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VALUATION

Solutions to Questions and Problems

Basic

1.

The difference is:

$11,836.82 9,500 = $2,336.82

2.

FV = PV(1 + r)t

a.

FV = $1,000(1.06)10

= $1,790.85

b.

10

= $2,367.36

20

= $3,207.14

c.

FV = $1,000(1.09)

FV = $1,000(1.06)

d.

3.

PV = FV / (1 + r)t

PV = $15,451 / (1.07)6

PV = $51,557 / (1.15)

= $10,295.65

= $14,655.72

18

= $135,411.60

23

= $12,223.79

PV = $886,073 / (1.11)

PV = $550,164 / (1.18)

4.

r = ($307 / $242)1/2 1

FV = $896 = $410(1 + r) ;

r = ($896 / $410)

15

FV = $162,181 = $51,700(1 + r) ;

1/9

r = ($162,181 / $51,700)

1

= 12.63%

= 9.07%

1/15

1 = 7.92%

FV = $1,284 = $625(1.06)t;

5.

t

FV = $4,341 = $810(1.13) ;

t

FV = $402,662 = $18,400(1.32) ;

FV = $173,439 = $21,500(1.16) ;

6.

FV = PV(1 + r)t

Solving for t, we get:

t = ln(FV / PV) / ln(1 + r)

FV = $2 = $1(1.09)t

t = ln 2 / ln 1.09 = 8.04 years

The length of time to quadruple your money is:

FV = $4 = $1(1.09)t

t = ln 4 / ln 1.09 = 16.09 years

7.

PV = FV / (1 + r)t

PV = $750,000,000 / (1.082)20 = $155,065,808.54

8.

FV = PV(1 + r)t

Solving for r, we get:

r = (FV / PV)1 / t 1

r = ($10,311,500 / $12,377,500)1/4 1 = 4.46%

9.

PV = C / r

PV = $120 / .057

PV = $2,105.26

10. To find the future value with continuous compounding, we use the equation:

FV = PVeRt

a.

FV = $1,900e.12(5)

= $3,462.03

b.

.10(3)

= $2,564.73

.05(10)

= $3,132.57

.07(8)

= $3,326.28

c.

d.

FV = $1,900e

FV = $1,900e

FV = $1,900e

11. To solve this problem, we must find the PV of each cash flow and add them. To find the

PV of a lump sum, we use:

PV = FV / (1 + r)t

PV@10% = $1,200 / 1.10 + $730 / 1.102 + $965 / 1.103 + $1,590 / 1.104 = $3,505.23

PV@18% = $1,200 / 1.18 + $730 / 1.182 + $965 / 1.183 + $1,590 / 1.184 = $2,948.66

PV@24% = $1,200 / 1.24 + $730 / 1.242 + $965 / 1.243 + $1,590 / 1.244 = $2,621.17

12. To find the PVA, we use the equation:

PVA = C({1 [1/(1 + r)]t } / r )

At a 5 percent interest rate:

X@5%:

Y@5%:

PVA = $8,000{[1 (1/1.05)5 ] / .05 } = $34,635.81

3

Y@22%: PVA = $8,000{[1 (1/1.22)5 ] / .22 } = $22,909.12

13. To find the PVA, we use the equation:

PVA = C({1 [1/(1 + r)]t } / r )

PVA@15 yrs:

PVA@40 yrs:

PVA@75 yrs:

PV = C / r

PV = $4,300 / .09

PV = $47,777.78

14. This cash flow is a perpetuity. To find the PV of a perpetuity, we use the equation:

PV = C / r

PV = $20,000 / .065 = $307,692.31

r = $20,000 / $340,000 = .0588 or 5.88%

15. For discrete compounding, to find the EAR, we use the equation:

EAR = [1 + (APR / m)]m 1

EAR = [1 + (.08 / 4)]4 1

= .0824 or 8.24%

= .1956 or 19.56%

= .1275 or 12.75%

EAR = eq 1

EAR = e.14 1 = .1503 or 15.03%

16. Here, we are given the EAR and need to find the APR. Using the equation for discrete

compounding:

EAR = [1 + (APR / m)]m 1

We can now solve for the APR. Doing so, we get:

APR = m[(1 + EAR)1/m 1]

EAR = .1030 = [1 + (APR / 2)]2 1

EAR = .0720 = [1 + (APR / 52)]52 1 APR = 52[(1.0720)1/52 1]= .0696 or 6.96%

EAR = eq 1;

We get:

APR = ln(1 + .1590)

APR = .1476 or 14.76%

17.

