# Prof.

Rushen Chahal

CHAPTER 5

The Time Value of Money
CHAPTER ORIENTATION
In this chapter the concept of a time value of money is introduced, that is, a dollar today is
worth more than a dollar received a year from now. Thus if we are to logically compare
projects and financial strategies, we must either move all dollar flows back to the present or
out to some common future date.

CHAPTER OUTLINE
I.

Compound interest results when the interest paid on the investment during the first
period is added to the principal and during the second period the interest is earned on
the original principal plus the interest earned during the first period.
A.

Mathematically, the future value of an investment if compounded annually at
a rate of i for n years will be
FVn
=
PV (l + i)n
where n
= the number of years during which the compounding
occurs
i = the annual interest (or discount) rate
PV = the present value or original amount invested at the
beginning of the first period
FVn
= the future value of the investment at the end of n
years
1.

The future value of an investment can be increased by either
increasing the number of years we let it compound or by compounding
it at a higher rate.

2.

If the compounded period is less than one year, the future value of an
investment can be determined as follows:
FVn
where m=

=

PV

mn

the number of times compounding occurs during the year

91

Prof. Rushen Chahal
II.

Determining the present value, that is, the value in today's dollars of a sum of money
to be received in the future, involves nothing other than inverse compounding. The
differences in these techniques come about merely from the investor's point of view.
A.

Mathematically, the present value of a sum of money to be received in the
future can be determined with the following equation:
PV

=

where: n
i
PV
FVn
1.

III.

FVn
=
=
=
=

the number of years until payment will be received,
the interest rate or discount rate
the present value of the future sum of money
the future value of the investment at the end of n
years

The present value of a future sum of money is inversely related to both
the number of years until the payment will be received and the interest
rate.

An annuity is a series of equal dollar payments for a specified number of years.
Because annuities occur frequently in finance, for example, bond interest payments,
we treat them specially.
A.

A compound annuity involves depositing or investing an equal sum of money
at the end of each year for a certain number of years and allowing it to grow.
1.

This can be done by using our compounding equation, and
compounding each one of the individual deposits to the future or by
using the following compound annuity equation:
FVn

 n −1

PMT  ∑ (1 + i) t 
 t =0

=

where: PMT

= the annuity value deposited at the end of each
year
= the annual interest (or discount) rate
= the number of years for which the annuity will
last
= the future value of the annuity at the end of the
nth year

i
n
FVn
B.

Pension funds, insurance obligations, and interest received from bonds all
involve annuities. To compare these financial instruments we would like to
know the present value of each of these annuities.
1.

This can be done by using our present value equation and discounting
each one of the individual cash flows back to the present or by using
the following present value of an annuity equation:
PV

=

 n
PMT  ∑
 t =1

92

1 

(1 + i) t 

Prof. Rushen Chahal
where: PMT

= the annuity deposited or withdrawn at the end
of each year
= the annual interest or discount rate
= the present value of the future annuity
= the number of years for which the annuity will
last

i
PV
n
C.

IV.

This procedure of solving for PMT, the annuity value when i, n, and PV are
known, is also the procedure used to determine what payments are associated
with paying off a loan in equal installments. Loans paid off in this way, in
periodic payments, are called amortized loans. Here again we know three of
the four values in the annuity equation and are solving for a value of PMT, the
annual annuity.

Annuities due are really just ordinary annuities where all the annuity payments have
been shifted forward by one year. Compounding them and determining their present
value is actually quite simple. Because an annuity, due merely shifts the payments
from the end of the year to the beginning of the year, we now compound the cash
flows for one additional year. Therefore, the compound sum of an annuity due is
FVn(annuity due)
A.

VI.

PMT (FVIFAi,n) (1 + i)

Likewise, with the present value of an annuity due, we simply receive each
cash flow one year earlier – that is, we receive it at the beginning of each year
rather than at the end of each year. Thus the present value of an annuity due
is
PV(annuity due)

V.

=

=

PMT (PVIFAi,n) (1 + i)

A perpetuity is an annuity that continues forever, that is every year from now on this
investment pays the same dollar amount.
A.

An example of a perpetuity is preferred stock which yields a constant dollar
dividend infinitely.

B.

The following equation can be used to determine the present value of a
perpetuity:
PV
=
where: PV =
the present value of the perpetuity
pp =
the constant dollar amount provided by the perpetuity
i
=
the annual interest or discount rate

To aid in the calculations of present and future values, tables are provided at the back
of Financial Management (FM).
A.

To aid in determining the value of FVn in the compounding formula
FVn

=

PV (1 + i)n = PV (FVIFi,n)

tables have been compiled for values of FVIFi,n or (i + 1)n in Appendix B,
"Compound Sum of \$1," in FM.

93

Prof. Rushen Chahal
B.

To aid in the computation of present values
PV

=

FVn = FVn (PVIFi,n)

tables have been compiled for values of
or PVIFi,n
and appear in Appendix C in the back of FM.
C.

Because of the time-consuming nature of compounding an annuity,
FVn

=

PMT

n −1

t=0

(1 + i) t

= PMT (FVIFAi,n)

Tables are provided in Appendix D of FM for
n −1

t=0

(1 + i) t or FVIFAi,n

for various combinations of n and i.
D.

To simplify the process of determining the present value of an annuity
 n
PV = PMT  ∑
 t =1

(1 + i) 
1

t

= PMT (PVIFAi,n)

tables are provided in Appendix E of FM for various combinations of n and i
for the value
n

1

t =1

(1 + i) t

or PVIFAi,n

V. Spreadsheets and the Time Value of Money.
A.

While there are several competing spreadsheets, the most popular one is
Microsoft Excel. Just as with the keystroke calculations on a financial
calculator, a spreadsheet can make easy work of most common financial
calculations. Listed below are some of the most common functions used with
Excel when moving money through time:

Calculation:

Formula:

Present Value
Future Value
Payment

= PV(rate, number of periods, payment, future value, type)
= FV(rate, number of periods, payment, present value, type)
= PMT(rate, number of periods, present value, future value,
type)
Number of Periods = NPER(rate, payment, present value, future value, type)
Interest Rate
= RATE(number of periods, payment, present value, future
value, type, guess)

94

Prof. Rushen Chahal
where: rate
= i, the interest rate or discount rate
number of periods = n, the number of years or periods
payment
= PMT, the annuity payment deposited or received at the
end of each period
future value
= FV, the future value of the investment at the end of n
periods or years
present value
= PV, the present value of the future sum of money
type
= when the payment is made, (0 if omitted)
0 = at end of period
1 = at beginning of period
guess
= a starting point when calculating the interest rate, if
omitted, the calculations begin with a value of 0.1 or
10%

END-OF-CHAPTER QUESTIONS
5-1.

The concept of time value of money is recognition that a dollar received today is
worth more than a dollar received a year from now or at any future date. It exists
because there are investment opportunities on money, that is, we can place our dollar
received today in a savings account and one year from now have more than a dollar.

5-2.

Compounding and discounting are inverse processes of each other. In compounding,
money is moved forward in time, while in discounting money is moved back in time.
This can be shown mathematically in the
compounding equation:
FVn

=

PV (1 + i)n

We can derive the discounting equation by multiplying each side of
this equation by and we get:
PV
5-3.

=

FVn

=

PV(1 + i)n

We know that
FVn

Thus, an increase in i will increase FVn and a decrease in n will
decrease FVn.
5-4.

Bank C which compounds daily pays the highest interest. This occurs because, while
all banks pay the same interest, 5 percent, bank C compounds the 5 percent daily.
Daily compounding allows interest to be earned more frequently than the other
compounding periods.

5-5.

The values in the present value of an annuity table (Table 5-8) are actually derived

95

Prof. Rushen Chahal
from the values in the present value table (Table 5-4). This can be seen, by
examining the values represented in each table. The present value table gives values
of
for various values of i and n, while the present value of an annuity table gives values
of
n

1

t =1

(1 + i) t

for various values of i and n. Thus the value in the present value of annuity table for
an n-year annuity for any discount rate i is merely the sum of the first n values in the
10

present value table. PVIFA

10%,10yrs

= 6.145.

PVIF10%,n = 6.144 = 0.909 +

n =1

0.826 + 0.751 + 0.683 + 0.621 + 0.564 + 0.513 + 0.467 + 0.424 + 0.386
5-6.

An annuity is a series of equal dollar payments for a specified number of years.
Examples of annuities include mortgage payments, interest payments on bonds, fixed
lease payments, and any fixed contractual payment. A perpetuity is an annuity that
continues forever, that is, every year from now on this investment pays the same
dollar amount. The difference between an annuity and a perpetuity is that a
perpetuity has no termination date whereas an annuity does.

