Chapter 5 - Time Value of Money Multiple Choice Questions

Chapter 5: Time Value of Money
Multiple Choice Questions

1. What is the total amount accumulated after three years if someone invests $1,000 today with a
simple annual interest rate of 5 percent? With a compound annual interest rate of 5 percent?
A. $1,150, $1,103
B. $1,110, $1,15
!. $1,150, $1,15
". $1,110, $1,103
#evel of difficulty$ %asy
&olution$ !.
&imple interest rate$ $1,000 ' ($1,000)(5*)(3) + $1,150
!ompound interest rate$ $1,000(1.05)
3
+ $1,15
,. Which of the followin- has the lar-est future value if $1,000 is invested today?
A. .ive years with a simple annual interest rate of 10 percent
B. 10 years with a simple annual interest rate of percent
!. %i-ht years with a compound annual interest rate of percent
". %i-ht years with a compound annual interest rate of / percent
&olution$ !.
A) $1,000 ' ($1,000)(10*)(5) + $1,500
B) $1,000 ' ($1,000)(*)(10) + $1,00
!) $1,000(1.0)

+ $1,51
") $1,000(1.0/)

+ $1,/1
0herefore, ! is the lar-est.
Interest rates in the following questions are compound rates unless otherwise stated
3. &uppose an investor wants to have $10 million to retire 15 years from now. 2ow much would
she have to invest today with an annual rate of return e3ual to 15 percent?
A. $1,541
B. $1/,11
!. $,0,003
". $,1,315
#evel of difficulty$ 5edium
&olution$ A.
67+$10,000,0008(1.15)
15
+10,000,000853./493+$1,541
Or using a financial calculator (TI BAII Plus),
:+15, ;8<+15, 650+0, .7+10,000,000, !60 67+ =1,541
Solutions Manual 1 Chapter 5
Copyright 2008 John Wiley & Sons Canada, Ltd. nauthori!ed "opying, distri#ution, or trans$ission is stri"tly prohi#ited.
1. Which of the followin- is false?
A. 0he lon-er the time period, the smaller the present value, -iven a $100 future value and
holdin- the interest rate constant.
B. 0he -reater the interest rate, the -reater the present value, -iven a $100 future value and
holdin- the time period constant.
!. A future dollar is always less valua>le than a dollar today if interest rates are positive.
". 0he discount factor is the reciprocal of the compound factor.
&olution$ B. 0he -reater the interest rate, the smaller the present value, -iven a $100 future
value and holdin- time period constant.
5. 5a--ie deposits $10,000 today and is promised a return of $1/,000 in ei-ht years. What is the
implied annual rate of return?
A. 4.4 percent
B. /.04 percent
!. 5.99 percent
". 4.0/ percent
&olution$ A.
.7+67(1'?)
n
1/,000+10,000(1' ?)
ln(1'?)+ln(1./), therefore ?+4.4*

:+, 67+ =10,000, 650+0, .7+1/,000, !60 ;8<+4.4*
4. 0o triple $1 million, 5i?a invested today at an annual rate of return of 9 percent. 2ow lon-
will it ta?e 5i?a to achieve his -oal?
A. 15.5 years
B. 13.9 years
!. 1,./ years
". 10 years
&olution $ !.
.7+67(1'?)
n
(3)(1,000,000)+1,000,000(1.09)
n
ln(3)+(n)ln(1.09)
n+1,./ years
;8<+9, 67+ =1,000,000, 650+0, .7+3,000,000, !60 :+1,./
/. Which of the followin- concepts is incorrect?
A. An ordinary annuity has payments at the end of each year.
B. An annuity due has payments at the >e-innin- of each year.
!. A perpetuity is considered a perpetual annuity.
". An ordinary annuity has a -reater 67 than an annuity due, if they >oth have the same
periodic payments, discount rate and time period.
&olution$ ". 0he annuity due has a -reater 67 >ecause it pays one year earlier than ordinary
annuity.
. @an plans to invest an e3ual amount of $,,000 in an e3uity fund every yearAend >e-innin- this
year. 0he eBpected annual return on the fund is 15 percent. &he plans to invest for ,0 years. 2ow
much could she eBpect to have at the end of ,0 years?
A. $,3/,4,0
B. $1/4,1,1
!. $,01,/
". $1/,1,1
#evel of difficulty$ "ifficult
&olution$ !.
1
]
1
P!T "#
1 ) 1 (
,0
,0
+$ / , ,01 $ ) 1134 . 10, ( 000 , ,
15 .
1 ) 15 . 1 (
000 , ,
,0

1
]
1
+
:+,0, ;8<+15, 67+0, 650+ A,,000, !60 .7+,01,/
9. ;n 6ro>lem , what is the present value of @anCs investments?
A. $1,,4,5
B. $1,,519
!. $11,394
". $1,,394
&olution$ B.
1
1
1
1
]
1
P!T P#
n
) 1 (
1
1
0
519 , 1, $ ) ,5933 . 4 ( 000 , ,
15 .
) 15 . 1 (
1
1
000 , , $
,0

1
1
1
1
]
1

:+,0, ;8<+15, .7+0, 650+ =,,000, !60 67+1,,519
10. What is the present value of a perpetuity with an annual yearAend payment of $1,500 and
eBpected annual rate of return e3ual to 1, percent?
A. $11,000
Solutions Manual % Chapter 5
B. $13,500
!. $11,100
". $1,,500
&olution$ ".
67
0
+6508?+$1,5008.1,+$1,,500
Practice Problems
11. After a summer of travellin- (and not wor?in-), a student finds himself $1,500 short for this
yearCs tuition fees. 2is parents have a-reed to loan him the money for three years at a simple
interest rate of 4 percent, with interest due at the end of each year.
A. 2ow much interest will he owe his parents after one year?
B. 2ow much will he owe, in total, after three years?
0opic$ &imple ;nterest
&olution$
A. ;n one year you will own 6 B ? + $1500 B 4* + $90 of interest.
B. After three years, the total (principal and interest) owin- will >e$ 6 ' (n B 6 B ?) + $1500 '
(3 B $1500 B 4*) + $1//0.
1,. <our sister has >een forced to >orrow money to pay her tuition this year. ;f she ma?es annual
payments on the loan at year end for the neBt three years, and the loan is for $,,500 at a
simple interest rate of 4 percent, how much will she pay each year?
&olution$
As the eBact amount of interest owin- each year will >e paid, there is no Dcompoundin-.E
0he amount of each annual payment will >e 6 B ? + $,500 B 4* + $150. Fnfortunately, these
payments never reduce the principal owin-, so the loan will never >e paid offG
13. HhalilCs summer Io> has -iven him $1,,00 more than he needs for tuition this year. 0he local
>an? pays simple interest at a rate of 0.5 percent per month. 2ow much interest will he earn
in one year?
&olution$
Hhalil will >e paid interest each month for 1, months, >ut without compoundin-. 0he total
interest earned is (n B 6 B ?) + (1, B $1,00 B 0.5*) + $/,.
11. A new ;nternet >an? pays compound interest of 0.5 percent per month on deposits. 2ow
much interest will HhalilCs summer savin-s of $1,,00 earn in one year with this online >an?
Solutions Manual & Chapter 5
account?
0opic$ !ompound ;nterest
&olution$
0he payment of compound interest means that we must compound (or find the future value)
of the amount invested (the present value)$

01 . 1,/1 $ ) 005 . 0 1 ( 1,00 $
1,
1,
+
months
"#
Jf this amount, $1,,00 was the ori-inal amount invested, so $/1.01 of interest will >e
earned.
15. 2istory tells us that a -roup of "utch colonists purchased the island of 5anhattan from the
:ative American residents in 14,4. 6ayment was made with wampum (li?ely -lass >eads and
trin?ets), which had an estimated value of $,1. &uppose the "utch had invested this money
>ac? home in %urope and earned an avera-e return of 5 percent per year. 2ow much would
this investment >e worth today, 30 years later, usin-$
A. &imple interest?
B. !ompound interest?
0opic$ &imple and !ompound ;nterest
&olution$
A. 7alue + 6 ' (n B 6 B ?) + $,1 ' (30 B $,1 B 5percent) + $10
B. /1 . 40, , 40 , /01 , , $ ) 05 . 0 1 ( ,1 $
30
30
+
years
"#
14. "avid has >een awarded a scholarship that will pay $,,500 one year from now. 2owever, he
really needs the money today, and has decided to ta?e out a loan. ;f the interest rate is
percent, how much can he >orrow so that the scholarship will Iust pay off the loan?
0opic$ "iscountin-
&olution$
0he future value of the loan (the amount to >e repaid) is $,,500. 0he amount that can >e
>orrowed is the present value amount, calculated as$
1 . ,311 $
) 0 . 1 (
1
,500 $
) 1 (
1
1 1 1 0

