Questions and Problems:

2 Calculating Future Compute the future value of $1,000 compounded annually for
Values a. 10 years at 6 percent
b. 10 years at 12 percent
c. 20 years at 6 percent
d. Why is the interest earned in part (c) not twice the amount earned in part
(a)?

Answers:

Formula:
Future Value of an Investment :

*C0 = the cash to be invested at date 0, r =

interest rate per period, T = the number of
periods over which the cash is invested

Calculation:
a) 10 years at 6%
FV = $1,000*(1+6%)^10
FV = $1,791

b) 10 years at 12%
FV = $1,000*(1+12%)^10
FV = $3,106

c) 20 years at 6%
FV = $1,000*(1+6%)^20
FV = $3,207

d) Why is the interest earned in part (c ) not twice the amount earned in part (a)?
Because future value of cash is counted based on the interest compounding
10 years = 1.0610 179%
20 years = 1.0620 321%
ed annually for

e the amount earned in part

Questions and Problems:

13 Calculating An investment offers $5,650 per year for 15 years, with the first payment occurring on
Annuity Present required return is 8 percent, what is the value of the investment? What would the valu
Value occurred for 40 years? For 75 years? Forever?

Answers:

Formula:
Present Value of Annuity:

*C = cash, r = interest rate per period, T = the number of periods over which the cash is invested

Manual Calculation:
15 years 75 years
PV = C*((1-(1/((1+r)T)))/r) PV =
PV = $5,650*((1-(1/((1+8%)^15)))/8%) PV =
PV = $48,361 PV =

40 years
PV = C*((1-(1/((1+r)T)))/r)
PV = $5,650*((1-(1/((1+8%)^40)))/8%)
PV = $67,374

Spreadsheet Calculation:
15 years
Payment amount per period $5,650
Number of payments 15
Discount rate 0.08
Annuity present value =PV(0.08,15,-5650,0)
Annuity present value $48,361

40 years
Payment amount per period $5,650
Number of payments 40
Discount rate 0.08
Annuity present value =PV(0.08,40,-5650,0)
Annuity present value $67,374
 s, with the first payment occurring one year from now. If the
the investment? What would the value be if the payments

he cash is invested

C*((1-(1/((1+r)T)))/r)
$5,650*((1-(1/((1+8%)^75)))/8%)
$70,405

75 years
Payment amount per period $5,650
Number of payments 75
Discount rate 0.08
Annuity present value =PV(0.08,75,-5650,0)
Annuity present value $70,405
Questions and Problems:

16 Calculating APR Find the APR, in each of the following cases:

Number of Times
APR Compounded EAR
Semiannually 8.9%
Monthly 18.8%
Weekly 10.4%
Infinite 13.6%

Answers:

Formula:
Effective Annual Rate (EAR): Continuous Coumpunding Effective Annual Rate
EAR = (1 + r/m) - 1
m
EAR = erT - 1
*m = times a year, r = annual percentage rate *e = constant and approximately equal to 2.718,
(APR) r = annual percentage rate (APR), T = number of
years over

Hence, Annual Percentage Rate (APR):
APR = ((EAR + 1)1/m-1)*m
*m = times a year, EAR = effective annual rate
Hence, Continuous Coumpunding Annual Percen
APR = e Log (EAR+1)
*e = constant and approximately equal to 2.718,
EAR = effective annual rate, T = number of years
over

Calculation:
1) Semiannually (m = 2), EAR 8.9% 3) Weekly (m = 52), EAR 10.4%
APR = ((8.9%+1)1/2-1)*2 APR =
APR = 8.7% APR =

2) Monthly (m = 12), EAR 18.8% 4) Infinite (T = 1), EAR 13.6%

APR = ((18.8%+1) -1)*12
1/12
APR =
APR = 17.4% APR =

Number of Times
APR EAR
Compounded
8.7% Semiannually 8.9%
17.4% Monthly 18.8%
9.9% Weekly 10.4%
12.8% Infinite 13.6%
uous Coumpunding Effective Annual Rate (EAR):
EAR = erT - 1
nstant and approximately equal to 2.718,
ual percentage rate (APR), T = number of
ver

Continuous Coumpunding Annual Percentage Rate (APR):

APR = e Log (EAR+1)
nstant and approximately equal to 2.718,
ffective annual rate, T = number of years

(m = 52), EAR 10.4%

((10.4%+1)1/52-1)*52
9.9%

(T = 1), EAR 13.6%

Log (13.6%+1)
2.718

12.8%
Questions and Problems:

27 Perpetuities A prestigious investment bank designed a new security that pays a quarterly dividend of $
The first dividend occurs one quarter from today. What is the price of the security if the A
compounded quarterly?

