Chapter 2.

The time value of money

CHAPTER 2. THE TIME VALUE OF MONEY

1. An investor deposits $10,000. Ten years later it is worth $17,910. What rate of return did the
investor earn on the investment?

2. Find the value of $10,000 today at the end of 10 periods at 5% per period.

3. Find the present value of $10,000 to be received at the end of 10 periods at 8% per period.

4. Question: Today your stock is worth $50,000. You invested $5,000 in the stock 18 years ago.
What average annual rate of return [i] did you earn on your investment?

5. You invest $10,000. During the first year the investment earned 20% for the year. During the
second year, you earned only 4% for that year. How much is your original deposit worth at the
end of the two years?

6. How much must you deposit today in a bank account paying interest compounded quarterly

A. if you wish to have $10,000 at the end of 3 months, if the bank pays 5.0% APR?

B. if you wish to have $50,000 at the end of 24months, if the bank pays 8.0%APR?

7. What rate of interest [APR] is the bank charging you

A. if you borrow $77,650 and must repay $80,000 at the end of 2 quarters, if interest is
compounded quarterly?

B. if you borrow $49,000 and must repay $50,000 at the end of 3 months, if interest is
compounded monthly?

8. Suppose you make an investment of $10,000. This first year the investment returns 15%, the
second year it returns 2%, and the third year in returns 10%. How much would this investment
be worth at the end of three years, assuming no withdrawals are made?

9. What is the present value/future value of a 4-year annuity, if the annual interest is 5%, and the
annual payment is $1,000?

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10. You borrow $60,000 and repay in 8 equal annual installments of $12,935 with the first payment
made exactly 1 year later. To the nearest percent, what rate of interest are you paying on your
loan?

11. An investment of $3000 per quarter for 6 years at annual interest rate of 8%, compounded
quarterly, will accumulate by the end of year 6 to:

12. You borrow $80,000 to be repaid in equal monthly installments for 30 years. The APR is 9%.
What is the monthly payment?

13. You make equal $400 monthly payments on a loan. The interest rate equals 15% APR,
compounded monthly. The loan is for 12 years. What is the amount of the loan?

14. Retire with a million: How much would must you deposit monthly in an account paying 6% a
year [APR], compounded monthly, to accumulate $1,000,000 by age 65 beginning at age 30?

15. Someone promises to pay you $1,000,000 every year for the next 15 years. The first payment
will be one year from today. The relevant effective annual interest rate is 7.0%. What is the
value of this promises?

16. What is the present value of $5,000 to be received at the end of every year in perpetuity if the
relevant annual effective interest rate is 5%?

17. You plan to borrow $389,000 now and repay it in 25 equal annual installments (payments will
be made at the end of each year). If the annual interest rate is 14%, how much will your annual
payments be?

18. You are told that if you invest $11,000 per year for 23 years (all payments made at the end of
each year) you will have accumulated $366,000 at the end of the period. What annual rate of
return is the investment offering?

19. You are offered an annuity that will pay $17,000 per year for 7 years (the first payment will be
made today). If you feel that the appropriate discount rate is 11%, what is the annuity worth to
you today?

20. You plan to buy a car that has a total "drive-out" cost of $25,700. You will make a down
payment of $3,598. The remainder of the car’s cost will be financed over a period of 5 years.
You will repay the loan by making equal monthly payments. Your quoted annual interest rate is

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8% with monthly compounding of interest. (The first payment will be due one month after the
purchase date.) What will your monthly payment be?

21. You are considering leasing a car. You notice an ad that says you can lease the car you want for
$477.00 per month. The lease term is 60 months with the first payment due at inception of the
lease. You must also make an additional down payment of $2,370. The ad also says that the
residual value of the vehicle is $20,430. After much research, you have concluded that you
could buy the car for a total "driveout" price of $33,800. What is the quoted annual interest rate
you will pay with the lease?

22. You are valuing an investment that will pay you $12,000 the first year, $14,000 the second
year, $17,000 the third year, $19,000 the fourth year, $23,000 the fifth year, and $29,000 the
sixth year (all payments are at the end of each year).

a. What is the value of the investment to you now if the appropriate annual discount rate is 11.00%?

b. What is the value of the investment in next 6 years if the appropriate annual discount rate is
11.00%?

c. What is the value of the investment in next 10 years if the appropriate annual discount rate is
11.00%?

23. You are valuing an investment that will pay you $27,000 per year for the first ten years,
$35,000 per year for the next ten years, and $48,000 per year the following ten years (all
payments are at the end of each year). If the appropriate annual discount rate is 9.00%, what is
the value of the investment to you today?

24. Mathew Jones plans to pay for his son’s college education for 4 years starting 8 years from
today. He estimates the annual tuition cost at $40,000 per year, when his son starts college. The
tuition fees are payable at the beginning of each year. How much money must Jones invest
every year, starting one year from today, for the next seven years? Assume the investment
earns 10 percent annually.

25. You have just won the Georgia Lottery with a jackpot of $40,000,000. Your winnings will be
paid to you in 26 equal annual installments with the first payment made immediately. If you
feel the appropriate annual discount rate is 8%, what is the present value of the stream of
payments you will receive?

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26. You are planning for retirement 34 years from now. You plan to invest $4,200 per year for the
first 7 years, $6,900 per year for the next 11 years, and $14,500 per year for the following 16
years (assume all cash flows occur at the end of each year). If you believe you will earn an
effective annual rate of return of 9.7%, what will your retirement investment be worth 34 years
from now?

27. You plan to retire 33 years from now. You expect that you will live 27 years after retiring. You
want to have enough money upon reaching retirement age to withdraw $180,000 from the
account at the beginning of each year you expect to live, and yet still have $2,500,000 left in
the account at the time of your expected death (60 years from now). You plan to accumulate
the retirement fund by making equal annual deposits at the end of each year for the next 33
years. You expect that you will be able to earn 12% per year on your deposits. However, you
only expect to earn 6% per year on your investment after you retire since you will choose to
place the money in less risky investments. What equal annual deposits must you make each
year to reach your retirement goal?

Note: doc I &II