SOLUTIONS TO
END-OF-CHAPTER PROBLEMS
Solutions to Problem Set A
5-1A. (a)

(b)

FVn

=

PV (1 + i)n

FV10

=

\$5,000(1 + 0.10)10

FV10

=

\$5,000 (2.594)

FV10

=

\$12,970

FVn

=

PV (1 + i)n

FV7

=

\$8,000 (1 + 0.08)7

FV7

=

\$8,000 (1.714)

FV7

=

\$13,712

96

Prof. Rushen Chahal
(c)

(d)

5-2A. (a)

(b)

(c)

(d)

5-3A. (a)

FV12

=

PV (1 + i)n

FV12

=

\$775 (1 + 0.12)12

FV12

=

\$775 (3.896)

FV12

=

\$3,019.40

FVn

=

PV (1 + i)n

FV5

=

\$21,000 (1 + 0.05)5

FV5

=

\$21,000 (1.276)

FV5

=

\$26,796.00

FVn

=

PV (1 + i)n

\$1,039.50

=

\$500 (1 + 0.05)n

2.079

=

FVIF 5%, n yr.

Thus n

=

15 years (because the value of 2.079 occurs in the 15 year
row of the 5 percent column of Appendix B).

FVn

=

PV (1 + i)n

\$53.87

=

\$35 (1 + .09)n

1.539

=

FVIF 9%, n yr.

Thus, n

=

5 years

FVn

=

PV (1 + i)n

\$298.60

=

\$100 (1 + 0.2)n

2.986

=

FVIF 20%, n yr.

Thus, n

=

6 years

FVn

=

PV (1 + i)n

\$78.76
1.486

=
=

\$53 (1 + 0.02)n
FVIF 2%, n yr.

Thus, n

=

20 years

FVn

=

PV (1 + i)n

\$1,948
3.896

=
=

\$500 (1 + i)12
FVIF i%, 12 yr.

Thus, i

=

12% (because the Appendix B value of 3.896 occurs in
97

Prof. Rushen Chahal
the 12 year row in the 12 percent column)

98

Prof. Rushen Chahal
(b)

(c)

(d)

5-4A. (a)

(b)

(c)

FVn

=

PV (1 + i)n

\$422.10

=

\$300 (1 + i)7

1.407

=

FVIFi%, 7 yr.

Thus, i

=

5%

FVn

=

PV (1 + i)n

\$280.20

=

\$50 (1 + i)20

5.604

=

FVIF i%, 20 yr.

Thus, i

=

9%

FVn

=

PV (1 + i)n

\$497.60

=

\$200 (1 + i)5

=

FVIFi%, 5 yr.

Thus, i

=

20%

PV

=

FVn

PV

=

\$800

PV

=

\$800 (0.386)

PV

=

\$308.80

PV

=

FVn

PV

=

\$300

PV

=

\$300 (0.784)

PV

=

\$235.20

PV

=

FVn

PV

=

\$1,000

PV

=

\$1,000 (0.789)

PV

=

\$789

99

Prof. Rushen Chahal
(d)

5-5A. (a)

(b)

(c)

(d)

PV

=

FVn

PV

=

\$1,000

PV

=

\$1,000 (0.233)

PV

=

\$233

FVn

=

 n −1

PMT  ∑ (1 + i) t 
t=0

FV10

=

 10 − 1
t
\$500  ∑ (1 + 0.05) 
 t =0

FV10

=

\$500 (12.578)

FV10

=

\$6,289

FVn

=

 n −1

PMT  ∑ (1 + i) t 
t=0

FV5

=

 5 −1

\$100  ∑ (1 + 0.1) t 
t =0

FV5

=

\$100 (6.105)

FV5

=

610.50

FVn

=

 n −1

PMT  ∑ (1 + i) t 
t=0

FV7

=

 7 −1
t
\$35  ∑ (1 + 0.07) 
t =0

FV7

=

\$35 (8.654)

FV7

=

\$302.89

FVn

=

 n −1

PMT  ∑ (1 + i) t 
t=0

FV3

=

 3 −1
t
\$25  ∑ (1 + 0.02) 
t =0

FV3

=

\$25 (3.060)

FV3

=

\$76.50

100

Prof. Rushen Chahal
5-6A. (a)

(b)

(c)

(d)

5-7A. (a)

=

 n
1 
PMT  ∑
t
 t = 1 (1 + i) 

PV

=

 10

1

\$2,500  ∑
t
(1
+
0.07)
 t =1

PV

=

\$2,500 (7.024)

PV

=

\$17,560

PV

=

 n
1 
PMT  ∑
t
 t = 1 (1 + i) 

PV

=

 3
1
\$70  ∑
t
 t = 1 (1 + 0.03)

PV

=

\$70 (2.829)

PV

=

\$198.03

PV

=

 n
PMT  ∑
 t =1

(1 + i) 

PV

=

 7
\$280  ∑
 t =1

(1 + 0.06) t 

PV

=

\$280 (5.582)

PV

=

\$1,562.96

PV

=

 n
PMT  ∑
 t =1

(1 + i) t 

PV

=

 10
\$500  ∑
 t =1

(1 + 0.1) t 

PV

=

\$500 (6.145)

PV

=

\$3,072.50

FVn

=

PV (1 + i)n

PV

1

t

1

1

1

compounded for 1 year
FV1

=

\$10,000 (1 + 0.06)1

FV1

=

\$10,000 (1.06)

FV1

=

\$10,600

101



Prof. Rushen Chahal
compounded for 5 years
FV5

=

\$10,000 (1 + 0.06)5

FV5

=

\$10,000 (1.338)

FV5

=

\$13,380

compounded for 15 years

(b)

FV15

=

\$10,000 (1 + 0.06)15

FV15

=

\$10,000 (2.397)

FV15

=

\$23,970

FVn

=

PV (1 + i)n

compounded for 1 year at 8%
FV1

=

\$10,000 (1 + 0.08)1

FV1

=

\$10,000 (1.080)

FV1

=

\$10,800

compounded for 5 years at 8%
FV5

=

\$10,000 (1 + 0.08)5

FV5

=

\$10,000 (1.469)

FV5

=

\$14,690

compounded for 15 years at 8%
FV15

=

\$10,000 (1 + 0.08)15

FV15

=

\$10,000 (3.172)

FV15

=

\$31,720

compounded for 1 year at 10%
FV1

=

\$10,000 (1 + 0.1)1

FV1

=

\$10,000 (1 + 1.100)

FV1

=

\$11,000

compounded for 5 years at 10%
FV5

=

\$10,000 (1 + 0.1)5

FV5

=

\$10,000 (1.611)

FV5

=

\$16,110

compounded for 15 years at 10%
FV15

=

\$10,000 (1 + 0.1)15

102

Prof. Rushen Chahal
FV15
(c)

5-8A.

=

FV15
=
\$41,770
There is a positive relationship between both the interest rate used to
compound a present sum and the number of years for which the compounding
continues and the future value of that sum.
FVn

=

Account
Theodore Logan III
Vernell Coles
Thomas Elliott
Wayne Robinson
Eugene Chung
Kelly Cravens
5-9A. (a)

(b)

(c)

\$10,000 (4.177)

FVn

=

PV (1 + )mn
PV
\$ 1,000
95,000
8,000
120,000
30,000
15,000

i
10%
12%
12%
8%
10%
12%

m
1
12
6
4
2
3

PV (1 + i)n

FV5

=

\$5,000 (1 + 0.06)5

FV5

=

\$5,000 (1.338)

FV5

=

\$6,690

FVn

=

PV (1 + )mn

FV5

=

2X5
\$5,000 (1 + )

FV5

=

\$5,000 (1 + 0.03)10

FV5

=

\$5,000 (1.344)

FV5

=

\$6,720

FVn

=

PV (1 + )mn

FV5

=

6X5
5,000 (1 + )

FV5

=

\$5,000 (1 + 0.01)

FV5

=

\$5,000 (1.348)

FV5

=

\$6,740

FVn

=

PV (1 + i)n

FV5

=

5
\$5,000 (1 + 0.12)

FV5

=

\$5,000 (1.762)

FV5

=

\$8,810

103

30

n
10
1
2
2
4
3

(1 + )mn
2.594
1.127
1.268
1.172
1.477
1.423

PV(1 + )mn
\$ 2,594
107,065
10,144
140,640
44,310
21,345

Prof. Rushen Chahal

(d)

(e)

5-10A.

mn

FV5

=

PV

FV5

=

\$5,000

FV5

=

\$5,000 (1 + 0.06)10

FV5

=

\$5,000 (1.791)

FV5

=

\$8,955

FV5

=

PV mn

FV5

=

\$5,000 6X5

FV5

=

\$5,000 (1 + 0.02)30

FV5

=

\$5,000 (1.811)

FV5

=

\$9,055

FVn

=

PV (1 + i)n

FV12

=

12
\$5,000 (1 + 0.06)

FV12

=

5,000 (2.012)

FV12

=

\$10,060

2X5

An increase in the stated interest rate will increase the future value of a given
sum. Likewise, an increase in the length of the holding period will increase
the future value of a given sum.
Annuity A:

PV

=

 n
PMT  ∑
 t =1

(1 + i) t 

PV

=

 12
\$8,500  ∑
 t =1

PV

=

\$8,500 (6.492)

PV

=

\$55,182

1

(1 + 0.11) 
1

t

Since the cost of this annuity is \$50,000 and its present value is \$55,182,
given an 11 percent opportunity cost, this annuity has value and should be
accepted.

