TVM Exercises Chua H, Dijamco G, Legrateja R,

Piad R

1. You have the opportunity to make an investment that costs $900. If you make this investment now,
you will receive $180 one year from today. You will also receive $215 and $785 two and three years
from today, respectively. The appropriate discount rate for this investment is 10%.

Should you make the investment?

2. Your aunt has promised to give you $3,170 in trade-in value for your car when you graduate one
year from now. Your roommate offered you $2,800 for the car now. The prevailing interest rate is
12%. Should you accept your roommate’s offer?

3. What is the future value three years hence of $1,000 invested in an account with a stated annual
interest rate of 8%? a) Compounded annually? b) Compounded semi-annually? c) Compounded
monthly?
4. What is the value today of a 10-year annuity that pays $300 a year? The annuity’s first cash flow is
at the end of year 6 and the last cash flow is at the end of year 15. The annual interest rate is 15% for
years 1 through 5 and 10% thereafter.

5. You are saving for the college education of your two children. They are two years apart in age; one
will begin college in 15 years, the other in 17 years. College expenses will be $21,000 per year per
child for a 4 year course. The annual interest rate is 15%, and it will remain 15% through the next 25
years. How much money must you place in an account each year to fund your children’s education?
You will begin payments one year from today. You will discontinue payments when your oldest child
enters college.

6. Your younger brother has come to you for advice. He is about to enter college and has two options
open to him. His first option is to study engineering. If he does this, his undergraduate degree would
cost him $12,000 a year for 4 years. Having obtained this, he would need to gain 2 years of practical
experience; in the first year he would earn $20,000, in the second year he would earn $25,000. He
then would need to obtain his master’s degree, which will cost $25,000 a year for 2 years. After that
he will be fully qualified and can earn $40,000 per year for 25 years.

His other alternative is to study accounting. If he does this, he would pay $13,000 a year for 4 years
and then he would earn $31,000 per year for 30 years.
The effort involved in the two careers is the same, so he is interested only in earnings the jobs
provide. All earnings and costs are paid at the end of the year. What advice would you give him if the
applicable interest rate is 5%? A day later he comes back and says he took your advice, but in fact,
the applicable interest rate was 6%. Has your brother made the right choice?