Chapter 3 The Time Value of Money 67

Chapter 3 The Time Value of Money

Solutions to End-of-Chapter Problems
Future Value of a Lump Sum
P3-1. You have $1,500 to invest today at 7 percent interest compounded annually.
a. How much will you have accumulated in the account at the end of the following
numer of years!
1. "hree years
#. $i% years
&. 'ine years
. (se your findings in part )a* to calculate the amount of interest earned in
1. the first three years )years 1 to &*
#. the second three years )years + to 6*
&. the third three years )years 7 to ,*
c. -ompare and contrast your findings in part )*. .%plain why the amount of interest
earned increases in each succeeding &/year period.
A3-1. 0uture 1alue2 01n 3 41 )1 5 r*
n
or 01n 3 41 )010r6,n*
a. 1. 01& 3 41 )1.07*
&
. 1. 7nterest earned 3 01& 8 41
01& 3 $1,500 )1.##50+* 7nterest earned 3 $1,9&7.57
01& 3 $1,9&7.57 /1,500.00
$ &&7.57
#. 016 3 41 )1.07*
6
#. 7nterest earned 3 016 8 01&
016 3 $1,500 )1.5007&* 7nterest earned 3 $#,#51.10
016 3 $#,#51.10 /1,9&7.57
$ +1&.5&
&. 01, 3 41 )1.07*
,
&. 7nterest earned 3 01, 8 016
01, 3 $1,500 )1.9&9+6* 7nterest earned 3 $#,757.6,
01, 3 $#,757.6, /#,#51.10
$ 506.5,
c. "he fact that the longer the investment period the larger the total amount of interest
collected is not une%pected and is due to the greater length of time that the principal
sum of $1,500 is invested. "he most significant point is that the incremental interest
earned per & year period increases with each suse:uent &/year period. "he total
interest for the first & years is $&&7.57, however, for the second & years )from year & to
6* the additional interest earned is $+1&.,&. 0or the third &/year period the incremental
interest is $506.1,. "his increasing change in interest earned is due to compounding,
the earning of interest on pervious interest earned. "he greater the previous interest
earned the greater the impact of compounding.
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69 Instructors Manual

Present Value of a Lump Sum
P3-2. You ;ust won a lottery that promises to pay you $1 million e%actly 10 years from today.
<ecause the $1 million payment is guaranteed y the state in which you live, opportunities
e%ist to sell the claim today for an immediate lump/sum cash payment.
a. =hat is the least you will sell your claim for if you could earn the following rates of
return on similar/ris> investments during the 10/year period!
1. 6 percent
#. , percent
&. 1# percent
. ?ewor> part )a* under the assumption that the $1 million payment will e received in
15 rather than 10 years.
c. <ased on your findings in parts )a* and )*, discuss the effect of oth the si@e of the
rate of return and the time until receipt of payment on the present value of a future
sum.
A3-2. a. )1* 41 3 $1,000,000 )1.06*
/10
)#* 41 3 $1,000,000 )1.0,*
/10
41 3 $1,000,000 ).559&,5* 41 3 $1,000,000 ).+##+11*
41 3 $559,&,5 41 3 $+##,+11
)&*
41 3 $1,000,000 )1.1#*
/10
41 3 $1,000,000 ).&#1,7&*
41 3 $&#1,,7&
. )1* 41 3 $1,000,000 )1.06*
/15
)#* 41 3 $1,000,000 )1.0,*
/15
41 3 $1,000,000 ).+17#65* 41 3 $1,000,000 ).#7+5&9*
41 3 $+17,#65 41 3 $#7+,5&9
)&* 41 3 $1,000,000 )1.1#*
/15
41 3 $1,000,000 ).19#6,6*
41 3 $19#,6,6
c. As the rate of return increases, the present value ecomes smaller. "his decrease arises
from the higher opportunity cost associated with the higher rate. Also, the longer the
time until the lottery payment is collected, the less the present value due to the greater
time over which the opportunity cost applies. 7n other words, the larger the rate of
return and the longer the time until the money is received, the smaller will e the
present value of a future payment.
P3-3. An 7ndiana state savings ond can e converted to $100 at maturity si% years from
purchase. 7f the state onds are to e competitive with (.$. savings onds, which pay 9
percent annual interest )compounded annually*, at what price must the state sell its onds!
7gnore ta%es and assume no cash payments on savings onds prior to redemption.

A3-3. 4resent 1alue2 41 3 01n
( )
1
]
1

+
n
r 1
1
or 01n )4170r6, n*
41 3 $100 )1.09*
/6
41 3 $100 ).6&0#*
41 3 $6&.0#
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resold, copied, or distriuted without the prior consent of the pulisher.
Chapter 3 The Time Value of Money 6,
Future Value of Cash Flow Streams
P3-4. Bim .dwards and -hris 4hillips are oth newly minted &0/year old C<As. Bim plans to
invest $1,000 per month into her +01)>* eginning ne%t month, while -hris intends to
invest $#,000 per month, ut he does not plan to egin investing until 10 years after Bim
egins investing. <oth Bim and -hris will retire at age 67, and the +01)>* plan averages a
1# percent annual return compounded monthly. =ho will have more +01)>* money at
retirement!

A3-4. BimDs future retirement account at age 67 )r 3 .1#E1# 3 .01F n = &7yrs G 1#mosEyr 3 +++ mos*2
01&7 3 $1,000 H )1.01*
+++
8 1I 3 $9,1,#,596
.01
-hrisD future retirement account at age 67 )r 3 .1#E1# 3 .01F n 3 #7yrs G 1#mosEyr 3 &#+mos*2
01&7 3 $#,000 G H )1.01*
&#+
8 1 I 3 $+,9#5,##0
.01
-learly, Bim will have far more money at retirement )$9,1,#,596* than will -hris )$+,9#5,##0*.
P3-5. ?oert =illiams is considering an offer to sell his medical practice, allowing him to retire
five years early. He has een offered $500,000 for his practice and can invest this amount
in an account earning 10 percent per year, compounded annually. 7f the practice is e%pected
to generate the following cash flows, should ?oert accept this offer and retire now!
End of Year Cash Flow
1 $150,000
2 150,000
3 125,000
4 125,000
5 100,000

A3-5. 01 on original retirement date if early retirement is chosen2
$500,000 )1.10*
5
3 $905,#55
01 on retirement date if early retirement is not chosen2
$150,000 G )1.10*
+
3 $#1,,615
$150,000 G )1.10*
&
3 1,,,650
$1#5,000 G )1.10*
#
3 151,#50
$1#5,000 G )1.10*
1
3 1&7,500
$100,000 G )1.10*
0
3 100,000
$909,015
?oert =illiams should not retire early ecause the future value of his cash flows at the
end of five years would e aout $&,000 less than if he continued wor>ing.
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70 Instructors Manual

P3-6. 0or the following :uestions, assume an annual annuity of $1,000 and a re:uired return of
1#
percent.
a. =hat is the future value of an ordinary annuity for 10 years!
. 7f you earned an additional yearDs worth of interest on this annuity, what would e the
future value!
c. =hat is the future value of a 10/year annuity due!
d. =hat is the relationship etween your answers in parts )* and )c*! .%plain.
A3-6. a. 01A10 3 $1,000 G H )1.1#*
10
8 1 I 3 $17,5+,
0.1#
. $17,5+, G )1.1#* 3 $1,,655
c. 01A10 )annuity due* 3 $1,000 G H )1.1#*
10
8 1 I G )1.1#* 3 $1,,655
0.1#
d. "he answers to parts and c are identical, implying that the future value of annuity due
is simply the future value of an ordinary annuity plus an additional interest payment.
P3-7. ?oert <landingDs employer offers its wor>ers a two/month paid saatical every seven
years. ?oert, who ;ust started wor>ing for the firm, plans to spend his saatical touring
.urope at an estimated cost of $#5,000. "o finance his trip, ?oert plans to ma>e si%
annual end/of/year deposits of $#,500 each, starting this year, into an investment account
earning 96 interest.
a. =ill ?oertDs account alance at the end of seven years e enough to pay for his trip!
. $uppose ?oert increases his annual contriution to $&,150. How large will his
account alance e at the end of seven years!
A3-7. a. 01 3 #,500 G 01A0 )7, 96* 3 $#,500 G 9.,##9 3 $##,&07. "herefore, ?oertDs alance
will not e enough for him to cover the trip.
. 01 3 &,150 G 9.,##9 3 $#9,107. 7n this case the account alance will e enough for
?oert to ma>e the trip.
P3-. Jina -oulson has ;ust contracted to sell a small parcel of land that she inherited a few
years ago. "he uyer is willing to pay $#+,000 at closing of the transaction or will pay the
amounts shown in the following tale at the beginning of each of the ne%t five years.
<ecause Jina doesnDt really need the money today, she plans to let it accumulate in an
account that earns 7 percent annual interest. Jiven her desire to uy a house at the end of
five years after closing on the sale of the lot, she decides to choose the payment alternative
K$#+,000 lump sum or mi%ed stream of payments in the following taleKthat provides
the highest future value at the end of five years.
!"#e$ Stream
Beginning of Year (t) Cash Flow (CF
t
)
1 $ 2,000
2 4,000
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resold, copied, or distriuted without the prior consent of the pulisher.
Chapter 3 The Time Value of Money 71
3 6,000
4 8,000
5 10,000
a. =hat is the future value of the lump sum at the end of year 5!
. =hat is the future value of the mi%ed stream at the end of year 5!
c. <ased on your findings in parts )a* and )*, which alternative should Jina ta>e!
d. 7f Jina could earn 10 percent rather than 7 percent on the funds, would your
recommendation in part )c* change! .%plain.
A3-. a. 015 3 41 G )1.07*
5
015 3 $#+,000 G )1.+0&*
015 3 $&&,661
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7# Instructors Manual