+

+

"# P#
:+1, ;8<+, 650+0, .7+ A,500, !60 67+,311.1
1/. Krace, a retired li>rarian, would li?e to donate some money to her alma mater to endow a
$1,000 annual scholarship. 0he university will mana-e the funds, and eBpects to earn /
percent per year. 2ow much will Krace have to donate so that the endowment fund never
runs out?
0opic$ 6erpetuities
&olution$
6resent value of the perpetual scholarship payment$
4 . 11, , 5/ $
0/ . 0
1
1000 $
1
0

1
]
1

1
]
1
P!T P#
1. Krace decides that creatin- a perpetual scholarship is too costly (see 6ro>lem 1/%rror$
Leference source not found). ;nstead, she would li?e to support the education of her favourite
-randAnephew, &tephen, who plans to >e-in university in three years. 2ow much will Krace
have to invest today, at / percent, to >e a>le to -ive &tephen $1,000 at the end of each year
for four years?
0opic$ Jrdinary Annuities
&olution$
.ind the present value of the fourAyear annuity at year 3$
5 . 51 , 13 $
0/ . 0
) 0/ . 0 1 (
1
1
1000 $
) 1 (
1
1
1
3

1
1
1
1
]
1

1
1
1
1
]
1
P!T P#
n
:ow, find the present value of this amount today$
90 . 059 , 11 $
) 0/ . 1 (
1
5 . 51 , 13 $
) 1 (
1
3 3
0

1
]
1

1
]
1
"# P#
19. Ban? A pays /.,5 percent interest compounded semiAannually, Ban? B pays /.,0 percent
compounded 3uarterly, and Ban? ! pays /.15 percent compounded monthly. Which >an?
pays the hi-hest effective annual rate?
0opic$ %ffective Annual Lates
&olution$
.or Ban? A, * 3 . / 1
,
0/,5 . 0
1
,

,
_
+
.or Ban? B, * 10 . / 1
1
0/,0 . 0
1
1

,
_
+
.or Ban? !, * 39 . / 1
1,
0/15 . 0
1
1,

,
_
+
Solutions Manual ' Chapter 5
Ban? B pays the hi-hest effective annual rate.
,0. @immie is >uyin- a new car. 2is >an? 3uotes a rate of 9.5 percent per year for a car loan.
!alculate the effective annual rate if the compoundin- occurs$
A. Annually
B. Muarterly
!. 5onthly
0opic$ "eterminin- %ffective Annual Lates
&olution$
A. .or annual compoundin-, the effective annual rate will >e the same as the 3uoted rate. 0o
chec? this$
* 5 . 9
1
* 5 . 9
1 1 1
1

,
_
+
,
_
+
m
m
$%
B. With 3uarterly compoundin-, set m+1,

* 1 . 9 1
1
* 5 . 9
1
1

,
_
+
!. With monthly compoundin-, set m+1,,
* 9, . 9 1
1,
* 5 . 9
1
1,

,
_
+
,1. ;f Alysha puts $50,000 in a savin-s account payin- 4 percent per year, how much money will
she have in total at the end of the first year if interest is compounded$
A. Annually?
B. 5onthly?
!. "aily?
0opic$ %ffective vs. Muoted Lates
&olution$
A.
000 , 53 $ ) 04 . 1 ( 000 , 50 $ ) 1 ( * 4
0 1
+ P# "# %ate $uoted
year
B. 90 . 03 , 53 $ ) 0414/ . 1 ( 000 , 50 $ * 14/ . 4 1
1,
1
1
1,

,
_
+
year
"#
$%
!. 55 . 091 , 53 $ ) 04131 . 1 ( 000 , 50 $ * 131 . 4 1

345
1
1
345

,
_
+
year
"#
$%
Solutions Manual ( Chapter 5

,,. 0ony started a small >usiness and was too >usy to consider savin- for retirement. 0ony sold
the >usiness for $550,000 when he was 55 years old. 2e thou-ht he could fund his
retirement, >ecause this was a lot more than his friend had amassed in his account. 0ony can
invest this total sum and earn 10 percent per year. 2ow much will his investment >e worth in
five years?
0opic$ ;nvestin- %arly
&olution$
50 . /0 , 5 $ ) 10 . 0 1 ( 000 , 550 $
5
5
+
years
"#
0ony will have less than his friend in five years >ecause he is not addin- more savin-s to his
account.
,3. 6u>lic corporations have no fiBed life spanN as such, they are often viewed as entities that
will pay dividends to their shareholders in perpetuity. &uppose HashHow ;nc. pays a
dividend of $, per share every year. ;f the discount rate is 1, percent, what is the present
value of all the future dividends?
0opic$ 6erpetuities
&olution$
0he value of any perpetual stream of payments can >e valued as a perpetuity$
4/ . 14 $
1, . 0
, $
0

P!T
P#
%ach share is worth $14.4/.
,1. 5aryABeth is plannin- to live in a university residence for four years while completin- her
de-ree. 0he annual cost for food and lod-in- is $5,00 and must >e paid at the start of each
school year. What is the total present value of 5aryABethCs residence fees if the discount rate
(interest rate) is 4 percent per year?
0opic$ Annuities "ue
&olution$
Because the fees are paid at the start of the year, this is not an ordinary annuity, >ut rather, an
annuity due.
1/ . 303 , ,1 $ ) 04 . 0 1 (
04 . 0
) 04 . 0 1 (
1
1
500 $
1
0
+
1
1
1
1
]
1
P#
,5. !alculate the effective annual rates for the followin-$
A. ,1 percent, compounded daily
B. ,1 percent, compounded 3uarterly
!. ,1 percent, compounded every four months
". ,1 percent, compounded semiAannually
%. ,1 percent, compounded continuously
.. !alculate the effective monthly rate for A to ".
#evel of difficulty$ 5edium.
&olution$
A. m + 345$ *. 11 . ,/ 1 )
345
,1 .
1 (
345
+
B. m + 1$ *. ,5 . ,4 1 )
1
,1 .
1 (
1
+
!. m + 3$ *. 9/ . ,5 1 )
3
,1 .
1 (
3
+
". m + ,$ *. 11 . ,5 1 )
,
,1 .
1 (
,
+
%. !ontinuous compoundin-$ *. 1, . ,/ 1
,1 .
e
.. 0he effectively monthly rate is$
A. m+345, f+1,
1 ) 1 ( +
f
m
m
$%
+ 1 )
345
,1 .
1 (
1,
345
+ +,.0,*
B. m+1, f+1,.
1 ) 1 ( +
f
m
m
$%
+ 1 )
1
,1 .
1 (
1,
1
+ +1.94*
!. m+3, f+1,.
1 ) 1 ( +
f
m
m
$%
+ 1 )
3
,1 .
1 (
1,
3
+ +1.91*
". m+,, f+1,.
1 ) 1 ( +
f
m
m
$%
+ 1 )
,
,1 .
1 (
1,
,
+ +1.91*
,4. Jn the advice of a friend, Kilda invests $,0,000 in a mutual fund which has earned 10
percent per year, on avera-e, in recent years. ;f this rate of return continues, how much will
her investment >e worth in$
A. one year?
B. five years?
!. ten years?
&olution$
A.
00 . 000 , ,, $ ) 10 . 0 1 ( 000 , ,0 $
1
1
+
year
"#
Solutions Manual ) Chapter 5
B.
,0 . ,10 , 3, $ ) 10 . 0 1 ( 000 , ,0 $
5
5
+
years
"#
!.
5 . /1 , 51 $ ) 10 . 0 1 ( 000 , ,0 $
10
10
+
years
"#
,/. <our investment research has turned up an interestin- mutual fund. ;t has had an avera-e
annual return 0.5 percent -reater than the one KildaCs friend recommended (see 6ro>lem ,4).
.or each time period from 6ro>lem ,4, calculate how much >etter off Kilda would >e if she
invested $,0,000 in this mutual fund.
&olution$
.irst find the value of the investment after each period of time, and then compare to the
values from 6ro>lem ,4 to determine how much difference a small chan-e in the interest rate
can ma?e.
A. 00 . 100 , ,, $ ) 105 . 0 1 ( 000 , ,0 $
1
1
+
year
"# . <ou are ($,,,100 = $,,,000) + $100 >etter
off after one year.
B. 91 . 91 , 3, $ ) 105 . 0 1 ( 000 , ,0 $
5
5
+
years
"# . <ou are ($3,,91.91 = $3,,,10.,0) +
$/3./1 >etter off after five years.
!. 4, . ,1 , 51 $ ) 105 . 0 1 ( 000 , ,0 $
10
10
+
years
"# <ou are ($51,,1.4, = $51,/1.5) +
$,,104.// >etter off after 10 years.
,. When @on -raduates in three years, he wants to throw a >i- party, which will cost $00. 0o
have this amount availa>le, how much does he have to invest today if he can earn a
compound return of 5 percent per year?
0opic$ "iscountin-
&olution$
@on needs $00 in three yearsN that is the future value amount. 0he present value e3uivalent
is$

