before a payment is made? • 4-14
a. What is the value of the bond immediately after a payment is made?
The cash flow timeline for part (a ) is:
Year 0 1 2 3
Cash Flows 500 500 500
The value of the bond is equal to the present value of the cash flows. By the perpetuity formula,

C
PV =
r
where C is the annual cash flow, and r is the interest rate.
Therefore,
500
PV = = 3,125
0.16
b. What is the value of the bond immediately before a payment is made?
The cash flow timeline for part (b ) is:
Years 1 2 3 4
Cash Flows 500 500 500 500
As in part (a ), the value of the bond is equal to the present value of the cash flows. The cash flows are a perpetuity plus the
payment that will be received immediately,
C
PV = +C
r
where C is the annual cash flow, and r is the interest rate.
Therefore,
500
PV = + 500 = 3,625
0.16
Course: 371
Date: 7/2/19
Time: 8:21 AM
You want to endow a scholarship that will pay $16,000 per year forever, starting one year from now. If the school's
endowment discount rate is 11% , what amount must you donate to endow the scholarship?
The timeline for the scholarship is:
Year 0 1 2 3 4 • 4-12
Cash Flows $16,000 $16,000 $16,000 $16,000
To determine the present value of the perpetuity use the following formula:
C
PV =
r
where C is the cash flow and r is the interest rate.
$16,000
PV = = $145,454.55
0.11
Course: 371
Date: 7/2/19
Time: 8:21 AM
You want to endow a scholarship that will pay $16,000 per year forever, starting one year from now. If the school's
endowment discount rate is 11% , what amount must you donate to endow the scholarship? How would your answer change
if you endow it now, but it makes the first award to a student 10 years from today?
Year 0 1 2 3 4
Cash Flows $16,000 $16,000 $16,000 $16,000 • 4-13
To determine the present value of the perpetuity use the following formula:
C
PV =
r
$16,000
PV = = $145,454.55
0.11
How would your answer change if you endow it now, but it makes the first award to a student 10 years from today?
Year 0 1 2 9 10 11
Cash Flows 0 0 0 $16,000 $16,000
1. Calculate the value of the perpetuity in year 9.
2. Discount that value back to the present.
The value of the perpeturity is the same as before, PV9 = $145,454.55.
To find the value of the deferred perpetuity today, discount the value back nine years as follows:
PV9
PV =
(1 + r)9
$145,454.55
PV = = $56,861.79
(1 + 0.11)9
Course: 371
Date: 7/2/19
Time: 8:22 AM
You are offered the right to receive $10,000 per year forever, starting in one year. If your discount rate is 8 %, what is this
offer worth to you?
The value of this right is equal to the present value of the cash flows. To calculate the present value of the cash flows, use
the following perpetuity formula:
CF • 4-15
PV =
r
Therefore,
$10,000
PV = = $125,000
0.08
This offer is worth $125,000.
Course: 371
Date: 7/2/19
Time: 8:22 AM
You have $600,000 to donate to your college. You want to endow a perpetual scholarship that makes its first payment in
one year. If the college's discount rate is 8 %, how large will the annual scholarship payment be?
To calculate the annual scholarship payment amount, use the following formula:
CF
PV =
r
However, since you are calculating the payment amount (CF ), the formula can be rearranged as:
CF = PV r
Therefore,
CF = $600,000 0.08 = $48,000
The annual scholarship payment will be $48,000. • 4-16
Course: 371
Date: 7/2/19
Time: 8:23 AM
You have $600,000 to donate to your college. The college's discount rate is 8 %. You donate the money today, but you ask
the college to delay the scholarship payment so that the first scholarship payment is made 10 years from today. How large
will the annual payment be?
To solve this problem, you need to know how much your donation will have grown to become one year before the first
payment. This is because the perpetuity formula always take the value one period before the first cash flow. To calculate the
value of your donation in year 9, use the following formula:
9
Value in year 9 = Donation amount (1 + Discount rate)
Here is the timeline:
0 1 2 ... 9 10 11 12
• 4-17
0 0 0 ... 0 CF CF CF
Therefore,
9
Value in year 9 = $600,000 (1.08) = $1,199,402.78
The value in year 9 is $1,199,402.78.
The formula to calculate a perpetuity is as follows:
CF
PV =
r
However, since you are calculating the payment amount (CF ), the formula can be rearranged as:
CF = PV r
where the value in year 9 is the present value (PV ).
Therefore,
CF = $1,199,402.78 0.08 = $95,952.22
The annual scholarship payment will be $95,952.22.
Course: 371
Date: 7/2/19
Time: 8:24 AM
What is the present value of $11,000 paid at the end of each of the next 101 years if the interest rate is 13% per year?
The cash flow timeline for the investment opportunity is:
Years 0 1 2 3 101
Cash flows $11,000 $11,000 $11,000 $11,000

• 4-18
The present value of an annuity is found using this formula:
1 1
PV = C 1−
r (1 + r)n
where C is the annuity amount, r is the interest rate, and n is the number of periods.
Therefore,
1 1
PV = $11,000 1− = $84,615.02
0.13 (1 + 0.13)101
Using a financial calculator or Excel:
N I/Y PV PMT FV
iven:
G 101 13 11,000 0
Solve for: − 84,615.02
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.13 ,101 ,11000 ,0)= − 84,615.02
Course: 371
Date: 7/2/19
Time: 8:24 AM
Your grandmother has been putting $6,000 into a savings account on every birthday since your first (that is, when you
turned one). The account pays an interest rate of 13%. How much money will be in the account immediately after your
grandmother makes the deposit on your 18th birthday
This is the cash flow timeline:
Year 0 1 2 3 18 • 4-19
Deposits $6,000 $6,000 $6,000 $6,000
The deposits are an 18year annuity. Use the following formula to calculate the future value of an annuity:
C
FV = (1 + r)n − 1
r
Therefore,
$6,000
FV = (1 + 0.13)18 − 1 = $370,351
0.13
N I/Y PV PMT FV
iven:
G 18 13 0 6,000
Excel Formula: = FV(RATE,NPER,PMT,PV) = FV(0.13 ,18,6000 ,0)= − 370,351
Course: 371
Date: 7/2/19
Time: 8:25 AM
Assume that your parents wanted to have $190,000 saved for college by your 18th birthday and they started saving on your
first birthday. They saved the same amount each year on your birthday and earned 13.0% per year on their investments.
a. How much would they have to save each year to reach their goal?
b. If they think you will take five years instead of four to graduate and decide to have $230,000 saved just in case, how
much more would they have to save each year to reach their new goal?
a. How much would they have to save each year to reach their goal?
The timeline for the cash flows is: • 4-20
Period 0 1 2 17 18
Cash flow C C C C
We need to find the equal annual payment, C , made at the end of each year for 18 years that when invested at 13.0% will
accumulate to $190,000.
The formula to find the FV of an anuity is as follows:

C
FV = (1 + r)n − 1
r
In this case we know the FV is $190,000 , and number of years, n , is 18 and the rate, r , is 13.0% , so we must solve for C ,
using this formula:
r
C = FV
n
(1 + r) − 1
Therefore,
0.130
C = $190,000 = $3,078.16
18
(1 + 0.130) −1
N I/Y PV PMT FV
iven:
G 18 13.0 0 190,000
Solve for: − 3,078.16
Excel Formula: = PMT(RATE,NPER,PV,FV) = PMT(0.130 ,18,0,190,000 )
Your parents would have to save $3,078.16 each year for 18 years in order to accumulate $190,000.
b. If they think you will take five years instead of four to graduate and decide to have $230,000 saved just in case, how
much more would they have to save each year to reach their new goal?
We need to find the equal annual payment, C , made at the end of each year for 18 years that when invested at 13.0% will
accumulate to $230,000.
0.130
C = $230,000 18
= $3,726.20
(1 + 0.130) −1
N I/Y PV PMT FV
iven:
G 18 13.0 0 230,000
Solve for: − 3,726.20
Excel Formula: = PMT(RATE,NPER,PV,FV) = PMT(0.130 ,18,0,230,000 )
Your parents would have to save $3,726.20 each year for 18 years in order to accumulate $230,000.
Course: 371
Date: 7/2/19
Time: 8:25 AM
When you purchased your car, you took out a fiveyear annualpayment loan with an interest rate of 7.0% per year. The
annual payment on the car is $6,000. You have just made a payment and have now decided to pay off the loan by repaying
the outstanding balance. What is the payoff amount for the following scenarios?
a. You have owned the car for one year (so there are four years left on the loan)?
b. You have owned the car for four years (so there is one year left on the loan)?
a. You have owned the car for one year (so there are four years left on the loan)?
The timeline if you have owned the car for one year is:
Cash Flows − PV − $6,000 − $6,000 − $6,000 − $6,000

• 4-21
Period 0 1 2 3 4
The remaining payments are a 4year annuity, so:
C 1
PV = 1−
r (1 + r)n
where r is the interest rate, C is the annual payment, and n is the number of periods.
Therefore,
$6,000 1
PV = 1− = $20,323.27
0.070 (1 + 0.070)4
N I/Y PV PMT FV
iven:
G 4 7.0 6,000 0
Solve for: − 20,323.27
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.070 ,4,6000 ,0)= − 20,323.27
b. You have owned the car for four years (so there is one year left on the loan)?
The timeline if you have owned the car for four years is:
Cash Flows − PV − $6,000
Period 0 1
The remaining payment is the present value of a future amount:
C
PV =
(1 + r)
where r is the interest rate and FV is the final payment.
Therefore,
$6,000
PV = = $5,607.48
(1 + 0.070)
N I/Y PV PMT FV
iven:
G 1 7.0 6,000 0
Solve for: − 5,607.48
Course: 371
Date: 7/2/19
Time: 8:26 AM
You figure that the total cost of college will be $111,000 per year 18 years from today. If your discount rate is 13%
compounded annually, what is the present value today of four years of college costs starting 18 years from today?
The following timeline shows the payments for each year:
Period 0 1 2 18 19 20 21
Cash Flows $0 $0 $111,000 $111,000 $111,000 $111,000
Use the following formula to determine the value of the annuity one year before it starts (beginning of year 18 or the end of
year 17):
• 4-22
C 1
PV = 1−
r (1 + r)n
where C is the cash flow, r is the interest rate, and n is the number of periods.
Therefore,
1 1
PV = $111,000 1− = $330,166.32
0.13 (1 + 0.13)4
N I/Y PV PMT FV
iven:
G 4 13 111,000 0
Solve for: − 330,166.32
To determine the value today of the lump sum, present value of the annuity, at the end of year 17, the timeline, where
cashflows are shown at the end of the year, is:
0 1 17
PV ? $0 $330,166.32
To determine the value today of the lump sum at the end of year 17, use the following formula:
C
PV =
(1 + r)n
where FV is the lump sum, r is the interest rate, and n is the number of periods.
Therefore,
$330,166.32
PV = 17
= $41,343
(1 + 0.13)
N I/Y PV PMT FV
iven:
G 17 13 0 330,166.32
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.13 ,17,0,330166.32 )= − 41,343
The present value today of four years of college costs starting 18 years from today is $41,343.
Course: 371
Date: 7/2/19
Time: 8:26 AM
Assume that Social Security promises you $51,000 per year starting when you retire 45 years from today (the first $51,000
will get paid 45 years from now). If your discount rate is 11% , compounded annually, and you plan to live for 19 years after
retiring (so that you will receive a total of 20 payments including the first one), what is the value today of Social Security's
promise?
The timeline is:
Years 0 1 45 64 • 4-23
Cash Flows $0 $51,000 $51,000
Use the following formula to determine the value of the annuity one year before it starts (Year 44):
C 1
PV44 = 1−
r (1 + r)n
where C is the annual payment from Social Security, r is the interest rate, and n is the number of periods.
Therefore,
1 1
PV44 = $51,000 1− = $406,129.73
0.11 (1 + 0.11)20
N I/Y PV PMT FV
iven:
G 20 11 $51,000 0
Solve for: − 406,129.73
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.11 ,20 ,51000 ,0)= − 406,129.73
To determine the value today of the lump sum at Year 44, the timeline is:
Year 0 1 44
Cash Flows $0 $406,129.73
To determine the value today of the lump sum of the deferred annuity at year 44, use the following formula:
C
PV =
n
(1 + r)
where C is the PV44 , r is the interest rate, and n is the number of periods.
Therefore,
$406,129.73
PV = 44
= $4,115.79
(1 + 0.11)
N I/Y PV PMT FV
iven:
G 44 11 0 406,129.73
Solve for: − 4,115.79
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.11 ,44 ,0,406129.73 )= − 4,115.79
Course: 371
Date: 7/2/19
Time: 8:27 AM
When Alex Rodriguez moved to the Texas Rangers, he received a lot of attention for his "$252 million" contract (the total of
the payments promised was $252 million). Assume the following about the contract:
Rodriguez earns $16 million in the first year, $17 million in years 2 through 4, $19 million in years 5 and 6, $23 million in
year 7 and $27 million in years 8 through 10. He would also receive his $10 million signing bonus spread equally over the
first 5 years ($2 million per year). His deferred payments will begin in 2011. The deferred payment amounts total $33
million and are $5 million, then $4 million, then 8 payments of $3 million (ending in 2020). However, the actual payouts will
be different. All of the deferred payments will earn 3% per year until they are paid. For example, the $5 million is deferred
from 2001 to 2011, or 10 years, meaning that it will actually be $6.72 million when paid. Assume that the $4 million
payment deferred to 2012 is deferred from 2002 (each payment is deferred 10 years).
The contract is a 10year contract, but each year has a deferred component so that cash flows are paidout over a total
of 20 years. The contractual payments, signing bonus, and deferred components are given below. Note that, by
contract, the deferred components are not paid in the year they are earned, but instead are paid (plus interest) 10 years
later.

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
$16 M $17 M $17 M $17 M $19 M $19 M $23 M $27 M $27 M $27 M
$2 M $2 M $2 M $2 M $2 M
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Deferred
$5 M $4 M $3 M $3 M $3 M $3 M $3 M $3 M $3 M $3 M
Assume that an appropriate discount rate for ARod to apply to the contract payments is 7% per year.
a. Calculate the true promised payments under this contract, including the deferred payments with interest.
b.
Calculate the present value of the contract.
c. Compare the present value of the contract to the quoted value of $252 million. What explains the difference?
Use the present value formula to help understand Mr. Rodriguez's complex contract.
Execute:
Payments in years 1 through 5 are the earnings in those years plus the bonus spread evenly over the 5 years.
Rodriguez earns $16 million in the first year, $17
million in years 2 through 4, and $19 million in year 5. He will receive his
$10 million signing bonus spread equally over the first 5 years ($2 million per year).
herefore, the true promised payments under this contract for years 1 through 5 are (all values are rounded to the nearest
T
million.) :
2001 2002 2003 2004 2005

$18 M $19 M $19 M $19 M $21 M
Payments 6 to 10 are the given payments. He would receive $19M in year 6, $23M in year 7 and $27M in years 8 through
10.
herefore, the true promised payments under this contract for years 6 through 10 are (all values are rounded to the nearest
T
million.) :
2006 2007 2008 2009 2010

$19 M $23 M $27 M $27 M $27 M
Payment 11 is the first deferred payment, $5 M, times (1.03)10 . Payment 12 is the second deferred payment, $4 M, times
(1.03)10 , and payments 13 through 20 are the third deferred payment, $3 M, times (1.03)10 .
Therefore, the true promised payments under this contract for years 11 through 20 are:
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
$6.72 M $5.38 M $4.03 M $4.03 M $4.03 M $4.03 M $4.03 M $4.03 M $4.03 M $4.03 M
b.
To find the present value of the contract, sum the present value of each of the promised cash flows found in part a.
$18 $19 $4.03
PV = + +•• •+ .
(1.07)1 (1.07)2 (1.07)20
The present value of each cash flow at 7% is given below:
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
$16.82 M $16.60 M $15.51 M $14.50 M $14.97 M $12.66 M $14.32 M $15.71 M $14.69 M $13.73 M
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
$3.19 M $2.39 M $1.67 M $1.56 M $1.46 M $1.37 M $1.28 M $1.19 M $1.11 M $1.04 M

