You are on page 1of 6

D-l6 aBpendix D Time Value of Money

Lfsing Financsn'E *ai*uEat*=r=


Use a financial calculator
to solve time value of
money problems.
lllustration D-25
Financial calculator keys
lllustration D-26
Calculator solution for
present value of a single
sum
Business professionals, once they have mastered the underlying concepts in
sections 1 and 2, often use a financial calculator to solve time value of money
problems. In many cases, they must use calculators if interest rates or time
periods do not correspond with the information provided in the compound
interest tables.
To use financial calculators, you enter the time value of money variables into
the calculator. Illustration D-25 shows the five most common keys used to solve
time value of money problems.l
where:
N
:
number of periods
I
:
interest rate per period (some calculators use VYR or i)
PV
:
present value (occurs at the beginning of the first period)
PMT
:
payment (all payments are equal, and none are skipped)
FV
:
future value (occurs at the end of the last period)
In solving time value of money problems in this appendix, you will gener-
ally be given three of four variables and will have to solve for the remaining vari-
able. The fifth key (the key not used) is given a value of zero to ensure that this
variable is not used in the computation.
Present Value of a Single Sum
To illustrate how to solve a present value problem using a financial calculatoL
assume that you want to know the present value of
$84,253
to be received in
five years, diicounted at llo/o compounded annually. Illustration D-26 depicts
this problem.
2On
many calculators, these keys are actual buttons on the face of the calculator; on others, they
appear on the display after the user accesses a present value menu.
lnputs: 5 11 ? 0 84,253
ffiffiffiffiry
Answer:
*50,000
ryryryffiltre
ru
.E
;
Present Value of an AnnuitY D'17
Illustration
D-26 shows you the information
(inputs) to enter into the calculator:
N
:
5, I
:
il,
pMT :
b, and FV
:
84,253. You then press PV for the answer:
-5so,ooo.
As indicated, the PMT key was given a value of zero because a series
of pal,.nnents did not occur in this probiem'
pg-tJs
A*\$s nfififr*6"is
The use of plus and minus signs in time value of money problems with a finan-
cial calculaior can be confusirg. Most financial calculators are programmed so
that the positive and negative cash flows in any problem offset each other' In
tfr" pr"r"rrt value probl"ir ubou", we identified the $84,253
future value initial
irr,restment
as a positive
(inflow); the answer
-$50,000
was shown as a negative
amount, reflecting a cash outflow. If the 84,253 were entered as a negative, then
the final answer would have been reported as a positive 50,000.
Hopefull5,,thesignconventionwillnotcauseconfusion.Ifyouunderstand
what is required in a-problem,
you should be able to interpret a positive or neg-
ative amount in determining
the solution to a problem'
ffisMp##ruffiBruffi
pffiffism#s
In the problem above, we assumed that compounding occurs once a
year' Some
financial calculators iru.r" u default setting, which assumes that compounding
occurs 12 times ayear. You must determine what default period has been pro-
grammed into your calculator and change it as necessary to arrive at the proper
compounding Period.
RSq.iNWEruffi
Most financial calculators
store and calculate using 12 decimal places' As a
result, because .o*forrnd interest tables generally have factors only up to five
a".i*.f
places, a ,tig1tt difference in the final answer can result' In most time
value of money proil.-r, the final answer will not include more than two
decimal
places.
Fresent
Value of an Annuity
To illustrate how to solve a present value of an annuify problem using a finan-
cial calculator, assume that ytu are asked to determine the present value of rental
receipts of $6,000
each to be received at the end of each of the next five vears,
*h"n dir"ounted
at 1'2o/o, as pictured in IllustrationD-27'
,j
I
1
il
I
J
ii
:i
I
:i
i
:l
;i
i!
