Tutorial 5

1. Why does money have a time value? Does inflation have anything to do with making a
dollar today worth more than a dollar tomorrow?

Solution:
Money has a time value because funds received today can be reinvested to reach a greater
value in the future. A person would rather receive $1 today than $1 in ten years, because a
dollar received today, invested at 6 percent, is worth $1.791 after ten years.
Inflation makes a dollar today worth more than a dollar in the future. Because inflation tends
to erode the purchasing power of money, funds received today will be worth more than the
same amount received in the future.
2. You invest $3,000 for three years at 12 percent.

a. What is the value of your investment after one year? Multiply $3,000 × 1.12.
b. What is the value of your investment after two years? Multiply your answer to
part a by 1.12.
c. What is the value of your investment after three years? Multiply your answer to
part b by 1.12. This gives your final answer.

d. Combine these three steps by using the formula to find the

future value of $3,000 in 3 years at 12 percent interest.
4-1. Solution:
a.

b.

c.

d.

Calculator Solution:
(d)
N I/Y PV PMT FV
3 12 3,000 0 CPT FV  −4,214.78
  
Answer: $4,214.78

Solution using TVM Tables:

a. $3,000 × 1.12 = $3,360.00

b. $3,360 × 1.12 = $3,763.20
c. $3,763.20 × 1.12 = $4,214.78
d. $3,000 × 1.405 = $4,215.00 (Appendix A)
3. You wish to make a substantial down payment on a lake cottage and you currently have
$18,325 invested at an annual rate of 4.75%. How much money will be in the account in 2.5
years if it continues to earn at its present rate?
A) $18,325
B) $19,464
C) $20,579
D) $20,605

Answer: C
Explanation: C) FV = PV ∗ (1 + r)n = $18,325 ∗ (1.0475)2.5 = $20,579

4. The current price on a 60-inch flat panel LCD HD television is $2,300. Big screen HD
television prices have dropped at an average rate of 9% per year in recent years. If you expect
this trend to continue, how much will this style of television cost in three years?
A) $2,979
B) $2,300
C) $1,958
D) $1,733

Answer: D
Explanation: D) Expected future value of television = $2,300 ∗ (1 - 0.09)3 = $1,733.21

5. You have purchased a Treasury bond that will pay $10,000 to your newborn child in 15
years. If this bond is discounted at a rate of 3.875% per year, what is today's price (present
value) for this bond?
A) $8,417
B) $8,500
C) $5,654
D) $10,000
Answer: C

Explanation: C) PV = = = $5,654
6. Your parents plan to spend $20,000 on a car for you upon graduation from college. If you
will graduate in three years and your parents can earn 4.125% annually on their investment,
how much money must they set aside today for your car?
A) $20,000
B) $17,704
C) $17,716
D) $16,387

Answer: C

Explanation: C) PV = = = $17,715.97
7. Dividend growth rate is important to many investors. You are considering investing in a
firm after looking at the firm's dividends over a seven-year period. At the end of the year
2002, the firm paid a dividend of $1.15. At year-end 2009, it paid a dividend of $1.84. What
was the average annual growth rate of dividends for this firm?
A) 7.25%
B) 9.86%
C) 6.94%
D) There is not enough information to answer this question.

Answer: C
Explanation: C) r = (FV/PV)1/n - 1 = ($1.84/$1.15)1/7 - 1 = 6.94%
MODE = END
8. Upon taking his first job out of college, your Dad earned an annual salary of $38,000 and
set a goal to earn $100,000 per year. If his salary increased at an average annual rate of 12%,
how long did it take to reach his goal?
A) At that rate of growth, your Dad still has not earned $100,000 in a single year.
B) 2.63 years
C) 26.31 years
D) 8.54 years

Answer: D

Explanation: D) n = = = 8.54 years

9. Kelvin has $2,500 but needs $5,000 to purchase a new golf cart. If he can invest his money
at a rate of 12% per year, approximately how many years will it take the money in Kelvin's
account to grow to $5,000? Use the Rule of 72 to determine your answer.
Note: The golf cart's price may have changed by the time Kelvin's account reaches a value of
$5,000.
A) 2 years
B) 4 years
C) 6 years
D) 8 years

Answer: C

Explanation: C) = 6 years via the Rule of 72.

10. Lesley will receive RM12,000 a year for the next 15 years as a result of her patent. If a 9
percent rate is applied, should she be willing to sell out her future rights now for RM100,000?
 Answer:
PVA = A x PVIFA (9%, 15 periods)
= RM12,000 x 8.061 = RM96,732
Yes, the present value of the annuity is worth less than RM100,000

PVIFA=PMT*((1-(1/(1+i)^n)/i)

PMT=12,000 ; n=15; i=9%p.a

12,000*((1-(1/(1+0.09)^15)/0.09) = RM96,728.26
11. (a) Air Atlantic (AA) has been offered a 3-year old jet airliner under a 12-year lease
(RENT) arrangement. The lease requires AA to make annual lease payments of
RM500,000 (PMT) at the beginning of each of the next 12 years(ANNUITY DUE).
Determine the present value of the lease payments if the opportunity cost of funds is 14
percent (i).

