Econ 134A

Professor Sarraf
1/19/20
Homework #1 Chapter 5

Self Test:

1. After 5 years: $24 * (1.05) ^ 5 = $30.63 | After 50 years: $24 * (1.05) ^ 30 = $275.22

2. 2250 * (1 + g) ^ 44 = 5,500,000,000, g = 0.397 = 39.7%; the actual growth rate g is not as big

as Gordon Moore’s prediction.

3. FV = PV * (1 + r) ^ t  PV = FV / (1 + r) ^ t = €1,000 / (1 + 0.01) ^ 3 = €970.59

4. PV = FV / (1 + r) ^ t = $10000 / (1.07) + $10000 / (1.07 ^ 2) + $10000 / (1.07 ^ 3) + $10000 /

(1.07 ^ 4) = $33872.11

FV = PV * (1 + r) ^ t = $10000 * (1.07 ^ 3) + $10000 * (1.07 ^ 2) + $10000 * (1.07) + $10000 =

$44399.43

5. Cash payment from perpetuity = interest rate * present value  interest rate = cash payment

from perpetuity / present value = £4 / £48 = 0.0833 = 8.33%

6. Discount factor = 1 / (1 + r) ^ t = 1 / (1.08 ^ 4) = 0.735

Annuity factor = (1 / r) – (1 / [r * (1 + r) ^ t] = (1 / 0.08) – (1 / [0.08 * (1.08 ^ 4)]) = 3.3121268

The present value of a $1 perpetuity starting next year and the present value of a $1 perpetuity

starting in year 5 equals the 4-year annuity factor.

8. Present value = mortgage payment * annuity factor  mortgage payment = present value /

annuity factor = $100000 / 180-month annuity factor = $100000 / [ (1 / 0.01) – (1 / [0.01 * (1.01

^ 180)])] = $100000 / 83.321664 = $1200.17 per month

$1,000 of the first payment is interest and $200.17 is amortization.

9. Future value of an annuity = future value of an annuity * (1 + r)

If you make them at the beginning instead of the end, the retirement savings will be $550000.

11. Inflation rate is 5%  $5 * (1.05 ^ 50) = $57.34

Inflation rate is 10%  $5 * (1.05 ^ 10) = $586.95

12. CPI of 1980 / CPI of 1950 = Purchase in 1980 / Purchase in 1950 

Purchase in 1980 = (CPI of 1980 / CPI of 1950) * Purchase in 1950 = (86.3 / 25) * $250 = $863

Salary in 1950 = Salary in 1980 / (CPI of 1980 / CPI of 1950) = $30000 / (86.3 / 25) = $8690.61

13. a. 1 + real interest rate = (1 + nominal interest rate) / (1 + inflation rate)

When inflation rate equals 0  1 + real interest rate = (1 + nominal interest rate) / 1

When there is no inflation, real and nominal rates are equal; therefore both of the rates would be

8%.

When there is 5% inflation  real interest rate = (1 + nominal interest rate) / (1 + inflation rate)

-1 = (1 + 0.08) / (1 + 0.05) -1 = 1.08/1.05 -1 = 0.0285714 = 2.86%

b. When there is no inflation, real and nominal rates are equal; therefore both of the rates would

be 3%.
Nominal interest rate = (1 + real interest rate) * (1 + inflation rate) = (1 + 0.03) * (1 + 0.05) – 1 =

1.03 * 1.05 – 1 = 0.0815 = 8.15%

14. Present value = Future value / (1 + nominal interest rate) = $5000 / 1.08 = $4629.63

Real interest rate = (1 + nominal interest rate) / (1 + inflation rate) – 1 = (1 + 0.08) / (1 + 0.05) –

1 = 0.02857 = 2.86%

Real cash payment = Future value owed / (1 + inflation rate) = $5000 / 1.05 = $4761.90

Present value = Real cash payment / (1 + real interest rate) = $4761.90 / (1.0286) = $4629.63

Questions & Problems:

1. Future value = Present value * (1 + r) ^ t; Interest earned = future value – present value of

previous year

a. $1000 * (1.04) = $1040; Interest earned = $1040 – $1000 = $40

b. $1000 * (1.04 ^ 2) = $1081.60; Interest earned = $1081.60 – $1040 = $41.60

c. $1000 * (1.04 ^ 9) = 1423.31 (In the 9th year)

$1000 * (1.04 ^ 10) = $1480.2; Interest earned = $1480.20 – $1423.31 = $56.89

4. Future value = Present value * (1 + r) ^ t

a. FV = $100 * (1+0.08) ^ 10 = $215.89

b. FV = $100 * (1+0.08) ^ 20 = $466.10

c. FV = $100 * (1+0.04) ^ 10 = $148.02

d. FV = $100 * (1+0.04) ^ 20 = $219.11

13. Present value = Future value / (1 + r) ^ t = $700 / (1 + 0.05) ^ 5 = $548.47

15. Future value = Present value * (1 + r) ^ t  r = (future value / present value) ^ (1 / t) – 1

r1 = ($684 / $400) ^ (1 / 11) – 1 = .04998 = 4.99%

r2 = ($249 / $183) ^ (1 / 4) – 1 = 0.08 = 8%

r3 = ($300 / $300) ^ (1 / 7) – 1 = 0%

25. Present Value of perpetuity = Cash payment / interest rate

a. £4 / 0.06 = £66.67

b. £2.50 / 0.06 = £41.67.

26. Present value of t-year annuity = C * ([1 / r] – 1 / [r * (1 + r) ^ t] )

a. Present value of the 3-year annuity = $100 * ([1 / 0.06] – 1 / [0.06 * (1 + 0.06) ^ 3]) = $267.30

b. Present value of the 3-year annuity if you wait 2 years = $100 * ([1 / 0.06] – 1 / [0.06 * (1 +

0.06) ^ 3]) * (1 / [1 + 0.06]) = $252.17

37. Cash payment = Present value of t-year annuity / ([1 / r] – 1 / [r * (1 + r) ^ t] )

a. Cash payment = $1000 / ([1 / 0.12] – 1 / [0.12 * (1 + 0.12) ^ 5] ) = $277.40

b. Immediate cash payment = $1000 / ([1 / 0.12] – 1 / [0.12 * (1 + 0.12) ^ 5] ) / (1 + 0.12) =

$247.69

41. Present value of t-year annuity = C * ([1 / r] – 1 / [r * (1 + r) ^ t] )

a. Present value of the 25-year annuity = $30000 * ([1 / 0.08] – [1 / (0.08 * [1.08 ^ 25]) ] =

$320243.29
Future value of annuity = C * [(1 + r) ^ t – 1] / r  C = Future value of annuity / [(1 + r) ^ t –

1] / r = $320243.29 / ( [(1 + 0.08) ^ 50 – 1] / 0.08) = $558.14

b. Future value = Present value * (1 + r) ^ t = $60000 * (1 + 0.08) ^ [50 – 20] = $603759.41

C = Future value of annuity with both values / [(1 + r) ^ t – 1] / r = ($320243.29 + $603759.41) /

[([1 + 0.08] ^ 50 – 1) / 0.08] = $1610.41

56. First National Bank  Future value = $C * (1 + 0.062 / 2) ^ 2 = 1.062961 C

Second National Bank  Future value = $C * (1 + 0.06 / 12) ^ 12 = 1.061678 C

First National Bank has higher value and offers the higher effective annual interest rate