CHAPTER 6 DISCOUNTED CASH FLOW VALUATION

Learning Objectives LO1 LO2 LO3 LO4 How to determine the future and present value of investments with multiple cash flows. How loan payments are calculated and how to find the interest rate on a loan. How loans are amortized or paid off. How interest rates are quoted (and misquoted).

Answers to Concepts Review and Critical Thinking Q estions 1! 2! 3! 4! "LO1# The four pieces are the present value (PV), the periodic cash flow ( C), the discount rate (r), and the number of payments, or the life of the annuity, t. "LO1# ssumin! positive cash flows, both the present and the future values will rise. "LO1# ssumin! positive cash flows, the present value will fall and the future value will rise. "LO1# "t#s deceptive, but very common. The basic concept of time value of money is that a dollar today is not worth the same as a dollar tomorrow. The deception is particularly irritatin! !iven that such lotteries are usually !overnment sponsored$ "LO1# "f the total money is fi%ed, you want as much as possible as soon as possible. The team (or, more accurately, the team owner) wants &ust the opposite. "LO1# The better deal is the one with equal installments.

$! %!

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&ol tions to Q estions and 'roble(s

NOTE: All end of chapter problems were solved using a spreadsheet. Many problems re uire multiple steps. !ue to space and readability constraints" when these intermediate steps are included in this solutions manual" rounding may appear to have occurred. #owever" the final answer for each problem is found without rounding during any step in the problem. Basic 1! "LO1# To solve this problem, we must find the PV of each cash flow and add them. To find the PV of a lump sum, we use' PV ( )V * (+ , r$t PV-+./ ( 012. * +.+. , 0+,.3. * +.+.4 , 0+,+5. * +.+.5 , 0+,.62 * +.+.3 ( 055.7.56 PV-+8/ ( 0+,12. * +.+8 , 0+.3. * +.+84 , 0++5. * +.+85 , 0+,.62 * +.+83 ( 04,613.44 PV-43/ ( 012. * +.43 , 0+.3. * +.434 , ++5. * +.435 , 0+,.62 * +.433 ( 04,381.88 2! "LO1# To find the PV , we use the equation' PV ( C(9+ : ;+*(+ , r$t< = * r ) t a 2 percent interest rate' >-2/' ?-2/' PV ( 07,...9;+ : (+*+..2)1 < * ..2 = ( 034,737.15 PV ( 08,...9;+ : (+*+..2)7< * ..2 = ( 03.,7.2.23

nd at a +2 percent interest rate' >-44/' PV ( 07,...9;+ : (+*+.+2)1 < * .+2 = ( 048.741.2. ?-44/' PV ( 08,...9;+ : (+*+.+2)7 < * .+2 = ( 05.,462.87 @otice that the PV of cash flow > has a !reater PV at a 2 percent interest rate, but a lower PV at a 44 percent interest rate. The reason is that > has !reater total cash flows. t a lower interest rate, the total cash flow is more important since the cost of waitin! (the interest rate) is not as !reat. t a hi!her interest rate, ? is more valuable since it has lar!er cash flows at the be!innin!. t the hi!her interest rate, these bi!!er cash flows early are more important since the cost of waitin! (the interest rate) is so much !reater. 3! "LO1# To solve this problem, we must find the )V of each cash flow and add them. To find the )V of a lump sum, we use' )V ( PV(+ , r$t )V-8/ ( 013.(+..8)5 , 0+,.1.(+..8)4 , 0+,53.(+..8) , 0+,3.2 ( 02,5.6.6+

)V-++/ ( 013.(+.++)5 , 0+..1.(+.++)4 , 0+,53.(+.++) , 0+,3.2 ( 02,24..17 )V-43/ ( 013.(+.43)5 , 0+.1.(+.43)4 , 0+,53.(+.43) , 0+,3.2 ( 07253.8+ @otice we are findin! the value at ?ear 3, the cash flow at ?ear 3 is simply added to the )V of the other cash flows. "n other words, we do not need to compound this cash flow.

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4!

"LO1# To find the PV , we use the equation' PV ( C(9+ : ;+*(+ , r$<t = * r ) PV -+2 yrs' PV -3. yrs' PV -62 yrs' PV ( 02,5..9;+ : (+*+..6)+2 < * ..6= ( 038,46+.13 PV ( 02,5..9;+ : (+*+..6)3. < * ..6= ( 06.,728..7 PV ( 02,5..9;+ : (+*+..6)62 < * ..6= ( 062,43..6.

To find the PV of a perpetuity, we use the equation' PV ( C * r PV ( 02,5.. * ..6 ( 062,6+3.41 @otice that as the len!th of the annuity payments increases, the present value of the annuity approaches the present value of the perpetuity. The present value of the 62 year annuity and the present value of the perpetuity imply that the value today of all perpetuity payments beyond 62 years is only 0365.28. $! "LO1# Here we have the PV , the len!th of the annuity, and the interest rate. Ae want to calculate the annuity payment. Bsin! the PV equation' PV ( C(9+ : ;+*(+ , r$<t = * r ) PV ( 053,... ( 0C9;+ : (+*+..672)+2 < * ..672= Ae can now solve this equation for the annuity payment. Coin! so, we !et' C ( 053,... * 8.63238+724 ( 05,886,64 %! "LO1# To find the PV , we use the equation' PV ( C(9+ : ;+*(+ , r$<t = * r ) PV ( 065,...9;+ : (+*+..82)8 < * ..82= ( 03++,77..57 )! "LO1# Here we need to find the )V . The equation to find the )V is' )V ( C9;(+ , r$t : +< * r= )V for 4. years ( 03,...;(+.++44. : +) * .++4< ( 0474,68+.+7 )V for 3. years ( 03,...;(+.++43. : +) * .++4< ( 04,321,.64.75 @otice that because of e%ponential !rowth, doublin! the number of periods does not merely double the )V . *! "LO1# Here we have the )V , the len!th of the annuity, and the interest rate. Ae want to calculate the annuity payment. Bsin! the )V equation' )V ( C9;(+ , r)t : +< * r= 01.,... ( 0C;(+..78+. : +) * ..78< Ae can now solve this equation for the annuity payment. Coin! so, we !et' C ( 01.,... * +5.7877+754 ( 07,262.66

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+!

"LO2# Here we have the PV , the len!th of the annuity, and the interest rate. Ae want to calculate the annuity payment. Bsin! the PV equation' PV ( C(9+ : ;+*(+ , r$<t = * r) 02.,... ( C9;+ : (+*+..62)6 < * ..62= Ae can now solve this equation for the annuity payment. Coin! so, we !et' C ( 02.,... * 2.4177.+54+ ( 01,33...4

1,. "LO1# Here we have the quarterly annuity payment, the len!th of the annuity in years, and the interest rate compounded monthly. Ae want to calculate the PV for an annuity due. Ae must first calculate the quarterly interest rate. r ( (+ , ..2* +4)5 : + ( ..+422 ( +.47/ t 2/ compounded monthly, the quarterly rate is'

Di% years is 43 quarters. Bsin! the PV equation for an ordinary annuity' PV ( C(9+ : ;+*(+ , r$<t = * r) PV ( 0+,.219;+ : (+*+..+47)43 < * ..+47= Ae can now solve this equation for the annuity payment. Coin! so, we !et the PV ' PV ( 04+,8+2.3. nnuity due value ( Erdinary annuity value % (+,r)' PV due ( 04+,8+2.3. % (+ , ..+47) ( 044,.1..48 11! "LO1# This cash flow is a perpetuity. To find the PV of a perpetuity, we use the equation' PV ( C * r PV ( 042,... * ..64 ( 0536,444.44 12! "LO1# -ere we need to find the interest rate that equates the perpetuity cash flows with the PV of the cash flows. Bsin! the PV of a perpetuity equation' PV ( C * r 0562,... ( 042,... * r Ae can now solve for the interest rate as follows' r ( 042,... * 0562,... ( ..776 or 7.76/ 13! "LO4# )or discrete compoundin!, to find the F G, we use the equation' F G ( ;+ , ( PG * m)<m : + F G ( ;+ , (..8 * 3)<3 : + F G ( ;+ , (.+7 * +4)<+4 : + F G ( ;+ , (.+4 * 572)<572 : + ( ..843 or 8.43/ ( .+645 or +6.45/ ( .+462 or +4.62/

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To find the F G with continuous compoundin!, we use the equation' F G ( eq : + F G ( e.+2 : + ( .+7+8 or +7.+8/ 14! "LO4# Here we are !iven the F G and need to find the PG. Bsin! the equation for discrete compoundin!' F G ( ;+ , ( PG * m)<m : + Ae can now solve for the PG. Coin! so, we !et' PG ( m;(+ , F G)+*m : +< F G ( ..87 ( ;+ , ( PG * 4)<4 : + F G ( .+18 ( ;+ , ( PG * +4)<+4 : + F G ( ..13 ( ;+ , ( PG * 24)<24 : + Dolvin! the continuous compoundin! F G equation' F G ( eq : + Ae !et' PG ( ln(+ , F G) PG ( ln(+ , .+72) PG ( .+246 or +2.42/ 1$! "LO4# )or discrete compoundin!, to find the F G, we use the equation' F G ( ;+ , ( PG * m)<m : + Do, for each banH, the F G is' IGoyal Jrandora' F G ( ;+ , (.+34 * +4)<+4 : + ( .+2+7 or +2.+7/ )irst Bnited' F G ( ;+ , (.+32 * 4)<4 : + ( .+2.5 or +2..5/ PG ( 4;(+..87)+*4 : +< PG ( +4;(+.+18)+*+4 : +< PG ( 24;(+..13)+*24 : +< ( ..834 or 8.34/ ( .+84 or +8.4/ ( ..811or 8.11/

