Solutions to Chapter 5

The Time Value of Money

1.
a.
Future value Year 1 = Present value × (1 + r)
= $1,000 × 1.04
= $1,040

Interest Year 1 = Future value Year 1 - Present value

= $1,040 - 1,000
= $40

b.
Future value Year 2 = Present value × (1 + r)2
= $1,000 × 1.042
= $1,081.60

Interest Year 2 = Future value Year 2 - Future value Year 1

= $1,081.60 - 1,040
= $41.60

c.
Future value Year 9 = Present value × (1 + r)9
= $1,000 × 1.049
= $1,423.31

Future value Year 10 = Present value × (1 + r)10

= $1,000 × 1.0410
= $1,480.24

Interest Year 10 = Future value Year 10 - Future value Year 9

= $1,480.24 - 1,423.31
= $56.93

Calculator computations:
a.

Enter 1 4 –1,000

N I/Y PV PMT FV

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Solve for 1,040

b.

Enter 2 4 –1,000

N I/Y PV PMT FV

Solve for 1,081.60

c.

Enter 9 4 –1,000

N I/Y PV PMT FV

Solve for 1,423.31

Enter 10 4 –1,000

N I/Y PV PMT FV

Solve for 1,480.24

Est time: 01–05

Interest rates

2. If you earneI simple interest (without compounIing), then the total growth in your
account after 25 years woulI be 4% per year x 25 years = 100%. Therefore, your money
woulI Iouble. With compounI interest, your money woulI grow faster than it woulI
with simple interest anI therefore woulI require less than 25 years to Iouble.
Est time: 01–05

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Simple and eompound interest

3. Since we are assuming that it is currently 2016, 116 years have passeI since 1900.

a.
Future value Year (2016 – 1900) = Present value × (1 + r)(2016 – 1900)
= $1,000 × 1.05116
= $287,050.75

b.
Present value = Future value / (1 + r)t
= $1,000,000 / (1.05)(2016 – 1900)
= $3,483.70

Calculator computations:
a.

Enter 116 5 –1,000

N I/Y PV PMT FV

Solve for 287,050.75

b.

Enter 116 5 –1,000,000

N I/Y PV PMT FV

Solve for 3,483.70

Est time: 01–05

Future value - single period

4.
a. $100  (1.08)10 = $215.89
b. $100  (1.08)20 = $466.10
c. $100  (1.04)10 = $148.02

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 d. $100  (1.04)20 = $219.11

Calculator computations:

Enter 10 8 –100

N I/Y PV PMT FV

Solve for 215.89

Enter 20 8 –100

N I/Y PV PMT FV

Solve for 466.10

Enter 10 4 –100

N I/Y PV PMT FV

Solve for 148.02

Enter 20 4 –100

N I/Y PV PMT FV

Solve for 219.11

Est time: 01–05

Future value - single period

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5.
a. With simple interest, you earn 4% of $1,000, or $40 each year. There is no interest on
interest. After 10 years, you earn total interest of $400, and your account
accumulates to $1,400.
FV Simple Interest = PV + PV × (r × t)
= $1,000 + $1,000 × (.04 × 10)
= $1,400

b. FV = PV × (1 + r)t
= $1,000 × 1.0410
= $1,480.24

With compounI interest, each year you earn interest on the interest accumulateI in all prior
years. In this case, the compounI interest amounts to:

CompounI interest = $1,480.24 – 1,400 = $80.24

Calculator computations:

Enter 10 4 –1,000

N I/Y PV PMT FV

Solve for 1,480.24

Est time: 01–05

Simple and eompound interest

6. FV = PV × (1 + r)t
$200 = $100 × 1.06t
1.06t = 2
t × ln1.06 = ln2
t = ln2 / ln1.06
t = .69315 / .05827
t = 11.90 years

Calculator computations:

Enter 6 –100 200

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 N I/Y PV PMT FV

Solve for 11.90

Est time: 01–05

Number of time periods

7. a. FV = A$100  (1.04)113 = A$8,409.45

b. FV = A$100  (1.08)113 = A$598,252.29

Calculator computations:
a.

Enter 113 4 –100

N I/Y PV PMT FV

Solve for 8,409.45

b.

Enter 113 8 –100

N I/Y PV PMT FV

Solve for 598,252.29

Est time: 01–05

Future value - single period

8. FV = PV × (1 + r)t
(1 + r)t = FV / PV
t × ln(1 + r) = ln(FV / PV)
t = ln(FV / PV) / ln(1 + r)
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 a. t = ln($1,000 / $400) / ln1.04
= .9163 / .0392
= 23.36 years

b. t = ln($1,000 / $400) / ln1.08

= .9163 / .0770
= 11.91 years

c. t = ln($1,000 / $400) / ln1.16

= .9163 / .1484
= 6.17 years

Calculator computations:
a.

Enter 4 –400 1,000

N I/Y PV PMT FV

Solve for 23.36

b.

Enter 8 –400 1,000

N I/Y PV PMT FV

Solve for 11.91

c.

Enter 16 –400 1,000

N I/Y PV PMT FV

Solve for 6.17

Est time: 01–05

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Number of time periods

9.
a. The present value of the future payoff is PV = FV / (1 + r)t = $2,000/(1.06)10 =
$1,116.79.
This is a good deal: Present value exceeds the initial investment.

b. The present value is now equal to PV = FV / (1 + r)t = $2,000/(1.10)10 = $771.09.

This is now less than the initial investment. Therefore, this is a baI Ieal.

Calculator computations:
a.

Enter 10 6 –2,000

N I/Y PV PMT FV

Solve for 1,116.79

b.