104

Prof. Rushen Chahal
Annuity B:

PV

=

 n
PMT  ∑
 t =1

(1 + i) t 

PV

=

 25
\$7,000  ∑
 t =1

PV

=

\$7,000 (8.442)

PV

=

\$59,094

1

(1 + 0.11) 
1

t

Since the cost of this annuity is \$60,000 and its present value is only \$59,094,
given an 11 percent opportunity cost, this annuity should not be accepted.
Annuity C:

 n
1 
PMT  ∑
t
 t = 1 (1 + i) 
 20

1

\$8,000  ∑
t
(1
+
0.11)
 t =1

PV

=

PV

=

PV

=

\$8,000 (7.963)

PV

=

\$63,704

Since the cost of this annuity is \$70,000 and its present value is only \$63,704,
given an 11 percent opportunity cost, this annuity should not be accepted.
5-11A. Year 1:FVn

Year 2:FVn

Year 3:

=

PV (1 + i)n

FV1

=

15,000(1 + 0.2)1

FV1

=

15,000(1.200)

FV1

=

18,000 books

=

PV (1 + i)n

FV2

=

15,000(1 + 0.2)2

FV2

=

15,000(1.440)

FV2

=

21,600 books

FVn

=

PV (1 + i)n

FV3

=

15,000(1.20)3

FV3

=

15,000(1.728)

FV3

=

25,920 books

105

Prof. Rushen Chahal
Book sales
25,000
20,000

15,000

years
1

2

3

The sales trend graph is not linear because this is a
compound growth trend. Just as compound interest occurs
when interest paid on the investment during the first period
is added to the principal of the second period, interest is
earned on the new sum. Book sales growth was
compounded; thus, the first year the growth was 20 percent
of 15,000 books for a total of 18,000 books, the second year
20 percent of 18,000 books for a total of 21,600, and the
third year 20 percent of 21,600 books for a total of 25,920.
5-12A.

FVn

=

PV (1 + i)n

FV1
FV1
FV1

=
=
=

FV2
FV2
FV2

=
=
=

41(1 + 0.10)1
41(1.10)
45.1 Home Runs in 1981 (in spite of the baseball strike).
41(1 + 0.10)2

FV3
FV3
FV3

=
=
=

FV4
FV4
FV4

=
=
=

41(1.21)
49.61 Home Runs in 1982
41(1 + 0.10)3
41(1.331)
54.571 Home Runs in 1983.
41(1 + 0.10)4
41(1.464)
60.024 Home Runs in 1984.

106

Prof. Rushen Chahal
FV5
FV5
FV5
5-13A.

5-14A.

5-15A.

=
=
=

41(1 + 0.10)5
41(1.611)
66.051 Home Runs in 1985 (for a new major league record).

PV

=

 n
PMT  ∑
 t =1

(1 + i) t 

\$60,000

=

 25
PMT  ∑

 t =1

(1 + 0.09) t 

\$60,000
Thus, PMT

=
=

PMT (9.823)
\$6,108.11 per year for 25 years.

FVn

=

 n −1

PMT  ∑ (1 + i) t 

t=0

\$15,000

=

 15 − 1
t
PMT  ∑ (1 + 0.06) 
 t=0

\$15,000

=

PMT (23.276)

Thus, PMT

=

\$644.44

FVn

=

PV (1 + i)n

\$1,079.50

=

\$500 (FVIF i%, 10 yr.)

2.159
Thus, i

=
=

FVIF i%, 10 yr.
8%

1

1

5-16A. The value of the home in 10 years
FV10

=

PV (1 + .05)10

=

\$100,000(1.629)

=

\$162,900

How much must be invested annually to accumulate \$162,900?

5-17A.

\$162,900

=

 10 − 1
t
PMT  ∑ (1 + .10) 
 t =0

\$162,900

=

PMT(15.937)

PMT

=

\$10,221.50

FVn

=

 n −1

PMT  ∑ (1 + i) t 
t=0

107

Prof. Rushen Chahal

5-18A.

\$10,000,000

=

 10 − 1
t
PMT  ∑ (1 + .09) 
 t =0

\$10,000,000

=

PMT(15.193)

Thus, PMT

=

\$658,197.85

One dollar at 12.0% compounded monthly for one year
FVn

=

PV nm

FV1

=

\$1(1 + .01)1

=

\$1(1.127)

=

\$1.127

One dollar at 13.0% compounded annually for one year
FVn

=

PV (1 + i)n

FV1

=

\$1(1 + .13)1

=

\$1(1.13)

=

\$1.13

The loan at 12% compounded monthly is more attractive.
5-19A. Investment A
PV

=

 n
PMT  ∑
 t =1

(1 + i) t 

=

 5
\$10,000  ∑
 t =1

=

\$10,000(2.991)

=

\$29,910

i

(1 + .20) 
1

t

Investment B
First, discount the annuity back to the beginning of year 5, which is the end of
year 4. Then, discount this equivalent sum to present.
 n
1 
PV
=
PMT  ∑
t
 t = 1 (1 + i) 
 6

1

=
\$10,000  ∑
t 
(1
+
.20)
 t =1

PV

=

\$10,000(3.326)

=
=

\$33,260--then discount the equivalent sum back to present.
FVn

108

Prof. Rushen Chahal
=

\$33,260

=

\$33,260(.482)

=

\$16,031.32

=

FVn

=

\$10,000 + \$50,000

Investment C
PV

+ \$10,000

5-20A.

5-21A. (a)

(b)

(c)

(d)

5-22A.

5-23A.

=

\$10,000(.833) + \$50,000(.335) + \$10,000(.162)

=

\$8,330 + \$16,750 + \$1,620

=

\$26,700

PV

=

FVn

PV

=

\$1,000

PV

=

\$1,000(.513)

PV

=

\$513

PV

=

PV

=

PV

=

PV

=

PV

=

PV

=

PV

=

PV

=

PV

=

PV

=

PV

=

PV

=

\$3,750

\$8,333.33

\$1,111.11

\$1,900

PV(annuity due) =

PMT(PVIFAi,n)(l+i)

=

\$1,000(6.145)(1+.10)

=

\$6145(1.10)

=

\$6759.50

FVn

=

.
PV (1 + )m n

4

=

.
1(1 + )2 n
109

Prof. Rushen Chahal
4

=

.
(1 + 0.08)2 n

4

=

FVIF 8%, 2n yr.

A value of 3.996 occurs in the 8 percent column and 18-year row of the table in
Appendix B. Therefore, 2n = 18 years and n = approximately 9 years.
5-24A. Investment A:
PV

=

FVn (PVIFi,n)

PV

=

\$2,000(PVIF10%, year 1) + \$3,000(PVIF10%, year 2) +
\$4,000(PVIF10%, year 3) - \$5,000(PVIF10%, year 4) +
\$5,000(PVIF10%, year 5)

=

\$2,000(.909) + \$3,000(.826) + \$4,000(.751) - \$5,000(.683) +
\$5,000(.621)

=

\$1,818 + \$2,478 + \$3,004 - \$3,415 + \$3,105

=

\$6,990.

=

FVn (PVIFi,n)

=

\$2,000(PVIF10%, year 1) + \$2,000(PVIF10%, year 2) +
\$2,000(PVIF10%, year 3) + \$2,000(PVIF10%, year 4) +
\$5,000(PVIF10%, year 5)

=

\$2,000(.909) + \$2,000(.826) + \$2,000(.751) + \$2,000(.683) +
\$5,000(.621)

=

\$1,818 + \$1,652 + \$1,502 + \$1,366 + \$3,105

=

\$9,443.

Investment B:
PV
PV

110

Prof. Rushen Chahal
Investment C:

5-25A.

PV

=

FVn (PVIFi,n)

PV

=

\$5,000(PVIF10%, year 1) + \$5,000(PVIF10%, year 2) \$5,000(PVIF10%, year 3) - \$5,000(PVIF10%, year 4) +
\$15,000(PVIF10%, year 5)

=

\$5,000(.909) + \$5,000(.826) - \$5,000(.751) - \$5,000(.683) +
\$15,000(.621)

=

\$4,545 + \$4,130 - \$3,755 - \$3,415 + \$9,315

=

\$10,820.

The Present value of the \$10,000 annuity over years 11-15.
PV

=

  15
PMT   ∑
  t =1

=

\$10,000(9.712 - 7.360)

=

\$10,000(2.352)

=

\$23,520

1
(1 + .06) t

  10
 −  ∑
  t =1

1
(1 + .06) t


 



The present value of the \$20,000 withdrawal at the end of year 15:
PV

=

FV15

=

\$20,000(.417)

=

\$8,340

Thus, you would have to deposit \$23,520 + \$8,340 or \$31,860 today.
5-26A.