The total present value for the 20 years is the sum of all the present values in the chart above, $166 million.
c. Compare the present value of the contract to the quoted value of $252 million. What explains the difference?
The reason for the difference is the $252 million value does not discount the future cash flows or adjust deferred payments
for accrued interest.
Evaluate:
The PV of the contract, $166 million, is much less than the $252 million quoted contract. The reason for the difference is
the $252 million value does not discount the future cash flows or adjust deferred payments for accrued interest.
Course: 371
Date: 7/2/19
Time: 8:28 AM
You are trying to decide how much to save for retirement. Assume you plan to save $7,000 per year with the first investment
made one year from now. You think you can earn 9.0 % per year on your investments and you plan to retire in 46 years,
immediately after making your last $7,000 investment.
a. How much will you have in your retirement account on the day you retire?
b. If, instead of investing $7,000 per year, you wanted to make one lumpsum investment today for your retirement that will
result in the same retirement saving, how much would that lump sum need to be?
c. If you hope to live for 31 years in retirement, how much can you withdraw every year in retirement (starting one year after
retirement) so that you will just exhaust your savings with the 31st withdrawal (assume your savings will continue to earn
9.0 % in retirement)?
d. If, instead, you decide to withdraw $804,000 per year in retirement (again with the first withdrawal one year after retiring),
how many years will it take until you exhaust your savings? (Use trialanderror, a financial calculator: solve for "N", or
Excel: function NPER)
e. Assuming the most you can afford to save is $3,500 per year, but you want to retire with $1,000,000 in your investment
account, how high of a return do you need to earn on your investments? (Use trialanderror, a financial calculator: solve for
the interest rate, or Excel: function RATE)
a. How much will you have in your retirement account on the day you retire?
The timeline is:
Years 0 1 2 46
Cash Flows $7,000 $7,000 $7,000
The amount in the retirement account in n years would be:
C n
FVn = 1+r −1
r
where C is the saving per year and r is return earned.
The amount in the retirement account in 46 years would be:
$7,000
FV43 = (1.090)46 − 1 = $4,019,302.14
0.090
N I/Y PV PMT FV
iven:
G 46 9.0 0 7,000
Solve for: − 4,019,302.14
Excel Formula: = FV(RATE,NPER,PMT,PV) = FV(0.090 ,46 ,7000 ,0) = − 4,019,302.14
b. If, instead of investing $7,000 per year, you wanted to make one lumpsum investment today for your retirement that will
result in the same retirement saving, how much would that lump sum need to be?
To solve for the lump sum amount today, find the PV of the amount needed at retirement using the following formula:
FVn
PV =
(1 + r)n
Therefore,
$4,019,302.14
PV = = $76,301.27
(1 + 0.090)46
N I/Y PV PMT FV
iven:
G 46 9.0 0 0 4,019,302.14
Solve for: − 76,301.27
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.090 ,46 ,0,4019302.14 ) = − 76,301.27
c. If you hope to live for 31 years in retirement, how much can you withdraw every year in retirement (starting one year after
retirement) so that you will just exhaust your savings with the 31st withdrawal (assume your savings will continue to earn
9.0 % in retirement)?
Timeline:
Years 0 1 2 31
Cash Flows$4,019,302.14 −C −C −C
Recall:
C 1
PV = 1−
r (1 + r)n
solving for C gives:
PV
C=
1 1
1−
r (1 + r)n
Therefore:
$4,019,302.14
C= = $388,608.64
1 1
1−
0.090 (1 + 0.090)31
N I/Y PV PMT FV
iven:
G 31 9.0 4,019,302.14 0
Solve for: − 388,608.64
Excel Formula: = PMT(RATE,NPER,PV,FV) = PMT(0.090 ,31 ,4019302.14 ,0) = − 388,608.64
d. If, instead, you decide to withdraw 804,000 per year in retirement (again with the first withdrawal one year after retiring),
how many years will it take until you exhaust your savings? (Use trialanderror, a financial calculator: solve for "N", or
Excel: function NPER)
The timeline is:
Years 0 1 2 n
Cash Flows $4,019,302.14 − 804,000 − 804,000 − 804,000
We want to solve for n , which is the length of time in which the PV of annual payments of $804,000 will equal
$4,019,302.14. Setting up the PV of an annuity formula and solving for n :
C 1
PV = 1−
r (1 + r)n
$804,000 1
$4,019,302.14 = 1−
0.090 (1 + 0.090)n
$4,019,302.14 0.090 1
= 1−
$804,000 (1 + 0.090)n
1 $4,019,302.14 0.090
=1−
(1 + 0.090)n $804,000
1
= 0.5500781
n
1.090
n
1.090 = 1.8179237
log (1.8179237)
n= = 6.94 years
log (1.090)
N I/Y PV PMT FV
iven:
G 9.0 4,019,302.14 804,000 0
Solve for: 6.94
Excel Formula: = NPER(RATE,PMT,PV,FV) = NPER(0.090 ,804000 ,4019302.14 ,0) = 6.94
e. Assuming the most you can afford to save is $3,500 per year, but you want to retire with $1,000,000 in your investment
account, how high of a return do you need to earn on your investments? (Use trialanderror, a financial calculator: solve for
the interest rate, or Excel: function RATE)
If we can only invest $3,500 per year, then set up the FV formula using $1,000,000 as the FV and $3,500 as the annuity
payment.
C n
FVn = 1+r −1
r
$3,500
$1,000,000 = (1 + r)46 − 1
r
To solve for r , we can either guess or use the annuity calculator. You can check and see that r = 6.768% solves this
equation. So, the required rate of return must be 6.768%.
N I/Y PV PMT FV
iven:
G 46 0 − 3,500 $1,000,000
Solve for: 6.768
Excel Formula: = RATE(NPER,PMT,PV,FV,0,GUESS) = RATE(46 ,3500 ,0,1000000 ,0,0.1) = 6.768
Course: 371
Student: Lama Alqahtani • 4-26 Book: Berk/DeMarzo/Harford: Fundamentals of Corporate
Date: 7/2/19
Time: 8:28 AM
A rich relative has bequeathed you a growing perpetuity. The first payment will occur in a year and will be $6,000. Each year
after that, you will receive a payment on the anniversary of the last payment that is 9% larger than the last payment. This
pattern of payments will go on forever. Assume that the interest rate is 17% per year.
a. What is today's value of the bequest?
b. What is the value of the bequest immediately after the first payment is made?
a. What is today's value of the bequest?
The following is the cash flow timeline for part (a ):
Year 0 1 2 3 Forever
Cash Flows $6,000 $6,000 1.09 $6,000 1.092
To solve part (a ), use the formula for the present value of a growing perpetuity:
CF1
PV =
( r − g)
where CF1 is the first payment, r is the interest rate, and g is the growth rate.
Therefore,
$6,000
PV = = $75,000
(0.17 − 0.09)
b. What is the value of the bequest immediately after the first payment is made?
The following is the cash flow timeline for part (b ):
Cash Flows $6,000 1.09 $6,000 1.092 $6,000 1.093
To solve part (b) you use the formula for the present value of a growing perpetuity:
CF2
PV =
( r − g)
where CF2 is the cash flow in the second year, r is the interest rate, and g is the growth rate.
Therefore,
$6,000 1.09
PV = = $81,750
(0.17 − 0.09)
Course: 371
Date: 7/2/19
Time: 8:29 AM
You are thinking of building a new machine that will save you $6,000 in the first year. The machine will then begin to wear
out so that the savings decline at a rate of 5% per year forever. What is the present value of the savings if the interest rate is
11% per year?
The cash flow timeline is:
Period 0 1 2 3
Cash Flows $6,000 $5,700 $5,415
From the timeline, it is clear that you must value a growing perpetuity.
Using the growing perpetuity formula:

C
PV =
( r − g)
where C is the annual cash flow, r is the interest rate, and g is the growth rate. In this case, the growth rate is the rate of
decline. That is, you use this negative rate in the growing perpetuity formula.
herefore,
T

$6,000
PV = = $37,500
(0.11 − ( − 0.05))
Course: 371
Date: 7/2/19
Time: 8:29 AM
When Alfred Nobel died, he left the majority of his estate to fund five prizes, each to be awarded annually in perpetuity
starting one year after he died (the sixth one, in economics, was added later).
a. If he wanted the cash award of each of the five prizes to be $62,000 and his estate could earn 11 % per year, how much
would he need to fund his prizes?
b. If he wanted the value of each prize to grow by 7 % per year (perhaps to keep up with inflation), how much would he need
to leave? Assume that the first amount was still $62,000.
c. His heirs were surprised by his will and fought it. If they had been able to keep the amount of money you calculated in
(b ), and had invested it at 11 % per year, how much would they have in 2014, 118 years after his death?
a. If he wanted the cash award of each of the five prizes to be $62,000 and his estate could earn 11 % per year, how much
would he need to fund his prizes?
a. To determine the total amount Nobel would need to endow the prizes at a constant amount, use the following formula:
C
PV =
r
Therefore,
$310,000
PV = = $2,818,182
0.11
b. If he wanted the value of each prize to grow by 7 % per year (perhaps to keep up with inflation), how much would he need
to leave? Assume that the first amount was still $62,000.
To determine the amount Nobel would need to leave in order for the value of the prize to grow by 7 % per year, use the
following formula:
C
PV =
r−g
where C is the cash flow, r is the interest rate, and g is the growth rate.
Therefore,
$310,000
PV = = $7,750,000
0.11 − 0.07
c. His heirs were surprised by his will and fought it. If they had been able to keep the amount of money you calculated in
(b ), and had invested it at 11 % per year, how much would they have in 2014, 118 years after his death?
To determine the amount the heirs would have in 2014, if they had been able to keep the money in part (b), use the
following formula:
FV = C (1 + r)n
where C is the present value of the growing perpetuity, r is the interest rate, and n is the number of years.
Therefore,
118
PV = $7,750,000 (1 + 0.11) = $1,727,480,681,479
Course: 371
Date: 7/2/19
Time: 8:30 AM
You work for a pharmaceutical company that has developed a new drug. The patent on the drug will last 17 years. You
expect that the drug's profits will be $6 million in its first year and that this amount will grow at a rate of 7% per year for the
next 17 years. Once the patent expires, other pharmaceutical companies will be able to produce the same drug and
competition will likely drive profits to zero. What is the present value of the new drug if the interest rate is 13% per year?
To determine the present value of the new drug, use the following formula:
n
C 1+g
PV = 1−
r−g 1+r
where C is the cash flow, r is the interest rate, g is the growth rate, and n is the number of periods.
Therefore,
17
$6 million 1 + 0.07
PV = 1− = $60.446 million
0.13 − 0.07 1 + 0.13
Course: 371
Student: Lama Alqahtani • 4-30
Date: 7/2/19
Time: 8:30 AM
A rich aunt has promised you $7,000 one year from today. In addition, each year after that, she has promised you a
payment (on the anniversary of the last payment) that is 7% larger than the last payment. She will continue to show this
generosity for 20 years, giving a total of 20 payments. If the interest rate is 10% , what is her promise worth today?
To determine the present value, use the following formula:
n
C 1+g
PV = 1−
r−g 1+r
where C is the cash flow, r is the interest rate, g is the growth rate, and N is the number of periods.
Therefore,
20
$7,000 1 + 0.07
PV = 1− = $99,119
0.10 − 0.07 1 + 0.10
Course: 371
Date: 7/2/19
Time: 8:31 AM
You are thinking about buying a savings bond. The bond costs $70 today and will mature in 16 years with a value of $140.
What annual interest rate will the bond earn?
To determine the annual rate, use the following formula:
FV = P (1 + r)n
where P is the amount you invest today, FV is the future value you will receive in n, number of years, and solve for r, the
annual rate.
1
• 4-31
n
FV
1+r=
P
1
n
FV
r= −1
P
Solving for r :
1
16
$140
r= − 1 = 0.04427 = 4.427%
$70
N I/Y PV PMT FV
iven:
G 16 70 0 140
Solve for: 4.427
Excel Formula: = RATE(NPER,PMT,PV,FV,0,GUESS) = RATE(16 ,0,70 ,140 ,0,0.1)= 0.04427
Course: 371
Date: 7/2/19
Time: 8:31 AM
You have an investment account that started with $5,000 10 years ago and which now has grown to $13,000.
a. What annual rate of return have you earned (you have made no additional contributions to the account)?
b. If the investment account earns 14% per year from now on, what will the account's value be 10 years from now?
a. What annual rate of return have you earned (you have made no additional contributions to the account)?
To determine the rate of return, use the following formula:
FV = PV (1 + r)n
where PV is the amount you invest today, FV is the future value you will receive in n, number of years, and solve for r, the
annual rate.
1
n
FV
r= −1
PV
Therefore,
1
10
$13,000
r= − 1 = 0.1003 = 10.03%
$5,000
N I/Y PV PMT FV
iven:
G 10 − 5,000 0 13,000
Solve for: 0.1003
Excel Formula: = RATE(NPER,PMT,PV,FV,0,GUESS) = RATE(10 ,0, − 5000 ,13000 ,0,0.1)= 0.1003
b. If the investment account earns 14% per year from now on, what will the account's value be 10 years from now?
To calculate the amount in your account ten years later, use the following formula:
FV = PV (1 + r)n
where r is the rate of return, PV is the present value, and n is the number of periods.
Therefore,
10
FV = $13,000 (1 + 0.14) = $48,193.88
N I/Y PV PMT FV
iven:
G 10 14 − 13,000 0
Solve for: 48,193.88
Excel Formula: = FV(RATE,NPER,PMT,PV) = FV(0.14 ,10 ,0,13000 )= 48,193.88
Course: 371
Date: 7/2/19
Time: 8:31 AM
You have an investment opportunity that requires an initial investment of $9,000 today and will pay $12,000 in one year.
What is the rate of return of this opportunity?
The cash flow timeline is as follows:
• 4-33
Year 0 1
Cash Flows − $9,000 $12,000
To find the rate of return, use the following formula:
n
FV = PV (1 + r)
where PV is the amount you invest today, FV is the future value you will receive in n, number of years, and solve for r, the
annual rate.
1
n
FV
r= −1
PV
Therefore,
$12,000
r= − 1 = 33.33%
$9,000
N I/Y PV PMT FV
iven:
G 1 − 9,000 0 12,000
Solve for: 33.33
Excel Formula: = RATE(NPER,PMT,PV,FV,0,GUESS) = RATE(1,0, − 9000 ,12000 ,0,0.1)= 0.3333
Course: 371
Instructor: Aminah Alsalim • 4-34 Book: Berk/DeMarzo/Harford: Fundamentals of Corporate
Date: 7/2/19
Time: 8:32 AM
You have decided to buy a perpetual bond. The bond makes one payment at the end of every year forever and has an
interest rate of 11%. If the bond initially costs $6,000 , what is the payment every year?
This is the cash flow timeline for this problem:
Cash Flows − $6,000 C C C C
The formula for the present value of a perpetuity is
C
PV =
r
where C is the annual cash flow, and r is the annual interest rate.
In this case, we know that the present value of the perpetuity is $6,000 , which is the amount invested in the bond. We also
know that the rate is 11%. Therefore, we can set up the perpetuity formula and solve for the unknown, which is the annual
cash flow.
C
$6,000 =
0.11
Solving for C:
C = $6,000 0.11 = $660
Course: 371
Date: 7/2/19
Time: 8:32 AM
You are thinking of purchasing a house. The house costs $500,000. You have $71,000 in cash that you can use as a down
payment on the house, but you need to borrow the rest of the purchase price. The bank is offering a 30 year mortgage that
requires annual payments and has an interest rate of 4% per year. What will be your annual payment if you sign this
mortgage?
The following is the cash flow timeline from the perspective of the bank:
Year 0 1 2 3 30
where C is the annual payment and $429,000 is the amount of the loan, which is the price of the house, $500,000 , less the
down payment, $71,000.
The loan payment is a 30 year annuity, and the loan amount is the present value of the 30 year annuity. Use the following
formula to determine the annual loan payment:
PV
C=
1 1
1−
r (1 + r)n
where C is the annual loan payment, PV is the loan amount, r is the interest rate, and n is the number of years.
Therefore,
$429,000
C= = $24,809
1 1
1−
0.04 (1 + 0.04)30
N I/Y PV PMT FV
iven:
G 30 4 429,000 0
Excel Formula: = PMT(RATE,NPER,PV,FV) = PMT(0.04 ,30 ,429000 ,0) = − 24,809
Course: 371
Date: 7/2/19
Time: 8:33 AM
You are thinking about buying a piece of art that costs $60,000. The art dealer is proposing the following deal: He will lend
you the money, and you will repay the loan by making the same payment every two years for the next 22 years (i.e., a total
of 11 payments). If the interest rate is 3% per year, how much will you have to pay every two years?
The following is the cash flow timeline:
• 4-36
Payment # 0 1 2 3 11
Year 0 2 4 6 22
As you can see from the above timeline, this cash flow stream is an annuity that consists of 11 equal payments of C.
However we cannot use the oneyear interest rate because the period of the above timeline is two years.
irst, we need to calculate the twoyear interest rate: the oneyear rate is 3% , so the twoyear rate is
F
(1.03)2 − 1 = 1.0609 − 1 = 0.0609 , or 6.09%.
The calculation of the loan payment is then found using the equation for an annuity payment:
PV
C=
1 1
1−
r (1 + r)n
where C is the loan payment, r is the twoyear interest rate, and n is the number of payments.
Therefore,
$60,000
C= = $7,643
1 1
1−
0.0609 (1 + 0.0609)22 2
N I/Y PV PMT FV
iven:
G 11 6.09 − 60,000 0
Solve for: 7,643
Excel Formula: = PMT(RATE,NPER,PV,FV) = PMT(0.0609 ,11 , − 60,000 ,0) = 7,643
Course: 371
Date: 7/2/19
Time: 8:33 AM
You would like to buy a house that costs $350,000. You have $50,000 in cash that you can put down on the house, but you
need to borrow the rest of the purchase price. The bank is offering you a 30year mortgage that requires annual payments
and has an interest rate of 6% per year. You can afford to pay only $21,030 per year. The bank agrees to allow you to pay
this amount each year, yet still borrow $300,000. At the end of the mortgage (in 30 years), you must make a balloon
payment; that is, you must repay the remaining balance on the mortgage. How much will be this balloon payment?
Hint: The balloon payment will be in addition to the 30th payment.
The cash flow timeline is as follows:
Year 0 1 2 3 30
Cash Flows − $300,000 $21,030 $21,030 $21,030 $21,030

+
• 4-37
X
where X is the balloon payment.
The present value of the loan payments must be equal to the amount borrowed, that is,
$300,000 = PV(annuity) + PV(X)
The present value of the annual payments, PV (annuity) is found using the following formula:
C 1
PV(annuity) = 1−
r (1 + r)n
where C is the annual loan payment, r is the interest rate, and n is the number of periods.
The present value of the balloon payment, PV (X ) is found using the following formula:
X
PV(X) =
n
(1 + r)
Using the present value of an annuity, PV (annuity),
$21,030 1
PV(annuity) = 1−
0.06 (1 + 0.06)30
and the present value of the balloon payment, PV (X ) ,
X
PV(X) = 30

(1 + 0.06)
therefore:
$21,030 1 X
$300,000 = 1− +
0.06 (1 + 0.06)30 (1 + 0.06)
30
Solving for X in the above equation brings:
$21,030 1 30
X = $300,000 − 1− (1 + 0.06)
0.06 (1 + 0.06)30
X = $60,454
N I/Y PV PMT FV
iven:
G 30 6 21,030 0
Solve for: − 289,474.40
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.06 ,30,21030 ,0)
The present value of the annuity is $289,474.40 , which is $10,525.60 less than the $300,000.
To make up for this shortfall with a balloon payment in year 30 would require a payment of $60,454.
N I/Y PV PMT FV
iven:
G 30 6 10,525.60 0
Excel Formula: = FV(RATE,NPER,PMT,PV) = FV(0.06 ,30,0,10525.60 )
Course: 371
Date: 7/2/19
Time: 8:34 AM
You are saving for retirement. To live comfortably, you decide you will need to save $5 million by the time you are 65. Today
is your 19th birthday, and you decide, starting today and continuing on every birthday up to and including your 65th
birthday, that you will put the same amount into a savings account. If the interest rate is 6.5% , how much must you set aside
each year to make sure that you will have $5 million in the account on your 65th birthday?
Below is the cash flow timeline:
Age 19 20 21 22 65
Years 0 1 2 3 46
C C C C C
$5 million
The cash flows consist of a 46 year annuity, plus a contribution today, so the PV is:
1 1
PV = C 1− +C
r (1 + r)n
where C is the annuity payment (the annual amount to be deposited), r is the interest rate, and n is the number of periods
(46 years in this case).
Therefore,
1 1
PV = C 1− +C
0.065 (1 + 0.065)46
To derive the PV so that you can solve for the unknown, C , you can discount the $5,000,000 to be received in 46 years
assuming a 6.5% interest rate using this formula:
C
PV =
(1 + r)n
where C is cash flow (future value), r is the interest rate, and n is the number of years.
Therefore,
$5,000,000
PV = = $275,986.63
(1 + 0.065)46
N I/Y PV PMT FV
iven:
G 46 6.5 0 5,000,000
Solve for: − 275,986.63
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.065 ,46 ,0,5000000 ) = − 275,986.63
n
Now you can restate the PV of annuity formula as follows:
Solving for C , you get the following:
$275,986.63
C= = $17,765
1 1
1− +1
0.065 (1 + 0.065)46
We need $275,986.63 today to have $5,000,000 in 46 years. If we do not have $275,986.63 today, we can make 47 equal
payments (the first payment is today making the payments an annuity due) of $17,765.
( Note: The financial calculator must be set to the begin mode and in EXCEL the type is set equal to 1 for an annuity due as
opposed to an ordinary annuity.)
N I/Y PV PMT FV
iven:
G 47 6.5 − 275,986.63 0
Solve for: 17,765
Excel Formula: =PMT(RATE,NPER,PV,FV,TYPE)
=PMT(0.065 ,47 ,275986.63 ,0,1) = 17,765
Course: 371
Date: 7/2/19
Time: 8:34 AM
You receive a $15,000 check from your grandparents for graduation. You decide to save it toward a down payment on a
house. You invest it earning 7.5 % per year and you think you will need to have $30,000 saved for the down payment. How
long will it be before the $15,000 has grown to $30,000 ?
To determine the number of years it will take, use the following formula:
n
FV = C (1 + r)
and solve for n :
FV
log
C
n=
log (1 + r)
Therefore,
$30,000
log
$15,000
n= = 9.6 years
log (1 + 0.075)
N I/Y PV PMT FV
iven:
G 7.5 − 15,000 0 30,000
Solve for: 9.6
Excel Formula: = NPER(RATE,PMT,PV,FV) = NPER(0.075 ,0, − 15000 ,30000 ) = 9.6
Course: 371
Date: 7/2/19
Time: 8:34 AM
A local bank is running the following advertisement in the newspaper: "For just $6,000 we will pay you $450 forever!" The
fine print in the ad says that for a $6,000 deposit, the bank will pay $450 every year in perpetuity, starting one year after the
deposit is made. What interest rate is the bank advertising (what is the rate of return of this investment)?
Below is the cash flow timeline.
Years 0 1 2 3 Forever
Cash Flow − $6,000 $450 $450 $450 $450
The payments of $450 per year represent a perpetuity.
To find the interest rate, use the formula for the present value of a perpetuity:
C
PV =
r
where PV is the amount of the deposit, C is the annual cash flow, and solve for r, the interest rate.
Substituting C in the cash flow of
$450 , and $6,000 for the present value of the cash flow brings:
$450
$6,000 =
r
and solving for r :
$450
r = = 0.0750 = 7.50%.
$6,000
Therefore, the rate of return is 7.50%.
Course: 371
Date: 7/2/19
Time: 8:35 AM
You are thinking of making an investment in a new plant. The plant will generate revenues of $2,200,000 per year for as
long as you maintain it. You expect that the maintenance cost will start at $143,000 per year and will increase 4.5% per year
thereafter. Assume that all revenue and maintenance costs occur at the end of the year. You intend to run the plant as long
as it continues to make a positive cash flow (as long as the cash generated by the plant exceeds the maintenance costs).
The plant can be built and become operational immediately and the interest rate is 5.5% per year.
a. What is the present value of the revenues?
b. What is the present value of the maintenance costs?
c. If the plant costs $22,000,000 to build, should you invest in the plant?
a. What is the present value of the revenues?
The cash flow timeline is shown below.
Year 0 1 2 n
Cash flow − $22,000,000 $2,200,000 $2,200,000 $2,200,000
− $143,000 − $143,000 1.045 − $143,000 1.045

