After reading this chapter, students should be able to:

Convert time value of money (TVM) problems from words to time lines
!"plain the relationship between compounding and discounting, between
future and present value
Calculate the future value of some beginning amount, and find the present
value of a single payment to be received in the future
#olve for time or interest rate, given the other three variables in the
TVM e$uation
%ind the future value of a series of e$ual, periodic payments (an annuity)
as well as the present value of such an annuity
!"plain the difference between an ordinary annuity and an annuity due, and
calculate the difference in their values
Calculate the value of a perpetuity
&emonstrate how to find the present and future values of an uneven series
of cash flows
&istinguish among the following interest rates: 'ominal (or (uoted) rate,
)eriodic rate, and !ffective (or !$uivalent) Annual *ate+ and properly
choose between securities with different compounding periods
#olve time value of money problems that involve fractional time periods
Construct loan amorti,ation schedules for both fully-amorti,ed and
partially-amorti,ed loans
Learning Objectives: 6 - 1
Chapter 6 Time Value of Money
LEARNING OBECTIVE!
.e regard Chapter / as the most important chapter in the boo0, so we spend a
good bit of time on it .e approach time value in three ways %irst, we try to
get students to understand the basic concepts by use of time lines and simple
logic #econd, we e"plain how the basic formulas follow the logic set forth in
the time lines Third, we show how financial calculators and spreadsheets can
be used to solve various time value problems in an efficient manner 1nce we
have been through the basics, we have students wor0 problems and become
proficient with the calculations and also get an idea about the sensitivity of
output, such as present or future value, to changes in input variables, such as
the interest rate or number of payments
#ome instructors prefer to ta0e a strictly analytical approach and have
students focus on the formulas themselves 1thers prefer to use the )resent
Value Tables, which have for many years been supplied with the te"t 2n both
cases, the argument is made that students treat their calculators as 3blac0
bo"es,4 and that they do not understand where their answers are coming from or
what they mean .e disagree .e thin0 that our approach shows students the
logic behind the calculations as well as alternative approaches, and because
calculators are so efficient, students can actually see the significance of what
they are doing better if they use a calculator .e also thin0 it is important
to teach students how to use the type of technology (calculators and
spreadsheets) they must use when they venture into the real world
2n the past, the biggest stumbling bloc0 to many of our students has been
time value, and the biggest problem there has been that they did not 0now how to
use their calculator when we got into time value Therefore, we strongly
encourage students to get a calculator early, learn to use it, and bring it to
class so they can wor0 problems with us as we go through the lectures 1ur
urging, plus the fact that we can now provide relatively brief, course-specific
manuals for the leading calculators, has reduced if not eliminated the problem
1ur research suggests that the best calculator for the money for most
students is the 5)-678 %inance and accounting ma9ors might be better off with
a more powerful calculator, such as the 5)-6:8 .e recommend these two for
people who do not already have a calculator, but we tell them that any financial
calculator that has an 2** function will do
.e also tell students that it is essential that they wor0 lots of
problems, including the end-of-chapter problems .e emphasi,e that this chapter
is critical, so they should invest the time now to get the material down .e
stress that they simply cannot do well with the material that follows without
having this material down cold Cost of capital and capital budgeting ma0e
little sense, and one certainly cannot wor0 problems in these areas, without
understanding time value of money first
%or other suggestions about the lecture, please see the 3;ecture
#uggestions4 in Chapter <, where we describe how we conduct our classes
&A=# 1' C5A)T!*: > 1% ?@ &A=# (?7-minute periods)
Lecture Suggestions: 6 - "
LECT#RE !#GGE!TION!
/-6 The opportunity cost rate is the rate of interest one could earn on an
alternative investment with a ris0 e$ual to the ris0 of the investment in
$uestion This is the value of i in the TVM e$uations, and it is shown on
the top of a time line, between the first and second tic0 mar0s 2t is
not a single rate--the opportunity cost rate varies depending on the
ris0iness and maturity of an investment, and it also varies from year to
year depending on inflationary e"pectations (see Chapter ?)
/-< True The second series is an uneven payment stream, but it contains an
annuity of A>77 for @ years The series could also be thought of as a
A677 annuity for 67 years plus an additional payment of A677 in =ear <,
plus additional payments of AB77 in =ears B through 67
/-B True, because of compounding effects--growth on growth The following
e"ample demonstrates the point The annual growth rate is i in the
following e$uation:
A6(6 C i)
67
D A<
The term (6 C i)
67
is the %V2% for i percent, 67 years .e can find i as
follows:
Esing a financial calculator input ' D 67, )V D -6, )MT D 7, %V D <, and
2 D F #olving for 2 you obtain :6@ percent
Viewed another way, if earnings had grown at the rate of 67 percent per
year for 67 years, then !)# would have increased from A677 to A<?G,
found as follows: Esing a financial calculator, input ' D 67, 2 D 67, )V
D -6, )MT D 7, and %V D F #olving for %V you obtain A<?G This
formulation recogni,es the 3interest on interest4 phenomenon
/-> %or the same stated rate, daily compounding is best =ou would earn more
3interest on interest4
/-? %alse 1ne can find the present value of an embedded annuity and add this
)V to the )Vs of the other individual cash flows to determine the present
value of the cash flow stream
/-/ The concept of a perpetuity implies that payments will be received
forever %V ()erpetuity) D )V ()erpetuity)(6 C i)

D
Answers and Solutions: 6 - $
AN!%ER! TO EN&-O'-C(A)TER *#E!TION!
/-6 7 6 < B > ?
H H H H H H
)V D 67,777 %V
?
D F
%V
?
D A67,777(667)
?
D A67,777(6/67?6) D A6/,67?67
Alternatively, with a financial calculator enter the following: ' D ?,
2 D 67, )V D -67777, and )MT D 7 #olve for %V D A6/,67?67
/-< 7 ?

67 6? <7
H H H H H
)V D F %V
<7
D ?,777
.ith a financial calculator enter the following: ' D <7, 2 D :, )MT D 7,
and %V D ?777 #olve for )V D A6,<G<67
/-B 7 n D F
H H
)V D 6

%V
n
D <
< D 6(67/?)
n

.ith a financial calculator enter the following: 2 D /?, )V D -6, )MT D

7, and %V D < #olve for ' D 6676 I 66 years
/-> Esing your financial calculator, enter the following data: 2 D 6<+ )V D
-><6@7?B+ )MT D -?777+ %V D <?7777+ ' D F #olve for ' D 66 2t will
ta0e 66 years for John to accumulate A<?7,777
/-? 7

6@
H H
)V D <?7,777

%V
6@
D 6,777,777
.ith a financial calculator enter the following: ' D 6@, )V D -<?7777,
)MT D 7, and %V D 6777777 #olve for 2 D @76K I @K
/-/ 7 6 < B > ?
H H H H H H
B77 B77 B77 B77 B77


%VA
?
D F
Answers and Solutions: 6 - +
!OL#TION! TO EN&-O'-C(A)TER )ROBLEM!
67K
:K
/?K
i D F
:K
.ith a financial calculator enter the following: ' D ?, 2 D :, )V D 7,
and )MT D B77 #olve for %V D A6,:<?<<
/-: 7 6 < B > ?
H H H H H H
B77 B77 B77 B77 B77
.ith a financial calculator, switch to 38!L4 and enter the following: ' D
?, 2 D :, )V D 7, and )MT D B77 #olve for %V D A6,@>?GG &onMt forget
to switch bac0 to 3!'&4 mode
/-@ 7 6 < B > ? /
H H H H H H H
677 677 677 <77 B77 ?77
)V D F %V D F
Esing a financial calculator, enter the following:
C%
7
D 7
C%
6
D 677, '
9
D B
C%
>
D <77 ('ote calculator will show C%
<
on screen)
C%
?
D B77 ('ote calculator will show C%
B
on screen)
C%
/
D ?77 ('ote calculator will show C%
>
on screen)
and 2 D @ #olve for ')V D AG<BG@
To solve for the %V of the cash flow stream with a calculator that doesnMt
have the '%V 0ey, do the following: !nter ' D /, 2 D @, )V D -G<BG@, and
)MT D 7 #olve for %V D A6,>//<> =ou can chec0 this as follows:
7 6 < B > ? /
H H H H H H H
677 677 677 <77 B77 ?77
B<>77
<BB<@
6<?G:
6B/7?
6>/GB
A6,>//<B
/-G Esing a financial calculator, enter the following: ' D /7, 2 D 6, )V D
-<7777, and %V D 7 #olve for )MT D A>>>@G
!A* D
m
'om
m
i
6

+ - 67
D (676)
6<
- 67
D 6</@K
Alternatively, using a financial calculator, enter the following: '1MK D
6< and )N=* D 6< #olve for !%%K D 6</@<?K *emember to change bac0 to
)N=* D 6 on your calculator
Answers and Solutions: 6 - ,
@K
@K
:K
(67@)
(67@)
<
(67@)
B
(67@)
>
(67@)
?
Answers and Solutions: 6 - 6
/-67 a 6GG: 6GG@ 6GGG <777 <776 <77<
H H H H H H
-/ 6< (in millions)
.ith a calculator, enter ' D ?, )V D -/, )MT D 7, %V D 6<, and then
solve for 2 D 6>@:K
b The calculation described in the $uotation fails to ta0e account of the
compounding effect 2t can be demonstrated to be incorrect as follows:
A/,777,777(6<7)
?
D A/,777,777(<>@@B) D A6>,G<G,@77,
which is greater than A6< million Thus, the annual growth rate is less
than <7 percent+ in fact, it is about 6? percent, as shown in )art a
/-66 7 6 < B > ? / : @ G

