Chapter 3

Time Value of Money

A4
Exercise and Self Correction Problems
Book: Financial Management by Van Horne

SELF CORRECTION PROBLEMS

1. The following cash-flow streams need to be analyzed:

a. Calculate the future (terminal) value of each stream at the

end of year 5 with a compound
annual interest rate of 10 percent.

Cash Flow
W
X
y
Z

b. Compute the present value of each stream if the discount

rate is 14 percent.

Cash Flow
W
X
y
Z

3. On a contract you have a choice of receiving $25,000 six

years from now or $50,000 twelve

years from now. At what implied compound annual interest

rate should you be indifferent
between the two contracts?
 Solution
Indifference implies that you could reinvest the $2
provide an equivalent $50,000 cash flow in year 12
6 years

BY SOLVER :

5. You borrow $10,000 at 14 percent compound annual interest

for four years. The loan is
repayable in four equal annual installments payable at the end
of each year.
a. What is the annual payment that will completely amortize
the loan over four years?
(You may wish to round to the nearest dollar.)

b. Of each equal payment, what is the amount of interest? The

amount of loan principal?
(Hint: In early years, the payment is composed largely of
interest, whereas at the end it
is mainly principal.)

Solution

Borrowing(PVo)=
years(n)=
interest=
By PMT function Annual Payment

LOAN AMM
 Year

0
1
2
3
4

7. A bank offers you a seven-month certificate of deposit (CD)

at a 7.06 percent annual rate
that would provide a 7.25 percent effective annual yield. For
the seven-month CD, is interest
being compounded daily, weekly, monthly, or quarterly? And,
by the way, having
invested $10,000 in this CD, how much money would you
receive when your CD matures
in seven months? That is, what size check would the bank give
you if you closed your
account at the end of seven months?

Solution

AS

Effective annual interest rate is 0.0724912255347681

Quarterly compunding interest rate

9. Xu Lin recently obtained a 10-year, $50,000 loan. The loan

carries an 8 percent compound
annual interest rate and calls for annual installment payments
of $7,451.47 at the end of
each of the next 10 years.

a. How much (in dollars) of the first year’s payment is principal?

b. How much total interest will be paid over the life of the
loan? (Hint: You do not need
to construct a loan amortization table to answer this question.
Some simple math is all
you need.)

Solution

Loan
interest
years(n)
Annual Pmt
for 1st year
Principal Pmt

Year

0
1
2
3
4
5
6
7
8
9
10

The following are exercises in future (terminal) values:

a. At the end of three years, how much is an initial deposit of
$100 worth, assuming a
compound annual interest rate of (i) 100 percent? (ii) 10
percent? (iii) 0 percent?

Solution

FV(i)
FV(ii)
Fv(iii)

b. At the end of five years, how much is an initial $500 deposit

followed by five year-end,
annual $100 payments worth, assuming a compound annual
interest rate of (i) 10 percent?
(ii) 5 percent? (iii) 0 percent?

Solution

i
ii
iii

c. At the end of six years, how much is an initial $500 deposit

followed by five year-end,
annual $100 payments worth, assuming a compound annual
interest rate of (i) 10 percent?
(ii) 5 percent? (iii) 0 percent?

Solution
interest(i)
Interest(ii)
Interest(iii)
 i
ii
iii

d. At the end of three years, how much is an initial $100

deposit worth, assuming a quarterly
compounded annual interest rate of (i) 100 percent? (ii) 10
percent

Solution interest(annual)
Interest(ii)annual

f)At the end of 10 years, how much is a $100 initial deposit

worth, assuming an annual
interest rate of 10 percent compounded (i) annually? (ii)
semiannually? (iii) quarterly?

Solution

3. Joe Hernandez has inherited $25,000 and wishes to purchase

an annuity that will provide
him with a steady income over the next 12 years. He has heard
that the local savings and
loan association is currently paying 6 percent compound
interest on an annual basis. If
he were to deposit his funds, what year-end equal-dollar
amount (to the nearest dollar)
would he be able to withdraw annually such that he would
have a zero balance after his
last withdrawal 12 years from now
Solution

Annual Pmt

5)Same as Problem 4 above, except that you deposit a certain

amount at the beginning of
each of the next 10 years. Now, how much will you have to
save each year (to the nearest
dollar)?

Annual Pmnt

7)You have been offered a note with four years to maturity,

which will pay $3,000 at the end
of each of the four years. The price of the note to you is
$10,200. What is the implicit
compound annual interest rate you will receive (to the nearest
whole percent)?

Initial investment
Periodic cash flow
Number of payments

Rate

9) If the appropriate annual discount rate is 14 percent, what is

the present value of this
cash-flow stream?

discount rate=
Year
1
 2
3
4
5
6
7
8
9
10

11. In connection with the United States Bicentennial, the

Treasury once contemplated offering
a savings bond for $1,000 that would be worth $1 million in 100
years. Approximately

what compound annual interest rate is implied by these terms?