:l
il
lllustration D-27
Calculator solution for
present value of an annuiiY
In this case,
You
enter N
:
5, I
:
12, PMT
:
to arrive at the answer of
-$21,628'66'
6,000, FV
:
0, and then
Press
PV
D-l8 ;ippsr'ldix # Tirne Value of Money
lllustration D.28
Calculator solution for
auto loan payments
lllustration D.29
Calculator solution for
mortgage amount
Useful Applications cf
the Financial Calculat<rr
With a financial calculator, you can solve for any interest rate or for any num-
ber of periods in a time value of money problem. Here are some examples of
these applications.
ATJ?'S L#Aru
Assume you are financing the purchase of a used car with a three-year ioan. The
loan has a9.5a/o stated annual interest rate, compounded monthly. The price of
the car is
$6,000,
and you want to determine the monthly payments, assuming
that the payments start one month after the purchase. This problem is pictured
in Illustration D-28.
I nputs: 9.5 6,000
-192.29
To solvethis problem, you enterN: 36
(12 x 3),I: 9.5, PV: 6,000, FV: 0,
and then press PMT. You will find that the monthly payments will be $192.20.
Note that the payment key is usually programmed fot 12 payments per year.
Thus, you must change the default
(compounding period) if the payments are
other than monthly.
MSRTGAGH LffAFd ATUft U NT
Let's say you are evaluating financing options for a loan on a house. You decide
that the maximum mortgage payment you can afford is
$700
per month. The
annual interest rate is 8.+oto. If you get a mortgage that requires you to make
monthly palTnents over a 15-year period, what is the maximum home loan you
can afford? Illustration D-29 depicts this problem.
You enterN
:
180 (12 x 15 years), I
:
8.4, PMT
:
-70O,FV
:
0, andpress
PV'
With the payments-per-year key set at 12, you find a present value of $7
1, 509. 8 1-
the maximum home loan you can afford, given that you want to keep your morl-
gage payments ar
$700.
Note that by changing any of the variables, you can
quickly conduct
"what-if"
analyses for different situations.
il
180 8.4 I nputs: -700
ffil ry
71,509.81
D-20 mppenc:x * Tirne Value of Money
Bnief Fxercises
(Use tables to solve exercises BED-I to BED-25.)
Compute the
future
value BED-I Randy Owen invested
$8,000
at 5o/o annual interest, and left the money invested
of a single amounr. without withdrawing any of the interest for 12 years. At the end of the 12 years, Randy
($0 2), AP withdrew the accumulated amount of money. (a) What amount did Randy withdraw,
assuming the investment earns simple interest? (b) What amount did Randy withdraw
assuming the investment earns interest compounded annuaily?
Use
future
value tables. BED-? For each of the following cases, indicate (a) to what interest rate columns and
iSil :,3), {} (b) to what number of periods you would refer in looking up the future value factor.
(1) In Table 1 (future value of 1):
Annual Number of
Rate Years Invested Compounded
Case A 6a/o
Case B 8o/o
(2) In Table 2 (future vaiue of an annuity of 1):
Annual Number of
Rate Years Invested Compounded
Case A 5o/o
Case B 60/o
3 Annually
4 Semiannually
8 Annually
6 Semiannuallv
Computethefuturevalue BED-3 ,,Joyce Company signed a iease for an office building for a period of 12 years.
of a single amount. .. U-n-derthe lease agreement, a security deposit of
$9,200
is made. The deposit will be re-
(S02),SP
'-'--turned
at the expiration of the lease with interest compounded at 4o/o per year. What
amount will Joyce receive at the time the lease expires?
Compute the
future
value BED-4., Bates Company issued
$1,000,000,
l0-year bonds and agreed to make annual sink-
of an annuity.
-.
ingfund deposits of
$78,000.
The deposits are made at the end of each year into an account
{S0
3), 4p payrng 5o/o annual interest. What amount will be in the sinking fund at the end of 10 years?
Compute the
future
talue BED-5
,.
Frank and Maureen Fantazzi invested $6,000
in a savings account paying 4o/o
of asingleqmountandof annual interest when their daughte4 Angela, was born. They also deposited $1,000
on
an annuity.
each of her birthdays until she was 18 (including her 18th birthday). How much was in
is{j
l.:), AP the savings account on her 18th birthday (after the last deposit)?
