Kenan-Flagler Business School

The University of North Carolina

MBA 772 / MAC718
Introductory Finance

Week 1 Homework: Problem Set 1

Weekly problem sets are to be submitted in a well-organized set of calculations with

clearly visible (suggest circled) answers PRIOR TO your synchronous session. You may
submit in Excel, Word, PDF, hand-written or typed. Homework may be done in groups up
to no more than 4 students, but assignments must be individually submitted and a student’s
own work (i.e. you cannot simply copy group work). If you work in a group, all students
names must be identified on your submission file.

1. Download the spreadsheet labeled Wk1 HW Prob 1 posted with this

homework file in the LMS. There are three columns of data: a monthly date, a
closing price for an individual stock, and the market close. Note: this
information is readily available for publicly traded securities from sources like
Yahoo Finance.

a. Calculate a monthly return series from the closing monthly prices of both
the market and the individual security.
b. Calculate the arithmetic mean return and the standard deviation of the
monthly return for both series.
c. Calculate the geometric mean return for both series.
d. What's your best estimate of a single month's return for the stock next
month?
e. If you invested $1,000 in the individual stock at the beginning, what
would your investment be worth by the end? (assume you are allowed to
buy a fraction of a stock)
f. How does this compare to your estimate from d) compounded?
2. You are considering various retirement plans. Your goal is to have a lump sum
of $3,000,000 available (‘in the bank’) when you retire at age 67.

a. The various plans, with their payment schedules, are listed below. In each
case, calculate the payment(s) that must be made into the plan to ensure that you
have the $3,000,000 available. For each plan, you may assume that your
opportunity cost of funds is 6% per year; for each plan, you may assume that the
phrase “at age XX” means the same thing as “on your XX’th birthday”.

Plan 1: Single lump sum at age 25

Plan 2: Single lump sum at age 50
Plan 3: Equal annual payments, commencing at age 31 and ending at age 67
Plan 4: Equal annual payments, commencing at age 51 and ending at age 67
Plan 5: Equal annual panicky payments, commencing at age 60 and ending at
age 67

b. You are trying to decide if $3,000,000 is enough for your retirement

comfort. Assume your first withdrawal occurs 1 year after you reach your
goal of $3,000,000 and that you will withdraw all of your savings by the
end.

What annual withdrawal will you be able to make if you think you'll live
until the following ages: Age 77, Age 87, Age 97
3. You have just taken out a mortgage for $575,000, at a fixed rate of 4.75% per
year, compounded monthly (i.e. 0.3958% per month), and a term of 30 years.

a) Calculate the monthly payments

b) For the first six months’ payments, calculate the portion that is interest and
the portion that is principal. From the total payment in a, how much goes
towards interest in the sixth payment?
c) For the first six months’ payments, calculate the portion that is interest and
the portion that is principal. From the total payment in a, how much goes
towards principal in the sixth payment?
d) Immediately after the sixth payment, what is the balance remaining on the
mortgage?
4. A recent graduate of the university has gotten into a little more credit card debt
than they had anticipated. They currently owes $22,000; the credit card
company charges 1.5% per month on this debt.

a) If they wish to pay off this credit card bill in 5 years of equal monthly
installments, promises to make the first payment next month and not use the
credit card again, what monthly payments must they make? You may
assume that there are no additional fees or charges related to the card, and
that the credit card interest rate is not expected to change.

b) The graduate’s parents hear of this plight. They offer to extend a loan to
pay off the debt, with the interest rate charged equal to .6667% per month.
The student wishes to know the incremental value of this new borrowing
opportunity (relative to the credit card debt) today (so that he can go
shopping.) That is, how much they can spend today and still have the same
monthly payments as in part a). What can they spend on today’s shopping
trip?
5. You are saving for your child’s college education. Your child will start college
in 16 years, and college tuition is due at the beginning of the year (i.e., the first
tuition payment will occur at t=16). Average college tuition at a private school
this year is $38,500 per year.

Scenario 1: Optimistic - tuition charges grow at the general inflation rate of

2.4266% per year.

a) Create a timeline that shows each of the four years’ worth of tuition
b) Calculate the present value, at t=16, of these payments if you assume that
your opportunity cost of funds is 0.5% per month which compounds to
6.1678% per year.
c) Calculate the single payment you must make into the child’s college account
to pay for the entire college experience, if you make the payment now.
d) Calculate the monthly payment you must make into your child’s college
account to pay for four years of college; you may assume that the first
payment into the college account comes in one month’s time and the last
payment will come one month prior to the first college tuition payment.

Scenario 2: Pessimistic - tuition charges grow at the recent education inflation

rate of 6.5911% per year.

Repeat the steps above with the pessimistic rate. If you have set up your
approach well you can use your previous work (sometimes easiest to copy the
entire tab you worked on) to just change the one assumption.

Better start saving!!

6. You have been offered the following opportunity: receive a tax ‘forbearance’ credit
of $10,000 today. (For example, instead of paying your $50,000 tax bill, you can pay
$40,000) In return, you must make higher tax payments of $1,000 per year for the
next 15 years. The first of the annual payments will come in one year’s time.
If you think of this like a loan (you have more $ now than you would otherwise, but
have to make future payments instead), what is the annual rate of return you are
paying?