Practice Time Value of Money Problems

Answers

1. How much will be in an account at the end of 5 years if you deposit $10,000 today at 8.7%
annual interest, compounded semi-annually?
Answer: $15,308.21

2. What is the balance at the end of 10 years if $2,500 is deposited today and the account
earns 4% interest annually? What about if it’s quarterly interest? Which one should be more
and why?
Answer: $3,700.61 annually. $ 3,722.16 quarterly.

3. Suppose you want to have $500,000 saved by the time you reach 30 years old. You are 20
years old today. If you can earn 5.73% annually on your savings, how much do you need to
invest today? Do you need to invest more or less if the interest rate increases to 7.9%?
Answer: $286,409.68. If the interest rate increases, the PV decreases, so you would need to
invest $233,752.12, which is less.

4. How long does it take for your money to grow to 10 times its original value at 5% annual
interest?
Answer: 47.19 years

5. Assuming a 5.04% interest rate, what is the present value of the following cashflows:
Year 1 = $0, Year 2 = $0, Year 3 = $4,372, Year 4 = $298. What is the present value if the
cashflows are Year 1 = $0, Year 2 = $0, Year 3 = $10,000, Year 4 = $10,000 and the interest
rate is 5%
Answer: $4,017.18..$16,865.40

6. How much must I deposit in an account today so that I can withdraw $100 per year for four
years, beginning at the end of two years from now, if my deposits earn 5% interest,
compounded annually?
o PV of ordinary annuity one year from today is $100 = $354.60.
o Value today of the $354.60 one year from today is $354.60 = $337.71.

7. As the frequency of compounding increases within an annual period, what happens to the
relationship between EAR and APR? Answer: The EAR becomes larger

8. After much haggling with the dealer, you decide to purchase a car that costs $37,000. You
will make a downpayment of 10% of the cost and borrow the rest with a 5 year auto loan. At
a 7.3% annual interest rate, how much will your monthly payments be?
Answer: $664 per month

9. You are evaluating a potential annuity investment opportunity. The salesperson said her firm
will pay you $7,000 annually for 4 years, with all payments made at the beginning of each
year, if you pay her $26,000 today. At a 10.6% annual interest rate, is this a good deal for
you? Answer: No because the present value of the payments is only $24,225.71

10. You are evaluating investing in a bank CD. Bank Astoria is offering a 1 year CD at an annual
interest rate of 11.85%, compounded daily. Bank Bravo is offering a 1 year CD at an annual
interest rate of 12% compounded semi-annually. Which CD is the better investment and
why? Answer: Bank Astoria’s rate is better because it has an effective annual rate (“EAR”) of
12.58% vs Bank Bravo’s EAR of 12.36%
Source: Pamela Peterson Drake and Cynthia P. Bush