e dnropdown
− 1
menu.)
The plant will be shut down when
C1 − M 1 ( 1 + g) n − 1 < 0
where C1 is the annual revenue, M1 is the year 1 maintenance cost, g is the annual growth rate of maintenance costs, and n
is the number of years until cash flow is negative.
Substituting in
$2,200,000 − $143,000 (1 + 0.045)n − 1 < 0
$2,200,000
(1.045)n − 1 > = 15.3846
$143,000
(n − 1) log (1.045) > log (15.3846)
log (15.3846)
n> + 1 = 63.10 years
log (1.045)
So the last year of production is year 63.
We now build an Excel spreadsheet with the cash flows to the 63 years.
A B C D E BK BL BM
1
2 G 0.045
3 R 0.055
4
5
6 T 0 1 2 3 61 62 63
7
8 − 22,000,000 2,200,000 2,200,000 2,200,000 2,200,000 2,200,000 2,200,000
9 − 143,000 − 149,435 − 156,160 − 2,005,919 − 2,096,186 − 2,190,514
10 − 22,000,000 2,057,000 2,050,565 2,043,840 194,081 103,814 9,486
11
12
13 =NPV(C3,C8:BM8)
14
Once you know the number of years the plant will be open, find the present value of the revenues by using the following
formula:
n
1 1
PV = C1 1− ,
r 1+r
where C1 is the annual revenue in the first year, r is the interest rate, and n is the number of periods.
Therefore,
1 1
PV = $2,200,000 1− 63
= $38,628,629m the dropdown menu.)
0.055 (1 + 0.055)
To solve with Excel, use the following Excel formula:
=NPV(C3,C8:BL8)
b. What is the present value of the maintenance costs?
To find the present value of the maintenance costs, use the following formula:
n
1 1+g
PV = M1 1−
r−g 1+r
where M1 is the maintenance costs in the first year, r is the interest rate, g is the growth rate, and n is the number of
periods.
Therefore,
63
1 1 + 0.045
PV = $143,000 1− = $6,452,029
0.055 − 0.045 1 + 0.055
To solve with Excel, use the following Excel formula:
=NPV(C3,C9:BM9)
c. If the plant costs $22,000,000 to build, should you invest in the plant?
To determine if you should build, solve for the NPV :
A B C D E BK BL BM
1
2 G 0.045
3 R 0.055
4
5
6 T 0 1 2 3 61 62 63
7
8 − 22,000,000 2,200,000 2,200,000 2,200,000 2,200,000 2,200,000 2,200,000
9 − 143,000 − 149,435 − 156,160 − 2,005,919 − 2,096,186 − 2,190,514
10 − 22,000,000 2,057,000 2,050,565 2,043,840 194,081 103,814 9,486
11
12 NPV 10,176,600
13 EXCEL NPV FORMULA =B10+NPV(C3,C10:BM10)
14
NPV = $38,628,629 − $6,452,029 − $22,000,000 = $10,176,600. Since the NPV is positive, you should build the new plant.
Course: 371
Date: 7/2/19
Time: 8:36 AM
You have just turned 22 years old, received your bachelor's degree, and accepted your first job. Now you must decide how
much money to put into your retirement plan. The plan works as follows: Every dollar in the plan earns 6.0% per year. You
cannot make withdrawals until you retire on your 65th birthday. After that, you can make withdrawals as you see fit. You
decide that you will plan to live to 100 and work until you turn 65. You estimate that to live comfortably in retirement, you will
need $135,000 per year, starting at the end of the first year of retirement and ending on your 100th birthday. You will
contribute the same amount to the plan at the end of every year that you work. How much do you need to contribute each
year to fund your retirement?
The timeline for this problem is:
Cash flow 0 −C −C −C $135,000 $135,000 $135,000
Period 0 1 2 43 44 45 78
Age 22 23 24 65 66 67 100
The present value of an annuity is given by:
C 1
PV = 1−
r (1 + r)n
where r is the interest rate and n is the number of periods.
The present value of the costs must equal the PV of the benefits. So begin by dividing the problem into two parts, the costs
and the benefits.
Costs: The costs are the contributions, a 43year annuity with the first payment in one year:
C 1
PVcosts = 1−
0.06 (1 + 0.06)43
enefits: The benefits are the payouts after retirement, a 35year annuity paying $135,000 per year with the first payment
B
44 years from today. The value of this annuity in year 43 is:
$135,000 1
PVbenefits = 1− = $1,957,263.26
0.06 (1 + 0.06)35
The value today is just the discounted value in 43 years:
1 $135,000 1
PV0 = 1− = $159,770.66
(1 + 0.06)43 0.06 (1 + 0.06)35
Using a financial calculator or Excel to find the value of this annuity in year 43 is:
N I/Y PV PMT FV
iven:
G 35 6.0 135,000 0
Solve for: − 1,957,263.26
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.06 ,35,135,000 ,0) = − 1,957,263.26
Then using a financial calculator or Excel to find the value today:
N I/Y PV PMT FV
iven:
G 43 6.0 0 1,957,263.26
Solve for: − 159,770.66
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.06 ,43,0,1,957,263.26 ) = − 159,770.66
Since the PV of the costs must equal the PV of the benefits (or equivalently the NPV of the cash flow must be zero):
C 1
$159,770.66 = 1−
0.06 (1 + 0.06)43
Solving for C gives:
$159,770.66 0.06
C= = $10,438.32
1
1−
(1 + 0.06)43
N I/Y PV PMT FV
iven:
G 43 6.0 − 159,770.66 0
Solve for: 10,438.32
Excel Formula: = PMT(RATE,NPER,PV,FV) = PMT (0.06 ,43,0,1,957,263.26 ) = 10,438.32
• 4-43
Course: 371
Date: 7/2/19
Time: 8:36 AM
Suppose you currently have $5,300 in your savings account, and your bank pays interest at a rate of 0.56% per month. If
you make no further deposits or withdrawals, how much will you have in the account in four years?
We calculate the future value as:
FV = C (1 + r)n
The initial amount C = $5,300 and the interest rate r = 0.56% per month. Because we have a monthly interest rate, we also

need to express the number of periods, n , in months, so n = 4 12 = 48. Thus,
FV = $5,300 (1 + 0.0056)48 = $6,929.29
You will have $6,929.29 in the account in 4 years' time.
We can also compute this result using a spreadsheet:
NPER RATE PV PMT FV Excel Formula

Given 48 0.56 % 0 − 5,300
Solve for FV 6,929.29 FV(0.0056 ,48 , − 5,300 ,0)
You will have $6,929.29 in the account in 4 years' time.
Course: 371
Date: 7/2/19
Time: 8:36 AM
Your firm spends $5,200 every month on printing and mailing costs, sending statements to customers. If the interest rate is

0.46% per month, what is the present value of eliminating this cost by sending the statements electronically?
The $5,200 cost is a monthly perpetuity. Using the perpetuity formula with monthly cash flows and the monthly interest rate,
C
PV =
r
Therefore,
• 4-44
$5,200
PV = = $1,130,435
0.0046
This cost has a present value of $1.13 million.
Course: 371
Date: 7/2/19
Time: 8:37 AM
You are looking to buy a car and can afford to pay $210 per month. If the interest rate on a car loan is 0.72% per month for
a 60 month loan, what is the most expensive car you can afford to buy?
The present value of the payments is:
C 1 • 4-45
PV = 1−
r (1 + r)n
$210 1
PV = 1− = $10,202
0.0072 (1 + 0.0072)60
We can also compute this result using a spreadsheet:
N I/Y PV PMT FV
iven:
G 60 0.72% − 210 0
Solve for: 10,202
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.0072 ,60 , − 210 ,0) = 10,202
7/2/2019 • 4-46 371-Lama Alqahtani
Course: 371
Date: 7/2/19
Time: 8:37 AM
You have just entered college and have decided to pay for your living expenses using a credit card that has no minimum
monthly payment. You intend to charge $1,100 per month on the card for the next 45 months. The card carries a monthly
interest rate of 1.1%. How much money will you owe on the card 46 months from now, when you receive your first
statement postgraduation?
The future value of the charges after 45 months is:
C
FVn = (1 + r)n − 1
r
$1,100
FV45 = (1 + 0.011)45 − 1 = $63,607.05
0.011
The future value of the charges after 46 months is:
FV46 = FV45 (1 + r)
FV46 = $63,607.05 (1 + 0.011) = $64,306.73
Course: 371
Date: 7/2/19
Time: 8:38 AM
You intend to endow a scholarship that pays $10,000 every 6 months, starting 6 months from now. If the appropriate
discount rate is 7 % per 6month period, how much money will you have to donate today to endow the scholarship?
To calculate the amount you will need to donate today to endow the scholarship, use the following formula:
CF
PV = • 4-47
r
Therefore,
$10,000
PV = = $142,857
0.07
The amount you will need to donate today is $142,857.
• 4-48 Course: 371
Date: 7/2/19
Time: 8:38 AM
You have just deposited $10,000 in an unusual bank account that pays interest biannually (once every 2 years). If the
2year interest rate is 5 % (total interest over 2 years is 5 %, not 5 % per year), how much will you have in the account after 6
years?
To calculate the amount you will have in the account, use the following formula:
n
FV = PV(1 + r)
where n is equal to the number of twoyear periods.
Therefore,
3
FV = $10,000 (1.05) = $11,576.25
After 6 years, the amount you will have in the account is $11,576.25.
Course: 371
Date: 7/2/19
Time: 2:42 PM
You are considering a car loan with a stated APR of 8 % based on monthly compounding. What is the effective annual rate
of this loan?
To calculate the monthly interest rate of a loan with a stated APR of 8 % based on monthly compounding, use the following
formula:
APR
Monthly interest rate =
12
Therefore, • 5-1
0.08
Monthly interest rate = = 0.00667
12
The montly interest rate is 0.667 %.
To calculate the effective annual rate, use the following formula:
12
Effective annual rate = (1 + Monthly interest rate) −1
Therefore,
12
Effective annual rate = (1.00667) − 1 = 0.0830 = 8.30%
The effective annual rate is 8.30 %.
Course: 371
Date: 7/2/19
Time: 2:44 PM
Your bank is offering you an account that will pay 22% interest in total for a twoyear deposit. Determine the equivalent
discount rate for a period length of:
a. Six months
b. One year
c. One month
(Note: Be careful not to round any intermediate steps less than six decimal places.)
a. Six months
To determine the equivalent discount rate, we use the following formula:
Equivalent n period discount rate = (1 + r) n − 1

where r is the interest rate for two years and n is the number of compounding periods in two years.
Since six months is 6/24 or onefourth of two years, we use our general rule for computing discount rates:
1
Equivalent n period Discount Rate = (1 + 0.22) 4 − 1
To convert the answer to a percentage, multiply your answer by 100. So the equivalent sixmonth rate is 5.10 %.
b. One year
Since one year is half of two years, we use our general rule for computing discount rates:
1
Equivalent n period discount rate = (1 + 0.22) 2 − 1
To convert the answer to a percentage, multiply your answer by 100. So the equivalent oneyear rate is 10.45 %.
c. One month
Since one month is 1/24 of two years, we use our general rule for computing discount rates:
1
Equivalent n period discount rate = (1 + 0.22) 24 −1
To convert the answer to a percentage, multiply your answer by 100. So the equivalent onemonth rate is 0.8320 %.
Course: 371
Date: 7/2/19
Time: 2:44 PM
You are looking to buy a car and you have been offered a loan with an APR of 6.3% , compounded monthly.
a. What is the true monthly rate of interest?
b. What is the EAR?
a. What is the true monthly rate of interest?
The monthly rate of interest is:
Equivalent n period discount rate = APR n • 5-3

Equivalent n period discount rate = ( + 0.063) 12 = 0.525%
b. What is the EAR?
The EAR is:
m
APR
EAR = 1 + −1
m
0.063 12
EAR = 1 + − 1 = 6.4851%
12
Course: 371
Date: 7/2/19
Time: 2:45 PM
You are considering two ways of financing a spring break vacation. You could put it on your credit card, at 17% APR,
compounded monthly, or borrow the money from your parents, who want an 9% interest payment every six months. Which
is the lower rate? (Note: Be careful not to round any intermediate steps less than six decimal places.)
To determine the effective annual rate, use this formula:
m
APR
EAR = 1 + −1
m
where m is the number of compounding period per year.
Substituting into the formula to find the effective rate of your credit card:
12
0.17
EAR = 1 + −1
12
Therefore,
12
EAR = (1.014167) − 1 = 0.18390
The effective annual rate for your credit card is 18.39%.
Now for the loan from your parents, substitute into the formula but do not divide the rate by two because you were provided
with the sixmonth rate (not the annual rate compounded semiannually):
m
EAR = (1 + r) − 1
2
EAR = (1 + 0.09) − 1 = 0.1881
The effective annual rate for the loan from your parents is 18.81%.
Therefore, your credit card has the lower effective annual rate
Course: 371
Date: 7/2/19
Time: 2:45 PM
An online bank is offering to pay 0.35 % interest per month on deposits. Your local bank offers to pay 0.60 % interest
quarterly (every 3 months). Which is the higher interest rate?
To calculate the EAR for each rate, use the following formula:
n
EAR = (1 + r) − 1
Therefore, for the online bank:
12
EAR = (1.0035) − 1 = 0.0428
For the local bank:
4
EAR = (1.0060) − 1 = 0.0242
The offer of 0.35 % per month is higher.
Course: 371
Date: 7/2/19
Time: 2:46 PM
Which do you prefer: a bank account that pays 6.2% per year (EAR) for three years or
a. An account that pays 2.6% every six months for three years?
b. An account that pays 6.8% every 18 months for three years?
c. An account that pays 0.75% per month for three years?
If you deposit $1 into a bank account, you can determine the amount you will receive in a given period of time by using the
following formula:
FV = $1 (1 + r)n
where r is the interest rate for each compounding period and n is the number of periods.
Then, to decide which you prefer, compare the returns from your $1 investment.
If you deposit $1 into a bank account that pays 6.2% per year for three years, the amount you will receive after three years
is:
FV = $1 (1 + 0.062)3 = $1.19777
a. An account that pays 2.6% every six months for three years?
If you deposit $1 into a bank account that pays 2.6% every six months for three years, the amount you will receive after
three years is (n is 6 because there are six, sixmonth periods in three years):
FV = $1 (1 + 0.026)6 = $1.16650
So you would prefer 6.2% per year for three years.the dropdown menu.)
b. An account that pays 6.8% every 18 months for three years?
If you deposit $1 into a bank account that pays 6.8% every 18 months for three years, the amount you will receive after
three years is (n is 2 because there are two 18month periods in three years):
o
FV = $1 (1 + 0.068)2 = $1.14062 o
So you would prefer 6.2% per year for three years.
c. An account that pays 0.75% per month for three years?
If you deposit $1 into a bank account that pays 0.75% per month for three years, the amount you will receive after three
years is (n is 36 because there are 36 months in three years):
FV = $1 (1 + 0.0075)36 = $1.30865 fr
So you would prefer 0.75% every month for three years...om the dropdown menu.)
• 5-7 Course: 371
Date: 7/2/19
Time: 2:46 PM
You have been offered a job with an unusual bonus structure. As long as you stay with the firm, you will get an extra
$76,000 every seven years, starting seven years from now. What is the present value of this incentive if you plan to work for
the company for 42 years and the interest rate is 6.8% (EAR)? (Note: Be careful not to round any intermediate steps less
than six decimal places.)
Here is the timeline for this problem:
Cash Flows 0 $76,000 $76,000 $76,000 $76,000
Period 0 7 14 35 42
The equivalent discount rate for n year periods is given by:
r = (1 + EAR)n − 1
Therefore,
r = (1 + 0.068)7 − 1 = 58.4889%
Then, use the annuity formula (in this case n is 6 because there are 6 sevenyear periods in 42 years):
C 1
PV = 1−
r (1 + r)n
Therefore,
$76,000 1
PV = 1− = $121,740
0.584889 (1 + 0.584889)6
Alternatively, we can use a financial calculator or MS Excel to compute the PV:
N I/Y PV PMT FV
iven:
G 6 58.4889 76,000 0
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.584889 ,6 ,76000 ,0) = − 121,740
Course: 371
Date: 7/2/19
Time: 2:47 PM
You have found three investment choices for a oneyear deposit: 13% APR compounded monthly, 13% APR compounded
annually, and 11% APR compounded daily. Compute the EAR for each investment choice. (Assume that there are 365 days
in the year.) (Note: Be careful not to round any intermediate steps less than six decimal places.)
To calculate the effective annual rate (EAR ) from a certain APR , use the following equation:
m
APR
EAR = 1 + −1
m
where EAR is the effective annual rate and m is the number of compounding periods in a year.
To calculate the effective annual rate (EAR ) from an account with 13% APR compounded monthly, use the following
equation:
0.13 12
EAR = 1 + − 1 = 13.803%
12
Therefore, the EAR = 13.803%.
To calculate the effective annual rate (EAR ) from an account with 13% APR compounded annually, use the following
equation:
1
0.13
EAR = 1 + − 1 = 13.000%
1
To calculate the effective annual rate (EAR ) from an account with 11% APR compounded daily, use the following equation:
365
0.11
EAR = 1 + − 1 = 11.626%
365
Course: 371
Date: 7/2/19
Time: 2:47 PM
Your bank account pays interest with an EAR of 7%. What is the APR quote for this account based on semiannual
compounding? What is the APR with monthly compounding? (Note: Be careful not to round any intermediate steps less
than six decimal places.)
What is the APR quote for this account based on semiannual compounding?