. %e&"nn"n& of 'um(er of
)ear )ears *t+ FV , CFt - *1 . ./7+
t
Future Value
1 5 $ #,000 G 1.+0& 3 $ #,905.10
# + $ +,000 G 1.&11 3 5,#+&.19
& & $ 6,000 G 1.##5 3 7,&50.#6
+ # $ 9,000 G 1.1++, 3 ,,15,.#0
5 1 $10,000 G 1.070 3 10,700.00
"otal 3 $&5,#57.7+
c. Jina should select the stream of payments rather than the upfront $#+,000.
d. Lump sum
015 3 41 x )1.10*
5
015 3 $#+,000 x )1.611*
015 3 $&9,65#.#+
Mixed stream
%e&"nn"n& of 'um(er of
)ear )ears *t+ FV , CFt G *1 . .1/+
t
Future Value
1 5 $ #,000 G 1.611 3 $ &,##1.0#
# + $ +,000 G 1.+6+ 3 5,956.+0
& & $ 6,000 G 1.&&1 3 7,,96.00
+ # $ 9,000 G 1.#10 3 ,,690.00
5 1 $10,000 G 1.100 3 11,000.00
"otal 3 $&7,7+&.+#
'ote that, although the future sums of each alternative are larger at 106 than at 76, the
106 upfront payments result in greater future value at the end of year 5 than does the
mi%ed stream. "herefore, the upfront lump/sum payment would e preferred. "his
conclusion differs from that in part c primarily due to the different patterns of cash flow
associated with the lump sum and mi%ed stream payment alternatives.
P3-0. Li%on $huttleworth has een offered the choice among three retirement/planning
investments. "he first investment offers a 5 percent return for the first 5 years, a 10 percent
return for the ne%t 5 years, and a #0 percent return thereafter. "he second investment offers
10 percent for the first 10 years and 15 percent thereafter. "he third investment offers a
constant 1# percent rate of return. Letermine, for each of the given numer of years, which
of these investments is the est for Li%on if he plans to ma>e one payment today into one
of these funds and plans to retire in the following numer of years2
a. 15 years
. #0 years
c. &0 years
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resold, copied, or distriuted without the prior consent of the pulisher.
Chapter 3 The Time Value of Money 7&
A3-0. a. 7nvestment M 12 0uture 1alue 0actor 3 )1.05*
5
)1.10*
5
x )1.#0*
5
3 5.115
7nvestment M #2 0uture 1alue 0actor 3 )1.10*
10
)1.15*
5
3 5.#17
7nvestment M &2 0uture 1alue 0actor 3 )1.1#*
15
3 5.+7+
7f $huttleworth retires in 15 years, investment M& has the highest future value
. 7nvestment M 12 0uture 1alue 0actor 3 )1.05*
5
)1.10*
5
)1.#0*
10
3 1#.7#7
7nvestment M #2 0uture 1alue 0actor 3 )1.10*
10
)1.15*
10
3 10.+,&
7nvestment M &2 0uture 1alue 0actor 3 )1.1#*
#0
3 ,.6+6
7f $huttleworth retires in #0 years, investment M 1 has the highest future value
c. 7nvestment M 12 0uture 1alue 0actor 3 )1.05*
5
)1.10*
5
)1.#0*
#0
3 79.90#
7nvestment M #2 0uture 1alue 0actor 3 )1.10*
10
)1.15*
#0
3 +#.+51
7nvestment M &2 0uture 1alue 0actor 3 )1.1#*
&0
3 #,.,5,
7f $huttleworth retires in &0 years, investment M 1 has the highest future value.
Present Value of Cash Flow Streams
P3-1/. 0or the following :uestions, assume an end/of/year cash flow of $#50 and a 10 percent
discount rate.
a. =hat is the present value of a single cash flow!
. =hat is the present value of a 5/year annuity!
c. =hat is the present value of a 10/year annuity!
d. =hat is the present value of a 100/year annuity!
e. =hat is the present value of a $#50 perpetuity!
f. Lo you detect a relationship etween the numer of periods of an annuity and its
resemlance to a perpetuity!
A3-1/. a. 41 3 $#50 )1.10*
/1
3 $##7.#7

. 41 3 $#50 H 1/ )1.10*
/5
I 3 $,+7.70
0.10
c. 41 3 $#50 H1/ )1.10*
/10
I 3 $1,5&6.1+
0.10
d. 41 3 $#50 H 1/)1.10*
/100
I3 $#,+,,.9#
0.10
e. 41 3 $#50 3 $#,500.00
0.10
f. As the numer of periods in an annuity increases )as we move from part to part d*
and approaches infinity, the value of the annuity approaches the value of a perpetuity
)part e*.
P3-11. Nog on to Hugh -houDs financial calculator we page
)http2EEwww.interest.comEhughEcalcEsimple.org*, and loo> over the various calculator lin>s
availale. ?efer ac> to some of the earlier time value prolems, and rewor> them with
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resold, copied, or distriuted without the prior consent of the pulisher.
7+ Instructors Manual

these calculators. 'ow, run through several numerical scenarios to determine the impact of
changing variales on your results.
A3-11. 7nternet e%ercise 8 answers will vary.
P3-12. Assume that you ;ust won the state lottery. Your pri@e can e ta>en either in the form of
$+0,000 at the end of each of the ne%t #5 years )i.e., $1 million over #5 years* or as a lump
sum of $500,000 paid immediately.
a. 7f you e%pect to e ale to earn 5 percent annually on your investments over the ne%t
#5 years, ignoring ta%es and other considerations, which alternative should you ta>e!
=hy!
. =ould your decision in part )a* e altered if you could earn 7 percent rather than 5
percent on your investments over the ne%t #5 years! =hy!
c. On a strict economic asis, at appro%imately what earnings rate would you e
indifferent when choosing etween the two plans!
A3-12. 41An 3 4C" H1 8 1 I
r )1 5 r*
n
a. 41A#5 3 )$+0,000 E 0.05* H1 8 )1 5 .05*
/#5
I
41A#5 3 $900,000 .70+6,7
41A#5 3 $56&,759
At 56, ta>ing the award as an annuity is etter ecause its present value of $56&,579 is
larger than the $500,000 lump/sum amount.
. 41A#5 3 )$+0,000 E 0.07* x H 1 8 )1 5 .07*
/#5
I
41A#5 3 $571,+#, .915751
41A#5 3 $+66,1++
At 76, ta>ing the award as a lump sum is etter ecause the present value of the
annuity of $+66,1++ is less than the $500,000 lump/sum payment.
c. <ecause the annuity is worth more than the lump sum at 56 and less at 76, try 662
41#5 3 )$+0,000E0.06* H 1 8 )1 5 .06*
/#5
I
41#5 3 $666,667 .767001
41#5 3 $511,&&5
"he rate at which you would e indifferent is greater than 66F aout 6.#56 using
interpolation. -alculator solution is 6.#+6.
P3-13. Catt $edgwic>, facilities and operations manager for the <irmingham <uffalo professional
footall team, has come up with an idea for generating income. Catt wants to e%pand the
stadium y uilding s>yo%es sold with lifetime )perpetual* season tic>ets. .ach s>yo%
will e guaranteed 10 season tic>ets at a cost of $#00 per tic>et per year for life. 7f each
s>yo% costs $100,000 to uild, what is the minimum selling price that Catt will have to
charge for the s>yo%es to rea> even, if the re:uired return is 10 percent!
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Chapter 3 The Time Value of Money 75
A3-13. 41 of tic>et sales 3 )$#00 10* 3 $#0,000
0.10