(b) Your firm, New Sunrise, has just leased a RM28,000 BMW for you. The lease requires
six beginning of the year payments that will fully amortize the cost of the car. What is the
amount of the payments if the interest rate is 12 percent?
Answer:
(a) PV = PMT [PVIFAi,n(1+i)] ; n = 12; i = 0.14; PMT = RM500,000
= RM500,000[5.660(1+.14)] = RM3,226,200
PMT= RM500,000 ; i=14%; n= 12years

OR

PVIFA=PMT*((1-(1/(1+i)^n)/i)*(1+i)
= 500,000*((1-(1/(1+0.14)^12)/0.14)*(1+0.14) = 3,226,366.51

(b) PMT = RM28,000 / (4.111)(1.12) = RM6,081.25

OR

PMT = PVIFA/PVIF = RM 28,000 / ((1-(1/(1+0.12)^6)/0.12)*(1+0.12) = 6,080.64

12. You plan to retire in exactly 20 years. Your goal is to create a fund that will allow you to
receive RM20,000 at the end of each year for 30 years. You know that you will be able to
earn 11 percent per year during the 30-year retirement period.
a. How large a fund will you need when you retire in 20 years to provide the 30-years,
RM20,000 retirement annuity?

b. How much will you need today as a single amount to provide the fund calculated in part (i)
if you earn 9 percent per year during the 20 years preceding retirement?

c. What effect would an increase in the rate you earn both during and prior to retirement have
on the vales found in parts (i) and (ii)? Explain.

Answer:
a. PVA = PMT x (PVIFA11%,30)
PVA = RM20,000 x (8.694)
PVA = RM173,880.00
Calculator solution: RM173,875.85

b. PV = FV x (PVIF9%,20)
PV = RM173,880 x (0.178)
PV = RM30,950.64
Calculator solution: RM31,024.82

OR

0-------------20--------------50
a.
b.
N= 30 years during retirement
PMT= RM 20,000
PVIFA= PMT*((1-(1/(1+i)^n)/i)
20,000*((1-(1/(1+0.11)^30)/0.11) = RM 173,875.85
PV=FV/(1+i)^n = RM 173,875.85/ (1+0.09)^20 = RM 31,024.82

c. Both values would be lower. In other words, a smaller sum would be needed in 20 years
for the annuity and a smaller amount would have to be put away today

13) Calculate the future value of an annuity of $5,000 each year for eight years, deposited at
6 percent.

Answer:

FV = CF[(1 + r)n - 1] / r = $5,000[(1.06)8 - 1] / 0.06 = $49,487.34

FVIFA= PMT*((1+i)^n-1)/i)= 5000*(((1+0.06)^8)-1)/0.06) = $49,487.34

If the compounding is semi-annual.

FVA= n= 8*2= 16 ; i=6%/2= 0.03

FVa= 5000[ ((1+0.03)^16 -1)/ 0.03) ]= 100,784.40

14) Calculate the present value of an annuity of $3,900 each year for four years, assuming an
opportunity cost of 10 percent.

Answer:

PV = (3,900/0.1)[1-(1/(1.1)4)] = $12,363

OR
PVIFA= PMT*((1-(1/(1+i)^n)/i)
3,900*((1-(1/(1+0.10)^4)/0.10) = RM 12,362.48

15) Dottie has decided to set up an account that will pay her granddaughter (Lexi) $5,000 a
year indefinitely. How much should Dottie deposit in an account paying 8 percent annual
interest?
Answer:

PV= PMT/r

PV = 5,000/0.08 = $62,500

16) Nico establishes a seven-year, 8 percent loan with a bank requiring annual end-of-year
payments of $960.43. Calculate the original principal amount.

Answer:

PVA = (960.43/0.08)[1-(1/(1.08)7)] = $5,000

OR
PVIFA= PMT*((1-(1/(1+i)^n)/i)
960.43*((1-(1/(1+0.08)^7)/0.08) = $5,000.35

17) A lottery administrator has just completed the state's most recent $50 million lottery.
Receipts from lottery sales were $50 million and the payout will be $5 million at the end of
each year for 10 years. The expenses of running the lottery were $800,000. The state can
earn an annual compound rate of 8 percent on any funds invested.
(a) Calculate the gross profit to the state from this lottery.
(b) Calculate the net profit to the state from this lottery (no taxes).
0----1-----2----3----4---^^^---10
5m 5m 5m 5m 5m

50m

PVIFA= PMT*((1-(1/(1+i)^n)/i)
5,000,000*((1-(1/(1+0.08)^10)/0.08) = $ 33,550,406.99

Answer:

16,449,593
15,649,593

18) Aunt Tillie has deposited $33,000 today in an account which will earn 10 percent
annually. She plans to leave the funds in this account for seven years earning interest. If the
goal of this deposit is to cover a future obligation of $65,000, what recommendation would
you make to Aunt Tillie?

Answer:

0--------------7 ; i=10%
33,000 65,000(want)

FV = 33,000(1.1)7 = $64,308

Aunt Tillie will only have $64,308 at the end of seven years under the stated arrangement.

What recommendation?

She must find an account with a higher interest rate or deposit a larger sum today.
The amount Aunt Tillie should invest today to receive $65,000 after 7 years,

PV = 65,000 / (1.1)7 = $33,355.28