To convert from an EAR to an APR quote begin with the following formula:
m
APR
EAR = 1 + −1
m
where EAR is the effective annual rate, APR is the annual percentage rate, and m is the number of compounding periods in
a year.
Therefore,
APR m
1+ = 1.07
m
Solving for the APR :
APR = 1.07 m − 1 m
with semiannual payments, for which m = 2.
Therefore,
1
2
APR = 1.07 − 1 2 = 6.882%
If your bank account pays interest with an EAR of 7.000% , then the APR quote for semiannual compounding is 6.882%.
What is the APR with monthly compounding?
Solving for the APR :
1
m
APR = 1.07 −1 m
with monthly payments, for which m = 12.
Therefore,
1
12
APR = 1.07 −1 12 = 6.785%
If your bank account pays interest with an EAR of 7.000% , then the APR quote for monthly compounding is 6.785%.
Course: 371
Date: 7/2/19
Time: 2:48 PM
Suppose the interest rate is 9.4% APR with monthly compounding. What is the present value of an annuity that pays $125
every six months for seven years? (Note: Be careful not to round any intermediate steps less than six decimal places.)
Month 0 6 12 18 84
Payment number 0 1 2 3 14
Payment $0 $125 $125 $125 $125
The annuity will generate 14 equal payments of $125 at 6 month intervals. An interest rate of 9.4% APR with monthly
compounding is equivalent to
9.4%
Monthly interest rate = = 0.7833%
12
and the equivalent 6 month interest rate is:
Equivalent 6 month interest rate = (1.007833)6 − 1 = 4.793%
Next, calculate the present value of the annuity.
To calculate the present value of an annuity, use the following formula:
C 1
PV = 1−
r (1 + r)n
Therefore, using the PV of an annuity formula where n = 14 payments, C = $125 and r = 4.793% gives:
$125 1
PV = 1− = $1,253.87
0.04793 (1 + 0.04793)14
N I/Y PV PMT FV
iven:
G 14 4.793 125 0
Solve for: − 1,253.87
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.04793 ,14 ,125 ,0) = − 1,253.87
Course: 371
Date: 7/2/19
Time: 2:48 PM
A payday loan is structured to obscure the true interest rate you are paying. For example, in Washington, you pay a $32
"fee" for a twoweek $210 payday loan (when you repay the loan, you pay $242 ). What is the effective annual interest rate
for this loan? (Assume 26 biweekly periods per year.)
The twoweek interest rate is:
Fee
r=
Amount Borrowed
$32
r= = 15.238%
$210
The effective annual interest rate is:
APR m
EAR = 1 + −1
m
EAR = (1 + 0.15238)26 − 1 = 3,894.74%
Course: 371
Date: 7/2/19
Time: 2:49 PM
You have been accepted into college. The college guarantees that your tuition will not increase for the four years you attend
college. The first $12,100 tuition payment is due in six months. After that, the same payment is due every six months until
you have made a total of eight payments. The college offers a bank account that allows you to withdraw money every six
months and has a fixed APR of 5.0% (semiannual) guaranteed to remain the same over the next four years. How much
money must you deposit today if you intend to make no further deposits and would like to make all the tuition payments
from this account, leaving the account empty when the last payment is made? (Note: Be careful not to round any
intermediate steps less than six decimal places.)
Here is the timeline for the problem:
Cash Flows 0 $12,100 $12,100 $12,100 $12,100
Period 0 1 2 7 8
The 5.0% APR (compounded semiannually) implies a semiannual discount rate of:
APR
r=
2
5.0%
r= = 2.50%
2
To determine the present value of an annuity, use the following formula:
C 1
PV = 1−
r (1 + r)N
Therefore,
$12,100 1
PV = 1− = $86,758.66
0.025 (1 + 0.025)8
N I/Y PV PMT FV
iven:
G 8 2.50 12,100 0
Solve for: − 86,758.66
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.0250 ,8,12100 ,0) = − 86,758.66
Course: 371
Date: 7/2/19
Time: 2:49 PM
You make monthly payments on your car loan. It has a quoted APR of 4.9% (monthly compounding). What percentage of
the outstanding principal do you pay in interest each month? (Note: Be careful not to round any intermediate steps less than
six decimal places.)
Using the formula for computing the discount rate from an APR quote:
APR
r=
12
Therefore,
4.9%
r= = 0.408333%
12
Course: 371
Date: 7/2/19
Time: 2:50 PM
Suppose Capital One is advertising a 60 month, 6.25% APR motorcycle loan. If you need to borrow $10,000 to purchase
your dream HarleyDavidson, what will be your monthly payment? (Note: Be careful not to round any intermediate steps
less than six decimal places.)
Period 0 1 2 59 60
The 6.25% APR compounded monthly implies a monthly discount rate of:
APR 6.25%
r= = = 0.520833%
12 12
Using the formula for computing a loan payment:
Loan amount
C=
1 1
1−
r (1 + r)n
Therefore,
$10,000
C= = $194.49
1 1
1−
0.005208 (1 + 0.005208)60
Alternatively, we can use a financial calculator or MS Excel to compute the PMT :
N I/Y PV PMT FV
iven:
G 60 0.520833 10,000 0
Excel Formula: = PMT(RATE,NPER,PV,FV) = PMT(0.005208 ,60 ,10000 ,0) = − 194.49
Course: 371
Date: 7/2/19
Time: 2:51 PM
Assume you graduate from college with $40,000 in student loans. If your interest rate is fixed at 4.25 % APR with monthly
compounding and you repay the loans over a 10 year period, what will be your monthly payment?
To calculate your monthly payment, use the following formula:
CF 1
PV = 1−
r (1 + r)n
Therefore,
1 1
$40,000 = CF −
120
0.0035417 (0.0035417)(1.0035417)
$40,000 u
CF = = $409.75
1 1
−
0.0035417 (0.0035417)(1.0035417)120
Your monthly payment will be $409.75.
You can also use a financial calculator or MS Excel to calculate the monthly payment.
To find the monthly payment, PMT, you will need to enter the values for PV, FV, N, and I. Since you are calculating the
monthly payment, be sure to divide the annual interest rate by 12 and multiple the number of years by 12. Therefore,
Therefore,
N I/Y PV PMT FV
iven:
G 120 0.0035417
0.35416 − 40,000 0
Solve for: 409.75
Excel Formula: = PMT(RATE,NPER,PV,FV) = PMT(0.0035417 ,120 , − 40000 ,0) = 409.75
Your monthly payment will be $409.75.
There may be a difference between the answer found using the formula and the answer found using a financial calculator or
Excel spreadsheet due to rounding.
• 5-16 Course: 371
Date: 7/2/19
Time: 2:51 PM
Ironwood Bank is offering a 25 year mortgage with an APR of 6.15% based on monthly compounding. If you plan to borrow
$168,000 , what will be your monthly payment?
Period 0 1 2 3 299 300
Cash flow $168,000 C C C C C
To solve for the loan payment, use the following formula:
P
C=
1 1
1−
r (1 + r)n
where P is the loan amount, r is the monthly interest rate (APR 12 = 6.15% 12 = 0.5125% ), and n is the number of periods.
The loan payment is:
$168,000
C= = $1,097.88
1 1
1−
0.005125 300
(1 + 0.005125)
Alternatively, we can use a financial calculator or MS Excel to compute the PMT:
N I/Y PV PMT FV
iven:
G 300 0.5125 % 168,000 0
Solve for: − 1,097.88
Excel Formula: = PMT(RATE, NPER, PV, [FV],[TYPE]) = PMT(0.5125 , 300 , 168,000 , 0) = − 1,097.88
Course: 371
Date: 7/2/19
Time: 2:52 PM
You have just taken out a $31,000 car loan with a 9% APR, compounded monthly. The loan is for five years. When you
make your first payment in one month, how much of the payment will go toward the principal of the loan and how much will
go toward interest? (Note: Be careful not to round any intermediate steps less than six decimal places.)
First, to solve for the loan payment, use the following formula:
P
C=
1 1
1−
r (1 + r)n
where P is the loan amount, r is the monthly interest rate (APR 12 = 9% 12 = 0.75% ), and n is the number of periods.
Therefore,
$31,000
C= = $643.51
1 1
1−
0.00750 60
(1 + 0.00750)
N I/Y PV PMT FV
iven:
G 60 0.75 31,000 0
Excel Formula: = PMT(RATE,NPER,PV,FV) = PMT(0.00750 ,60 ,31000 ,0) = − 643.51
Then, solve for the interest portion of the payment using this formula:
Interest payment = P r
where P is the loan amount and r is the monthly interest rate.
Therefore,
Interest payment = $31,000 0.00750 = $232.50
Subtracting the interest payment from the total monthly payment will give you the amount that goes toward the principal of
the loan:
Principal payment = $643.51 − $232.50 = $411.01
Course: 371
Date: 7/2/19
Time: 2:52 PM
You have taken out a 60 month, $15,000 car loan with an APR of 3 %, compounded monthly. The monthly payment on the
loan is $269.53. Assume that right after you make your 50th payment, the balance of the loan is $2,658.61. How much of
your next payment goes toward principal and how much goes toward interest? Compare this with the prinicipal and interest
paid in the first month's payment.
To calculate the interest paid, use the following formula:
Interest paid = Loan balance Monthly interest rate
Therefore,
Interest paid = $2,658.61 0.0025 = $6.65
The amount that goes towards interest is $6.65.
To calculate the principal paid, subtract the interest paid from the monthly payment amount. Therefore,
Principal paid = $269.53 − $6.65 = $262.88
The amount that goes towards the principal is $262.88.
In the first month, the amount that goes towards principal is $232.03 and toward interest is $37.50 , while in the most recent
month, $262.88 went towards principal and $6.65 went towards interest. Therefore, you can see that over time, as you pay
down the principal of the loan, less of your payment has to go to cover interest and more of your payment can go towards
reducing the principal.
Course: 371
Date: 7/2/19
Time: 2:53 PM
You are buying a house and the mortgage company offers to let you pay a "point" (1.0% of the total amount of the loan) to
reduce your APR from 6.60% to 6.35% on your $435,000 , 30 year mortgage with monthly payments. If you plan to be in the
house for at least five years, should you do it? (Note: Be careful not to round any intermediate steps less than six decimal
places.)
First, solve for the monthly mortgage payment at 6.60% APR using the following formula:
APR
r=
12
Therefore,
6.60%
r= = 0.550000%
12
To find the monthly mortgage payment, use the following formula:
Mortgage amount
C=
1 1
1−
r (1 + r)n
Therefore,
$435,000
C= = $2,778.17
1 1
1−
0.00550000 (1 + 0.00550000)12 30
N I/Y PV PMT FV
iven:
G 360 0.550000 435,000 0
Solve for: − 2,778.17
Excel Formula: = PMT(RATE,NPER,PV,FV) = PMT(0.00550000 ,360,435000 ,0) = − 2,778.17
Next, solve for the monthly mortgage payment at 6.35% APR using the following formula:
APR
r=
12
Therefore,
6.35%
r= = 0.5291667%
12
In this case,
$435,000
C= = $2,706.73
1 1
1−
0.005291667 (1 + 0.005291667)12 30
N I/Y PV PMT FV
iven:
G 360 0.5291667 435,000 0
Solve for: − 2,706.73
The monthly savings is the difference between the two payment amounts, $2,778.17 − $2,706.73 = $71.44. The lower
interest rate on the mortgage results in a savings of $71.44 each month.
The present value of the monthly savings is given by:
Savings 1
PV = 1−
r (1 + r)n
Therefore,
$71.44 1
PV = 1− = $3,664.35
0.005291667 (1 + 0.005291667)12 5
N I/Y PV PMT FV
iven:
G 60 0.5291667 71.44 0
Solve for: − 3,664.35
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.005291667 ,60,71.44 ,0) = − 3,664.35
The reduction in the principal balance at the end of the 5 years needs to be determined.
To find the balance of the loan at the end of 5 years use the following formula:
C 1
PV = 1−
r n
(1 + r)
where PV is the balance of the mortgage, C is the monthly payment, r is the rate, and n is the number of months left in the
mortgage.
To solve for the balance of the mortgage we need to find the PV of the mortgage payments remaining in the loan after 5
years. Use the 6.60% APR as the interest rate (since this is the opportunity cost of the money) in this formula:
$2,778.17 1
PV = 1− = $407,673.66
0.00550000 (1 + 0.00550000)300
N I/Y PV PMT FV
iven:
G 300 0.550000 2,778.17 0
Solve for: − 407,673.66
To solve for the balance of the mortgage we need to find the PV of the mortgage payments remaining in the loan after 5
years. Use the 6.35% APR as the interest rate (since this is the opportunity cost of the money) in this formula:
$2,706.73 1
PV = 1− = $406,498.73
0.005291667 (1 + 0.005291667)300
N I/Y PV PMT FV
iven:
G 300 0.5291667 2,706.73 0
Solve for: − 406,498.73
To determine the reduction in principal, find the difference between the two balances in loans at 5 years,
$407,673.66 − $406,498.73 = $1,174.93.
To compute the present value of the reduction in principal, use the following formula:
FV
PV =
(1 + r)n
where FV is the principal reduction, r is the rate, and N is the number of periods.
To find the present value of the principal reduction use the following formula:
$1,174.93
PV = = $856.03
(1 + 0.005291667)60
N I/Y PV PMT FV
iven:
G 60 0.5291667 0 1,174.93
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.005291667 ,60,0,1174.93 ) = − 856.03
Use the lower rate here because you could finance the point by rolling it into the principal of the loan at the lower rate,
therefore the lower rate becomes your new cost of capital.
The initial cost is the 1 point you would have to pay to get the lower rate, which is 1% of the loan or $4,350. If we know that
we'll stay at least 5 years in the house, then we need to determine if this monthly savings is worth the initial cost of $4,350.
To determine this, we will use the net benefits as shown below:
Net benefits (Costs) = PV (Benefits) − PV (Costs)
Net benefit (Cost) = $3,664.35 + $856.03 − $4,350 = $170.38
Course: 371
Date: 7/2/19
Time: 2:55 PM
You have decided to refinance your mortgage. You plan to borrow whatever is outstanding on your current mortgage. The
current monthly payment is $2,271 and you have made every payment on time. The original term of the mortgage was 30
years, and the mortgage is exactly four years and eight months old. You have just made your monthly payment. The
mortgage interest rate is 6.250% (APR). How much do you owe on the mortgage today? (Note: Be careful not to round any
Here is the timeline for the original mortgage term and for the remaining term:
Original period in months 56 57 58 360
Remaining months 0 1 2 304
Cash Flow $2,271 $2,271 $2,271
To find out what is owed for the remaining period, you have to compute the present value of the remaining payments. To do
this, you first have to compute the discount rate by using the loan interest rate (or APR), as follows:
APR
r=
m
where APR is the loan interest rate and m is the number of compounding periods in a year.
Therefore,
6.250%
= 0.52083%
12
Then, use the discount rate to compute the present value of the remaining payments (PV ) use the following formula:
C 1
PV = 1−
r (1 + r)n
where C is the monthly payment, r is the discount rate, and n is the number of periods.
Therefore,
$2,271 1
PV = 1− = $346,152
0.0052083 (1 + 0.0052083)304
N I/Y PV PMT FV
iven:
G 304 0.52083 2,271 0
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.0052083 ,304 ,2,271 ,0) = − 346,152
Course: 371
Date: 7/2/19
Time: 2:55 PM
You have just sold your house for $1,050,000 in cash. Your mortgage was originally a 30year mortgage with monthly
payments and an initial balance of $850,000. The mortgage is currently exactly 18.50 years old, and you have just made a
payment. If the interest rate on the mortgage is 6.50% (APR), how much cash will you have from the sale once you pay off
the mortgage? (Note: Be careful not to round any intermediate steps less than six decimal places.)
Execute:
Here is the cash flow timeline for the original loan:
Month 0 1 2 3 360
Cash Flow − $850,000 C C C C
First, an APR of 6.50% (monthly) implies a discount rate of r = APR m , or 6.50% 12 = 0.54167%.
Next, we need to compute the original loan payment, C, using the formula for a loan payment:
P
C=
1 1
1−
r (1 + r)n
where P is the loan amount, r is the discount rate, and n is the number of periods.
Therefore,
$850,000
C = = $5,372.60
1 1
1−
0.0054167 (1 + 0.0054167)360
N I/Y PV PMT FV
iven:
G 360 0.54167 850,000 0
Solve for: − 5,372.60
The monthly payment for the original loan is $5,372.60.
We use the formula for the present value of an annuity to compute the remaining balance (PV ) on the original mortgage
loan, using the following formula:
C 1
PV = 1−
r (1 + r)n
where C is the monthly loan payment, r is the discount rate, and n is the number of periods.
Therefore,
$5,372.60 1
PV = 1− = $521,219
0.0054167 (1.0054167)138
Thus,
You would keep $1,050,000 − $521,219 = $528,781 from the sale of the home.
N I/Y PV PMT FV
iven:
G 138 0.54167 5,372.60 0
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.0054167 ,138 ,5372.60 ,0) = − 521,219
Then,
You would keep $1,050,000 − $521,219 = $528,781 from the sale of the home.
Course: 371
Date: 7/2/19
Time: 2:56 PM
You have just purchased a car and taken out a $60,000 loan. The loan has a fiveyear term with monthly payments and an
APR of 7.0%.
a. How much will you pay in interest, and how much will you pay in principal, during the first month, second month, and first
year? (Hint: Compute the loan balance after one month, two months, and one year.)
b. How much will you pay in interest, and how much will you pay in principal, during the fourth year (i.e., between three and
four years from now)?
a. How much will you pay in interest, and how much will you pay in principal, during the first month, second month, and first
year? (Hint: Compute the loan balance after one month, two months, and one year.)
Cash Fow $60,000 −C −C −C −C
Period 0 1 2 59 60
First, solve for the monthly discount rate at 7.0% APR using this formula:
APR
r=
12
Therefore,
7.0%
r= = 0.583333%
12
Next, solve for the monthly payments using the following formula:
P
C=
1 1
1−
r (1 + r)n
Therefore,
$60,000
C= = $1,188.07
1 1
1−
0.00583333 (1 + 0.00583333)60
N I/Y PV PMT FV
iven:
G 60 0.583333 60,000 0
Solve for: − 1,188.07
Excel Formula: = PMT(RATE,NPER,PV,FV) = PMT(0.00583333 ,60 ,60000 ,0) = − 1,188.07
Each monthly payment is $1,188.07.
After 1 month, the balance (principal) of the loan will be the PV of the 59 remaining payments:
$1,188.07 1
PV = 1− = $59,161.84
0.00583333 (1 + 0.00583333)59
Alternatively, we can use a financial calculator or MS Excel to compute the PV :
N I/Y PV PMT FV
iven:
G 59 0.583333 1,188.07 0
Solve for: − 59,161.84
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.00583333 ,59 ,1188.07 ,0) = − 59,161.84
Therefore, the amount that went toward principal in the first month is:
Principal = Previous Loan Balance − Current Loan Balance
Principal = $60,000 − $59,161.84 = $838.16
The amount paid in interest in the first month is:
Interest = Monthly Payment − Principal Payment
Interest = $1,188.07 − $838.16 = $349.91
For the second month, solve for the present value of the remaining 58 payments:
$1,188.07 1
PV = 1− = $58,318.88
0.00583333 (1 + 0.00583333)58
N I/Y PV PMT FV
iven:
G 58 0.583333 1,188.07 0
Solve for: − 58,318.88
Therefore, the amount that went toward principal in the second month is:
Principal = $59,161.84 − $58,318.88 = $842.96
The amount paid in interest in the second month is:
Interest = $1,188.07 − $842.96 = $345.11
For the first year, solve for the present value of the remaining 48 payments:
$1,188.07 1
PV = 1− = $49,614.05
0.00583333 (1 + 0.00583333)48
N I/Y PV PMT FV
iven:
G 48 0.583333 1,188.07 0
Solve for: − 49,614.05
Therefore, the amount that went toward principal in the first year is:
Principal = $60,000 − $49,614.05 = $10,385.95
The amount paid in interest in the first year is:
Interest = 12 $1,188.07 − $10,385.95 = $3,870.89
b. How much will you pay in interest, and how much will you pay in principal, during the fourth year (i.e., between three and
four years from now)?