0/ . 491 $
) 05 . 1 (
1
00 $
) 1 (
1
3 3 3 0

+

+

"# P#
:+3, ;8<+5, 650+0, .7+ A00, !60 67+491.0/
,9. ;n 6ro>lem ,, suppose @on had only $500 to invest. 2ow much can he plan to spend on the
-raduation party in three years, if the return on the investment will >e$
A. simple interest at 5 percent per year?
B. compound interest at 5 percent per year?
0opic$ &imple and !ompound ;nterest
&olution$
A. @on will earn ,5 $ * 5 $500 per year in interest. 0he value of his investment (or the
amount availa>le to spend on the party) will >e$
5/5 $ ) 05 . 0 500 3 ( 500 $ ) ( 7alue + + P n P
B. 0he interest earned -rows (compounds) each yearN the total availa>le in three years is$
1 . 5/ $ ) 05 . 1 ( 500 $ ) 1 (
3 3
0 3
+ + P# "#
30. At the a-e of 10, .eliB decided that he wanted to attend a very presti-ious (and eBpensive)
university. 2ow much will his parents have to save each year to accumulate $10,000 >y the
time .eliB needs the funds in ei-ht years? Assume .eliBCs parents can earn / percent
(compounded annually) on their savin-s, and that each yearCs savin-s are deposited at the end
of the year.
&olution$
0he future value amount is $10,000. 0he amount to >e saved each year is really the payment
on an ordinary annuity$
/1 . 39 $
0/ . 0
1 ) 0/ . 0 1 (
000 , 10 $

1
]
1
+
P!T P!T
:+, ;8<+/, 67+0, .7+ A10,000, !60 650+ 39./1
31. .eliBCs parents can only afford to save $3,000 per year for his university education, which
>e-ins in ei-ht years. What rate of return would they re3uire on these savin-s if they must
accumulate $10,000?
0opic$ Jrdinary Annuities (&olvin- for ;LL)
&olution$
&olve for the interest rate (or internal rate of return) on an ordinary annuity. 0his is 3uite
difficult to do al-e>raically, >ut is easily handled with a financial calculator (TI BAII Plus).
:ote that we must use a ne-ative si-n for the annual payment (savin-s) or the future value
amount, >ut not >oth.
:+, 650 + 3,000, 67+0, .7+ =10,000, !60 ;8<+11.,04/*
3,. &hortly after @ohn was >orn, his parents >e-an to put money in a savin-s account to pay for
his postAsecondary education. 0hey save $1,000 each year, and earn a return of 9 percent per
year. 2owever, the interest income is taBed each year at a rate of 30 percent. 2ow much will
@ohnCs account >e worth after 1/ years?
0opic$ Jrdinary Annuity (.uture 7alue)
&olution$
0aBation of the interest income has the effect of reducin- the rate of return. ;n effect$
* 3 . 4 ) 30 . 0 1 ( * 9
. Fsin- this rate of return we find the future value of @ohnCs account
to >e $
11 . 9/3 , , $
043 . 0
1 ) 043 . 0 1 (
1000 $
1/
1/

1
]
1
+
"#
33. @ohnCs parents used a re-ular savin-s account to save for his postAsecondary education. Based
on the amount accumulated (from your answer in 6ro>lem 3,), how much can @ohn withdraw
from the account at the >e-innin- of each year for his four years at university? 0he account
will continue to earn 9 percent per year, >ut interest income is taBed at a rate of 30 percent.
&olution$
As in 6ro>lem 3,,
* 3 . 4 ) 30 . 0 1 ( * 9
>ecause of taBation. @ohnCs withdrawals at the
>e-innin- of each year are essentially DpaymentsE on an annuity due$
95 . /919 $ ) 043 . 0 1 (
043 . 0
) 043 . 0 1 (
1
1
11 . 9/3 , ,
1
+
1
1
1
1
]
1
P!T P!T
31. @aneCs parents save $1,000 per year for 1/ years to pay for her university tuition costs. 0hey
deposit the money into a Le-istered %ducation &avin-s 6lan (L%&6) account so that no taB is
paya>le on the interest income. 0his L%&6 account provides a return of 4 percent per year.
A. 2ow much will @aneCs account >e worth when she >e-ins her university studies?
B. As an incentive to save for hi-her education, the -overnment will add ,0 percent to any
money contri>uted to an L%&6 each year. ;ncludin- these -rants, how much will @ane have in
her account?
0opic$ Jrdinary Annuity (.uture 7alue)
&olution$
A. 0he future value of @aneCs account will >e$
. ,1, , , $
04 . 0
1 ) 04 . 0 1 (
1000 $
1/
1/

1
]
1
+
"#
B. 0he -rant has the effect of increasin- the amount saved from $1,000 to $1,,00. 0he future
value of the account will now >e$
14 . 55 , 33 $
04 . 0
1 ) 04 . 0 1 (
1,00 $
1/
1/

1
]
1
+
"#
35. @aneCs parents used an L%&6 account to save for her postAsecondary education. Based on the
amount accumulated (from your answer in 6ro>lem 31), @ane would li?e to withdraw the
same amount of money at the >e-innin- of each year of her fourAyear de-ree pro-ram. All
funds (interest and principal) withdrawn from this account are taBed at a rate of 15 percent,
and the account will earn 4 percent per year on any remainin- funds. 2ow much will @ane
have availa>le for tuition each year?
&olution$
%ach year, @ane can withdraw$
34 . 9,1/ $ ) 04 . 0 1 (
04 . 0
) 04 . 0 1 (
1
1
14 . 55 , 33
1
+
1
1
1
1
]
1
P!T P!T
2owever, this amount will >e su>Iect to income taB at a rate of 15*. 0he net amount that
@ane will have availa>le for tuition is then$
/5 . /31 $ ) 15 . 0 1 ( * 34 . 9,1/
34. &tephen has learned that his -reatAaunt (see 6ro>lem 1%rror$ Leference source not found)
intends to -ive him $1,000 each year he is studyin- at university. 0uition must >e paid in
advance, so &tephen would li?e to receive his payments at the >e-innin- of each school year.
2ow much will his -reatAaunt have to invest today at / percent, to ma?e the four annual
(startAofAyear) payments?
&olution$
.ind the present value of the fourAyear annuity due$
,4 . 19/ , 11 $ ) 0/ . 0 1 (
0/ . 0
) 0/ . 0 1 (
1
1
1000 $ ) 1 (
) 1 (
1
1
1
0
+
1
1
1
1
]
1
+
1
1
1
1
]
1
P!T P#
n
:ow, discount this amount >ac? three years$
0 . 31 , 11 $
) 0/ . 1 (
1
,4 . 19/ , 11 $
) 1 (
1
3 3
0

1
]
1

1
]
1
"# P#
3/. Lather than -ive her -randAnephew some money each year while he is studyin-, &tephenCs
-reatAaunt has decided to save the money and pay off &tephenCs student loans when he
Solutions Manual 1% Chapter 5
finishes his de-ree. 0he total amount owin- at that time will >e $14,000. 2ow much will she
have to save each year until that time if her investments earn a return of / percent per year?
&olution$
Assumin- the savin-s are invested at the end of each year, find the payment (amount to >e
saved) for an ordinary annuity with a future value of $14,000.
5 . 1 , 1 $
0/ . 0
1 ) 0/ . 0 1 (
000 , 14 $
/
1

1
]
1
+
P!T P!T "#
3. @immieCs new car (see 6ro>lem ,0) will cost $,9,000. 2ow much will his monthly car
payments >e if he o>tains a loan that is amortiOed over 40 months, and the nominal interest
rate is .5 percent per year with monthly compoundin-?
0opic$ %ffective ;nterest Lates and #oan Arran-ements
&olution$
.irst, find the effective interest correspondin- to the fre3uency of @immieCs car payments (f
+1,)N with monthly compoundin-, set m+1,,
* /03 . 0 1
1,
* 5 .
1 1 1
1,
1,

,
_
+
,
_
+
f
m
monthly
m
$%
0he 40 car payments form an DannuityE whose present value is the amount of the loan (the
price of the car)$
9 . 591 $
00/03 . 0
) 00/03 . 0 1 (
1
1
000 , ,9 $
40

