Homework 2

1. A certain investment produces cash flows of $4,350 a year for 15 years. The first cash flow
occurs one year from now. The required rate of return is 6% per annum, what is the value
of this investment? If this type of cash flow continues for 40 years to come, what is the
value of this investment? If it continues for 75 years, what is the value of this investment?
If it lasts forever, what is the value of this investment? (Exercise 4)

For one year from now, the invest could be known with the formula of present value of a
C
single cash flow, which is PV =
1+r
So PV= 4350/1.06 = 4103.77

But in order to the know the invest of 15 years we must use the formula of present value

[ ]
1
1−
of annuity which is ( 1+r )t
PV =C
r

The value of investment then is

[ ]
1
1−
PV =4350
1.06 15
0.06
=4350 [
0.582734939264459
0.06 ]
=4350 [ 9.71224898774099 ] =42,248.28

Following the same formula we can calculate the present value of 40 years.

[ ]
1
1−
PV =4350
1.06 40
0.06
= 4350 [
0.902777 812291494
0.06 ]
= 4350 [ 15.0462968 715249 ] =65,451.39

For 75 years we use the same formula.

[ ]
1
1−
PV =4350
1.06 75
0.06
=4350 [
0. 987350 886044411
0.06 ]
=4350 [ 16.45584810074018 ] =71,582.9 4

But if it lasts forever, the formula would be the preset value with perpetuity, which is

c
PV =
r
 4350
Then PV = =72,500.00
0.06

2. Assume the interest rate per annum of 5.1%. You are going to save $41,000 in order to
get a fixed amount of money per year for 15 years. How much are you supposed to get
every year? (Exercise 6).

In order to know the answer, we need to know the formula. The future formula can help

us. FV =C
[ ( 1+r )t −1
r ]
This way we can say. 41000=C
[ ( 1.051 )15−1
0.051 ]
41000=C
[ 1.108825966017043
0.051 ]
41000=C [ 21.74168560817732 ]
41000
C=
21.74168560817732
C=1,885.79
3. You wish to save $60,000 in 12 years in your savings account by saving up the same
amount of money every year. The saving account pays 6.4% per annum. How much
should you save every year? (Exercise 8).

The future formula can help us. FV =C

[ ( 1+r )t −1
r ]
This way we can say. 60,000=C
[ ( 1.0 64 )1 2−1
0.0 64 ]
60 000=C
[ 1.10 5229928864213
0.0 64 ]
60 000=C [ 17.26 921763850333 ]

60 000
C=
17.26921763850333
C=3 , 474.39

4. Maybe Pay Life Insurance Co. is trying to sell an investment security to pay you or your
heirs $35,000 every year permanently. If the required rate of interest is 4.7% per annum,
how much are you willing to pay for the investment security? (Exercise 10).

For this part we need the formula of perpetuity.

 c 35000
PV = = =744,680.85
r 0.047

5. Assume the price of the investment security in Q. 4 is $800,000. In order for this trade to
be fair, what should be the required rate of return? (Exercise 11).

We need to substitute the values in the perpetuity formula in order to get the rate.

C
PV =
R
35,000
800,000=
r
800,000 ( r ) =35,000
35,000
R=
800,000

R=0.04375=4.375 %