FIN 7000

Problem Set 1 FIN 7000

Problem 1:
Part 1: Using the annual interest rate of 4 percent (i.e., r = .04), calculate the
present values (at t = 0) for the following payments:
a. $1,000,000 at t = 1 PV = (1,000,000) / (1.04)1 = 961,538.46
b. $1,000,000 at t = 2 PV = (1,000,000) / (1.04)2 = 924,556.21
c. $1,000,000 at t = 3 PV = (1,000,000) / (1.04)3 = 888,996.36
Is the present value of $1,000,000 at t = 2 larger than, smaller than, or equal to the
average of the present values of $1,000,000 at t = 1 and $1,000,000 at t = 3?
Average of values at t = 1 and t = 3 is: (961538.46 + 888996.36) / 2 = 925,267.41
Therefore, the present value at t=2 is smaller than the average of present values at
t=1 and t=3.
Part 2: Next calculate the present values of $1,000,000 at t = 3 for the following
interest rates:
a. r = .10 (10%) PV = (1,000,000) / (1.10)3 = 751,314.80
b. r = .15 (15%) PV = (1,000,000) / (1.15)3 = 657,516.23
c. r = .20 (20%) PV = (1,000,000) / (1.20)3 = 578,703.70
Is the present value of $1,000,000 at t = 3 with r = .15 larger than, smaller than, or
equal to the average of the present values using r = .10 and r = .20?
Average of values with r = 0.10 and r = 0.20 is: (751,314.8009+ 657,516.2324)/ 2
= 665009.25
Therefore, the present value at r = 0.15 is smaller than the average of present
values at r=0.10 and r = 0.20.
Problem 2:
Let t denote years. Consider the following stream of payments:
t=
1
2

Payment
$200
$400

a. Calculate the future value at t = 3 of the payment at t = 1 given an interest

rate is 1% (r = .01).
FV = 200*(1+0.01)2 = 204.02

b. Calculate the future value at t = 3 of the payment at t = 2 given an interest

rate is 1% (r = .01).
FV = 400*(1+0.01)1 = 404.00
c. As with the present value of a set of payments, the future value of a set of
payments is simply the sum of the future values of the individual payments.
Given your answers to parts a and b above, what is the future value at t = 3
of the stream of payments listed in the table above?
The value is 204.02 + 404 = 608.02
Problem 3:
Consider the following stream of payments:
t=
1
2
3
4

Payment
$200
$400
$600
$200

a. Calculate the present value at t = 0 of the above stream of payments given

an annual interest rate is 1% (i.e., r = .01).
PV = ((200) / (1.01)1) + ((400) / (1.01)2) + ((600) / (1.01)3) + ((200) / (1.01)4)
= 198.02 + 392.12 + 582.35 + 192.20 = 1,364.69
b. Calculate the future value at t = 5 of the above stream of payments given an
annual interest rate of 1% (r = .01)
FV = (200*(1+0.01)4) + (400*(1+0.01)3) + (600*(1+0.01)2) +
(200*(1+0.01)1)
= 208.12 + 412.12 + 612.06 + 202 = 1,434.30
c. Calculate the present value at t = 0 of your answer to b above at t = 5 given
an annual interest rate of 1% (r = .01). How does this answer compare to
your answer to part a above?
PV = (1,434.30) / (1.01)5 = 1364.69