<rea>even selling price 3 $100,000 8 $#0,000 3 $90,000.
P3-14. Celissa Jould wants to invest today in order to assure ade:uate funds for her sonDs college
education. $he estimates that her son will need $#0,000 at the end of 19 yearsF $#5,000 at
the end of 1, yearsF $&0,000 at the end of #0 yearsF and $+0,000 at the end of #1 years.
How much will Celissa have to invest in a fund today if the fund earns the following
interest rate!
a. 6 percent per year with annual compounding
. 6 percent per year with :uarterly compounding
c. 6 percent per year with monthly compounding
A3-14. a. Amount re:uired today with annual compounding )rate 3 .06F M periods 3 1 n*
$#0,000 G )1.06*
/19
3 $ 7,007
#5,000 G )1.06*
/1,
3 9,#6&
&0,000 G )1.06*
/#0
3 ,,&5+
+0,000 G )1.06*
/#1
3 11,766
"otal 3 $&6,&,0
. Amount re:uired today with :uarterly compounding )rate 3 .06E+ 3 .015F M periods 3 +
n*
$#0,000 G )1.015*
/7#
3 $ 6,9+7
#5,000 G )1.015*
/76
3 9,06&
&0,000 G )1.015*
/90
3 ,,117
+0,000 G )1.015*
/9+
3 11,+5&
"otal 3 $&5,+90

c. Amount re:uired today with monthly compounding )rate3 .06E1# 3 .005F M periods 3
1# n*2
$#0,000 )1.005*
/#16
3 $ 6,910
#5,000 )1.005*
/##9
3 9,019
&0,000 )1.005*
/#+0
3 ,,06&
+0,000 )1.005*
/#5#
3 11,&9#
"otal 3 $&5,#7&
P3-15. Poan =allace, corporate finance specialist for <ig <la@er <umpers, has een charged with
the responsiility of funding an account to cover anticipated future warranty costs.
=arranty costs are e%pected to e $5 million per year for three years, with the first costs
e%pected to occur four years from today. How much will Poan have to place into an account
today earning 10 percent per year to cover these e%penses!
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76 Instructors Manual

A3-15. 41 of deferred annuityQ 3 $5,000,000 H1/)1.10*
/&
I )1.10*
/&
3 $,,&+#,0++
.10
Q 'ote the present value of the three deposits is measured at the eginning of year +, i.e.,
the end of year &.
P3-16. ?uth 'ail has ;ust received two offers for her seaside home. "he first offer is for $1 million
today. "he second offer is for an owner/financed sale with a payment schedule as follows2
End of Year Payment
0 (Today) $200,000
1 200,000
2 200,000
3 200,000
4 200,000
5 300,000
Assuming no differential ta% treatment etween the two options and that ?uth earns a rate
of 9 percent on her investments, which offer should she ta>e!
A3-16. 41 of owner/financed sale2
1n$ of
)ear *t+ Cash Flow G *1../+
-t
, Present Value
0 $#00,000 G 1.000000 3 $ #00,000
1 #00,000 G .,#5,#6 3 195,196
# #00,000 G .957&&, 3 171,+69
& #00,000 G .7,&9&# 3 159,766
+ #00,000 G .7&50&0 3 1+7,006
5 &00,000 G .69059& 3 #0+,175
$1,066,601
?uth should ta>e the second offer for the series of payments ecause it has a higher present
value than the $1,000,000 payment today.
P3-17. Nandon Nowman, star :uarterac> of the university footall team, has een approached
aout forgoing his last two years of eligiility and ma>ing himself availale for the
professional footall draft. "alent scouts estimate that Nandon could receive a signing
onus of $1 million today along with a 5/year contract for $& million per year )payale at
the end of the year*. "hey further estimate that he could negotiate a contract for $5 million
per year for the remaining seven years of his career. "he scouts elieve, however, that
Nandon will e a much higher draft pic> if he improves y playing out his eligiility. 7f he
stays at the university, he is e%pected to receive a $# million signing onus in two years
along with a 5/year contract for $5 million per year. After that, the scouts e%pect Nandon to
otain a 5/year contract for $6 million per year to ta>e him into retirement. Assume that
Nandon can earn a 10 percent return over this time. $hould Nandon stay or go!
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Chapter 3 The Time Value of Money 77
A3-17. 41 of Nandon entering the draft2
$igning onus 3 $ 1,000,000
7nitial contract 3 $&,000,000 x H 1/)1.10*
/5
I 3 11,&7#,&60
.10

$use:uent contract 3 $5,000,000 x H 1/)1.10*
/7
I )1.10*
/5
3 15,11+,5#5
.10 41 3 $#7,+96,995
41 of Nandon playing out his eligiility2
$igning onus 3 $#,000,000 x )1.10*
/#
3 $ 1,65#,9,&
7nitial contract 3 $5,000,000 x H 1/)1.10*
/5
I )1.10*
/#
3 15,66+,+09
.10
$use:uent contract 3 $6,000,000 x H1/)1.10*
/5
I )1.10*
/7
3 11,671,6&9
.10 41 3 $#9,,99,,&,
$ince the 41 of playing out his eligiility and then entering the draft is higher, Nandon
should stay in college.
P3-1. As part of your personal udgeting process, you have determined that in each of the ne%t
five years you will have udget shortfalls. 7n other words, you will need the amounts
shown in the following tale at the end of the given year to alance your udgetKthat is,
inflows e:ual outflows. You e%pect to e ale to earn 9 percent on your investments during
the ne%t five years and wish to fund the udget shortfalls over these years with a single
initial deposit.
1n$ of )ear %u$&et Shortfall
1 $ 5,000
# +,000
& 6,000
+ 10,000
5 &,000
a. How large must the lump/sum deposit e today into an account paying 9 percent
annual interest to provide for full coverage of the anticipated udget shortfall!
. =hat effect would an increase in your earnings rate have on the amount calculated in
part a! .%plain.
A3-1. a. 1n$ of %u$&et
)ear *t+ Shortfall G *1 . ./+
-t
, Present Value
1 $5,000 G .,#5,#6 3 $ +,6&0
# $+,000 G .957&&, 3 &,+#,
& $6,000 G .7,&9&# 3 +,76&
+ $10,000 G .7&50&0 3 7,&50
5 $&,000 G .69059& 3 #,0+#
$ ##,#1+
An initial deposit of $##,#1+ would e needed to fund the shortfall for the pattern
shown in the tale.
. An increase in the earnings rate would reduce the amount calculated in part a.
"his edition is intended for use outside of the (.$. only, with content that may e different from the (.$. .dition. "his may not e
resold, copied, or distriuted without the prior consent of the pulisher.
79 Instructors Manual

P3-10. (se the following tale of cash flows to answer parts a / c. Assume an 9 percent discount
rate.
End of Year Cash Flow
1 $10,000
2 10,000
3 10,000
4 12,000
5 12,000
6 12,000
7 12,000
8 15,000
9 15,000
10 15,000
a. $olve for the present value of the cash flow stream y summing the present value of
each individual cash flow.
. 'ow, solve for the present value y summing the present value of the three separate
annuities )one current and two deferred*.
c. =hich method is etter for a long series of cash flows with emedded annuities!
A3-10. a. )ear Cash Flow Present Value
1 $10,000 $ ,,#5,
# 10,000 9,57&
& 10,000 7,,&9
+ 1#,000 9,9#0
5 1#,000 9,167
6 1#,000 7,56#
7 1#,000 7,00#
9 15,000 9,10+
, 15,000 7,50+
10 15,000 6,,+9
"otal $7,,977

. 41 3 $10,000 H1/)1.09*
/&
I 5 $1#,000 H1/ )1.09*
/+
I )1.09*
/&
5 $15,000 H1/)1.09*
/&
I
)1.09*
/7
0.09 0.09 0.09
41 3 $#5,771 5 $&1,551 5 $##,556
41 3 $7,,979
c. 0or a long series of cash flows with emedded annuities it is more efficient to calculate
and sum the present values of the separate annuities as in part . "his >ind of prolem
can also e solved using the cash flow >eys of a financial calculator.
P3-2/. Jiven the mi%ed streams of cash flows shown in the following tale, answer parts )a* and
)*2
"his edition is intended for use outside of the (.$. only, with content that may e different from the (.$. .dition. "his may not e
resold, copied, or distriuted without the prior consent of the pulisher.
Chapter 3 The Time Value of Money 7,
Cash Flow Stream
Year A B
1 $ 50,000 $ 10,000
2 40,000 20,000
3 30,000 30,000
4 20,000 40,000
5 10,000 50,000
Totals $150,000 $150,000
a. 0ind the present value of each stream, using a 15 percent discount rate.
. -ompare the calculated present values, and discuss them in light of the fact that the
undiscounted total cash flows amount to $150,000 in each case.