5-27A.

5-28A.

PV

=

 10
1
PMT  ∑
t
 t = 1 (1 + .10)

\$40,000

=

PMT (6.145)

PMT

=

\$6,509

PV

=

 5
PMT  ∑
 t =1

\$30,000

=

\$10,000 (PVIFAi%, 5 yr.)

3.0

=

PVIFAi%, 5 yr.

i

=

20%

PV

=

FVn
111

(1 + i) t 
1

Prof. Rushen Chahal

5-29A.

5-30A.

\$10,000

=

\$27,027 (PVIFi%, 5 yr.)

.370

=

PVIF22%, 5 yr.

Thus, i

=

22%

PV

=

 n
1 
PMT  ∑
t
 t = 1 (1 + i) 

\$25,000

=

 5

1

PMT  ∑
t

 t = 1 (1 + .12) 

\$25,000

=

PMT (3.605)

PMT

=

\$6,934.81

The present value of \$10,000 in 12 years at 11 percent is:
PV

=

 1
FVn 
n
 (1 + i)



PV

=

1
\$10,000 
12
 (1 + .11)

PV

=

\$10,000 (.286)

PV

=

\$2,860



The present value of \$25,000 in 25 years at 11 percent is:
PV

=

1
\$25,000 
25
 (1 + .11)

=

\$25,000 (.074)

=

\$1,850



Thus take the \$10,000 in 12 years.
5-31A.

=

 n −1

PMT  ∑ (1 + i) t 
t=0

\$20,000

=

 5 −1
t
PMT  ∑ (1 + .12) 
t =0

\$20,000

=

PMT(6.353)

PMT

=

\$3,148.12

FVn

112

Prof. Rushen Chahal
5-32A. (a)

(b)

(c)

=

 n −1
t
PMT  ∑ (1 + i) 
t=0

\$50,000

=

 15 − 1
t
PMT  ∑ (1 + .07) 
 t=0

\$50,000

=

PMT (FVIFA7%, 15 yr.)

\$50,000

=

PMT(25.129)

PMT

=

\$1,989.73. per year

PV

=

FVn

PV

=

\$50,000 (PVIF7%, 15 yr.)

PV

=

\$50,000(.362)

PV

=

\$18,100 deposited today

FVn

The contribution of the \$10,000 deposit toward the \$50,000 goal is
FVn

=

PV(1 + i)n

FVn

=

\$10,000 (FVIF7%, 10 yr.)

FV10

=

\$10,000(1.967)

=

\$19,670

Thus only \$30,330 need be accumulated by annual deposit.

5-33A. (a)

FVn

=

 n −1
t
PMT  ∑ (1 + i) 
t=0

\$30,330

=

PMT (FVIFA7%, 15 yr.)

\$30,330

=

PMT [25.129]

PMT

=

\$1,206.97 per year

This problem can be subdivided into (1) the compound value of the \$100,000
in the savings account (2) the compound value of the \$300,000 in stocks, (3)
the additional savings due to depositing \$10,000 per year in the savings
account for 10 years, and (4) the additional savings due to depositing \$10,000
per year in the savings account at the end of years 6-10. (Note the \$20,000
deposited in years 6-10 is covered in parts (3) and (4).)
(1)

Future value of \$100,000
FV10

=

\$100,000 (1 + .07)10

FV10

=

\$100,000 (1.967)

FV10

=

\$196,700
113

Prof. Rushen Chahal
(2)

(3)

Future value of \$300,000
FV10

=

\$300,000 (1 + .12) 10

FV10

=

\$300,000 (3.106)

FV10

=

\$931,800

Compound annuity of \$10,000, 10 years
FV10

(4)

=

 n −1

PMT  ∑ (1 + i) t 
t=0

=

 10 − 1

\$10,000  ∑ (1 + .07) t 
 t =0

=

\$10,000 (13.816)

=

\$138,160

Compound annuity of \$10,000 (years 6 - 10)
FV5

=

 5 −1

\$10,000  ∑ (1 + .07) t 
t =0

=

\$10,000 (5.751)

=

\$57,510

At the end of ten years you will have \$196,700 + \$931,800 + \$138,160 + \$57,510 =
\$1,324,170.
(b)

5-34A.

5-35A.

PV

=

 20
PMT  ∑
 t =1

\$1,324,170

=

PMT (8.514)

PMT

=

\$155,528

PV

=

PMT (PVIFAi%, n yr.)

\$100,000

=

PMT (PVIFA15%, 20 yr.)

\$100,000

=

PMT(6.259)

PMT

=

\$15,977

PV

=

PMT (PVIFAi%, n yr.)

\$150,000

=

PMT (PVIFA10%, 30 yr.)

\$150,000

=

PMT(9.427)

PMT

=

\$15,912

114

(1 + .10) t 
1

Prof. Rushen Chahal
5-36A.

At 10%:
PV

=

\$50,000 + \$50,000 (PVIFA10%, 19 yr.)

PV

=

\$50,000 + \$50,000 (8.365)

PV

=

\$50,000 + \$418,250

PV

=

\$468,250

PV

=

\$50,000 + \$50,000 (PVIFA20%, 19 yr.)

PV

=

\$50,000 + \$50,000 (4.843)

PV

=

\$50,000 + \$242,150

PV

=

\$292,150

FVn(annuity due)

=

PMT(FVIFAi,n)(l+i)

=

\$1000(FVIFA10%,10 years)(1+.10)

=

\$1000(15.937)(1.1)

=

\$17,530.70

=

PMT(FVIFAi,n)(l+i)

=

\$1,000(FVIFA15%,10 years)(1+.15)

=

\$1,000(20.304)(1.15)

=

\$23,349.60

=

PMT(PVIFAi,n)(l+i)

=

\$1,000(PVIFA10%,10 years)(1+.10)

=

\$1,000(6.145)(1.10)

=

\$6,759.50

=

PMT(PVIFAi,n)(l+i)

=

\$1,000(PVIFA15%,10 years)(l+.15)

=

\$1,000(5.019)(1.15)

=

\$5,771.85

At 20%:

5-37A.

FVn(annuity due)

5-38A.

PV (annuity due)

PV (annuity due)

5-39A.

PV

=

PMT(PVIFAi,n)(PVIFi,n)

=

PMT(PVIFA10%,10 years)(PVIF10%,7 years)

=

\$1,000(6.145)(.513)

=

\$3,152.39

115

Prof. Rushen Chahal
5-40A.

FVn

=

PV (FVIFi%, n yr.)

\$6,500

=

.12(FVIFi%, 37 yr.)

solving using a financial calculator:
i

=

34.2575%

5-41A. (a)
1/04

1/09

1/14

1/19

1/24

1/29

\$50,000
\$50,000 per year

\$250,000

\$100,000

There are a number of equivalent ways to discount these cash flows back to present,
one of which is as follows (in equation form):
PV

=

\$50,000(PVIFA10%, 19 yr. - PVIFA10%, 4 yr.)
+ \$250,000(PVIF10%, 20 yr.)
+ \$50,000(PVIF10%, 23 yr. + PVIF10%, 24 yr.)
+ \$100,000 (PVIF10%, 25 yr.)

=

\$50,000 (8.365-3.170) + \$250,000 (.149)
+ \$50,000 (0.112 + .102) + \$100,000 (.092)

(b)
life.

=

\$259,750 + \$37,250 + \$10,700 + \$9,200

=

\$316,900

If you live longer than expected you could end up with no money later on in

116

Prof. Rushen Chahal
5-42A.

rate (i)
number of periods (n)
payment (PMT)
present value (PV)
type (0 = at end of period)

=
=
=
=
=

8%
7
\$0
\$900
0

Future value

=

\$1,542.44

Excel formula: =FV(rate,number of periods,payment,present value,type)
Notice that present value (\$900) took on a negative value.
5-43A In 20 years you’d like to have \$250,000 to buy a home, but you only have \$30,000. At
what rate must your \$30,000 be compounded annually for it to grow to \$250,000 in 20
years?
number of periods (n)
payment (PMT)
present value (PV)
future value (FV)
type (0 = at end of period)
guess
i

=
=
=
=
=
=
=

20
\$0
\$30,000
\$250,000
0
11.18%

Excel formula: =RATE(number of periods,payment,present value,future
value,type,guess)
Notice that present value (\$30,000) took on a negative value.
5-44A. To buy a new house you take out a 25 year mortgage for \$300,000. What will your
monthly interest rate payments be if the interest rate on your mortgage is 8 percent?
Two things to keep in mind when you're working this problem: first, you'll have to
convert the annual rate of 8 percent into a monthly rate by dividing it by 12, and
second, you'll have to convert the number of periods into months by multiplying 25
times 12 for a total of 300 months.
Excel formula: =PMT(rate,number of periods,present value,future value,type)
rate (i)
number of periods (n)
present value (PV)
future value (FV)
type (0 = at end of period)

=
=
=
=
=

monthly mortgage payment =

8%/12
300
\$300,000
\$0
0
(\$2,315.45)

117

Prof. Rushen Chahal
Notice that monthly payments take on a negative value because you pay them.
You can also use Excel to calculate the interest and principal portion of any loan
amortization payment. You can do this using the following Excel functions:
Calculation:

Formula:

Interest portion of payment

=IPMT(rate,period,number of periods,present
value,future value,type)

Principal portion of payment

=PPMT(rate,period,number of periods,present
value,future value,type)

Where period refers to the number of an individual periodic payment.
Thus, if you would like to determine how much of the 48th monthly payment went
toward interest and principal you would solve as follows:
Interest portion of payment 48:

(\$1,884.37)

The principal portion of payment 48:
5-45A.a.

b.

c.

d.