Enter 10 10 –2,000

N I/Y PV PMT FV

Solve for 771.09

Est time: 01–05

Present value - single period

10. You earneI compounI interest of 6% for 8 years anI 4% for 13 years. Your $1,000 has
grown to:
$1,000  (1.06)8  (1.04)13 = $2,653.87
Est time: 06–10
Future value - single period

11.
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 a. The present value of the ultimate sales price is PV = FV / (1 + r)t = $4 million/
(1.08)5 = $2.722 million.

b. The present value of the sales price is less than the purchase price of the property,
so this woulI not be an attractive opportunity.

c. PV = Per-year rent × ((1 / r) – {1 / [r(1 + r)t]}) + Sales price / (1 + r)t

= $200,000 × ((1 / .08) – {1 / [.08 (1.08)5]}) + $4,000,000 / 1.085
= $3,520,874.80, or $3.521 million
The investment is attractive now because the present value of the future cash flows
exceeIs the current purchase price of the property.

Calculator computations:
a.

Enter 5 8 –4,000,000

N I/Y PV PMT FV

Solve for 2,722,332.79

c.

Enter 5 8 –200,000 –4,000,000

N I/Y PV PMT FV

Solve for 3,520,874.80

Est time: 06–10

Annuities

12. PV = FV / (1 + r)t
a. $100/(1.08)10 = $46.32

b. $100/(1.08)20 = $21.45

c. $100/(1.04)10 = $67.56

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 I. $100/(1.04)20 = $45.64

Calculator computations:
a.

Enter 10 8 –100

N I/Y PV PMT FV

Solve for 46.32

b.

Enter 20 8 –100

N I/Y PV PMT FV

Solve for 21.45

c.

Enter 10 4 –100

N I/Y PV PMT FV

Solve for 67.56

I.

Enter 20 4 –100

N I/Y PV PMT FV

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Solve for 45.64

Est time: 01–05

Annuities

13. PV = FV / (1 + r)t = $700/(1.05)5 = $548.47

Calculator computations:

Enter 5 5 –700

N I/Y PV PMT FV

Solve for 548.47

Est time: 01–05

Present value - single period

14. PV = C1 / (1 + r)1 + C2 / (1 + r)2 + C3 / (1 + r)3 = ($200/1.06) + ($400/1.062) +

($300/1.063) = $188.68 + $356.00 + $251.89 = $796.57

Calculator computations:
CF0 = 0
C01 = 200 F01 = 1
C02 = 400 F02 = 1
C03 = 300 F03 = 1
I=6
CPT NPV = 796.56

Est time: 01–05

Present value - multiple eash flows

15.
Present Value Years Future Value Interest Rate

[ ]
( 1/11)
684
a. $400 11 $684
−1=5. 00 %
400

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 [ ]
(1/4 )
249
b. $183 4 $249
−1=8 . 00 %
183

[ ]
(1/7 )
300
c. $300 7 $300
−1=0 %
300

To finI the interest rate, we rearrange the basic future value equation as follows:

[ ]
(1/t )
FV
−1
FV = PV  (1 + r)  r = t PV

Calculator computations:

Enter 11 –400 684

N I/Y PV PMT FV

Solve for 5

Enter 4 –183 249

N I/Y PV PMT FV

Solve for 8

Est time: 06–10

Present value - single period

16. FV = PV × (1 + r)t
r = (FV / PV)1/t – 1
$100  (1 + r)3 = $115.76  r = 5.00%
$200  (1 + r)4 = $262.16  r = 7.00%
$100  (1 + r)5 = $110.41  r = 2.00%
Calculator computations:

Enter 3 –100 115.76

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 N I/Y PV PMT FV

Solve for 5

Enter 4 –200 262.16

N I/Y PV PMT FV

Solve for 7

Enter 5 –100 110.41

N I/Y PV PMT FV

Solve for 2

Est time: 06–10

Future value - single period

17. FV = PV × (1 + r)t
r = (FV / PV)1/t – 1
r = ($1,000 / $422.41)1/10 – 1 = .09, or 9%

Calculator computations:

Enter 10 –422.41 1,000

N I/Y PV PMT FV

Solve for 9

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Est time: 01–05
Interest rates

18.
a. PV = C1 / (1 + r)1 + C2 / (1 + r)2 + C3 / (1 + r)3
= $120,000 / 1.12 + $180,000 / 1.122 + $300,000 / 1.123 - $400,000
= $464,171.83

b. The PV exceeds the cost of the factory, so the investment is attractive.

Calculator computations:
CF0 = -400,000
C01 = 120,000 F01 = 1
C02 = 180,000 F02 = 1
C03 = 300,000 F03 = 1
I = 12
CPT NPV = 64,171.83
Est time: 01–05
Present value - multiple eash flows

19. PV = FVt=2  (2-year Iiscount factor) = $1  0.92 = $0.92

PV = FVt=2  (2-year Iiscount factor) = $2,000  0.92 = $1,840

Est time: 06–10

Future value - single period

20. The PV for the quarterback is the present value of a 5-year, $3 million annuity:
$3 million  annuity factor (10%, 5 years) =

$ 3 million ×
[ 1
−
1
0 .10 0 .10 (1 . 10)5 ]
=$11. 37 million

The receiver gets $4 million now plus a 5-year, $2 million annuity. The present value of
the annuity is:

$ 2 million ×
[ 1
−
1
0. 10 0 .10(1 . 10)5 ]
=$ 7 . 58 million

With the $4 million immeIiate payment, the receiver’s contract is worth:

$4 million + $7.58 million = $11.58 million

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 The receiver’s contract is worth more than the quarterback’s even though the receiver’s
undiscounted total payments are less than the quarterback’s.

Calculator computations:
a.

Enter 5 10 –3,000,000

N I/Y PV PMT FV

Solve for 11,372,360.31

b.
CF0 = 4,000,000
C01 = 2,000,000 F01 = 5
I = 10
CPT NPV = 11,581,573.54
Est time: 06–10
Annuities

21. You shoulI compare the present values of the two annuities.
PV = C((1 / r) – {1 / [r(1 + r)t]})

a.
PV=$1,000×
[ 1
−
1
0 . 05 0. 05×(1 .05 )10 ]
=$ 7 ,721 .73

PV=$800×
[ 1
−
1
0 . 05 0. 05×(1 .05 )15 ]
=$ 8 ,303 . 73

b.
PV=$1,000×
[ 1
−
1
0 . 20 0 . 20×(1. 20 )10 ]
=$ 4 , 192. 47

PV=$800×
[ 1
−
1
0 . 20 0 . 20×(1. 20 )15 ]
=$ 3 , 740 .38

When the interest rate is low, as in part (a), the longer (i.e., 15-year) but smaller
annuity is more valuable because the impact of Iiscounting on the present value of
future payments is less significant.

