TIME VALUE OF MONEY – SAMPLE PROBLEMS

Problem 1. ABC Company wishes to purchase an annuity contract that will pay $10,000 a year (every
beginning of each year) for a fire and theft property insurance. The Rest Assured Insurance Company figures
that the expectancy coverage is for 30 years, based on its actuary tables. The company imputes a compound

annual interest rate of 6 percent in its annuity contracts. What is the present value of all the payments that you
have to pay for the annuity contracts?

Solutions:
PRESENT VALUE OF ANNUITY DUE

PV = $ 10,000 {[1 – 1/ (1.06)30 ] / (.06)} (1.06)

PV = $10,000 (14.591)
PV= $145,910

Problem 2. You borrow $5,000 at 13.5 percent compound annual interest for five years. The loan is repayable
in five equal annual installments payable at the end of each year. What is the annual payment that will
completely amortize the loan over five years?

Solutions:
PRESENT VALUE OF ORDINARY ANNUITY (Workback for PMT – annual payment)

$5,000 = PMT {1-[1/(1.135)5 ] / (.135)}

$5,000 = PMT (3.475)
$5,000 / 3.475 = PMT
$1,438.85 = PMT

Problem 3. Vernal Equinox wishes to borrow $10,000 for three years. A group of individuals agrees to lend
him this amount if he contracts to pay them $19,000 at the end of the three years.
What is the implicit compound annual interest rate implied by this contract (to the nearest whole percent)?

Solutions:
SINGLE LUMP SUM (Workback for interest rate)

FV = PV (1 + i)3
$19,000 = $10,000 (1 + i)3
$19,000 / $10,000 = (1 + i)3
3
√1.9 = 1 + i
1.24 = 1 + i
1.24 -1 = i
.24 = i
24% = i