N

=

378

I/Y

=

6

PV

=

-24

PMT

=

0

CPT FV =

88.27 billion dollars

N

=

10

I/Y

=

10

CPT PV =

-77.108 billion dollars

PMT

=

0

FV

=

200. billion

N

=

10

CPT I/Y

=

14.87%

PV

=

-50 billion

PMT

=

0

FV

=

200. billion

N

=

40

I/Y

=

7

PV

=

-100. billion

CPT PMT
FV

=
=

7.5 billion dollars

0

118

(\$431.08)

Prof. Rushen Chahal
5-46A. What will the car cost in the future?
N

=

6

I/Y

=

3

PV

=

-15,000

PMT

=

0

CPT FV

=

17,910.78 dollars

How much must Bart put in an account today in order to have \$17,910.78 in 6
years?

5-47A.

N

=

6

I/Y

=

7.5

CPT PV =

-11,605.50 dollars

PMT

=

0

FV

=

17,910.78

N

=

45

I/Y

=

8.75

PV

=

0

CPT PMT
FV

=

-2,054.81 dollars

= 1,000,000

5-48A.First, we must calculate what Mr. Burns will need in 20 years, then we will know what
he needs in 20 years and we can then calculate how much he needs to deposit each
year in order to come up with that amount (note: once you calculate the present
value, you must multiply your answer, in this case -\$4.192 billion times (1 + i)
because this is an annuity due):
N

=

10

I/Y

=

20

CPT PV =

-4.1925 billion × 1.20 = -5.031 billion dollars

PMT

=

1 billion

FV

=

0

Next, we will determine how much Mr. Burns needs to deposit each year for 20 years
to reach this goal of accumulating \$5.031 billion at the end of the 20 years:
N

=

20

I/Y

=

20

PV

=

0

CPT PMT
FV

= -26.9 million dollars
=

5.031 billion
119

Prof. Rushen Chahal
5-49A. What’s the \$100,000 worth in 25 years (keep in mind that Homer invested the money
5 years ago and we want to know what it will be worth in 20 years)?
N

=

25

I/Y

=

7.5

PV

=

-100,000

PMT

=

0

CPT FV =

609,833.96 dollars

Now we determine what the additional \$1,500 per year will grow to (note that since
Homer will be making these investments at the beginning of each year for 20 years
we have an annuity due, thus, once you calculate the present value, you must multiply
N

=

20

I/Y

=

7.5

PV

=

0

PMT

=

-1,500

CPT FV =

64,957.02 × 1.075 = 69,828.80 dollars

Finally, we must add the two values together:
\$609,833.96 +

\$69,828.80

=

\$679,662.76

5-50A.
Since this problem involves monthly payments we
must first, make P/Y = 12. Then, N becomes the number of months
or compounding periods,
N

=

60

I/Y

=

6.2

PV

=

-25,000

CPT PMT
FV

=
=

485.65 dollars

0

5-51A. Since this problem involves monthly payments we must first, make P/Y = 12. Then,
N becomes the number of months or compounding periods,
N

=

36

CPT I/Y =

11.62%

PV

=

-999

PMT

=

33

FV

=

0

120

Prof. Rushen Chahal
5-52A. First, what will be the monthly payments if Suzie goes for the 4.9 percent financing?
Since this problem involves monthly payments we must first, make P/Y = 12. Then,
N becomes the number of months or compounding periods,
N

=

60

I/Y

=

4.9

PV

=

-25,000

CPT PMT
FV

=
=

470.64 dollars

0

Now, calculate how much the monthly payments would be if Suzie took the \$1,000
cash back and reduced the amount owed from \$25,000 to \$24,000. Again, since this
problem involves monthly payments we must first, make P/Y = 12.
N

=

60

I/Y

=

6.9

PV

=

-24,000

CPT PMT
FV

=
=

474.10 dollars

0

5-53A. Since this problem involves quarterly compounding we must first, make P/Y = 4.
Then, N becomes the number of quarters or compounding periods,
N

=

16

I/Y

=

6.4%

PV

=

0

PMT

=

-1000

CPT FV = 18,071.11 dollars
5-54A. There are several ways you could solve this problem. One way would be to calculate
the future value of an amount, say \$100, deposited in each of these CDs would grow
to at the end of a year. Let’s try this first. Since the first part of this problem involves
daily compounding we must first, make P/Y = 365. Then, N becomes the number of
days in a year,
N

=

365

I/Y

=

4.95

PV

=

-100

PMT

=

0

CPT FV =

105.0742 or 5.0742%

121

Prof. Rushen Chahal
Now, let’s look at monthly compounding we must first, and again, we’ll see what
\$100 will grow to at the end of a year. First, we make P/Y = 12.
N

=

12

I/Y

=

5.0

PV

=

-100

PMT

=

0

CPT FV =

105.1162 or 5.1162%

An alternative approach would be to use the ICONV button on a Texas Instruments
BA II-Plus calculator. That button calculates the APY, or annual percentage yield,
also called the effective rate.
5-55A.
Since this problem involves monthly payments we must first,
make P/Y = 12. Then, N becomes the number of months or
compounding periods,
CPT N = 41.49 (rounded up to 42 months)
I/Y =

12.9

PV =

-5000

PMT = 150
FV =
5-56A. a.

Since this problem begins using annual payments, make sure your calculator
is set to P/Y=1.
N

b.

0

=

12

CPT I/Y =

8.37%

PV

=

-160,000

PMT

=

0

FV

=

420,000

Again, since this problem begins using annual payments, make sure your
calculator is set to P/Y=1
N

=

10

CPT I/Y =

11.6123%

PV

=

-140,000

PMT

=

0

FV

=

420,000

122

Prof. Rushen Chahal
c.

Since this problem now involves monthly payments we must first, make P/Y
= 12. Then, N becomes the number of months or compounding periods,
N

=

120

I/Y

=

6

PV

=

-140,000

CPT PMT
FV
d.

=
=

-1,008.57 dollars

420,000

Since this problem now involves monthly payments we must first, make P/Y
= 12. Then, N becomes the number of months or compounding periods.
Also, since Professor ME will be depositing both the \$140,000 (immediately)
and \$500 (monthly), they must have the same sign,
N

=

120

CPT I/Y =

8.48%

PV

=

-140,000

PMT

=

-500

FV

=

420,000

SOLUTION TO INTEGRATIVE PROBLEM
1.

Discounting is the inverse of compounding. We really only have one formula to
move a single cash flow through time. In some instances we are interested in
bringing that cash flow back to the present (finding its present value) when we
already know the future value. In other cases we are merely solving for the future
value when we know the present value.

2.

The values in the present value of an annuity table (Table 5-8) are actually derived
from the values in the present value table (Table 5-4). This can be seen, by
examining the value, represented in each table. The present value table gives values
of
for various values of i and n, while the present value of an annuity table gives values
of
n
1

t = 1 (1 + i) t
for various values of i and n. Thus the value in the present value of annuity table for
an n-year annuity for any discount rate i is merely the sum of the first n values in the
present value table.

123

Prof. Rushen Chahal
3.

(a)

(b)

(c)

4.

5.

6.

FVn

=

PV (1 + i)n

FV10

=

\$5,000(1 + 0.08)10

FV10

=

\$5,000 (2.159)

FV10

=

\$10,795

FVn

=

PV (1 + i)n

\$1,671 =

\$400 (1 + 0.10)n

4.1775 =

FVIF 10%, n yr.

Thus n=

15 years (because the value of 4.177 occurs in the 15 year row of
the 10 percent column of Appendix B).

FVn

PV (1 + i)n

=

\$4,046 =

\$1,000 (1 + i)10

4.046 =

FVIF i%, 10 yr.

Thus, i =

15% (because the Appendix B value of 4.046 occurs in the 10
year row in the 15 percent column)

FVn

=

mn
PV

=

\$1,000

=

10
\$1,000(1+.05)

=

\$1,629

2•5

An annuity due is an annuity in which the payments occur at the beginning of each
period as opposed to occurring at the end of each period, which is when the payment
occurs in an ordinary annuity.
PV

PV(annuity due)

=

PMT(PVIFAi,n)

=

\$1,000(PVIFA10%,7 years)

=

\$1,000(4.868)

=

\$4,868

=

PMT(PVIFAi,n)(l+i)

=

\$1000(4.868)(l+.10)

=

\$5,354.80

124

Prof. Rushen Chahal
7.