A3-2/.
a. Cash Flow
Stream )ear *t+ CFt G *1..15+
-t
, Present Value
A 1 $50,000 G .96,565 3 $ +&,+7,
# $+0,000 G .7561++ 3 &0,#+6
& $&0,000 G .657516 3 1,,7#5
+ $#0,000 G .57175& 3 11,+&5
5 $10,000 G .+,7177 3 +,,7#
"otal 3 $10,,957

Cash Flow
Stream )ear *t+ CFt G *1..15+
-t
, Present Value
< 1 $10,000 G .96,565 3 $ 9,6,6
# $#0,000 G .7561++ 3 15,1#&
& $&0,000 G .657516 3 1,,7#5
+ $+0,000 G .57175& 3 ##,970
5 $50,000 G .+,7177 3 #+,95,
"otal 3 $ ,1,#7&
. -ash flow stream A has a higher present value )$10,,957* than cash flow stream <
)$,1,#7&* ecause cash flow stream A has larger cash flows in the early years when
their present value is greater, while the smaller cash flows are received further in the
future. Although oth cash flow streams total $150,000 on an undiscounted asis, the
large early/year cash flows of stream A result in its higher present value.
Spe2"al Appl"2at"ons of 3"me Value
P3-21. 0ind the present value of a &/year, $#0,000 ordinary annuity deposited into an account that
pays 1# percent interest, compounded monthly. $olve for the present value of the annuity
in the following ways2
a. As three single cash flows discounted at the stated rate of interest
. As three single cash flows discounted at the appropriate effective rate of interest
c. As a &/year annuity discounted at the effective rate of interest
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90 Instructors Manual

A3-21. a. 41 3 $#0,000 )1.01*
/1#
5 $#0,000 )1.01*
/#+
5 $#0,000 )1.01*
/&6
3 $+7,+7,
. .ffective rate 3 )1 5 .1#*
1#
8 1 3 1#.696
1#
41 3 $#0,000 )1.1#69*
/1
5 $#0,000 )1.1#69*
/#
5 $#0,000 )1.1#69*
/&
3 $+7,+91
)rounding*
c. 41A& 3 $#0,000 H 1 8 )1.1#69*
/&
I 3 $+7,+91 )rounding*
0.1#69
P3-22. Answer parts a8c for each of the following cases. Answer parts a8c for each of the
following cases.
Case
Amount
of Initial
Deposit
($)
Stated
Annual
Rate, r (%)
Compounding
Frequency, m
(times/year)
Deposit
Period
(years)
A 2,500 6 2 5
B 50,000 12 6 3
C 1,000 5 1 10
D 20,000 16 4 6
a. -alculate the future value at the end of the specified deposit period.
. Letermine the effective annual rate )!"*.
c. -ompare the stated annual rate )r* to the effective annual rate)!"*. =hat relationship
e%ists etween compounding fre:uency and the stated and effective annual rates!
A3-22. a. -ompounding 0re:uency2 01n 3 41 )1 5 r*
n
A. 015 3 $#,500 )1.0&*
10
<. 01& 3 $50,000 )1.0#*
19
015 3 $#,500 )1.&++* 01& 3 $50,000 )1.+#9*
015 3 $&,&60 01& 3 $71,+1#
-. 0110 3 $1,000 )1.05*
10
L. 016 3 $#0,000 )1.0+*
#+
0110 3 $1,000 )1.6#,* 016 3 $#0,000 )#.56&*
0110 3 $1,6#, 016 3 $51,#66
. .ffective Annual ?ate2 .A? 3 1
m
r
1
m

,
_

+
A. .A? 3 )1 5 .06E#*
#
8 1 <. .A? 3 )1 5 .1#E6*
6
.A? 3 )1 5 .0&*
#
8 1 .A? 3 )1 5 .0#*
6
8 1
.A? 3 )1.061* 8 1 .A? 3 )1.1#6* 8 1
.A? 3 .061 3 6.16 .A? 3 .1#6 3 1#.66
-. .A? 3 )1 5 .05E1*
1
8 1 L. .A? 3 )1 5 .16E+*
+
8 1
.A? 3 )1 5 .05*
1
8 1 .A? 3 )1 5 .0+*
+
8 1
.A? 3 )1.05* 8 1 .A? 3 )1.170* 8 1
"his edition is intended for use outside of the (.$. only, with content that may e different from the (.$. .dition. "his may not e
resold, copied, or distriuted without the prior consent of the pulisher.
Chapter 3 The Time Value of Money 91
.A? 3 .05 3 56 .A? 3 .17 3 176
c. "he effective rates of interest rise with increasing compounding fre:uency.
P3-23. Pohn "ye has ;ust een hired as the new corporate finance analyst at 7/.ll .nterprises and
has received his first assignment. Pohn is to ta>e the $#5 million in cash received from a
recent divestiture and use part of these proceeds to retire an outstanding $10 million ond
issue and the remainder to repurchase common stoc>. However, the ond issue cannot e
retired for another two years. 7f Pohn can place the funds necessary to retire this $10
million det into an account earning 6 percent compounded monthly# how much of the $#5
million remains to repurchase stoc>!
A3-23. 41 of det oligation 3 $10,000,000 )1.005*
/#+
3 $9,971,957
0unds remaining for stoc> repurchase 3 $#5,000,000 8 $9,971,957 3 $16,1#9,1+&.
P3-24. Pason $pector has shopped around for the est interest rates for his investment of $10,000
over the ne%t year. He has found the following2
Stated Rate Compounding
6.10% Annual
5.90% Semiannual
5.85% Monthly
a. =hich investment offers Pason the highest effective rate of return!
. 'ow, assume that Pason wishes to invest his money for only si% months and the annual
compounded rate of 6.10 percent is not availale. =hich of the remaining investments
should Pason choose!

A3-24 a.
'om"nal 4ate Compoun$"n& 1ffe2t"5e Annual 4ate
6.106 Annual 6.106
5.,06 $emiannual
6 ,, . 5 1
#
5, . 0
1
#
+
,
_

5.956 Conthly
6 01 . 6 1
1#
0595 .
1
1#
+

,
_

"he annual/compounded rate of 6.106 is also the highest effective rate

. He would prefer the monthly compounding case ecause it offers a slightly higher
effective annual rate of interest.
P3-25. "ara -utler is newly married and is now preparing a surprise gift of a trip to .urope for her
husand on their tenth anniversary. "ara plans to invest $5,000 per year until that
anniversary and plans to ma>e her first $5,000 investment on their first anniversary. 7f she
earns an 9 percent rate on her investments, how much will she have saved for their trip if
the interest is compounded in each of the following ways!
a. Annually
. Ruarterly
c. Conthly
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resold, copied, or distriuted without the prior consent of the pulisher.
9# Instructors Manual

A3-25. a. .ffective rate 3 nominal rate 3 96
01A10 3 $5,000 H )1.09*
10
81 I 3 $7#,+&&
0.09