67
H H H H H H H H H H H
-> @ (in millions)
.ith a calculator, enter ' D 67, )V D ->, )MT D 7, %V D @, and then solve
for 2 D :6@K
/-6< 7 6 < B > B7
H H H H H H
@?,777 -@,<:B?G -@,<:B?G -@,<:B?G -@,<:B?G -@,<:B?G
.ith a calculator, enter ' D B7, )V D @?777, )MT D -@<:B?G, %V D 7, and
then solve for 2 D GK
/-6B a 7 6 < B >
H H H H H
)V D F -67,777 -67,777 -67,777 -67,777
.ith a calculator, enter ' D >, 2 D :, )MT D -67777, and %V D 7 Then
press )V to get )V D ABB,@:<66
b 6 At this point, we have a B-year, : percent annuity whose value is
A</,<>B6/ =ou can also thin0 of the problem as follows:
ABB,@:<(67:) - A67,777 D A</,<>B7>
< Oero after the last withdrawal
/-6> 7 6 < B > ? /
H H H H H H H
6,<?7 6,<?7 6,<?7 6,<?7 6,<?7 F
%V D 67,777
Answers and Solutions: 6 - -
F
i D F
i D F
:K
6<K
.ith a financial calculator, get a 3ballpar04 estimate of the years by
entering 2 D 6<, )V D 7, )MT D -6<?7, and %V D 67777, and then pressing
the ' 0ey to find ' D ?G> years This answer assumes that a payment of
A6,<?7 will be made G>N677th of the way through =ear ?
'ow find the %V of A6,<?7 for ? years at 6< percent+ it is A:,G>67/
Compound this value for 6 year at 6< percent to obtain the value in the
account after / years and before the last payment is made+ it is
A:,G>67/(66<) D A@,@GBGG Thus, you will have to ma0e a payment of
A67,777 - A@,@GBGG D A6,67/76 at =ear /, so the answer is: it will ta0e
/ years, and A6,67/76 is the amount of the last payment
/-6? Contract 6: )V D
> B <
) 6 6 (
777 , 777 , B A
) 6 6 (
777 , 777 , B A
) 6 6 (
777 , 777 , B A
6 6
777 , 777 , B A
+ + +
D A<,:<:,<:<:B C A<,>:G,BB@@> C A<,<?B,G>>>7 C
A<,7>G,7>7B:
D AG,?7G,?G/B>
Esing your financial calculator, enter the following data: C%
7
D 7+ C%
6->
D
B777777+ 2 D 67+ ')V D F #olve for ')V D AG,?7G,?G/B>
Contract <: )V D
> B <
) 67 6 (
777 , 777 , ? A
) 67 6 (
777 , 777 , > A
) 67 6 (
777 , 777 , B A
67 6
777 , 777 , < A
+ + +
D A6,@6@,6@6@< C A<,>:G,BB@@> C AB,77?,<?G<7 C
AB,>6?,7/:<@
D A67,:6:,@>:6>
Alternatively, using your financial calculator, enter the following data:
C%
7
D 7+ C%
6
D <777777+ C%
<
D B777777+ C%
B
D >777777+ C%
>
D ?777777+ 2 D 67+
')V D F #olve for ')V D A67,:6:,@>:6>
Contract B: )V D
> B <
) 67 6 (
777 , 777 , 6 A
) 67 6 (
777 , 777 , 6 A
) 67 6 (
777 , 777 , 6 A
67 6
777 , 777 , : A
+ + +
D A/,B/B,/B/B/ C A@</,>>/<@ C A:?6,B6>@7 C A/@B,76B>/
D A@,/<>,>67G7
Alternatively, using your financial calculator, enter the following data:
C%
7
D 7+ C%
6
D :777777+ C%
<
D 6777777+ C%
B
D 6777777+ C%
>
D 6777777+ 2 D 67+
')V D F #olve for ')V D A@,/<>,>67G7
Contract < gives the $uarterbac0 the highest present value+ therefore, he
should accept Contract <
/-6/ )V D A677N77: D A6,><@?: )V D A677N76> D A:6><G
.hen the interest rate is doubled, the )V of the perpetuity is halved
/-6: 7 > @ 6< 6/
Answers and Solutions: 6 - .
<K
H H H H H H H H H H H H H H H H H
)V D F 7 7 7 ?7 7 7 7 ?7 7 7 7 ?7 7 7 7 6,7?7
i
)!*
D @KN> D <K
The cash flows are shown on the time line above .ith a financial calcu-
lator enter the following cash flows into your cash flow register: C%
7
D
7, C%
6-B
D 7, C%
>
D ?7, C%
?-:
D 7, C%
@
D ?7, C%
G-66
D 7, C%
6<
D ?7,
C% 6? - 6B
D 7,
C%
6/
D 67?7+ enter 2 D <, and then press the ')V 0ey to find )V D A@GB6/
/-6@ This can be done with a calculator by specifying an interest rate of
? percent per period for <7 periods with 6 payment per period
' D 67 < D <7
2 D 67KN< D ?
)V D -67777
%V D 7
#olve for )MT D A@7<>B
#et up an amorti,ation table:
8eginning )ayment of !nding
)eriod 8alance )ayment 2nterest )rincipal 8alance

6 A67,77777 A@7<>B A?7777 AB7<>B AG,/G:?:
< G,/G:?: @7<>B >@>@@
AG@>@@
=ou can also wor0 the problem with a calculator having an amorti,ation
function %ind the interest in each /-month period, sum them, and you
have the answer !ven simpler, with some calculators such as the 5)-6:8,
9ust input < for periods and press 2'T to get the interest during the
first year, AG@>@@ The 5)-678 does the same thing
/-6G A6,777,777 loan P 6? percent, annual )MT, ?-year amorti,ation .hat is
the fraction of )MT that is principal in the second yearF %irst, find )MT
by using your financial calculator: ' D ?, 2N=* D 6?, )V D -6777777, and
%V D 7 #olve for )MT D A<G@,B6???
Then set up an amorti,ation table:
8eginning !nding
=ear 8alance )ayment 2nterest )rincipal 8alance

6 A6,777,77777 A<G@,B6??? A6?7,77777 A6>@,B6??? A@?6,/@>>?
< @?6,/@>>? <G@,B6??? 6<:,:?</: 6:7,?/<@@ /@6,6<6?:
%raction that is principal D A6:7,?/<@@NA<G@,B6??? D 7?:6@ D ?:6@K I ?:<K
Answers and Solutions: 6 - /
/-<7 a 8egin with a time line:
7 6 < B > ? / : @ G 67 6/ 6: 6@ 6G <7 /-
mos
7 6 < B > ? @ G 67 =ears
H H H H H H H H H H H



H H H H H
677 677 677 677 677 %VA
#ince the first payment is made today, we have a ?-period annuity due
The applicable interest rate is 6<KN< D /K %irst, we find the %VA of
the annuity due in period ? by entering the following data in the
financial calculator: ' D ?, 2 D 6<N< D /, )V D 7, and )MT D -677
#etting the calculator on 38!L,4 we find %VA (Annuity due) D A?G:?B
'ow, we must compound out for 6? semiannual periods at / percent
A?G:?B <7 Q ? D 6? periods P /K A6,>B<7<
b 7 6 < B > ? >7 $uarters
H H H H H H H
)MT )MT )MT )MT )MT

%V D 6,>B<7<
The time line depicting the problem is shown above 8ecause the
payments only occur for ? periods throughout the >7 $uarters, this
problem cannot be immediately solved as an annuity problem The
problem can be solved in two steps:
6 &iscount the A6,>B<7< bac0 to the end of (uarter ? to obtain the )V
of that future amount at (uarter ?
2nput the following into your calculator: ' D B?, 2 D B, )MT D 7,
%V D 6>B<7<, and solve for )V at (uarter ? )V D A?7@G<
< Then solve for )MT using the value solved in #tep 6 as the %V of the
five-period annuity due
The )V found in step 6 is now the %V for the calculations in this
step Change your calculator to the 8!L2' mode 2nput the
following into your calculator: ' D ?, 2 D B, )V D 7, %V D ?7@G<,
and solve for )MT D AGB7:
/-<6 5ere we want to have the same effective annual rate on the credit e"tended
as on the ban0 loan that will be used to finance the credit e"tension
%irst, we must find the !A* D !%%K on the ban0 loan !nter '1MK D 6?,
)N=* D 6<, and press !%%K to get !A* D 6/7@K
'ow recogni,e that giving B months of credit is e$uivalent to $uarterly
compounding--interest is earned at the end of the $uarter, so it is
available to earn interest during the ne"t $uarter Therefore, enter )N=*
D >, !%%K D !A* D 6/7@K, and press '1MK to find the nominal rate of 6?6G
percent (&onMt forget to change your calculator bac0 to )N=* D 6)
Answers and Solutions: 6 - 10
/K
BK
Therefore, if you charge a 6?6G percent nominal rate and give credit
for B months, you will cover the cost of the ban0 loan
Alternative solution: .e need to find the effective annual rate (!A*) the
ban0 is charging first Then, we can use this !A* to calculate the
nominal rate that you should $uote your customers
8an0 !A*: !A* D (6 C i
'om
Nm)
m
- 6 D (6 C 76?N6<)
6<
- 6 D 6/7@K
Answers and Solutions: 6 - 11
'ominal rate you should $uote customers:
6/7@K D (6 C i
'om
N>)
>
- 6
66/7@ D (6 C i
'om
N>)
>
67B@7 D 6 C i
'om
N>
i
'om
D 77B@7(>) D 6?6GK
/-<< 2nformation given:
6 .ill save for 67 years, then receive payments for <? years
< .ants payments of A>7,777 per year in todayMs dollars for first payment
only *eal income will decline 2nflation will be ? percent
Therefore, to find the inflated fi"ed payments, we have this time line:
7 ? 67
H H H
>7,777 %V D F
!nter ' D 67, 2 D ?, )V D ->7777, )MT D 7, and press %V to get %V D
A/?,6??:G
B 5e now has A677,777 in an account that pays @ percent, annual
compounding .e need to find the %V of the A677,777 after 67 years
!nter ' D 67, 2 D @, )V D -677777, )MT D 7, and press %V to get %V D
A<6?,@G<?7
> 5e wants to withdraw, or have payments of, A/?,6??:G per year for <?
years, with the first payment made at the beginning of the first retirement
year #o, we have a <?-year annuity due with )MT D /?,6??:G, at an
interest rate of @ percent (The interest rate is @ percent annually, so
no ad9ustment is re$uired) #et the calculator to 38!L4 mode, then enter '
D <?, 2 D @, )MT D /?6??:G, %V D 7, and press )V to get )V D A:?6,6/?B?
This amount must be on hand to ma0e the <? payments
? #ince the original A677,777, which grows to A<6?,@G<?7, will be
available, we must save enough to accumulate A:?6,6/?B? - A<6?,@G<?7
D A?B?,<:<@?
/ The A?B?,<:<@? is the %V of a 67-year ordinary annuity The payments
will be deposited in the ban0 and earn @ percent interest Therefore,
set the calculator to 3!'&4 mode and enter ' D 67, 2 D @, )V D 7, %V D
?B?<:<@?, and press )MT to find )MT D AB/,G>G/6
/-<B a 8egin with a time line:
7 6 6G <7
H H H H
6:? 6:?

6:? (in millions)
)V D F
Answers and Solutions: 6 - 1"
?K
@K
2t is important to recogni,e that this is an annuity due since payments
start immediately Esing a financial calculator input the following
after switching to 8!L2' mode:
' D <7, 2 D @, )MT D 6:?7777, %V D 7, and solve for )V D A6@,??/,<GG
b 7 6 6G <7
H H H H
6:? 6:?

6:? (in millions)


%V D F
2t is important to recogni,e that this is an annuity due since payments
start immediately Esing a financial calculator input the following
after switching to 8!L2' mode:
' D <7, 2 D @, )V D 7, )MT D 6:?7777, and solve for %V D A@/,>G7,66B
c 7 6 6G <7
H H H H
6:?

6:? 6:? (in millions)
)V D F
Esing a financial calculator input the following:
' D <7, 2 D @, )MT D 6:?7777, %V D 7, and solve for )V D A6:,6@6,:?@
7 6 6G <7
H H H H
6:?

6:? 6:? (in millions)


%V D F
Esing a financial calculator input the following:
' D <7, 2 D @, )V D 7, )MT D 6:?7777, and solve for %V D A@7,7@B,>B@
/-<> a 8egin with a time line:
>7 >6 /> /?

