Tutorial 2 (TVM)- Questions

Question 1
Find the interest rate implied by the following combinations of present and future values
Present value Years Future value
$400 11 $684
$183 4 $249

Question 2
How long will it take for $400 to grow to $1,000 at the interest rate specified?
a. 4%
b. 8%

Question 3
What is the present value of a 3-year payment of $100 (paid every year at year end) if the
discount rate is 6%?

Question 4
Your landscaping company can lease a truck for $8,000 a year (paid at year-end) for 6
years. It can instead buy the truck for $40,000. The truck will be valueless after 6 years.
If the interest rate your company can earn on its funds is 7%, is it cheaper to buy or lease?

Question 5
A property will provide $10,000 a year forever. If its value is $125,000, what must be
the discount rate?

Question 6
Suppose you just won the lottery and must choose one of the following (guaranteed)
payoffs. Which one would you choose? The interest rate is 5% per year; ignore tax
consequences.

a. £80,000 paid today.

b. £110,000 paid five years from today.
c. £50,000 paid today and £40,000 paid four years from today.
d. £17,000 paid per year during 6 years, with the first payment made today.
e. All the same value.

Question 7

Mr. and Mrs. Palin want to buy a house worth £200,000. They have £50,000 which they
will use as initial payment and they are now considering borrowing the remaining from a
mortgage lender. Assuming that the mortgage is paid monthly in 30 years (the payments
are done at the end of each month) and that the mortgage interest rate is 0.5% (per month)
how much will Mr. and Mrs. Palin have to pay per month to the mortgage lender?
Question 8
a. If you borrow $1,000 and agree to repay the loan in 5 equal annual
payments at an interest rate of 12%, what will your payment be?
b. What if you make the first payment on the loan immediately instead of at
the end of the 1st year?

Question 9 (future value of annuity)

You believe you will need to have saved $500,000 by the time you retire in 40 years in
order to live comfortably. If the interest rate is 6% per year, how much must you save
each year to meet your retirement goal? Assume you will save the same amount each
year.

Question 10
A couple will retire in 50 years; they plan to spend about $30,000 a year in retirement,
which should last about 25 years. They believe that they can earn 8% interest on
retirement savings.
a. If they make constant annual payments into a savings plan, how much will
they need to save each year? Assume the first payment comes in 1 year.
b. How would the answer to part (a) change if the couple also realise that in
20 years, they will need to spend $60,000 on their child’s college
education? Note that again the payments should be constant.

Question 11
Suppose you can borrow money at 8.6% (nominal rate) compounded semi-annually or
8.4% (nominal rate) compounded monthly. Which is the better deal?

Question 12
Suppose that BankX is paying you an EAR of 4% what is the equivalent semi-annual
rate? (hint: since the rates are equivalent, it has to be the same for you to invest your
money for 1 year at 4% or for 1 year at this new rate).

Question 13
John just bought a house. He paid a deposit of £30,000 and he asked for a 25 years
mortgage for the remaining. The mortgage lender charges an interest rate of 5.75%(EAR)
and John will repay the mortgage through monthly payments (end of month) of £779.51.
The first mortgage payment will be done in three months’ time. What is the house price?