FVn

FVn(annuity due)

8.

PV

=

PMT(FVIFAi,n)

=

\$1,000(9.487)

=

\$9,487

=

PMT(FVIFAi,n)(l+i)

=

\$1000(9.487)(l+.10)

=

\$10,435.70

=

PMT(PVIFAi,n)

\$100,000= PMT(PVIFA10%, 25 years)
\$100,000= PMT(9.077)
\$11,016.86 =
9.

PV

PMT

=
=

10.

11.

PV

PV

=

\$12,500

=

PMT(PVIFAi,n)(PVIFi,n)

=

\$1,000(PVIFA10%,10 years)(PVIF10%, 9 years)

=

\$1,000(6.145)(.424)

=

\$2,605.48

=
=

(PVIF10%, 9 years)

=
=
12.

APY

\$4,240.00
m

=

4

=

-1

-1

=

4
[1 + .02] - 1

=

1.0824 - 1

=

.0824 or 8.24%

Solutions to Problem Set B
5-1B. (a)

FVn
FV11

=

PV (1 + i)n
=

\$4,000(1 + 0.09)11

125

Prof. Rushen Chahal

(b)

(c)

(d)

5-2B. (a)

(b)

(c)

(d)

FV11

=

\$4,000 (2.580)

FV11

=

\$10,320

FVn

=

PV (1 + i)n

FV10

=

\$8,000 (1 + 0.08)10

FV10

=

\$8,000 (2.159)

FV10

=

\$17,272

FVn

=

PV (1 + i)n

FV12

=

\$800 (1 + 0.12)12

FV12

=

\$800 (3.896)

FV12

=

\$3,117

FVn

=

PV (1 + i)n

FV6

=

\$21,000 (1 + 0.05)6

FV6

=

\$21,000 (1.340)

FV6

=

\$28,140

FVn

=

PV (1 + i)n

\$1,043.90

=

\$550 (1 + 0.06)n

1.898

=

FVIF6%, n yr.

Thus n

=

11 years (because the value of 1.898 occurs in the 11 year
row of the 6 percent column of Appendix B).

FVn

=

PV (1 + i)n

\$88.44

=

\$40 (1 + .12)n

2.211

=

FVIF12%, n yr.

Thus, n

=

7 years

FVn

=

PV (1 + i)n

\$614.79

=

\$110 (1 + 0.24)n

5.589

=

FVIF24%, n yr.

Thus, n

=

8 years

FVn

=

PV (1 + i)n

126

Prof. Rushen Chahal

5-3B. (a)

(b)

(c)

(d)

5-4B. (a)

(b)

(c)

\$78.30

=

\$60 (1 + 0.03)n

1.305

=

FVIF3%, n yr.

Thus, n

=

9 years

FVn

=

PV (1 + i)n

\$1,898.60

=

\$550 (1 + i)13

3.452

=

FVIFi%, 13 yr.

Thus, i

=

10% (because the Appendix B value of 3.452 occurs in
the 13 year row in the 10 percent column)

FVn

=

PV (1 + i)n

\$406.18

=

\$275 (1 + i)8

1.477

=

FVIFi%, 8 yr.

Thus, i

=

5%

FVn

=

PV (1 + i)n

\$279.66

=

\$60 ( 1 + i)20

4.661

=

FVIFi%, 20 yr.

Thus, i

=

8%

FVn

=

PV ( 1 + i)n

\$486.00

=

\$180 (1 + i)6

2.700

=

FVIFi%, 6 yr.

Thus, i

=

18%

PV

=

FVn

PV

=

\$800

PV

=

\$800 (0.386)

PV

=

\$308.80

PV

=

FVn

PV

=

\$400

PV

=

\$400 (0.705)

PV

=

\$282.00

PV

=

FVn

127

Prof. Rushen Chahal

(d)

5-5B. (a)

(b)

PV

=

\$1,000

PV

=

\$1,000 (0.677)

PV

=

\$677

PV

=

PV

=

\$900

PV

=

\$900 (0.194)

PV

=

\$174.60

FVn

=

 n −1

PMT  ∑ (1 + i) t 
t=0

FV10

=

 10 − 1
t
\$500  ∑ (1 + 0.06) 
 t =0

FV10

=

\$500 (13.181)

FV10

=

\$6,590.50

FVn

=

 n −1

PMT  ∑ (1 + i) t 
t=0

FV5

=

 5 −1
t
\$150  ∑ (1 + 0.11) 
t =0

FV5

=

\$150 (6.228)

FV5

=

\$934.20

FVn

128

Prof. Rushen Chahal
(c)

(d)

5-6B. (a)

(b)

(c)

FVn

=

 n −1

PMT  ∑ (1 + i) t 
t=0

FV8

=

 8 −1
t
\$35  ∑ (1 + 0.07) 
t =0

FV8

=

\$35 (10.260)

FV8

=

\$359.10

FVn

=

 n −1

PMT  ∑ (1 + i) t 
t=0

FV3

=

 3 −1
t
\$25  ∑ (1 + 0.02) 
t =0

FV3

=

\$25 (3.060)

FV3

=

PV

=

\$76.50
 n
1
PMT  ∑
t
 t = 1 (1 + i)

PV

=

 10
1
\$3,000  ∑
t
 t = 1 (1 + 0.08)

PV

=

\$3,000 (6.710)

PV

=

\$20,130

PV

=

 n
PMT  ∑
 t =1

(1 + i) t 

PV

=

 3
\$50  ∑
 t =1

t 
(1 + 0.03) 

PV

=

\$50 (2.829)

PV

=

\$141.45

PV

=

 n
PMT  ∑
 t =1

t 
(1 + i) 

PV

=

 8
\$280  ∑
 t =1

(1 + 0.07) t 

PV

=

\$280 (5.971)

PV

=

\$1,671.88

1

1

1

129

1

Prof. Rushen Chahal
(d)

5-7B. (a)

PV

=

 n
1
PMT  ∑
t
 t = 1 (1 + i)

PV

=

 10
\$600  ∑
 t =1

PV

=

\$600 (6.145)

PV

=

\$3,687.00

FVn

=

PV (1 + i)n

(1 + 0.1) t 
1

compounded for 1 year
FV1

=

\$20,000 (1 + 0.07)1

FV1

=

\$20,000 (1.07)

FV1

=

\$21,400

compounded for 5 years
FV5

=

\$20,000 (1 + 0.07)5

FV5

=

\$20,000 (1.403)

FV5

=

\$28,060

compounded for 15 years

(b)

FV15

=

\$20,000 (1 + 0.07)15

FV15

=

\$20,000 (2.759)

FV15

=

\$55,180

FVn

=

PV (1 + i)n

compounded for 1 year at 9%
FV1

=

\$20,000 (1 + 0.09)1

FV1

=

\$20,000 (1.090)

FV1

=

\$21,800

compounded for 5 years at 9%
FV5

=

\$20,000 (1 + 0.09)5

FV5

=

\$20,000 (1.539)

FV5

=

\$30,780

compounded for 15 years at 9%
FV5
FV5

=

\$20,000 (1 + 0.09)15
= \$20,000 (3.642)
130

Prof. Rushen Chahal
FV5

=

\$72,840

compounded for 1 year at 11%
FV1

=

\$20,000 (1 + 0.11)1

FV1

=

\$20,000 (1.11)

FV1

=

\$22,200

compounded for 5 years at 11%
FV5

=

\$20,000 (1 + 0.11)5

FV5

=

\$20,000 (1.685)

FV5

=

\$33,700

compounded for 15 years at 11%

(c)

5-8B.