H H H H


?,777 ?,777 ?,777
Esing a financial calculator input the following:
' D <?, 2 D 6<, )V D 7, )MT D ?777, and solve for %V D A///,//GB?
b >7 >6 /G :7

H H H H


?,777 ?,777 ?,777


%V D F
Esing a financial calculator input the following:
Answers and Solutions: 6 - 1$
@K
@K
@K
6<K
6<K
' D B7, 2 D 6<, )V D 7, )MT D ?777, and solve for %V D A6,<7/,//B><
Answers and Solutions: 6 - 1+
/-<? 8egin with a time line:
7 6 < B > ?
6<NB6N76 6<NB6N7< 6<NB6N7B 6<NB6N7> 6<NB6N7? 6<NB6N7/ 76N76N7:
H H H H H H H
B>,777 B/,777 B:,7@7 B@,6G<>7 BG,BB@6: >7,?6@B< >6,:BB@:
677,777
<7,777
)V D F
#tep 6: Calculate the )V of the lost bac0 pay:
AB>,777(67:) C AB/,777 D A:<,B@7
#tep <: Calculate the )V of future salary (<77B - <77:):
C%
7
D 7
C%
6
D B/,777(67B) D B:7@777
C%
<
D B/,777(67B)
<
D B@6G<>7
C%
B
D B/,777(67B)
B
D BGBB@6:
C%
>
D B/,777(67B)
>
D >7?6@B<
C%
?
D B/,777(67B)
?
D >6:BB@:
2 D :
#olve for ')V D A6/7,:G6?7
#tep B: 8ecause the costs for pain and suffering and court costs are
already on a present value basis, 9ust add to the )V of costs
found in #teps 6 and <
)V D A:<,B@7 C A6/7,:G6?7 C A677,777 C A<7,777 D AB?B,6:6?7
/-</ 8egin with a time line:
7 6 < B
H H H H
?,777 ?,?77 /,7?7
%V D F
Ese a financial calculator to calculate the present value of the cash
flows and then determine the future value of this present value amount:
#tep 6: C%
7
D 7
C%
6
D ?777
C%
<
D ??77
C%
B
D /7?7
2 D :
#olve for ')V D A6>,>6?>6
#tep <: 2nput the following data:
' D B, 2 D :, )V D -6>>6?>6, )MT D 7, and solve for %V D
A6:,/?G?7
Answers and Solutions: 6 - 1,
:K
:K
/-<: 8egin with a time line:
7 6 ? / 6?
H H H H H
-B>7>/@G ?7 ?7 )MT )MT
This security is essentially two annuities and the present value of the
security is the sum of the present values for each of the two annuities
Esing a financial calculator solve as follows:
#tep 6: &etermine the present value of the first annuity:
2nput ' D ?, 2 D G, )MT D ?7, %V D 7, and solve for )V D
A6G>>@</
#tep <: Calculate the present value of the second annuity:
AB>7>/@G - A6G>>@</ D A6>?G@/B
#tep B: Calculate the value of the second annuity as of =ear ?:
2nput ' D ?, 2 D G, )V D -6>?G@/B, )MT D 7, and solve for %V D
A<<>/6@7
#tep >: Calculate the payment amount of the second annuity:
2nput ' D 67, 2 D G, )V D -<<>/6@7, %V D 7, and solve for )MT D
AB?77
/-<@ 7 6 < B > ? / : @ (trs
H H H H H H H H H
<7 <7 <7 <7
%V D F
To solve this problem two steps are needed %irst, determine the present
value of the cash flow stream #econd, calculate the future value of this
present value Esing a financial calculator input the following:
C%
7
D 7+ C%
6
D 7+ C%
<
D <7+ C%
B
D 7+ C%
>
D <7+ C%
?
D 7+ C%
/
D <7+ C%
:
D 7+
C%
@
D <7+ 2 D :N> D 6:?+ and then solve for ')V D A:B>7@<
Calculate the future value of this ')V amount:
2nput ' D @, 2 D 6:?, )V D -:B>7@<, )MT D 7, and solve for %V D A@>B>
/-<G a Esing the information given in the problem, you can solve for the
length of time re$uired to reach A6 million
2 D @+ )V D B7777+ )MT D ?777+ %V D -6777777+ and then solve for ' D
B6:6G/
Therefore, it will ta0e !ri0a B6:< years to reach her investment goal
b Again, you can solve for the length of time re$uired to reach A6 million
Answers and Solutions: 6 - 16
GK
6:?K
2 D G+ )V D B7777+ )MT D ?777+ %V D -6777777+ and then solve for ' D
<G6?/:
2t will ta0e Ratherine <G6/ years to reach her investment goal The
difference in time is B6:< - <G6/ D <?/ years
c Esing the B6:6G/ year target, you can solve for the re$uired payment
' D B6:6G/+ 2 D G+ )V D B7777+ %V D -6777777+ then solve for )MT D
B,B/@77
2f Ratherine wishes to reach the investment goal at the same time as
!ri0a, she can contribute as little as AB,B/@ every year
/-B7 a 2f Crissie e"pects a :K annual return upon her investments:
6 payment 67 payments B7 payments
' D 67 ' D B7
2 D : 2 D :
)MT D G?77777 )MT D ??77777
%V D 7 %V D 7
)V D /6,777,777 )V D //,:<>,7<? )V D /@,<>G,:<:
Crissie should accept the B7-year payment option as it carries the
highest present value (A/@,<>G,:<:)
b 2f Crissie e"pects an @K annual return upon her investments:
6 payment 67 payments B7 payments
' D 67 ' D B7
2 D @ 2 D @
)MT D G?77777 )MT D ??77777
%V D 7 %V D 7
)V D /6,777,777 )V D /B,:>?,::B )V D /6,G6:,@7@
Crissie should accept the 67-year payment option as it carries the
highest present value (A/B,:>?,::B)
c 2f Crissie e"pects a GK annual return upon her investments:
6 payment 67 payments B7 payments
' D 67 ' D B7
2 D G 2 D G
)MT D G?77777 )MT D ??77777
%V D 7 %V D 7
)V D /6,777,777 )V D /7,G/:,:>@ )V D ?/,?7?,7G:
Crissie should accept the lump-sum payment option as it carries the
highest present value (A/6,777,777)
Answers and Solutions: 6 - 1-
/-B6 Esing the information given in the problem, you can solve for the ma"imum
car price attainable
%inanced for >@ months %inanced for /7 months
' D >@ ' D /7
2 D 6 (6<KN6< D 6K) 2 D 6
)MT D B?7 )MT D B?7
%V D 7 %V D 7
)V D 6B,<G7@G )V D 6?,:B></
=ou must add the value of the down payment to the present value of the car
payments 2f financed for >@ months, Jarrett can afford a car valued up
to A6:,<G7@G (A6B,<G7@G C A>,777) 2f financing for /7 months, Jarrett
can afford a car valued up to 6G,:B></ (A6?,:B></ C A>,777)
/-B< a Esing the information given in the problem, you can solve for the
length of time re$uired to eliminate the debt
2 D < (<>KN6<)+ )V D B7?>>+ )MT D -67+ %V D 7+ and then solve for ' D
>://B@
8ecause #imon ma0es payments on his credit card at the end of the
month, it will re$uire >@ months before he pays off the debt
b %irst, you should solve for the present value of the total payments
made through the first >: months
' D >:+ 2 D <+ )MT D -67+ %V D 7+ and then solve for )V D B7<@/?@
This represents a difference in present values of payments of A<?:><
(AB7?>> - AB7<@/?@) 'e"t, you must find the value of this
difference at the end of the >@th month
' D >@+ 2 D <+ )V D -<?:><+ )MT D 7+ and then solve for %V D //?G/
Therefore, the >@th and final payment will be for A///
c 2f #imon ma0es monthly payments of AB7, we can solve for the length of
time re$uired before the account is paid off
2 D <+ )V D B7?>>+ )MT D -B7+ %V D 7+ and then solve for ' D 66>G:@
.ith AB7 monthly payments, #imon will only need 6< months to pay off
the account
d %irst, we must find out what the final payment will be if AB7 payments
are made for the first 66 months
Answers and Solutions: 6 - 1.
' D 66+ 2 D <+ )MT D -B7+ %V D 7+ and then solve for )V D <GB/7?>
This represents a difference in present values of payments of A66@B>/
(AB7?>> - A<GB/7?>) 'e"t, you must find the value of this difference
at the end of the 6<th month
' D 6<+ 2 D <+ )V D -66@B>/+ )MT D 7+ and then solve for %V D 6?77G6
Therefore, the 6<th and final payment will be for A6?76
The difference in total payments can be found to be:
S(>: A67) C A///T - S(66 AB7) C A6?76T D A6B6/?
/-BB Esing the information given in the problem, you can solve for the return
on the investment
' D ?+ )V D -6B77+ )MT D >77+ %V D 7+ and then solve for 2 D 6/B<K
/-B> a 7 6
H H A?77(67/) D A?B777
-?77 %V D F
b 7 6 <
H H H A?77(67/)
<
D A?/6@7
-?77 %V D F
c 7 6
H H A?77(6N67/) D A>:6:7
)V D F ?77
d 7 6 <
H H H A?77(6N67/)
<
D A>>?77
)V D F ?77
/-B? a 7 6 < B > ? / : @ G 67
H H H H H H H H H H H A?77(67/)
67
D A@G?><
-?77 %V D F
b 7 6 < B > ? / : @ G 67
H H H H H H H H H H H A?77(66<)
67
D A6,??<G<
-?77 %V D F
c 7 6 < B > ? / : @ G 67
H H H H H H H H H H H A?77N(67/)
67
D A<:G<7
)V D F ?77
d 7 6 < B > ? / : @ G 67
H H H H H H H H H H H
)V D F 6,??<G7
Answers and Solutions: 6 - 1/
/K
/K
/K
/K
/K
/K
6<K
6<K
A6,??<G7N(66<)
67
D A>GGGG
A6,??<G7N(67/)
67
D A@/:6B
The present value is the value today of a sum of money to be received
in the future %or e"ample, the value today of A6,??<G7 to be
received 67 years in the future is about A?77 at an interest rate of 6<
percent, but it is appro"imately A@/: if the interest rate is
/ percent Therefore, if you had A?77 today and invested it at 6<
percent, you would end up with A6,??<G7 in 67 years The present
value depends on the interest rate because the interest rate determines
the amount of interest you forgo by not having the money today
/-B/ a F
H H
-<77 >77
.ith a financial calculator, enter 2 D :, )V D -<77, )MT D 7, and %V D
>77 Then press the ' 0ey to find ' D 67<> 1verride 2 with the
other values to find ' D :<:, >6G, and 677
b F
H H !nter: 2 D 67, )V D -<77, )MT D 7, and %V D >77
-<77 >77 ' D :<:
c F
H H !nter: 2 D 6@, )V D -<77, )MT D 7, and %V D >77
-<77 >77 ' D >6G
d F
H H !nter: 2 D 677, )V D -<77, )MT D 7, and %V D >77
-<77 >77 ' D 677
/-B: a 7 6 < B > ? / : @ G 67
H H H H H H H H H H H
>77 >77 >77 >77 >77 >77 >77 >77 >77 >77
%V D F
.ith a financial calculator, enter ' D 67, 2 D 67, )V D 7, and )MT D
->77 Then press the %V 0ey to find %V D A/,B:>G:
b 7 6 < B > ?
H H H H H H
<77 <77 <77 <77 <77
%V D F
.ith a financial calculator, enter ' D ?, 2 D ?, )V D 7, and )MT D
-<77 Then press the %V 0ey to find %V D A6,67?6B
c 7 6 < B > ?
H H H H H H
>77 >77 >77 >77 >77
%V D F
Answers and Solutions: 6 - "0
:K
67K
6@K
67K
?K
7K
.ith a financial calculator, enter ' D ?, 2 D 7, )V D 7, and )MT D
->77 Then press the %V 0ey to find %V D A<,777
d To solve )art d using a financial calculator, repeat the procedures
discussed in )arts a, b, and c, but first switch the calculator to
38!L4 mode Ma0e sure you switch the calculator bac0 to 3!'&4 mode
after wor0ing the problem
6 7 6 < B > ? / : @ G 67
H H H H H H H H H H H
>77 >77 >77 >77 >77 >77 >77 >77 >77 >77 %V D F
.ith a financial calculator on 8!L, enter: ' D 67, 2 D 67, )V D
7, and )MT D ->77 %V D A:,76<>:
< 7 6 < B > ?
H H H H H H
<77 <77 <77 <77 <77 %V D F
.ith a financial calculator on 8!L, enter: ' D ?, 2 D ?, )V D 7,
and )MT D -<77 %V D A6,6/7B@
B 7 6 < B > ?
H H H H H H
>77 >77 >77 >77 >77 %V D F
.ith a financial calculator on 8!L, enter: ' D ?, 2 D 7, )V D 7,
and )MT D ->77 %V D A<,777
/-B@ The general formula is )VA
n
D )MT()V2%A
i,n
)
a 7 6 < B > ? / : @ G 67
H H H H H H H H H H H
)V D F >77 >77 >77 >77 >77 >77 >77 >77 >77 >77
.ith a financial calculator, simply enter the 0nown values and then
press the 0ey for the un0nown !nter: ' D 67, 2 D 67, )MT D ->77,
and %V D 7 )V D A<,>?:@B
b 7 6 < B > ?
H H H H H H
)V D F <77 <77 <77 <77 <77
.ith a financial calculator, enter: ' D ?, 2 D ?, )MT D -<77, and %V
D 7 )V D A@/?G7
c 7 6 < B > ?
H H H H H H
)V D F >77 >77 >77 >77 >77
.ith a financial calculator, enter: ' D ?, 2 D 7, )MT D ->77, and %V
D 7 )V D A<,77777
Answers and Solutions: 6 - "1
67K
?K
7K
67K
?K
7K
d 6 7 6 < B > ? / : @ G 67
H H H H H H H H H H H
>77 >77 >77 >77 >77 >77 >77 >77 >77 >77
)V D F
.ith a financial calculator on 8!L, enter: ' D 67, 2 D 67, )MT D
->77, and %V D 7 )V D A<,:7B/6
< 7 6 < B > ?
H H H H H H
<77 <77 <77 <77 <77
)V D F
.ith a financial calculator on 8!L, enter: ' D ?, 2 D ?, )MT D
-<77, and %V D 7 )V D AG7G6G
B 7 6 < B > ?
H H H H H H
>77 >77 >77 >77 >77
)V D F
.ith a financial calculator on 8!L, enter: ' D ?, 2 D 7, )MT D
->77, and %V D 7 )V D A<,77777
/-BG a Cash #tream A Cash #tream 8
7 6 < B > ? 7 6 < B > ?
H H H H H H H H H H H H
)V D F 677 >77 >77 >77 B77 )V D F B77 >77 >77 >77 677
.ith a financial calculator, simply enter the cash flows (be sure to
enter C%
7
D 7), enter 2 D @, and press the ')V 0ey to find ')V D )V D
A6,<?6<? for the first problem 1verride 2 D @ with 2 D 7 to find the
ne"t )V for Cash #tream A *epeat for Cash #tream 8 to get ')V D )V D
A6,B77B<
b )V
A
D A677 C A>77 C A>77 C A>77 C AB77 D A6,/77
)V
8
D AB77 C A>77 C A>77 C A>77 C A677 D A6,/77
/->7 These problems can all be solved using a financial calculator by entering
the 0nown values shown on the time lines and then pressing the 2 button
a 7 6
H H
C:77 -:>G
.ith a financial calculator, enter: ' D 6, )V D :77, )MT D 7, and %V
D -:>G 2 D :K
b 7 6
H H
-:77 C:>G
Answers and Solutions: 6 - ""
67K
?K
7K
@K @K
i D F
i D F
.ith a financial calculator, enter: ' D 6, )V D -:77, )MT D 7, and
%V D :>G 2 D :K
c 7 67
H H
C@?,777 -<76,<<G
.ith a financial calculator, enter: ' D 67, )V D @?777, )MT D 7, and
%V D -<76<<G 2 D GK
d 7 6 < B > ?
H H H H H H
CG,777 -<,/@>@7 -<,/@>@7 -<,/@>@7 -<,/@>@7 -<,/@>@7
.ith a financial calculator, enter: ' D ?, )V D G777, )MT D
-</@>@7, and %V D 7 2 D 6?K
/->6 a 7 6 < B > ?
H H H H H H
-?77 %V D F
.ith a financial calculator, enter ' D ?, 2 D 6<, )V D -?77, and )MT D
7, and then press %V to obtain %V D A@@66:
b 7 6 < B > ? / : @ G 67
H H H H H H H H H H H
-?77 %V D F
!nter the time line values into a financial calculator to obtain %V D
A@G?><
Alternatively, %V
n
D )V
mn
m
i
6

