Harlika Dawn C.

Cristobal AUGUST 7, 2018

BSAC – 1 AEC 13 ACB

ASSIGNMENT

A. Draw time lines for (1) a $100 lump sum cash flow at the end of Year 2, (2) an ordinary
annuity of $100 per year for 3 years, and (3) an uneven cash flow stream of -$50, $100, $75,
and $50 at the end of Years 0 to 3.
1 1 2 Years LUMP SUM
(1) I/YR%

$100 Cash Flow

0 1 2 3 Years ANNUITY
(2) I/YR%

$100 $100 $100

0 1 2 3 Years
(3) I/YR%
UNEVEN CASH
-$50 $100 $75 $50 FLOW STREAM

B. (1) What’s the future value of $100 after 3 years if it earns 10%, annual compounding?

FV N = PV (1+ I )N
FV 3 = $ 100(1+0.10)3
= $100(1.3310)
FV 3 = $133.10

(2) What’s the present value of $100 to be received in 3 years if the interest rate is 10%,
annual compounding?
3
FV N = PV (1+ I )N 1
PV = $100( )
1+ 0.10
FV N 1 3
PV = PV = $100 ( )
(1+ I ) N 1.10
1 N
PV = FV N ( ) PV = $100(0.7513)
1+ I
PV = $75.13

C. What annual interest rate would cause $100 to grow $125.97 in 3 years?
FV = PV (1+ I )N I=¿
3
$125.97 = $ 100(1+ I ) I = (1.2597)1/ 3−1
$ 125.97
(1+ I )3 = I = (1.079996571) – 1
$ 100
 $ 125.97 1 /3
(1+ I )3 x1 /3 = I = 0. 079996571
$ 100
$ 125.97 1 /3
(1 + I) = I = 0.079
$ 100
$ 125.97 1 /3
(1 + I) – 1 = −1 I = 7.90% or 8%
$ 100
D. If a company’s sales are growing at a rate of 20% annually, how long will it take sales to
double?

FV = PV (1+ I )N
2 = 1(1+0.20)N
2 = 1.20 N
ln 2 = N ln(1.20)
ln2
N=
ln(1.20)
N = 3.80

Thus, it will take 3.80 years for the sales to double.

E. What’s the difference between an ordinary annuity and an annuity due? What type of
annuity is shown here? How would you change it to the other type of annuity?

Ordinary Annuity is when payments are made at the end of the period while Annuity Due has
beginning of period payments.

0 1 2 3 Years

0 $100 $100 $100

The timeline shown above is an example of an Ordinary Annuity where the $100 are paid at the
end of each period. To make the annuity to be an Annuity Due, the payments made should be
moved to the left where the first payment is at the beginning Year 0 and none at Year 3.

0 1 2 3 Years

$100 $100 $100 0

Thus, this timeline above is now an example of an Annuity Due.

F. (1) What is the future value of a 3-year, $100 ordinary annuity if the annual interest rate is
10%?

0 1 2 3 Years
10%
 0 $100 $100 $100
110
121
$331
N
FVA 3 = Pmt[ ( 1+ I ) −1 ] = $100 (3.31)
I
( 1+0.10 )3 −1
= $100[ ] = $331
0.10

(2) What is its present value?

0 1 2 3 Years
10%

0 $100 $100 $100

$90.91
$82.64
$75.13
$248.68
−N
PVA 3= Pmt [ 1− (1+ I ) ]
I
1− (1+ 0.10 )−3
= $100 [ ]
0.10
= $100 (2.4868)
= $248.68

(3) What would the future and present values be if it was an annuity due?

N +1
FVA 3 Due = Pmt ( 1+ I ) −1 − Pmt
[ I ] PVA 3 Due = $248.68(1.10)1

( 1+0.10 )3 +1−1
= $100
[ 0.10 ] −100 = $273.55

= 464.1 – 100
= $364.10

G. A 5-year $100 ordinary annuity has an annual interest rate of 10%.

(1) What is its present value?
−N
PVA 5= Pmt [ 1− (1+ I ) ]
I
1− (1+ 0.10 )−5
= $100 [ ]
0.10
= $100 (3.790786769)
= $379.08

(2) What would the present value be if it was a 10-year annuity?