FV5

=

\$20,000 (1 + 0.11)15

FV5

=

\$20,000 (4.785)

FV5
=
\$95,700
There is a positive relationship between both the interest rate used to
compound a present sum and the number of years for which the compounding
continues and the future value of that sum.
FVn

=

Account
Korey Stringer
Erica Moss
Ty Howard
Rob Kelly
Mary Christopher
Juan Diaz
5-9B. (a)

(b)

FVn

=

PV (1 + )mn

PV
2,000
50,000
7,000
130,000
20,000
15,000

i
12%
12%
18%
12%
14%
15%

m
6
12
6
4
2
3

PV (1 + i)n

FV5

=

\$6,000 (1 + 0.06)5

FV5

=

\$6,000 (1.338)

FV5

=

\$8,028

FVn

=

PV (1 + )mn

FV5

=

\$6,000 (1 + )2 x 5

FV5

=

\$6,000 (1 + 0.03)10

FV5

=

\$6,000 (1.344)

FV5

=

\$8,064

131

n
2
1
2
2
4
3

(1 + )mn
1.268
1.127
1.426
1.267
1.718
1.551

PV(1 + )mn
\$2,536
56,350
9,982
164,710
34,360
23,265

Prof. Rushen Chahal

(c)

(d)

(e)

FVn

=

PV (1 + )mn

FV5

=

6X5
\$6,000 (1 + )

FV5

=

\$6,000 (1 + 0.01)30

FV5

=

\$6,000 (1.348)

FV5

=

\$8,088

FVn

=

PV (1 + i)n

FV5

=

\$6,000 (1 + 0.12)5

FV5

=

\$6,000 (1.762)

FV5

=

\$10,572

FV5

=

PV

FV5

=

\$6,000

FV5

=

\$6,000 (1 + 0.06)10

FV5

=

6,000 (1.791)

FV5

=

\$10,746

FV5

=

PV mn

FV5

=

\$6,000

FV5

=

\$6,000 (1 + 0.02)30

FV5

=

\$6,000 (1.811)

FV5

=

\$10,866

FVn

=

PV (1 + i)n

FV12

=

\$6,000 (1 + 0.06)12

FV12

=

\$6,000 (2.012)

FV12

=

\$12,072

mn
2X5

6X5

An increase in the stated interest rate will increase the future value of a given
sum. Likewise, an increase in the length of the holding period will increase
the future value of a given sum.

5-10B. Annuity A:

PV

=

 n
PMT  ∑
 t =1

132

t 
(1 + i) 
1

Prof. Rushen Chahal
PV

=

 12
\$8,500  ∑
 t =1

(1 + 0.12) t 

PV

=

\$8,500 (6.194)

PV

=

\$52,649

1

Since the cost of this annuity is \$50,000 and its present value is \$52,649, given a 12
percent opportunity cost, this annuity has value and should be accepted.
Annuity B:

PV

=

 n
PMT  ∑
 t =1

t 
(1 + i) 

PV

=

 25
\$7,000  ∑
 t =1

PV

=

\$7,000 (7.843)

PV

=\$54,901

1

(1 + 0.12) t 
1

Since the cost of this annuity is \$60,000 and its present value is only \$54,901 given a
12 percent opportunity cost, this annuity should not be accepted.
Annuity C:

PV

=

 n
1
PMT  ∑
t
 t = 1 (1 + i)

PV

=

 20
\$8,000  ∑
 t =1

1

PV

=

\$8,000 (7.469)

(1 + 0.12) t 

PV
=
\$59,752
Since the cost of this annuity is \$70,000 and its present value is only \$59,752,
given a 12 percent opportunity cost, this annuity should not be accepted.
5-11B. Year 1:

Year 2:

Year 3:

FVn

=

PV (1 + i)n

FV1

=

10,000(1 + 0.15)1

FV1

=

10,000(1.15)

FV1

=

11,500 books

FVn

=

PV (1 + i)n

FV2

=

10,000(1 + 0.15)2

FV2

=

10,000(1.322)

FV2

=

13,220 books

FVn

=

PV (1 + i)n

133

Prof. Rushen Chahal
FV3

=

10,000(1 + 0.15)3

FV3

=

10,000(1.521)

FV3

=

15,210 books

Book sales
20,000

15,000

10,000

1

2

3

years

The sales trend graph is not linear because this is a compound growth trend.
Just as compound interest occurs when interest paid on the investment during
the first period is added to the principal of the second period, interest is
earned on the new sum. Book sales growth was compounded; thus, the first
year the growth was 15 percent of 10,000 books, the second year 15 percent of
11,500 books, and the third year 15 percent of 13,220 books.
5-12B.

FVn

=

PV (1 + i)n

FV1

=

41(1 + 0.12)1

FV1

=

41(1.12)

FV1

=

45.92 Home Runs in 1981 (in spite of the baseball strike).

FV2

=

41(1 + 0.12)2

FV2

=

41(1.254)

FV2

=

51.414 Home Runs in 1982

FV3

=

41(1 + 0.12)3

FV3

=

41(1.405)

134

Prof. Rushen Chahal
FV3

=

57.605 Home Runs in 1983.

FV4

=

41(1 + 0.12)4

FV4

=

41(1.574)

FV4

=

64.534 Home Runs in 1984 (for a new major league
record).

FV5

=

41(1 + 0.12)5

FV5

=

41(1.762)

FV5

=

72.242 Home Runs in 1985 (again for a new major league
record).

Actually, Reggie never hit more than 41 home runs in a year. In 1982, he only hit 15,
in1983 he hit 39, in 1984 he hit 14, in 1985 25 and 26 in 1986. He retired at the end of
1987 with 563 career home runs.
5-13B.

5-14B.

5-15B.

5-16B.

PV

=

 n
PMT  ∑
 t =1

t 
(1 + i) 

\$120,000

=

 25
PMT  ∑
 t =1

(1 + 0.1) t 

\$120,000

=

PMT(9.077)

Thus, PMT

=

\$13,220.23 per year for 25 years

FVn

=

 n −1

PMT  ∑ (1 + i) t 
t=0

\$25,000

=

 15 − 1
t
PMT  ∑ (1 + 0.07) 
 t=0

\$25,000

=

PMT(25.129)

Thus, PMT

=

\$994.87

FVn

=

PV (1 + i)n

\$2,376.50

=

\$700 (FVIFi%, 10 yr.)

3.395

=

FVIFi%, 10 yr.

Thus, i

=

13%

1

The value of the home in 10 years
FV10

=

PV (1 + .05)10

=

\$125,000(1.629)

=

\$203,625

135

1

Prof. Rushen Chahal
How much must be invested annually to accumulate \$203,625?

5-17B.

5-18B.

\$203,625

=

 10 − 1
t
PMT  ∑ (1 + .10) 
 t =0

\$203,625

=

PMT(15.937)

PMT

=

\$12,776.87

FVn

=

 n −1

PMT  ∑ (1 + i) t 
t=0

\$15,000,000

=

 10 − 1
t
PMT  ∑ (1 + .10) 
 t =0

\$15,000,000

=

PMT(15.937)

Thus, PMT

=

\$941,206

One dollar at 24.0% compounded monthly for one year
FVn

=

PV (1 + )nm

FV1

=

\$1(1 + .02)1

=

\$1(1.268)

=

\$1.268

One dollar at 26.0% compounded annually for one year
FVn

=

PV (1 + i)n

FV1

=

\$1(1 + .26)1

=

\$1(1.26)

=

\$1.26

The loan at 26% compounded annually is more attractive.
5-19B. Investment A
PV

=

 n
PMT  ∑
 t =1

(1 + i) t 

=

 5
\$15,000  ∑
 t =1

=

\$15,000(2.991)

=

\$44,865

i

(1 + .20) 
1

t

Investment B
First, discount the annuity back to the beginning of year 5, which is the end of year 4.
Then discount this equivalent sum to present.
136

Prof. Rushen Chahal
PV

PV

=

 n
PMT  ∑
 t =1

(1 + i) t 

=

 6
\$15,000  ∑
 t =1

=

\$15,000(3.326)

=

\$49,890--then discount the equivalent sum back to present.

=

FVn

=

\$49,890

=

\$49,890(.482)

=

\$24,046.98

=

FVn

=

\$20,000 + \$60,000

1

(1 + .20) t 
1

Investment C
PV

+ \$20,000

5-20B.

5-21B. (a)

(b)

(c)

(d)

=

\$20,000(.833) + \$60,000(.335) + \$20,000(.162)

=

\$16,660 + \$20,100 + \$3,240

=

\$40,000

PV

=

FVn

PV

=

\$1,000

=

\$1,000(.502)

=

\$502

PV

=

PV

=

PV
PV

=
=

PV

=

PV

=

PV

=

PV

=

PV

=

PV

=

PV

=

\$4,444

\$11,538

\$1,500

137

Prof. Rushen Chahal
PV

=

\$1,667

=

PMT(PVIFAi,n)(l + i)

=

\$1000(3.791)(1 + .10)

=

\$3791(1.1)

=

\$4,170.10

FVn

=

.
PV (1 + )m n

7

=

.
1(1 + )2 n

7

=

.
(1 + 0.05)2 n

7

=

FVIF5%, 2n yr.

5-22B. PV(annuity due)

5-23B.

A value of 7.040 occurs in the 5 percent column and 40-year row of the table in
Appendix B. Therefore, 2n = 40 years and n = approximately 20 years.
5-24A. Investment A:
PV

=

FVn (PVIFi,n)

PV

=

\$5,000(PVIF10%, year 1) + \$5,000(PVIF10%, year 2) +
\$5,000(PVIF10%, year 3) - \$15,000(PVIF10%, year 4) +
\$15,000(PVIF10%, year 5)

=

\$5,000(.909) + \$5,000(.826) + \$5,000(.751) - \$15,000(.683) +
\$15,000(.621)

=

\$4,545 + \$4,130 + \$3,755 - \$10,245 + \$9,315

=

\$11,500.