+ D A?77
) ? ( <
<
6< 7
6

+
D A?77(67/)
67
D A@G?><
c 7 > @ 6< 6/ <7
H H H H H H
-?77 %V D F
!nter the time line values into a financial calculator to obtain %V D
AG7B7/
Alternatively, %V
n
D A?77

>
76<
C 6
>(?)
D A?77(67B)
<7
D AG7B7/
d 7 6< <> B/ >@ /7
H H H H H H
-?77 F
!nter the time line values into a financial calculator to obtain %V D
AG7@B?
Answers and Solutions: 6 - "$
i D F
i D F
6<K
/K
BK
6K
Alternatively, %V
n
D A?77

6<
76<
C 6
6<(?)
D A?77(676)
/7
D AG7@B?
/->< a 7 < > / @ 67
H H H H H H
)V D F ?77
!nter the time line values into a financial calculator to obtain )V D
A<:G<7
Alternatively, )V D %V
n
m
i
C 6
6
mn

D A?77

<
76<
C 6
6
<(?)
D A?77

67/
6
67
D A<:G<7
b 7 > @ 6< 6/ <7
H H H H H H
)V D F ?77
!nter the time line values into a financial calculator to obtain )V D
A<:/@>
Alternatively, )V D A?77

>
76<
C 6
6
(?) >
D A?77

B 67
6
7 <
D A<:/@>
c 7 6 < 6<
H H H H
)V D F

?77
!nter the time line values into a financial calculator to obtain )V D
A>>B:<
Alternatively, )V D A?77

6<
76<
C 6
6
) 6 ( 6<
D A?77

6 67
6
6<
D A>>B:<
/->B a 7 6 < B G 67
H H H H

H H
->77 ->77 ->77 ->77 ->77
%V D F
!nter ' D ? < D 67, 2 D 6<N< D /, )V D 7, )MT D ->77, and then press
%V to get %V D A?,<:<B<
b 'ow the number of periods is calculated as ' D ? > D <7, 2 D 6<N>
D B, )V D 7, and )MT D -<77 The calculator solution is A?,B:>7:
Answers and Solutions: 6 - "+
/K
BK
6K
/K
The solution assumes that the nominal interest rate is compounded at
the annuity period
c The annuity in )art b earns more because some of the money is on
deposit for a longer period of time and thus earns more interest Also,
because compounding is more fre$uent, more interest is earned on
interest
Answers and Solutions: 6 - ",
/->> a %irst City 8an0: !ffective rate D :K
#econd City 8an0:
!ffective rate D
>
>
7/ 7
6

+ - 67 D (676?)
>
Q 67
D 67/6> Q 67 D 77/6> D /6>K
.ith a financial calculator, you can use the interest rate conversion
feature to obtain the same answer =ou would choose the %irst City
8an0
b 2f funds must be left on deposit until the end of the compounding
period (6 year for %irst City and 6 $uarter for #econd City), and you
thin0 there is a high probability that you will ma0e a withdrawal
during the year, the #econd City account might be preferable %or
e"ample, if the withdrawal is made after 67 months, you would earn
nothing on the %irst City account but (676?)
B
Q 67 D >?:K on the
#econd City account
Ten or more years ago, most ban0s and #U;s were set up as described
above, but now virtually all are computeri,ed and pay interest from the
day of deposit to the day of withdrawal, provided at least A6 is in the
account at the end of the period
/->? a .ith a financial calculator, enter ' D ?, 2 D 67, )V D -<?777, and %V D
7, and then press the )MT 0ey to get )MT D A/,?G>G> Then go through
the amorti,ation procedure as described in your calculator manual to
get the entries for the amorti,ation table
*epayment *emaining
=ear )ayment 2nterest of )rincipal 8alance
6 A /,?G>G> A<,?7777 A >,7G>G> A<7,G7?7/
< /,?G>G> <,7G7?6 >,?7>>B 6/,>77/B
B /,?G>G> 6,/>77/ >,G?>@@ 66,>>?:?
> /,?G>G> 6,6>>?@ ?,>?7B/ ?,GG?BG
? /,?G>GBV ?GG?> ?,GG?BG 7
AB<,G:>/G A:,G:>/G A<?,77777
VThe last payment must be smaller to force the ending balance to ,ero
b 5ere the loan si,e is doubled, so the payments also double in si,e to
A6B,6@G@:
c The annual payment on a A?7,777, 67-year loan at 67 percent interest
would be A@,6B:<: 8ecause the payments are spread out over a longer
time period, each payment is lower but more interest must be paid on
the loan The total interest paid on the 67-year loan is AB6,B:<:7
versus interest of A6?,G>GB: on the ?-year loan
Answers and Solutions: 6 - "6
/->/ a Esing your financial calculator, input the following data: ' D B7 6<
D B/7+ 2 D @N6< D 7///:+ )V D -6<?777+ %V D 7+ )MT D F #olve for )MT
D AG6:<6
b After finding the monthly mortgage payment, use the amorti,ation
feature of your calculator to find interest and principal repayments
during the year and the remaining mortgage balance as follows:
6 2')ET 6< AM1*T
D A G,G/<<B (2nterest)
D A 6,7>><G ()rincipal)
D A6<B,G??:6 (8alance)
Total mortgage payments made during the first year e$uals 6< AG6:<6
D A66,77/?<
)ortion of first year mortgage payments that go towards interest e$uals
AG,G/<<BNA66,77/?< D G7?6K
c After finding the monthly mortgage payment, use the amorti,ation
feature of your calculator to find interest and principal payments
during the first five years and the remaining mortgage balance as
follows:
6 2')ET /7 AM1*T
D A >@,@/G// (2nterest)
D A /,6/</@ ()rincipal)
D A66@,@B:B< (8alance)
The remaining mortgage balance after ? years will be A66@,@B:B<
d Esing your financial calculator, input the following data: ' D B7 6<
D B/7+ 2 D @N6< D 7///:+ )MT D 6<77+ %V D 7+ )V D F #olve for )V D
A6/B,?>76G
2f the Jac0sons are willing to have a A6,<77 monthly mortgage payment,
the can borrow A6/B,?>76G today
/->: 7

