FIN 310 Spring 2007

Exam Chapter Four

Name: ____________________________________

Instructions: Answer each question in a complete and well-organized manner. Show all
calculations and clearly identify your answers. Unsupported answers will receive no
credit. Questions 1 3 are worth 10 points each, questions 4 7 are worth 13 points
each, and question 8 is worth 18 points.
1.

Dan plans to fund his individual retirement account (IRA) with a contributions of
$4,000 at the end of each year for the next 25 years. If Dan can earn 7 percent per
year on his contributions, how much will he have at the end of the 25th year?
Solution:
PMT
Nper
Rate

= $4,000
= 25
= 7%

By using FV function, FV = $252,996.15

2.

If a Zero Coupon Bond can be purchased for $450 today and can be redeemed at
the end of 10 years of $1,000, what is the annual rate of return on the bond?
Solution:
PV
= $450
FV
= $1,000
Nper = 10
By using the rate function, Annual rate of return = 8.31%

3.

Betty borrows $30,000 at 8 percent compounded annually. The loan is to be

repaid in six equal annual end-of-year payments. How much must each loan
payment be?
Solution:
PV
Rate
Nper

= $30,000
= 8%
=6

By using PMT function, the annual end of year payment = $6,489.46

4.

A ski chalet in Aspen costs $500,000 today. Inflation is expected to cause this
price to increase at 8 percent per year over the next 10 years. Barbara and Phil
plan to retire in 10 years, and they want to buy the chalet the day they retire.
They will save the money they need by making ten equal end-of-year deposits

into an investment account that pays 12 percent per year. What is the amount of
each deposit?
Solution:
There are two parts in this question, first of all, we have to determine the
future value of the house after ten years due to inflation and then we have to
determine the annual payment to achieve that future value considering the
investment rate.
Part -1 (Determining the future value of the house)
PV
500,000
r
8%
N
10
By using future value function in MS-Excel
FV

$1,079,462.50

Part -2 (Determining the annual equal payment)

FV
$1,079,462.50
r
12%
N
10
By using the PMT function
PMT $61,512.27
5.

You would like your grandson to have $1,000,000 to use for his retirement. You
open a retirement account for your grandson on your grandsons 2nd birthday and
immediately deposit $30,000. If the interest rate earned on the retirement account
is 6 percent compounded monthly, how old will your grandson be when his
account reaches $1,000,000?
Solution:
PV
= $30,000
R
= 0.50%
(6% / 12)
FV
= $1,000,000
By using the Nper function
NPER = 703 monthly payments or 59 years
The grandson will be of 61 years (59 + 2)

6.

Today is your 40th birthday and you must choose between two retirement options.
The first option will provide you with 10 equal annual payments of $120,000
beginning on your 65th birthday. The second option will provide you with one
payment of $1,200,000 on your 70th birthday. If the interest rate is 6 percent per
year and you are certain to live to at least age 80, which option is better? Clearly
explain your choice.
Solution:
Option 1
PMT
Nper
Rate

= $120,000
= 10
= 6%

Using the PV function, The present value = $883,210.45

Option 2
Present value of option II at the 65th year (1,200,000 x 0.74726 ) = $896,712.00
So, option- 2 is having the more present value, so, the option-2 is the choice.
7.

You have $25,000 in an investment account earning 6 percent per year. You
decide to purchase a new car with a sticker price of $25,000. The car dealer
offers you either $3,000 cash back or 0% financing for 5 years. If you take the
financing, you will make 5 equal annual end of year payments of $5,000.
Otherwise, you will pay $22,000 today for the car. Based on the time value of
money, should you take the $3,000 cash back or the 0% financing? Clearly
explain and defend your choice.
Solution:
PMT
Nper
Rate

= $5,000
=5
= 6%

By using the PV function, The present value = $21,061.82

So, the 5 equal annual end of year payment is better than the payment of
$22,000 today.
8.

Today is your 28th birthday. You have developed a lifetime budget that includes
the following expenditures: $100,000 on your 41st birthday for a college fund,
and $25,000 per year to supplement your retirement, the first payment to occur on
your 65th birthday and the last payment to occur on your 79th birthday. You open
an investment account on your 28th birthday. The account promises to pay 9
percent per year. You want to deposit equal amounts into the account every year,
starting today (your 28th birthday) and continuing until you are 40 years old (that

is, the last deposit will be made on your 40th birthday). What is the amount of
each deposit?
Solution:
Present value of college fund:
FV
= $100,000
Nper (41-28) = 13
R
= 9%
PV

= $32,617.86

Present value of retirement:

PMT
= $25,000
Nper (79-65)
= 14
R
= 9%
PV

= $194,653.76

Total amount needed ($32,617.86 + $194,653.76)

Now, we have to determine the annual deposit amount:
FV
Nper (40-28)
R

= $227,271.62
= 12
= 9%

By using the PMT function:

PMT

= $11,284.19

= $227,271.62