A kind and caring politician offers to pay you $500 million

in 300 short years.

A kind and caring politician offers to pay you $500 million in 300 short years.

Question
1. A kind and caring politician offers to pay you $500 million in 30
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A kind and caring politician offers to pay you $500 million in 300 short years.

Question
1. A kind and caring politician offers to pay you $500 million in 300 short years. Because this
politician is from the political party you vote for, you believe that the amount will be paid with
certainty.

A. How much is this promise worth today if the appropriate discount rate is 10%?
B. How much is this promise worth today if the appropriate discount rate is 0%?
C. Explain why your answer to B, while mathematically correct, does not make sense in
reality. In your (short) answer, include 2 reasons why interest rates are positive.
2. You won the lottery, and can choose one of two (guaranteed) payments: Choice A pays
$10,000
three years from today; Choice B pays $1,000,000 exactly 100 years from now.

A. If the discount rate is 8%, which option should you choose?

B. If the discount rate is 4%, which option should you choose?
C. At what discount rate would you be indifferent between these two choices? (Hint:
When will the two choices have the same present value?)
3.

Bank A pays 6% simple interest annually. Bank B pays 5.9% interest, with annual
compounding. Bank C pays 5.8% interest, with monthly compounding.

A. How long will it take for your money to double in each of the three banks? Please
state your answers in years, rounded to the nearest tenth of a year (e.g., 6.3 years).
B. In one or two sentences, what does your answer to part A illustrate about compound
interest?
4. Maybepay Life Insurance Company is selling a annuity contract for $70,000. The contract
will make monthly payments of $350 for the next 35 years.

A. What is the monthly interest rate on this contract?

B. What is the APR?
C. What is the effective annual return?
5. Eight years from now you will begin to receive cash flows of $5,000 per year. These cash
flows
will continue for twenty years. If the discount rate is 8%, what is the present value (today) of
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these cash flows?

6. An investment will pay $3,600 per year for 10 years, with the first payment occurring today.
If the interest rate is 7%, what is the value of this investment today? What would the value of the
investment be if the cash flows last 20 years (again, with the first payment today!)? How come
the value of the investment IS NOT twice as much? (After all, you will receive twice as much
cash in the 20 year annuity: 3600 X 20 vs. 3600 X 10).

7. You just opened a retirement account with a $5,000 deposit. Assuming that you can earn an
8% annual return (and that you make no additional deposits), what will this account be worth
when you retire in 35 years? Now, assume that you wait 15 years before making the initial (and
only) deposit to your retirement account. What will your account be worth when you retire (note,
you are still retiring 35 years from today)? Does this suggest an optimal retirement strategy?
8. If Debbies Drug Co. chooses to develop a new drug, it expects to receive cash flows of
$150,000 in year 3, $300,000 in year 4, and $100,000 in year 5. The discount rate is 8%.

A. What is the present value of the expected future cash flows?

B. Assume that this project requires a $400,000 investment today (or else the future cash
flows will not happen). Should the firm make this investment?
9. Over the last three years, Sally the investor earned the following returns on her portfolio
(assume that all dividends were reinvested in the portfolio, and are reflected in the stated
returns):
+35% (year 1), -20% (year 2), and +5% (year 3). What was Sallys effective, annual,
(compounded) return over this three year period? If Sally requires an annual return of 5% to be
happy, is she happy?
10. You borrow $500,000 to purchase a house. The mortgage is a 30-year fixed rate mortgage,
with monthly payments.

A. Assume that you have good credit, and can borrow money at a 3.75% annual
interest rate. What will your monthly payment be?

B. Now, assume that you have lousy credit, and must pay a 6.5% annual interest rate
to obtain a mortgage. What will your monthly payment be?
C. Having lousy credit can be costly. How much additional interest will you pay over
the 30-year period if you have bad credit, relative to what you would pay if you
have good credit? (Hint: Calculate the total interest over the 30-year period on the
loan in Part A, and the total interest over the 30-year period for the loan in Part D.
What is the difference between the two amounts?).
D. Is it ethical for banks to charge people with poor credit histories higher interest
rates? [After all, people with lousy credit will benefit more from lower interest
rates than people with good histories & high paying jobs (who could afford to pay
more interest)].

A kind and caring politician offers to pay you $500 million in 300 short years.

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Preview: that xxx can xxxx an 8% xxxxxx return (and xxxx you xxxx xx additional xxxxxxxxxx
what will xxxx account be xxxxx when xxx xxxxxx in xx years? Now, xxxxxx that you xxxx 15
xxxxx xxxxxx making xxx initial (and xxxxx deposit to xxxx retirement xxxxxxx xxxx will xxxx
account be xxxxx when you xxxxxx (note, xxx xxx still xxxxxxxx 35 years xxxx today)? Does
xxxx suggest xx xxxxxxx retirement xxxxxxxxxxxxxxxxxx have PV x 5,000, I x 8% xxx x = xx –
15 x 20FV = xx (1 x xxxx = xxxxx (1 08)^20 x 5000 (4 xxxxx = xxxxxx xxxx is xxx an optimal
xxxxxxxxxx strategy because xx deposits xxxx xxxx for xx years 8 xx Debbie’s Drug xx chooses
xx xxxxxxx a xxx drug, it xxxxxxx to receive xxxx flows xx xxxxxxxx in xxxx 3, $300,000 xx year
4, xxx $100,000 xx xxxx 5 xxx discount rate xx 8% What xx the xxxxxxx xxxxx of xxx expected
future xxxx flows?Assume that xxxx project xxxxxxxx x $400,000 xxxxxxxxxx today (or xxxx the
future xxxx flows xxxx xxx happen) xxxxxx the firm xxxx this investment? xxxxxxxxxxx (year xx x
$150,000/1 xxxx + $300,000/1 xxxx + $100,000/1 xxxx = xxxxxxx xxx (today) x $407642 1/1 xxx
= $349487 xxxx firm xxxxxx xxx make xxx investment because xxxxxxx value today xx lower x
xxxx the xxxx three years, xxxxx the investor xxxxxx the xxxxxxxxx xxxxxxx on xxx portfolio
(assume xxxx all dividends xxxx reinvested xx xxx portfolio, xxx are reflected xx the stated
xxxxxxxxx +35% xxxxx xxx -20% xxxxx 2), and xxx (year 3) xxxx was xxxxxxxxx xxxxxxxxxx
annual, xxxxxxxxxxxx return over xxxx three year xxxxxxx If xxxxx xxxxxxxx an xxxxxx return of
xx to be xxxxxx is xxx xxxxxx Solution:EAR

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