G 67
H H H H H
O: -><<>6 7 7

7 6,77777
8: -6,77777 @7 @7

@7 6,7@777
a .ith a financial calculator, for O, enter ' D 67, )V D -><<>6, )MT
D 7, %V D 6777, and press 2 to get 2 D G77K %or 8, enter ' D 67, )V
D -6777, )MT D @7, %V D 6777, and press 2 to get 2 D @K
(Alternatively, enter the values e"actly as shown on the time line in
the C% register, and use the 2** 0ey to obtain the same answer)
b .ith a calculator, for the 3,ero coupon bond,4 enter ' D 67, 2 D /, )MT
D 7, %V D 6777, and press )V to get the value of the security today,
Answers and Solutions: 6 - "-
A??@BG The profit would be A??@BG - A><<>6 D A6B?G@, and the
percentage profit would be A6B?G@NA><<>6 D B<<K
%or the 3coupon bond,4 enter ' D 67, 2 D /, )MT D @7, %V D 6777, and
then press )V to get )V D A6,6>:<7 The profit is A6>:<7, and the
percentage profit is 6>:< percent
c 5ere we compound cash flows to obtain a 3terminal value4 at =ear 67,
and then find the interest rate that e$uates the TV to the cost of the
security
There are no intermediate cash flows with #ecurity O, so its TV is
A6,777, and, as we saw in )art a, G percent causes the )V of A6,777 to
e$ual the cost, A><<>6 %or #ecurity 8, we must compound the cash
flows over 67 years at / percent !nter ' D 67, 2 D /, )V D 7, )MT D
@7, and then press %V to get the %V of the 67-year annuity of A@7 per
year: %V D A6,7?>>/ Then add the A6,777 to be received at =ear 67
to get TV
8
D A<,7?>>/ Then enter ' D 67, )V D -6777, )MT D 7, %V D
<7?>>/, and press 2 to get 2 D :>:K
#o, if the firm buys #ecurity O, its actual return will be G percent
regardless of what happens to interest rates--this security is a ,ero
coupon bond that has ,ero reinvestment rate ris0 5owever, if the firm
buys the @ percent coupon bond, and rates then fall, its 3true4 return
over the 67 years will be only :>: percent, which is an average of the
old @ percent and the new / percent
d The value of #ecurity O would fall from A><<>6 to AB<6G:, so a loss
of A677>>, or <B@ percent, would be incurred The value of #ecurity
8 would fall to A::BGG, so the loss here would be A<</76, or <</
percent of the A6,777 original investment The percentage losses for
the two bonds is close, but only because the ,eroMs original return was
G percent versus @ percent for the coupon bond
The 3actual4 or 3true4 return on the ,ero would remain at G percent,
but the 3actual4 return on the coupon bond would rise from @ percent to
G6: percent due to reinvestment of the A@7 coupons at 6< percent
/->@ a %irst, determine the annual cost of college The current cost is
A6<,?77 per year, but that is escalating at a ? percent inflation rate:
College Current =ears 2nflation Cash
=ear Cost from 'ow Ad9ustment *e$uired
6 A6<,?77 ? (67?)
?
A6?,G?>
< 6<,?77 / (67?)
/
6/,:?6
B 6<,?77 : (67?)
:
6:,?@G
> 6<,?77 @ (67?)
@
6@,>/@
'ow put these costs on a time line:
6B 6> 6? 6/ 6: 6@ 6G <7 <6

H H H H H H H H H


-6?,G?> Q6/,:?6 Q6:,?@G Q6@,>/@
Answers and Solutions: 6 - ".
5ow much must be accumulated by age 6@ to provide these payments at
ages 6@ through <6 if the funds are invested in an account paying
@ percent, compounded annuallyF
.ith a financial calculator enter: C%
7
D 6?G?>, C%
6
D 6/:?6, C%
<
D
6:?@G, C%
B
D 6@>/@, and 2 D @ #olve for ')V D A/6,<7>>6
Thus, the father must accumulate A/6,<7> by the time his daughter
reaches age 6@
b #he has A:,?77 now (age 6B) to help achieve that goal %ive years
hence, that A:,?77, when invested at @ percent, will be worth A66,7<7:
A:,?77(67@)
?
D A66,7<7
c The father needs to accumulate only A/6,<7> - A66,7<7 D A?7,6@> The
0ey to completing the problem at this point is to reali,e the series of
deposits represent an ordinary annuity rather than an annuity due,
despite the fact the first payment is made at the beginning of the
first year The reason it is not an annuity due is there is no
interest paid on the last payment that occurs when the daughter is 6@
Esing a financial calculator, ' D /, 2 D @, )V D 7, and %V D -?76@>
)MT D A/,@>7@? I A/,@>6
Answers and Solutions: 6 - "/
/->G The detailed solution for the spreadsheet problem is available both on the
instructorMs resource C&-*1M and on the instructorMs side of #outh-.esternMs
web site, http:NNbrighamswlearningcom
Spreadsheet Problem: 6 - $0
!)REA&!(EET )ROBLEM
'ir1t National Ban2
Time Value of Mone Analsis
6-50 ASSUME THAT YOU ARE NEARING GRADUATION AND THAT YOU HAVE APPLIED FOR A
JOB WITH A LOCAL BANK, FIRST NATIONAL BANK. AS PART OF THE BANKS
EVALUATION PROCESS, YOU HAVE BEEN ASKED TO TAKE AN EAMINATION THAT
COVERS SEVERAL FINANCIAL ANALYSIS TECHNI!UES. THE FIRST SECTION OF THE
TEST ADDRESSES TIME VALUE OF MONEY ANALYSIS. SEE HOW YOU WOULD DO BY
ANSWERING THE FOLLOWING !UESTIONS.
A. DRAW TIME LINES FOR "#$ A %#00 LUMP SUM CASH FLOW AT THE END OF YEAR &,
"&$ AN ORDINARY ANNUITY OF %#00 PER YEAR FOR ' YEARS, AND "'$ AN UNEVEN
CASH FLOW STREAM OF -%50, %#00, %(5, AND %50 AT THE END OF YEARS 0
THROUGH '.
ANSWER) S#51. #/-6 T5*1EL5 #/-> 5!*!T A T2M! ;2'! 2# A L*A)52CA;
*!)*!#!'TAT21' T5AT 2# E#!& T1 #51. T5! T2M2'L 1% CA#5 %;1.# T5! T2CR
MA*R# *!)*!#!'T !'& 1% )!*21&# (1%T!' =!A*#), #1 T2M! 7 2# T1&A=+ T2M!
6 2# T5! !'& 1% T5! %2*#T =!A*, 1* 6 =!A* %*1M T1&A=+ A'& #1 1'
7 6 < =!A*
H H H ;EM) #EM
677 CA#5 %;1.
7 6 < B
H H H H A''E2T=
677 677 677
7 6 < B
H H H H E'!V!' CA#5 %;1. #T*!AM
-?7 677

:? ?7
A ;EM) #EM 2# A #2'L;! %;1.+ %1* !WAM);!, A A677 2'%;1. 2' =!A* <,
A# #51.' 2' T5! T1) T2M! ;2'!
A' A''E2T= 2# A #!*2!# 1% !(EA; CA#5 %;1.# 1CCE**2'L 1V!* !(EA;
2'T!*VA;#, A# 2;;E#T*AT!& 2' T5! M2&&;! T2M! ;2'!
!ntegrated "ase: 6 - $1
INTEGRATE& CA!E
iK
iK
iK
A' E'!V!' CA#5 %;1. #T*!AM 2# A' 2**!LE;A* #!*2!# 1% CA#5 %;1.# T5AT
&1 '1T C1'#T2TET! A' A''E2T=, A# 2' T5! ;1.!* T2M! ;2'! -?7
*!)*!#!'T# A CA#5 1ET%;1. *AT5!* T5A' A *!C!2)T 1* 2'%;1.
B. #. WHAT IS THE FUTURE VALUE OF AN INITIAL %#00 AFTER ' YEARS IF IT IS
INVESTED IN AN ACCOUNT PAYING #0 PERCENT, ANNUAL COMPOUNDING*
ANSWER) S#51. #/-? T5*1EL5 #/-: 5!*!T #51. &1;;A*# C1**!#)1'&2'L T1 (E!#T21'
MA*R, CA;CE;AT!& A# %1;;1.#:
7 6 < B
H H H H
677 %V D F
A%T!* 6 =!A*:
%V
6
D )V C 2
6
D )V C )V(i) D )V(6 C i) D A677(667) D A66777
#2M2;A*;=:
%V
<
D %V
6
C 2
<
D %V
6
C %V
6
(i)


D %V
6
(6 C i) D A667(667) D A6<677


D )V(6 C i)(6 C i) D )V(6 C i)
<

%V
B
D %V
<
C 2
B
D %V
<
C %V
<
(i)


D %V
<
(6 C i) D A6<6(667) D A6BB67


D )V(6 C i)
<
(6 C i) D )V(6 C i)
B

2' L!'!*A;, .! #!! T5AT:

%V
n
D )V(6 C i)
n
,
#1 %V
B
D A677(667)
B
D A677(6BB67) D A6BB67
'1T! T5AT T52# !(EAT21' 5A# > VA*2A8;!#: %V
n
, )V, i, A'& n 5!*! .!
R'1. A;; !WC!)T %V
n
, #1 .! #1;V! %1* %V
n
.! .2;;, 51.!V!*, 1%T!' #1;V!
%1* 1'! 1% T5! 1T5!* T5*!! VA*2A8;!# 8= %A*, T5! !A#2!#T .A= T1 .1*R
A;; T2M! VA;E! )*18;!M# 2# .2T5 A %2'A'C2A; CA;CE;AT1* JE#T );EL 2'
A'= T5*!! 1% T5! %1E* VA;E!# A'& %2'& T5! %1E*T5
!ntegrated "ase: 6 - $"
67K
%2'&2'L %ETE*! VA;E!# (M1V2'L T1 T5! *2L5T A;1'L T5! T2M! ;2'!) 2#
CA;;!& C1M)1E'&2'L '1T! T5AT T5!*! A*! B .A=# 1% %2'&2'L %V
B
:
*!LE;A* CA;CE;AT1*:
6 A677(667)(667)(667) D A6BB67
< A677(667)
B
D A6BB67
%2'A'C2A; CA;CE;AT1*:
T52# 2# !#)!C2A;;= !%%2C2!'T %1* M1*! C1M);!W )*18;!M#, 2'C;E&2'L
!WAM )*18;!M# 2')ET T5! %1;;1.2'L VA;E!#: ' D B, 2 D 67, )V D
-677, )MT D 7, A'& #1;V! %1* %V D A6BB67
#)*!A&#5!!T:
#)*!A&#5!!T )*1L*AM# A*! 2&!A;;= #E2T!& %1* #1;V2'L T2M! VA;E! 1%
M1'!= )*18;!M# T5! #)*!A&#5!!T CA' 8! #!T E) E#2'L T5! #)!C2%2C %V
#)*!A&#5!!T %E'CT21' 1* 8= !'T!*2'L A %V %1*ME;AN!(EAT21'
B. &. WHAT IS THE PRESENT VALUE OF %#00 TO BE RECEIVED IN ' YEARS IF THE
APPROPRIATE INTEREST RATE IS #0 PERCENT, ANNUAL COMPOUNDING*
ANSWER) S#51. #/-@ T5*1EL5 #/-67 5!*!T %2'&2'L )*!#!'T VA;E!#, 1* &2#C1E'T2'L
(M1V2'L T1 T5! ;!%T A;1'L T5! T2M! ;2'!), 2# T5! *!V!*#! 1%
C1M)1E'&2'L, A'& T5! 8A#2C )*!#!'T VA;E! !(EAT21' 2# T5! *!C2)*1CA; 1%
T5! C1M)1E'&2'L !(EAT21':
7 6 < B
H H H H
)V D F 677
%V
n
D )V(6 C i)
n
T*A'#%1*M# T1:
) i C (6
%V
D
i C 6
6