1
1
1
1
]
1
P!T P!T
39. !reate an amortiOation schedule for @immieCs car loan (see 6ro>lem 3%rror$ Leference
source not found). What portion of the first monthly payment -oes towards repayin- the
principal amount of the loan? What portion of the last monthly payment -oes towards the
principal?
0opic$ #oan Arran-ements
&olution$
Fse the effective monthly interest rate from 6ro>lem 3, ?+0./03*
*eriod +1, *rin"ipal
-utstanding
+2,
*ay$ent
+%,
.nterest
+&,
*rin"ipal
/nding
*rin"ipal
Solutions Manual 1& Chapter 5
012+1, 3epay$ent
0 +2,4+%,
0 +1,4+&,
1 2),000.00 5)&.)8 205.&2 %8).5' 28,'10.&&
2 28,'10.&& 5)&.)8 202.'' %)2.%2 28,218.12
% 28,218.12 5)&.)8 1)).88 %)5.10 2(,82%.01
& 2(,82%.01 5)&.)8 1)(.08 %)(.)0 2(,&25.11
5 2(,&25.11 5)&.)8 1)&.2' &00.(2 2(,02&.&0
' 2(,02&.&0 5)&.)8 1)1.&2 &0%.5' 2','20.8&
( 2','20.8& 5)&.)8 188.5' &0'.&2 2',21&.&2
8 2',21&.&2 5)&.)8 185.') &0).2) 25,805.1%
) 25,805.1% 5)&.)8 182.() &12.1) 25,%)2.)&
10 25,%)2.)& 5)&.)8 1().8( &15.11 2&,)((.82
11 2&,)((.82 5)&.)8 1('.)% &18.05 2&,55).((
12 2&,55).(( 5)&.)8 1(%.)( &21.01 2&,1%8.('
1% 2&,1%8.(' 5)&.)8 1(0.)8 &2&.00 2%,(1&.('
...
%5 1&,08%.18 5)&.)8 )).(' &)5.22 1%,58(.)5
%' 1%,58(.)5 5)&.)8 )'.25 &)8.(% 1%,08).22
%( 1%,08).22 5)&.)8 )2.(2 502.2' 12,58'.)'
...
5) 1,1((.&% 5)&.)8 8.%& 58'.'& 5)0.()
'0 5)0.() 5)&.)8 &.18 5)0.() 0.00
0he first monthly payment repays $39.54 of the principal amount of the loan and the last
payment repays $590./9.
10. Fsin- the amortiOation schedule from 6ro>lem 39, determine how much @immie still owes on
the car loan after three years of payments on the fiveAyear loan. What is the present value of
this amount?
0opic$ #oan Arran-ements and "iscountin-
&olution$
After three years, or 34 monthly payments, the principal outstandin- is $13,09.,, (from the
amortiOation ta>le). 0he present value of this amount is$
30 . 15, , 10 $
) 00/03 . 0 1 (
1
,, . 09 , 13 $
34 0

,
_
+
P#
11. @immie would li?e to pay off his car loan in three years (see 6ro>lem 3), >ut can only afford
monthly payments of $591.9. 2ow >i- a downApayment must @immie ma?e on the $,9,000
car if the nominal interest rate is .5 percent with monthly compoundin-?
0opic$ #oan Arran-ements
&olution$
Fse the effective monthly interest rate from 6ro>lem 3, ?+0./03*
.ind the present value of @immieCs 34 payments$
95 . 1/ , 1 $
00/03 . 0
) 00/03 . 0 1 (
1
1
9 . 591 $
34
0

1
1
1
1
]
1
P#
0herefore, @immie must ma?e a down payment of
05 . 15, , 10 $ 95 . 1/ , 1 $ 00 . 000 , ,9 $
1,. @immie is offered another loan of $,9,000 that re3uires 40 monthly payments of $5.0, (see
6ro>lem 3%rror$ Leference source not found). What is the effective annual interest rate on
this loan? What would the 3uoted rate >e?
0opic$ #oan arran-ements and %ffective Annual Lates
&olution$
0he 40 monthly payments form an annuity whose present value is $,9,000. .indin- the
interest rate is most easily done with a financial calculator (TI BAII Plus)&
:+40, 650+5.0,/, 67+ A,9,000, !60 ;8< + 0.444/*
:ote that we used :+40 months, so the solution is a monthly interest rate, however, the
pro>lem as?s for the effective annual rate.
* 30 . 1 ) 00444/ . 0 1 ( 1 ) 1 (
1, 1,
+ +
monthly

0he 3uoted rate would >e$
* 00 . 1 ) 030 . 0 1 ( 1, P 1 ) 1 Q(
1,
1
1,
1
+ + m $%
Jr simply$
* 00 . 00444/ . 0 1,
monthly
m $%
13. 0o start a new >usiness, &u 5ei intends to >orrow $,5,000 from a local >an?. ;f the >an?
as?s her to repay the loan in five e3ual annual instalments of $4,935.,1, determine the >an?Cs
effective annual interest rate on the loan transaction. With annual compoundin-, what
nominal rate would the >an? 3uote for this loan?
0opic$ "eterminin- Lates of Leturn and %ffective ;nterest Lates
&olution$
&olve the annuity e3uation to find ?, the interest rate$
?
) 1 (
1
1
,1 . 4935 $ 00 . 000 , ,5 $
5

1
1
1
1
]
1
0he calculations are most easily done with a financial calculator (TI BAII Plus),
67 + A,5,000, 650+4935.,1, :+ 5, .7+0, !60 ;8< + 1,*
Solutions Manual 1' Chapter 5
0he effective annual interest rate is 1, percent. With annual compoundin-, the nominal rate
(or 3uoted rate) will also >e 1, percent per year.
11. 0he Business "evelopment Ban? is willin- to loan &u 5ei the $,5,000 she needs to start her
new company. 0he loan will re3uire monthly payments of $554.11 over five years.
A. What is the effective monthly rate on this loan?
B. With monthly compoundin-, what is the nominal (annual) interest rate on this loan?
0opic$ "eterminin- Lates of Leturn and %ffective ;nterest Lates
&olution$
A. 0here will >e 5 B 1, + 40 monthly payments. 0he calculations are most easily done with a
financial calculator (TI BAII Plus),
67 + =,5,000, 650+554.11, :+ 40, !60 ;8< + 1.0*
Because we used monthly payments, and months as the time period, 1.0* is the effective
monthly rate.
B. 0he compoundin- period matches the payment fre3uency, so the nominal rate, or 3uoted
rate, is$
* 0 . 1, * 0 . 1 1,
monthly
m $%
per year.
15. !ompare the loans in pro>lems 13 and 11. Which is the >etter deal, and why?
0opic$ %ffective ;nterest Lates
&olution$
0he two loans have the same principal amountN one re3uires monthly payments, the other
annual, so they cannot >e compared on that >asis. We need an effective rate for the same
period of time for comparison. ;n 6ro>lem 13, the effective annual rate was 1,*. .or
6ro>lem 11, the effective annual rate is$
* / . 1, 1 ) 01 . 0 1 ( 1 ) 1 (
1, 1,
+ +
monthly

.
!learly, the loan in 6ro>lem 13 is a >etter deal >ecause the effective interest rate char-ed is
lower.
14. After losin- money playin- onAline po?er, &cott visits a loan shar? for a $/50 loan. 0o avoid
a visit from the Dcollection a-ency,E he will have to repay $00 in Iust one wee?.
A. What is the nominal interest rate per wee?? 6er year?
B. What is the effective annual interest rate?
0opic$ %ffective ;nterest Lates
Solutions Manual 1( Chapter 5
&olution$
A. <ou will pay interest of (00=/50) + $50 after one wee?. 0his implies a nominal interest
rate of 508/50 + 4.4/* per wee?. With 5, wee?s in the year, the nominal rate per year is then
5, B 4.4/* + 314.4/*.
B. 0he effective annual interest rate is * 10 . //, , , /,10 . ,/ 1 ) 044/ . 0 1 (
5,
+
,,/,.1* = 1+,,//,.1*
1/. @osephine needs to >orrow $10,000 to purchase her new house in <armouth, :ova &cotia.
&he would li?e to pay off the mort-a-e in ,0 years, ma?in- monthly payments. .or the initial
threeAyear term, 6rovidence Ban? has offered her a 3uoted annual rate of 4.10 percent.
A. What is the effective annual interest rate?
B. What is the effective monthly interest rate?
!. 2ow much will @osephineCs monthly mort-a-e payments >e?
0opic$ 5ort-a-e #oans and %ffective ;nterest Lates
&olution$
A. ;n !anada, fiBedArate mort-a-es use semiAannual compoundin- of interest, so m+,. 0he
effective annual rate is therefore$
* 50,1 . 4 1
,
041 . 0
1 1 1
,

,
_
+
,
_
+
m
m
$%
B. With monthly payments, f+1,. We can find the effective monthly interest rate from the
effective annual rate, ?$
( ) ( ) * 5,41 . 0 1 * 50,1 . 4 1 1 1
1,
1 1
+ +
f
monthly

!. 0he amortiOation period is ,0 years, or ,0 B1 , + ,10 months. @osephineCs monthly
payments can >e computed as$
49 . 3,, , 1 $
005,41 . 0
) 005,41 . 0 1 (
1
1
000 , 10 $
,10