Calculator computations:
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a.

Enter 10 5 –1,000

N I/Y PV PMT FV

Solve for 7,721.73

Enter 15 5 –800

N I/Y PV PMT FV

Solve for 8,303.73

b.

Enter 10 20 –1,000

N I/Y PV PMT FV

Solve for 4,192.47

Enter 15 20 –800

N I/Y PV PMT FV

Solve for 3,740.38

Est time: 01–05

Annuities

22. The present value of your payments to the bank equals:

PV=
$100×
[ 1
−
1
0 . 06 0 . 06×(1. 06 )10 ]
=$ 736 . 01

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 The present value of your receipts is the value of a $100 perpetuity IeferreI for 10
years:
100 1
× =$ 930 .66
0. 06 (1 . 06)10
This is a gooI Ieal if you can earn 6% on your other investments.

Calculator computations:
a.

Enter 10 6 –100

N I/Y PV PMT FV

Solve for 736.01

b.

Enter 10 6 –1,666.67

N I/Y PV PMT FV

Solve for 930.66

Est time: 06–10

Perpetuities

23. If you live forever, you will receive a $100 perpetuity that has present value equal to
$100/r.
Therefore: $100/r = $2,500  r = 4%.
Est time: 01–05
Perpetuities

24. PV = C / r
r = C / PV
r = $10,000/$125,000 = 0.08 = 8%
Est time: 01–05
Perpetuities

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25. Using the perpetuity formula, the 4% perpetuity will sell for £4/0.06 = £66.67.
The 2½% perpetuity will sell for £2.50/0.06 = £41.67.
Est time: 06–10
Perpetuities

26. a. PV = 100  annuity factor (6%, 3 perioIs) = 100 

[ 1
−
1
0. 06 0 .06 (1. 06 )3 ]
=$267 . 30

b. If the payment stream is IeferreI by an aIIitional year, then each payment is

IiscounteI by an aIIitional factor of 1.06. Therefore, the present value is reIuceI
by a factor of 1.06 to $267.30/1.06 = $252.17.

Calculator computations:
a.

Enter 3 6 –100

N I/Y PV PMT FV

Solve for 267.30

b.

Enter 1 6 –267.30

N I/Y PV PMT FV

Solve for 252.17

Est time: 01–05

Annuities

27. a. This is an annuity problem; use trial anI error to solve for r in the following equation:
$600× −
1
[ 1
r r×(1+ r )240 ]
=$ 80 , 000 ⇒r =0 . 548 %

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 b. EAR = (1 + 0.00548)12  1 = 0.0678 = 6.78%

c. Compute the payment by solving for C in the following equation:

C×
[ 1
−
1
0 .005 0 . 005×(1. 005 )240 ]
=$ 80 , 000⇒ C=PMT=$ 573 . 14

Calculator computations:
a.

Enter 20 × 12 –80,000 600

N I/Y PV PMT FV

Solve for .55

The monthly interest rate is .55%.

c.

Enter 20 × 12 .5 –80,000

N I/Y PV PMT FV

Solve for 573.14

Est time: 01–05

Annuities

28. a. First, compute the monthly interest rate:

Monthly rate = Annual rate / 12
= 12% / 12 = 1%

SeconI, compute the amount you can afforI to borrow:

PV = C((1 / r) – {1 / [r(1 + r)t]})

= $400 × ((1 / .01) – {1 / [.01(1.0148)]})
= $15,189.58

ThirI, compute the maximum purchase price you can afforI:

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 Maximum purchase price = Cash Ieposit + Loan amount
= $2,000 + 15,189.58
= $17,189.58

b. First, compute the monthly interest rate:

Monthly rate = Annual rate / 12

= 12% / 12 = 1%

SeconI, compute the amount you can afforI to borrow:

PV = C((1 / r) – {1 / [r(1 + r)t]})

= $400 × ((1 / .01) – {1 / [.01(1.0160)]})
= $17,982.02

ThirI, compute the maximum purchase price you can afforI:

Maximum purchase price = Cash Ieposit + Loan amount

= $2,000 + 17,982.02
= $19,982.02

Calculator computations:
a.

Enter 48 1 –400

N I/Y PV PMT FV

Solve for 15,189.58

The monthly interest rate is 1%.

c.

Enter 60 1 –400

N I/Y PV PMT FV

Solve for 17,982.02

Est time: 01–05

Annuities

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29. a. Present value = Cash payment – Rebate
= $24,000 – 2,000
= $22,000
t
b. PV = C((1 / r) – {1 / [r(1 + r) ]})
= $500 × ((1 / .01) – {1 / [.01(1.0148)]})
= $18,986.98
Option b is the better Ieal as it has the lower present value.
Est time: 01–05
Annuities

30. a. PV = C((1 / r) – {1 / [r(1 + r)t]})

$100,000 = $804.62 × ((1 / r) – {1 / [r(1 + r)(30 × 12)]})

You must use trial-anI-error, a financial calculator, or a computer to solve for r. See the
calculator solution below.

Using the monthly interest rate:

APR = Monthly rate × 12
= .0075 × 12
= .0900, or 9%

b. Using the monthly interest rate computeI in part a:

EAR = (1 + Monthly rate)12 – 1

= 1.007512 – 1
= .0938, or 9.38%

c. If lenIers only quote one rate, it is most apt to be the APR.

Calculator computations:

Enter 30 × 12 100,000 –804.62

N I/Y PV PMT FV

Solve for .75

The monthly interest rate is .75%, or .0075.