Answers:

Formula:
Present Value of Perpetuity:

*C is the cash flow to be received one period, r

is the appropriate discount rate

Calculation:
Present Value of Perpetuity:
PV = ($2.75*4)/5.3%
PV = $208

So, price of the security is $208

 ecurity that pays a quarterly dividend of $2.75 in perpetuity.
y. What is the price of the security if the APR is 5.3 percent,
Questions and Problems:

31 Calculating You receive a credit card application from Shady Banks Savings and Loan offering an introd
Interest Expense percent per year, compounded monthly for the first six months, increasing thereafter to 1
compounded monthly. Assuming you transfer the $10,800 balance from your existing cred
subsequent payments, how much interest will you owe at the end of the first year?

Answers:

Formula:
Future Value of an Investment :

*C0 = the cash to be invested at date 0, r =

interest rate per period, T = the number of
periods over which the cash is invested

Calculation:
a) FV of a lumpsum for 6 months, with interest 2.4%
FV = $10,800*((1+2.4%/12))^6
FV = $10,930

b) FV of a lumpsum for another 6 months, with interest 18%

FV = $10,930*((1+18%/12))^6
FV = $11,951

c) How much interest will you owe at the end of the first year?
Interest = FV with interest 18% - transfer balance
Interest = $11,951 - $10,800 = $1,151
 Banks Savings and Loan offering an introductory rate of 2.40
first six months, increasing thereafter to 18 percent
e $10,800 balance from your existing credit card and make no
ou owe at the end of the first year?
Questions and Problems:

42 Present Value and Consider a firm with a contract to sell an asset for $135,000 three years from now. The as
Break-Even produce today. Given a relevant discount rate on this asset of 13 percent per year, will the
Interest on this asset? At what rate does the firm just break even?

Answers:

Formula:
Present Value of Investment: Hence, break even interest:
r = (CT/PV)1/T-1

*CT is the cash flow at date T and r is the

appropriate discount rate

Calculation:
PV of the sales price Profit on asset
PV = $135,000/(1+13%)^ 3
Profit =
PV = $93,562 Profit =

Interest rate for break even

r = $135,000/$89,000^(1/3)-1
r = 14.9%
or $135,000 three years from now. The asset costs $89,000 to
n this asset of 13 percent per year, will the firm make a profit
eak even?

break even interest:

r = (CT/PV)1/T-1

$93,562 - $89,000
$4,562
Questions and Problems:

45 Comparing Cash You have your choice of two investment accounts. Investment A is a 15-year annuity that
Flow Streams month $1,300 payments and has an interest rate of 7.2 percent compounded monthly. Inv
percent continuously compounded lump-sum investment, also good for 15 years. How mu
you need to invest in B today for it to be worth as much as Investment A 15 years from no

Answers:

Formula:
Effective Annual Rate (EAR):

*r is the annual percentage rate (APR), m is

times a year

Future Value of Annuity: Future Value with Continuous Compounding:

*C is the cash flow to be received one period, r is the * C0 is the initial investment, r is the APR, and T is
appropriate discount rate number of years, e is a constant and is approxima
to 2.718

Calculation:
EAR for 1 month, compounded monthly
EAR = (1+(7.2%/12))^1-1
EAR = 0.6%

Future value of anuity - investment A The initial for investment B to be worth as much
FV = $1,300*((((1+0.6%)^180)/0.6%)-(1/0.6%)) C0 =
FV = $419,292 C0 =
 s. Investment A is a 15-year annuity that features end-of-
e of 7.2 percent compounded monthly. Investment B is an 8
vestment, also good for 15 years. How much money would
s much as Investment A 15 years from now?

Value with Continuous Compounding:

FV =

he initial investment, r is the APR, and T is the

r of years, e is a constant and is approximately equal
8

tial for investment B to be worth as much as investment A

$419,292/(2.718^(8%*15))
$126,304
Questions and Problems:

56 Balloon Payments On September 1, 2013, Susan Chao bought a motorcycle for $34,000. She paid $2,000 dow
balance with a five-year loan at an annual percentage rate of 7.2 percent, compounded m
the monthly payments exactly one month after the purchase (i.e., October 1, 2013). Two
end of October 2015, Susan got a new job and decided to pay off the loan. If the bank cha
prepayment penalty based on the loan balance, how much must she pay the bank on Nov

Answers:

Formula:
Effective Annual Rate (EAR): Present Value of Annuity:

*C is the cash flow to be received one period, r

*r is the annual percentage rate (APR), m is is the appropriate discount rate
times a year

Calculation:
EAR for 1 month, compounded monthly
EAR = (1+(7.2%/12))^1-1
EAR = 0.6%