 −N
PVA 10= Pmt [ 1− (1+ I ) ]
I
1− (1+ 0.10 )−10
= $100 [ ]
0.10
= $100 (6.144567106)
= $614.46

(3) What would the present value be if it was a 25-year annuity?

−N
PVA 25= Pmt [ 1− (1+ I ) ]
I
1− (1+ 0.10 )−25
= $100 [ ]
0.10
= $100 (9.077040018)
= $907.70

(4) What would the present value be if this was a perpetuity?

Pmt
PV Perpetuity = PV Perpetuity = $1,000
I
$ 100
=
0.10

H. A 20-year-old student wants to save $3 a day for her retirement. Every day she places $3 in
a drawer. At the end of each year, she invests the accumulated savings ($1,095) in
a brokerage account with an expected annual return of 12%.
(1) If she keeps saving in this manner, how much will she have accumulated at age 65?
N
FVA 45 = Pmt[ ( 1+ I ) −1 ] = $1,095 (1,358.230032)
I
( 1+0.12 )45−1
= $1,095[ ] = $1,489,261.89
0.12
(2) If a 40-year-old investor began saving in this manner, how much would he have at age
65?
N
FVA 25 = Pmt[ ( 1+ I ) −1 ] = $1,095 (133.3338701)
I
( 1+0.12 )25−1
= $1,095[ ] = $146,000.59
0.12

(3) How much would the 40-year-old investor have to save each year to accumulate the
same amount at 65 as the 20-year-old investor?
N
$ 1,489,261.885
FVA 25 = Pmt[ ( 1+ I ) −1 ] =
I 133.3338701
 ( 1+0.12 )25−1
$1,489,261.885 = Pmt [ ] = $11,154.42
0.12

I. What is the present value of the following uneven cash flow stream? The annual interest

rate is 10%.

0 1 2 3 4 Years
10%

0 $100 $300 $300 -$50

90.91
247.93
225.39
(34.15)
$530.08

CF 1 CF 2 CF 3 CF 4
PV UnevenCash Flow = + + +
(1+ I )1 (1+ I )2 (1+ I )3 (1+ I )4
100 300 300 −50
= 1
+ 2
+ 3
+ 4
(1+0.10) (1+ 0.10) (1+ 0.10) (1+0.10)
= 90.91 + 247.93 + 225.39 + 34.15
= $530.08

J. (1) Will the future value be larger or smaller if we compound an initial amount more often
that for example, semiannually, holding the stated (nominal) rate constant? Why?

Accounts that pay interest more frequently than once a year, for example, semiannually,
quarterly, or daily, have future values that are higher because interest is earned on interest more
often.

(2) Define (a) the stated (or quoted, or nominal) rate,

The quoted, or nominal, rate is merely the quoted percentage rate of return

(b) the periodic rate, and

The periodic rate is the rate charged by a lender or paid by a borrower each
period

(c)the effective annual rate (EAR or EFF%)

The effective annual rate (EAR) is the rate of interest that would provide an
identical future dollar value under annual compounding.

(4) What is the EAR corresponding to a nominal rate of 10% compounded semiannually?

Compounded quarterly? Compounded daily?

EAR 2 = Effective annual rate = ¿

EAR 2 = ¿ EAR 4 = ¿
= (1.1025) – 1.0 = (1.103812891) – 1.0
 = 0.1025 = 0.10381289
= 10.25% = 10.38%

Semiannual Compounding have an effective annual rate of 10.25% while Daily Compounding
have and effective annual rate of 10.38%

(5) What is the future value of $100 after 3 years under 10% semiannual compounding?
Quarterly compounding?

Semiannual: Quarterly:
FV 3 = Pmt ¿ FV 3 = Pmt ¿
FV 3 = $100 ¿ FV 3 = $100 ¿
FV 3 = $100 (1.340095641) FV 3 = $100 (1.344888824)
FV 3 = $134.01 FV 3 = $134.01