@otice that the hi!her PG does not necessarily mean the hi!her F G. The number of compoundin! periods within a year will also affect the F G. 1%! "LO4# The reported rate is the PG, so we need to convert the F G to an PG as follows' F G ( ;+ , ( PG * m)<m : + PG ( m;(+ , F G)+*m : +< PG ( 572;(+.+7)+*572 : +< ( .+382 or +3.82/ This is deceptive because the borrower is actually payin! annualized interest of +7/ per year, not the +3.82/ reported on the loan contract. 1)! "LO1# )or this problem, we simply need to find the )V of a lump sum usin! the equation'

55

)V ( PV(+ , r$t "t is important to note that compoundin! occurs semiannually. To account for this, we will divide the interest rate by two (the number of compoundin! periods in a year), and multiply the number of periods by two. Coin! so, we !et' )V ( 04,+..;+ , (..83*4)<53 ( 08,2.2.15 1*! "LO1# )or this problem, we simply need to find the )V of a lump sum usin! the equation' )V ( PV(+ , r$t "t is important to note that compoundin! occurs daily. To account for this, we will divide the interest rate by 572 (the number of days in a year, i!norin! leap year), and multiply the number of periods by 572. Coin! so, we !et' )V in 2 years ( 03,2..;+ , (..15*572)<2(572) ( 06,+75.73 )V in +. years ( 03,2..;+ , (..15*572)<+.(572) ( 0++,3.5.13 )V in 4. years ( 03,2..;+ , (..15*572)<4.(572) ( 048,811.16 1+! "LO1# )or this problem, we simply need to find the PV of a lump sum usin! the equation' PV ( )V * (+ , r$t "t is important to note that compoundin! occurs daily. To account for this, we will divide the interest rate by 572 (the number of days in a year, i!norin! leap year), and multiply the number of periods by 572. Coin! so, we !et' PV ( 028,... * ;(+ , .+.*572)6(572)< ( 048,8.3.6+ 2,! "LO4# The PG is simply the interest rate per period times the number of periods in a year. "n this case, the interest rate is 5. percent per month, and there are +4 months in a year, so we !et' PG ( +4(5./) ( 57./ To find the F G, we use the F G formula' F G ( ;+ , ( PG * m)<m : + F G ( (+ , .5.)+4 : + ( 4,441.8+/ @otice that we didn#t need to divide the PG by the number of compoundin! periods per year. Ae do this division to !et the interest rate per period, but in this problem we are already !iven the interest rate per period. 21! "LO2. 4# Ae first need to find the annuity payment. Ae have the PV , the len!th of the annuity, and the interest rate. Bsin! the PV equation' PV ( C(9+ : ;+*(+ , r$<t = * r) 078,2.. ( 0C;+ : 9+ * ;+ , (..71*+4)<7.= * (..71*+4)<

Dolvin! for the payment, we !et'

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C ( 0782.. * 2..7442 ( 0+,525.+2 To find the F G, we use the F G equation' F G ( ;+ , ( PG * m)<m : + F G ( ;+ , (..71 * +4)<+4 : + ( ..6+44 or 6.+44/ 22! "LO3# Here we need to find the len!th of an annuity. Ae Hnow the interest rate, the PV, and the payments. Bsin! the PV equation' PV ( C(9+ : ;+*(+ , r$<t = * r) 0+8,... ( 02..9;+ : (+*+..+5)t < * ..+5= @ow we solve for t' +*+..+5t ( + : 9;(0+8,...)*(02..)<(..+5)= +*+..+5t ( ..254 +..+5t ( +*(..254) ( +.8616 t ( ln +.86164 * ln +..+5 ( 38.87 months 23! "LO4# Here we are tryin! to find the interest rate when we Hnow the PV and )V. Bsin! the )V equation' )V ( PV(+ , r) 03 ( 05(+ , r) r ( 3*5 : + ( 55.55/ per weeH The interest rate is 55.55/ per weeH. To find the PG, we multiply this rate by the number of weeHs in a year, so' PG ( (24)55.55/ ( +,655.55/ nd usin! the equation to find the F G' F G ( ;+ , ( PG * m)<m : + F G ( ;+ , .5555<24 : + ( 5,+52,.86.837/ 24! "LO1# Here we need to find the interest rate that equates the perpetuity cash flows with the PV of the cash flows. Bsin! the PV of a perpetuity equation' PV ( C * r 012,... ( 0+,8.. * r Ae can now solve for the interest rate as follows' r ( 0+,8.. * 012,... ( ..+81. or +.81./ per month The interest rate is +.81./ per month. To find the year, so' PG ( (+4)+.81./ ( 44.78/ nd usin! the equation to find an F G' F G ( ;+ , ( PG * m)<m : + F G ( ;+ , ..+81.<+4 : + ( 42.+1/ 2$! "LO1# This problem requires us to find the )V . The equation to find the )V is' PG, we multiply this rate by the number of months in a

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)V ( C9;(+ , r$t : +< * r= )V ( 05..;9;+ , (.+.*+4) <57. : += * (.+.*+4)< ( 0768,+37.58 2%! "LO1# "n the previous problem, the cash flows are monthly and the compoundin! period is monthly. This assumption still holds. Dince the cash flows are annual, we need to use the F G to calculate the future value of annual cash flows. "t is important to remember that you have to maHe sure the compoundin! periods of the interest rate times with the cash flows. "n this case, we have annual cash flows, so we need the F G since it is the true annual interest rate you will earn. Do, findin! the F G' F G ( ;+ , ( PG * m)<m : + F G ( ;+ , (.+.*+4)<+4 : + ( .+.36 or +..36/ Bsin! the )V equation, we !et' )V ( C9;(+ , r$t : +< * r= )V ( 05,7..;(+.+.365. : +) * .+.36< ( 0736,745.32 2)! "LO1# The cash flows are simply an annuity with four payments per year for four years, or +7 payments. Ae can use the PV equation' PV ( C(9+ : ;+*(+ , r$<t = * r) PV ( 04,5..9;+ : (+*+...72)+7< * ...72= ( 053,835.6+ 2*! "LO1# The cash flows are annual and the compoundin! period is quarterly, so we need to calculate the F G to maHe the interest rate comparable with the timin! of the cash flows. Bsin! the equation for the F G, we !et' F G ( ;+ , ( PG * m)<m : + F G ( ;+ , (.++*3)<3 : + ( .++37 or ++.37/ nd now we use the F G to find the PV of each cash flow as a lump sum and add them to!ether' PV ( 0642 * +.++37 , 018. * +.++374 , 0+57. * +.++373 ( 04,54..57 2+! "LO1# Here the cash flows are annual and the !iven interest rate is annual, so we can use the interest rate !iven. Ae simply find the PV of each cash flow and add them to!ether. PV ( 0+,72. * +..832 , 03,4.. * +..8325 , 04,35. * +..8323 ( 07,26..87

Intermediate

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3,! "LO4# The total interest paid by Vanscoy KanH is the interest rate per period times the number of periods. "n other words, the interest by )irst Dimple KanH paid over +. years will be' ..6(+.) ( .6 Vade KanH pays compound interest, so the interest paid by this banH will be the )V factor of 0+, or' (+ , r)+. Dettin! the two equal, we !et' (..6)(+.) ( (+ , r)+. : + r ( +.6+*+. : + ( ..2331 or 2.331/ 31! "LO4# Here we need to convert an F G into interest rates for different compoundin! periods. Bsin! the equation for the F G, we !et' F G ( ;+ , ( PG * m)<m : + F G ( .+6 ( (+ , r)4 : +L F G ( .+6 ( (+ , r)3 : +L F G ( .+6 ( (+ , r)+4 : +L r ( (+.+6)+*4 : + ( ..8+77 or 8.+77/ per si% months r ( (+.+6)+*3 : + ( ..3. or 3/ per quarter r ( (+.+6)+*+4 : + ( ..+5+6 or +.5+6/ per month

@otice that the effective si% month rate is not twice the effective quarterly rate because of the effect of compoundin!. 32! "LO2# Here we need to find the )V of a lump sum, with a chan!in! interest rate. Ae must do this problem in two parts. fter the first si% months, the balance will be' )V ( 02,... ;+ , (..+2*+4)<7 ( 02,.56.74 This is the balance in si% months. The )V in another si% months will be' )V ( 02,.56.74 ;+ , (.+8*+4)<7 ( 02,2.8.52 The problem asHs for the interest accrued, so, to find the interest, we subtract the be!innin! balance from the )V. The interest accrued is' "nterest ( 02,2.8.52 : 2,...... ( 02.8.52 33! "LO1# Ae need to find the annuity payment in retirement. Eur retirement savin!s ends and the retirement withdrawals be!in, so the PV of the retirement withdrawals will be the )V of the retirement savin!s. Do, we find the )V of the stocH account and the )V of the bond account and add the two )Vs. DtocH account' )V ( 06..;9;+ , (.++*+4) <57. : += * (.++*+4)< ( 0+,175,+75.84 Kond account' )V ( 05..;9;+ , (..7*+4) <57. : += * (..7*+4)< ( 05.+,523.2+ Do, the total amount saved at retirement is' 0+,175,+75.84 , 05.+,523.2+( 04,473,2+8.55

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Dolvin! for the withdrawal amount in retirement usin! the PV equation !ives us' PV ( 04,473,2+8.55 ( 0C;+ : 9+ * ;+ , (..1*+4)<5..= * (..1*+4)< C ( 04,473,2+8.55 * ++1.+7+7444 ( 0+1,..5.67 withdrawal per month 34! "LO1# Ae need to find the )V of a lump sum in one year and two years. "t is important that we use the number of months in compoundin! since interest is compounded monthly in this case. Do' )V in one year )V in two years ( 0+(+..++6)+4 ( 0+.+316172364 ( 0+(+..++6)43 ( 0+.544.54.11

There is also another common alternative solution. Ae could find the F G, and use the number of years as our compoundin! periods. Do we will find the F G first' F G ( (+ , ..++6)+4 : + ( .+31617236 or +3.161/ Bsin! the F G and the number of years to find the )V, we !et' )V in one year )V in two years ( 0+(+.+3161)+ ( 0+.+3161 ( 0+(+.+3161)4 ( 0+.544.