Cornpute the
future
value tsED-6 Hugh Curtin borrowed $34,000
on July 1, 2012. This amount plus accrued in-
of a single amount. .
terest at 9o/o compounded annually is to be repaid on July l,2AI7. How much will Hugh
iSO
Z}, ilF have to repay on July 1,2017?
(Jse
present value tables. BED'? For each of the following cases, indicate (a) to what interest rate columns and
isg 5 :l) if
(b) to what number of periods you would refer in looking up the discount rate.
(1) in Table 3 (present value of 1):
Annual Number of Discounts
Rate Years Involved
Per
Year
CaseA 1.2o/o 6 AnnuallY
Case B 10a/o 11 AnnuallY
CaseC 60/o 9 SemiannuallY
(2) In Table 4 (present value of an annuity of 1):
Annual Nurnber of Number of Frequency of
Rate Years Involved Pa)rrnents Involved Payments
Case A L2o/o 20 20 AnnuallY
CaseB 10o/o 5 5 AnnuallY
CaseC 8a/o 4 8 Semiannually
Brief Exercises
D-21
BED-8(a)Whatisthepresentvalueof$23,000duegperiodsfromnowdiscountedatDeterminepresentvalue
(sB 5,6), AF
"'
'
.-
l0o/o?
(b) What is the
present ytl":-:i
$28'000
to be received
at the end of each of
BED-e
J::::rl";::::::*T:y.:"investment
that w*i return
a lump sum of compute
the present tatue of
,__..g-750,000
five years f.;;;*.
What amo'r,f;fua
Chaffee
C"'t;;;;;v
fo' this invest-
a singte amount
investment'
i$0
5i &r
ffi;:"ffi;'::ffi
earns
roo/o::
u, investment
that will return
g480,000 computethepresentuarueof
eight
years t orrr rro*-w#t
is the
^*o*rrr,
rifi
should
i.rrr".r
rro*io
".r-t-,rtir
rate of
a singreamount
investmen,
{S"l
5;. &F
return?
BED_I1
Arthur
company
is consjdering
investing
in an annuity
contract
that-will,re-
compute
the present value of
turn 945,000
"rr"iroliii'eend
of
"""h
v;;;;;;'i"t;;;t''
wh""";;;;
sno"ld
Arthur
an annuitv
iwestmen'
company
pay for;i:
ffiJi;;;
";;;
5o/o reiurn?
_, o*o
ge0,000 at th
(5i 6; AF'
l BED-12 'Kaehler
Enterprises
":y,
q7,,:'
an investment
that pays back $90,000
at the Compute
the present tlalue
,
dnrl_of each of the next 6 years. what is ,h" ;;;*
Kaehrer
u*"tinr"r"i"*li"a
,o
"u*
of an annuitv i'Nestment'
is{l -il,
sr
H|T:|]ffioad
co.
i1
about
to issue
g300,000 of l0-vear
bonds
pavin
s
?
s%
compute
the present ratue
interest
rate,
with i*"r".t
payable
,"-itrr,t"^*y'
The discount
tli" i"t t""h^securities
is
of bonds'
8o/o. Howmuch
can Hanna
expect
," ."""*ll"i
i-t'"-'^f"
of these bonds?
f't I' i l;' &r'
BED-14
Assume
the same information
as BED-13
except
that the discount
rate.was
computethepresentvalueof
l0olo instead
of
ga/o.In this case,
how *rr"h
"r'
Hanna
expect t" t"t"l*
from the sale of
'u,Jfi
,, no
ffi:"T;mas
raco companv
o':i"":
i,J^'--in'i,::::,xil;J:,5;:fi;:l1:Ti$:?
"iT'l:::":-presentvatue
(paid annually)
lrofr-;
"rr.a-o'*.i
^,
a time *f'"t
'f'"
discount
tut.- it-Sq"'
frhat ls the pres-
of a note'
ent value of the n;;;"tei"ed
bY Tomas?