Est time: 01–05
Annuities
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31. Your savings goal is FV = $30,000. You currently have in the bank PV = $20,000.
Solve the following equation for t:

[ ]
t
1 . 005 −1
($20,000×1 . 005t )+$100× = $ 30 , 000⇒ t=44 . 74
0 .005 months
Calculator computations:

Enter .5 –20,000 –100 30,000

N I/Y PV PMT FV

Solve for 44.74

Since the interest rate and payment are in months, the time period must also be in months. Thus, it will
take you 44.74 months to accumulate the down payment.
Est time: 06–10
Future value - annuity

32. Real interest rate = Nominal interest rate – Inflation rate

When the nominal interest rate anI the inflation rate are equal, the real interest rate must be
zero. With a zero real rate, the annual real amount available for spenIing will be:

Annual real spenIing = Current savings / Number of years

= $450,000 / 30
= $15,000
Est time: 01–05
Annuities

33. This problem can be approacheI in two steps. Since the first payment occurs in Year 4,
the present value of the annuity will be as of the prior year, or Year 3.

PV3 = C((1 / r) – {1 / [r(1 + r)t]})

= $10,000 × ((1 / .05) – {1 / [.05(1.05)10]})
= $77,217.35
Now, Iiscount this amount to toIay:
PV0 = PV3 / (1 + r)3
= $77,217.35 / 1.053
= $66,703.25

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Calculator computations:

Enter 10 5 –10,000

N I/Y PV PMT FV

Solve for 77,217.35

Enter 3 5 –77,217.35

N I/Y PV PMT FV

Solve for 66,703.25

Est time: 01–05

Annuities

34. a. Leasing the truck means that the firm must make a series of payments in the form of
an annuity. Calculate the present value as follows:

PV=
$8,000×
[ 1
−
1
0 . 07 0 . 07×(1. 07 )6 ]
=$38 , 132. 32

b. Since $38,132.32 < $40,000 (the cost of buying a truck), it is less expensive to lease
than to buy.

c. PV of Lease =
$8,000×
[ 1
−
1
0 . 07 0 . 07×(1. 07 )5 ]
+8 , 000=$ 40 ,801 .58

I. Buying the truck is now cheaper.

Est time: 01–05
Present value - annuity

35.
a. If we assume cash flows come at the end of each period
(ordinary annuity) when in fact they actually come at the beginning (annuity due),

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 we discount each cash flow by one period too many. Therefore, we can obtain the
PV of an annuity due by multiplying the PV of an ordinary annuity by (1 + r).

b. Similarly, the FV of an annuity due equals the FV of an

ordinary annuity times (1 + r). Because each cash flow comes at the beginning of
the period, it has an extra period to earn interest compared to an ordinary
annuity.
Est time: 06–10
Annuities

36. a. Compare the present value of the payments. Assume the proIuct sells for $100.
Installment plan:
PV = $25 + [$25  annuity factor (5%, 3 years)]

PV=
$25+$25×
[ 1
−
1
0. 05 0 . 05×(1. 05 )3 ]
=$ 93 . 08

Pay in full: Payment net of Iiscount = $90

Choose the seconI payment plan for its lower present value of payments.

b. PV=
$25×
[ 1
−
1
0 . 05 0 .05×(1 . 05) 4 ]
=$ 88 . 65

The payment plan has a PV of $88.65, so it is a better Ieal.

Est time: 01–05
Annuities

37.
a. Solve for C in the following equation:
C  annuity factor (12%, 5 years) = $1,000

C×
[ 1
−
1
0 .12 0 .12×(1. 12)5 ]
=$ 1, 000

C  3.6048 = $1,000  C = PMT = $277.41

b. If the first payment is maIe immeIiately insteaI of in a year, the annuity factor
will be greater by a factor of 1.12. Therefore:
C  (3.6048  1.12) = $1,000  C = PMT = $247.69
Est time: 01–05
Annuities

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38. a. The present value of the $2 million, 20-year annuity, IiscounteI at 8%, is:

PV=
$2 million×
[ 1
−
1
0. 08 0. 08×(1 . 08)20 ]
=$ 19 .64
million
b. If the payment comes immeIiately, the present value increases by a factor of 1.08 to
$21.21 million.
Est time: 01–05
Annuities

39. The payment on the mortgage is computeI as follows:

C×
[ 1
−
1
(0 . 06/12) (0 . 06/12)×[ 1+(0 . 06/12)]360 ]
=$ 100 , 000 ⇒C=PMT=$ 599. 55

After 12 years, 216 months remain on the loan, so the loan balance is:

$599 .55×
[ 1
−
1
(0 . 06/12) (0 . 06/12)×[ 1+(0 . 06/12)]216 ]
=$ 79 , 079 .37

Est time: 01–05

Future value - annuity

40. a.
C×
[ 1
−
1
0 .08 0 . 08×(1. 08 )4 ]
=$ 1 , 000 ⇒C=PMT=$ 301. 92

Using a financial calculator, enter PV = ()1,000, FV = 0, i = 8%, n = 4; compute

PMT = $301.92.

b.

PV=
$301. 92×
[ 1
−
1
0. 08 0 . 08×(1 . 08)3 ]
=$ 778. 08

Therefore, the loan balance is $778.08 after 1 year.

Est time: 06–10
Future value – annuity

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41. a. The present value of the planneI consumption stream as of the retirement date will
be:

PV=
$30,000×
[ 1
−
1
0 . 08 0 .08×(1 . 08)25 ]
=$ 320 , 243. 29

Therefore, they neeI to have accumulateI this amount of savings by the time they
retire. So their savings plan must proviIe a future value of $320,243.29.
With 50 years to save at 8%, the savings annuity must be:

[ ]
50
1. 08 −1
C× = $ 320 , 243. 29 ⇒C=PMT=$ 558 .14
0. 08
Another way to think about this is to recognize that the present value of the savings
stream must equal the present value of the consumption stream. The PV of
consumption as of toIay is $320,243.29/(1.08)50 = $6,827.98.
Therefore, we set the present value of savings equal to this value anI solve for the
requireI savings stream.

b. The couple neeIs to accumulate aIIitional savings with a present value of:
$60,000/(1.08)20 = $12,872.89
The total PV of savings is now $12,872.89 + $6,827.98 = $19,700.87.
Now we solve for the requireI savings stream as follows:

