FIN2001 – Financial Management Problem Set 5

Name: ___________________________________

Please make sure to SHOW your work and answer all parts of each question.

1. Joey has finally landed a lead on the famous sitcom, Days of our Lives! The role comes with
a $72,000 signing bonus. He is determined to be financially responsible and invest the
amount in a new savings account. As a new customer, with high prospects, the bank has
offered him an 8.35% interest compounded annually on his investments. Answer the
following questions using the appropriate time value of money formula.

a. How much money will Joey have in his account if he invests his money for 1 year?

b. How much money will Joey have in his account if he invests his money for 2
years?

c. How much money will Joey have in his account if he invests his money for 5
years?

d. How much money will Joey have in his account if he invests his money for 10
years?

e. What can we expect for Joey’s investment as the amount of years he invests his
money for increases? Explain why in 1-3 sentences.

2. Monica wants to open her own restaurant. She estimates that she will need $137,000 to
start (this amount will not change independently of when she opens the restaurant).
Monica can earn 6.65% interest on her investments. Use the appropriate time value of
money formula to answer the questions below.

a. How much money will Monica have to invest now if she wants to start her
restaurant in 1 year?

b. How much money will Monica have to invest now if she wants to start her
restaurant in 2 years?

c. How much money will Monica have to invest now if she wants to start her
restaurant in 5 years?

d. How much money will Monica have to invest now if she wants to start her
restaurant in 10 years?
FIN2001 – Financial Management Problem Set 5

e. What can we conclude about Monica’s investment if she decides to wait more
and more years? Explain why in 1-3 sentences.

3. Phoebe, a struggling musician, slipped and fell as she walked into her favorite coffeehouse -
Central Perk. Not only did Phoebe hurt her back, she also broke her guitar. Central Perk’s
manager would like to compensate Phoebe for her accident. The coffeehouse has given
Phoebe three options.

- Option 1: She can receive 5,000 today

- Option 2: She can receive $7,500 in five years
- Option 3: She can receive $10,000 in ten years

Phoebe has become friends with the bank manager, and she can earn 8.95% on her
investments (compounded annually). Luckily, she has enough money in her savings account
to fix her guitar and check her back. As she does not particularly need the money yet, she
would like to choose the option with the highest value.

a. Phoebe’s fortune teller insists that Phoebe should take the $10,000 because
it is the highest amount of money. Would you agree with the fortune teller?
Why or why not? Explain in 2-3 sentences.

b. What option should Phoebe take? Explain why. Show your work.

4. Five years ago, Rachel’s father gave her $2.25 million as part of her inheritance. However,
instead of providing her with the cash, her father decided to open a certificate of deposit
(savings account) earning 7.45% interest compounded annually. Based on the amount of
money invested and her 7.45% interest rate, Rachel calculated how much money she should
have now, using simple interest. Rachel’s friend, Chandler, insists that her calculations are
wrong because she is not accounting for compound interest.

a. Explain what compound interest means in 1-2 sentences

b. Show Rachel the difference between a $2.25 million investment earning simple
7.45% interest and a $2.25 million investment earning 7.45% compounded
interest by building a table like the one below.
FIN2001 – Financial Management Problem Set 5

c. Calculate total simple interest, total compounded interest and total interest
earned (the sum of the corresponding columns in the table above). How much
more did Rachel earn by having her interest compounded annually?

5. Ross would like to pursue a PhD program in Paleontology, and he estimates that he will
need $73,500 to begin. Assume that the cost of the program will remain the same
regardless of when Ross starts the program.

a. If Ross invests $50,000 at an interest rate of 6.15%, will he have enough to start
his PHD program in 5 years? Answer in complete sentences and show your
calculations.

b. If Ross can earn 6.15% on his investments and he saves $50,000 today, how long
will he have to wait until he can start the program? Answer in complete
sentences and keep 2 decimal places (0.00).

c. If Ross wants to start the program in five years how much would he have to save
today if he can earn a 6.15% interest rate?

d. What interest rate would Ross have to earn if he wants to start the program in 5
years, but only has $50,000 to invest? Express your answer in percentage terms
and keep 2 decimal places (0.00%).