3.

Time Value of Money_Solutions

Slide 5C-20 (Quick Quiz-Part I)

What is the difference between simple interest and compound interest?
Simple Interest
▪ Interest is earned each period only on the original principal.

Compound Interest
▪ Subsequent interest in each period is earned on the original
principal and previous interest incurred.

Suppose you have $500 to invest and you believe that you can earn 8% per year
over the next 30 years.
▪ How much would you have 15 years from now using compound interest?
$500(1 + 8%)15 = $𝟏𝟓𝟖𝟔. 𝟎𝟖

▪ How much would you have at the end of 15 years using simple interest?
$500(1 + 8% × 15) = $𝟏𝟏𝟎𝟎

3. Time Value of Money_Solutions

3. Time Value of Money_Solutions

Slide 5C-24 (Quick Quiz-Part II)

What is the relationship between present value and future value?
𝐏𝐕(𝟏 + 𝐫)𝐭 = 𝐅𝐕

Suppose you need $15,000 in 3 years. If you can earn 6% annually, how much do
you need to invest today?
FV
PV =
(1 + r)t
$15,000
PV =
(1 + 6%)3
PV = $𝟏𝟐, 𝟓𝟗𝟒. 𝟐𝟗

If you could invest the money at 8%, would you have to invest more or less than
at 6%? How much?
FV
PV =
(1 + r)t
$15,000
PV =
(1 + 8%)3
PV = $𝟏𝟏, 𝟗𝟎𝟕. 𝟒𝟖

You would have to invest less today by $12,594.29 - $11,907.48 = $686.81

given a higher interest rate.

3. Time Value of Money_Solutions

3. Time Value of Money_Solutions

Slide 5C-27 (Quick Quiz-Part III)

What are some situations in which you might want to know the implied interest
rate?
When you know the present value, future value, and the number of periods.

You are offered the following investments:

(1.) You can invest $500 today and receive $600 in 5 years. The investment is
considered low risk.
(2.) You can invest the $500 in a bank account paying 4%.
What is the implied interest rate for the first choice and which investment should
you choose?
PV(1 + r)t = FV
$500(1 + r)5 = $600
r = 𝟑. 𝟕𝟏𝟑𝟕%

You should choose the second choice as its return is higher.

3. Time Value of Money_Solutions

3. Time Value of Money_Solutions

Slide 5C-31 (Quick Quiz-Part IV)

When might you want to compute the number of periods?
When you know the present value, future value, and the interest rate.

Suppose you want to buy some new furniture for your family room. You
currently have $500, and the furniture you want costs $600. If you can earn 6%,
how long will you have to wait if you don’t add any additional money?
PV(1 + r)t = FV
$500(1 + 6%)t = $600
t = 𝟑. 𝟏𝟑

3. Time Value of Money_Solutions

3. Time Value of Money_Solutions

Slide 5C-32 (Comprehensive Problem)

You have $10,000 to invest for five years. How much additional interest will you
earn if the investment provides a 5% annual return, when compared to a 4.5%
annual return?
$10,000(1 + 5%)5 = $12,762.82
$10,000(1 + 4.5%)5 = $12,461.82

Additional interest you will earn is $12,762.82 − $12,461.82 = $𝟑𝟎𝟏

How long will it take your $10,000 to double in value if it earns 5% annually?
$10,000(1 + 5%)t = $20,000
t = 𝟏𝟒. 𝟐𝟏 𝐲𝐞𝐚𝐫𝐬

What annual rate has been earned if $1,000 grows into $4,000 in 20 years?
$1,000(1 + r)20 = $4,000
r = 𝟕. 𝟏𝟖%

3. Time Value of Money_Solutions