C×
[ 1
−
1
0 .08 0 . 08×(1. 08 )50 ]
=$ 19 , 700 .87 ⇒ C=PMT=$ 1 , 610 . 41

Using a financial calculator, enter n = 50, i = 8, PV = ()19,700.87, FV = 0; then

compute PMT = $1,610.41.
Est time: 06–10
Present value – annuity

42. The future value of the payments into your savings funI must accumulate to $500,000.
We choose the payment (C) so that:
C  future value of an annuity = $500,000

[ ]
40
1. 06 −1
C× =$ 500 ,000 ⇒C=PMT=$ 3 , 230 .77
0 .06
Using a financial calculator, enter n = 40, i = 6, PV = 0, FV = 500,000;
compute PMT = $3,230.77.
Est time: 01–05

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Future value – annuity

43. Nothing . The future value of your inheritance will be 100,000 x (1+.06)30 = 574,349.12
at retirement. Since this exceeIs your $500,000 goal, you Io not neeI to save any
money.
Est time: 01–05
Time value of money

44. By the time you retire, you will neeI:

PV=
$40,000×
[ 1
−
1
0 . 06 0 . 06×(1. 06 )20 ]
=$ 458 ,796 . 85

The future value of the payments into your savings funI must accumulate to
$458,796.85.
We choose the payment (C) so that:
C  future value of an annuity = $458,796.85

[ ]
40
1. 06 −1
C× =$ 458 , 796 .85 ⇒C=PMT=$ 2 , 964 . 53
0 .06
Using a financial calculator, enter n = 40, i = 6, PV = 0, FV = 458,796.85; compute PMT
= $2,964.53.
Est time: 01–05
Future value – annuity

45. a. After 30 years, the couple will have accumulateI the future value of a $3,000
annuity, plus the future value of the $10,000 gift. The sum of the savings from these sources
is:

[ ]
30
1 .08 −1
$3,000× + ( $ 10 ,000×1 .08 25 )=
0 . 08
$339,849.63 + $68,484.75 = $408,334.38

b. If they wish to accumulate $800,000 by retirement, they have to save an additional

amount per year to proviIe aIIitional accumulations of $391,665.62.
This requires aIIitional annual savings of:

[ ]
30
1. 08 −1
C× = $ 391 , 665. 62⇒ C=PMT=$ 3 , 457 . 40
0. 08
[Using a financial calculator, enter i = 8, n = 30, PV = 0, FV = 391,665.62;
compute PMT.]

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Est time: 06–10
Future value – annuity

46. Suppose the purchase price is $1. If you pay toIay, you get the Iiscount anI pay only
$0.97. If you wait a month, you pay $1. Thus, you can view the IeferreI payment as saving a
cash flow of $0.97 toIay but paying $1 in a month. Therefore, the monthly rate is:
0.03/0.97 = 0.0309 = 3.09%
The effective annual rate is (1.0309)12  1 = 0.4408 = 44.08%.
Est time: 01–05
Interest rates

47. The interest rate per 3 months is 6%/4 = 1.5%.

Therefore, the value of the perpetuity is $100/0.015 = $6,666.67.
Est time: 06-10
Perpetuities

48. a. Using the annuity table, the annuity factor is 11.4699. The annual payment on the
loan is therefore $100,000/11.4699 = $8,718.47.

b.

Year-End
Beginning-of- Interest Due on Year-End Amortization End-of-Year
Year Year Balance Balance Payment of Loan Balance
1 100,000.00 6,000 8,718.46 2,718.46 97,281.54
2 97,281.54 5,837 8,718.46 2,881.56 94,399.98
3 94,399.98 5,664 8,718.46 3,054.46 91,345.52
4 91,345.52 5,481 8,718.46 3,237.72 88,107.80
5 88,107.80 5,286 8,718.46 3,431.99 84,675.81
6 84,675.81 5,081 8,718.46 3,637.91 81,037.91
7 81,037.91 4,862 8,718.46 3,856.18 77,181.72
8 77,181.72 4,631 8,718.46 4,087.55 73,094.17
9 73,094.17 4,386 8,718.46 4,332.81 68,761.37
10 68,761.37 4,126 8,718.46 4,592.77 64,168.59
11 64,168.59 3,850 8,718.46 4,868.34 59,300.25
12 59,300.25 3,558 8,718.46 5,160.44 54,139.81
13 54,139.81 3,248 8,718.46 5,470.07 48,669.75
14 48,669.75 2,920 8,718.46 5,798.27 42,871.47
15 42,871.47 2,572 8,718.46 6,146.17 36,725.31
16 36,725.31 2,204 8,718.46 6,514.94 30,210.37
17 30,210.37 1,813 8,718.46 6,905.83 23,304.54
18 23,304.54 1,398 8,718.46 7,320.18 15,984.35
19 15,984.35 959 8,718.46 7,759.39 8,224.96
20 8,224.96 493 8,718.46 8,224.96 0.00

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 c. The initial interest is $6,000 of $8,718.46, or 69%.

I. Amortization is 31%.

e. The enI of year 10 balance is 64,168.59. Thus, 35,831.41 has been paiI off.

f. If the inflation rate is 2%, the real interest rate on the loan is approximately
4%. The real value of the first payment is $8,718.46/(1 + .04)1, or $8,383.13.

g. The real value of the last payment is $8,718.46/(1 + .04)20, or $3,978.99.

h. If the inflation rate is 8% anI the real interest rate is unchangeI, the nominal
interest rate is approximately 12%.