Fither method is correct and acceptable. Ae have simply made sure that the interest compoundin! period is the same as the number of periods we use to calculate the )V. 3$! "LO1# Here we are findin! the annuity payment necessary to achieve the same )V. The interest rate !iven is a +. percent PG, with monthly deposits. Ae must maHe sure to use the number of months in the equation. Do, usin! the )V equation' )V in 3. years ( C;9;+ , (.+4*+4) <38. : += * (.+4*+4)< C ( 0+,...,... * ++673.6642+ ( 082 )V in 5. years ( C;9;+ , (.+4*+4) <57. : += * (.+4*+4)< C ( 0+,...,... * 5,313.173+55 ( 0487.+5 )V in 4. years ( C;9;+ , (.+4*+4) <43. : += * (.+4*+4)< C ( 0+,...,... * 181.422 ( 0+,.+..87 @otice that a deposit for half the len!th of time, i.e. 4. years versus 3. years, does not mean that the annuity payment is doubled. "n this e%ample, by reducin! the savin!s period by oneMhalf, the deposit necessary to achieve the same terminal value is about nine times as lar!e. 3%! "LO2# Dince we are looHin! to quadruple our money, the PV and )V are irrelevant as lon! as the )V is three times as lar!e as the PV. The number of periods is four, the number of quarters per year. Do' )V ( 03 ( 0+(+ , r)(3) r ( .3+34 or 3+.34/

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"LO1# Dince we have an PG compounded monthly and an annual payment, we must first convert the interest rate to an F G so that the compoundin! period is the same as the cash flows. F G ( ;+ , (.+. * +4)<+4 : + ( .+.36+5 or +..36+5/ PV PV
+

( 012,... 9;+ : (+ * +.+.36+5)4< * .+.36+5= ( 0+75,851.+. ( 032,... , 06.,...9;+ : (+*+.+.36+5)4< * .+.36+5= ( 0+72,645.23

?ou would choose the second option since it has a hi!her PV. 3*! "LO1# Ae can use the present value of a !rowin! perpetuity equation to find the value of your deposits today. Coin! so, we find' PV ( 9C *(r : g)=9;+ : ;(+ , g)*(+ , r)<t= PV ( 90+,...,...*(..1 : ..2)=9;+ : ;(+ , ..2)*(+ , ..1)<5.= PV ( 0+7,827,426.54 3+! "LO1# Dince your salary !rows at 3 percent per year, your salary ne%t year will be' @e%t year#s salary ( 02.,... (+ , ..3) @e%t year#s salary ( 024,... This means your deposit ne%t year will be' @e%t year#s deposit ( 024,...(..2) @e%t year#s deposit ( 04,7.. Dince your salary !rows at 3 percent, you deposit will also !row at 3 percent. Ae can use the present value of a !rowin! perpetuity equation to find the value of your deposits today. Coin! so, we find' PV ( 9C *(r : g)=9;+ : ;(+ , g)*(+ , r)<t= PV ( 904,7..*(.++ : ..3)=9;+ : ;(+ , ..3)*(+ , .++)<3.= PV ( 053,511.32 @ow, we can find the future value of this lump sum in 3. years. Ae find' )V ( PV(+ , r)t )V ( 053,511.32(+ , .++)3. )V ( 02,235,994.31 This is the value of your savin!s in 3. years. 4,! "LO1# The relationship between the PV and the interest rate is' PV falls as r increases, and PV rises as r decreases )V rises as r increases, and )V falls as r decreases The present values of 07,... per year for +. years at the various interest rates !iven are' PV -+./ ( 07,...9;+ : (+*+.+.)+.< * .+.= PV -2/ ( 07,...9;+ : (+*+..2)+.< * ..2= PV -+2/ ( 07,...9;+ : (+*+.+2)+.< * .+2= ( 057,876.3. ( 037,55..3+ ( 05.,++4.7+

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41! "LO2# Here we are !iven the )V , the interest rate, and the amount of the annuity. Ae need to solve for the number of payments. Bsin! the )V equation' )V ( 04.,... ( 053.;9;+ , (..7*+4)<t : + = * (..7*+4)< Dolvin! for t, we !et' +...2t ( + , ;(04.,...)*(053.)<(..7*+4) t ( ln +.413++6736 * ln +...2 ( 2+.71 payments 42! "LO2# Here we are !iven the PV , number of periods, and the amount of the annuity. Ae need to solve for the interest rate. Bsin! the PV equation' PV ( 065,... ( 0+,32.;9+ : ;+ * (+ , r)<7.=* r< To find the interest rate, we need to solve this equation on a financial calculator, usin! a spreadsheet, or by trial and error. "f you use trial and error, remember that increasin! the interest rate lowers the PV , and decreasing the interest rate increases the PVA . Bsin! a spreadsheet, we find' r ( ..21343+5/ The PG is the periodic interest rate times the number of periods in the year, so' PG ( +4(..21343+5/) ( 6.+5/ 43! "LO2# Here we have the monthly annuity payment, the len!th of the annuity, and the annual interest rate. Ae want to calculate the PV for an annuity due. Ae must first calculate the monthly interest rate. r ( ..8 * +4 ( ...776 ( ..76/ There are 51 monthly payments includin! the current Nuly + st payment. ordinary annuity' PV ( C(9+ : ;+*(+ , r$<t = * r) nnuity due value ( Erdinary annuity value % (+,r)' PV due ( C(9+ : ;+*(+ , r$<t = * r) % (+,r) PV due ( 04,1..9;+ : (+*+...76)51 < * ...76= (+ , ...76) PV due ( 011,172..2 44! "LO2# The amount of principal paid on the loan is the PV of the monthly payments you maHe. Do, the present value of the 0+,+2. monthly payments is' /ortgages are co(po nded se(i0ann all1 there2ore we need to deter(ine the 3/R 2irst! A'R 4 %!3$5 C&A! There2ore we calc late the 3AR 4 " 1 6 A'R7(#8( 9 1 3AR 4 "16!,%3$72#82 01 4 ,!,%4$ or %!4$5 Then we can calc late the periodic rate or 3/R 4 "16 3AR#817( 01 3/R 4 "16!,%4$#81712 01 4 ,!,,$222++1 or !$222++15 per (onth PV ( 0+,+2.;(+ : 9+ * ;+ , !,,$222++1)<=57.) * !,,$222++1)< ( 0+87,346.22 Bsin! the PV equation for an t 8/ compounded monthly, the monthly rate is'

62

The monthly payments of 0+,+2. will amount to a principal payment of 0+87,346.22. The amount of principal you will still owe is' 043.,... : +87,346.22 ( 025,264.32 This remainin! principal amount will increase at the interest rate on the loan until the end of the loan period. Do the balloon payment in 5. years, which is the )V of the remainin! principal will be' Kalloon payment ( 025,264.32 ;+ , (!,,$222++1)<57. ( 0531,36..4. 4$! "LO1# Ae are !iven the total PV of all four cash flows. "f we find the PV of the three cash flows we Hnow, and subtract them from the total PV, the amount left over must be the PV of the missin! cash flow. Do, the PV of the cash flows we Hnow are' PV of ?ear + O)' 0+,6.. * +.+. PV of ?ear 5 O)' 04,+.. * +.+.5 PV of ?ear 3 O)' 04,8.. * +.+.3 Do, the PV of the missin! O) is' 07,22. : +,232.32 : +,266.67 : +,1+4.33 ( 0+,2+3.52 The question asHs for the value of the cash flow in ?ear 4, so we must find the future value of this amount. The value of the missin! O) is' 0+2+3.52(+.+.)4 ( 0+,854.57 4%! "LO1# To solve this problem, we simply need to find the PV of each lump sum and add them to!ether. "t is important to note that the first cash flow of 0+ million occurs today, so we do not need to discount that cash flow. The PV of the lottery winnin!s is' 0+,...,... , 0+,2..,...*+..1 , 04,...,...*+..14 , 04,2..,...*+..15 , 05,...,...*+..13 , 05,2..,...*+..12 , 03,...,...*+..17 , 03,2..,...*+..16 , 02,...,...*+..18 , 02,2..,...*+..11 , 07,...,...*+..1+. ( 044,8+4,865.3. 4)! "LO4# Here we are findin! interest rate for an annuity cash flow. Ae are !iven the PV , number of periods, and the amount of the annuity. Ae need to solve for the number of payments. Ae should also note that the PV of the annuity is not the amount borrowed since we are maHin! a down payment on the warehouse. The amount borrowed is' mount borrowed ( ..8.(04,1..,...) ( 04,54.,... Bsin! the PV equation' PV ( 04,54.,... ( 0+2,...;9+ : ;+ * (+ , r)<57.=* r< Bnfortunately this equation cannot be solved to find the interest rate usin! al!ebra. To find the interest rate, we need to solve this equation on a financial calculator, usin! a spreadsheet, or by trial and error. "f you use trial and error, remember that increasin! the interest rate lowers the PV , and decreasing the interest rate increase s the PVA Bsin! a spreadsheet, we find' r ( 0.55993289% The PG is the monthly interest rate times the number of months in the year, so' ( 0+,232.32 ( 0+,266.67 ( 0+,1+4.33