Total financed Monhtly installment

= $34,000 - $2,000 C = $32,000/((1-(1/(1+0.6%)^60))/0.6%)
= $32,000 C = $637

The loan balance or PV of remaining installment after Nov 1, 2015 (34 times)
PV = $637*((1-(1/(1+0.6%)^34))/0.6%)
PV = $19,529

Total should be paid on Nov 1, 2015

Monthly installment on Nov 1, 2015 $637
The loan balance $19,529
Prepayment penalty 1% of the loan balance $195
Total payment $20,361
otorcycle for $34,000. She paid $2,000 down and financed the
ntage rate of 7.2 percent, compounded monthly. She started
the purchase (i.e., October 1, 2013). Two years later, at the
ecided to pay off the loan. If the bank charges her a 1 percent
how much must she pay the bank on November 1, 2015?

w to be received one period, r

discount rate

0/((1-(1/(1+0.6%)^60))/0.6%)
Questions and Problems:

59 Calculating An All-Pro defensive lineman is in contract negotiations.

Annuity Values The team has offered the following salary structure:
Time Salary
0 $8,500,000
1 $3,900,000
2 $4,600,000
3 $5,300,000
4 $5,800,000
5 $6,400,000
6 $7,300,000
All salaries are to be paid in a lump sum. The player has asked you as his agent to renegotiate the terms. He w
signing bonus payable today and a contract value increase of $2,700,000. He also wants an equal salary paid
with the first paycheck three months from now. If the interest rate is 5.7 percent
compounded daily, what is the amount of his quarterly check? Assume 365 days in a year

Answers:

Formula:
Effective Annual Rate (EAR): Present Value of Annuity:

*C is the cash flow to be received one period, r

*r is the annual percentage rate (APR), m is is the appropriate discount rate
times a year

Calculation:
EAR for 1 year, compounded daily EAR for 1 quarter, compounded daily
EAR = (1+(5.7%/365))^ -1 365
EAR = (1+(5.7%/365))^(365/4)-1
EAR = 5.9% EAR = 1.4%

Sum of the PV cash flow

Time Salary Present values Formula used

0 $8,500,000 $8,500,000 =PV($C$29,B33,0,-C33)

1 $3,900,000 $3,683,933 =PV($C$29,B34,0,-C34)
2 $4,600,000 $4,104,423 =PV($C$29,B35,0,-C35)
3 $5,300,000 $4,467,014 =PV($C$29,B36,0,-C36)
4 $5,800,000 $4,617,603 =PV($C$29,B37,0,-C37)
5 $6,400,000 $4,812,998 =PV($C$29,B38,0,-C38)
6 $7,300,000 $5,185,680 =PV($C$29,B39,0,-C39)
PV $35,371,652

With assumption contract value increase of $2,700,000 and a signing bonus payable today of $10,000,000,
then the remaining amount will be the PV of the quarterly paychecks:
PV = $35,371,652 + $2,700,000 - $10,000,000
PV = $28,071,652

Quaterly check
C = $28,071,652/((1-(1/(1+1.4%)^24))/1.4%)
C = $1,390,910
*T = 24, with assumption 4 times a year for 6 years
 tiations.
ure:

s his agent to renegotiate the terms. He wants a $10 million

0,000. He also wants an equal salary paid every three months,
s 5.7 percent
me 365 days in a year

w to be received one period, r

discount rate

compounded daily
%/365))^(365/4)-1

ayable today of $10,000,000,

Questions and Problems:

70 Perpetual Cash What is the value of an investment that pays $50,000 every other year forever, if the first
Flows year from today and the discount rate is 13 percent compounded daily? What is the value
payment occurs four years from today? Assume 365 days in a year

Answers:
"every other year" means "every two years"

Formula:
Effective Annual Rate (EAR):

*r is the annual percentage rate (APR), m is times a year

Present Value of Perpetuity: Present Value of Investment:

*C is the cash flow to be received one period, r *CT is the cash flow at date T and r is the
is the appropriate discount rate appropriate discount rate

Calculation:
EAR for 1 year, compounded daily EAR for 2 years, compounded daily
EAR = (1+(13%/365))^ -1 365
EAR = (1+(13%/365))^(365*2)-1
EAR = 13.9% EAR = 29.7%

a) The value of investment

PV = $50,000/29.7%
PV = $168,424

b) The value today if the first payment occurs four years from today
PV = $168,424/(1+13.9%)^2
PV = $129,869
If the first payment occurs four years from today, then we can calculate PV for 2 years of the value of investment
0,000 every other year forever, if the first payment occurs one
ent compounded daily? What is the value today if the first
365 days in a year

w at date T and r is the

unt rate

ompounded daily
%/365))^(365*2)-1

2 years of the value of investment