Year-End
Beginning-of- Interest Due on Year-End Amortization End-of-Year
Year Year Balance Balance Payment of Loan Balance
1 100,000.00 12,000 13,387.88 1,387.88 98,612.12
2 98,612.12 11,833 13,387.88 1,554.42 97,057.70
3 97,057.70 11,647 13,387.88 1,740.95 95,316.74
4 95,316.74 11,438 13,387.88 1,949.87 93,366.88
5 93,366.88 11,204 13,387.88 2,183.85 91,183.02
6 91,183.02 10,942 13,387.88 2,445.92 88,737.11
7 88,737.11 10,648 13,387.88 2,739.43 85,997.68
8 85,997.68 10,320 13,387.88 3,068.16 82,929.53
9 82,929.53 9,952 13,387.88 3,436.33 79,493.19
10 79,493.19 9,539 13,387.88 3,848.70 75,644.50
11 75,644.50 9,077 13,387.88 4,310.54 71,333.96
12 71,333.96 8,560 13,387.88 4,827.80 66,506.16
13 66,506.16 7,981 13,387.88 5,407.14 61,099.02
14 61,099.02 7,332 13,387.88 6,056.00 55,043.02
15 55,043.02 6,605 13,387.88 6,782.72 48,260.30
16 48,260.30 5,791 13,387.88 7,596.64 40,663.66
17 40,663.66 4,880 13,387.88 8,508.24 32,155.42
18 32,155.42 3,859 13,387.88 9,529.23 22,626.20
19 22,626.20 2,715 13,387.88 10,672.73 11,953.46
20 11,953.46 1,434 13,387.88 11,953.46 0.00

i. The real value of the first payment is $13,387.88/(1 + .04)1, or $12,872.96.

j. The real value of the last payment is $13,387.88/(1 + .04)20, or $6,110.05.

Est time: 16–20

Nominal and real returns

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49. The monthly payment is baseI on a $100,000 loan:
C×
1
[ −
1
0 .01 0 . 01×(1 . 01)360 ]
=$ 100 , 000⇒ C=PMT=$ 1 , 028 .61

The net amount receiveI is $98,000. Therefore:

1
$1,028 .61× −
[1
r r ×(1+r )360 ]
=$ 98 , 000⇒ r=1 . 023%
per month
The effective rate is (1.01023)12  1 = 0.1299 = 12.99%.
Est time: 06–10
Interest rates

50. The loan repayment is an annuity with present value equal to $4,248.68. Payments are
maIe monthly, anI the monthly interest rate is 1%. We neeI to equate this expression to the
amount borroweI ($4,248.68) anI solve for the number of months (t).
$200×
1
−
[ 1
0 . 01 0. 01×(1. 01 )t ]
=$ 4 , 248 .68 ⇒t=24
months, or 2 years
Using a financial calculator, enter PV = ()4,248.68, FV = 0, i = 1%, PMT = 200; compute n =
24.
The effective annual rate on the loan is (1.01)12  1 = 0.1268 = 12.68%.
Est time: 06–10
Interest rates

51. r = 0.5% per month

$1,000  (1.005)12 = $1,061.68
$1,000  (1.005)18 = $1,093.93
Est time: 01–05
Interest rates

52. EAR = e0.06  1 = 1.0618  1 = 0.0618 = 6.18%

Est time: 01–05
Interest rates

53. a. With PV = $9,000 anI FV = $10,000, the annual interest rate is IetermineI by solving
the following equation for r:
$9,000  (1 + r) = $10,000  r = 11.11%

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 b. With PV = $8,000 anI FV = $10,000, the annual interest rate is IetermineI by solving the
following equation for r:
$8,000  (1 + r) = $10,000  r = 25.00%
Est time: 06–10
Interest rates

54.
a. You borrow $1,000 anI repay the loan by making 12 monthly payments of $100.
Solve for r in the following equation:
$100× −
1
[ 1
r r×(1+r )12 ]
=$ 1 ,000 ⇒ r=2 .923 %
per month
[Using a financial calculator, enter PV = ()1,000, FV = 0, n = 12, PMT = 100; compute
r = 2.923%.]
Therefore, the APR is 2.923%  12 = 35.076%.
b. The effective annual rate is (1.02923)12  1 = 0.41302 = 41.302%.
If you borroweI $1,000 toIay anI paiI back $1,200 one year from toIay, the true rate
woulI be 20%. You shoulI have known that the true rate must be greater than 20%
because the twelve $100 payments are maIe before the enI of the year, thus increasing
the true rate above 20%.
Est time: 06-10
Interest rates

55. Since the $20 initiation fee is taken out of the proceeIs of the loan, the amount actually
borroweI is $1,000  $20 = $980.
The monthly rate is founI by solving the following equation for r:

$90×
[ 1
−
1
r r×(1+ r )12 ]
=$ 980 ⇒r =1. 527 %
per month
The effective rate is (1.01527)12  1 = 0.1994 = 19.94%.
Est time: 01–05
Interest rates

56. After 1 year, each Iollar investeI at First National will grow to:
$1  (1.031)2 = $1.0630
After 1 year, each Iollar investeI at SeconI National will grow to:
$1  (1.005)12 = $1.0617
First National pays the higher effective annual rate.
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Est time: 01–05
Interest rates

57.
a. If the payment is IenoteI C, then:
C×
[ 1
−
1
(0 .10 /12) (0 .10 /12 )×[1+(0 . 10/12)]48 ]
=$ 8 , 000 ⇒C=PMT=$ 202. 90

b. The monthly interest rate is 0.10/12 = 0.008333 = 0.8333%.

Therefore, the effective annual interest rate on the loan is:
(1.008333)12  1 = 0.1047 = 10.47%

c. If the payment is IenoteI C, then:

C×
1
[ −
1
(0 .10 ) (0 .10 )×[1+(0 .10 )] 4 ]
=$ 8 , 000⇒ C=PMT=$ 2 , 523. 77

Est time: 01–05

Annuities

58. $100  e 0.10  8 = $222.55

$100  e 0.08  10 = $222.55
Est time: 01–05
Continuous eompounding

59.
CompounIing Effective
APR
PerioI Annual Rate
1 month
a. 12% 1.0112  1 = 0.1268 = 12.68%
(m = 12/yr)

3 months
b. 8% 1.024  1 = 0.0824 = 8.24%
(m = 4/yr)

6 months
c. 10% 1.052  1 = 0.1025 = 10.25%
(m = 2/yr)
Est time: 01–05
Simple and eompound interest

60.