At the end of year 3, there are 24 payments remaining. The balance of the loan is:
$1,188.07 1
PV = 1− = $26,535.66
0.00583333 (1 + 0.00583333)24
N I/Y PV PMT FV
iven:
G 24 0.583333 1,188.07 0
Solve for: − 26,535.66
At the end of year 4, there are only 12 payments remaining. The balance of the loan at the end of the fourth year is:
$1,188.07 1
PV = 1− = $13,730.67
0.00583333 (1 + 0.00583333)12
N I/Y PV PMT FV
iven:
G 12 0.583333 1,188.07 0
Solve for: − 13,730.67
Therefore, the amount that went toward principal during the fourth year is:
Principal = $26,535.66 − $13,730.67 = $12,804.99
The amount paid in interest during the fourth year is:
Interest = 12 $1,188.07 − $12,804.99 = $1,451.85
• 5-23 Course: 371
Date: 7/2/19
Time: 2:57 PM
You are thinking about leasing a car. The purchase price of the car is $36,000. The residual value (the amount you could
pay to keep the car at the end of the lease) is $15,000 at the end of 36 months. Assume the first lease payment is due one
month after you get the car. The interest rate implicit in the lease is 7.25% APR, compounded monthly. What will be your
lease payments for a 36 month lease? (Note: Be careful not to round any intermediate steps less than six decimal places.)
Period 0 1 35 36
Cash Flows $36,000 − PMT − PMT − PMT

− $15,000
First, compute the discount rate using the following formula:
APR
r=
m
where APR is given and m is the number of periods.
Therefore,
7.25%
r= = 0.604166667%
12
Next, solve for the present value of the residual value of the car using the following formula:
FV
PV =
(1 + r)n
where FV is the residual value (balloon payment), r is the discount rate, and n is the number of periods.
Therefore,
$15,000
PV = = $12,075.81
(1 + 0.006041667)36
N I/Y PV PMT FV
iven:
G 36 0.604166667 0 15,000
Solve for: − 12,075.81
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.006041667 ,36 ,0,15000 ) = − 12,075.81
To determine the present value of the lease, use the following formula:
Present Value of Lease = Purchase Price of Car − Present Value of Residual Value
Therefore,
Present Value of Lease = $36,000 − $12,075.81 = $23,924.19
Then, to solve for the monthly payment, use the following formula:
P
C=
1 1
1−
r (1 + r)n
where PV is the present value of the lease, r is the discount rate, and n is the number of periods.
Therefore,
$23,924.19
C= = $741.45
1 1
1−
0.006041667 (1 + 0.006041667)36
N I/Y PV PMT FV
iven:
G 36 0.604166667 − 23,924.19 0
Solve for: 741.45
Excel Formula: = PMT(RATE,NPER,PV,FV) = PMT(0.006041667 ,36 , − 23924.19 ,0) = 741.45
Course: 371
Date: 7/2/19
Time: 2:57 PM
You have some extra cash this month and you are considering putting it toward your car loan. Your interest rate is 8.0% ,
your loan payments are $575 per month, and you have 36 months left on your loan. If you pay an additional $1,600 with
your next regular $575 payment (due in one month), how much will it reduce the amount of time left to pay off your loan?
(Note: Be careful not to round any intermediate steps less than 6 decimal places.)
Cash Flows PV − $575 − $575 − $575 − $575
Period 0 1 2 35 36
The 8.0% APR implies a monthly rate of:
APR
r=
12
Therefore,
8.0%
r= = 0.666667%
12
The balance of the loan is the present value of the cash flows and can be found by using the following formula:
C 1
PV = 1−
r (1 + r)n
Therefore,
$575 1
PV = 1− = $18,349.29
0.00666667 (1 + 0.00666667)36
N I/Y PV PMT FV
iven:
G 36 0.666667 575 0
Solve for: − 18,349.29
If you plan on paying an additional $1,600 next month, here is the timeline:
Cash flow 0 − $2,175 − $575 − $575 − $575
Period 0 1 2 35 36
We want to know how long the payments will last if you include an additional $1,600 in next month's payment. The principal
of the loan must equal the PV of the payments made on the loan, so we can solve for the remaining length of time on the
loan (N ):
$575 1 $1,600
$18,349.29 = 1− n
+
0.00666667 (1.00666667) (1.00666667)
Therefore,
$575 1 $1,600
$18,349.29 = 1− +
0.00666667 (1.00666667)n (1.00666667)
$1,600 $575 1
$18,349.29 − = 1−
(1.00666667) 0.00666667 (1.00666667)n
$575 1
$16,759.89 = 1−
0.00666667 (1.00666667)n
0.00666667 1
$16,759.89 = 1−
$575 (1.00666667)n
1
0.194 = 1 −
(1.00666667)n
1
0.806 =
(1.00666667)n
1
(1.00666667)n =
0.806
1
log
0.806
n= = 32.5 months
log (1.00666667)
hus, the addition of an extra payments of $1,600 next month will reduce the time remaining on the loan from 36 months to
T
32.5 months, a reduction of 3.5 months.
Course: 371
Date: 7/2/19
Time: 2:58 PM
You have an outstanding student loan with required payments of $575 per month for the next four years. The interest rate
on the loan is 11% APR (monthly). You are considering making an extra payment of $125 today (i.e., you will pay an extra
$125 that you are not required to pay). If you are required to continue to make payments of $575 per month until the loan is
paid off, what is the amount of your final payment? What effective rate of return (expressed as an APR with monthly
compounding) have you earned on the $125 ? (Note: Be careful not to round any intermediate steps less than six decimal
places.)
If you are required to continue to make payments of $575 per month until the loan is paid off, what is the amount of your
final payment?
Here is the timeline for your required payments:
Month 0 1 2 47 48
Cash Flows PV − $575 − $575 − $575 − $575
irst, compute the remaining balance on your student loan. The remaining balance equals the present value of the
F
remaining payments. The loan interest rate is 11% APR, or 11% 12 = 0.91666667% per month. The present value of the
payments can be computed using this formula:
1 1
PV = C 1−
r (1 + r)n
where C is the cash flow (monthly payment), r is the interest rate, and n is the date of the last cash flow in a stream of cash
flows.
Therefore,
$575 1
PV = 1− = $22,247.57
0.00916667 (1 + 0.00916667)48
N I/Y PV PMT FV
iven:
G 48 0.91666667 575 0
Solve for: − 22,247.57
If you prepay an extra $125 today, you will lower your remaining balance to $22,247.57 − $125 = $22,122.57. Though your

balance is reduced, your required monthly payment does not change. Instead, you will pay off the loan more quickly, and
the extra payment will reduce the payment you need to make at the end of the loan.
With the extra payment, the timeline changes:
Month 0 1 2 47 48
Cash Flows $22,122.57 − $575 − $575 − $575 FV
You will be paying $575 per month for 47 months, and some smaller amount, $575 − X , in the last month. To solve for X ,
recall that the present value of the remaining cash flows equals the outstanding balance when the loan interest rate is used
as the discount rate. Solve for X using the following formula:
C 1 X
PV = 1− −
r (1 + r)n (1 + r)n
where C is the cash flow (monthly payment), r is the interest rate, and n is the date of the last cash flow in a stream of cash
flows.
Therefore,
$575 1 X
$22,122.57 = 1− −
0.00916667 (1.00916667)48 (1.00916667)48
Solving for X gives
X
$22,122.57 = $22,247.57 −
48
1.00916667
X = $193.70
Alternatively, we can use a financial calculator or MS Excel to compute the FV :
N I/Y PV PMT FV
iven:
G 48 0.91666667 22,122.57 − 575
Solve for: 193.70
Excel Formula: = FV(RATE,NPER,PMT,FV) = FV(0.00916667 ,48, − 575 ,22122.57 ) = 193.70
So, X = $193.70 , and the regular payment of $575 will be reduced by this amount.
The last payment will be $381.30.
b. What rate of return (expressed as an APR with monthly compounding) have you earned on the $125 ?
The extra payment effectively lets us exchange $125 today for $193.70 in four years. We claimed that the return on this
investment should be the loan interest rate. Let's see if this is the case:
48
$125 1.00916667 = $193.70 , so it is.
Thus, you earn a(n) 11% APR compounded monthly (the rate on the loan).
Course: 371
Date: 7/2/19
Time: 2:59 PM
You have an outstanding student loan with required payments of $575 per month for the next four years. The interest rate
on the loan is 11% APR (compounded monthly). Now that you realize your best investment is to prepay your student loan,
you decide to prepay as much as you can each month. Looking at your budget, you can afford to pay an extra $225 a
month in addition to your required monthly payments of $575 , or $800 in total each month. How long will it take you to pay
off the loan? (Note: Be careful not to round any intermediate steps less than six decimal places.)
Here is the timeline for your student loan:
Month 0 1 2 47 48
Cash Flows $575 $575 $575 $575
There are three parts to this problem:
1. Compute the discount rate for the loan.
2. Compute the original loan balance.
3. Compute the time remaining until the loan is repaid with the extra payment.
First, the discount rate of the cash flow is 11% 12 = 0.91666667% per month.
Next, compute the original outstanding balance using the following formula:
1 1
PV = C 1−
r (1 + r)n
Therefore,
$575 1
PV = 1− = $22,247.57
0.00916667 (1 + 0.00916667)48
N I/Y PV PMT FV
iven:
G 48 0.91666667 575 0
Solve for: − 22,247.57
Here is the timeline for your student loan when $800 is paid every month instead of $575 is
Months 0 1 2 n
Cash Flow $22,247.57 − $800 − $800 − $800
and we want to determine the number of monthly payments, N, that we will need to make. That is, we need to determine
what length annuity with a monthly payment of $800 has the same present value as the loan balance, using the loan
interest rate as the discount rate.
hen, using the new payment amount ($800 ) and the present value you just determined, solve for n using the following
T
formula:
1 1
PV = C 1−
r (1 + r)n
where C is the new monthly payment and r is the discount rate.
Therefore,
$800 1
1− = $22,247.57
0.00916667 (1.00916667)n
1 $22,247.57 0.00916667
1− = = 0.25492017
n $800
1.00916667
1
= 1 − 0.25492017 = 0.74507983
n
1.00916667
n
1.00916667 = 1.34213806
log (1.34213806)
n= = 32.25 months
log (1.00916667)
Alternatively, we can use a financial calculator or MS Excel to compute the n :
N I/Y PV PMT FV
iven:
G 0.91666667 22247.57 − 800 0
Solve for: 32.25
Excel Formula: = NPER(RATE,PMT,PV,FV) = NPER(0.00916667 , − 800 ,22247.57 , 0) = 32.25
Course: 371
Date: 7/2/19
Time: 3:00 PM
Oppenheimer Bank is offering a 30 year mortgage with an APR of 5.15% based on monthly compounding. With this
mortgage your monthly payments would be $1,970 per month. In addition, Oppenheimer Bank offers you the following deal:
Instead of making the monthly payment of $1,970 every month, you can make half the payment every two weeks (so that
you will make 52 2 = 26 payments per year). With this plan, how long will it take to pay off the mortgage if the EAR of the
loan is unchanged? Note: Make sure to round all intermediate calculations to at least 8 decimal places.
Formula Solution
What is the original loan amount?
For the original mortgage, we are paying $1,970 per month, at a monthly interest rate of 5.15% 12 = 0.42916667% per
month, for 360 months. Therefore the original loan amount is equal to the present value:
1 1
PV = C 1−
r (1 + r)n
1 1
PV = $1,970 1− = $360,788.53
0.0042916667 (1 + 0.0042916667)360
What is the equivalent twoweek interest rate with the same EAR as the loan?
The new loan will have payments of $985 every two weeks or 26 times per year. First we must solve for the equivalent
twoweek interest rate r which has the same EAR as the original loan:
(1 + r)26 = (1 + 0.0042916667)12
r = (1 + 0.0042916667)12 26 − 1 = 0.1978485592%
What is the number of $985 payments required so that the present value of the annuity will equal the original loan amount?
To compute the number of payments N , we set the present value of the loan payments equal to the original balance:
1 1
PV = $985 1− = $360,788.53
0.001978485592 (1 + 0.001978485592)N
$360,788.53 0.001978485592
log 1 −
$985
N= = 652.58
1
log
(1 + 0.001978485592)
So it will take 653 payments to pay off the mortgage (the last payment will be a bit less than $985 ). Since there are 26
payments per year, this will take 653 26 = 25 years + 6 weeks. We shorten the payment time by nearly 5 years because
there are approximately 2 extra payments every year (26 $985 = $25,610 total payments per year versus
12 $1,970 = $23,640 per year).
Spreadsheet Solution
We can use an Excel spreadsheet to perform the calculations:
A B
1
2 Number of monthly payments 360
3 APR 5.15 %
4 Number of payments per year 12
5 Monthly rate 0.42916667 %
6 Monthly payment 1,970.00
7 Number of biweekly payments/year 26
8 PV of loan 360,788.53
9 Equivalent 2week rate 0.1978485592 %
10 Biweekly payment 985.00
11 Number of biweekly payments 652.58
Entry in Cell B5 is =B3/B4
Entry in Cell B8 is =PV(B5,B2,B6,0,0)
Entry in Cell B9 is =(1+B5)^(B4/B7)1
Entry in Cell B10 is =B6/2
Entry in Cell B11 is =NPER(B9,B10,B8,0,0)
Course: 371
Date: 7/2/19
Time: 3:00 PM
Your friend tells you he has a very simple trick for taking onethird of the time it takes to repay your mortgage: Use your
Christmas bonus to make an extra payment on January 1 of each year (that is, pay your monthly payment due on that day
twice). Assume that the mortgage has an original term of 30 years and has an APR of 12%.
a. If you take out your mortgage on January 1 (so that your first payment is due on February 1), and you make your first
extra payment at the end of the first year, in what year will you finish repaying your mortgage?
b. If you take out your mortgage on July 1 (so that the first payment is on August 1), and you make the extra payment each
January, in how many months will you pay off your mortgage?
c. How will the amount of time it takes to pay off the loan given this strategy vary with the interest rate on the loan?
a. If you take out your mortgage on January 1 (so that your first payment is due on February 1), and you make your first
extra payment at the end of the first year, in what year will you finish repaying your mortgage?
The principal balance does not matter, so just pick $100,000. Begin by computing the monthly payment.
The discount rate is 12% 12 = 1%.
Here is the cash flow timeline for this problem:
Month 0 1 2 360
Cash flow $100,000 −C −C −C
Using the formula for the loan payment, C :
PV r
C=
1
1−
(1 + r)n
$100,000 0.0100
C= = $1,028.61
1
1−
(1 + 0.0100)360
We can compute the loan payment using a financial calculator or a spreadsheet:

Given 360 1 % − 100,000 0
Solve for PMT 1,028.61 =PMT(0.0100 ,360 , − 100000 ,0)
The monthly mortgage payment is $1,028.61.
Next we write out the cash flows with the extra payment (shown in the second line):

Month 0 1 12 13 24 25 N
Cash flow $100,000 − $1,028.61 − $1,028.61− $1,028.61 − $1,028.61− $1,028.61 − $1,0

− $1,028.61 − $1,028.61
et's find the equivalent one time annual payment to these cash flows (as though we only made a single payment each
L
February). The future value of the above cash flows is the future value of the monthly annuity plus the future value of the
extra January payment:
$1,028.61 12
FV1 yr = 1.01 − 1 + $1,028.61 = $14,073.96
0.0100
herefore, the new payment plan is equivalent to paying $14,073.96 at the end of every year. At that rate, how long will it
T
take to pay off the loan? We need to find the number of years N for an annual annuity of $14,073.96 , such that given a
discount rate is 12.683% (EAR of (1.01)12 = 1.12683 − 1 ), the PV = $100,000 :
N
$14,073.96 1
$100,000 = 1−
0.12683 1.12683
We can solve for N using an annuity calculator, with Excel (NPER function), by trial and error, or directly as follows:
N
1 $100,000 0.12683
=1− = 0.098832
1.12683 $14,073.96
Therefore,
log(0.098832)
N= = 19.38
1
log
1.12683
We can solve for N using an annuity calculator, with Excel (NPER function), as follows:

Given 12.683 % − 100,000 14,073.96 0
Solve for
19.38 =NPER(0.12683 ,14,073.96 , − 100000 ,0)
NPER
You will have payments in the first five months of the 20th year. Because the mortgage will take about 19 years to pay off
this way—which is close to 2 3 of its life of 30 years—your friend is right.
b. If you take out your mortgage on July 1 (so that the first payment is on August 1), and you make the extra payment each
January, in how many months will you pay off your mortgage?
Next we write out the cash flows with the extra payment (shown in the second line):
Month 0 1 6 7 18 19 N
Cash flow $100,000 − $1,028.61 − $1,028.61− $1,028.61 − $1,028.61− $1,028.61 − $1,0