1
1
1
1
]
1
P!T P!T
1. 0he <armouth !redit Fnion will provide @osephine with a mort-a-e at a rate of 4.34 percent,
>ut unli?e most !anadian mort-a-es, the compoundin- will occur monthly. &hould
@osephine ta?e out the mort-a-e loan from the !redit Fnion, or from 6rovidence Ban? (see
6ro>lem 1/)? !an you answer this 3uestion without calculatin- the monthly mort-a-e
payment?
0opic$ 5ort-a-e #oans and %ffective ;nterest Lates
&olution$
With monthly compoundin- and payments, the effective monthly interest rate is$
* 530 . 0 1
1,
0434 . 0
1 1 1
1,
1,

,
_
+
,
_
+
f
m
monthly
m
$%
%ven thou-h the 3uoted rate is lower at the !redit Fnion than at the Ban? (see 6ro>lem 1/), the
effective rate is hi-her. @osephine should ta?e the mort-a-e loan from the Ban? in this case.
0he monthly payment for the !redit Fnion mort-a-e would >e $1,3,/.,1, which, as
eBpected, is hi-her than that at the Ban?.
19. Assume @osephine chose the 6rovidence Ban? option (see 6ro>lem 1/). ;f @osephine can -et
the same interest rate for a second threeAyear term as she did ori-inally, how much will her
monthly payments >e now?
0opic$ 5ort-a-e #oans
&olution$
;f we assume that @osephine does not chan-e the amortiOation period (now 1/ years), then the
same interest rate will result in ma?in- the same monthly payments. We can confirm this >y
computin- the payment for a mort-a-e with a principal amount e3ual to the amount now
outstandin- ($145,1/,.3 >ased on 6ro>lem 1/), that lasts ,01 months (1/ years)$
49 . 13,, $
005,41 . 0
) 005,41 . 0 1 (
1
1
3 . 1/, , 145 $
,01

1
1
1
1
]
1
P!T P!T
50. A la?efront house in Hin-ston, Jntario is for sale with an as?in- price of $199,000. 0he realA
estate mar?et has >een 3uite active, so the house will almost certainly attract several offers,
and may sell for more than the as?in- price. !harlie is very ea-er to purchase this house, >ut
is concerned that he may not >e a>le to afford it. 2e has $130,000 availa>le for a down
payment, and can pay up to $1,950.00 per month on a mort-a-e loan. As a lon-Atime
customer, !harlieCs >an? has offered him a -reat mort-a-e rate of 3.90 percent on a oneAyear
term. ;f the loan will >e amortiOed over ,5 years, what is the most that !harlie can afford to
pay for the house?
&olution$
With semiAannual compoundin- (the norm in !anada) and monthly payments, m+, and f+1,.
0he effective monthly rate is$
* 3,,1 . 0 1
,
039 . 0
1 1 1
1,
,

,
_
+
,
_
+
f
m
monthly
m
$%
Solutions Manual 1) Chapter 5

0he present value of the mort-a-e payments over the amortiOation period (,5 years B 1, +
300 months) is$
/, . 553 , 3/1 $
003,,1 . 0
) 003,,1 . 0 1 (
1
1
00 . 1950 $
300
0

1
1
1
1
]
1
P#
;n addition, !harlie has $130,000 availa>le as a down paymentN the most he can pay for the
house is, therefore, $3/1,553./, ' $130,000 + $501,553./,.
51. 0immy sets himself a -oal of amassin- $1 million in his retirement fund >y the time he turns
41. 2e >e-ins savin- $3,000 each year, startin- on his ,1
st
>irthday (10 years of savin-).
A. ;f his savin-s earn 10 percent per year, will 0immy achieve his -oal?
B. Will 0immy >e a>le to retire >efore he turns 40? 0hat is, at what a-e will the value of his
savin-s plan >e worth $1 million?
&olution$
A. 0immyCs savin-s eBtend ri-ht to a-e 41 (end of each year), so this is an ordinary annuity.
4/ . /// , 3,/ , 1 $
10 . 0
1 ) 10 . 0 1 (
000 , 3 $
10
10

1
]
1
+
"#
<es, 0immy will achieve his -oal >y a comforta>le mar-in.
B. ;n the e3uation for part A set .7+$1,000,000, and solve for the num>er of years, n. 0his
is easiest done with a financial calculator (TI BAII Plus),
.7 + =1,000,000, ;8< + 10, 650 + 3000, !60 : + 3/.1.
0immy will hit the $1 million dollar mar? in Iust over 3/ years, or shortly after his 5
th
>irthday.
5,. 0ommy set the same retirement -oal as his friend 0immy (see 6ro>lem 51). 2owever, there
always seemed to >e a reason not to save money, so he put it off for many years. .inally, with
Iust 15 years to retirement, he >e-an to save. .ortunately, 0ommyCs eBecutiveAlevel Io>
allowed him to save $30,000 per year. ;f these savin-s earn 10 percent per year, will 0ommy
achieve his $1million -oal at the desired time?
&olution$
0his is an ordinary annuity.
15 . 1/1 , 953 $
10 . 0
1 ) 10 . 0 1 (
000 , 30 $
15
15

1
]
1
+
"#
:o, 0ommy will not 3uite achieve his -oal >y a-e 41.
53. @ac? is , years old now and plans to retire in 35 years. 2e wor?s in a local >an? and has an
annual afterAtaB income of $15,000. 2is eBpected annual eBpenditure is $34,000 and the rest
of his income will >e invested at the >e-innin- of each of the neBt 35 years at an eBpected
annual rate of return of 1,.4 percent. !alculate the amount @ac? will receive when he retires.
#evel of difficulty$ "ifficult.
&olution$
Annual investment + Annual income = Annual eBpenditure + $15,000 = $34,000 + $9,000.
0his is an annuity due.
) 1 (
1 ) 1 (
P!T "#
n
n
+
1
]
1
+

31 , 039 , 5 $ ) 1,4 . 1 )( ,/19 . 19/ )( 000 , 9 ( ) 1,4 . 1 (
1,4 .
1 ) 1,4 . 1 (
000 , 9
35

1
]
1

2it Q,
nd
P QBK:P Q,
nd
P Q&etP
:+35, ;8<+1,.4, 67+0, 650+ A9,000, !60 .7+5,039,31
51. ;n 6ro>lem 53, if @ac? prefers to invest a lumpAsum amount today instead of investin-
annually, >ut still eBpects to receive the same amount of money when he retires, how much
should he invest today?
&olution$ 0here are two ways to -et the answer$
1). 67+.78(1'?)
n
+5,039,318(1.1,4)
35
+5,039,31843.4544+$/9,145
:+35, ;8<+1,.4, 650+0, .7+5,039,31, !60 67+ A /9,145
,).
) 1 (
) 1 (
1
1
0
P!T P#
n
+
1
1
1
1
]
1
145 , /9 $ ) 1,4 . 1 )( 11311 . / )( 000 , 9 ( ) 1,4 . 1 (

1,4 .
) 1,4 . 1 (
1
1
000 , 9 $
35

1
1
1
1
]
1

2it Q,
nd
P QBK:P Q,
nd
P Q&etP
:+35, ;8<+1,.4, 650+ A9,000, .7+0, !60 67+/9,145
55. ;n 6ro>lem 53, if @ac? invests the same annual amount at the end of each of the neBt 35 years
instead of at the 'eginning of the years, how much he will receive when he retires? %Bplain
why this amount is -reater or smaller than the result calculated in 6ro>lem 53.
&olution$ :ow it is an ordinary annuity.