63

PG ( 12 (0.55993289%) = 6.719% nd the F G is' F G ( (+ , 0.0055993289 )+4 : + ( 0.0693 or 7.15/ 4*! "LO1# The profit the firm earns is &ust the PV of the sales price minus the cost to produce the asset. Ae find the PV of the sales price as the PV of a lump sum' PV ( 0+72,... * +.+55 ( 0++3,525.48 nd the firm#s profit is' Profit ( ++3,525.46: 13,...... ( 04.,525.48 To find the interest rate at which the firm will breaH even, we need to find the interest rate usin! the PV (or )V) of a lump sum. Bsin! the PV equation for a lump sum, we !et' 013,... ( 0+72,... * ( + , r)5 r ( (0+72,...* 013,...)+*5 : + ( .4.75 or 4..75/ 4+! "LO1# Ae want to find the value of the cash flows today, so we will find the PV of the annuity, and then brin! the lump sum PV bacH to today. The annuity has +8 payments, so the PV of the annuity is' PV ( 03,...9;+ : (+*+.+.)+8< * .+.= ( 054,8.2.72 Dince this is an ordinary annuity equation, this is the PV one period before the first payment, so it is the PV at t ( 6. To find the value today, we find the PV of this lump sum. The value today is' PV ( 054,8.2.72 * +.+.6 ( 0+7,853.38 $,! "LO1# This question is asHin! for the present value of an annuity, but the interest rate chan!es durin! the life of the annuity. Ae need to find the present value of the cash flows for the last ei!ht years first. The PV of these cash flows is' PV
4

( 0+,2.. ;9+ : + * ;+ , (..6*+4)<17= * (..6*+4)< ( 0++.,.4+.52

@ote that this is the PV of this annuity e%actly seven years from today. @ow we can discount this lump sum to today. The value of this cash flow today is' PV ( 0++.,.4+.52 * ;+ , (.++*+4)<83 ( 02+,+4..54 @ow we need to find the PV of the annuity for the first seven years. The value of these cash flows today is' PV
+

( 0+,2.. ;9+ : + * ;+ , (.++*+4)<83= * (.++*+4)< ( 0867.3.57

The value of the cash flows today is the sum of these two cash flows, so' PV ( 02+,+4..54 , 086,7.3.57 ( 0+58,643.78 $1! "LO1# Here we are tryin! to find the dollar amount invested today that will equal the )V with a Hnown interest rate, and payments. )irst we need to determine how much we would have in the annuity account. )indin! the )V of the annuity, we !et'

64

)V ( 0+,4.. ;9; + , (..82*+4)<+8. : += * (..82*+4)< ( 0353,+35.74 @ow we need to find the PV of a lump sum that will !ive us the same )V. Do, usin! the )V of a lump sum with continuous compoundin!, we !et' )V ( 0353,+35.74( PVe..8(+2) PV ( 0353,+35.74 e%+.4 ( 0+5.,67+.22 $2! "LO1# To find the value of the perpetuity at t ( 6, we first need to use the PV of a perpetuity equation. Bsin! this equation we find' PV ( 05,2.. * ..74 ( 027,32+.7+ Gemember that the PV of a perpetuity (and annuity) equations !ive the PV one period before the first payment, so, this is the value of the perpetuity at t ( +3. To find the value at t ( 6, we find the PV of this lump sum as' PV ( 027,32+.7+ * +..746 ( 056,.2+.3+ $3! "LO4# To find the PG and F G, we need to use the actual cash flows of the loan. "n other words, the interest rate quoted in the problem is only relevant to determine the total interest under the terms !iven. The interest rate for the cash flows of the loan is' PV ( 042,... ( 04,3+7.769(+ : ;+ * (+ , r)<+4 ) * r = !ain, we cannot solve this equation for r, so we need to solve this equation on a financial calculator, usin! a spreadsheet, or by trial and error. Bsin! a spreadsheet, we find' r ( 4.57.6+4+/ or 4.57+/per month Do the PG is' PG ( +4(4.57+/) ( 48.55/ nd the F G is' F G ( (+..457+)+4 : + ( .545+72 or 54.54/ $4! "LO1# The cash flows in this problem are semiannual, so we need the effective semiannual rate. The interest rate !iven is the PG, so the monthly interest rate is' Ponthly rate ( .+. * +4 ( ...855 To !et the semiannual interest rate, we can use the F G equation, but instead of usin! +4 months as the e%ponent, we will use 7 months. The effective semiannual rate is' Demiannual rate ( (+...855)7 : + ( ..2+.54377+ or 2.+.5./ Ae can now use this rate to find the PV of the annuity. The PV of the annuity is' PV - t ( 8' 06,...9;+ : (+ * +..2+.54377+)+.< * ..2+.45377+= ( 025,684.+2 @ote, this is the value one period (si% months) before the first payment, so it is the value at t ( 1. Do, the value at the various times the questions asHed for uses this value 1 years from now. PV - t ( 2' 025,684.+2 * +..2+.54377+7 ( 051,816.++

65

@ote, you can also calculate this present value (as well as the remainin! present values) usin! the number of years. To do this, you need the F G. The F G is' F G ( (+ , ...855)+4 : + ( .+.36 or +..36/ Do, we can find the PV at t ( 2 usin! the followin! method as well' PV - t ( 2' 025,667.64 * +.+.365 ( 051,888.55 The value of the annuity at the other times in the problem is' PV - t ( 5' 025,687.64 * +..2+++. PV - t ( 5' 025,667.64 * +.+.362 PV - t ( .' 025,667.64 * +..2+++7 PV - t ( .' 025,667.64 * +.+.368 ( 054,783.88 ( 054,783.88 ( 043,435.76 ( 043,435.76

$$! "LO1# a. Oalculatin! the PV of an ordinary annuity, we !et' PV ( 012.9;+ : (+*+..12)8 < * ..12= ( 02,+7+.67 b. To calculate the PV due, we calculate the PV of an ordinary annuity for t : + payments, and add the payment that occurs today. Do, the PV of the annuity due is' PV ( 012. , 012.9;+ : (+*+..12)6< * ..12= ( 02,724.+5 $%! "LO1# Ae need to use the PV due equation, that is' PV
due

( (+ , r) PV

Bsin! this equation' PV

due

( 078,... ( ;+ , (..682*+4)< Q C;9+ : + * ;+ , (..682*+4)<7.= * (..682*+4)

076,228..7 ( 0C9+ : ;+ * (+ , ..682*+4)7.<= * (..682*+4) C ( 0+,573.11 @otice, when we find the payment for the PV due, we simply discount the PV of the annuity due bacH one period. Ae then use this value as the PV of an ordinary annuity. $)! "LO3# The payment for a loan repaid with equal payments is the annuity payment with the loan value as the PV of the annuity. Do, the loan payment will be' PV ( 034,... ( C 9;+ : + * (+ , ..8)2< * ..8= C ( 0+.,2+1.+6 The interest payment is the be!innin! balance times the interest rate for the period, and the principal payment is the total payment minus the interest payment. The endin! balance is the be!innin! balance minus the principal payment. The endin! balance for a period is the be!innin! balance for the ne%t period. The amortization table for an equal payment is'

66

?ear + 4 5 3 2

Ke!innin! Kalance 034,...... 53,83..85 46,+.8.15 +8,628.36 1,651.16

Total Payment 0+.,2+1.+6 +.,2+1.+6 +.,2+1.+6 +.,2+1.+6 +.,2+1.+6

"nterest Payment 05,57. 4,686.46 4,+78.63+ +,2...78 661.4.

Principal Payment 06,+21.+6 6,65+.1. 852..37 1,.+8.31 1651.16

Fndin! Kalance 053,83..85 46,+.8.145 +8,628.36 1,651.16 ....

"n the third year, 04,+78.6+ of interest is paid. Total interest over life of the loan ( 05,57. , 4,686.46 , 4,+78.6+ , +,2...78 , 661.4. ( 0+.,212.87 $*! "LO3# This amortization table calls for equal principal payments of 08,3.. per year. The interest payment is the be!innin! balance times the interest rate for the period, and the total payment is the principal payment plus the interest payment. The endin! balance for a period is the be!innin! balance for the ne%t period. The amortization table for an equal principal reduction is' Ke!innin! Kalance 034,...... 55,7..... 42,4..... +7,8..... 8,3..... Total Payment 0++,67. ++,.88... +.,3+7... 1,633... 1,.64... "nterest Payment 0557.... 4,788... 4.+7... +,533... 764... Principal Payment 08,3..... 8,3..... 8,3..... 8,3..... 8,3..... Fndin! Kalance 055,7..... 42,4..... +7,8..... 8,3..... ....

?ear + 4 5 3 2

"n the third year, 04,.+7 of interest is paid. +,533 , 764 ( 0+.,.8.

