Economics and Financial Studies for Managers (EM601) Summer 2012

Assignment # 3 Time Value of Money

Question # 1 You sold a car and accepted a note with the following cash flow stream as your payment. What was the effective price you received for the car assuming an interest rate of 8%?

Years: CFs:

0 | $0

1 | $1,500

2 | $2,000

3 | $2,2000

4 | $2,500

Ans 1.

FV = PV (1 + I)n
PV=FV/

(1 + I)n

PV1=1500/1.08

PV1=$1388.88---------------------1 PV2= 2000/(1.08) 2

PV2=1714.67

$ 2

PV3= 22000/ 1.08 3

PV3=$ 17464.309-----------3
PV4= 2500/(1.08)
4

PV4= $1837.5-----------------------4
Now

adding all four values of eq 1,2,3 & 4

EM601 Assignment # 3

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P(total)= $ 22405.4

Question # 2 To complete your last year in business school and then go through law school, you will need $14,000 per year for 4 years, starting next year (that is, you will need to withdraw the first $14,000 one year from today). Your rich uncle offers to put you through school, and he will deposit in a bank paying 8.5% interest, compounded annually, a sum of money that is sufficient to provide the 4 payments of $14,000 each. His deposit will be made today. a) How large must the deposit be? b) How much will be in the account immediately after the sthird withdrawal? Ans2

PV

14000

14000

14000

14000

PVA = PMT [(1 - (1 / (1 + i)n)) / i]1

where PVA=? i=8.5% PMT=$ 14000 n=4 Putting values in eq 1 PV=14000

(1 / (1 + .085)4)) / 0.085]

PVA= $ 45858.35ans to part a Now for part b amortization table is required

years Beginning installment intrset principle ending principle

EM601 Assignment # 3

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amount 0 1 2 3 4 45858.35 45858.35 35756.35 24795.789 12903.43 ---14000 14000 14000 14000 ----3898 3039.28 2107.642 1096.57

amount -----10102 10960.7 11892.35 12903.43 45858.35 35756.35 24795.789

12903.43
0

Ans for part b is

12903.43$

Question # 3 The prize in last weeks Florida lottery was estimated to be worth $10 million. If you were lucky enough to win, the state will pay you $2 million per year over the next 5 years. Assume that the first installment is received immediately. If the interest rates are 7 percent, what is the present value of the prize?

Ans #3

PVA = PMT [(1 - (1 / (1 + i)n)) / i]1 PMT= 2 million I=7% N= 5 years PVA=? Putting values in eq 1 PVA = 2 [(1 - (1 / (1 + 0.07)5)) / 0.07]

EM601 Assignment # 3

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PVA= 8.774 million

Question # 4 An investment pays you $800 at the end of each of the next 3 years. The investment will then pay you $900 at the end of Year 4, $950 at the end of Year 5, and $990 at the end of Year 6. If the interest rate earned on the investment is 6 percent, what is its present value? What is its future value? Ans #4

Future value

FV = PV (1 + i)n FV1 = 800 (1 + .06)5 FV2 = 800 (1 + .06)4

= $1070.58 = $1009.98

FV3 = 800 (1 + .06)3 = $952.81 FV4 = 900 (1 + 0.06)2 =$1011.24 FV 5= 950 (1 +0.06 )1= $1007 FV6 = $990 FV (Total)= $ 6041.61

Present value

EM601 Assignment # 3

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FV = PV (1 + I)n PV = FV / (1 + I)n PV1 = FV / (1 + I)n PV1 = 800 / (1 + 0.06)1 PV1 = $754 PV2 = 800 / (1 + 0.06)2 PV2 = $711 PV3 = 800 / (1 + 0.06)3 PV3 = $671.69 PV4 = 900 / (1 + 0.06)4 PV4 = $ 712.88 PV5 = 950 / (1 + 0.06)5 PV5 = $ 709.84 PV6 = 990 / (1 + 0.06)6 PV6 = $ 679.91

Question # 5
EM601 Assignment # 3 Page 5

Your company is planning to borrow $8,000,000 on a 5-year, 11% annual payment fully amortized term loan. Prepare an amortization table to show the full payments for five years along with breakdown of each payment into interest and reduction in principal amount. Ans #5