%V
D
i) C (6
%V
D )V
n -
n
n
n
n
n

T5E#:
A:?6B D B) A677(7:?6 D
667
6
A677 D )V
B

!ntegrated "ase: 6 - $$
67K
4 3 2 1 0
1
2
Y e a r
3.8
FV
T5! #AM! M!T51&# (*!LE;A* CA;CE;AT1*, %2'A'C2A; CA;CE;AT1*, A'&
#)*!A&#5!!T )*1L*AM) E#!& %1* %2'&2'L %ETE*! VA;E!# A*! A;#1 E#!& T1
%2'& )*!#!'T VA;E!#, .52C5 2# CA;;!& &2#C1E'T2'L
E#2'L A %2'A'C2A; CA;CE;AT1* 2')ET ' D B, 2 D 67, )MT D 7, %V D
677, A'& T5!' #1;V! %1* )V D A:?6B
C. WE SOMETIMES NEED TO FIND HOW LONG IT WILL TAKE A SUM OF MONEY "OR
ANYTHING ELSE$ TO GROW TO SOME SPECIFIED AMOUNT. FOR EAMPLE, IF A
COMPANYS SALES ARE GROWING AT A RATE OF &0 PERCENT PER YEAR, HOW LONG
WILL IT TAKE SALES TO DOUBLE*
ANSWER) S#51. #/-66 5!*!T .! 5AV! T52# #2TEAT21' 2' T2M! ;2'! %1*MAT:
7 6 < B B@ >
H H H H H H
-6 <
#A= .! .A'T T1 %2'& 1ET 51. ;1'L 2T .2;; TAR! E# T1 &1E8;! 1E* M1'!= AT
A' 2'T!*!#T *AT! 1% <7 )!*C!'T .! CA' E#! A'= 'EM8!*#, #A= A6 A'& A<,
.2T5 T52# !(EAT21':
%V
n
D A< D A6(6 C i)
n
D A6(6<7)
n

.! .1E;& );EL 2 D <7, )V D

-6, )MT D 7, A'& %V D < 2'T1 1E*
CA;CE;AT1*, A'& T5!' )*!## T5! '
8ETT1' T1 %2'& T5! 'EM8!* 1%
=!A*# 2T .1E;& TAR! 6 (1* A'=
1T5!* 8!L2''2'L AM1E'T) T1 &1E8;!
.5!' L*1.T5 1CCE*# AT A <7
)!*C!'T *AT! T5! A'#.!* 2# B@
=!A*#, 8ET #1M! CA;CE;AT1*# .2;;
*1E'& T52# VA;E! E) T1 T5! '!WT
52L5!#T .51;! 'EM8!* T5! L*A)5
A;#1 #51.# .5AT 2# 5A))!'2'L
!ntegrated "ase: 6 - $+
<7K
OPTIONAL !UESTION
A FARMER CAN SPEND %60+ACRE TO PLANT PINE TREES ON SOME MARGINAL LAND. THE
EPECTED REAL RATE OF RETURN IS , PERCENT, AND THE EPECTED INFLATION RATE IS
6 PERCENT. WHAT IS THE EPECTED VALUE OF THE TIMBER AFTER &0 YEARS*
ANSWER) %V
<7
D A/7(6 C 77> C 77/)
<7
D A/7(667)
<7
D A>7B/? )!* AC*!
.! C1E;& 5AV! A#R!&: 51. ;1'L .1E;& 2T TAR! A/7 T1 L*1. T1 A>7B/?,
L2V!' T5! *!A; *AT! 1% *!TE*' 1% > )!*C!'T A'& A' 2'%;AT21' *AT! 1%
/ )!*C!'T 1% C1E*#!, T5! A'#.!* .1E;& 8! <7 =!A*#
D. WHAT IS THE DIFFERENCE BETWEEN AN ORDINARY ANNUITY AND AN ANNUITY DUE*
WHAT TYPE OF ANNUITY IS SHOWN BELOW* HOW WOULD YOU CHANGE IT TO THE
OTHER TYPE OF ANNUITY*
0 # & '
- - - -
#00 #00 #00
ANSWER) S#51. #/-6< 5!*!T T52# 2# A' 1*&2'A*= A''E2T=--2T 5A# 2T# )A=M!'T# AT
T5! !'& 1% !AC5 )!*21&+ T5AT 2#, T5! %2*#T )A=M!'T 2# MA&! 6 )!*21&
%*1M T1&A= C1'V!*#!;=, A' A''E2T= &E! 5A# 2T# %2*#T )A=M!'T T1&A= 2'
1T5!* .1*&#, A' 1*&2'A*= A''E2T= 5A# !'&-1%-)!*21& )A=M!'T#, .52;! A'
A''E2T= &E! 5A# 8!L2''2'L-1%-)!*21& )A=M!'T#
T5! A''E2T= #51.' A81V! 2# A' 1*&2'A*= A''E2T= T1 C1'V!*T 2T T1 A'
A''E2T= &E!, #52%T !AC5 )A=M!'T T1 T5! ;!%T, #1 =1E !'& E) .2T5 A
)A=M!'T E'&!* T5! 7 8ET '1'! E'&!* T5! B
E. #. WHAT IS THE FUTURE VALUE OF A '-YEAR ORDINARY ANNUITY OF %#00 IF THE
APPROPRIATE INTEREST RATE IS #0 PERCENT, ANNUAL COMPOUNDING*
ANSWER) S#51. #/-6B 5!*!T
7 6 < B
H H H H
677 677 677
667
6<6
ABB6
!ntegrated "ase: 6 - $,
67K
L1 T5*1EL5 T5! %1;;1.2'L &2#CE##21' 1'! A))*1AC5 .1E;& 8! T1 T*!AT
!AC5 A''E2T= %;1. A# A ;EM) #EM 5!*! .! 5AV!
%VA
n
D A677(6) C A677(667) C A677(667)
<
D A677S6 C (667) C (667)
<
T D A677(BB677) D ABB677
%ETE*! VA;E!# 1% A''E2T2!# MA= 8! CA;CE;AT!& 2' B .A=#: (6) T*!AT T5!
)A=M!'T# A# ;EM) #EM# (<) E#! A %2'A'C2A; CA;CE;AT1* (B) E#! A
#)*!A&#5!!T
E. &. WHAT IS THE PRESENT VALUE OF THE ANNUITY*
ANSWER) S#51. #/-6> 5!*!T
7 6 < B
H H H H
677 677 677
G7G6
@</>
:?6B
<>@/@
T5! )*!#!'T VA;E! 1% T5! A''E2T= 2# A<>@/@ 5!*! .! E#!& T5! ;EM) #EM
A))*1AC5, 8ET T5! #AM! *!#E;T C1E;& 8! 18TA2'!& 8= E#2'L T5! A''E2T=
TA8;! 1* A CA;CE;AT1* 2')ET ' D B, 2 D 67, )MT D 677, %V D 7, A'&
)*!## T5! )V 8ETT1'
E. '. WHAT WOULD THE FUTURE AND PRESENT VALUES BE IF THE ANNUITY WERE AN
ANNUITY DUE*
ANSWER) S#51. #/-6? A'& #/-6/ 5!*!T 2% T5! A''E2T= .!*! A' A''E2T= &E!, !AC5
)A=M!'T .1E;& 8! #52%T!& T1 T5! ;!%T, #1 !AC5 )A=M!'T 2# C1M)1E'&!&
1V!* A' A&&2T21'A; )!*21& 1* &2#C1E'T!& 8ACR 1V!* 1'! ;!## )!*21&
2' 1E* #2TEAT21', T5! %ETE*! VA;E! 1% T5! A''E2T= &E! 2# AB/>67:
%VA
B &E!
D ABB677(667)
6
D AB/>67
T52# #AM! *!#E;T C1E;& 8! 18TA2'!& 8= E#2'L T5! T2M! ;2'!: A6BB67 C
A6<677 C A66777 D AB/>67
!ntegrated "ase: 6 - $6
67K
T5! 8!#T .A= T1 .1*R A''E2T= &E! )*18;!M# 2# T1 #.2TC5 =1E*
CA;CE;AT1* T1 38!L4 1* 8!L2''2'L 1* 3&E!4 M1&!, A'& L1 T5*1EL5 T5!
'1*MA; )*1C!## '1T! T5AT 2TM# C*2T2CA; T1 *!M!M8!* T1 C5A'L! 8ACR T1
3!'&4 M1&! A%T!* .1*R2'L A' A''E2T= &E! )*18;!M .2T5 =1E* CA;CE;AT1*
2' 1E* #2TEAT21', T5! )*!#!'T VA;E! 1% T5! A''E2T= &E! 2# A<:B??:
)VA
B &E!
D A<>@/@(667)
6
D A<:B??
T52# #AM! *!#E;T C1E;& 8! 18TA2'!& 8= E#2'L T5! T2M! ;2'!: A677 C
AG7G6 C A@</> D A<:B??
F. WHAT IS THE PRESENT VALUE OF THE FOLLOWING UNEVEN CASH FLOW STREAM*
THE APPROPRIATE INTEREST RATE IS #0 PERCENT, COMPOUNDED ANNUALLY.
0 # & ' , YEARS
- - - - -
0 #00 '00 '00 -50
ANSWER) S#51. #/-6: A'& #/-6@ 5!*!T 5!*! .! 5AV! A' E'!V!' CA#5 %;1. #T*!AM
T5! M1#T #T*A2L5T%1*.A*& A))*1AC5 2# T1 %2'& T5! )Vs 1% !AC5 CA#5 %;1.
A'& T5!' #EM T5!M A# #51.' 8!;1.:
7 6 < B > =!A*#
H H H H H
7 677 B77 B77 -?7
G7G6
<>:GB
<<?BG
(B>6?)
?B77@
'1T! (6) T5AT T5! A?7 =!A* > 1ET%;1. *!MA2'# A' 1ET%;1. !V!' .5!'
&2#C1E'T!& T5!*! A*! 'EM!*1E# .A=# 1% %2'&2'L T5! )*!#!'T VA;E! 1% A'
E'!V!' CA#5 %;1. #T*!AM 8ET 8= %A* T5! !A#2!#T .A= T1 &!A; .2T5 E'!V!'
CA#5 %;1. #T*!AM# 2# .2T5 A %2'A'C2A; CA;CE;AT1* CA;CE;AT1*# 5AV! A
%E'CT21' T5AT 1' T5! 5)-6:8 2# CA;;!& 3C%;1,4 %1* 3CA#5 %;1.4 1T5!*
CA;CE;AT1*# C1E;& E#! 1T5!* &!#2L'AT21'# #EC5 A# C%
7
A'& C%
9
, 8ET T5!=
!W);A2' 51. T1 E#! T5!M 2' T5! MA'EA; A'=.A=, =1E .1E;& 2')ET T5! CA#5
%;1.#, #1 T5!= A*! 2' T5! CA;CE;AT1*M# M!M1*=, T5!' 2')ET T5! 2'T!*!#T
*AT!, 2, A'& T5!' )*!## T5! ')V 1* )V 8ETT1' T1 %2'& T5! )*!#!'T VA;E!
!ntegrated "ase: 6 - $-
67K
G. WHAT ANNUAL INTEREST RATE WILL CAUSE %#00 TO GROW TO %#&5..( IN ' YEARS*
ANSWER) S#51. #/-6G 5!*!T
7 6 < B
H H H H
-677 6<?G:
A677(6 C i) A677(6 C i)
<


