FIN2212E Financial Management

TUTORIAL
CHAPTER: TIME VALUE OF MONEY

1. Calculate the value in five years of $1,000 deposited in a savings account today if the
account pays interest at a rate of:

(a) 8% per year, compounded annually. [Answer = $1,469.33]

(b) 8% per year compounded quarterly. [Answer = $1,485.95]

2. Easton Bank gives 6% annual interest, compounded monthly, on its savings deposits.
Suppose you deposit $100 on the first of every month in the bank, how long will it take you
to accumulate $10,000? [Answer = 81 months]

3. Suppose you are a property owner and you are collecting rent for an apartment. The tenant
has signed a one-year lease with $600 a month rent, payable in advance. Find the present
value of the lease contract if the discount rate is 12% per year. [Answer = $6,820.58]

4. Strikler Inc. has issued a $10 million, 10-year bond issue. The bonds require Strikler to
establish a sinking fund and make 10 equal, end-of-year deposits into the fund. These
deposits will earn 8% annually, and the sinking fund should have enough accumulated in it
at the end of 10 years to retire the bonds. What are the annual sinking fund payments?
[Answer = $1,490,294.89]

5. You deposit $4,500 per year at the end of each of the next 25 years into an account that
pays 10% compounded annually. How much could you withdraw at the end of each of the
20 years following your last deposit? [Answer = $257,737.50]

6. If you receive $1,000 one year from now, calculate the value of that $1,000 if the opportunity
cost (discount rate) is 6%. [Answer = $1,060]

7. A business is considering purchasing a machine that is projected to yield cash savings of

$1,000 per year over a 10-year period. Using a 12% discount rate, calculate the present
value of the savings. (Assume that the cash savings occur at the end of each year.)
[Answer = $5,650.22]

8. A downtown bank is advertising that if you deposit $1,000 with them, and leave it there for
65 months, you can get $2,000 back at the end of this period. Assuming monthly
compounding, what is the monthly rate of interest paid by the bank? [Answer = 1.07%]

9. Yolanda is 35 years old today and is beginning to plan for her retirement. She wants to set
aside an equal amount at the end of each of the next 25 years so that she can retire at age
60. She expects to live to an age of 80 and wants to be able to withdraw $50,000 per year
from the account on her 61st through 80th birthdays. The account is expected to earn 10%
per year for the entire period of time. Compute the size of the annual deposits that she must
make. [Answer = $4,328.37]

10. Your parents bought a house for $160,000. They paid 20% down payment and agreed to
pay the balance in 20 equal annual installments at the end of each year. Calculate the equal
installments if the annual interest rate is 8%. [Answer = $13,037.08]
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11. Your mother is planning to retire this year. Her firm has offered her a lump-sum retirement
payment of $50,000 or a $6,000 lifetime annuity-whichever she chooses. Your mother is in
reasonably good health and expects to live for at least 15 more years. Which option should
she choose, assuming that an 8% interest rate is appropriate to evaluate the annuity?

12. You are planning to save for retirement over the next 30 years. To do this, you will invest
$700 a month in a stock account and $300 a month in a bond account. The return of the
stock account is expected to be 11%, and the bond account will pay 6%. When you retire,
you will combine your money into an account with a 9% return. [Answer = $1,368.16]

13. A client has a $5 million portfolio and invests 5 percent of it in a money market fund
projected to earn 3 percent annually. Estimate the value of this portion of his portfolio after
seven years. [Answer = $307,468.47]

14. For liquidity purposes, a client keeps $100,000 in a bank account. The bank quotes a stated
annual interest rate of 7 percent. The bank’s service representative explains that the stated
rate is the rate one would earn if one were to cash out rather than invest the interest
payments. How much will your client have in his account at the end of one year, assuming
no additions or withdrawals, using the following types of compounding? 

