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Solution for lecture -1

Problem 1
Solved in the class. Previous year question

Problem 2

FVA2 = 1000=R(FVIFA, 10%, 2)= R(2.10)


Therefore R=1000/2.10= 476.19. Replacing 1000 with equivalent 2 year
annuity gives us 476.19 for 20 years.

= 476.19x8.514 = 4054.28

Alternatively, we can increase interest rate for two years and period by 10
years (20/2)

=(1.10)x(1.10)-1= 21%

=1000Xpvifa 10years
= 4047.62

Problem 3

a. The annuity of $10,000 per year for 15 years at 5 percent. The discount
factor in the PVIFA table is 10.380
Purchase price is = 10000x10.380= 103,800

b. Discount factor for 10 percent for 15 years is 7.606


Purchase price is 10000x7.606 = 76060

As the insurance company is able to earn more on the amount put up,
it requires a lower purchase price.

c. Annuity payment for 5 percent is 30000/10.380 = 2890

Annual annuity payment for 10 percent is 30000/7.606


= 3944
The higher the interest rate embodied in the yield calculation, the higher
annual payments

Problem 4

Present value of immediate annual salary + bonus

Only salary is 45000


Salary with annual bonus =45000X1.1= 49500
Growing annuiy formula = C[1-(1+g/1+r)t/r-g]=49500[1-
(1.035/1+0.12)25/.12-.035] 501400

Pv of total remuneration = 10000+ 501400= 511400

Problem 5

Answer:

First, we will calculate the present value of the college expenses for each child.
Total expenses: $35,000 x 2 = $70,000
T = 4 years of college
PVA = C (1-1/(1+r)t / r )
PVA = $70,000 ( 1- 1/ (1+0.085)4 / 0.085)
PVA = $ 70,000 (1 – 1/1.3858 / 0.085)
PVA =$70,000 (1 – 0.72160 /0.085)
PVA = $70,000 (0.2784 / 0.085)
PVA = $70,000 (3.2753)
PVA = $229270.59 total expenses for two Childs

@ = $229270.59 /2
@=$114635.29 expenses for each child.
This is the cost of each child college expenses one year before they enter
college. So, the cost of the oldest child’s college expenses today will be:

PV = FV/(1+r)14
PV = $114635.29 / 1.08514
PV = $114635.29 / 3.1334
PV = $36584.95

And the cost of the youngest child college expenses today will be:

PV = FV/ (1+r)16
PV = $114635.29 / 1.08516
PV = $114635.95 / 3.6887
PV = $31077.43

Therefore, the total cost today of your children’s college expenses is:
Cost today = $36584.95 + $31077.43
Cost today = $67662.38

This is the present value of your annual savings, which are an annuity. So,
the amount you must save each year will be:

PVA = C (1-1/(1+r)t / r )
$67662.38 = C (1 – 1/(1.085)15 /0.085)
$67622.38 = C (1 – 1/ 3.3997 / 0.085)
$67622.38 = C (0.7059 / 0.085)
$67622.38 = 8.3047 C
C =$ 8142.66

Note:

“An annuity is a level stream of regulars payments that last for a fixed number
of periods. Not surprisingly, annuities are among the most common kinds of
financial instruments. The pensions that people receive when they retire are
often in the form of an annuity. Leases and mortgages are also often
annuities…”