1
]
1
P!T "#
1 ) 1 (
35
35
+
1/1 , 1/5 , 1 $ ) ,/19 . 19/ ( 000 , 9
1,4 .
1 ) 1,4 . 1 (
000 , 9
35

1
]
1
+
:+35, ;8<+1,.4, 67+0, 650+ =9,000, !60 .7+ 1,1/5,1/1.
&o, 1,1/5,1/1R5,039,31.
As eBpected, .7 of an ordinary annuity is less than an otherwise identical annuity due.
Because each annual investment is compounded one year less in an ordinary annuity, where
the annual investment is at each yearAend, while in the annuity due this amount is invested at
the >e-innin- of each year. Alternatively, we can loo? at %3uation 5A1 and %3uation 5A4. 0he
difference is due to the compound factor (1'?).
54. A. "etermine the monthAend payment for a $,00,000, 10Ayear loan with an interest rate of 1,
percent, compounded monthly. (Assume there is no down payment)
B. !alculate the outstandin- loan amount after 1 months.
!. Ledo part A, assumin- it is a mort-a-e loan with monthly payments.
A. #evel of difficulty$ difficult.
&olution$
67+,00,000, monthly rate+1,*81,+1*, : + (10)(1,)+1,0 months
1
1
1
1
]
1
01 .
) 01 . 1 (
1
1
000 , ,00
1,0
P!T
1
1
1
1
]
1
01 .
) 01 . 1 (
1
1
8 000 , ,00
1,0
P!T
&o, 650+$,,49
:+1,0, ;8<+1, 67+A,00,000, .7+0, !60 650+,,49
B. Lemainin- months to pay+1,0 = 1+10, months
1
1
1
1
]
1
01 .
) 01 . 1 (
1
1
49 , ,
10,
0
P#
+$1,,9,0
:+10,, ;8<+1, 650+A ,,49, .7+0, !60 67+1,,9,0
!. ?
monthly
+ 1 )
,
1, .
1 (
1,
,
+ +.9/59*
1
1
1
1
]
1
009/59 .
) 009/59 . 1 (
1
1
000 , ,00
1,0
P!T
1
1
1
1
]
1
009/59 .
) 009/59 . 1 (
1
1
8 000 , ,00
1,0
P!T
&o, 650+$,,34
:+1,0, ;8<+.9/59, 67+A,00,000, .7+0, !60 650+,,34
5/. ;nvestor A Iust turned ,0 years old and currently has no investments. &he plans to invest
$5,500 at the end of each ei-ht years, >e-innin- in five years. 0he rate of return on her
investment is 15 percent, continuously compounded. ;nvestor B is 10 years old and he Iust
started to invest at the >e-innin- of every year an e3ual amount of money startin- today. 2e
will invest for 10 years. 0he rate of return on his investment is 14 percent, compounded
3uarterly. "etermine the yearly payment ;nvestor B has to ma?e in order to have the same
present value as ;nvestor A.
&olution$
;nvestor A$
?+e
.15
= 1+14.131,1*.
(
st
, consider an ordinary annuity and the present )alue of the in)estment when A turns *+
years old is&
1
1
1
1
]
1
14131,1 .
) 14131,1 . 1 (
1
1
500 , 5
,5
P#
+$,3,/19.19
Solutions Manual 2% Chapter 5
:+, ;8<+14.131,1, 650+5,500, .7+0, !60 67+A ,3,/19.19
*
nd
, discount this amount for fi)e years 'ac to today when she is *,-
67+.78(1'?)
5
+,3,/19.198(1.14131,1)
5
+$11,,1.3,31
Jr, :+5, ;8<+14.131,1, 650+0, .7+A ,3,/19.19, !60 67+11,,1.3,31
;nvestor B$
?+ 1 )
1
14 .
1 (
1
+ +14.9554*
) 149554 . 1 (
149554 .
) 149554 . 1 (
1
1
3,31 . ,1 , 11
10
1
1
1
1
]
1
P!T
650+$,,05/.3
2it Q,
nd
P QBK:P Q,
nd
P Q&etP
:+10, ;8<+14.9554, 67+11,,1.3,31, .7+0, !60 650+ A ,,05/.3
0herefore, ;nvestor B has to ma?e an e3ual amount of $,,05/.3 so that the present value of
the two investments is the same.
5. 6aul and 5aria want to have enou-h money to travel around the world when they retire.
0hey Iust turned 30 and will retire when they turn 40. 0hey earn a total of $9,000 after taBes
each month. 0heir monthly eBpenditures include $3,000 in mort-a-e payments, $50 in car
payments, and $1,150 in other eBpenses. 0hey approached a fund mana-er and decided to
invest the rest of their income at the end of each year. 0hey eBpect to earn a 10 percent
eBpected annual rate of return for each of the neBt 30 years. When they retire, they will sell
their cotta-e for an eBpected price of $50,000.
A. "etermine how much they will have when they retire.
B. 2ow much can 6aul and 5aria withdraw annually at the >e-innin- of the year for
travellin- after they retire if they eBpect to live until they are 90?
A. #evel of difficulty$ "ifficult
&olution$
(
st
.alculate their yearly income a)aila'le for in)estment
5onthly income availa>le+$9,000 = $3,000 = $50 =$1,150+$3,/00
<early availa>le+$(3,/00)(1,)+$11,100
*
nd
.alculate the "# of their in)estment when they retire&
1
]
1
1 .
1 ) 1 . 1 (
100 , 11
30
30
"#
+$/,303,535
Solutions Manual 2& Chapter 5
:+30, ;8<+10, 67+0, 650+A 11,100, !60 .7+/,303,535
/
rd
.alculate the amount they will ha)e when they retire&
$/,303,535 ' $50,000 + $/,353,535
B. #evel of difficulty$ "ifficult
&olution$
0his is an annuity due pro>lem.
67+/,353,535, ?+10*, n+30
) 1 . 1 (
1 .
) 1 . 1 (
1
1
535 , 353 , /
30
+
1
1
1
1
]
1
P!T
&o, 650+/09,113
2it Q,
nd
P QBK:P Q,
nd
P Q&etP
:+30, ;8<+10, 67+A /,353,535, .7+0, !60 650+/09,113
59. 7eda has to choose >etween two investments that have the same cost today. Both investments
will ultimately pay $1,300 >ut at different times, as shown in the ta>le >elow. ;f 7eda doesnCt
choose one of these investments, she could leave the funds in a >an? account payin- 5
percent per year. Which investment should 7eda choose?
<ear ;nvestment A ;nvestment B
1 $0 $,00
, $500 $100
3 $00 $/00
0opic$ "iscountin-
&olution$
.ind the present value of the money paid >ac? to 7eda >y each investment, usin- the interest
rate on the alternative (the >an? account) as the discount rate.
.or ;nvestment A$
5 . 1111 $ 0/ . 491 $ 51 . 153 $
) 05 . 0 1 (
00 $
) 05 . 0 1 (
500 $
3 , 0
+
+
+
+
P#
.or ;nvestment B$
9 . 115/ $ 49 . 401 1 . 34, 1 . 190
) 05 . 0 1 (
/00
) 05 . 0 1 (
100
) 05 . 0 1 (
,00
3 , 1 0
+ +
+
+
+
+
+
P#
7eda would prefer ;nvestment B, >ecause it has the hi-her present value.
40. ;f the cost of each investment in 6ro>lem 59 is $1,000, should 7eda invest in one of them, or
simply leave the money in the >an? account? Would her decision chan-e if the investments
cost $1,,00 each?
0opic$ "iscountin- and "eterminin- Lates of Leturn
&olution$
J>serve that the present value of the money returned >y >oth investments, usin- the 5
percent discount rate, is -reater than the $1,000 cost (see 6ro>lem 59). 0herefore, they >oth
have a positive Dnet present value.E Jn this >asis, either investment would >e prefera>le to
the >an? account (returnin- 5*)N ;nvestment B is more prefera>le.
;f the cost of the investments was $1,,00, neither would >e accepta>le, as the present
value of the money returned is less than the cost (they have a ne-ative net present value).
41. ;nstead of a $10,000 lump sum, .eliB will need $10,000 per year for four years to pay for
tuition (see 6ro>lem 30). 2ow much will .eliBCs parents have to invest at the end of each
year for the ei-ht years >efore he >e-ins his studies if their savin-s earn compound interest at
/ percent per year? Assume the tuition payments also occur at the end of each year.
&olution$
We have two separate annuities to consider$ the tuition payments, and the savin-s amounts.
.irst, find the present value of the four annual tuition payments (at time , when .eliB is due
to >e-in university studies)$
11 . /, , 33 $
0/ . 0
) 0/ . 0 1 (
1
1
000 , 10
1
,
_
P#
0his is the amount of savin-s re3uired at time . .rom the perspective of time 0, this is a
future value amount (replaces the $10,000 in 6ro>lem .) :eBt, find the annual savin-s
amount$
11 . 301 , 3 $
0/ . 0
1 ) 0/ . 0 1 (
11 . /, , 33 $

1
]
1
+
P!T P!T
4,. Lepeat 6ro>lem 41 assumin- the tuition payments occur at the >e-innin- of each year (the
savin-s are still invested at the end of each year).
&olution$
0his pro>lem can >e solved in the same two step manner used in 6ro>lem 41. 2owever, the
first step involves an Dannuity due,E as the tuition payments occur at the start of each year$
Solutions Manual 2' Chapter 5
14 . ,13 , 34 $ ) 0/ . 0 1 (
0/ . 0
) 0/ . 0 1 (
1
1
000 , 10
1
,
_
P#
2it Q,
nd
P QBK:P Q,
nd
P Q&etP
:+1, ;8<+/, 650+10,000, .7+0, !60 67+ =34,,13.14
0his answer is used as the future value amount in the second step$
51 . 353, $
0/ . 0
1 ) 0/ . 0 1 (
14 . ,13 , 34 $