(a) Quarterly. [Answer = $107,185.90]

(b) Monthly. [Answer = $107,229.01]

(c) Annually. [Answer = $107,000]

15. A bank pays a stated annual interest rate of 8 percent. What is the effective annual rate
using the following types of compounding?

(a) Quarterly [Answer = 8.24%]

(b) Monthly [Answer = 8.30%]

(c) Weekly [Answer = 8.32%]

16. At retirement, a client has two payment options: a 20-year annuity at $50,000 per year
starting after one year or a lump sum of $500,000 today. If the client’s required rate of return
on retirement fund investments is 6 percent per year, which plan has the higher present
value and by how much?

17. Suppose you plan to send your daughter to college in three years. You expect her to earn
two-thirds of her tuition payment in scholarship money, so you estimate that your payments
will be $10,000 a year for four years. To estimate whether you have set aside enough
money, you ignore possible inflation in tuition payments and assume that you can earn 8
percent annually on your investments. How much should you set aside now to cover these
payments. [Answer = $28,396.15]
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18. A client plans to send a child to college for 4 years starting 18 years from now. Having set
aside money for tuition, she decides to plan for room and board also. She estimates these
costs at $20,000 per year, payable at the beginning of each year, by the time her child goes
to college. If she starts next year and makes 17 payments into a savings account paying 5
percent annually, what annual payments must she make? [Answer = $2,744.50]

19. Mr. Smith is planning his retirement. He has decided that he needs to withdraw $12,000 per
year from his bank account to supplement his other income from Social Security and a
private pension plan. How much money should he plan to have in the bank at the start of his
retirement, if the bank pays 10% per year, compounded annually, and if he wants money to
last for a 12-year retirement period? [Answer = $81, 764.30]

20. Suppose you are in the market for a new car worth $18,000. You are offered a deal to make
a $1,800 down payment now and to pay the balance in equal end-of-month payments of
$421.85 over a 48-month period.

Instead of going through a dealer’s financing, you want to make a down payment of $1,800
and take out an auto loan from a bank at 11.75% compounded monthly. What would be your
monthly payment to pay off the loan in four years? [Answer = $424.62]

21. Ms. Brown deposits $750 in a savings account at the beginning of each year for the next 10
years. If the bank pays 7% per year, compounded annually, how much money will Ms.
Brown have accumulated by the end of the 10th year? [Answer = $11,087.70]

22. Ms Tan Er will pay out $6,000 at the end of Year 2, $8,000 at the end of Year 3 and receive
$10,000 at the end of Year 4. With interest rate of 13 percent, what is the net value of the
payments vs receipts in today’s dollar? [Answer = -$4110.09]

23. On the day his son was born, a father decided to establish s fund for his son’s college
education. The father wants the son to be able to withdraw $4,000 on his 18th to 21st
birthdays. If the fund earns interest at 9% per year, compounded annually, how much should
the father deposit at the end of each year, up through the 17th year? [Answer = $350.49]

24. Dr. J. wants to buy a Dell computer which will cost $2,788 four years from today. He would
like to set aside an equal amount at the end of each year in order to accumulate the amount
needed. He can earn 7% annual return. How much should he set aside? [Answer =
$627.93]

25. You are buying a home for $250,000. If you make a down payment of $50,000 and take out
a mortgage on the rest of the money at 8.5% compounded monthly, what will be your
monthly payment to retire the mortgage in 15 years? [Answer = $1,969.50]

26. John borrowed money from a bank to finance a house. The bank’s term allowed him to defer
payments (including interest) on the loan for four months and to make 36 equal end-of-
month payments thereafter. The original loan was $216,000, with an interest rate of 12%
compounded monthly. After 21 monthly payments, John found himself in a financial bind
and went to a loan company for assistance in lowering his monthly payments. Fortunately,
the loan company offered to pay his debts in one lump sum if he would pay the company
 FIN2212E Financial Management

$7,285 per month for the next 36 months. What monthly interest rate is the loan company
charging on this transaction? [Answer = 6.24%]