Solution

PV
FV
years

Rate=

13. The Happy Hang Glide Company is purchasing a building

and has obtained a $190,000
mortgage loan for 20 years. The loan bears a compound annual
interest rate of 17 percent
and calls for equal annual installment payments at the end of
each of the 20 years. What
is the amount of the annual payment?

Solution
15. You have borrowed $14,300 at a compound annual interest
rate of 15 percent. You feel
that you will be able to make annual payments of $3,000 per
year on your loan. (Payments
include both principal and interest.) How long will it be before
the loan is entirely paid
off (to the nearest year)?

Solution

Borrowing(PV)=
Annual pmt (R)=
rate
years(n)

17. Earl E. Bird has decided to start saving for his retirement.
Beginning on his twenty-first
birthday, Earl plans to invest $2,000 each birthday into a
savings investment earning a
7 percent compound annual rate of interest. He will continue
this savings program for a
total of 10 years and then stop making payments. But his
savings will continue to compound
at 7 percent for 35 more years, until Earl retires at age 65. Ivana
Waite also plans
to invest $2,000 a year, on each birthday, at 7 percent, and will
do so for a total of 35 years.
However, she will not begin her contributions until her thirty-
first birthday. How much
will Earl’s and Ivana’s savings programs be worth at the
retirement age of 65? Who is
better off financially at retirement, and by how much?

note
 Birds Plan

deposits
interest rate
years

FV (i)

Now same amount

for 35 years
years
so
FV (Total)

Earl Investment program

19. Assume that you will be opening a savings account today by

depositing $100,000. The
savings account pays 5 percent compound annual interest, and
this rate is assumed to
remain in effect for all future periods. Four years from today
you will withdraw R
dollars. You will continue to make additional annual
withdrawals of R dollars for a
while longer – making your last withdrawal at the end of year 9
– to achieve the following
pattern of cash flows over time. (Note: Today is time period
zero; one year from
today is the end of time period 1; etc.)
How large must R be to leave you with exactly a zero balance
after your final R withdrawal
is made at the end of year 9? (Tip: Making use of an annuity
table or formula will make
your work a lot easier!)

Solution
21. “Want to win a million dollars? Here’s how. . . . One winner,
chosen at random from all
entries, will win a $1,000,000 annuity.” That was the statement
announcing a contest on
the World Wide Web. The contest rules described the “million-
dollar prize” in greater
detail: “40 annual payments of $25,000 each, which will result
in a total payment of
$1,000,000. The first payment will be made January 1;
subsequent payments will be
made each January thereafter.” Using a compound annual
interest rate of 8 percent,
what is the present value of this “million-dollar prize” as of the
first installment on
January 1?

Solution
 interest = 10%

END OF YEARS Future Value for Ind

1 2 3 4 5 1
$100.00 $200.00 $200.00 $300.00 $300.00 $146.41
$600.00 $878.46
$1,200.00 $0.00
$200.00 $500.00 $300.00 $292.82

discount rate 14%

END OF YEARS Pvo of Individua

1 2 3 4 5 1
$100.00 $200.00 $200.00 $300.00 $300.00 $87.72
$600.00 $526.32
$1,200.00 $0.00
$200.00 $500.00 $300.00 $175.44
ies that you could reinvest the $25,000 receipt for 6 years at X% to
alent $50,000 cash flow in year 12. In short, $25,000 would double in

FV= 50000.0048344
PV= 25000
i= 0.1224620664
n= 6

so X%= 12.20%

10,000
4
14%
$3,432.05

LOAN AMMORTIZATION TABLE

 Interest Principle Principle owing
Payment at end of period Payment at next year
$10,000
$3,432.05 $1,400.00 $2,032.05 $7,967.95
$3,432.05 $1,115.51 $2,316.53 $5,651.42
$3,432.05 $791.20 $2,640.85 $3,010.57
$3,432.05 $421.48 $3,010.57 $0.00

i 7.06%
i(annualy) 7.25% m(quarter)= 4
PV= $10,000.00
n= 7 months n(quarters) 2.33
7.25%
erly compunding interest rate