1
]
1
+
P!T P!T
(%emem'er to clear the calculator, or turn off 0B123 mode for this step, as this is an
ordinary annuity, not an annuity due)
:+, ;8<+/, 67+0, .7+ A34,,13.14, !60 650+ 353,.51
43. Lo-er has his eye on a new car that will cost $,0,000. 2e has $15,000 in his savin-s account,
earnin- interest at a rate of 0.5 percent per month.
A. 2ow lon- (to the nearest month) will it >e >efore he can >uy the car?
B. 2ow lon- will it >e >efore Lo-er can >uy the car if, in addition to his eBistin- savin-s, he
can save $,50 per month?
0opic$ "eterminin- 2oldin- 6eriods
&olution$
A. We ?now the future value and present value amounts, as well as the monthly interest rate.
.indin- the num>er of time periods (months) is most easily done with a financial calculator
(TI BAII Plus),
67 + 15,000, .7 + A,0,000, ;8< + 0.5, !60 : + 5/.4
;t will ta?e nearly 5 months, or close to 5 years >efore Lo-er can afford to >uy the carG
B. &olvin- the followin- e3uation for DnE we -et$
1
]
1

+
005 .
1 ) 005 . 1 (
,50
) 005 . 1 (
000 , 15
000 , ,0
n
n
n+ 11.4.
;8<+0.5, 67+15,000, .7+ A,0,000, 650 + ,50, !60 n + 11.4
41. 2ow many years will it ta?e for an investment to dou>le in value if the rate of return is 9
percent, and compoundin- occurs$
A. annually?
Solutions Manual 2( Chapter 5
B. 3uarterly?
0opic$ %ffective ;nterest Lates and 2oldin- 6eriods
&olution$
#etCs assume the present value of the investment is $1. 0he future value, after dou>lin- is
then $,.
A. Annually$ With annual compoundin-, the effective rate is the same as the 3uoted rate, 9*.
Fsin- a financial calculator (TI BAII Plus),
67 + =1, .7 + ,, ;8< + 9, !60 : + .01
&o the investment will dou>le in Iust over years.
B. Muarterly$ With 3uarterly compoundin-, the effective annual rate is,
* 30 . 9 1 )
1
09 . 0
1 (
1
+ , and a financial calculator allows us to find$
67 + A1, .7 + ,, ;8< + 9.30, !60 : + /./9
0he hi-her effective rate means that only /./9 years are needed to dou>le the value of the
investment.
45. Assume @osephine chose the 6rovidence Ban? option (see 6ro>lem 1/). 0he threeAyear term
on @osephineCs mort-a-e is now over, and she must renew the loan for another term. 2ow
much of the ori-inal $10,000 principal amount does she still owe?
&olution$
0he principal outstandin- at any time is the present value of the remainin- payments. After
three years, there are 1/ years remainin- of the ori-inal ,0Ayear amortiOation period, or 1/ B
1, + ,01 monthly payments remainin-. Based on 6ro>lem 1/, the payment amount is
$1,3,,.49. 0herefore$

3 . 1/, , 145 $
005,41 . 0
) 005,41 . 0 1 (
1
1
49 . 13,, $
,01
3

1
1
1
1
]
1

years
P#
44. 2ow much interest did @osephine pay over the threeAyear term of her mort-a-e loan (see
6ro>lem 1/)?
&olution$
@osephine has made 3 B 1, + 34 payments, of $13,,.49. 0he total amount she has paid over
the three years is therefore, 34 B $1,3,,.49 + $1/,414.1.
Based on the solution to 6ro>lem , she has paid off ($10,000 = $145,1/,.3) + $11,,/.4,
of the principal amount of the mort-a-e loan.
0herefore, of her total payments, ($1/,414.1 = $11,,/.4,) + $3,,/9.,, was interest.
4/. A year has passed since !harlie purchased his house (see 6ro>lem 50). Assume the ori-inal
mort-a-e amount (from your answer in 6ro>lem 50) was to >e amortiOed over ,5 years, with
an initial oneAyear term at 3.90 percent. ;f the interest rate on a oneAyear term has increased
to 5.35 percent, what will >e !harlieCs new monthly mort-a-e payments?
&olution$
0here are ,1 years, or ,1 B 1, + , months remainin- on the mort-a-e. Fsin- the effective
monthly interest rate from 6ro>lem 50, the outstandin- principle amount is$
// . 11 , 345 $
003,,1 . 0
) 003,,1 . 0 1 (
1
1
00 . 950 , 1 $
,
1

1
1
1
1
]
1

year
P#
0he new effective monthly interest rate is$
* 1109 . 0 1
,
0535 . 0
1
1,
,

,
_
+
monthly
.
Fsin- this rate, and the outstandin- principal, the new mort-a-e payment will >e$
31 . ,13 , , $
001109 . 0
) 001109 . 0 1 (
1
1
// . 11 , 345 $
,

1
1
1
1
]
1
P!T P!T
4. 0he new and hi-her mort-a-e payments calculated in 6ro>lem 4/ creates a >i- pro>lem for
!harlie, >ecause he can afford to pay only $1,950.00 per month. Lather than sell the house,
!harlie has convinced his >an? to eBtend the amortiOation period on the loan, which will
reduce the monthly payments. 2ow lon- must the amortiOation period >e for this mort-a-e
so that !harlie can afford to ma?e the payments?
&olution$
2ere we must solve the annuity e3uation to find the amortiOation period re3uired$
?
001109 . 0
) 001109 . 0 1 (
1
1
00 . 1950 $ // . 11 , 345 $
1
1
1
1
]
1
n
n
0his can >e done al-e>raically if you are familiar with the lo-arithm function$
Solutions Manual 2) Chapter 5
( ) 9 . 39/ ) 001109 . 0 1 ( 1
00 . 1950 $
001109 . 0 // . 11 , 345 $
1 +
,
_

4n 4n n
An easier method is to use a financial calculator (TI BAII Plus),
;8<+0.1109, 650+1950, 67+ A345,11.//, .7+0, !60 :+ 39/.9
We have used a monthly interest rate, so our solution is in terms of months, not years. Jur
final answer is that !harlie must eBtend the amortiOation period to at least 39 months (or 33
years and , months) so that he can still afford the monthly payments.
49. !Sline has Iust won a lottery. &he will receive a payment of $4,000 each year for nine years.
As an alternative, she can choose an immediate payment of $50,000.
A. Which alternative should she pic? if the interest rate is 5 percent?
B. What would the interest rate have to >e for !Sline to >e indifferent a>out the two
alternatives?
!. 0he lottery offers a third alternative for lottery priOe payments$ !Sline can opt to receive
annual payments of $3,000 per year for the rest of her life. &hould !Sline choose this option
to the $50,000 lump sum payment today, if the interest rate is 5 percent per year?
0opics$ Jrdinary Annuities, "eterminin- Lates of Leturn, 6erpetuities
&olution$
A. 0he present value of the annual payments can >e found with a financial calculator, (TI
BAII Plus), :+9, 650 + A4000, ;8< + 5.0, .7+0, !60 67 + 1,,414.93
As this is less than $50,000, the immediate payment alternative is >etter.
B. 0his pro>lem can >e solved >y trial and error, >ut the tas? is much easier with a financial
calculator, (TI BAII Plus), :+9, 650 + =4,000, 67 + 50,000, .7+0, !60 ;8< + 1.54/5*. At
an interest rate >elow 1.54/5* per year, the nineAyear annuity would >e prefera>leN a>ove
the rate the immediate payment is >etter.
!. 0his alternative is a perpetuity. ;ts present value is$
000 , 40 $
05 . 0
000 , 3 $
0

P!T
P# .
!learly this is prefera>le to a $50,000 lump sum payment.
/0. After ,0 years, the lottery company in 6ro>lem 49 -oes out of >usiness, and !SlineCs
payments of $3,000 annually, which were supposed to continue for the rest of her life, stop.
A. What is the present value of the lost payments?
B. 2ow much were these lost payments worth ,0 years a-o when !Sline won the priOe?
!. 2ad she >een a>le to predict that the lottery company would -o out of >usiness, should
!Sline have chosen the perpetual payments, or the $50,000 lump sum?
Solutions Manual %0 Chapter 5
0opic$ 6erpetuities and "iscountin-
&olution$
A. %ven after ,0 years, the remainin- payments form a perpetuity.
000 , 40 $
05 . 0
000 , 3 $
,0

P!T
P#
years
B. We must discount the fi-ure from part (a) >ac? ,0 years$
3/ . 413 , ,, $
) 05 . 0 1 (
000 , 40 $
,0 0

