I

d t be analyzed:
f, llowing cash-flow streams nee o
The o END OF YEAR
4 5
CASH-FLOW 2 3
1 $300 $300
STREAM $200
$100 $200
w 600 1,200
X
y 500
300
z 200

a. Calculate the future (terminal) value of each stream at the end of year 5 with
a com-
pound annual interest rate of 10 percent.
b. Compute the present value of each stream if the discount rate is 14 percent.
fin Meg abuc ks is considering two different savings plan s. The first plan wou ld have her
Muf
ual rate,
deposit $500 every six months, and she would receive interest at a 7 percent ann
every year
compounded semiannually. Under the second plan she would deposit $1,000
with a rate of interest of 7.5 percent, compounded annually. The initial
deposit with
Plan 1 would be made six months from now and, with Plan 2, one year hence.
a. What is the future (terminal) value of the first plan at the end of IO year
s?
b. What is the future (terminal) value of the second plan at the end of IO years?
 •

3 The Time Value of Money

c. Which plan should Muffin use, assuming that her only conce
rn is with the value of her
sa~g s at the end of 10 years?
·
d. Would your answer change if the rate of interest on the
3 • On a contr secon d plan were 7 percent?
act you have a choice of receiving $25,000 six years from now or $50,0
00 twelve
years from now. At what implied compound annual interest rate
between the two contracts? shoul d you be indiff erent
4 • Emerson
Cammack wishes to purchase an annuity contract that will pay him
$7,00 0 a year
for the rest of his life. The Philo Life Insurance Company figures
20 years, based on its actua that his life expectancy is
ry tables. The company imputes a comp ound annual interest
rate of 6 percent in its annuity contracts.
a. How much will Cammack have to pay for the annuity?
b. How much would he have to pay if the interest rate were 8 perce
5• You borro nt?
w $10,000 at 14 percent comp ound annual interest for four years.
The loan is
repayable in four equal annual installments payable at the end
of each year.
a. Wha t is the annua l payment that will completely amortize
the loan over four years?
(You may wish to round to the nearest dollar~)
h. Of each equal payment, what is the amou nt of interest? The
amou nt of loan principal?
(Hint: In early years, the paym ent is composed largely of interest, where
as at the end it
is main ly principal.)
6. Your late Uncle Vern 's will entitles you to receive $1,000
at the end of every other year for
the next two decades. The first cash flow is two years from now.
At a 10 perce nt comp ound
annu al intere st rate, what is the prese nt value of this unusu al
cash-flow pattern? (Try to
solve this probl em in as few steps as you can.)
7. A bank offers you a seven -mon th certificate of depos it (CD)
at a 7.06 perce nt annu al rate
that woul d provi de a 7.25 perce nt effective annu al yield. For the
seven -mon th CD, is inter -
est being comp ound ed daily, weekly, mont hly, or quarterly?
And, by the way, havin g
inves ted $10,000 in this CD, how much mone y woul d you receiv
e when your CD matu res
in seven mont hs? That is, what size check woul d the bank give you
if you close d your
acco unt at the end of seven mont hs?
8. A Dillo nvale , Ohio , man saved ·pennies for 65 years. Whe
n he finally decid ed to cash them
in, he had rough ly 8 milli on of them (or $80,000 worth ), filling 40
trash cans. On average,
the man saved $1,23 0 wort h of ·pennies a year. If he had
depo sited the penn ies saved
each year, at each year,s end, into a savings accou nt earni ng
5 perce nt comp ound annu al
inter est, how much woul d he have had in this accou nt after
65 years of saving? How much
more "cent s" (sens e) woul d this have mean t for our "pen ny
saver " comp ared with simply
putti ng his penn ies into trash cans?
.
9. Xu Lin recen tly obtai ned a IO-year, $50,000 loan. The loan carrie
s an 8 perce nt comp ound
annu al inter est rate and calls for annu al insta llmen t paym
ents of $7,451.47 at the end of
each of the next IO years .
a. How muc h (in dolla rs) of the first year' s paym ent is princ
ipal?
b. How muc h total inter est will be paid over the life of the loan? (Hint
. You do not need
to cons truct a loan amor tizati on table to answ er this quest
ion. Some simp le math is all
you need .)