. .ffective rate 3 )1 5 .09*
+
81 3 9.#+6
+
01A10 3 $5,000 H )1.09#+*
10
81 I 3 $7&,#6+
0.09#+

c. .ffective rate 3 )1 5 .09*
1#
8 1 3 9.&0 6
1#
01A 3 $5,000 )1.09&*
10
81 3 $7&,+7&
0.09&
P3-26. You plan to invest $#,000 in an individual retirement arrangement )7?A* today at a stated
interest rate of 9 percent, which is e%pected to apply to all future years.
a. How much will you have in the account at the end of 10 years if interest is
compounded as follows!
)1* Annually
)#* $emiannually
)&* Laily )assume a &60/day year*
)+* -ontinuously
. =hat is the effective annual rate )!"* for each compounding period in part a!
c. How much greater will your 7?A account alance e at the end of 10 years if interest is
compounded continuously rather than annually!
d. How does the compounding fre:uency affect the future value and effective annual rate
for a given deposit! .%plain in terms of your findings in parts a8c.
A3-26. a. )1* 0110 3 $#,000 )1.09*
10
)#* 0110 3 $#,000 )1.0+*
#0
0110 3 $#,000 )#.15,* 0110 3 $#,000 )#.1,1*
0110 3 $+,&19 01 10 3 $+,&9#
)&* 0110 3 $#,000 )1.000##*
&600
)+* 0110 3 $#,000 e
.9
0110 3 $#,000 )#.#09* 0110 3 $#,000 )#.##6*
0110 3 $+,+16 0110 3 $+,+5#
. )1* .A? 3 )1 5 .09E1*
1
81 )#* .A? 3 )1 5 .09E#*
#
/1
.A? 3 )1 5 .09*
1
/ 1 .A? 3 )1 5 .0+*
#
/ 1
.A? 3 )1.09* 8 1 .A? 3 )1.0916* / 1
.A? 3 .09 3 96 .A? 3 .0916 3 9.166
)&* .A? 3 )1 5 .09E&60*
&60
8 1 )+* .A? 3 )e
>
8 1*
.A? 3 )1 5 .000##*
&60
8 1 .A? 3 )e
09
8 1*
.A? 3 )1.09#+* 8 1 .A? 3 )1.09&& 8 1*
.A? 3 .09#+ 3 9.#+6 .A? 3 .09&& 3 9.&&6
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resold, copied, or distriuted without the prior consent of the pulisher.
Chapter 3 The Time Value of Money 9&

c. "he 7?A account alance at the end of 10 years will e $1&+ )$+,+5# 8 $+,&19* larger
with continuous rather than annual compounding.
d. "he more fre:uently interest is compounded at a given nominal annual rate, the greater
the future value and the higher the effective annual rate, .A?.
P3-27. "o supplement your planned retirement in e%actly +# years, you estimate that you need to
accumulate $##0,000 y the end of +# years from today. You plan to ma>e e:ual annual
end/of/year deposits into an account paying 9 percent annual interest.
a. How large must the annual deposits e to create the $##0,000 fund y the end of +#
years!
. 7f you can afford to deposit only $600 per year into the account, how much will you
have accumulated y the end of the forty/second year!
A3-27. a. 4C" 3 01A+# H )15.09*
+#
8 1 I . 01A+# 3 4C" H )15.09*
+#
8 1 I
.09 .09
4C" 3 $##0,000 )&0+.#++* 01A+# 3 $600 )&0+.#++*
4C" 3 $7#&.10 01A+# 3 $19#,5+6.+0
P3-2. You are planning to purchase a uilding for $+0,000, and you have $10,000 to apply as a
down payment. You may orrow the remainder under the following terms2 a 10/year loan
with semiannual repayments and a stated interest rate of 6 percent. You intend to ma>e
$6,000 payments, applying the e%cess over your re:uired payment to the reduction of the
principal alance.
a. Jiven these terms, how long )in years* will it ta>e you to fully repay your loan!
. =hat will e your total interest cost!
c. =hat would your interest cost e if you made no prepayments and repaid your loan y
strictly adhering to the terms of the loan!
A3-2. a. ?e:uired 4ayment2
4C" 3 $&0,000 3 $&0,000 3 $#,016.+7
H 1 8 )1 5 S.06E#T
/# % 10
I 1 8 )1.0&*
/#0
.06 E# .0&

Amort"6at"on S2he$ule
Per"o$
%e&"nn"n&
%alan2e Pa7ment
8nterest
*./3 Pr"n2"pal+
Pr"n2"pal Prepa7
1n$"n&
%alan2e
1 $&0,000.00 $#,016.+7 $ ,00.00 $1,116.+7 $&,,9&.5& $#+,,00.00
# #+,,00.00 #,016.+7 7+7.00 1,#6,.+7 &,,9&.5& 1,,6+7.00
& 1,,6+7.00 #,016.+7 59,.+1 1,+#7.06 &,,9&.5& 1+,#&6.+1
+ 1+,#&6.+1 #,016.+7 +#7.0, 1,59,.&9 &,,9&.5& 9,66&.50
5 9,66&.50 #,016.+7 #5,.,1 1,756.56 &,,9&.5& #,,#&.+1
6 #,,#&.+1 #,016.+7 97.70 1,,#9.77 ,,+.6+ 0
$&,011.11
"he loan will e paid off in 6 periods or & years.
. "otal interest cost 3 $&,011.11
c. "otal interest cost with no prepayments2
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resold, copied, or distriuted without the prior consent of the pulisher.
9+ Instructors Manual

#0 $#,016.+7 8 $&0,000 3 $10,&#,.+0
P3-20. 0or e%cellent :ualitative discussions of the value of compounded interest on saving for
future )retirement* oligations, see the following wesites2
http2EEwww.prudential.comEretirement )4rudential 0inancial*
http2EEwww.vanguard.com )"he 1anguard Jroup*
http2EEwww.fid/inv.com )0idelity 7nvestments*
http2EEwww.loomerg.com )<loomerg*
=hat can you conclude aout the timing of cash flows and future values availale for
retirement, considering the information provided on these wesites!
A3-20. 7nternet e%ercise 8 answers will vary.
P3-3/. Poan Cessineo orrowed $15,000 at a 1+ percent annual interest rate to e repaid over
three years. "he loan is amorti@ed into three e:ual annual end/of/year payments.
a. -alculate the annual end/of/year loan payment.
. 4repare a loan amorti@ation schedule showing the interest and principal rea>down of
each of the three loan payments.
c. .%plain why the interest portion of each payment declines with the passage of time.
A3-3/. a. 4C" 3 $15,000 H 1 8 )1.1+*
/&
I
0.1+
4C" 3 $15,000 #.&#16&#
4C" 3 $6,+60.,7
.
1n$ of Loan %e&"nn"n& of Pa7ment 1n$ of )ear
)ear Pa7ment )ear Pr"n2"pal 8nterest Pr"n2"pal Pr"n2"pal
1 $ 6,+60.,7 $15,000.00 $#,100.00 $+,&60.,7 $10,6&,.0&
# 6,+60.,7 10,6&,.0& 1,+9,.+6 +,,71.51 5,667.5#
& 6,+60.,7 5,667.5# 7,&.+5 5,667.5# 0.00
c. "hrough annual end/of/year payments, the principal alance of the loan is declining, causing
less interest to e accrued on the alance in each suse:uent year.
P3-31. "o analy@e various retirement/planning options, chec> out the financial calculator at
<loomerg )http2EEwww.loomerg.com*. Letermine the effect of waiting versus
immediate planning for
retirement. =hat is the impact of changing interest/rate assumptions on your retirement
Unest eggV!
A3-31. 7nternet e%ercise 8 answers will vary.
P3-32. -raig and NaLonna Allen are trying to estalish a college fund for their son $pencer, who
;ust turned three today. "hey plan for $pencer to withdraw $10,000 on his eighteenth
irthday and $11,000, $1#,000, and $15,000 on his suse:uent irthdays. "hey plan to fund
these withdrawals with a 10/year annuity, with the first payment to occur one year from
today, and e%pect to earn an average annual return of 9 percent.
a. How much will the Allens have to contriute each year to achieve their goal!
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resold, copied, or distriuted without the prior consent of the pulisher.
Chapter 3 The Time Value of Money 95
. -reate a schedule showing the cash inflows )including interest* and outflows of this
fund. How much remains on $pencerDs twenty/first irthday!
A3-32. a. Amount needed at $pencerDs 1&
th
irthday )in 10 years*2
3 $10,000 )1.09*
/5
5 $11,000 )1.09*
/6
5 $1#,000 )1.09*
/7
5 $15,000 )1.09*
/9
3 $6,905.9& 5 $6,,&1.97 5 $7,001.99 5 $9,10+.0& 3 $#9,9+&.61
0unding payment H )1 5.09*
10
8 1 I 3 $#9,9+&.61
.09
0unding payment 1+.+9656# 3 $#9,9+&.61
0unding payment 3 $#9,9+&.61 3 $1,,,1.06
1+.+9656#

