Assignment II: Time Value of Money

Submission Deadline: 12th of May (to be handed over to me on the day at the beginning of the
session)
Submission Details: To be submitted in A4 Size paper, clean and handwritten form (no need to
write the question), well stapled/ bound with title pages having the name of the learner.
For participants who are participating through virtual mode – submission to be done (PDF
document) over my email – sohan.khatri@gmail.com within 9 AM of 12th of May.
Any late submissions will not be accepted.

1. Solve for the unknown time period in each of the following: 

                        Present value   Future value  Interest rate  Time (years)

                           4,100              $ 8,523              5%                ?

2. Solve for the unknown interest rate in each of the following: 

       Present value   Future value  Interest rate  Time

(years)                       
         10,543               $21,215          ?                12   

3. You have just joined the investment banking firm of Knot, Wirthem, et al.  They have offered you
two different salary arrangements.  You can have $50,000 per year for the next 3 years or $25,000
per year for the next 3 years, along with a $50,000 signing bonus today.  If the market interest rate
is 16%, which salary arrangement do you prefer?

4. Judi Jordan wishes to accumulate $8,000 by the end of 5 years by making equal annual deposits
over the next 5 years beginning now. If Judi can earn 7% on her investments, how much should
her annual deposit be to meet this goal?

5. Mr. Binod requires a stream of cash flow of Rs 2000 for coming three years and then Rs 3000 per
year for next six years.
a) How much he needs to deposit now in the bank if the interest rate offered is 10% monthly
interest compounding?
b) How much he needs to deposit for first 7 years equally every year if interest rate offered is
12% annual compounding?

6. A finance company advertises that it will pay a lump sum of Rs 10,000 at the end of six years to
investors who deposit annually Rs 1,000 for 6 years. What is the interest rate implicit in this
offer?

7. Suppose someone offers you the following financial contract. If you deposit Rs 20,000 with him,
he promises to pay Rs 4,000 annually for 10 years. What interest rate would you earn on this
deposit?

8. Company A has to retire Rs 10 million of debentures each at the end of 8, 9, and 10 years from
now. How much should the firm deposit in a sinking fund account annually for 5 years, in order
to meet the debenture retirement need? The net interest rate earned is 8%.

9. An individual is planning to draw, after six years, a fixed sum semiannually for 5 years. If his
bank pays 10% p.a. (compounded semiannually), how much will he be able to draw
semiannually:

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 (a) if he deposits Rs 34 million now?
(b) if he deposits Rs 3 million semiannually for six years?

10. A client, 35 years old, who would like to retire at age 65 (30 years from today). Her goal is to
have enough in her retirement account to provide an income of $75,000 a year, starting a year
after retirement or year 31, for 25 years thereafter. She had a late start on saving for retirement,
with a current balance of $10,000. To catch up, she is now committed to saving $5,000 a year,
with the first contribution a year from now. A single parent with two children, both of which will
be attending college starting in five years, she won't be able to increase the annual $5,000
commitment until after the kids have graduated. Once the children are finished with college, she
will have extra disposable income, but is worried about just how much of an increase it will take
to meet her ultimate retirement goals. To help her meet this goal, estimate how much she will
need to save every year, starting 10 years from now, when the kids are out of college. Assume an
average annual 8% return in the retirement account.

11. After graduating from Ohio State University with a degree in Finance, Kate Myers took a position
as a stock broker with Merrill Lynch in Cleveland. Although she had several college loans to
make payments on, her goal was to set aside funds for the next eight years in order to make a
down payment on a house. After considering the various suburbs of Cleveland, Kate chose
Lakewood as her desired future residency. Based on median house price data, she learned that a
three-bedroom, two-bath house currently costs $98,000. To avoid paying Private Mortgage
Insurance (PMI), Kate wanted to make a down payment of 20%.

Because it will be eight years before Kate buys a house, the $98,000 price will surely not be the
same in the future. To estimate the rate at which the median house price will increase, she
considered the historical price appreciation in Lakewood. In the past, homes appreciated by nearly
4% per annum. Kate was satisfied with this estimation.

Merrill Lynch provides several opportunities for Kate to invest the funds that will be devoted to
the purchase of her future home. She feels that a balanced account containing stocks, bonds, and
government securities would realistically achieve an annual rate of return of 8%.