.sfb_re Gleason
Enterprises
issued
9,o/o,
g-year,$2,600,000
par value bonds that
pay in- compute
the present value of
idierse*lu"""utiv
o" o"tober
1 and o#ii
i;"-;;i;
"'"'d";"Jap-r
t'2012'
""q:'"
bonds'
i,.'"a
on that d# ;i";;;;
;ryi'J*#tfii#:f*#"t
i' zot'z' is roo/o {sG
}' E ?)' AF
,H::;-;;::::"T,:r;.*"d
is contempratingpurchasing
a tire rerreadin E
comnltl
t\orelfltvatue
of
m'aihine
for $18,000.
After
estimat,*
.".,,
"'J,".,"''",,
M"'ffi;j:"?'.;;;;;'h
fffi
a machine for
purposes
of
from rhe ."tr"uai.,g
machine
of $3,30i
;;;;;li;
io' a
v'*''
ruruti iJp"'
to earn
i ::y;
makins
a purchase
decision'
of t0 percent.";H';;;;il""ir.
wr'.it;;;;;;;#"alue
of th' retreading
operation?
ist l' 7' A'r
Should
fUutt
p"tt:ft*e
the retreading
machine?
BED_'g
Fraziercompany
issues
an.golo,
5-year
mortga,ge
note on January
r,
-2orz,
to compute
the present value of
obtain
financing
for new equipm".rr.
r-una-iJ;;;J"t
"9rlilta
for the note'
The terms
anote'
nrovide for semiannual
installmen, o"#l*
l"rtfou,,to'
wr'^t *"t" the cash
proceeds
l$3 8) eF
i;;;;^ft""'
the issuance
of the note?
: BED-19
Leffler
company
_is
considering
purchasing
equ]prnent.
The equipment
will compute
the maximum
price
, pioduce the following
"..h
no*r,
""u"'i:-$#;'*ff;;
fi9'ffi; -JY;-*:'
$s0'000'
to pav
for
a machine'
Leffler
requires
u *iiri*rr*
rate of t;'-;;1-0
il"'
wt'''utit
Jrt" *t-i"tum
price Leffler
($$ [, ii AF
J"Ja
pty fot this equipment?
-:-.^
o 1^ Aoo qr rhe compute
the interest
rate on
BgnliO
If Colleen
Mooney
invest-s.$4'172'65
low'and
she-will
receive $10'000
at the computetheinter
end*of-l5
y".rr,'*fruiunnual
rate of ini"t"'t
will Colleen
";;;
tttt lt"""tt*.'l?
(Hint:
a single amoun,
is8 5) &fi
use Table 3')
r
'1-^ ^--^*"'itw
of investing $25'490
now' The
compute
the number
of
.l?3,j"".Y,f:#f,ffi.:E:ffi*:l::x5Ti#l'.sjffiii;1ffi;i?1";J;'Jd;:
}inJil."i"
'',-ngle
amount.
How many
y"^.r;Jw;yre
wait r" *-."i"" Isot,ool?
(Hint: use Table 3')
{si:5;'
AF"
B]ED-22JoanneQuickmadeaninve.stmentof$g,128.55.Fromthisinvestment,shewillComputetheinterestrateon
receive
g1,000 .rrrarv
for the .r"*t i0 y"..s starting
on"
d;;il* "o*'
what rate of
anannuity'
interest
*il ioi""Jt
ii*t*t"t
b"
";"i;;;"t
i"tiiai"'
use Table 4')
(s!
Ei' Art
BED-23
?attv
Schleis
invests
F:iii,i'3"H:
:::'ilTi"i,"1,
T;ttl1"il$
'-Ti:tr*H
""#:f'"";n"ffif;'
ginning one Year
from
now' Pltl{
Yl
How manv t""'-tur
pavrnents
of $1'00il;ift;6;;
"*tt
tiii''
use Table 4')
igt 5; &tt.