.
1n$ of Spen2er9s
%"rth$a7 )ear
:epos"t
*;"th$rawal+
%e&"nn"n&
%alan2e
1n$"n& %alan2e
*%e&"n %alan2e 1./+
+ $ 1,,,1.06 $ 1,,,1.06 $ #,150.&+
5 1,,,1.06 +,1+1.+0 +,+7#.7#
6 1,,,1.06 6,+6&.79 6,,90.99
7 1,,,1.06 9,,71.,+ ,,69,.6,
9 1,,,1.06 11,690.75 1#,615.#1
, 1,,,1.06 1+,606.#7 15,77+.79
10 1,,,1.06 17,765.9+ 1,,197.10
11 1,,,1.06 #1,179.16 ##,97#.+#
1# 1,,,1.06 #+,96&.+9 #6,95#.56
1& 1,,,1.06 #9,9+&.6# &1,151.11
1+ 0 &1,151.11 &&,6+&.#0
15 0 &&,6+&.#0 &6,&&+.65
16 0 &6,&&+.65 &,,#+1.+&
17 0 &,,#+1.+& +#,&90.7+
19 )10,000* &#,&90.7+ &+,,71.#0
1, )11,000* #&,,71.#0 #5,999.,0
#0 )1#,000* 1&,999.,0 15,000.00
#1 )15,000* 0
'othing remains in the account after the $15,000 withdrawal is made on $pencerDs #1
st

irthday.
P3-33. Jo to the home page of the <an>rate.com )http2EEwww.an>rate.com*, and otain current
average mortgage rates. =ith this information, go to Hugh -houDs mortgage calculator
)http2EEwww.interest.comEhughEcalcEsimple.org*. 4rovide the re:uested variales to create
an amorti@ation schedule. 'ow, re/create the schedule with different prepayment amounts.
=hat impact does the prepayment have on total interest and the term of the loan!
A3-33. 7nternet e%ercise 8 answers will vary.
P3-34. Cary $ullivan, capital outlay manager for =a%y =idgets, has een instructed to estalish a
contingency fund to cover the e%penses over the ne%t two years )#+ months* associated
with repairing defective widgets from a new production process. =a%y =idgetsD controller
wants to ma>e e:ual monthly cash deposits into this fund. 7f Cary faces the following
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96 Instructors Manual

monthly repair costs and has $1 million to start the fund today, what will e her monthly
payments into the fund in order to assume that all repair costs will e covered! Cary will
ma>e her first payment one month from today, and the fund will earn 6 percent,
compounded monthly.
Months Repair Costs per Month
14 $500,000
512 $250,000
1324 $100,000

A3-34. 4resent 1alue of 0uture Niailities 3 4resent 1alue of ?e:uired 0unding Annuity
)rate 3 .06E1# 3 .005F M periods 3 1# n*
$500,000 H 1 8 )1.005*
/+
I
.005
5 $#50,000 H1 8 )1.005*
/9
I )1.005*
/+
3 Annuity H18 )1.005*
/#+
I 5 $1,000,000
.005 .005
5$100,000 H 1 8 )1.005*
/1#
I )1.005*
/1#
.005
$+,,96,751 3 Annuity ##.56#, 5 1,000,000
$&,,96,750 3 Annuity ##.56#,
Annuity 3 $176,6,5
P3-35. (se a spreadsheet to create amorti@ation schedules for the following five scenarios. =hat
happens to the total interest paid under each scenario!
a. $cenario 12
Noan amount2 $1 million
Annual rate2 5 percent
"erm2 &60 months
4repayment2 $0
. $cenario #2 $ame as 1, e%cept annual rate is 7 percent
c. $cenario &2 $ame as 1, e%cept term is 190 months
d. $cenario +2 $ame as 1, e%cept prepayment is $#50 per month
e. $cenario 52 $ame as 1, e%cept loan amount is $1#5,000
A3-35. a.
%e&"nn"n& 1n$"n&
Per"o$ %alan2e Pa7ment 8nterest Pr"n2"pal %alan2e
1 $1,000,000.00 $5,&69.## $+,166.67 $1,#01.55 $,,9,7,9.+5
# $,,9,7,9.+5 $5,&69.## $+,161.66 $1,#06.56 $,,7,5,1.9,
& $,,7,5,1.9, $5,&69.## $+,156.6& $1,#11.59 $,,6,&90.&1
QQQQ Years in etween are not shown for practical purposes QQQQ
&59 $15,,71.&7 $5,&69.## $66.55 $5,&01.67 $10,66,.70
"his edition is intended for use outside of the (.$. only, with content that may e different from the (.$. .dition. "his may not e
resold, copied, or distriuted without the prior consent of the pulisher.
Chapter 3 The Time Value of Money 97
&5, $10,66,.70 $5,&69.## $++.+6 $5,&#&.76 $5,&+5.,+
&60 $5,&+5.,+ $5,&69.## $##.#7 $5,&+5.,+ $0.00
"otal $,&#,557.9+ $1,000,000.00
.
%e&"nn"n& 1n$"n&
Per"o$ %alan2e Pa7ment 8nterest Pr"n2"pal %alan2e
1 $1,000,000.00 $6,65&.0# $5,9&&.&& $91,.6, $,,,,190.&1
# $,,,,190.&1 $6,65&.0# $5,9#9.55 $9#+.+7 $,,9,&55.9+
& $,,9,&55.9+ $6,65&.0# $5,9#&.7+ $9#,.#9 $,,7,5#6.55
QQQQ Years in etween are not shown for practical purposes QQQQ
&59 $1,,7#9.+6 $6,65&.0# $115.09 $6,5&7.,+ $1&,1,0.5#
&5, $1&,1,0.5# $6,65&.0# $76.,+ $6,576.09 $6,61+.++
&60 $6,61+.++ $6,65&.0# $&9.59 $6,61+.++ $0.00
"otal $1,&,5,099.,9 $1,000,000.00
c.
%e&"nn"n& 1n$"n&
Per"o$ %alan2e Pa7ment 8nterest Pr"n2"pal %alan2e
1 $1,000,000.00 $7,,07.,+ $+,166.67 $&,7+1.#7 $,,6,#59.7&
# $,,6,#59.7& $7,,07.,+ $+,151.09 $&,756.96 $,,#,501.97
& $,,#,501.97 $7,,07.,+ $+,1&5.+# $&,77#.51 $,99,7#,.&6
QQQQ Years in etween are not shown for practical purposes QQQQ
179 $#&,5#7.+7 $7,,07.,+ $,9.0& $7,90,.,1 $15,717.57
17, $15,717.57 $7,,07.,+ $65.+, $7,9+#.+5 $7,975.1#
190 $7,975.1# $7,,07.,+ $&#.91 $7,975.1# $0.00
"otal $+#&,+#9.5& $1,000,000.00
d.
%e&"nn"n& 1n$"n&
Per"o$ %alan2e Pa7ment 8nterest Pr"n2"pal Prepa7 %alan2e
1 $1,000,000.00 $5,&69.## $+,166.67 $1,#01.55 $#50.00 $,,9,5+9.+5
# $,,9,5+9.+5 $5,&69.## $+,160.6# $1,#07.60 $#50.00 $,,7,0,0.95
& $,,7,0,0.95 $5,&69.## $+,15+.55 $1,#1&.67 $#50.00 $,,5,6#7.19
QQQQ Years in etween are not shown for practical purposes QQQQ
QQQ =ith the prepayment of $#50.00 per month youDll have paid the loan in full y month &#6QQQ
&#+ $1&,977.&, $5,&69.## $57.9# $5,&10.&, $#50.00 $9,&17.00
&#5 $9,&17.00 $5,&69.## $&+.65 $5,&&&.56 $#50.00 $#,7&&.+&
&#6 $#,7&&.+& $5,&69.## $11.&, $#,7&&.+& $0.00 $0.00
"otal $9#9,665.10 $,19,750.00 $91,#50.00
4rincipal 5 4repay $1,000.000.00
e.
%e&"nn"n& 1n$"n&
Per"o$ %alan2e Pa7ment 8nterest Pr"n2"pal %alan2e
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99 Instructors Manual