A677(6 C i)
B
%V D A677(6 C i)
B
D

A6<?G:
E#2'L A %2'A'C2A; CA;CE;AT1*+ !'T!* ' D B, )V D -677, )MT D 7, %V D
6<?G:, T5!' )*!## T5! 2 8ETT1' T1 %2'& 2 D @K
CA;CE;AT1*# CA' %2'& 2'T!*!#T *AT!# (E2T! !A#2;=, !V!' .5!' )!*21&#
A'&N1* 2'T!*!#T *AT!# A*! '1T .51;! 'EM8!*#, A'& .5!' E'!V!' CA#5 %;1.
#T*!AM# A*! 2'V1;V!& (.2T5 E'!V!' CA#5 %;1.#, .! ME#T E#! T5! 3C%;14
%E'CT21', A'& T5! 2'T!*!#T *AT! 2# CA;;!& T5! 2**, 1* 32'T!*'A; *AT! 1%
*!TE*'+4 .! .2;; E#! T52# %!ATE*! 2' CA)2TA; 8E&L!T2'L)
H. A &0-YEAR OLD STUDENT WANTS TO BEGIN SAVING FOR HER RETIREMENT. HER
PLAN IS TO SAVE %' A DAY. EVERY DAY SHE PLACES %' IN A DRAWER. AT THE
END OF EACH YEAR, SHE INVESTS THE ACCUMULATED SAVINGS "%#,0.5$ IN AN
ONLINE STOCK ACCOUNT THAT HAS AN EPECTED ANNUAL RETURN OF #& PERCENT.
#. IF SHE KEEPS SAVING IN THIS MANNER, HOW MUCH WILL SHE HAVE ACCUMULATED
BY AGE 65*
ANSWER) S#51. #/-<7 A'& #/-<6 5!*!T 2% #5! 8!L2'# #AV2'L T1&A=, A'& #T2CR# T1
5!* );A', #5! .2;; 5AV! #AV!& A6,>@:,</6@G 8= T5! T2M! #5! *!AC5!# /?
.2T5 A %2'A'C2A; CA;CE;AT1*, !'T!* T5! %1;;1.2'L 2')ET#: ' D >?, 2 D
6<, )V D 7, )MT D -67G?, T5!' )*!## T5! %V 8ETT1' T1 #1;V! %1*
A6,>@:,</6@G
&. IF A ,0-YEAR OLD INVESTOR BEGAN SAVING IN THIS MANNER, HOW MUCH WOULD
HE HAVE BY AGE 65*
ANSWER) S#51. #/-<< 5!*!T T52# (E!#T21' &!M1'#T*AT!# T5! )1.!* 1% C1M)1E'&
2'T!*!#T A'& T5! 2M)1*TA'C! 1% L!TT2'L #TA*T!& 1' A *!LE;A* #AV2'L#
)*1L*AM AT A' !A*;= AL! T5! >7-=!A* 1;& 2'V!#T1* .2;; 5AV! #AV!& 1';=
!ntegrated "ase: 6 - $.
A6>/,777?G 8= T5! T2M! 5! *!AC5!# /? .2T5 A %2'A'C2A; CA;CE;AT1*,
!'T!* T5! %1;;1.2'L 2')ET#: ' D <?, 2 D 6<, )V D 7, )MT D -67G?, T5!'
)*!## T5! %V 8ETT1' T1 #1;V! %1* A6>/,777?G
'. HOW MUCH WOULD THE ,0-YEAR OLD INVESTOR HAVE TO SAVE EACH YEAR TO
ACCUMULATE THE SAME AMOUNT AT AGE 65 AS THE &0-YEAR OLD INVESTOR
DESCRIBED ABOVE*
ANSWER) S#51. #/-<B 5!*!T ALA2', T52# (E!#T21' &!M1'#T*AT!# T5! )1.!* 1%
C1M)1E'& 2'T!*!#T A'& T5! 2M)1*TA'C! 1% L!TT2'L #TA*T!& 1' A *!LE;A*
#AV2'L# )*1L*AM AT A' !A*;= AL! T5! >7-=!A* 1;& 2'V!#T1* .2;; 5AV! T1
#AV! A66,6?>>< !V!*= =!A*, 1* AB7?/ )!* &A=, 2' 1*&!* T1 5AV! A# MEC5
#AV!& A# T5! <7-=!A* 1;& 2'V!#T1* 8= T5! T2M! 5! *!AC5!# /? .2T5 A
%2'A'C2A; CA;CE;AT1*, !'T!* T5! %1;;1.2'L 2')ET#: ' D <?, 2 D 6<, )V D
7, %V D 6>@:</6@G, T5!' )*!## T5! )MT 8ETT1' T1 #1;V! %1* A66,6?>><
I. #. WILL THE FUTURE VALUE BE LARGER OR SMALLER IF WE COMPOUND AN INITIAL
AMOUNT MORE OFTEN THAN ANNUALLY, FOR EAMPLE, EVERY 6 MONTHS, OR
SEMIANNUALLY, HOLDING THE STATED INTEREST RATE CONSTANT* WHY*
ANSWER) S#51. #/-<> 5!*!T ACC1E'T# T5AT )A= 2'T!*!#T M1*! %*!(E!'T;= T5A'
1'C! A =!A*, %1* !WAM);!, #!M2A''EA;;=, (EA*T!*;=, 1* &A2;=, 5AV!
%ETE*! VA;E!# T5AT A*! 52L5!* 8!CAE#! 2'T!*!#T 2# !A*'!& 1' 2'T!*!#T
M1*! 1%T!' V2*TEA;;= A;; 8A'R# '1. )A= 2'T!*!#T &A2;= 1' )A##811R A'&
M1'!= %E'& ACC1E'T#, #1 T5!= E#! &A2;= C1M)1E'&2'L
I. &. DEFINE "A$ THE STATED, OR !UOTED, OR NOMINAL, RATE, "B$ THE PERIODIC
RATE, AND "C$ THE EFFECTIVE ANNUAL RATE "EAR$.
ANSWER) S#51. #/-<? A'& #/-</ 5!*!T T5! (E1T!&, 1* '1M2'A;, *AT! 2# M!*!;=
T5! (E1T!& )!*C!'TAL! *AT! 1% *!TE*', T5! )!*21&2C *AT! 2# T5! *AT!
C5A*L!& 8= A ;!'&!* 1* )A2& 8= A 81**1.!* !AC5 )!*21& ()!*21&2C *AT! D
i
'om
Nm), A'& T5! !%%!CT2V! A''EA; *AT! (!A*) 2# T5! *AT! 1% 2'T!*!#T
T5AT .1E;& )*1V2&! A' 2&!'T2CA; %ETE*! &1;;A* VA;E! E'&!* A''EA;
C1M)1E'&2'L
!ntegrated "ase: 6 - $/
I. '. WHAT IS THE EFFECTIVE ANNUAL RATE CORRESPONDING TO A NOMINAL RATE OF
#0 PERCENT, COMPOUNDED SEMIANNUALLY* COMPOUNDED !UARTERLY* COMPOUNDED
DAILY*
ANSWER) S#51. #/-<: T5*1EL5 #/-<G 5!*!T T5! !%%!CT2V! A''EA; *AT! %1*
67 )!*C!'T #!M2A''EA; C1M)1E'&2'L, 2# 67<? )!*C!'T:
67 -
m
i C 6
D *AT! A''EA; !%%!CT2V! D !A*
'om
m

2% i
'om
D 67K A'& 2'T!*!#T 2# C1M)1E'&!& #!M2A''EA;;=, T5!':
67<?K D 767<? D 67 - 667<? D 67 - ) (67? D 67 -
<
767
C 6 D !A*
<
<

%1* (EA*T!*;= C1M)1E'&2'L, T5! !%%!CT2V! A''EA; *AT! 2# 67B@ )!*C!'T:

(67<?)
>
- 67 D 667B@ - 67 D 767B@ D 67B@K
&A2;= C1M)1E'&2'L .1E;& )*1&EC! A' !%%!CT2V! A''EA; *AT! 1% 67?<
)!*C!'T
I. ,. WHAT IS THE FUTURE VALUE OF %#00 AFTER ' YEARS UNDER #0 PERCENT
SEMIANNUAL COMPOUNDING* !UARTERLY COMPOUNDING*
ANSWER) S#51. #/-B7 5!*!T E'&!* #!M2A''EA; C1M)1E'&2'L, T5! A677 2#
C1M)1E'&!& 1V!* / #!M2A''EA; )!*21&# AT A ?7 )!*C!'T )!*21&2C *AT!:
i
'om
D 67K
%V
n
D
mn
'om
m
i
6