PVA = PMT [(1 - (1 / (1 + i)n)) / i].1 PVA= $ 8000000 I= 11% N=5 So PMT from eq 1 PMT= $ 2164502.165

Years

Begning amount 8000000 8000000 6715497.83 5289700.42 3707065.296 1950340.309

Installment

INTREST

Principal amount -----1284502.17 1425797.41 1582635.124 1756724.987 1950340.309

Ending amount 8000000 6715497.83 5289700.42 3707065.29 1950340.309 ----nil----

0 1 2 3 4 5

-----2164502.17 2164502.17 2164502.17 2164502.17 2164502.17

-----880000 738704.76 581867.046 407777.18 214161.86

Question # 6

EM601 Assignment # 3

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After graduation, you plan to work for a company for 15 years and then start your own business. You expect to save and deposit $5,000 a year for the first 8 years (t = 1 through t = 8) and $8,000 annually for the following 7 years (t = 9 through t = 15). The first deposit will be made a year from today. In addition, your grandfather just gave you a $20,000 graduation gift which you will deposit immediately (t = 0). If the account earns 7% compounded annually, how much will you have when you start your business 15 years from now? Ans #6

FV = PV (1 + I)n
as $ 20000 graduation gift at t=0 so future value at t= 15 will be

FV = 20000 (1 + 0.07)15 FV1 = $ 55180.630.1

Deposit pf $ 5000 for 8 years so PMT= $ 5000 n=8 i=7%

FV(t=1 to t=8) = PMT [((1 + i)n - 1) / i] FV(t=1 to t=8) = 5000 [((1 + 0.07)8 - 1) / 0.07] FV(t=1 to t=8) = $ 51299 As the amount will be in account for next 7 more years i.e t= 9 to 15 so Future value of $ 5000 annuity at 15 years will be

FV = 51299 (1 + 0.07)7 FV (at t=15) = $ 82374.98--------2 Now for PMT= $ 8000 for 7 years future value will be
EM601 Assignment # 3 Page 7

FVA(t=9 to t=15) = PMT [((1 + i)n - 1) / i]

FVA(t=9 to t=15) = 8000 [((1 + 0.07)7 - 1) / 0.07] FVA(t=9 to t=15) = $ 69232.168 .3 Now adding three eqs 1,2 and 3 FV total at 15th year will be= 55180.63 + 82374.98+69232.168= $ 206787.7 ...........

Question # 7 Your sister turned 32 today, and she is planning to save $12,000 per year for retirement, with the first deposit to be made one year from today. She will invest in a mutual fund that's expected to provide a return of 6.5% per year. She plans to retire when she turns 65, and she expects to live for 20 years after retirement, to age 85. Under these assumptions, how much can she spend each year after she retires? Her first withdrawal will be made at the end of her first retirement year. Ans # 7

FVA(t=32 to t=65) = PMT [((1 + i)n - 1) / i] N= 33 I= 0.065 PMT= $ 12000 FVA(t=32 to t=65) = 12000 [((1 + 0.065)33 - 1) / 0.065] FVA(at t=65) = $ 1290428.5 Now at t= 65th year my FVA will be my PVA PVA= $ 1290428.5
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PMT= ? N= 20 I= 7% PVA = PMT [(1 - (1 / (1 + i)n)) / i] 1290428.5=PMT(11.0185) PMT=$ 117114.63 She can spend $ 117114.63

Question # 8 You just deposited $6,500 in a bank account that pays a 9% interest rate, compounded quarterly. If you also add another $8,000 to the account one year (4 quarters) from now and another $9,500 to the account two years (8 quarters) from now, how much will be in the account three years (12 quarters) from now?

I= 9% annually or for quarterly=0.09/4=0.0225 n=3 years or 3x4= 12

FV = PV (1 + I)n FV(for $ 6500at t=3 years) = 6500 (1 + .0225)12 FV(for $ 6500at t=3 years) = $8489.32 FV( for $ 8000 at 2 year)= 8000 (1 + .0225)8 FV( for $ 8000 at 2 year)= $ 9558.64 FV( for $9500 at 1 year)= 9500 (1 + .0225)4
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FV( for $ 8000 at I year)= $ 10384.29 FV (Total at 3 years or $8489.32+$ 9558.64+$ 10384.29= $ 28432.25 at 12th quater)=

EM601 Assignment # 3

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