1 $1#5,000.00 $671.0& $5#0.9& $150.1, $1#+,9+,.91
# $1#+,9+,.91 $671.0& $5#0.#1 $150.9# $1#+,6,9.,,
& $1#+,6,9.,, $671.0& $51,.59 $151.+5 $1#+,5+7.5+
QQQQ Years in etween are not shown for practical purposes QQQQ
&59 $1,,,6.+# $671.0& $9.&# $66#.71 $1,&&&.71
&5, $1,&&&.71 $671.0& $5.56 $665.+7 $669.#+
&60 $669.#+ $671.0& $#.79 $669.#+ $0.00
"otal $116,56,.7& $1#5,000.00
P3-36. Letermine the annual payment re:uired to fund a future annual annuity of $1#,000 per
year. You will fund this future liaility over the ne%t five years, with the first payment to
occur one year from today. "he future $1#,000 liaility will last for four years, with the
first payment to occur seven years from today. 7f you can earn 9 percent on this account,
how much will you have to deposit each year over the ne%t five years to fund the future
liaility!
A3-36. 4resent 1alue of 0uture Niaility 3 4resent 1alue of 0unding Annuity
H 1 8 )1.09*
/+
I )1.09*
/6
$1#,000 3 H 1 8 )1.09*
$%
I 0unding annuity
.09 .09
$#5,0+6.+# 3 &.,,#71 0unding annuity
0unding annuity 3 $6,#7&.0+
A$$"t"onal Appl"2at"ons of 3"me-Value 3e2hn"<ues
P3-37. Pill -hew wishes to choose the est of four immediate retirement annuities availale to her.
7n each case, in e%change for paying a single premium today, she will receive e:ual annual
end/of/year cash enefits for a specified numer of years. $he considers the annuities to e
e:ually ris>y and is not concerned aout their differing lives. Her decision will e ased
solely on the rate of return she will earn on each annuity. "he >ey terms of each of the four
annuities are shown in the following tale.
Annu"t7
Prem"um
Pa"$ 3o$a7
Annual
%enef"t
L"fe
*7ears+
A $&0,000 $&,100 #0
< #5,000 &,,00 10
- +0,000 +,#00 15
L &5,000 +,000 1#
a. -alculate to the nearest 1 percent the rate of return on each of the four annuities Pill is
considering.
. Jiven PillDs stated decision criterion, which annuity would you recommend!
A3-37. a. Noan A Noan <
$&0,000 3 $&,100 )410A#r, #0 yrs.* $#5,000 3 $&,,00 )410Ar&,10 yrs.*
,.677 3 410A r&, #0 yrs.* 6.+10 3 4170A r&, 10 yrs.
r 3 96 r 3 ,6
-alculator solution2 9.1,6 -alculator solution2 ,.0&6
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Chapter 3 The Time Value of Money 9,
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,0 Instructors Manual

Noan - Noan L
$+0,000 3 $+,#00 )410Ar&, 15 yrs.* $&5,000 3 $+,000 )410Ar&# 1# yrs.*
,.5#+ 3 410Ar&, 15 yrs. 9.75 3 4170Ar&, 1# yrs.
r 3 66 r 3 56
-alculator solution2 6.&06 -alculator solution2 5.#&6
. Annuity < gives the highest rate of return at ,6 and would e the one selected ased
upon ?ainaWsDcriteria.
P3-3. Nog on to C$' Coney )http2EEwww.investor.msn.com*, and select five stoc>s to analy@e.
(se their returns over the last five years to determine the value of $1,000 invested in each
stoc> five years ago. =hat is the compound annual rate of return for each of the five stoc>s
over the 5/year period!
A3-3. 7nternet e%ercise 8 answers will vary.
P3-30. You are the pension fund manager for "an;uDs "offees, and your -0O has ;ust made a
re:uest of you. "he -0O wants to >now the minimum annual return re:uired on the
pension fund in order to ma>e all re:uired payments over the ne%t five years and not
diminish the current asset ase. "he fund currently has assets of $500 million.
a. Letermine the re:uired return if outflows are e%pected to e%ceed inflows y $50
million per year.
. Letermine the re:uired return with the following fund cash flows.
End of Year Inflows Outflows
1 $55,000,000 $100,000,000
2 60,000,000 110,000,000
3 60,000,000 120,000,000
4 60,000,000 135,000,000
5 64,000,000 145,000,000
c. -onsider the cash flows in part . =hat will happen to your asset ase if you earn 10
percent! #0 percent!

A3-30. a. $50,000,000 3 106
$500,000,000
'et OutflowsQ
. $500,000,000 3 $ +5,000,000 ) 15 r*
/1
5 50,000,000 )1 5 r*
/#
5 60,000,000 )1 5 r*
/&
5 75,000,000 )1 5 r*
/+
5 91,000,000 )1 5 r*
/5
5 500,000,000 )1 5 r*
/5
Q Outflows 8 inflows in each year.
(sing trial and error techni:ues or a financial calculator results in a re:uired rate of
return of 1#6 to fund the difference etween inflows and outflows over the ne%t five
"his edition is intended for use outside of the (.$. only, with content that may e different from the (.$. .dition. "his may not e
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Chapter 3 The Time Value of Money ,1
years without depleting the asset ase of $500,000,000.
c. .arning less than 1#6 will diminish the asset ase while earning greater than 1#6 will
grow the asset ase.
P3-4/. You plan to start saving for your sonDs college education. He will egin college when he
turns 19 years old and will need $+,000 at that time and in each of the following three
years. You will ma>e a deposit at the end of this year in an account that pays 6 percent
compounded annually, and an identical deposit at the end of each year, with the last deposit
occurring when he turns 19. 7f an annual deposit of $1,+9+ will allow you to reach your
goal, how old is your son now!
A3-4/. 41 of funding annuity 3 41 of college e%pense annuity
$1,+9+ H 1/ )1.06*
/n
I 3 $+,000 H1 8 )1.06*
/+
I )1.06*
/Hn 81I
.06 .06
$1,+9+ H 1/)1.06*
/n
I 3 $1&,960.+# )1.06*
/Hn/1I
.06
1ia trial and error or a financial calculator, solve for n 3 9.
"hus, your son will turn 19 eight years from today and is 10 years old now.
P3-41. Letermine the length of time re:uired to doule the value of an investment, given the
following rates of return.
a. + percent
. 10 percent
c. &0 percent
d. 100 percent
A3-41. a. 01 3 41 )1 5 r*
n
#.0 3 )1.0+*
n
log# 3 nlog1.0+
0.&01 3 n 0.017
n 3 17.7 years
. #.0 3 )1.1*
n
log# 3 nlog1.1
0.&01 3 n 0.0+1+
n 3 7.#7 years
c. #.0 3 )1.&'
n
log# 3 nlog1.&
0.&01 3 n 0.11&,
n 3 #.6+ years
d. #.0 3 )#'
n
n 3 1 year
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,# Instructors Manual

P3-42. -onsider the following three investments of e:ual ris>. =hich offers the greatest rate of
return!
8n5estment
1n$ of )ear A % C
0 /$10,000 /$#0,000 /$#5,000
1 0 ,,500 #0,000
# 0 ,,500 &0,000
& #+,600 ,,500 /1#,600
A3-42. 'ote that all returns were calculated using a financial calculator.
?eturn on 7nvestment A2
$#+,600 3 $10,000 ) 1 5 r *
&
r 3 &56
?eturn on 7nvestment <2
$#0,000 3 $,,500 H 1 8 )1 5 r *
/&
I
r
r 3 #06
?eturn on 7nvestment -2
$#5,000 3 $#0,000 x )1 5 r *
/1
5 $&0,000 )1 5 r *
/#
/ $1#,600 )1 5 r *
/&
r 3 +06
P3-43. You are given the series of cash flows shown in the following tale.
Cash Flows
Year A B C
1 $500 $1,500 $2,500
2 560 1,550 2,600
3 640 1,610 2,650
4 720 1,680 2,650
5 800 1,760 2,800
6 1,850 2,850
7 1,950 2,900
8 2,060
9 2,170
10 2,280
a. -alculate the compound annual growth rate associated with each cash flow stream.
. 7f year/1 values represent initial deposits in a savings account paying annual interest,
what is the annual rate of interest earned on each account!
c. -ompare and discuss the growth rate and interest rate found in parts a and ,
respectively.
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Chapter 3 The Time Value of Money ,&
A3-43. a. 41 3 01n
( )
1
]
1