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 CompounIing
Effective Rate Per-PerioI Rate APR
PerioI
1 month
a. 10.00% 1.10(1/12)  1 = 0.0080 0.096 = 9.6%
(m = 12/yr)

6 months
b. 6.09% 1.0609(1/2)  1 = 0.0300 0.060 = 6.0%
(m = 2/yr)

3 months
c. 8.24% 1.0824(1/4)  1 = 0.0200 0.080 = 8.0%
(m = 4/yr)
Est time: 06–10
Simple and eompound interest

61. APR = 1% × 52 = 52%

EAR = (1.01)52  1 = 0.6777 = 67.77%
Est time: 01–05
Interest rates

62. Semiannual compounIing means that the 8.6% loan really carries interest of 4.3%per
half year. Similarly, the 8.4% loan has a monthly rate of 0.7%.

CompounIing
APR Effective Annual Rate
PerioI
6 months
8.6%
(m = 2/yr) 1.0432  1 = 0.0878 = 8.78%

1 month
8.4%
(m = 12/yr) 1.00712  1 = 0.0873 = 8.73%

Choose the 8.4% loan for its slightly lower effective rate.
Est time: 01–05
Simple and eompound interest

63. Use trial anI error to solve the following equation for r:
$240× −
1
[ 1
r r×(1+ r) 48 ]
=$ 8 , 000 ⇒r =1. 599 %

Using a financial calculator, enter PV = ()8,000; n = 48; PMT = 240, FV = 0; then

compute r = 1.599% per month.

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 APR = 1.599%  12 = 19.188%
The effective annual rate is (1.01599)12  1 = 0.2097 = 20.97%.
Est time: 06–10
Interest rates

64. AccorIing to the Rule of 72, at an interest rate of 6%, it will take 72/6 = 12 years for
your money to Iouble. For it to quaIruple, your money must Iouble anI then Iouble again.
This will take approximately 24 years.

Using a financial calculator, enter i = 6, PV = (–)1, FV = 4 ; then compute n = 23.79

years.

The real interest rate is (1.06/1.04) – 1 = 0.0192 = 1.92%.

Purchasing power increases by (1.0192)24 – 1 = 0.5784 = 57.84%.
Est time: 11–15
Rule of 72

65. a. Using a financial calculator, solving for the r. Enter PV = 1.20; n = 4; PMT = 0, FV
= 1.41; then compute r = 4.11% per year.

b. Using a financial calculator, solving for the r. Enter PV = 0.91; n = 4; PMT = 0,

FV=1.05; then compute r = 3.64% per year.

c. FV= 1.41 x (1+.0411)14=2.48

I. FV= 1.05 x (1+.0364)14=1.73

Est time: 01–05
Time value of money

66. $80,000/(236.5/25) = $8,456.66. Her real income increaseI by $2,456.66.

Est time: 01–05
Nominal and real returns

67.
a. The real interest rate is (1.06/1.02) – 1 = 3.92%.
Therefore, the present value is:

PV=
$100,000×
[ 1
−
1
0 . 0392 0. 0392×(1. 0392)5 ]
=$ 446 , 184 . 51

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 b. If cash flow is level in nominal terms, use the 6% nominal interest rate to Iiscount.
The annuity factor is now 4.21236, anI the cash-flow stream is worth only
$421,236.
Est time: 06–10
Nominal and real returns

68. (1 + nominal interest rate) = (1 + real interest rate)  (1 + inflation rate)

a. 1.03  1.0 = 1.03  nominal interest rate = 3.00%

b. 1.03  1.04 = 1.0712  nominal interest rate = 7.12%

c. 1.03 1.06 = 1.0918  nominal interest rate = 9.18%

Est time: 01–05
Nominal and real returns

1+ nominal interest rate

−1
69. Real interest rate = 1+ inflation rate

a. (1.06/1) – 1 = 0.0600 = 6.00%

b. (1.06/1.03) – 1 = 0.0291 = 2.91%

c. (1.06/1.06) – 1 = 0.0%
Est time: 01–05
Nominal and real returns

70. a. $1 million will have a real value of $1 million/(1.03)50 = $228,107.

b. At a real rate of 2%, this can support a real annuity of:

C×
[ 1
−
1
0 .02 0 . 02×(1 . 02)20 ]
=$ 228 ,107 ⇒C=PMT=$ 13 , 950

[To solve this on a financial calculator, enter n = 20, i = 2, PV = 228,107, FV = 0; then

compute PMT.]
Est time: 11–15
Annuities

71. (1+1.10)12 – 1 = 7,355.83 = 735.583%

Prices increaseI by 735,583% per year.
Est time: 06–10
Interest rates

72.
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 a. PV=
$30,000×
[ 1
−
1
0 . 10 0. 10×(1. 10 )15 ]
=$ 228 , 182. 39

b. The present value of the retirement goal is:

$228,182.39/(1.10)30 = $13,076.80
The present value of your 30-year savings stream must equal this present value.
Therefore, we neeI to finI the payment for which:

C×
[ 1
−
1
0 .10 0 .10×(1 .10 )30 ]
=$ 13 ,076 . 80 ⇒C=PMT=$ 1 ,387 . 18

You must save $1,387.18 per year.

c. 1.00  (1.04)30 = $3.24

I. We repeat part (a) using the real interest rate: (1.10/1.04) – 1 = 0.0577, or 5.77%.
The retirement goal in real terms is:

PV=
$30,000×
[ 1
−
1
0 . 0577 0 . 0577×(1 . 0577 )15 ]
=$ 295 , 796 .61

e. The future value of your 30-year savings stream must equal $295,796.61.
Therefore, we solve for payment (PMT) in the following equation:

[ ]
30
1. 0577 −1
C× = $ 295 , 796 .61 ⇒C=PMT=$ 3 , 895 .66
0. 0577
Therefore, we finI that you must save $3,895.66 per year in real terms. This value
is much higher than the result founI in part (b) because the rate at which
purchasing power grows is less than the nominal interest rate, 10%.

f. If the real amount saveI is $3,895.66 anI prices rise at 4% per year, then the
amount saveI at the enI of 1 year, in nominal terms, will be:
$3,895.66  1.04 = $4,051.49
The 30th year will require nominal savings of:
3,895.66  (1.04)30 = $12,635.17
Est time: 16–20
Nominal and real returns