+
D A677
) B ( <
<
67 7
6

+
D A677(67?)
/
D A6B>76
(EA*T!*;=: %V
n
D A677(67<?)
6<
D A6B>>G
T5! *!TE*' .5!' E#2'L (EA*T!*;= C1M)1E'&2'L 2# C;!A*;= 52L5!*
A'1T5!* A))*1AC5 5!*! .1E;& 8! T1 E#! T5! !%%!CT2V! A''EA; *AT! A'&
C1M)1E'& 1V!* A''EA; )!*21&#:
!ntegrated "ase: 6 - +0
#!M2A''EA;;=: A677(667<?)
B
D A6B>76
(EA*T!*;=: A677(667B@)
B
D A6B>>G
J. WHEN WILL THE EFFECTIVE ANNUAL RATE BE E!UAL TO THE NOMINAL "!UOTED$
RATE*
ANSWER) 2% A''EA; C1M)1E'&2'L 2# E#!&, T5!' T5! '1M2'A; *AT! .2;; 8! !(EA; T1
T5! !%%!CT2V! A''EA; *AT! 2% M1*! %*!(E!'T C1M)1E'&2'L 2# E#!&, T5!
!%%!CT2V! A''EA; *AT! .2;; 8! A81V! T5! '1M2'A; *AT!
K. #. WHAT IS THE VALUE AT THE END OF YEAR ' OF THE FOLLOWING CASH FLOW
STREAM IF THE !UOTED INTEREST RATE IS #0 PERCENT, COMPOUNDED
SEMIANNUALLY*
0 & , 6 PERIODS
- - - -
#00 #00 #00
ANSWER) S#51. #/-B6 T5*1EL5 #/-BB 5!*!T
7 6 < B
H H H H
677 677 67777
667<? D A677(67?)
<
6<6?? D A677(67?)
>
ABB6@7
5!*! .! 5AV! A &2%%!*!'T #2TEAT21' T5! )A=M!'T# 1CCE* A''EA;;=, 8ET
C1M)1E'&2'L 1CCE*# !AC5 / M1'T5# T5E#, .! CA''1T E#! '1*MA; A''E2T=
VA;EAT21' T!C5'2(E!#
K. &. WHAT IS THE PV OF THE SAME STREAM*
ANSWER) S#51. #/-B> 5!*!T
7 6 < B
H H H H
677 677 677
A G7:7
@<<: )V D 677(67?)
->
:>/<
A<>:?G
!ntegrated "ase: 6 - +1
?K
?K
T1 E#! A %2'A'C2A; CA;CE;AT1*, 2')ET ' D B, 2 D 67<?, )MT D 677, %V
D 7, A'& T5!' )*!## T5! )V R!= T1 %2'& )V D A<>:?G
K. '. IS THE STREAM AN ANNUITY*
ANSWER) T5! )A=M!'T #T*!AM 2# A' A''E2T= 2' T5! #!'#! 1% C1'#TA'T AM1E'T# AT
*!LE;A* 2'T!*VA;#, 8ET T5! 2'T!*VA;# &1 '1T C1**!#)1'& .2T5 T5!
C1M)1E'&2'L )!*21&# T52# R2'& 1% #2TEAT21' 1CCE*# 1%T!' 2' T52#
#2TEAT21' T5! 2'T!*!#T 2# C1M)1E'&!& #!M2A''EA;;=, #1 .2T5 A (E1T!&
*AT! 1% 67 )!*C!'T, T5! !A* .2;; 8! 67<? )!*C!'T 5!*! .! C1E;& %2'&
T5! !%%!CT2V! *AT! A'& T5!' T*!AT 2T A# A' A''E2T= !'T!* ' D B, 2 D
67<?, )MT D 677, A'& %V D 7 '1. )*!## )V T1 L!T A<>:?G
K. ,. AN IMPORTANT RULE IS THAT YOU SHOULD NEVER SHOW A NOMINAL RATE ON A TIME
LINE OR USE IT IN CALCULATIONS UNLESS WHAT CONDITION HOLDS* "HINT)
THINK OF ANNUAL COMPOUNDING, WHEN /
N01
2 EAR 2 /
PER
.$ WHAT WOULD BE WRONG
WITH YOUR ANSWER TO PARTS K"#$ AND K"&$ IF YOU USED THE NOMINAL RATE, #0
PERCENT, RATHER THAN THE PERIODIC RATE, /
N01
+& 2 #03+& 2 53*
ANSWER) i
'om
CA' 8! E#!& 2' T5! CA;CE;AT21'# 1';= .5!' A''EA; C1M)1E'&2'L
1CCE*# 2% T5! '1M2'A; *AT! 1% 67 )!*C!'T .!*! E#!& T1 &2#C1E'T T5!
)A=M!'T #T*!AM, T5! )*!#!'T VA;E! .1E;& 8! 1V!*#TAT!& 8= A<:<B< -
A<>:?G D A<>:B
L. #. CONSTRUCT AN AMORTI4ATION SCHEDULE FOR A %#,000, #0 PERCENT, ANNUAL
COMPOUNDING LOAN WITH ' E!UAL INSTALLMENTS.
&. WHAT IS THE ANNUAL INTEREST EPENSE FOR THE BORROWER, AND THE ANNUAL
INTEREST INCOME FOR THE LENDER, DURING YEAR &*
ANSWER) S#51. #/-B? T5*1EL5 #/->6 5!*!T T1 8!L2', '1T! T5AT T5! %AC! AM1E'T
1% T5! ;1A', A6,777, 2# T5! )*!#!'T VA;E! 1% A B-=!A* A''E2T= AT A
67 )!*C!'T *AT!:
7 6 < B
H H H H
-6,777 )MT )MT )MT
!ntegrated "ase: 6 - +"
67K
)VA
B
D )MT

i C 6
6
6
C )MT

i C 6
6
<
C )MT

i C 6
6
B
A6,777 D )MT(6 C i)
-6
C )MT(6 C i)
-<
C )MT(6 C i)
-B
.! 5AV! A' !(EAT21' .2T5 1';= 1'! E'R'1.', #1 .! CA' #1;V! 2T T1 %2'&
)MT T5! !A#= .A= 2# .2T5 A %2'A'C2A; CA;CE;AT1* 2')ET ' D B,
2 D 67, )V D -6777, %V D 7, A'& T5!' )*!## T5! )MT 8ETT1' T1 L!T
)MT D >7<66>@7B/, *1E'&!& T1 A>7<66
AM1*T2OAT21' #C5!&E;!:
8!L2''2'L )A=M!'T 1% !'&2'L
)!*21& 8A;A'C! )A=M!'T 2'T!*!#T )*2'C2)A; 8A;A'C!
6 A6,77777 A>7<66 A67777 AB7<66 A/G:@G
< /G:@G >7<66 /G:G BB<B< B/??:
B B/??: >7<6BV B/?/ B/??: 777
V&E! T1 *1E'&2'L, T5! T52*& )A=M!'T .A# 2'C*!A#!& 8= A77< T1 CAE#! T5!
!'&2'L 8A;A'C! A%T!* T5! T52*& =!A* T1 !(EA; A7
'1. MAR! T5! %1;;1.2'L )12'T# *!LA*&2'L T5! AM1*T2OAT21' #C5!&E;!:
T5! A>7<66 A''EA; )A=M!'T 2'C;E&!# 81T5 2'T!*!#T A'& )*2'C2)A;
2'T!*!#T 2' T5! %2*#T =!A* 2# CA;CE;AT!& A# %1;;1.#:
6#T =!A* 2'T!*!#T D i 8!L2''2'L 8A;A'C! D 76 A6,777 D A677
T5! *!)A=M!'T 1% )*2'C2)A; 2# T5! &2%%!*!'C! 8!T.!!' T5! A>7<66
A''EA; )A=M!'T A'& T5! 2'T!*!#T )A=M!'T:
6#T =!A* )*2'C2)A; *!)A=M!'T D A>7<66 - A677 D AB7<66
T5! ;1A' 8A;A'C! AT T5! !'& 1% T5! %2*#T =!A* 2#:
6#T =!A* !'&2'L 8A;A'C! D 8!L2''2'L 8A;A'C! Q )*2'C2)A; *!)A=M!'T
D A6,777 Q AB7<66 D A/G:@G
.! .1E;& C1'T2'E! T5!#! #T!)# 2' T5! %1;;1.2'L =!A*#
'1T2C! T5AT T5! 2'T!*!#T !AC5 =!A* &!C;2'!# 8!CAE#! T5! 8!L2''2'L
;1A' 8A;A'C! 2# &!C;2'2'L #2'C! T5! )A=M!'T 2# C1'#TA'T, 8ET T5!
2'T!*!#T C1M)1'!'T 2# &!C;2'2'L, T5! )*2'C2)A; *!)A=M!'T )1*T21' 2#
!ntegrated "ase: 6 - +$
2'C*!A#2'L !AC5 =!A*
T5! 2'T!*!#T C1M)1'!'T 2# A' !W)!'#! T5AT 2# &!&ECT28;! T1 A
8E#2'!## 1* A 51M!1.'!*, A'& 2T 2# TAWA8;! 2'C1M! T1 T5! ;!'&!* 2%
=1E 8E= A 51E#!, =1E .2;; L!T A #C5!&E;! C1'#T*ECT!& ;2R! 1E*#, 8ET
;1'L!*, .2T5 B7 6< D B/7 M1'T5;= )A=M!'T# 2% =1E L!T A B7-=!A*,
%2W!&-*AT! M1*TLAL!
T5! )A=M!'T MA= 5AV! T1 8! 2'C*!A#!& 8= A %!. C!'T# 2' T5! %2'A;
=!A* T1 TAR! CA*! 1% *1E'&2'L !**1*# A'& MAR! T5! %2'A; )A=M!'T
)*1&EC! A O!*1 !'&2'L 8A;A'C!
T5! ;!'&!* *!C!2V!& A 67 )!*C!'T *AT! 1% 2'T!*!#T 1' T5! AV!*AL!
AM1E'T 1% M1'!= T5AT .A# 2'V!#T!& !AC5 =!A*, A'& T5! A6,777 ;1A' .A#
)A2& 1%% T52# 2# .5AT AM1*T2OAT21' #C5!&E;!# A*! &!#2L'!& T1 &1
M1#T %2'A'C2A; CA;CE;AT1*# 5AV! AM1*T2OAT21' %E'CT21'# 8E2;T 2'
M. SUPPOSE A HOUSE IS ON THE MARKET FOR %&50,000, AND A BANK AGREES TO
LEND THE POTENTIAL HOME BUYER %&&0,000 SECURED BY A MORTGAGE ON THE
HOUSE. THUS, THE BUYER MUST COME UP WITH %'0,000 TO COMPLETE THE
TRANSACTION. FOR PURPOSES OF THIS !UESTION, IGNORE ANY ADDITIONAL
CLOSING COSTS. SUPPOSE THE BUYER HAS ONLY %(,500 CASH, AND THE SELLER
AGREES TO TAKE A NOTE WITH THE FOLLOWING TERMS) A FACE VALUE OF
%&&,500, A (.5 PERCENT ANNUAL INTEREST RATE, AND PAYMENTS AT THE END OF
THE YEAR BASED ON A &0-YEAR AMORTI4ATION SCHEDULE, BUT WITH THE LOAN
MATURING AT THE END OF THE #0
TH
YEAR.
#. WHAT IS THE BALLOON PORTION OF THE PAYMENT DUE AT THE END OF THE #0
TH
YEAR*
ANSWER) S#51. #/->< T5*1EL5 #/->> 5!*!T 8A#!& E)1' T5! ;1A' 2'%1*MAT21', T5!
51M! 8E=!* ME#T MAR! A''EA; )A=M!'T# 1% A<,<7:7: 1' T5! ;1A' A#
CA;CE;AT!& 8!;1.:
' D <7+ 2 D :?+ )V D -<<?77+ A'& %V D 7 #1;V! %1* )MT D A<,<7:7:>B
I A<,<7:7:
!ntegrated "ase: 6 - ++
NOW, WE NEED TO FIND THE REMAINING BALANCE OF THE LOAN AT THE END OF #0
YEARS. IF WE USE THE AMORTI4ATION FEATURE OF THE CALCULATOR, WE CAN
FIND THAT THE BALLOON PAYMENT IS %#5,#,..5,.
# INPUT #0 AMORT
2 "INTEREST$ #,,(&0.&500
2 "PRINCIPAL$ (,'50.,6'0
2 "BALANCE$ #5,#,..5'(0 6 %#5,#,..5,.
M. &. WHAT IS THE TOTAL PAYMENT THAT WILL BE DUE AT THE END OF THE #0
TH
YEAR*
ANSWER) T1TA; )A=M!'T D A<,<7:7: C A6?,6>G?> D A6:,B?//6
!ntegrated "ase: 6 - +,