Total interest over life of the loan ( 05,57., 4,788 , 4.+7 ,

@otice that the total payments for the equal principal reduction loan are lower. This is because more principal is repaid early in the loan, which reduces the total interest e%pense over the life of the loan. Challenge $+! "LO1# The cash flows for this problem occur monthly, and the interest rate !iven is the F G. Dince the cash flows occur monthly, we must !et the effective monthly rate (FPG). Ene way to do this is to find the PG based on monthly compoundin!, and then divide by +4 or simply' 3/R 4 "163AR#81712 9 1 There2ore the pre0retir(ent 3/R 4 "16!1#81712 01 4 ,!,,)+)414 or !)+)4145 And the post0retire(ent 3/R 4 "16!,)#81712 01 4 ,!,,$%$414$ or ,!$%$414$5 L '

)irst, we will calculate how much he needs at retirement. The amount needed at retirement is the PV of the monthly spendin! plus the PV of the inheritance. The PV of these two cash flows is'

67

PV ( 04.,...9+ : ;+ * (+ , ...2723+32)+4(42)<= * (...2723+32) ( 04,882,317.32 PV ( 01..,... * ;+ , (...2723+32)<5.. ( 0+72843.48 EG 01..,... * +..6R42 since we can use the F G as it is a lump sum value and not an annuity. Do, at retirement, he needs' 04,882,317.32 , +72,843.48 ( 05,.2+,54..82 He will be savin! 04,2.. per month for the ne%t +. years until he purchases the cabin. The value of his savin!s after +. years will be' )V ( 04,2..;9; + , (...6163+3)<+4(+.) : += * (...6163+3)< ( 0311,721.73 fter he purchases the cabin, the amount he will have left is' 0311,721.73 : 58.,... ( 0++1,721.73 He still has 4. years until retirement. Ahen he is ready to retire, this amount will have !rown to' )V ( 0++1,721.73;+ , (...6163+3)<+4(4.) ( 08.2,.+..44 EG 0++1,721.73 (+.+R4.) as it is a lump sum and not annuity and you can use the F G. Do, when he is ready to retire, based on his current savin!s, he will be short' 05,.45,785.52 :08.2,.+..44 ( 04,437,5+..68 This amount is the )V of the monthly savin!s he must maHe between years +. and 5.. Do, findin! the annuity payment usin! the )V equation, we find his monthly savin!s will need to be' )V ( 04,437,5+..68 ( C;9; + , (...6163+3)<+4(4.) : += * (...6163+3)< C ( 05,+46.33 %,! "LO1# To answer this question, we should find the PV of both options, and compare them. Dince we are purchasin! the car, the lowest PV is the best option. The PV of the leasin! is simply the PV of the lease payments, plus the 011. The interest rate we would use for the leasin! option is the same as the interest rate of the loan. The PV of leasin! is' PV ( 011 , 032.9+ : ;+ * (+ , ..6*+4)+4(5)<= * (..6*+4) ( 0+3,764.1+ The PV of purchasin! the car is the current price of the car minus the PV of the resale price. The PV of the resale price is' PV ( 045,... * ;+ , (..6*+4)<+4(5) ( 0+8,723.8+ The PV of the decision to purchase is' 054,... : +8,723.84 ( 0+5,532.+8 "n this case, it is cheaper to buy the car than lease it since the PV of the buyin! cash flows is lower. To find the breaHeven resale price, we need to find the resale price that maHes the PV of the two options the same. "n other words, the PV of the decision to buy should be' 054,... : PV of Gesale price ( 0+3,764.1+ PV of resale price ( 0+6,546..1

68

The resale price that would maHe the PV of the lease versus buy decision is the )V of this value, so' KreaHeven resale price ( 0+6,546..1;+ , (..6*+4)<+4(5) ( 04+,575..+

69

%1! "LO1# To find the quarterly salary for the player, we first need to find the PV of the current contract. The cash flows for the contract are annual, and we are !iven a daily interest rate. Ae need to find the F G so the interest compoundin! is the same as the timin! of the cash flows. The F G is' F G ( ;+ , (..22*572)<572 : + ( 2.72/ The PV of the current contract offer is the sum of the PV of the cash flows. Do, the PV is' PV ( 06,...,... , 03,2..,...*+..272 , 02,...,...*+..2724 , 07,...,...*+..2725 , 07,8..,...*+..2723 , 06,1..,...*+..2722 , 08,8..,...*+..2727 PV ( 058,46+,54..86 The player wants the contract increased in value by 0+,3..,..., so the PV of the new contract will be' PV ( 058,462,534.87 , +,3..,... ( 051,762,534.87 The player has also requested a si!nin! bonus payable today in the amount of 01 million. Ae can simply subtract this amount from the PV of the new contract. The remainin! amount will be the PV of the future quarterly paychecHs. 051,76+,54..86 : 1,...,... ( 05.,76+,54..86 To find the quarterly payments, first realize that the interest rate we need is the effective quarterly rate. Bsin! the daily interest rate, we can find the quarterly interest rate usin! the F G equation, with the number of days bein! 1+.42, the number of days in a quarter (572 * 3). The effective quarterly rate is' Fffective quarterly rate ( ;+ , (..22*572)<1+.42 : + ( ..+583 or +.583/ @ow we have the interest rate, the len!th of the annuity, and the PV. Bsin! the PV the payment, we !et' PV ( 05.,76+,54..87 ( C9;+ : (+*+..+583)43< * ..+583= C ( 0+,2+.,626,88 "LO1# a. Oalculatin! the monthly interest rate' r ( ..7+*+4 ( ...2.85555 ( ..2.85/ Bsin! the PV equation to find the monthly payments' PV ( 072,4.. M 03,6.. M 04,... ( C;9+ : ;+ * (+ , r)<38=* r< PV ( 028,2.. ( C;9+ : ;+ * (+ , ...2.85)<38=* ...2.85< Dolvin! for the monthly payment' C ( 0+,567.27 @ow calculate the PV of this option with an annual discount rate of 8/' The monthly interest rate ( ..8* +4 ( ...776( ..776/ PV ( 03,6.. , 0+,567.27;9+ : ;+ * (+ , ...776)<38=* ...776< PV ( 03,6.. , 027,587.33 ( 07+,.87.33 equation and solvin! for

%2!

70

b.

Oalculatin! the monthly interest rate' r ( ..+4*+4 ( ...+ ( ..+/ Bsin! the PV equation to find the monthly payments' PV ( 072,4.. M 03,6.. ( C;9+ : ;+ * (+ , r)<38=* r< PV ( 07.,2.. ( C;9+ : ;+ * (+ , ...+)<38=* ...+< Dolvin! for the monthly payment' C ( 0+,41+.23 @ow calculate the PV of this option with an annual discount rate of 1/' The monthly interest rate ( ..8 * +4 ( ...776 ( ..776/ PV ( 03,6.. , 0+,41+.23;9+ : ;+ * (+ , ...776)<38=* ...776< PV ( 03,6.. , 052,903.89 = $57,603.89

Eption b is the better deal. %3! "LO4# To find the PG and F G, we need to use the actual cash flows of the loan. "n other words, the interest rate quoted in the problem is only relevant to determine the total interest under the terms !iven. The cash flows of the loan are the 042,... you must repay in one year, and the 04+,42. you borrow today. The interest rate of the loan is' 042,... ( 04+,42.(+ , r) r ( (042,... * 4+,42.) : + ( .+672 or +6.72/ Kecause of the discount, you only !et the use of 04+,42., and the interest you pay on that amount is +6.72/, not +2/. %4! "LO1# Here we have cash flows that would have occurred in the past and cash flows that would occur in the future. Ae need to brin! both cash flows to today. Kefore we calculate the value of the cash flows today, we must ad&ust the interest rate so we have the effective monthly interest rate. )indin! the PG with monthly compoundin! and dividin! by +4 will !ive us the effective monthly rate. The PG with monthly compoundin! is' PG ( +4;(+..8)+*+4 : +< ( 6.64/ To find the value today of the bacH pay from two years a!o, we will find the )V of the annuity, and then find the )V of the lump sum. Coin! so !ives us' )V ( (036,...*+4) ;9; + , (..664*+4)<+4 : += * (..664*+4)< ( 038,711.51 )V ( 038,711.51(+..8) ( 024,212.53 @otice we found the )V of the annuity with the effective monthly rate, and then found the )V of the lump sum with the F G. lternatively, we could have found the )V of the lump sum with the effective monthly rate as lon! as we used +4 periods. The answer would be the same either way. @ow, we need to find the value today of last year#s bacH pay' )V ( (02.,...*+4) ;9; + , (..664*+4)<+4 : += * (..664*+4)< ( 02+,8.6,87 @e%t, we find the value today of the five year#s future salary'

71

PV ( (022,...*+4)9;9+ : 9+ * ;+ , (..664*+4)<+4(2)=< * (..664*+4)=( 0446,251.+3 The value today of the &ury award is the sum of salaries, plus the compensation for pain and sufferin!, and court costs. The award should be for the amount of' ward ( 024,212.53 ,2+,8.6.87 , 446.251*+3234.73 , +..,... , 4.,... ( 032+,134.53 s the plaintiff, you would prefer a lower interest rate. "n this problem, we are calculatin! both the PV and )V of annuities. lower interest rate will decrease the )V , but increase the PV . Do, by a lower interest rate, we are lowerin! the value of the bacH pay. Kut, we are also increasin! the PV of the future salary. Dince the future salary is lar!er and has a lon!er time, this is the more important cash flow to the plaintiff. %$! "LO4# )irst we will find the PG and F G for the loan with the refundable fee. Gemember, we need to use the actual cash flows of the loan to find the interest rate. Aith the 04,5.. application fee, you will need to borrow 0434,5.. to have 043.,... after deductin! the fee. Dolvin! for the payment under these circumstances, we !et' 3/R 4 !,%*712 since it is co(po nded (onthl1 4 ,!,,$%) PV ( 0434,5.. ( C 9;+ : +*(+...276)57.<*...276= C ( 0+,261.7+ Ae can now use this amount in the PV Dolvin! for r, we find' equation with the ori!inal amount we wished to borrow, 043.,....