First National:

First United:

18. The cost of a case of wine is 10 percent less than the cost of 12 individual bottles, so the

cost of a case will be:

Cost of case = (12)($10)(1 .10)

Cost of case = $108

Now, we need to find the interest rate. The cash flows are an annuity due, so:

$108 = (1 + r) $10({1 [1 / (1 + r)12] / r )

Solving for the interest rate, we get:

r = .0198 or 1.98% per week

So, the APR of this investment is:

APR = .0198(52)

APR = 1.0277 or 102.77%

And the EAR is:

EAR = (1 + .0198)52 1

EAR = 1.7668 or 176.68%

The analysis appears to be correct. He really can earn about 177 percent buying wine by

the case. The only question left is this: Can you really find a fine bottle of Bordeaux for

$10?

19.

t = ln 1.381 / ln 1.009 = 36.05 months

20.

APR = (52)33.33% = 1,733.33%

And using the equation to find the EAR:

EAR = [1 + (APR / m)]m 1

EAR = [1 + .3333]52 1 = 313,916,515.69%

Intermediate

21. To find the FV of a lump sum with discrete compounding, we use:

FV = PV(1 + r)t

a.

b.

FV = $1,000(1.08)7

FV = $1,000(1 + .08/2)

= $1,713.82

14

84

= $1,731.68

c.

FV = $1,000(1 + .08/12)

d.

To find the future value with continuous compounding, we use the equation:

= $1,747.42

FV = PVeRt

FV = $1,000e.08(7)

= $1,750.67

e.

22.

r = 1.61/10 1 = .0481 or 4.81%

23.

C = $1,883,696.06 / 129.5645 = $14,538.67 withdrawal per month

24.

r = .4142 or 41.42%

25. Here, we need to find the interest rate for two possible investments. Each investment is a

lump sum, so:

G:

r = (1.80)1/6 1 = .1029 or 10.29%

H:

26.

PV = C / (r g)

PV = $215,000 / (.10 .04)

PV = $3,583,333.33

PV = FV / (1 + r)t

PV = $3,583,333.33 / (1 + .10)1

PV = $3,257,575.76

27. PV = C / r

PV = $5 / .0175

PV = $285.71

28.

PVA = $51,855.29

PV = FV/(1 + r)t

PV = $51,855.29 / (1 + .08)2

PV = $44,457.56

29.

PV = $4,385.53 / (1 + .12)5

PV = $2,488.47

30. The amount borrowed is the value of the home times one minus the down payment, or:

Amount borrowed = $450,000(1 .20)

Amount borrowed = $360,000

The monthly payments with a balloon payment loan are calculated assuming a longer

amortization schedule, in this case, 30 years. The payments based on a 30-year

repayment schedule would be:

PVA = $360,000 = C({1 [1 / (1 + .075/12)]360} / (.075/12))

C = $2,517.17

Now, at time = 8, we need to find the PV of the payments which have not been made.

The balloon payment will be:

PVA = $2,517.17({1 [1 / (1 + .075/12)]22(12)} / (.075/12))

PVA = $325,001.73

31.

The interest accrued is:

Interest = $6,639.78 6,000 = $639.78

8

32.

r = $13,000 / $150,000

r = .0867 or 8.67%

33.

The company will accept the project if the present value of the increased cash flows is

greater than the cost. The cash flows are a growing perpetuity, so the present value is:

PV = C {[1/(r g)] [1/(r g)] [(1 + g)/(1 + r)]t}

PV = $18,000{[1/(.11 .04)] [1/(.11 .04)] [(1 + .04)/(1 + .11)]5}

PV = $71,479.47

The company should accept the project since the cost is less than the increased cash

flows.

34. FV = PV(1 + r)t

FV = $52,861.98(1 + .09)40

FV = $1,660,364.12

This is the value of your savings in 40 years.