+
n
r 1
1
.
-ase -ase
A 41 3 01+ 410r6,yrs A $ame value
$500 3 $900 410r6, + yrs
.6#5 3 410r6,+ yrs
1#6 X r X 1&6
-alculator $olution2 1#.+76
< 41 3 016 410r6, 6 yrs < $ame value
$1,500 3 $1,,50 410r6, 6 yrs.
.76, 3 410r6, 6 yrs.
+6XrX56
-alculator solution2 +.+76
- 41 3 01, 410r6,, - $ame value
$#,#90 3 $#,500 410r6, , yrs.
.,1# 3 410r6, , yrs.
16XrX#6
-alculator solution2 1.0&6
c. "he growth and the interest rate should e e:ual, ecause they represent the same
thing.
P3-44. Letermine which of the following three investments offers you the highest rate of return on
your $1,000 investment over the ne%t five years.
7nvestment 12 $#,000 lump sum to e received in five years
7nvestment #2 $&00 at the end of each of the ne%t five years
7nvestment &2 $#50 at the eginning of each of the ne%t five years
a. =hich investment offers the highest return!
. =hich offers the highest return if the payouts are douled )i.e., $+,000, $600, and
$500*!
c. =hat causes the ig change in the returns on the annuities!
A3-44. a. ?eturn on 7nvestment M 12
$#,000 3 $1,000 )1 5 r*
5
#.0 3 )1 5 r *
5

)#.0*
1E5
3 1 5 r
1.1+97 3 1 5 r
r = 1+.976
?eturn on 7nvestment M #2
$1,000 3 $&00 1 H 1 8 1 I
r )15r*
n

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resold, copied, or distriuted without the prior consent of the pulisher.
,+ Instructors Manual


1ia trial and error or a financial calculator2 r 15.#+6
?eturn on 7nvestment M &2
$1,000 3 $#50 1 H 1 8 1 I )1 5 r*
r )1 5 r *
n
1ia trial and error or a financial calculator2 r 1#.5,6

"hus, 7nvestment M # has the highest return.
. ?eturn on 7nvestment M 12
$+,000 3 $1,000 )1 5 r *
5
r 3 &1.,56
?eturn on 7nvestment M#2
$1,000 3 600 1 H 1 8 1 I
r )1 5 r *
n
r 5#.906

?eturn on 7nvestment M &2
$1,000 3 $500 1 H 1 8 1 I )1 5 r*
r )1 5 r *
n
r ,#.766
"hus, 7nvestment M & has the highest return.
c. "he annuities have much greater sensitivity ecause their intermediate cash flows are
reinvested whereas the lump sum investment does not generate any intermediate cash
flows that can e reinvested.
P3-45. 0ind the rates of return re:uired to do the following2
a. Loule an investment in + years
. Loule an investment in 10 years
c. "riple an investment in + years
d. "riple an investment in 10 years
A3-45. 01 3 41 )1 5 r*
+
a. #.0 3 )1 5 r*
+
)#*
Y
3 )1 5 r*
1.19,#07 3 1 5 r
r 19.,#6
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Chapter 3 The Time Value of Money ,5
. #.0 3 )15 r*
10
)#*
1E10
3 )15 r*
1.07177& 3 1 5 r
r 7.196
c. &.0 3 )15 r'
+
)&*
1E+
3 )1 5 r*
1.&1607 3 1 5 r
r &1.616

d. &.0 3 )15 r'
10
)&*
1E10
3 )1 5 r*
1.1161#& 3 1 5 r
r 3 11.616

P3-46. "he viatical industry offers a rather grim e%ample of present value concepts. A firm in this
usiness, called a viator, purchases the rights to the enefits from a life insurance contract
from a terminally ill client. "he viator may then sell claims on the insurance payout to
other investors. "he industry egan in the early 1,,0s as a way to help A7L$ patients
capture some of the proceeds from their life insurance policies for living e%penses.
$uppose a patient has a life e%pectancy of 19 months and a life insurance policy with a
death enefit of $100,000. A viator pays $90,000 for the right to the enefit, and then sells
that claim to another investor for $90,500.
a. 0rom the point of view of the patient, this contract is li>e ta>ing out a loan. =hat is the
compound annual interest rate on the loan if the patient lives e%actly 19 months! =hat
if the patient lives &6 months!
. 0rom the point of view of the investor, this transaction is li>e lending money. =hat is
the compound annual interest rate earned on the loan if the patient lives 19 months!
=hat if the patient lives ;ust 1# months!
A3-46. a. 90,000 3 100,000E)15r*
1.5
r 3 166, if the patient lives 19 months
90,000 3 100,000E)15r*
&
r 3 7.76, if the patient lives &6 months
. 90,500 3 100,000E)15r*
1.5
r 3 15.756, if the patient lives 19 months
90,500 3 100,000E)15r*
r 3 #+.&6, if the patient lives 1# months
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,6 Instructors Manual

3=>!S>' >'1 %us"ness S2hool 1$"t"on? $ince P3-47 and P3-4 are ased on using a live
data ase, answers will vary from moment to moment. "his is a chance for your students to use a
version of a tool that -0As use every day. 7f you would li>e to use "homson O'. ut are unsure
aout how to proceed, contact your rep for copies of ! (uide to )sing Thomson *ne +, y
?osemary -arlson at Corehead $tate (niversity. Her guide will lead you through this powerful
tool availale to your students with the purchase of any new copy of this te%t.
Answer to MiniCase
Present Value
-asino.com -orporation is uilding a $#5 million office uilding in Nas 1egas and is financing the
construction at an 90 percent loan/to/value ratio, where the loan is in the amount of $#0,000,000.
"his loan has a ten/year maturity, calls for monthly payments, and is contracted at an interest rate
of 9 percent.
Ass"&nment
(sing the aove information, answer the following :uestions.
1. =hat is the monthly payment!
#. How much of the first payment is interest!
&. How much of the first payment is principal!
+. How much will -asino.com -orporation owe on this loan after ma>ing monthly payments for
three years )the amount owed immediately after the thirty/si%th payment*!
5. $hould this loan e refinanced after three years with a new seven/year 7 percent loan, if the
cost to refinance is $#50,000! "o ma>e this decision, calculate the new loan payments and then
the present value of the difference in the loan payments.
6. ?eturning to the original ten/year 9 percent loan, how much is the loan payment if these
payments are scheduled for :uarterly rather than monthly payments!
7. 0or this loan with :uarterly payments, how much will -asino.com -orporation owe on this
loan after ma>ing :uarterly payments for three years )the amount owed immediately after the
twelfth payment*!
9. =hat is the annual percentage rate on the original ten/year 9 percent loan!
,. =hat is the effecti-e annual rate .!"' on the original ten/year 9 percent loan!
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Chapter 3 The Time Value of Money ,7
Answers
1. 41 3 #0,000,000
n 3 10 1# 3 1#0
i 3 9E1# 3 .6667
Conthly payment 3 4C" 3 $#+#,655.1,
#. 7nterest 3 Noan amount Conthly interest rate
3 $#0,000,000 96E1#
3 $1&&,&&&.&&
&. 4rincipal first month 3 Conthly payment 8 7nterest first month
3 $#+#,655.1, 8 $1&&,&&&.&&
3 $10,,&#1.96
+. 7 Years 1# Conths 3 9+ 4ayments remaining
4C" 3 $#+#,655.1,
n 3 9+
i 3 96E1# 3 .6667
4rincipal after & years 3 41 3 $15,569,577.6#
5. 'ew loan payments2
41 3 $15,569,577.6#
n 3 7 Years 1# Conths 3 9+ Conths
i 3 76E1# 3 .59&&
4C" 3 $#&+,,71.55
Lifference in loan payments 3 $#+#,655.1, 8 $#&+,,71.55 3 $769&.6&
4resent value of difference2
4C" 3 $7,69&.6&
n 3 7 Years 1# Conths 3 9+
i 3 76E1# 3 .59&&
41 3 $50,,0,6.+9
$ince savings from refinancing is greater than the cost to refinance )$50,,0,6.+9 Z $#50,000*,
then the loan should e refinanced.
6. 41 3 $#0,000,000
n 3 10 Years + Ruarters 3 +0 Ruarters
i 3 96E+ 3 #6
Ruarterly payments 3 4C" 3 $7&1,11+.,6
7. n 3 7 Years + Ruarters 3 #9
i 3 96E+ 3 #6
4C" 3 $7&1,11+.,6
Amount owed after & years 3 41 3 $15,55,,056.50
9. Annual percentage rate 3 96
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,9 Instructors Manual

,. .A? 3 )1 5 r *
m
8 1
#70& . +
* 055 . 1 )
1
1
055 . 0
1
* r 1 )
1
1
r
1
5 n

1
]
1

1
]
1

+

"his edition is intended for use outside of the (.$. only, with content that may e different from the (.$. .dition. "his may not e
resold, copied, or distriuted without the prior consent of the pulisher.