PV ( 043.,... ( 0+,28..47;9+ : ;+ * (+ , r)<57.=* r< Dolvin! for r with a spreadsheet, on a financial calculator, or by trial and error, !ives' r ( ..263372+/ per month PG ( +4(..263372+/) ( 7.8157/ F G ( (+ , ...263372+)+4 : + ( 6.+4/ Aith the nonrefundable fee, the considered part of the loan. Do' PG ( 7.8./ F G ( ;+ , (..78*+4)<+4 : + ( 6..4/ %%! "LO4# Ke careful of interest rate quotations. The actual interest rate of a loan is determined by the cash flows. Here, we are told that the PV of the loan is 0+,..., and the payments are 03+.+2 per month for three years, so the interest rate on the loan is' PV ( 0+,... ( 03+.+23.8; 9+ : ;+ * (+ , r)<57 = * r < Dolvin! for r with a spreadsheet, on a financial calculator, or by trial and error, !ives' r ( 4.5./ per month PG ( +4(4.5./) ( 46.71.1./ F G ( (+ , ..45)+4 : + (5+.51/ PG of the loan is simply the quoted PG since the fee is not

72

"t#s called addMon interest because the interest amount of the loan is added to the principal amount of the loan before the loan payments are calculated. %)! "LO1# Here we are solvin! a twoMstep time value of money problem. Fach question asHs for a different possible cash flow to fund the same retirement plan. Fach savin!s possibility has the same )V, that is, the PV of the retirement spendin! when your friend is ready to retire. The amount needed when your friend is ready to retire is' PV ( 0+.2,...9;+ : (+*+..6)4.< * ..6= ( 0+,++4,56+.2. This amount is the same for all three parts of this question. a. "f your friend maHes equal annual deposits into the account, this is an annuity with the )V equal to the amount needed in retirement. The required savin!s each year will be' )V ( 0+,++4,56+.2. ( C;(+..65. : +) * ..6< C ( 0++,667..+ b. Here we need to find a lump sum savin!s amount. Bsin! the )V for a lump sum equation, we !et' )V ( 0+,++4,56+.2. ( PV(+..6)5. PV ( 0+37,+41..3 c. "n this problem, we have a lump sum savin!s in addition to an annual deposit. Dince we already Hnow the value needed at retirement, we can subtract the value of the lump sum savin!s at retirement to find out how much your friend is short. Coin! so !ives us' )V of trust fund deposit ( 0+2.,...(+..6)+. ( 0412,.64.6. Do, the amount your friend still needs at retirement is' )V ( 0+,++4,56+.2. : 412,.64.6. ( 08+6,418.8. Bsin! the )V equation, and solvin! for the payment, we !et' 08+6,418.8. ( C;(+..6 5. : +) * ..6< C ( 08,724.42 This is the total annual contribution, but your friend#s employer will contribute 0+,2.. per year, so your friend must contribute' )riendSs contribution ( 08,724.42 : +,2.. ( 06,+24.42 %*! "LO2# Ae will calculate the number of periods necessary to repay the balance with no fee first. Ae simply need to use the PV equation and solve for the number of payments. nnual rate without fee ( +1.8/' PV ( 0+.,... ( 04..9;+ : (+*+..+72)t < * ..+72 = where ..+72 ( .+18*+4 Dolvin! for t, we !et' +*+..+72t ( + : (0+.,...*04..)(..+72) +*+..+72t ( .+62 t ( ln (+*.+62) * ln +..+72

73

t ( +.7.2. months nnual rate without fee ( 7.4/' PV ( 0+.,... ( 04..9;+ : (+*+...2+6)t < * ...2+6 = where ...2+6 ( ..74*+4 Dolvin! for t, we !et' +*+...2+6t ( + : (0+.,...*04..)(...2+6) +*+...2+6t ( .6+32 t ( ln (+*.6+32) * ln +...2+6 t ( 26.11 months @ote that we do not need to calculate the time necessary to repay your current credit card with a fee since no fee will be incurred. The time to repay the new card with a transfer fee is' Aith fee and annual rate ( 7.4./' PV ( 0+.,4.. ( 04..9 ;+ : (+*+...2+6)t < * ...2+6 = where ...2+6 ( ..74*+4 Dolvin! for t, we !et' +*+...2+6t ( + : (0+.,4..*04..)(...2+6) +*+...2+6t ( .65755 t ( ln (+*.65755) * ln +...2+6 t ( 21.52 months

%+!

"LO1# Ae need to find the )V of the premiums to compare with the cash payment promised at a!e 72. Ae have to find the value of the premiums at year 7 first since the interest rate chan!es at that time. Do' )V+ ( 01..(+.+4)2 ( 0+,287.++ )V4 ( 01..(+.+4)3 ( 0+,3+7.+6 )V5 ( 0+,...(+.+4)5 ( 0+,3.3.15 )V3 ( 0+,...(+.+4)4 ( 0+,423.3. )V2 ( 0+,+..(+.+4)+ ( 0+,454 Value at year si% ( 0+,287.++ , +,3+7.+6 , +,3.3.15 , +,423.3. , +,454... , +,+.. ( 06,115.7. )indin! the )V of this lump sum at the child#s 72th birthday' )V ( 06,115.7+(+..8)21 ( 0631,324.27 The policy is not worth buyin!L the future value of the deposits is 0631,324.27, but the policy contract will pay off 02..,.... The premiums are worth 0431,324.27 more than the policy payoff. @ote, we could also compare the PV of the two cash flows. The PV of the premiums is' PV ( 01..*+.+4 , 01..*+.+44 , 0+,...*+.+45 , 0+,...*+.+43 , 0+,+..*+.+42 , 0+,+..*+.+47 ( 03,.31.8+

74

nd the value today of the 02..,... at a!e 72 is' PV ( 02..,...*+..821 ( 02,554.17 PV ( 02,554.17*+.+47 ( 04,6.+.83 The premiums still have the hi!her cash flow. t time zero, the difference is 0+,536.17. Ahenever you are comparin! two or more cash flow streams, the cash flow with the hi!hest value at one time will have the hi!hest value at any other time. Here is a question for you' Duppose you invest 0+,536.17, the difference in the cash flows at time zero, for si% years at an +4 percent interest rate, and then for 21 years at a 8 percent interest rate. How much will it be worthT Aithout doin! calculations, you Hnow it will be worth 0431,324.27, the difference in the cash flows at time 72$ ),! "LO2# The monthly payments with a balloon payment loan are calculated assumin! a lon!er amortization schedule, in this case, 5. years. The payments based on a 5.Myear repayment schedule would be' )irst you need to !et the FPG (periodic monthly rate) since it is paid monthly and the mort!a!e is 8.+/ PG which under the KanH ct is compounded semiMannually. Thus the FPG ( (+,..8+*4)R+*7 M+ ( ....7758853 or ...773 rounded. PV ( 062.,... ( C(9+ : ;+ * (+ , ...773)<57.= * (...773)) C ( 02,382.68 @ow, at time ( 8, we need to find the PV of the payments which have not been made. The balloon payment will be' PV ( 02,382.68(9+ : ;+ * (+ , ...773)<+4(44)= * (...773)) PV ( 0784,464.83

)1! "LO4# Here we need to find the interest rate that maHes the PV , the colle!e costs, equal to the )V , the savin!s. The PV of the colle!e costs are' PV ( 04.,...;9+ : ;+ * (+ , r)3<= * r < nd the )V of the savin!s is' )V ( 01,...9;(+ , r)7 : + < * r = Dettin! these two equations equal to each other, we !et' 04.,...;9+ : ;+ * (+ , r)<3 = * r < ( 01,...9; (+ , r)7 : + < * r = Geducin! the equation !ives us' (+ , r)7 : 5.444(+ , r)3 , 4.444 ( . @ow we need to find the roots of this equation. Ae can solve usin! trial and error, a rootMsolvin! calculator routine, or a spreadsheet. Bsin! a spreadsheet, we find' r ( 8..6/

75

)2! "LO4# Here we need to find the interest rate that maHes us indifferent between an annuity and a perpetuity. To solve this problem, we need to find the PV of the two options and set them equal to each other. The PV of the perpetuity is' PV ( 04.,... * r nd the PV of the annuity is' PV ( 048,...;9+ : ;+ * (+ , r)<4. = * r < Dettin! them equal and solvin! for r, we !et' 04.,... * r & 048,...; 9+ : ;+ * (+ , r)<4. = * r < 04.,... * 048,... ( + : ;+ * (+ , r)<4. .4826+3+*4. ( + * (+ , r) r ( ..7373+246 or 7.373// )3! "LO1# The cash flows in this problem occur every two years, so we need to find the effective two year rate. Ene way to find the effective two year rate is to use an equation similar to the F G, e%cept use the number of days in two years as the e%ponent. (Ae use the number of days in two years since it is daily compoundin!L if monthly compoundin! was assumed, we would use the number of months in two years.) Do, the effective twoM year interest rate is' Fffective 4Myear rate ( ;+ , (.+.*572)<572(4) : + ( .44+56or 44.+56/ Ae can use this interest rate to find the PV of the perpetuity. Coin! so, we find' PV ( 0+2,... *.44+56 ( 076,67...6 This is an important point' Gemember that the PV equation for a perpetuity (and an ordinary annuity) tells you the PV one period before the first cash flow. "n this problem, since the cash flows are two years apart, we have found the value of the perpetuity one period (two years) before the first payment, which is one year a!o. Ae need to compound this value for one year to find the value today. The value of the cash flows today is' PV ( 076,67...6(+ , .+.*572)572 ( 063,882.33 The second part of the question assumes the perpetuity cash flows be!in in four years. "n this case, when we use the PV of a perpetuity equation, we find the value of the perpetuity two years from today. Do, the value of these cash flows today is' PV ( 076,67...67 * (+ , .+.*572)4(572) ( 022,368.68 )4! "LO1# To solve for the PV due'

C C C + + .... + 4 (+ + r ) (+ + r ) (+ + r ) t C C + .... + PV due ( C + (+ + r ) (+ + r ) t M +

PV (

C C C ( (+ + r ) (+ + r ) + (+ + r ) 4 + .... + (+ + r ) t PV due ( (+ , r) PV
PV
due

nd the )V due is'