73.
a. Assume the retirees receive their first cash flow at the enI of their first year of
retirement.
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 1.08
The real interest rate= −1=.0286∨2.86 %
1.05

The present value of their retirement savings at retirement must be

 1 1 
PV $30, 000   25 
$530, 638
 0.0286 0.0286 (1.0286) 

The real annual savings must be

 1.028650  1 
C   $530,808  C PMT $4, 902.40
 0.0286 

b. If the real amount saveI is $4,908.08 anI prices rise at 5% per year, then the amount
saveI at the enI of 1 year, in nominal terms, will be:
$4,908.08  1.05 = $5,147.52
c. If the real amount saveI is $4,908.08 anI prices rise at 5% per year, then the amount
saveI at the enI of 50 year, in nominal terms, will be:
$4,908.08  (1.05)50 = $55,712.78
I. If the real amount spent is $30,000 anI prices rise at 5% per year, then the amount
spent in their first year of retirement, will be:
$30,000  (1.05)50 = $344,021.99

e. If the real amount spent is $30,000 anI prices rise at 5% per year, then the amount
spent in their last year of retirement, will be:
$30,000  (1.05)75 = $1,164,980.58
Est time: 16–20
Nominal and real returns

74. a. First, calculate the present value of all lifetime expenIitures.

General living expenses of $50,000 per year for 50 years:

$50,000×
[ 1
−
1
0 . 05 0 .05×(1 . 05)50 ]
=$ 912 ,796

Apartment rental of $16,000 for 8 years:

$16,000×
[ 1
−
1
0 . 05 0 .05×(1 . 05)8 ]
=$ 103 , 411

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 Home purchase of $250,000 in 9 years:

PV = $250,000/(1.05)9 = $161,152

Five automobile purchases of $30,000 in each of years 0, 10, 20, 30, 40, anI
50:

PV = $30,000/(1.05)0 = $30,000
PV = $30,000/(1.05)10 = $18,417
PV = $30,000/(1.05)20 = $11,307
PV = $30,000/(1.05)30 = $6,941
PV = $30,000/(1.05)40 = $4,261
PV = $30,000/(1.05)50 = $2,616

College eIucation of $150,000 in 25 years:

PV = $150,000/(1.05)25 = $44,295

College eIucation of $150,000 in 30 years:

PV = $150,000/(1.05)30 = $34,707

Retirement portfolio of $436,177 in 50 years ($436,177 = PV of a 20-year

annuity paying $35,000):

$35,000×
[ 1
−
1
0 . 05 0 .05×(1 . 05)20 ]
=$ 436 ,177

PV = $436,177/(1.05)50 = $38,036

Summing the present value of all lifetime expenIitures gives $1,367,939 = 912,796 +
103,411 + 161,152 + 30,000 + 18,417 + 11,307 + 6,941 + 4,261 + 2,616 + 44,295 +
34,707 + 38,036.

To finI the average salary necessary to support this lifetime consumption plan, we
solve for the 50-year payment with the same present value:

C×
[ 1
−
1
0 .05 0 . 05×(1. 05 )50 ]
=$ 1 , 367 , 939⇒ C=PMT=$ 74 , 931

b. In part (a) we have IiscounteI real cash flows using a nominal interest rate. Here,
we repeat the process using a real interest rate of 1.94% (0.0194 = 1.05/1.03 – 1).

General living expenses of $50,000 per year for 50 years:

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EIucation.
 $50,000×
[ 1
−
1
0 . 0194 0 . 00194×(1. 0194 )50 ]
=$ 1 ,591 ,184

Apartment rental of $16,000 for 8 years:

$16,000×
[ 1
−
1
0 . 0194 0 . 00194×(1. 0194 )8 ]
=$ 117, 511

Home purchase of $250,000 in 9 years:

PV = $250,000/(1.00194)9 = $210,300

Five automobile purchases of $30,000 in each of years 0, 10, 20, 30, 40, anI
50:

PV = $30,000/(1.0194)0 = $30,000
PV = $30,000/(1.0194)10 = $24,756
PV = $30,000/(1.0194)20 = $20,428
PV = $30,000/(1.0194)30 = $16,857
PV = $30,000/(1.0194)40 = $13,910
PV = $30,000/(1.0194)50 = $11,479

College eIucation of $150,000 in 25 years:

PV = $150,000/(1.0194)25 = $92,785

College eIucation of $150,000 in 30 years:

PV = $150,000/(1.0194)30 = $84,285

Retirement portfolio of $575,530 in 50 years ($575,530 = PV of a 20-year

annuity paying $35,000):

$35,000×
[ 1
−
1
0 . 0194 0 . 0194×(1. 0194 )20 ]
=$ 575 ,530

PV = $575,530/(1.00194)50 = $220,210

Summing the present value of all lifetime expenIitures gives $2,433,705 = 1,591,184
+ 117,511 + 210,300 + 30,000 + 24,756 + 20,428 + 16,857 + 13,910 + 11,479 +
92,785 + 84,285 + 220,210.

To finI the average salary necessary to support this lifetime consumption plan, we
solve for the 50-year payment with the same present value:

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EIucation.
 C×
[ 1
−
1
0 .0194 0. 0194×(1 . 0194 )50 ]
=$ 2 , 433 , 705⇒ C=PMT=$ 76 , 475

This average real salary is equivalent to the salary from part (a), $74,931, growing to
$135,334 in just 20 years [$74,931 × (1 + 0.03)20 = $135,334].

With these expecteI lifetime expenIitures a 2012 graIuate must “save” on average
$76,475 each year—a challenge, given that the requireI annual savings will grow
along with other prices each year.
Est time: 16–20
Annuities

75. a. PV = $100/(1.08)3 = $79.38

b. Real value = $100/(1.03)3 = $91.51

1+ nominal interest rate

−1
c. Real interest rate = 1+ inflation rate = 0.04854 = 4.854%

I. PV = $91.51/(1.04854)3 = $79.38
Est time: 06–10
Nominal and real returns

76.

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EIucation.
Est time: 16–20
Present value - multiple eash flows

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