35. The relationship between the PVA and the interest rate is:

PVA falls as r increases, and PVA rises as r decreases

FVA rises as r increases, and FVA falls as r decreases

The present values of $7,500 per year for 12 years at the various interest rates given are:

PVA@10% = $7,500{[1 (1/1.10)12] / .10} = $51,102.69

PVA@5%

= $66,474.39

36.

t = ln 2 / ln 1.00833 = 83.52 payments

37.

APR = 12(0.727%) = 8.72%

38.

Balloon payment = $65,929.80[1 + (.068/12)]360 = $504,129.05

39.

$1,783.10(1.10)2 = $2,157.55

40.

$1,000,000

$2,400,000/1.09

$1,350,000/1.09

4

+ 2,750,000/1.09

$1,700,000/1.092

+ $3,100,000/1.09

10

+

6

$2,050,000/1.093

+ $3,450,000/1.09

41.

APR = 12(0.593%) = 7.12%

And the EAR is:

EAR = (1 + .00593)12 1 = .0735 or 7.35%

42.

r = ($135,000 / $96,000)1/3 1 = .1204 or 12.04%

43.

PV = $39,052.89 / 1.078 = $22,729.14

44.

PV = $82,453.99 + 41,415.70 = $123,869.99

45.

PV = $488,328.61e1.35 = $126,594.44

46.

PV = $28,767.12 / 1.0737 = $17,567.03

10

+

+

47.

APR = 12(2.219%) = 26.62%

And the EAR is:

EAR = (1.02219)12 1 = 30.12%

48.

PV @ t = 5: $32,883.16 / 1.06158 = $20,396.12

EAR = (1 + .01)12 1 = 12.68%

PV @ t = 5: $32,883.16 / 1.12684 = $20,396.12

The value of the annuity at the other times in the problem is:

PV @ t = 3: $32,883.16 / 1.061512 = $16,063.29

PV @ t = 3: $32,883.16 / 1.12686

= $16,063.29

PV @ t = 0: $32,883.16 / 1.12689 = $11,227.04

49. a.

PVAdue = $41,024.46

b.

FVAdue = $69,128.60

c.

50.

C = $1,531.74

51.

C = $160.76

52.

C = $8,148.66

11

53.

PV = $511,397.80

54.

The aftertax cash flows from Option A are in the form of an annuity due, so the present

value of the cash flow today is:

PVAdue = $1,313,791.22

For Option B, the aftertax cash flows are:

PV = $1,378,422.30

You should choose Option B because it has a higher present value on an aftertax basis.

55.

Percentage of salary = .0999 or 9.99%

56.

Total payment = Balloon amount(1 + Prepayment penalty) + Current payment

Total payment = $14,817.47(1 + .01) + $491.24

Total payment = $15,456.89

57.

C = $2,486.12

58.

Breakeven resale price = $21,404.86[1 + (.08/12)]12(3) = $27,189.25

59.

C = $1,420,476.43

60.

Because of the discount, you only get the use of $17,200, and the interest you pay on that

amount is 16.28%, not 14%.

12

61. Here, we have cash flows that would have occurred in the past and cash flows that would

occur in the future. We need to bring both cash flows to today. Before we calculate the

value of the cash flows today, we must adjust the interest rate, so we have the effective

monthly interest rate. Finding the APR with monthly compounding and dividing by 12

will give us the effective monthly rate. The APR with monthly compounding is:

APR = 12[(1.09)1/12 1] = 8.65%

To find the value today of the back pay from two years ago, we will find the FV of the

annuity (salary), and then find the FV of the lump sum value of the salary. Doing so

gives us:

FV = ($42,000/12) [{[ 1 + (.0865/12)]12 1} / (.0865/12)] (1 + .09) = $47,639.05

13

Notice we found the FV of the annuity with the effective monthly rate, and then found

the FV of the lump sum with the EAR. Alternatively, we could have found the FV of the

lump sum with the effective monthly rate as long as we used 12 periods. The answer

would be the same either way.

Now, we need to find the value today of last years back pay:

FVA = ($45,000/12) [{[ 1 + (.0865/12)]12 1} / (.0865/12)] = $46,827.37

Next, we find the value today of the five years future salary:

PVA = ($49,000/12){[{1 {1 / [1 + (.0865/12)]12(5)}] / (.0865/12)}= $198,332.55

The value today of the jury award is the sum of salaries, plus the compensation for pain

and suffering, and court costs. The award should be for the amount of:

Award = $47,639.05 + 46,827.37 + 198,332.55 + 150,000 + 25,000

Award = $467,798.97

As the plaintiff, you would prefer a lower interest rate. In this problem, we are

calculating both the PV and FV of annuities. A lower interest rate will decrease the FVA,

but increase the PVA. So, by a lower interest rate, we are lowering the value of the back

pay. But, we are also increasing the PV of the future salary. Since the future salary is

larger and has a longer time, this is the more important cash flow to the plaintiff.