76

)V ( C , O(+ , r) , C(+ , r)4 , U. , C(+ , r)t : + )V due ( C(+ , r) , O(+ , r)4 , U. , C(+ , r)t )V due ( (+ , r);C , O(+ , r) , U. , C(+ , r)t : +< )V due ( (+ , r))V )$! "LO1# Ae need to find the first payment into the retirement account. The present value of the desired amount at retirement is' PV ( )V*(+ , r)t PV ( 04,...,...*(+ , .++)3. PV ( 05.,678.84 This is the value today. Dince the savin!s are in the form of a !rowin! annuity, we can use the !rowin! annuity equation and solve for the payment. Coin! so, we !et' PV ( C 9;+ : ((+ , g)*(+ , r))t < * (r : g)= 05.,678.84 ( C9;+ : ((+ , ..5)*(+ , .++))3. < * (.++ : ..5)= C ( 04,21+.27 This is the amount you need to save ne%t year. Do, the percenta!e of your salary is' Percenta!e of salary ( 04,21+.27*03.,... Percenta!e of salary ( ..7368 or 7.368/ @ote that this is the percenta!e of your salary you must save each year. Dince your salary is increasin! at 5 percent, and the savin!s are increasin! at 5 percent, the percenta!e of salary will remain constant. )%! "LO4# a. The PG is the interest rate per weeH times 24 weeHs in a year, so' PG ( 24(6/) ( 573/ F G ( (+ , ..6)24 : + ( 54.6425 or 5,464.25/ b. "n a discount loan, the amount you receive is lowered by the discount, and you repay the full principal. Aith a 6 percent discount, you would receive 01.5. for every 0+. in principal, so the weeHly interest rate would be' 0+. ( 01.5.(+ , r) r ( (0+. * 01.5.) : + ( ..624788+6 or 6.246/ @ote the dollar amount we use is irrelevant. "n other words, we could use 0..14 and 0+, 014 and 0+.., or any other combination and we would !et the same interest rate. @ow we can find the PG and the F G' PG ( 24(6.246/) ( 51+.518/ F G ( (+ , ..6246)24 : + ( 34.2518 or 3,425.18/ c. Bsin! the cash flows from the loan, we have the PV interest rate, so' PV ( 078.14 ( 042;9+ : ;+ * (+ , r)<3=* r < Bsin! a spreadsheet, trial and error, or a financial calculator, we find' and the annuity payments and need to find the

77

r ( +7.62/ per weeH PG ( 24(+7.62/) ( 86+.../ F G ( +.+76224 : + ( 5+34.+264 or 5+3,4+2.64/

))! "LO1# To answer this, we need to dia!ram the perpetuity cash flows, which are' (@ote, the subscripts are only
to differentiate when the cash flows be!in. The cash flows are all the same amount.) C4 C+ C5 C4 C+ U..

C+

Thus, each of the increased cash flows is a perpetuity in itself. Do, we can write the cash flows stream as' C+*G C4*G C5*G C3*G U.

Do, we can write the cash flows as the present value of a perpetuity, and a perpetuity of' C4*G C5*G C3*G U.

The present value of this perpetuity is' PV ( (C*G) * G ( C*G4 Do, the present value equation of a perpetuity that increases by C each period is' PV ( C*G , C*G4 )*! "LO4# Ae are only concerned with the time it taHes money to double, so the dollar amounts are irrelevant. Do, we can write the future value of a lump sum as' )V ( PV(+ , G)t 04 ( 0+(+ , G)t Dolvin! for t, we find' ln(4) ( t;ln(+ , G)< t ( ln(4) * ln(+ , G) Dince G is e%pressed as a percenta!e in this case, we can write the e%pression as' t ( ln(4) * ln(+ , G*+..) To simplify the equation, we can maHe use of a Taylor Deries e%pansion' ln(+ , G) ( G : G4*4 , G5*5 : ... Dince G is small, we can truncate the series after the first term'

78

ln(+ , G) ( G Oombine this with the solution for the doublin! e%pression' t ( ln(4) * (G*+..) t ( +..ln(4) * G t ( 71.5+36 * G This is the e%act (appro%imate) e%pression, Dince 71.5+36 is not easily divisible, and we are only concerned with an appro%imation, 64 is substituted. )+! "LO4# Ae are only concerned with the time it taHes money to double, so the dollar amounts are irrelevant. Do, we can write the future value of a lump sum with continuously compounded interest as' 04 ( 0+eGt 4 ( eGt Gt ( ln(4) Gt ( .715+36 t ( .71+536 * G Dince we are usin! interest rates while the equation uses decimal form, to maHe the equation correct with percenta!es, we can multiply both numerator and denominator of the R.H.S of the equation by 100: t ( 71.+536 * (G % +..)

79

Calc lator &ol tions 1! LO1# C:o C,1 :,1 C,2 :,2 C,3 :,3 C,4 :,4 " ( +. @PV OPT 05,5.7.56 2! "LO1# Fnter Dolve for Fnter Dolve for Fnter Dolve for Fnter Dolve for 3! "LO1# Fnter Dolve for Fnter Dolve for Fnter + ; 8/ <7= 0+,53. '> 4 ; 8/ <7= 0+,.1. '> 5 ; 8/ <7= 7 ; 44/ <7= 1 ; +2/ <7= 7 ; 2/ <7= 0. 012. + +.3. + 0++5. + 0+,.62 + C:o C,1 :,1 C,2 :,2 C,3 :,3 C,4 :,4 " ( +8 @PV OPT 4613.44 0. 12. + +.3. + ++5. + 0+,.62 + C:o C,1 :,1 C,2 :,2 C,3 :,3 C,4 :,4 " ( 43 @PV OPT 4381.88 0. 12. + +.3. + 0++5. + +.62 +

1 ;

2/ <7=

'> 034,737.15

07,... '/T

:>

'> 03.,7.2.23

08,... '/T

:>

'> 044,6+6.6+

07,... '/T

:>

'> 042,552.53 013. '>

08,... '/T

:>

'/T

:> 0++83.+5

'/T

:> 0+,46+.58

'/T

Dolve for )V ( 0++83.+5 , +,46+.58 , +,336.4., +,3.2 ( 02,5.6.6+

:> 0+,336.4.

80

Fnter Dolve for Fnter Dolve for Fnter

5 ;

++/ <7=

013. '>

'/T

:> +,482.26

4 ;

++/ <7=

0+.1. '>

'/T

:> 0+534.11

+ ;

++/ <7=

0+53. '>

'/T

Dolve for )V ( 0+482.26 , +,534.11 , +386.3. , +,3.2 ( 0224..17 Fnter Dolve for Fnter Dolve for Fnter + ; 43/ <7= 0+,53. '> 4 ; 43/ <7= 0+.1. '> 5 ; 43/ <7= 013. '>

:> 0+,386.3.

'/T

:> 0+614.45

'/T

:> 0+,762.18

'/T

Dolve for )V ( 0+,614.45 , +,762.18 , +,+77+.7. , +,3.2 ( 07253.8+ 4! "LO1# Fnter Dolve for Fnter Dolve for Fnter Dolve for 62 ; 6/ <7= 3. ; 6/ <7= +2 ; 6/ <7= 02,5.. '/T

:> 0+,77+.7.

'> 038,46+.13

:>

'> 06.,728..7

02,5.. '/T

:>

'> 062,43..6.

02,5.. '/T

:>

81

$! "LO1# Fnter Dolve for %! "LO1# Fnter Dolve for )! "LO1# Fnter Dolve for Fnter Dolve for *! "LO1# Fnter Dolve for +! "LO2# Fnter Dolve for 13! "LO4# Fnter Dolve for Fnter Dolve for Fnter Dolve for 14! "LO4# Fnter Dolve for Fnter Dolve for

+2 ;

6.72/ <7=

053,... '>

'/T 05,886.64 065,... '/T

:>

8 ;

8.2/ <7=

'> 03++,77..5.

:>

4. ;

++.4/ <7=

'>

03,... '/T

:> 0474,68+.+7

3. ;

++.4/ <7=

'>

03,... '/T

:> 04,321..64.75 01.,... :>

+. ;

7.8/ <7=

'>

'/T 07262.66

6 ;

6.2/ <7=

02.,... '>

'/T 0133...4

:>

8/ ;O/

3:: 8.43/

3 C7=

+7/ ;O/

3:: +6.45/

+4 C7=

+4/ ;O/

3:: +4.62/ 8.7/ 3:: +1.8/ 3::

572 C7=

;O/ 8.34/ ;O/ +8.4/

4 C7= +4 C7=

82

Fnter Dolve for 1$! "LO4# Fnter Dolve for Fnter Dolve for 1%! "LO4# Fnter Dolve for 1)! "LO1# Fnter Dolve for 1*! "LO1# Fnter Dolve for Fnter Dolve for Fnter Dolve for 1+! "LO1# Fnter Dolve for 2,! "LO4# Fnter Dolve for 57./ ;O/ 6 572 ; 4. 572 ; +. 572 ; 2 572 ; ;O/ +3.82/ +6 Q 4 ; +3.2/ ;O/ ;O/ 8.11/ +3.4/ ;O/

1.3/ 3::

24 C7=

3:: +2.+7/

+4 C7=

3:: +2..5/ +7../ 3::

4 C7=

572 C7=

8.3/*4 <7=

04,+.. '>

'/T

:> 08,2.2.15

1.5/ * 572 <7=

032.. '>

'/T

:> 06+75.73

1.5/ * 572 <7=

032.. '>

'/T

:> 0++,3.5.13

1.5/ * 572 <7=

032.. '>

'/T

:> 048,811.16 028,... :>

+./ * 572 <7=

'> 048,8.3.6+ +4 C7=

'/T

3:: 4441.8+/

83

21! "LO2. 4# Fnter Dolve for Fnter Dolve for 22! "LO3# Fnter Dolve for 23! "LO4# Fnter Dolve for 24! "LO1# Fnter Dolve for 2$! "LO1# Fnter Dolve for 2%! "LO1# Fnter Dolve for Fnter Dolve for 2)! "LO1# Fnter Dolve for

7. ;

