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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%

ANSWERS TO

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

your answer, in this case $64,957.02 times (1 + i)):

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

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