Questions

a) Taking into consideration the fact that the $98,000 home price will grow at 4% per year, what
will be the future median home selling price in Lakewood in eight years? What amount will
Kate Myers have to accumulate as a down payment if she does decide to buy a house in
Lakewood?
b) Based on your answer from number 1, how much will have to be deposited into the Merrill
Lynch account (which earns 8% per year) at the end of each month to accumulate the required
down payment?
c) If Kate decides to make end-of-the-year deposits into the Merrill Lynch account, how much
would these deposits be?
d) If homes in Lakewood appreciate by 6% per annum over the next eight years instead of the
assumed 4%, how much would Kate have to deposit at the end of each month to make the
down payment? What if the appreciation is only 2% per year?
e) If Kate decided to deposit her down payment funds in less risky certificates of deposit (CDs)
earning only 4%, how much would she have to deposit at the end of each month to make the
down payment? What if she pursued a more risky investment of growth stocks that have an
expected return of 12%?

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12. Greg and Debra Quilici own a four bedroom home in an affluent neighborhood just north of San
Francisco, California. Greg is a partner in the family owned commercial painting business. Debra
now stays home with their child, Brady, who is age 5. Until recently, the Quilicis have felt very
comfortable with their financial position.

After visiting Lawrence Krause, a family financial planner, the couple became concerned that
they were spending too much and not putting enough funds aside for both their child's future
education needs and their own retirement. Greg earns $85,000 per year, but with the rising costs
of education, their past contribution efforts have left them short of their financial goals.

To estimate the amount of money the Quilicis need to begin putting away for future security some
general information was obtained by their financial planner. The couple felt that the amount of
money they currently contribute to their Koegh plan would be sufficient for their retirement
needs. What they had not accounted for was Brady's education.

Greg is an alumni of Stanford University, a private school with an extremely high tuition of
approximately $20,000 per year. Debra graduated from the University of North Carolina at
Chapel Hill. The tuition expense there is only $2,500 per year. When Brady turns 18, the couple
wishes to send him to either of these exceptional universities. They have a slight preference for
the much more local Stanford University. The problem, however, is that with the rate at which
tuition is increasing the Quilicis are not sure they can raise enough money.

To assist in the calculations, assume the tuition at both universities will increase at an annual rate
of 5%. Living expenses are currently estimated at $6,000 per year at both schools. This expense is
expected to grow at only 3% per year. Further assume the Quilicis can deposit their money into a
growth oriented mutual fund at Neuberger & Berman Management, Inc., which has historically
earned a 12% return per annum (1% per month).

The couple wishes to have a pre-determined monthly amount automatically drafted from their
checking account to a special account opened for Brady’s Education till the year Brady starts
college.. When Brady starts college they will slowly liquidate the account by making an annual
payment to Brady to cover tuition and living expenses at the beginning of each year for the four
years he will be in college.

Questions

a) How much will be the tuition and living expenses per year when Brady is ready to attend?
Give an answer for each university.
b) Once Brady starts college what will his total expenses are in each of his four years? Again,
give an answer for each university.
c) How much money will Greg and Debra have to deposit per month to allow Brady to attend
Stanford University? How much money will have to be deposited per month to allow Brady to
attend the University of North Carolina?
d) What if the Quilicis feel the Neuberger & Berman mutual fund will only yield 10%. How
much will have to be deposited per month in order for Brady to attend each college?
13. As an investment advisor, you have been approached by a client called Peter for advice on his
investment plan. He is 30 years old and has Rs.300,000 in his bank. He plans to work for 20 years
and retire at the age of 50, so that he can pursue his hobbies and travel widely in his post-
retirement period. His present salary is Rs.600,000 per year. He expects his salary to increase at
the rate of 12 percent per year until his retirement.

Peter has decided to invest his bank balance and future savings in a balanced mutual fund scheme
which he believes will provide a return of 10 percent per year. You concur with his assessment.

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 Peter seeks your help in answering several questions given below. In answering these questions,
ignore the tax factor.

a) Once he retires at the age of 50, he would like to withdraw Rs. 1,000,000 per year for his
consumption needs for the following 30 years (His life expectancy is 80 years). Each annual
withdrawal will be made at the beginning of the year. How much should be the value of his
investments be when he turns 50, to meet his retirement need?

b) How much should Peter save each year for the next 20 years to be able to withdraw Rs.1,000,
000 per year from the beginning of the 21st year for a period of 30 years? Assume that the
savings will occur at the end of each year. Remember that he already has some bank balance. (
Approximate it to the nearest ‘000)
c) Suppose Peter wants to donate Rs.800,000 per year in the last 10 years of his life to a
charitable cause. Each donation would be made at the beginning of the year. Further, he wants
to bequeath Rs. 3,000,000 to his son at the end of his life. How much should he have in his
investment account when he reaches the age of 50 to meet this need for donation and
bequeathing? (Approximate it to the nearest ‘000.)

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