− $1,028.61 − $1,028.61
et's find the equivalent one time annual payment to these cash flows (as though we only made a single payment each
L
July). The future value of the above cash flows is the future value of the monthly annuity plus the future value of the extra
January payment:
$1,028.61 12 6
FV1 yr = 1.01 − 1 + $1,028.61 (1.01) = $14,137.24
0.0100
o, the new payment plan is equivalent to paying $14,137.24 at the end of every year. At that rate, how long will it take to
S
pay off the loan? We need to find the number of years N for an annual annuity of $14,137.24 , such that given an EAR of
(1.01)12 = 1.12683 − 1 , so the discount rate is 12.683% , the PV = $100,000 :
N
$14,137.24 1
$100,000 = 1−
0.12683 1.12683
We can solve for N using an annuity calculator, with Excel (NPER function), by trial and error, or directly as follows:
N $100,000 0.12683
1
=1− = 0.102866
1.12683 $14,137.24
Therefore,
log(0.102866)
N= = 19.05
1
log
1.12683
We can solve for N using an annuity calculator, with Excel (NPER function), as follows:
Given 12.683 % − 100,000 14,137.24 0
Solve for
19.05 =NPER(0.12683 ,14,137.24 , − 100000 ,0)
NPER
You will have a partial payment in the first month of the 20th year. Because the mortgage will take about 19 years to pay off
this way—which is close to 2 3 of its life of 30 years—your friend is right.
c. How will the amount of time it takes to pay off the loan given this strategy vary with the interest rate on the loan?
This strategy will reduce the amount of time to pay off the loan by a greater amount as the interest rate increases.
Course: 371
Date: 7/2/19
Time: 3:01 PM
The mortgage on your house is five years old. It required monthly payments of $1,485 , had an original term of 30 years, and
had an interest rate of 11% (APR). In the intervening five years, interest rates have fallen and so you have decided to
refinance—that is, you will roll over the outstanding balance into a new mortgage. The new mortgage has a 30year term,
requires monthly payments, and has an interest rate of 7.250% (APR).
a. What monthly repayments will be required with the new loan?
b. If you still want to pay off the mortgage in 25 years, what monthly payment should you make after you refinance?
c. Suppose you are willing to continue making monthly payments of $1,485. How long will it take you to pay off the
mortgage after refinancing?
d. Suppose you are willing to continue making monthly payments of $1,485 , and want to pay off the mortgage in 25 years.
How much additional cash can you borrow today as part of the refinancing?
a. What monthly repayments will be required with the new loan?
First we calculate the outstanding balance of the original mortgage today. There are 25 12 = 300 months remaining on the
loan. Here is the timeline:
Month 60 61 62 63 360
Adj months 0 1 2 3 300
Cash Flows ? $1,485 $1,485 $1,485 $1,485
To determine the outstanding balance, we discount the monthly payments at the original rate, i.e., 11% 12 = 0.9167%.
So, the outstanding balance can be computed using this present value formula:
$1,485 1
PV = 1− = $151,508.66
0.009167 (1 + 0.009167)300
N I/Y PV PMT FV
iven:
G 300 0.9167 1,485 0
Solve for: − 151,508.66
The next step is to calculate the loan payment on the new mortgage. Here is the timeline:
Month 0 1 2 3 360
Cash Flows $151,508.66 −C −C −C −C
The discount rate on the new loan is the new loan rate 7.250% 12 = 0.6042%.
Use the formula for the loan payment to compute the new monthly payment amount:
$151,508.66 0.006042
C = = $1,033.60
1
1−
360
(1.006042)
N I/Y PV PMT FV
iven:
G 360 0.6042 151,508.66 0
Solve for: − 1,033.60
So, the new monthly loan payments will be $1,033.60.
b. If you still want to pay off the mortgage in 25 years, what monthly payment should you make after you refinance?
How much additional cash can you borrow today as part of the refinancing?
Use the formula for the loan payment to compute the new monthly payment amount where the number of periods is
25 12 = 300 months:
$151,508.66 0.006042
C= = $1,095.15
1
1−
300
(1.006042)
N I/Y PV PMT FV
iven:
G 300 0.6042 151,508.66 0
Solve for: − 1,095.15
So, to pay the mortgage off in 25 years, you will need to pay $1,095.15 per month.
c. Suppose you are willing to continue making monthly payments of $1,485. How long will it take you to pay off the
mortgage after refinancing?
Use the annuity formula, where the monthly payments are $1,485 , the PV of the payments is $151,508.66 , and N , the
number of payments to be made, is unknown.
$1,485 1
PV = 1− = $151,508.66
0.006042 (1 + 0.006042)n
Solving for n brings:
$1,485
ln
$1,485 − ($151,508.66 0.006042) ln (2.6072)
n= = = 159.08 months
ln (1.006042) ln (1.006042)
Alternatively, we can use a financial calculator or MS Excel to compute the N:
N I/Y PV PMT FV
iven:
G 0.6042 151508.66 − 1,485 0
Solve for: 159.08
Excel Formula: = NPER(RATE,PMT,PV,FV) = NPER(0.006042 , − 1485 ,151508.66 ,0) = 159.08
So, to pay off the mortgage after refinancing while paying the original monthly payment amount would take 159 months.
d. Suppose you are willing to continue making monthly payments of $1,485 and want to pay off the mortgage in 25 years.
Use the annuity formula, where the monthly payments are $1,485 and n = 300 to find the PV of the payments:
$1,485 1
PV = 1− = $205,441.75
0.006042 (1 + 0.006042)300
N I/Y PV PMT FV
iven:
G 300 0.6042 1,485 0
Solve for: − 205,441.75
So you can keep $205,441.75 − $151,508.66 = $53,933. (Note: results may differ slightly due to rounding.)
Course: 371
Date: 7/2/19
Time: 3:01 PM
You have credit card debt of $24,000 that has an APR (monthly compounding) of 14%. Each month you pay the minimum
monthly payment. You are required to pay only the outstanding interest. You have received an offer in the mail for an
otherwise identical credit card with an APR of 8%. After considering all your alternatives, you decide to switch cards, roll
over the outstanding balance on the old card into the new card, and borrow additional money as well. How much can you
borrow today on the new card without changing the minimum monthly payment you will be required to pay? (Note: Be
careful not to round any intermediate steps less than six decimal places.)
Execute:
The discount rate on the original card is:
APR
r=
m
Therefore,
14%
r = = 1.16666667%
12
Assuming that your current monthly payment is the interest that accrues, it equals:
Original monthly payment = P r
Therefore,
Original monthly payment = $24,000 0.011666667 = $280.00
The timeline to help solve this problem is as follows:
Month 0 1 2 3
Cash Flows ($) ? − 280.00 − 280.00 − 280.00
This is a perpetuity. The amount you can borrow at the new interest rate is the cash flow shown in the timeline above,
discounted at the new discount rate.
The new discount rate is
8%
r= = 0.66666667%
12
Next, use the formula for the present value of a perpetuity to find the present value of your monthly payments:
$280.00
PV = = $42,000
0.0066666667
The new amount you can borrow is $42,000.
Course: 371
Date: 7/2/19
Time: 3:02 PM
Your firm has taken out a $560,000 loan with 7.5% APR (compounded monthly) for some commercial property. As is
common in commercial real estate, the loan is a five year loan based on a 15 year amortization. This means that your loan
payments will be calculated as if you will take 15 years to pay off the loan, but you actually must do so in five years. To do
this, you will make 59 equal payments based on the 15 year amortization schedule and then make a final 60th payment to
pay the remaining balance.
a. What will be your monthly payments?
b. What will be your final payment?
a. What will be your monthly payments?
The payments are established as if the loan will last 15 years. The timeline for determining the payments looks like this:
Cash Flows $560,000 −C −C −C −C
Period 0 1 2 179 180
First, determine the discount rate using the following formula:
APR
r=
m
Therefore,
7.5%
r= = 0.625000%
12
To determine the monthly payment, use the following formula:
Loan Amount
C=
1 1
1−
r (1 + r)n
Therefore,
$560,000
C= = $5,191.27
1 1
1−
0.00625000 (1 + 0.00625000)180
N I/Y PV PMT FV
iven:
G 180 0.625000 560,000 0
Solve for: − 5,191.27
b. What will your final payment be?
The actual timeline of payments is:
Cash Flows $560,000 − $5,191.27 − $5,191.27 − $5,191.27 − X
Period 0 1 2 59 60
To determine the final payment, we need to solve for X in the expression for the PV of the payments equal to $560,000 :
C 1 X
PV = $560,000 = 1− n−1
+
r (1 + r) (1 + r)n
Therefore,
$5,191.27 1 X
$560,000 = 1− +
0.00625000 (1.00625000)59 (1.00625000)60
$5,191.27 1 X
$560,000 − 1− =
0.00625000 (1.00625000)59 (1.00625000)60
X
$304,500.14 =
(1.00625000)60
X = $304,500.14 (1.00625000)60 = $442,528.35
Or we could solve for X by finding the present value of the remaining payments at the end of year five.
Alternatively, we can use a financial calculator (beginning of period mode) or MS Excel to compute the PV :
N I/Y PV PMT FV
iven:
G 121 0.625000 5,191.27 0
Solve for: − 442,528.35
Excel Formula: = PV(RATE,NPER,PMT,FV,TYPE) = PV(0.00625000 ,121,5191.27 ,0,1) = − 442,528.35
Course: 371
Date: 7/2/19
Time: 3:02 PM
Five years ago you took out a 5/1 adjustable rate mortgage and the fiveyear fixed rate period has just expired. The loan
was originally for $295,000 with 360 payments at 4.4% APR, compounded monthly.
a. Now that you have made 60 payments, what is the remaining balance on the loan?
b. If the interest rate increases by 0.9% , to 5.3% APR, compounded monthly, what will be your new payments?
a. Now that you have made 60 payments, what is the remaining balance on the loan?
The monthly interest rate is:
APR
r=
12
4.4%
r= = 0.36667%
12
The monthly payment is:
Loan Amount
C=
1 1
1−
r (1 + r)n
$295,000
C= = $1,477.25
1 1
1−
0.0036667 (1 + 0.0036667)360
N I/Y PV PMT FV
iven:
G 360 0.36667 − 295,000 0
Solve for: 1,477.25
Excel Formula: = PMT(RATE,NPER,PV,FV) = PMT(0.0036667 ,360 , − 295000 ,0) = 1,477.25
After 60 payments, the number of payments remaining is n = 360 − 60 = 300. The present value of the remaining payments

is:
C 1
PV = 1−
r (1 + r)n
$1,477.25 1
PV = 1− = $268,505.98
0.0036667 (1 + 0.0036667)300
N I/Y PV PMT FV
iven:
G 300 0.36667 1,477.25 0
Solve for: 268,505.98
Excel Formula: = PV(RATE,NPER,PMT,FV,TYPE) = PV(0.0036667 ,300 ,1477.25 ,0,1) = 268,505.98
b. If the interest rate increases by 0.9% , to 5.3% APR, compounded monthly, what will be your new payments?
The new payment is:
$268,505.98
C= = $1,616.95
1 1
1−
0.0044167 (1 + 0.0044167)300
N I/Y PV PMT FV
iven:
G 300 0.44167 − 268,505.98 0
Solve for: 1,616.95
Excel Formula: = PMT(RATE,NPER,PV,FV) = PMT(0.0044167 ,300 , − 268505.98 ,0) = 1,616.95
Course: 371
Date: 7/2/19
Time: 3:03 PM
In 1975, interest rates were 7.85% and the rate of inflation was 12.3% in the United States. What was the real interest rate
in 1975? How would the purchasing power of your savings have changed over the year? (Note: Be careful not to round any
What was the real interest rate in 1975?
The real rate of interest is given by the following formula:
Nominal Rate − Inflation Rate
Real Rate =
1 + Inflation Rate
Now, substituting the appropriate values, the result is as follows:
0.0785 − 0.1230
Real Rate = = − 0.0396 = − 3.96%
1.1230
How would the purchasing power of your savings have changed over the year?
The growth in purchasing power is
Growth in Purchasing Power = 1 + Real Rate = 1 + ( − 0.0396) = 0.9604
The purchasing power declined by 3.96% over that year because there is only growth in purchasing power if the solution to
the equation is greater than 1.
Course: 371
Date: 7/2/19
Time: 3:03 PM
If the rate of inflation is 6.2% , what nominal interest rate is necessary for you to earn a 4.1% real interest rate on your
investment? (Note: Be careful not to round any intermediate steps less than six decimal places.)
The relation among inflation rate, nominal interest rate, and the real rate of interest is given by the following expression:
Real Rate =
1 + Inflation Rate
Solving for nominal interest rate and substituting the appropriate values we have the following:
Nominal Rate = Real Rate (1 + Inflation Rate) + Inflation Rate
Nominal rate = 0.0410 1.0620 + 0.0620 = 0.1055 = 10.55%
The nominal rate needed is 10.55%.
• 5-35
• The big table in the end.
• 5-36 Course: 371
Date: 7/2/19
Time: 3:05 PM
Assume inflation is 0.23% per month. Would you rather earn a nominal return of 0.72% per month, compounded monthly, or
a real return of 6.46% APR, compounded annually? ( Note: Be careful not to round any intermediate steps less than six
decimal places.)
To convert from a monthly rate to an annual rate use the following formula:
Annual Rate = (1 + Monthly Rate)12 − 1
The annual inflation rate is:
Annual Rate (Inflation) = (1 + 0.0023)12 − 1 = 0.02795183
The annual rate for the nominal return of 0.72% per month is:
Annual Rate (Nominal) = (1 + 0.0072)12 − 1 = 0.0899049
The real return has annual compounding, so APR = EAR = 0.0646. To convert a real rate to a nominal rate, use the following

formula:
Nominal Rate = (1 + Real Rate) (1 + Inflation Rate) − 1
Nominal Rate = (1 + 0.0646) (1 + 0.02795183) − 1 = 0.09435752
Based on a comparison of the two rates and the current inflation rate, you would prefer the
real return compounded annually option over the nominal return compounded monthly option.
• 5-37 Course: 371
Date: 7/2/19
Time: 3:05 PM
You are pleased to see that you have been given a 7.50% raise this year. However, you read on the Wall Street Journal
Web site that inflation over the past year has been 3.20%. How much better off are you in terms of real purchasing power?
To determine your purchasing power, use the following formula and solve for the real rate:
1 + Nominal Rate
Growth in Purchasing Power = 1 + Real Rate =
1 + Inflation Rate
1 + Nominal Rate
Real Rate = −1
1 + Inflation Rate
Therefore,
1 + 0.075
Real rate = − 1 = 0.0417 or 4.17%
1 + 0.032
Course: 371
Date: 7/2/19
Time: 3:06 PM
6. What is the shape of the yield curve given in the following term structure? What expectations are investors likely to have
about future interest rates?
Term 1 year 2 years 3 years 5 years 7 years 10 years 20 years

Rate (EAR, %) 1.98 2.42 2.73 3.29 3.77 4.14 4.94
What is the shape of the yield curve given the term structure?
A. The yield curve is a normal yield curve (increasing).
B. The yield curve is a flat yield curve.
C. The yield curve is an inverted yield curve (decreasing).
D. It is hard to tell because we are not given an EAR for every year.
What expectations are investors likely to have about future interest rates?
A. Interest rates might decrease in the future.
B. The yield curve provides no clues as to future interest rate levels.
C. Interest rates will likely stay the same in the future.
D. Interest rates might rise in the future.
Course: 371
Date: 7/2/19
Time: 3:06 PM
You are thinking about investing $5,300 in your friend's landscaping business. Even though you know the investment is
risky and you can't be sure, you expect your investment to be worth $5,850 next year. You notice that the rate for oneyear
Treasury bills is 1%. However, you feel that other investments of equal risk to your friend's landscape business offer an
expected return of 12% for the year. What should you do?
To help you make your decision, use the following formula to find the present value of the return:
FV
PV = n
(1 + r)
where FV is your expected return in one year, r is the cost of capital, and n is the number of periods.
Therefore,
$5,850
PV = = $5,223.21
1
(1 + 0.12)
You should invest if the present value of the benefit is greater than the amount you originally invested; in this case you
should not invest in the business.
• 5-41 Course: 371
Date: 7/2/19
Time: 3:07 PM
You have invested in a business that proudly reports that it is profitable. Your investment of $5,200 has produced a profit of
$315. The managers think that if you leave your $5,200 invested with them, they should be able to generate $315 per year
in
profits for you in perpetuity. Evaluating other investment opportunities, you note that other longterm investments of similar
risk offer an expected return of 7.6%. Should you remain invested in this firm?
The expected return is given by:
Profit
Return =
Investment
$315
Return = = 6.1%
$5,200
If projects that are similar in horizon and risk are offering an expected return of 7.6% , then this business is not earning your
opportunity cost of capital, and you should invest elsewhere.
Course: 371
Date: 7/2/19
Time: 3:04 PM
Assume the inflation rate is 3.75% APR, compounded annually. Would you rather earn a nominal return of 6.20% APR,
compounded semiannually, or a real return of 2.54% APR, compounded quarterly?
(Note: Be careful not to round any
To determine the EAR for the 6.20% APR, compounded semiannually, first determine the actual interest rate per period
using the following formula:
APR
r=
m
where APR is given and m is the number of periods.
Therefore,
0.062
r= = 0.0310
2
Then, to find the EAR, use the following formula:
EAR = (1 + r)m − 1
Therefore,
2
EAR = (1 + 0.0310) − 1 = 0.0629610
To determine the nominal EAR for the real rate of 2.54% APR, compounded quarterly, first determine the actual interest rate
per period using the following formula:
APR
r=
m
Therefore,
0.0254
r= = 0.00635
4
Next, to find the real EAR, use the following formula:
EAR = (1 + r)m − 1
Therefore,
4
EAR = (1 + 0.00635) − 1 = 0.0256430
To find the nominal EAR, use the following formula and solve for the nominal rate:
Real Rate =
1 + Inflation Rate
Therefore,
Nominal Rate = Real Rate (1 + Inflation Rate) + Inflation Rate
Nominal Rate = 0.0256430 1.0375 + 0.0375 = 0.0641046
Course: 371
Date: 7/2/19
Time: 3:19 PM
Consider a 15 year bond with a face value of $1,000 that has a coupon rate of 5.8% , with semiannual payments.
a. What is the coupon payment for this bond?
b. Draw the cash flows for the bond on a timeline.
a. What is the coupon payment for this bond?
• 6-1
The formula to compute the semiannual coupon payment on the bond is:
Coupon Rate Face Value
CPN =
Number of Coupon Payments per Year
where the annual coupon rate is 5.8% , the face value is $1,000 , and the number of coupon payments per year is 2.
Therefore, the coupon payment is:
0.058 $1,000
CPN = = $29.00
2
b. Draw the cash flows for the bond on a timeline.
Using the semiannual coupon payment, we can create a timeline for the bond's cash flows with coupon payments received
every six months. Here is the cash flow timeline for this bond:
Period 0 1 2 29 30
Cash Flows CPN CPN CPN CPN + FV
where CPN is the coupon payment and FV is the face value.
Therefore, when we substitute, here is the cash flow timeline:
Period 0 1 2 29 30
Cash Flows $29.00 $29.00 $29.00 $29.00 + $1,000
Course: 371
Date: 7/2/19
Time: 3:20 PM
Assume that a bond will make payments every six months as shown on the following timeline (using sixmonth periods):
Period 0 1 2 29 30
Cash Flows $22.00 $22.00 $22.00 $22.00 + $1,000
a. What is the maturity of the bond (in years)?
b. What is the coupon rate (as a percentage)?
6-2
c. What is the face value?
a. What is the maturity of the bond (in years)?
The maturity of the bond is the number of years until the issuer returns the face value to the buyer. For the case of a bond
that will make payments every six months, the maturity is the number of payments divided by 2.
The maturity of the bond is 15 years.
b. What is the coupon rate (as a percentage)?
We can see that the bond consists of an annuity of 30 payments of $22.00 , paid every six months, and one lumpsum
payment of $1,000 (face value) in 15 years (30 sixmonth periods). We can rearrange the equation below to find the coupon
rate, knowing the coupon payment of $22.00.
Coupon Rate Face Value
CPN =
Number of Coupon Payments per Year
where CPN is the semiannual coupon payment.
By rearranging the equation above, we come up with:
CPN Number of Coupon Payments per Year
Coupon Rate =
Face Value
Therefore,
$22.00 2
Coupon Rate = = 4.4%
$1,000
c. What is the face value?
The face value is the principal of the bond, which has to be repaid at maturity. Therefore, the face value is $1,000.
Course: 371
Date: 7/2/19
Time: 3:21 PM
Your company wants to raise $8.5 million by issuing 25 year zerocoupon bonds. If the yield to maturity on the bonds will be
6.5% (annual compounded APR ), what total face value amount of bonds must you issue?
To determine the total face value amount of bonds to be issued, use the following formula:
n
FV = PV (1 + r)
where PV is the amount to be raised, r is the interest rate, and n is the number of periods.
Therefore,
25
FV = $8,500,000 (1 + 0.065) = $41,035,442.42
N I/Y PV PMT FV
iven:
G 25 6.5 8,500,000 0
Solve for: − 41,035,442.42
Excel Formula: = FV(RATE,NPER,PMT,PV) = PV(0.065 ,25 ,0,8,500,000 )= − 41,035,442.42
Course: 371
Date: 7/2/19
Time: 3:21 PM
The following table summarizes prices of various defaultfree zerocoupon bonds (expressed as a percentage of the face
value):
Maturity (years) 1 2 3 4 5
Price (per $100 face value) $97.15 $92.75 $87.95 $82.97 $77.67
a. Compute the yield to maturity for each bond.
b. Plot the zerocoupon yield curve (for the first five years).
c. Is the yield curve upward sloping, downward sloping, or flat?
a. Compute the yield to maturity for each bond.
To determine the yield to maturity for each bond, use the following formula:
1
n
Face Value
YTMn = −1
Price
For the first bond:
1
1
$100
YTM1 = − 1 = 2.93%
$97.15
N I/Y PV PMT FV
iven:
G 1 − 97.15 0 100
Solve for: 2.93
Excel Formula: = RATE(NPER,PMT,PV,FV) = RATE(1,0, − 97.15 ,100) = 2.93
For the second bond,
1
2
$100
YTM2 = − 1 = 3.83%
$92.75
N I/Y PV PMT FV
iven:
G 2 − 92.75 0 100
Solve for: 3.83
For the third bond,
1
3
$100
YTM3 = − 1 = 4.37%
$87.95
N I/Y PV PMT FV
iven:
G 3 − 87.95 0 100
Solve for: 4.37
For the fourth bond,
1
4
$100
YTM4 = − 1 = 4.78%
$82.97
N I/Y PV PMT FV
iven:
G 4 − 82.97 0 100
Solve for: 4.78
For the fifth bond,
1
5
$100
YTM5 = − 1 = 5.18%
$77.67
N I/Y PV PMT FV
iven:
G 5 − 77.67 0 100
Solve for: 5.18
b. Plot the zerocoupon yield curve (for the first five years).
The following graph depicts the yield curve for these zerocoupon bonds:
YIELD CURVE
7.0
6.5
6.0
5.5
Yield to Maturity (%)
5.0
4.5
4.0
3.5
3.0
2.5
2.0
0 1 2 3 4 5
Maturity (years)
c. Is the yield curve upward sloping, downward sloping, or flat?
From the graph above, you can see that the yield curve is upward sloping because the yield increases as the
maturity increases.
Course: 371
Date: 7/2/19
Time: 3:21 PM
The current zerocoupon yield curve for riskfree bonds is as follows:
YTM 5.15% 5.60% 5.85% 6.20% 6.40%
What is the price per $100 face value of a twoyear, zerocoupon, riskfree bond?
The price of the zerocoupon bond is given by:
FV
P=
(1 + y)n
where FV is the face value, y is the yield to maturity, and n is the number of periods (years).
Therefore,
$100
P= = $89.68
(1 + 0.0560)2
N I/Y PV PMT FV
iven:
G 2 5.60 0 100
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.0560 ,2,0,100 ) = − 89.68
Course: 371
Date: 7/2/19
Time: 3:22 PM
The current zerocoupon yield curve for riskfree bonds is as follows:
YTM 5.15% 5.60% 5.85% 6.20% 6.40%
What is the price per $100 face value of a fouryear, zerocoupon, riskfree bond?
The price of the zerocoupon bond is given by:
FV
P=
(1 + y)n
Therefore,
$100
P= = $78.61
(1 + 0.062)4
N I/Y PV PMT FV
iven:
G 4 6.20 0 100
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.062 ,4,0,100 ) = − 78.61
Course: 371
Date: 7/2/19 • 6-7 Time: 3:23 PM
4. The current zerocoupon yield curve for riskfree bonds is as follows:
YTM 5.02% 5.52% 5.71% 5.92% 6.05%
What is the riskfree interest rate for a fiveyear maturity?
The riskfree interest rate for a fiveyear maturity is 6.05 %. (Round to two decimal places.)
Course: 371
Date: 7/2/19
Time: 3:24 PM
1. For each of the following pairs of Treasury securities (each with $1,000 par value), identify which will have the higher
price:
a. A threeyear zerocoupon bond or a fiveyear zerocoupon bond?
b. A threeyear zerocoupon bond or a threeyear 4% coupon bond?
c. A twoyear 5% coupon bond or a twoyear 6% coupon bond?
a. A threeyear zerocoupon bond or a fiveyear zerocoupon bond?
Which will have the higher price? (Select the best choice below.)
A. A threeyear zerocoupon bond, because the present value is received sooner and the
future value is higher.
B. A fiveyear zerocoupon bond, because the present value is received sooner and the
future value is higher.
C. A fiveyear zerocoupon bond, because the future value is received later and the present
value is higher.
D. A threeyear zerocoupon bond, because the future value is received sooner and the
present value is higher.
b. A threeyear zerocoupon bond or a threeyear 4% coupon bond?