,t
t
,$i
,fi
:fi
'E
1
,.E !
j:
,}.
:.E
:t
,I
I
I
I
,!
i
I
r,i
,tl
I
.'i
!
l
'i
I
I
i
D'22 appendix D Time Value of MoneY
Compute the present value of
a machine
for
purposes of
making a purchase decision.
isc
t], AP
Compute the maximum price
to pay
for
a machine.
lsc
8), $il
Detennine interest rate.
rsO
g).
3p
Deteftnine interest rate.
{sfi s}, AP
Deteftnine interest rate
iso 3), nF
Various time value of money
situations.
it0 !), iiP
Vaious time value of money
situations.
13il !i. ilF
BED-24 Barney Googal owns a
Earage
and is contemplating purchasing a tire retread-
"in! aaCfrine for
$14,280.
After estimating costs and revenues, Barney projects a net cash
flow from the retreading machine of
$2,900
annually for 8 years. Barney hopes to earn
a return of l|o/o on such investments. What is the present value of the retreading opera-
tion? Should Barney Googal purchase the retreading machine?
BED-25 Ramos Company is considering purchasing equipment. The equipment will
produce the following cash flows: Year 1,
$30,000;
Year 2,
$40,000;
Year 3,
$50,000.
Ramos
requiresaminimumrateof return of l2o/o. WhatisthemaximumpriceRamosshouid
pay for this equipment?
BED-25 Carly Simon wishes to invest $13,000
on July I,2012, and have it accumulate
to
$50,000
by July 1, 2022.
Instructions
Use a financial calculator to determine at what exact annual rate of interest Carly must
invest the
$18,000.
BED-27 On July 17
,2012,
James Taylor borrowed $60,000
from his grandfather to open
a clothing store. Starting July 17, 2018, James has to make 10 equal annual pa1'rnents of
$8,860
each to repay the loan.
Instructions
Use a firrancial calculator to determine what interest rate James is paying.
BED-28 As the purchaser of a new house, Carrie Underwood has signed a mortgage
=-note'to
pay the Nashville National Bank and Trust Co. $8,400
every 6 months for 20 years,
at the
"nd
of which time she will own the house. At the date the mortgage is signed, the
purchase price was
$198,000
and Underwood made a down payment of
$20,000.
The first
payment will be made 6 months after the date the mortgage is signed.
Instructions
Using a financial calculator, compute the exact rate of interest earned on the mortgage
by the bank.
BED-29 Using a financial calculato4 solve for the unknowns in each of the following
"situaticins.
(a) On June 1, 2012, Holly Golightly purchases lakefront properry from her neighbo4
George Peppard, and agrees to pay the purchase price in seven payments of
$16,000
each, the first payment to be payable June l,2Ol3.
(Assume that interest compounded
at an annual rate of 6.9a/o is implicit in the payments.) What is the purchase price of
the property?
(b) Onl.6rry 1,201.2, SammisCorporationpurchased200of
the91,000facevalue,
7
o/o
cottpon, I 0-year bonds of Malone Inc. The bonds mature on January I
,
2020 , and
pay interest annually beginning January 1, 2013. Sammis purchased the bonds to
yteld 8.650/o. How much did Sammis pay for the bonds?
BED-30 Using a financial calculatot provide a solution to each of the following
'Situatibns.
(a) Lynn Anglin owes a debt of
g42,000
from the purchase of her new sport utility vehi-
cie. The debt bears annual interest of 7.8a/o compounded monthly. Lynn wishes to
pay the debt and interest in equal monthly pa)ments over 8 years, beginning one
month hence. What equal monthly pa).rnents will pay off the debt and interest?
(b) On January l,2Ol2, Roger Molony offers to buy Dave Feeney's used snowmobile for
$8,000,
payable in five equal annual installments, which are to include 7.25o/o intet-
est on the unpaid balance and a portion of the principal. If the first pal'ment is to
be made on December 31,2012, how much will each payment be?
t'.a:
.3-