+
P#
!. 0he value of ,0 years of $3,000 payments (an annuity) can >e easily found usin- a
financial calculator (TI BAII Plus), :+,0, 650 + A3000, ;8< + 5.0, .7+0, !60 67 +
3/,34.43.
;n hindsi-ht, the $50,000 lumpAsum payment would have >een prefera>le. 0he same result
could >e found >y su>tractin- the result in part B from that in AN this demonstrates that an
annuity can >e thou-ht of as the difference >etween two perpetuitiesG
/1. Alysha has decided to use her $50,000 to ma?e a down payment on a house. &he will live in
the house for the neBt two years while still at university, and then sell it when she -raduates.
0he >an? has offered her a mort-a-e rate of 5.1 percent compounded semiAannually on a
twoAyear term, with an amortiOation period of ,5 years. 0he house she is interested in
purchasin- costs $,0,000.
A. ;f two friends will rent rooms from Alysha for $1/5 per room, paya>le at the end of each
month, how much additional money must she pay to meet her monthly mort-a-e payments?
B. ;n two years, Alysha wants to sell the house for a hi-h enou-h price to cover the
remainin- principal amount on the mort-a-e, and return her down payment. What is the
minimum sale price she should accept?
&olution$
A. 0he effective monthly interest rate is,
* 1,04 . 0 1
,
051 . 0
1
1,
,

,
_
+
monthly
0he amount of the mort-a-e loan will >e ($,0,000 = $50,000) + $,30,000, and there will >e
1, B ,5 + 300 monthly payments, the value of which can >e found with a financial calculator,
(TI BAII Plus), :+300, 67 + =,30,000, ;8< + 0.1,04, !60 650 + 1350.9. AlyshaCs two
friends will >e payin- , B $1/5 + $950 in rent, so she will need an additional $1,350.1 =
$950 + $100.1 to ma?e the mort-a-e payments.
B. ;n two years, Alysha will have made ,1 payments, leavin- ,/4. 0he present value of these
payments is the outstandin- value of the mort-a-e loan. Fsin- the calculator a-ain, :+,/4,
;8< + 0.1,04, 650 + 1350.9, !60 67 + ,,0,334.5. 0o pay off the loan, and recoup her
down payment, Alysha would have to sell the house for at least $,,0,334.5 ' $50,000 +
$,/0,334.5.
/,. 2ow much will 0ommy have to earn on his savin-s (see 6ro>lem 5,) to >e a>le to amass $1
million in 15 years?
&olution$
;n the e3uation for 6ro>lem 5,, set .7+$1,000,000, and solve for the interest rate. 0his is
easiest done with a financial calculator (TI BAII Plus),
: + 15, 67+0, .7 + A1,000,000, 650 + 30,000, !60 ;8< + 10.403
;t will ta?e only a little hi-her return, 10.4*, for 0ommy to reach his -oal.
/3. HashHow ;nc. has Iust declared that its dividend neBt year will >e $3 per share. 0hat rate of
payment will continue for an additional four years, after which the dividends will fall >ac? to
their usual $, per share (see 6ro>lem ,3). What is the present value of all the future
dividends?
0opic$ 5ultiple Annuities
&olution$
0he dividends for the first five years form an ordinary annuity. &tartin- in year 4, the reduced
dividend stream can >e thou-ht of as a perpetuity. 2owever, the value of this perpetuity, as
determined >y our formula, occurs at year 5 (one year >efore the first $, dividend), and must
>e discounted to the present$
[ ] [ ] ,/ . ,0 $ 54/1 . 0 4/ . 14 1 . 10
) 1, . 0 1 (
1
1, . 0
00 . , $
1, . 0
) 1, . 0 1 (
1
1
00 . 3 $
5
5
0
+
1
]
1
,
_
+
1
1
1
1
]
1
,
_
P#
/1. After one year livin- in a university residence, 5aryABeth (see 6ro>lem ,1) decides to rent
an apartment for the remainin- three years of her de-ree. &he has found a nice location that
will cost $150 per monthN rent for the first and last month must >e paid up front. 2ow much
money would 5aryABeth need to have in her >an? account ri-ht now to >e sure she will
always have enou-h for rent? 0he >an? account pays 3./5 percent interest, compounded
monthly.
&olution$
* 31,5 . 0
1,
03/5 . 0

monthly

Lent payments are typically made at the start of each month (so this is an annuity due). Jver
three years, we would eBpect 34 monthly rent payments. 2owever, the last monthCs rent must
>e paid up front, so the annuity includes only 35 paymentsN the present value of the last
monthCs rent is $150 >ecause it will >e paid today.
// . 393 , 15 $ 150 $ ) 0031,5 . 0 1 (
0031,5 . 0
) 0031,5 . 0 1 (
1
1
150 $
35
0
+ +
1
1
1
1
]
1
P#
/5. &uppose that 5aryABeth plans to return home for four months each summer, and will su>Alet
her apartment for the same amount she pays in rent (see 6ro>lem /1). ;n other words, she
will pay $150 rent, >ut for only ei-ht months of the year, durin- each of three years. ;n this
situation, how much would she need to have in her >an? account, earnin- 3./5 percent
compounded monthly? (Assume that rent payments are made at the start of each month.)
0opic$ Annuities "ue and 5ultiple Annuities
&olution$
As in 6ro>lem /1,
* 31,5 . 0
monthly
.
!onsider one year, or months of rent payments made at the start of each month$
99 . 540 , 3 $ ) 0031,5 . 0 1 (
0031,5 . 0
) 0031,5 . 0 1 (
1
1
150 $
0
+
1
1
1
1
]
1
P#
5aryABeth will need to have this sum now, plus the same amount one year from now, and
a-ain two years from now. ;n essence, this is a threeAyear annuity due, whose value must >e
calculated usin- the effective annual interest rate.
* 151 . 3 1
1,
03/5 . 0
1
1,

,
_
+
19 . ,95 , 10 $ ) 03151 . 0 1 (
03151 . 0
) 03151 . 0 1 (
1
1
99 . 540 , 3 $
3
0
+
1
1
1
1
]
1
P#
/4. A 45AyearAold man intends to use his retirement funds to purchase an annuity from a life
insurance company. Kiven the amount of money the man has availa>le to invest, the
insurance company is a>le to offer two alternatives. 0he first option is to receive $,,/5 each
month for as lon- as he livesN the second option is to receive $3,500 each month, >ut for only
,0 years (payments will >e made to his estate if he should die >efore that time). 0he relevant
interest rate is 4 percent per year. 2ow lon- must the man live so that the first option is a
Solutions Manual %% Chapter 5
>etter deal?
0opic$ Jrdinary Annuities and 5ultiple Annuities
&olution$
;t is temptin- to view the first option as a perpetuity, >ut this would >e incorrect as the man
will die at some time, and the payment will then cease. 0hus, option one is an ordinary
annuity, with an uncertain num>er of payments. Jption two is much easier to valueN it
includes eBactly ,10 monthly payments.
* 5 . 0
1,
04 . 0

monthly
Fsin- a financial calculator (TI BAII Plus),

: + ,10, 650 + 3500, ;8< + 0.5, .7+0, !60 67 + =1,53,./0
.or the first option to >e a >etter deal, it must include enou-h payments so that its present
value is at least as -reat as for option two. A-ain usin- the calculator,
67 + =1,53,./0, 650 + ,/5, ;8< + 0.5, !60 : + 1,0.3
&o option one must continue for 1,0.3 monthly payments to e3ual the value of option two, or
1,1 payments to surpass it. 0his is Iust over 35 years. 2ence, the man must live to >e at least
100 years old for option one to >e a >etter dealG
Solutions Manual %& Chapter 5
Legal Notice
Copyright
Copyright 200& #y John Wiley & Sons Canada, Ltd. or related "o$panies. 5ll rights reser6ed.
7he data "ontained in this 8ile is prote"ted #y "opyright. 7his $anual is 8urnished under li"en"e and $ay
#e used only in a""ordan"e 9ith the ter$s o8 su"h li"en"e.
7he $aterial pro6ided herein $ay not #e do9nloaded, reprodu"ed, stored in a retrie6al syste$, $odi8ied,
$ade a6aila#le on a net9or1, used to "reate deri6ati6e 9or1s, or trans$itted in any 8or$ or #y any
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Chapter 5 - Time Value of Money Multiple Choice Questions

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Chapter 5: Time Value of Money

Multiple Choice Questions

ln(1'?)+ln(1./), therefore ?+4.4*

Or using a financial calculator (TI BAII Plus),

B. With 3uarterly compoundin-, set m+1,

!. 55 . 091 , 53 $ ) 04131 . 1 ( 000 , 50 $ * 131 . 4 1

Solutions Manual ( Chapter 5

Solutions Manual 1) Chapter 5

Or using a financial calculator (TI BAII Plus),

145 , /9 $ ) 1,4 . 1 )( 11311 . / )( 000 , 9 ( ) 1,4 . 1 (

Or using a financial calculator (TI BAII Plus),

Solutions Manual %2 Chapter 5

Fsin- a financial calculator (TI BAII Plus),

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