138

Prof. Rushen Chahal
Investment B:
PV

=

FVn (PVIFi,n)

PV

=

\$1,000(PVIF10%, year 1) + \$3,000(PVIF10%, year 2) +
\$5,000(PVIF10%, year 3) + \$10,000(PVIF10%, year 4) \$10,000(PVIF10%, year 5)

=

\$1,000(.909) + \$3,000(.826) + \$5,000(.751) + \$10,000(.683) \$10,000(.621)

=

\$909 + \$2,478 + \$3,755 + \$6,830 - \$6,210

=

\$7,762.

PV

=

FVn (PVIFi,n)

PV

=

\$10,000(PVIF10%, year 1) + \$10,000(PVIF10%, year 2) +
\$10,000(PVIF10%, year 3) + \$10,000(PVIF10%, year 4) \$40,000(PVIF10%, year 5)

=

\$10,000(.909) + \$10,000(.826) + \$10,000(.751) +
\$10,000(.683) - \$40,000(.621)

=

\$9,090 + \$8,260 + \$7,510 + \$6,830 - \$24,840

=

\$6,850.

Investment C:

5-25B. The Present value of the \$10,000 annuity over years 11-15.
PV

=

  15
PMT   ∑
  t =1

=

\$10,000(9.108 - 7.024)

=

\$10,000(2.084)

=

\$20,840

  10
1
 − ∑
(1 + .07) t   t = 1


1

t 
(1 + .07)  

The present value of the \$15,000 withdrawal at the end of year 15:
PV

=

FV15

=

\$15,000(.362)

=

\$5,430

Thus, you would have to deposit \$20,840 + \$5,430 or \$26,270 today.

139

Prof. Rushen Chahal
5-26B.

5-27B. PV

5-28B. PV

5-29B. PV

PV

=

 10
PMT  ∑
 t =1

(1 + .09) t 

\$45,000

=

PMT(6.418)

PMT

=

\$7,012

=

 5
PMT  ∑
 t =1

\$45,000

=

\$9,000 (PVIFAi%, 5 yr.)

5.0

=

PVIFAi%, 5 yr.

i

=

0%

=

FVn

\$15,000

=

\$37,313 (PVIFi%, 5 yr.)

.402

=

Thus, i

=

PVIF20%, 5 yr.
20%

=

 n
PMT  ∑
 t =1

\$30,000

=

 4
PMT  ∑
 t =1

\$30,000

=

PMT(2.974)

PMT

=

\$10,087

1

t 
(1 + i) 
1

(1 + i) t 
1

t 
(1 + .13) 
1

5-30B. The present value of \$10,000 in 12 years at 11 percent is:
PV

=

 1
FVn 
n
 (1 + i)



PV

=

\$10,000 ()

PV

=

\$10,000 (.286)

PV

=

\$2,860

The present value of \$25,000 in 25 years at 11 percent is:
PV
=
\$25,000 ()
=
\$25,000 (.074)
=
\$1,850
Thus take the \$10,000 in 12 years.
5-31B.

FVn

=

 n −1

PMT  ∑ (1 + i) t 
t=0

140

Prof. Rushen Chahal

5-32B. (a)

(b)

(c)

\$30,000

=

 5 −1
t
PMT  ∑ (1 + .10) 
t =0

\$30,000

=

PMT(6.105)

PMT

=\$4,914

FVn

=

 n −1
t
PMT  ∑ (1 + i) 
t=0

\$75,000

=

 15 − 1
t
PMT  ∑ (1 + .08) 
 t=0

\$75,000

=

PMT (FVIFA8%, 15 yr.)

\$75,000

=

PMT(27.152)

PMT

=

\$2,762.23 per year

PV

=

FVn

PV

=

\$75,000 (PVIF8%, 15 yr.)

PV

=

\$75,000(.315)

PV

=

\$23,625 deposited today

The contribution of the \$20,000 deposit toward the \$75,000 goal is
FVn

=

PV (1 + i)n

FVn

=

\$20,000 (FVIF8%, 10 yr.)

FV10

=

\$20,000(2.159)

=

\$43,180

Thus only \$31,820 need be accumulated by annual deposit.
FVn

=

 n −1
t
PMT  ∑ (1 + i) 
t=0

\$31,820

=

PMT (FVIFA8%, 15 yr.)

\$31,820

=

PMT [27.152]

PMT

=

\$1,171.92 per year

141

Prof. Rushen Chahal
5-33B.(a)

This problem can be subdivided into (1) the compound value of the \$150,000
in the savings account, (2) the compound value of the \$250,000 in stocks, (3)
the additional savings due to depositing \$8,000 per year in the savings
account for 10 years, and (4) the additional savings due to depositing \$2,000
per year in the savings account at the end of years 6-10. (Note the \$10,000
deposited in years 6-10 is covered in parts (3) and (4).)
(1)

(2)

(3)

Future value of \$150,000
FV10 =

\$150,000 (1 + .08)10

FV10 =

\$150,000 (2.159)

FV10 =

\$323,850

Future value of \$250,000
FV10 =

\$250,000 (1 + .12)10

FV10 =

\$250,000 (3.106)

FV10 =

\$776,500

Compound annuity of \$8,000, 10 years
FV10 =

(4)

 n −1

PMT  ∑ (1 + i) t 
t=0

=

 10 − 1

\$8,000  ∑ (1 + .08) t 
 t =0

=

\$8,000 (14.487)

=

\$115,896

Compound annuity of \$2,000 (years 6-10)
FV5

=

 5 −1

\$2,000  ∑ (1 + .08) t 
t =0

=

\$2,000 (5.867)

=

\$11,734

At the end of ten years you will have \$323,850 + \$776,500 + \$115,896
+ \$11,734 = \$1,227,980.
PV

=

 20
1
PMT  ∑
t
 t = 1 (1 + .11)

\$1,227,980

=

PMT (7.963)

(b)

PMT =

\$154,210.72

142

Prof. Rushen Chahal
5-34B.

PV

=

PMT (PVIFAi%, n yr.)

\$200,000

=

PMT (PVIFA10%, 20 yr.)

\$200,000

=

PMT(8.514)

PMT =

\$23,491

PV

=

PMT (PVIFAi%, n yr.)

\$250,000

=

PMT (PVIFA9%, 30 yr.)

\$250,000

=

PMT(10.274)

5-35B.

PMT =

\$24,333

5-36B. At 10%:
PV

=

\$40,000 + \$40,000 (PVIFA10%, 24 yr.)

PV

=

\$40,000 + \$40,000 (8.985)

PV

=

\$40,000 + \$359,400

PV

=

\$399,400

PV

=

\$40,000 + \$40,000 (PVIFA20%, 24 yr.)

PV

=

\$40,000 + \$40,000 (4.937)

PV

=

\$40,000 + \$197,480

PV

=

\$237,480

5-37B FVn(annuity due)

=

PMT(FVIFAi,n)(l + i)

=

\$1000(FVIFA5%, 5 years)(l + .05)

=

\$1000(5.526)(1.05)

=

\$5802.30

=

PMT(FVIFAi,n)(l + i)

=

\$1,000(FVIFA8%, 5 years)(1 + .08)

=

\$1,000(5.867)(1.08)

=

\$6,336.36

=

PMT(PVIFAi,n)(l + i)

=

\$1000 (PVIFA12%, 15 years)(1 + .12)

=

\$1000(6.811)(1.12)

=

\$7,628.32

At 20%:

FVn(annuity due)

5-38B. PV(annuity due)

143

Prof. Rushen Chahal
PV(annuity due)

5-39B.

=

PMT(PVIFAi,n)(l + i)

=

\$1000(PVIFA15%, 15 years)(l + .15)

=

\$1000(5.847)(1.15)

=

\$6,724.05

=

PMT(PVIFAi,n)(PVIFi,n)

=

\$1000(PVIFA15%,10 years)(PVIF15%, 7 years)

=

\$1000(5.019)(.376)

=

\$1,887.14

FVn

=

PV (FVIFi%, n yr.)

\$3,500

=

.12(FVIFi%, 38 yr.)

PV

5-40B.

solving using a financial calculator:
i

=

31.0681%

5-41B. (a)
1/05

1/10

1/15

1/20

1/25

1/30

\$60,000
\$60,000 per year
\$300,000
\$100,000
There are a number of equivalent ways to discount these cash flows back to
present, one of which is as follows (in equation form):
PV

=

\$60,000 (PVIFA10%, 19 yr. - PVIFA10%, 4 yr.)
+ \$300,000 (PVIF10%, 20 yr.)
+ \$60,000 (PVIF10%, 23 yr. + PVIF10%, 24 yr.)
+ \$100,000 (PVIF10%, 25 yr.)

=
=
=
(b)

\$60,000 (8.365-3.170) + \$300,000 (.149)
+ \$60,000 (0.112 + .102) + \$100,000 (.092)
\$311,700 + \$44,700 + \$12,840 + \$9,200
\$378,440

If you live longer than expected you could end up with no money later on in
life.
144