FV= $10,416.08
$ 50,000
8%
10
$ 7,451.47

Principle
Annual Payment Interest Paymnet
$ 7,451.47 $ 4,000 $ 3,451.47

Interest Principle Principle owing

Payment at end of period Payment at next year
$ 50,000
$ 7,451.47 $4,000.00 $ 3,451.47 $46,548.53
$ 7,451.47 $3,723.88 $ 3,727.59 $42,820.94
$ 7,451.47 $3,425.68 $ 4,025.79 $38,795.15
$ 7,451.47 $3,103.61 $ 4,347.86 $34,447.29
$ 7,451.47 $2,755.78 $ 4,695.69 $29,751.60
$ 7,451.47 $2,380.13 $ 5,071.34 $24,680.26
$ 7,451.47 $1,974.42 $ 5,477.05 $19,203.21
$ 7,451.47 $1,536.26 $ 5,915.21 $13,288.00
$ 7,451.47 $1,063.04 $ 6,388.43 $6,899.57
$ 7,451.47 $551.97 $ 6,899.50 $0.06

TOTAL INTEREST $24,514.76

PROBLEMS
interest(i) 100% year= 3
interest(ii) 10% Deposit= $ 100.00
interest(iii) 0%

$800.00
$133.10
$100.00

interest(i) 10% year 5

Interest(ii) 5% annual deposit $ 100.00

interest(iii) 0% intial deposit $ 500.00

FV(initial) FV(Periodic) FV(total)

$805.26 $610.51 $1,415.77
$638.14 $552.56 $1,190.70
$500.00 $500.00 $1,000.00

10% Initial Dep $ 500.00

5% Annual Pmt $ 100.00
0% year 6
FV(for Initial Deposit) FV(Annual) FV (total)
$ 885.78 $771.56 $ 1,657.34
$ 670.05 $680.19 $ 1,350.24
$ 500.00 $600.00 $ 1,100.00

100% Int(i)quartr 25% Init depst $ 100.00

10% Int(ii)qurtr 2.5% m(years) 3
n(quarterly) 12

FV(i) quarterly $ 1,455.19

FV(ii) quarterly $ 134.49

interest(i)annualy 10% n(i) annualy 10 Initial dps $ 100.00

interest(ii) semiannualy 5% n(ii) semi annual 20
interest(iii) quarterly 2.5% n(iii) quarterly 40

FV(i)annualy $ 259.37
FV(ii) semi annual $ 265.33
FV(iii) quarterly $ 268.51
interest 6%
Initial Deeposit 25000
n 12

$2,981.93
(By PMT function)
solver is not giving right ans

Future value 50000

years 10
interest 8%

$3,195.81
(By PMT function)

10,200
3000
4

7%
(Using rate function)

14%
Cash Flow PV Of each CF
1200 $1,052.63 (using PV Fn)
 2000 $1,538.94
2400 $1,619.93
1900 $1,124.95
1600 $830.99
1400 $637.82
1400 $559.49
1400 $490.78
1400 $430.51
1400 $377.64
Sum of PV $8,663.69
Using NPV $8,663.69

$ 1,000
$ 1,000,000
100

7%
(Rate fnc is not working)

Loan(PV)= $ 190,000
Years(n) 20
interest rate= 17%

Annual Payment (R)= $33,761.17

(Using PMT fn)
$ 14,300
$ 3,000
15%
9
Using NPER fn

As it has calcultions of 45
years so table is not drawn
Birds Plan Ivana plan

2000 deposits 2000

7% interest rate 7%
10 years 35

$27,632.90
FV for deposits

will be compounded @7%

35

$295,024.86 FV(Total) $276,473.76

is worth more than ivana plan

deposit 100000
interest rate 5%
 Balance at end
Years Annual Pmt interest Principle amtof year
0 $ (100,000)
1 0 $ - 0 $ (100,000)
2 0 $ - 0 $ (100,000)
3 0 $ - 0 $ (100,000)
4 17543.8596492 $ 877 16666.6666668 $ (83,333)
5 17543.8596492 $ 877 16666.6666668 $ (66,667)
6 17543.8596492 $ 877 16666.6666668 $ (50,000)
7 17543.8596492 $ 877 16666.6666668 $ (33,333)
8 17543.8596492 $ 877 16666.6666668 $ (16,667)
9 17543.8596492 $ 877 16666.6666668 $ 0
(by solver)

ANNUITY DUE

FV= $ 1,000,000
Annual Payments $ 25,000
No of pmnt(n) 40
interest rate 8%

PV $321,964.56
(using PV)
Future Value for Individual CF(End of year)
2 3 4 5 Total Future Value
$266.20 $242.00 $330.00 $300.00 $1,284.61
$0.00 $0.00 $0.00 $0.00 $878.46
$0.00 $0.00 $0.00 $1,200.00 $1,200.00
$0.00 $605.00 $0.00 $300.00 $1,197.82

Pvo of Individual CF(End of Year) Sum Of Present

2 3 4 5 Value
$153.89 $134.99 $177.62 $155.81 $710.04
$0.00 $0.00 $0.00 $0.00 $526.32
$0.00 $0.00 $0.00 $623.24 $623.24
$0.00 $337.49 $0.00 $155.81 $668.73