A. The threeyear zerocoupon bond, because the zerocoupon bond is riskfree.
B. The threeyear zerocoupon bond, because a pure discount bond pays higher interest
payments than a 4% coupon bond.
C. The threeyear 4% coupon bond, because the 4% coupon bond pays interest payments;
whereas the zerocoupon bond is a pure discount bond.
D. Since they both have a threeyear maturity, they are equal in price.
c. A twoyear 5% coupon bond or a twoyear 6% coupon bond?
A. The twoyear 6% coupon bond, because the coupon (interest) payments are higher,
even though the timing is the same.
B. The twoyear 5% coupon bond, because the future value will be received sooner,
therefore the present value must be higher.
C. The twoyear 5% coupon bond, because the coupon (interest) payments are higher,
even though the timing is the same.
D. Because they are both twoyear coupon bonds, they are equal in price.
YOU ANSWERED: B.
B.
B.
Course: 371
Date: 7/2/19
Time: 3:24 PM
The yield to maturity of a $1,000 bond with a 8.0% coupon rate, semiannual coupons, and two years to maturity is 9.5%
APR, compounded semiannually. What is its price?
To determine the price of the bond, use the following formula:
CPN 1 FV
P= 1− +
y (1 + y)n (1 + y)n
where CPN is the coupon payment, y is the semiannual rate, n is the number of periods, and FV is the face value.
Therefore, the price of the bond is:
$40.00 1 $1,000
P= 1− + = $973.25
0.0475 (1 + 0.0475)4 (1 + 0.0475)4
N I/Y PV PMT FV
iven:
G 4 4.75 40.00 1000
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.0475 ,4 ,40.00 ,1000 ) = − 973.25
Course: 371
Date: 7/2/19
Time: 3:25 PM
Assume the current Treasury yield curve shows that the spot rates for six months, one year, and one and a half years are
1% , 1.1% , and 1.3% , all quoted as semiannually compounded APRs. What is the price of a $1,000 par, 5.75% coupon bond
maturing in one and a half years (the next coupon is exactly six months from now)?
Here is the timeline:
Period Today 6 months 1 year 1.5 years
Cash Flows $28.75 $28.75 $1,028.75
CPN CPN CPN + FV

P= 1
+ 2
+
1 + r6 months 1 + r1 year 1 + r18 months 3
where CPN is the coupon payment and r is the sixmonth spot rate for the period.
Therefore,
$28.75 $28.75 $28.75 + $1,000

P= + + = $1,065.99
1 2 3
(1 + 0.005) (1 + 0.0055) (1 + 0.0065)
The price of the bond is $1,065.99.
Course: 371
Date: 7/2/19
Time: 3:25 PM
Suppose a 10year, $1,000 bond with an 9.2% coupon rate and semiannual coupons is trading for $1,038.00.
a. What is the bond's yield to maturity (expressed as an APR with semiannual compounding)?
b. If the bond's yield to maturity changes to 10.5% APR, what will be the bond's price?
a. What is the bond's yield to maturity (expressed as an APR with semiannual compounding)?
To find the bond's yield to maturity, you use the following equation:
CPN 1 FV
P= 1− +
y (1 + y)n (1 + y)n
where P is the bond's price, CPN is the coupon payment, y is the semiannual rate, FV is the face value, and n is the
number of periods. You need to solve for y and multiply it by two to obtain the yield to maturity expressed as an APR with
semiannual compounding.
Using the equation above to find the bond's yield to maturity:
$46.00 1 $1,000
$1,038.00 = 1− +
y (1 + y)20 (1 + y)20
y = 0.04313
N I/Y PV PMT FV
iven:
G 20 − 1038.00 46.00 1000
Solve for: 4.313
Excel Formula: = RATE(NPER,PMT,PV,FV) = RATE(20 ,46.00 , − 1038.00 ,1000 ) = 4.313
Thus, the bond's yield to maturity (expressed as an APR with semiannual compounding) is:
YTM = 0.04313 2 = 8.626%
b. If the bond's yield to maturity changes to 10.5% APR, what will be the bond's price?
To find the bond's new price, you use the following equation:
CPN 1 FV
P= 1− +
y (1 + y)n (1 + y)n
where CPN is the coupon payment, y is the semiannual rate, FV is the face value, and n is the number of periods. Given
the yield, we can compute the price using the equation below. Note that a 10.5% APR is equivalent to a semiannual rate of
5.25%.
Using the equation above, the price will be:
$46.00 1 $1,000
P= 1− + = $920.69
0.0525 (1 + 0.0525)20 (1 + 0.0525)20
N I/Y PV PMT FV
iven:
G 20 5.25 46.00 1000
Course: 371
Date: 7/2/19
Time: 3:26 PM
Suppose a fiveyear, $1,000 bond with annual coupons has a price of $903.15 and a yield to maturity of 6.3%. What is the
bond's coupon rate?
The price of the bond is:
CPN 1 FV
P= 1− +
y (1 + y)n (1 + y)n
You can rearrange the equation to compute the coupon payment:
y FV
CPN = P−
1 (1 + y)n
1−
(1 + y)n
where y is the yield to maturity, P is the bond's price, FV is the face value, and n is the number of years. Then, you will
need to compute the coupon rate:
CPN
r=
FV
When we substitute the data we have into the equation:
0.063 $1,000
CPN = $903.15 − = $39.82
1 (1 + 0.063)5
1−
(1 + 0.063)5
N I/Y PV PMT FV
iven:
G 5 6.3 − 903.15 1000
Solve for: 39.82
Excel Formula: = PMT(RATE,NPER,PV,FV) = PMT(0.063 ,5 , − 903.15 ,1000 ) = 39.82
Therefore, the coupon rate is:
$39.82
r= = 3.982%
$1,000
Course: 371
Date: 7/2/19
Time: 3:26 PM
Assume that the sixmonth Treasury spot rate is 1.7% APR, and the oneyear rate is 2.1% APR, both compounded
semiannually. What is the price of a oneyear $1,000 par Treasury bond with 2.1% coupons?
The price of the Treasury bond is:
CPN FV + CPN
P= +
1 + y1 1 + y2 2
$10.50 $1,000 + $10.50

P= + = $1,000.02
(1 + 0.0085) (1 + 0.0105)2
Course: 371
Date: 7/2/19
Time: 9:27 PM
1. The prices of several bonds with face values of $1,000 are summarized in the following table:
Bond A B C D
Price $972.89 $1,042.57 $1,150.65 $1,000.00
For each bond, state whether it trades at a discount, at par, or at a premium.
Bond A is selling at a discount . (Select from the dropdown menu.)
Bond B is selling at a premium . (Select from the dropdown menu.)
Bond C is selling at a premium . (Select from the dropdown menu.)
Bond D is selling at par . (Select from the dropdown menu.)
YOU ANSWERED: par
par
Course: 371
Date: 7/2/19
Time: 9:27 PM
2. You have purchased a 8 % coupon bond for $1,030. What will happen to the bond's price if market interest rates rise?
If market interest rates rise, the bond's price will decrease . (Select from the dropdown menu.)
YOU ANSWERED: stay the same
Course: 371
Date: 7/2/19
Time: 9:28 PM
Suppose a sevenyear, $1,000 bond with a 7.8% coupon rate and semiannual coupons is trading with a yield to maturity of
6.50%.
a. Is this bond currently trading at a discount, at par, or at a premium? Explain.
b. If the yield to maturity of the bond rises to 7.20% (APR with semiannual compounding), what price will the bond trade for?
a. Is this bond currently trading at a discount, at par, or at a premium? Explain.
When the coupon rate is greater than the yield to maturity, the bond trades at a premium. When the coupon rate is less than
the yield to maturity, the bond trades at a discount. When the coupon rate is equal to the yield to maturity, the bond trades at
par. Because the yield to maturity is less than the coupon rate, the bond is trading at a premium.
b. If the yield to maturity of the bond rises to 7.20% (APR with semiannual compounding), what price will the bond trade for?
The new price of the bond is given by:
CPN 1 FV
P= 1− +
y (1 + y)n (1 + y)n
where CPN is the coupon payment, y is the semiannual yield to maturity, FV is the face value, and n is the number of
periods.
Therefore, the new price of the bond is:
$39.00 1 $1,000
P= 1− + = $1,032.54
0.0360 (1 + 0.0360)14 (1 + 0.0360)14
N I/Y PV PMT FV
iven:
G 14 3.60 39.00 1000
Course: 371
Date: 7/2/19
Time: 9:29 PM
Suppose that General Motors Acceptance Corporation issued a bond with 10 years until maturity, a face value of $1,000 ,
and a coupon rate of 7.3% (annual payments). The yield to maturity on this bond when it was issued was 5.7%. What was
the price of this bond when it was issued?
The price of the bond is given by:
CPN 1 FV
P= 1− +
y (1 + y)n (1 + y)n
where CPN is the coupon payment, y is the yield to maturity, FV is the face value, and n is the number of years
(payments).
Therefore, when it was issued, the price of the bond was:
$73.00 1 $1,000
P= 1− + = $1,119.45
0.057 (1 + 0.057)10 (1 + 0.057)10
N I/Y PV PMT FV
iven:
G 10 5.7 73.00 1000
Course: 371
Date: 7/2/19
Time: 9:29 PM
and a coupon rate of 7.3% (annual payments). The yield to maturity on this bond when it was issued was 5.7%. Assuming
the yield to maturity remains constant, what is the price of the bond immediately before it makes its first coupon payment?
We should recognize that we can find the value of the bond by using our formula for the value of a bond as if the coupon
has been paid and then adding the amount of the pending coupon. Before the first coupon payment, the price of the bond
is determined using the following formula:
CPN 1 FV
P = CPN + 1− +
y (1 + y)n (1 + y)n
(payments).
Therefore,
$73.00 1 $1,000
P = $73.00 + 1− + = $1,183.26
0.057 (1 + 0.057)9 (1 + 0.057)9
Course: 371
Date: 7/2/19
Time: 9:30 PM
meet
and a coupon rate of 7.30% (annual payments). The yield to maturity on this bond when it was issued was 5.70%.
Assuming the yield to maturity remains constant, what is the price of the bond immediately after it makes its first coupon
payment?
To determine the price of the bond after the first coupon payment, use the following formula:
CPN 1 FV
P= 1− +
y (1 + y)n (1 + y)n
(payments).
Therefore,
$73.00 1 $1,000
P= 1− + = $1,110.26
0.057 (1 + 0.057)9 (1 + 0.057)9
N I/Y PV PMT FV
iven:
G 9 5.70 73.00 1000
Course: 371
Date: 7/2/19
Time: 9:30 PM
Your company currently has $1,000 par, 5.75% coupon bonds with 10 years to maturity and a price of $1,085. If you want to
issue new 10year coupon bonds at par, what coupon rate do you need to set? Assume that for both bonds, the next
coupon payment is due in exactly six months.
To determine the coupon rate that must be set, use the following formula and solve for y , the yield:
CPN 1 FV
P= 1− +
y (1 + y)n (1 + y)n
where P is the price, CPN is the coupon payment, FV is the face value, and n is the number of periods.
Therefore,
$28.75 1 $1,000
$1,085 = 1− +
20 20
y (1 + y) (1 + y)
and through trial and error, we can determine that y = 0.0234.
N I/Y PV PMT FV
iven:
G 20 − 1085 28.75 1000
Solve for: 2.34
Excel Formula: = RATE(NPER,PMT,PV,FV) = RATE(20 ,28.75 , − 1085 ,1000 ) = 2.34
Since 2.34 % (or 0.0234 ) is the 6month rate, the semiannually compounded APR would be twice that amount or 4.68% (or
0.0468 ). Because the market is currently pricing your company's bonds to yield 4.68 %, you would need to offer a 4.68%
coupon rate in order to have them priced at par.
Course: 371
Date: 7/2/19
Time: 9:31 PM
Suppose you purchase a 10year bond with 7.2% annual coupons. You hold the bond for four years, and sell it immediately
after receiving the fourth coupon. If the bond's yield to maturity was 5.8% when you purchased and sold the bond,
a. What cash flows will you pay and receive from your investment in the bond per $100 face value?
b. What is the annualized rate of return of your investment?
a. What cash flows will you pay and receive from your investment in the bond per $100 face value?
irst, you need to compute the initial price of the bond by discounting its 10 annual coupons of $7.20 and its final face value
F
of $100 at the 5.8% yield to maturity using the following equation:
CPN 1 FV
P= 1− +
y (1 + y)n (1 + y)n
Therefore,
$7.20 1 $100
P= 1− + = $110.40
0.058 (1 + 0.058)10 (1 + 0.058)10
N I/Y PV PMT FV
iven:
G 10 5.8 7.20 100
Thus, the initial price of the bond is $110.40. (Note that the bond trades above par, as its coupon rate exceeds its yield.)
Next we compute the price at which the bond is sold, which is the present value of the bond's cash flows when only six
years remain until maturity:
$7.20 1 $100
P= 1− + = $106.93
0.058 (1 + 0.058)6 (1 + 0.058)6
N I/Y PV PMT FV
iven:
G 6 5.8 7.20 100
Therefore, the bond was sold for a price of $106.93.
Here is the cash flows timeline for the investment:
Year 0 1 2 3 4
Purchase Bond − $110.40
Receive Coupons $7.20 $7.20 $7.20 $7.20
Sell Bond $106.93
Cash Flows − $110.40 $7.20 $7.20 $7.20 $114.13
b. What is the annualized rate of return of your investment?
We can compute the annualized rate of return (ARR) of the investment using the annuity spreadsheet and/or a financial
calculator. The PV is the purchase price, the PMT is the coupon amount, and the FV is the sale price. The length of the
investment n = 4 years. We then calculate the ARR of the investment, ARR = 5.8%. Because the YTM was the same at the
time of purchase and sale, the ARR of the investment matches the YTM.
N I/Y PV PMT FV
iven:
G 4 − 110.40 7.20 106.93
Solve for: 5.8
Excel Formula: = RATE(NPER,PMT,PV,FV) = RATE(4 ,7.20 , − 110.40 ,106.93 ) = 5.8
Course: 371
Date: 7/2/19
Time: 9:31 PM
Consider the following bonds:
Bond Coupon Rate (annual payments) Maturity (years)

A 0.0 % 15
B 0.0 % 10
C 5.0 % 15
D 9.0 % 10
What is the percentage change in the price of each bond if its yield to maturity falls from 6.5% to 5.5% ?
To compute the price of each bond for each yield to maturity, use the following formula:
CPN 1 FV
P= 1− +
y (1 + y)n (1 + y)n
where CPN is the coupon payment, y is the yield to maturity, FV is face value, and n is the number of periods.
The price of bond A at 6.5 % YTM per $100 face value is:
$0 1 $100
PA (6.5%) = 1− + = $38.88
0.065 (1 + 0.065)15 (1 + 0.065)15
N I/Y PV PMT FV
iven:
G 15 6.5 0 100
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.065 ,15 ,0 ,100 ) = − 38.88
The price of bond A at 5.5 % YTM per $100 face value is:
$0 1 $100
PA (5.5%) = 1− + = $44.79
0.055 (1 + 0.055)15 (1 + 0.055)15
N I/Y PV PMT FV
iven:
G 15 5.5 0 100
The price of bond B at 6.5% YTM per $100 face value is:
$0 1 $100
PB (6.5%) = 1− + = $53.27
0.065 (1 + 0.065)10 (1 + 0.065)10
N I/Y PV PMT FV
iven:
G 10 6.5 0 100
The price of bond B at 5.5% YTM per $100 face value is:
$0 1 $100
PB (5.5%) = 1− 10
+ = $58.54
0.055 (1 + 0.055) (1 + 0.055)10
N I/Y PV PMT FV
iven:
G 10 5.5 0 100
The price of bond C at 6.5% YTM per $100 face value:
$5.00 1 $100
PC (6.5%) = 1− + = $85.90
0.065 (1 + 0.065)15 (1 + 0.065)15
N I/Y PV PMT FV
iven:
G 15 6.5 5.00 100
The price of bond C at 5.5% YTM per $100 face value:
$5.00 1 $100
PC (5.5%) = 1− + = $94.98
0.055 (1 + 0.055)15 (1 + 0.055)15
N I/Y PV PMT FV
iven:
G 15 5.5 5.00 100
The price of bond D at 6.5% YTM per $100 face value:
$9.00 1 $100
PD (6.5%) = 1− + = $117.97
0.065 (1 + 0.065)10 (1 + 0.065)10
N I/Y PV PMT FV
iven:
G 10 6.5 9.00 100
The price of bond D at 5.5% YTM per $100 face value:
$9.00 1 $100
PD (5.5%) = 1− + = $126.38
0.055 (1 + 0.055)10 (1 + 0.055)10
N I/Y PV PMT FV
iven:
G 10 5.5 9.00 100
Once we have the price of each bond for each YTM , we can compute the % price change using the following formula:
Price at 5.5% YTM − Price at 6.5% YTM
Percentage Change =
Price at 6.5% YTM
The percentage change in the price of bond A is:
$44.79 − $38.88
Percentage ChangeA = = 15.2%
$38.88
The percentage change in the price of bond B is:
$58.54 − $53.27
Percentage ChangeB = = 9.9%
$53.27
The percentage change in the price of bond C is:
$94.98 − $85.90
Percentage ChangeC = = 10.6%
$85.90
The percentage change in the price of bond D is:
$126.38 − $117.97
Percentage ChangeD = = 7.1%
$117.97
Course: 371
Date: 7/2/19
Time: 9:32 PM
10. Consider the following bonds:
Bond Coupon Rate (annual payments) Maturity (years)