62.

r = ($10,900 / $9,700) 1 = .1237 or 12.37%

With a 12 percent quoted interest rate loan and two points, the EAR is:

r = ($11,200 / $9,800) 1 = .1429 or 14.29%

The effective rate is not affected by the loan amount, since it drops out when solving for

r.

14

63.

APR = 12(0.5752%) = 6.90%

EAR = (1 + .005752)12 1 = .0713 or 7.13%

With the nonrefundable fee, the APR of the loan is simply the quoted APR since the fee

is not considered part of the loan. So:

APR = 6.80%

EAR = [1 + (.068/12)]12 1 = .0702 or 7.02%

64. Be careful of interest rate quotations. The actual interest rate of a loan is determined by

the cash flows. Here, we are told that the PV of the loan is $1,000, and the payments are

$43.36 per month for three years, so the interest rate on the loan is:

PVA = $1,000 = $43.36[ {1 [1 / (1 + r)]36 } / r ]

Solving for r with a spreadsheet, on a financial calculator, or by trial and error, gives:

r = 2.64% per month

APR = 12(2.64%) = 31.65%

EAR = (1 + .0264)12 1 = .3667 or 36.67%

Its called add-on interest because the interest amount of the loan is added to the

principal amount of the loan before the loan payments are calculated.

65.

a.

C = $7,926.81

b

PV = $81,437.29

c.

15

66.

68.

You should not take the offer since the value of the offer is less than the present value of

the payments.

69.

r = 10.57%

70.

r = .0576 or 5.76%

71.

PV = $28,632.06 / (1 + .13/365)2(365) = $22,077.81

72. To solve for the PVA due:

PVA =

C

C

C

....

2

(1 r ) (1 r )

(1 r ) t

PVAdue = C

C

C

....

(1 r )

(1 r ) t - 1

C

C

C

PVAdue = (1 r )

....

2

(1 r ) t

(1 r ) (1 r )

PVAdue = (1 + r) PVA

FVA = C + C(1 + r) + C(1 + r)2 + . + C(1 + r)t 1

FVAdue = C(1 + r) + C(1 + r)2 + . + C(1 + r)t

FVAdue = (1 + r)[C + C(1 + r) + . + C(1 + r)t 1]

FVAdue = (1 + r)FVA

73. a. The APR is the interest rate per week times 52 weeks in a year, so:

16

b.

APR = 52(9.89%) = 514.29%

EAR = (1 + .0989)52 1 = 133.8490 or 13,384.90%

c.

APR = 52(25.19%) = 1,309.92%

EAR = 1.251952 1 = 118,515.0194 or 11,851,501.94%

74.

PV = C/R + C/R2

75. Since it is only an approximation, we know the Rule of 72 is exact for only one interest

rate. Using the basic future value equation for an amount that doubles in value and

solving for t, we find:

FV = PV(1 + R)t

$2 = $1(1 + R)t

ln(2) = t ln(1 + R)

t = ln(2) / ln(1 + R)

We also know the Rule of 72 approximation is:

t = 72 / R

We can set these two equations equal to each other and solve for R. We also need to

remember that the exact future value equation uses decimals, so the equation becomes:

.72 / R = ln(2) / ln(1 + R)

0 = (.72 / R) / [ ln(2) / ln(1 + R)]

It is not possible to solve this equation directly for R, but using Solver, we find the

interest rate for which the Rule of 72 is exact is 7.846894 percent.

17

76. We are only concerned with the time it takes money to double, so the dollar amounts are

irrelevant. So, we can write the future value of a lump sum with continuously

compounded interest as:

$2 = $1eRt

2 = eRt

Rt = ln(2)

Rt = .693147

t = .693147 / R

Since we are using percentage interest rates while the equation uses decimal form, to

make the equation correct with percentages, we can multiply by 100:

t = 69.3147 / R

18

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