A 0.0% 15
B 0.0% 10
C 3.9% 15
D 7.9% 10
Which of the bonds A to D is most sensitive to a 1% drop in interest rates from 6.8% to 5.8% ? Which bond is least
sensitive?
Bond A is most sensitive. (Select from the dropdown menu.)
Bond D is the least sensitive. (Select from the dropdown menu.)
YOU ANSWERED: C
Course: 371
Date: 7/2/19
Time: 9:33 PM
Suppose you purchase a 30 year, zerocoupon bond with a yield to maturity of 7.0%. You hold the bond for five years before
selling it.
a. If the bond's yield to maturity is 7.0% when you sell it, what is the annualized rate of return of your investment?
b. If the bond's yield to maturity is 8.0% when you sell it, what is the annualized rate of return of your investment?
c. If the bond's yield to maturity is 6.0% when you sell it, what is the annualized rate of return of your investment?
d. Even if a bond has no chance of default, is your investment risk free if you plan to sell it before it matures? Explain.
a. If the bond's yield to maturity is 7.0% when you sell it, what is the annualized rate of return of your investment?
To find the price of a zerocoupon bond, use the formula:
FV
P=
(1 + YTM)n
where FV is the future value to be received in year n , and YTM is the yield to maturity.
Then, to find the YTM for each of these problems, use the following formula:
1
n
Face Value
YTMn = −1
Price
where Price is the price at time 0, when the bond was purchased, and Face Value is the price when the bond is sold after
five years.
The purchase price of the bond is:
$100
P0 = = $13.14
(1 + 0.07)30
N I/Y PV PMT FV
iven:
G 30 7.0 0 100
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.07 ,30 ,0,100 ) = − 13.14
The sale price of the bond for this case is:
$100
P5 = = $18.42
(1 + 0.07)25
or the face value.
N I/Y PV PMT FV
iven:
G 25 7.0 0 100
The annualized rate of return of the bond for this case is:
1
5
$18.42
YTM = − 1 = 7%
$13.14
N I/Y PV PMT FV
iven:
G 5 − 13.14 0 18.42
Solve for: 7
Excel Formula: = RATE(NPER,PMT,PV,FV) = RATE(5 ,0, − 13.14 ,18.42 ) = 7
The YTM of the bond in this case is 7 %. The YTM is the same at purchase and sale.
b. If the bond's yield to maturity is 8.0% when you sell it, what is the annualized rate of return of your investment?
$100
P5 = = $14.60
(1 + 0.08)25
or the face value.
N I/Y PV PMT FV
iven:
G 25 8.0 0 100
1
5
$14.60
YTM = − 1 = 2.13%
$13.14
N I/Y PV PMT FV
iven:
G 5 − 13.14 0 14.60
Solve for: 2.13
Excel Formula: = RATE(NPER,PMT,PV,FV) = RATE(5 ,0, − 13.14 ,14.60 ) = 2.13
The YTM of the bond for this case is 2.13 %.
c. If the bond's yield to maturity is 6.0% when you sell it, what is the annualized rate of return of your investment?
$100
P5 = = $23.30
(1 + 0.06)25
or the face value.
N I/Y PV PMT FV
iven:
G 25 6.0 0 100
1
5
$23.30
YTM = − 1 = 12.14%
$13.14
N I/Y PV PMT FV
iven:
G 5 − 13.14 0 23.30
Solve for: 12.14
Excel Formula: = RATE(NPER,PMT,PV,FV) = RATE(5 ,0, − 13.14 ,23.30 ) = 12.14
The YTM of the bond for this case is 12.14 %.
d. Even if a bond has no chance of default, is your investment risk free if you plan to sell it before it matures? Explain.
Even without default, if you sell prior to maturity, you are exposed to risk that the YTM may change. In this example, if the
bond is sold after five years and the yield to maturity increases only 1%, then the annualized rate of return on the
investment is only 2.13% , not the 7% at which it was purchased.
• 6-26 Course: 371
Date: 7/2/19
Time: 9:34 PM
The following table summarizes the yields to maturity on several oneyear, zerocoupon securities:
Security Yield (%)
Treasury 3.20
AAA corporate 3.40
BBB corporate 4.45
B corporate 5.10
a. What is the price (expressed as a percentage of the face value) of a oneyear, zerocoupon corporate bond with a AAA
rating?
b. What is the credit spread on AAArated corporate bonds?
c. What is the credit spread on Brated corporate bonds?
d. How does the credit spread change with the bond rating? Why?
a. What is the price (expressed as a percentage of the face value) of a oneyear, zerocoupon corporate bond with a AAA
rating?
To determine the price of this bond, use the following formula:
FV
P=
(1 + YTM)n
where FV is the future value to be received in year n and YTM is the yield to maturity.
Therefore,
$100
P= = 96.712
(1 + 0.0340)1
The price (expressed as a percentage of the face value) of a oneyear, zerocoupon corporate bond with a AAA rating
96.712 %
N I/Y PV PMT FV
iven:
G 1 3.40 0 100
b. What is the credit spread on AAArated corporate bonds?
The credit spread on AAArated corporate bonds is:
Spread = AAA Bond Yield − Treasury Yield
Spread = 3.40% − 3.20% = 0.20%
c. What is the credit spread on Brated corporate bonds?
The credit spread on Brated corporate bonds is:
Spread = B Bond Yield − Treasury Yield
Spread = 5.10% − 3.20% = 1.90%
d. How does the credit spread change with the bond rating? Why?
The credit spread increases as the bond rating falls because lowerrated bonds are riskier.
Course: 371
Date: 7/2/19
Time: 9:34 PM
Andrew Industries is contemplating issuing a 30 year bond with a coupon rate of 7.40% (annual coupon payments) and a
face value of $1,000. Andrew believes it can get a rating of A from Standard & Poor's. However, due to recent financial
difficulties at the company, Standard & Poor's is warning that it may downgrade Andrew Industries' bonds to BBB. Yields on
Arated, longterm bonds are currently 6.70% , and yields on BBBrated bonds are 7.20%.
a. What is the price of the bond if Andrew Industries maintains the A rating for the bond issue?
b. What will be the price of the bond if it is downgraded?
a. What is the price of the bond if Andrew Industries maintains the A rating for the bond issue?
CPN 1 FV
P= 1− +
y (1 + y)n (1 + y)n
where CPN is the coupon payment, y is the annual rate, FV is the face value, and n is the number of periods.
The price of the bond if it maintains the A rating is:
$74.00 1 $1,000
P= 1− + = $1,089.55
0.067 (1 + 0.067)30 (1 + 0.067)30
Alternatively, you can use a financial calculator or MS Excel to compute the price:
N I/Y PV PMT FV
iven:
G 30 6.70 74.00 1000
b. What will be the price of the bond if it is downgraded?
If the bond is downgraded, its price will fall to:
$74.00 1 $1,000
P= 1− + = $1,024.33
0.072 (1 + 0.072)30 (1 + 0.072)30
N I/Y PV PMT FV
iven:
G 30 7.20 74.00 1000
Course: 371
Date: 7/2/19
Time: 9:34 PM
Your firm has a credit rating of A. You notice that the credit spread for fiveyear maturity A debt is 82 basis points (0.82%).
Your firm's fiveyear debt has an annual coupon rate of 6.4%. You see that new fiveyear Treasury notes are being issued at
par with an annual coupon rate of 1.9%. What should be the price of your outstanding fiveyear bonds?
The prevailing interest rate is:
r = Risk Free Rate + Credit Spread
r = 1.9% + 0.82% = 2.72%
The price of the bond is:
CPN 1 FV
P= 1− +
y (1 + y)n (1 + y)n
$64 1 $1,000
P= 1− + = $1,169.89
0.0272 (1 + 0.0272)5 (1 + 0.0272)5
N I/Y PV PMT FV
iven:
G 5 2.72 % 64 1000
Course: 371
Date: 7/2/19
Time: 9:35 PM
HMK Enterprises would like to raise $10.0 million to invest in capital expenditures. The company plans to issue fiveyear
bonds with a face value of $1,000 and a coupon rate of 6.65% (annual payments). The following table summarizes the yield
to maturity for fiveyear (annualpayment) coupon corporate bonds of various ratings:
Rating AAA AA A BBB BB

YTM 6.25 % 6.46 % 6.65 % 7.10 % 7.65 %
a. Assuming the bonds will be rated AA, what will be the price of the bonds?
b. How much of the total principal amount of these bonds must HMK issue to raise $10.0 million today, assuming the bonds
are AA rated? (Because HMK cannot issue a fraction of a bond, assume that all fractions are rounded to the nearest whole
number.)
c. What must be the rating of the bonds for them to sell at par?
d. Suppose that when the bonds are issued, the price of each bond is $959.70. What is the likely rating of the bonds? Are
they junk bonds?
a. Assuming the bonds will be rated AA, what will be the price of the bonds?
The bond's price can be determined by using the following formula:
CPN 1 FV
P= 1− +
y (1 + y)n (1 + y)n
where CPN is the coupon, y is the yield to maturity, FV is the face value, and n is the number of years.
$66.50 1 $1,000
P= 1− + = $1,007.90
0.0646 (1 + 0.0646)5 (1 + 0.0646)5
N I/Y PV PMT FV
iven:
G 5 6.46 66.50 1000
b. How much of the total principal amount of these bonds must HMK issue to raise $10.0 million today, assuming the bonds
are AA rated? (Because HMK cannot issue a fraction of a bond, assume that all fractions are rounded to the nearest whole
number.)
Using the price of the bond, we can find the total principal amount of these bonds by dividing the price of the bonds into the
$10.0 million HMK would like to raise.
Each bond will raise $1,007.90 , so the firm must issue:
Amount to Raise
Number of Bonds =
Bond's Price
$10.0 million
Number of Bonds = = 9,922 bonds
$1,007.90 per bond
This will correspond to a principal amount of $1,000 per bond 9,922 bonds = $9,922,000.
c. What must be the rating of the bonds for them to sell at par?
To find the rating that would sell the bonds at par, the coupon rate of the bond must equal the yield of the bond.
For the bonds to sell at par, the coupon must equal the yield. Since the coupon is 6.65% , the yield must also be 6.65% , or A
rated.
d. Suppose that when the bonds are issued, the price of each bond is $959.70. What is the likely rating of the bonds? Are
they junk bonds?
You need to find the annualized rate of return of a bond that pays $66.50 coupon and that will repay the face value of
$1,000 in 5 years. To find the rating of the bond given the price, we can use the equation below to solve for the yield to
maturity and then match that yield to maturity to the bond ratings to find the specific rating, as well as whether or not the
bonds are junk bonds.
CPN 1 FV
P= 1− +
y (1 + y)n (1 + y)n
First, compute the yield on these bonds:
$66.50 1 $1,000
P= 1− + = $959.70
y (1 + y)5 (1 + y)5
YTM = 7.65%
N I/Y PV PMT FV
iven:
G 5 − 959.70 66.50 1000
Solve for: 7.65
Excel Formula: = RATE(NPER,PMT,PV,FV) = RATE(5 ,66.50 , − 959.70 ,1000 ) = 7.65
Given a yield of 7.65% , it is likely these bonds are rated BB. Yes, BB rated bonds are junk bonds.
• 6-30 Course: 371
Date: 7/2/19
Time: 9:35 PM
A BBBrated corporate bond has a yield to maturity of 15.2%. A U.S. treasury security has a yield to maturity of 13.0%.
These yields are quoted as APRs with semiannual compounding. Both bonds pay semiannual coupons at a rate of 14.1%
and have five years to maturity.
a. What is the price (expressed as a percentage of the face value) of the treasury bond?
b. What is the price (expressed as a percentage of the face value) of the BBBrated corporate bond?
c. What is the credit spread on the BBB bonds?
a. What is the price (expressed as a percentage of the face value) of the treasury bond?
The price of the treasury bond can be determined using the following formula:
CPN 1 FV
P= 1− 10
+ 10
y (1 + y) (1 + y)
where CPN is the coupon payment, y is the yield to maturity for the semiannual period, and FV is the face value.
Then, determine the price as a percentage of face value.
The coupon payment is (0.141 $1,000) 2 = $70.50 ; the annual payment is divided by two because it is paid semiannually.
The discount rate you would use to price the treasury bond is the yield to maturity of the bond divided by two:
y = 0.130 2 = 0.0650
Using the formula above, the price of the treasury bond is:
$70.50 1 $1,000
P= 1− + = $1,039.54
0.0650 (1 + 0.0650)10 (1 + 0.0650)10
N I/Y PV PMT FV
iven:
G 10 6.50 70.50 1000
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.0650 ,10,70.50 ,1000) = − 1039.54
Then the price as a percentage of face value is $1,039.54 $1,000 = 103.954%.
b. What is the price (expressed as a percentage of the face value) of the BBBrated corporate bond?
The price of the BBBrated bond can be determined using the following formula:
CPN 1 FV
P= 1− +
10 10
y (1 + y) (1 + y)
where CPN is the coupon payment, y is the yield to maturity for the semiannual period, and FV is the face value.
Then, determine the price as a percentage of face value.
The coupon payment is (0.141 $1,000) 2 = $70.50 ; the annual payment is divided by two because it is paid semiannually.
The discount rate you would use to price the BBB bond is the yield to maturity of the BBB bond divided by two:
y = 0.152 2 = 0.0760
Using the formula above, the price of the BBB bond will be:

$70.50 1 $1,000
P= 1− 10
+ = $962.42
(0.0760) (1 + 0.0760) (1 + 0.0760)10
N I/Y PV PMT FV
iven:
G 10 7.60 70.50 1000
Excel Formula: = PV(RATE,NPER,PMT,FV) = PV(0.0760 ,10,70.50 ,1000) = − 962.42
Then the price as a percentage of face value is $962.42 $1,000 = 96.242%.
c. What is the credit spread on the BBB bonds?
The credit spread is the yield on the BBBrated bond minus the yield on the treasury. Therefore,
Spread = 15.2% − 13.0% = 2.20%

Ch. 3,4,5,6 - Study Plan

Uploaded by

Copyright:

Available Formats

You might also like

Ch. 3,4,5,6 - Study Plan

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Ch. 3,4,5,6 - Study Plan

Uploaded by

Copyright:

Available Formats

7/2/2019 371-Lama Alqahtani

Cost = Loss per Vehicle Vehicles that Would Have Sold Without Rebate

Cost = ($32,000 − $29,700) per vehicle 43,000 vehicles = $98.9 million

Benefit = Profit per Vehicle Additional Vehicles Sold

Benefit = $7,100 per vehicle (58,000 − 43,000) vehicles = $106.5 million

Benefit − Cost = $106.5 million − $98.9 million = $7.6 million

Value of the Stock Bonus Today = Number of Shares Price per Share

Value of the Stock Bonus Today = 100 shares $65.00 per share = $6,500

BBRY (US$) = BBRY (C$) Rate of the US$ per C$

Market Value of the Almond Crop = Quantity in Tons Price per Ton

Market Value of the Almond Crop = 1,060 tons $111 per ton = $117,660

Market Value of the Walnut Crop = Quantity in Tons Price per Ton

Market Value of the Walnut Crop = 805 tons $121 per ton = $97,405

FV = $1,300 (1 + 0.065) = $1,384.50

Interest saved = Interest paidOriginal − Interest paidNew

Interest paid = Loan amount Interest rate

Interest paidOriginal = $15,000 0.11 = $1,650

Interest paidNew = $15,000 0.08 = $1,200

Interest saved = $1,650 − $1,200 = $450

FV = $56 (1 + 0.070) = $59.92

FVn = C (1 + r)n • 3-17

FV = $700 (1 + 0.050) = $735.00

FVn = $650 (1 + 0.017)6 = $719.18 • 3-19

FV = $1,200 (1 + 0.09)5 = $1,846.35

FV = $1,200 9% 5 + $1,200 = $1,740.00

Interest on interest = FV (compounded interest) − FV (simple interest)

Interest on interest = $1,846.35 − $1,740.00 = $106.35

FV = $1,200 (1 + 0.09)36 = $26,701.47

FV = $1,200 9% 36 + $1,200 = $5,088.00

Interest on interest = $26,701.47 − $5,088.00 = $21,613.47

At an interest rate of r = 11% per year, the future value of $12,000 in 4 years, FV4 , is below:

At an interest rate of r = 11% per year, the future value of $12,000 in 8 years, FV8 , is below:

At an interest rate of r = 22% per year, the future value of $12,000 in 4 years, FV4 , is below:

FVn = C (1 + r)n • 3-25

FV2 = $1,300 (1 + 0.027)2 = $1,371.15

FV1 = $600 (1 + 0.027) = $616.20

FV = $1,371.15 + $616.20 = $1,987.35

Value of the second option = $96,000 + $10,967.87 = $106,967.87

FV = $11,000 (1 + 0.13)7 = $25,879

FV = $11,000 (1 + 0.13)47 = $3,436,209

$12 $21 $30 $39 $48

$48 $39 $30 $21 $12

$95 − $95 $206 − $206

$2,130 $2,970 $3,540 $3,860

$495 $550 $825 $880

$95 − $95 $206 − $206

$2,130 $2,970 $3,540 $3,860

$495 $550 $825 $880

Cash Flow $6,500 − $1,150 − $1,150 − $1,150 − $1,150 − $1,150

Cash Flow $5,300 − $1,150 − $1,150 − $1,150 − $1,150 − $1,150

Cash Flow − $1,200 $1,150 $1,150 $1,150 $1,150 $1,150

Cash Flow − $5,300 $1,150 $1,150 $1,150 $1,150 $1,150

Cash Flow $6,500 − $1,150 − $1,150 − $1,150 − $1,150 − $1,150

Cash Flow $5,300 − $1,150 − $1,150 − $1,150 − $1,150 − $1,150

Cash Flow − $1,200 $1,150 $1,150 $1,150 $1,150 $1,150

Cash Flow − $5,300 $1,150 $1,150 $1,150 $1,150 $1,150

Cash Flow $200 $200 $200 $200 $200

Cash Flow − $200 − $200 − $200 − $200 − $200 − $200