7.1/ * +4 <7=

078,2.. '>

'/T 0+,525.+2

:>

7.1/ ;O/

3:: 6.+44 +.5/ <7=

+4 C7=

; 38.87 +,655.55/ ;O/

0+8,... '>

02.. '/T

:>

3:: 5,+51,+72.+7/

24 C7=

44.78/ ;O/

3:: 42.+1/ +./ * +4 <7=

+4 C7=

5. +4 ;

'>

05.. '/T

:> 768,+37.58

+..../ ;O/

3:: +..36/ +..36/ <7=

+4 C7=

5. ;

'>

05,7.. '/T

:> 0736,623.45

33 ;

..72/ <7=

'> 053,835,6+

04,5.. '/T

:>

84

2*! "LO1# Fnter Dolve for

++.../ ;O/

3:: ++.37/ 0. 0642 + 018. + 0. + 0+,57. +

3 C7=

C:o C,1 :,1 C,2 :,2 C,3 :,3 C,4 :,4 " ( ++.37/ @PV OPT 0454..57 2+! "LO1# C:o C,1 :,1 C,2 :,2 C,3 :,3 C,4 :,4 " ( 8.32/ @PV OPT 07831.+. 31! "LO4# Fnter ;O/ Dolve for +7.555./ +7.554 * 4 ( 8.+77/ Fnter ;O/ Dolve for +7..+/ +7..+/ * 3 ( 3/ Fnter

0. 0+72. + 0. + 034.. + 0435. +

+6/ 3::

4 C7=

+6/ 3::

3 C7=

;O/ Dolve for +2.8./ +2.8./ * +4 ( +.5+6/

+6/ 3::

+4 C7=

85

32! "LO2# Fnter Dolve for Fnter

7 ;

+.2./ * +4 <7=

02,... '>

'/T

:> 02.56.74

7 ;

+8/ * +4 <7=

02,.56.74 '>

'/T

Dolve for 02,2.8.52 : 2,... ( 02.8.52 33! "LO1# Fnter Dolve for Kond account' Fnter Dolve for Davin!s at retirement ( 0+,175,+75.84 , 5.+,523.2+ ( 04,473,2+8.55 Fnter Dolve for 34! "LO1# Fnter Dolve for Fnter Dolve for 3$! "LO1# Fnter Dolve for Fnter Dolve for 57. ; +4/ * +4 <7= 38. ; +4/ * +4 <7= 43 ; +.+6/ <7= 0+ '> +4 ; +.+6/ <7= 0+ '> 5.. ; 1/ * +4 <7= 04,473,2+8.55 '> 57. ; 7/ * +4 <7= '> 05.. '/T DtocH account' 57. ; ++/ * +4 <7= '> 06.. '/T

:> 02,2.8.52

:> 0+,175,+75.84

:> 05.+,523.2+

'/T 019,003.76

:>

'/T

:> 0+.+2

'/T

:> 0+.54 0+,...,... :>

'>

'/T 082

'>

'/T 0487.+5

0+,...,... :>

Fnter Dolve for

43. ;

+4/ * +4 <7=

'>

'/T 0+,.+..87

0+,...,... :>

86

3%! "LO2# Fnter Dolve for 3)! "LO1# Fnter Dolve for Fnter Dolve for

+4 * 5 ;

<7= 3+.34/

0+ '>

'/T

03 :>

+..../ ;O/

3:: +..36/ +..36/ <7=

+4 C7=

4 ;

'> 0+75,851.+.

012,... '/T

:>

C:o C,1 :,1 " ( +..36/ @PV OPT 0+72,645.23 4,! "LO1# Fnter Dolve for Fnter Dolve for Fnter Dolve for 41! "LO2# Fnter Dolve for 42! "LO2# Fnter ; 2+.71 +. ; +. ; +. ;

032,... 06.,... 4

+./ <7=

'> 057,876.3.

07,... '/T

:>

2/ <7=

'> 037,55..3+

07,... '/T

:>

+2/ <7=

'> 05.,++4.7+

07,... '/T

:>

7/ * +4 <7=

'>

053. '/T

04.,... :>

<7= Dolve for ..21343+5/ ..21343+5/ +4 ( 6.+5/

7. ;

065,... '>

0+,32. '/T

:>

87

44! "LO2# Fnter

57. ;

.244411+ <7=

Dolve for 043.,... : +87,346.22 ( 025,264.32 Fnter Dolve for 4$! "LO1# C:o C,1 :,1 C,2 :,2 C,3 :,3 C,4 :,4 " ( +./ @PV OPT 02.52.72 0. 0+,6.. + 0. + 04,+.. + 04,8.. + 57. ; .244411+ <7=

'> 0+87,346.22

0+,+2. '/T

:>

025,264.32 '>

'/T

:> 0531,36..47

PV of missin! O) ( 07,682 : 2.52.72 ( 0+2+3.52 Value of missin! O)' Fnter Dolve for 4%! "LO1# C:o C,1 :,1 C,2 :,2 C,3 :,3 C,4 :,4 C,$ :,$ C,% :,% C,) :,) C,* :,* C,+ :,+ C,1, " ( 1/ @PV OPT 0+,...,... 0+,2..,... + 04,...,... + 04,2..,... + 05,...,... + 05,2..,... + 03,...,... + 03,2..,... + 02,...,... + 02,2..,... + 07,...,... 4 ; +./ <7= 0+2+3.52 '> '/T :> 0+854.57

88

044,8+4,865.3. 4)! "LO4# Fnter 57. ; Dolve for <7= .55993289 / . 8.(04,1..,... ) '> 0+2,... '/T :>

PG ( .. .55993289 / +4 ( 6.719 / Fnter Dolve for 4*! "LO1# Fnter Dolve for 5 ; 6.719 / ;O/ 3:: 7.15/ +5/ <7= +4 C7=

'> 0++3,525.48

'/T

0+72,... :>

Profit ( 0++3,525.48 : 13,... ( 04.,525.48 Fnter Dolve for 4+! "LO1# Fnter Dolve for Fnter Dolve for $,! "LO1# Fnter Dolve for Fnter Dolve for Fnter Dolve for 086,7.3.57 , 2+,+4..54 ( 0+58,643.78 $1! "LO1# 83 ; ++/ * +4 <7= 17 ; 6/ * +4 <7= 83 ; ++/ * +4 <7= 6 ; +./ <7= 5 ; 013,... '> 0+72,... :>

<7= 4..75/

'/T

+8 ;

+./ <7=

'> 054,8.2.2.

03,... '/T

:>

'> 0+7,853.38

'/T

054,8.2.72 :>

'> 086,7.3.57

0+,2.. '/T

:>

'> 0++.,.4+.52

0+,2.. '/T

:>

'> 02+,+4..54

'/T

0++.,.4+.52 :>

89

Fnter

+2 Q +4 ;

8.2/*+4 <7=

'>

0+,4.. '/T

Dolve for )V ( 0353,+35.74 ( PV e..8(+2)L PV ( 0434,143.62 e%+.4 ( 0+5.,67+.22 $2! "LO1# Fnter Dolve for $3! "LO4# Fnter Dolve for +4 ; PV- t ( +3' 05,2.. * ...74 ( 027,32+.7+ 6 ; 7.4/ <7= '> 056,.2+.3+ 042,... '> '/T

:> 0353,+35.74

027,32+.7+ :>

<7= 4.57.6+4+/

04,3+7.76 '/T

:>

PG ( 4.57.6+4+/ +4 ( 48.55/ Fnter Dolve for $4! "LO1# Fnter Dolve for Fnter Dolve for Fnter Dolve for Fnter Dolve for $$! "LO1# a. Fnter Dolve for b. Fnter Dolve for 4nd KJ@ 4nd DFT 8 ; 1.2/ <7= '> 02,724.+5 012. '/T :> +7 ; 2.++/ <7= +. ; 2.++/ <7= 7 ; 2.++/ <7= 48.55/ ;O/ 3:: 54.5+/ +4 C7= semiannual rate ( (+...85)7 : + ( 2.++/ '> 025,667.64 06,... '/T :>

Ponthly rate ( .+. * +4 ( ...85L +. ; 2.++/ <7=

'> 051,888.558

'/T

025,667.64 :>

'> 054,783.88

'/T

025,667.64 :>

'> 043,43516

'/T

025,667.64 :>

8 ;

1.2/ <7=

'> 02,+7+.67

012. '/T

:>

90

$%! "LO1# Fnter Dolve for $+! "LO1# Fnter Dolve for

2nd ?@; 2nd &3T 7. ; 6.82/ * +4 <7= 078,... '> '/T 0+,573.11 :>

PreMretirement PG' ;O/ 1.271/ +./ 3:: +4 C7=

PostMretirement PG' Fnter Dolve for ;O/ 7.682/ 6/ 3:: +4 C7=

t retirement, he needs' Fnter Dolve for "n +. years, his savin!s will be worth' Fnter Dolve for fter purchasin! the cabin, he will have' 0311,721.73: 58.,... ( 0++1,721.73 Fach month between years +. and 5., he needs to save' Fnter Dolve for %,! "LO1# Fnter PV of purchase' 57 6/ * +4 ; <7= 43. ; 1.271/ * +4 <7= 0++1,721.73 '> '/T 05.88 05,.45,785.55V :> +4. ; 1.271/ * +4 <7= '> 04,2.. '/T :> 0311,721.75 43. ; 7.682/ * +4 <7= '> 05,.45,785.55 04.,... '/T 01..,... :>

Dolve for 054,... : +8,723.84 ( 0+5,532.+8 Fnter PV of lease' 57 ; 6/ * +4 <7=

'> 0+8,723.84

'/T

045,... :>

Dolve for 0+3,265.1+ , 11 ( 0+3,764,1+ Wease the car.

'> 0+3,265.1+

032. '/T

:>

?ou would be indifferent when the PV of the two cash flows are equal. The present value of the purchase decision must be 013,345.18 . Dince the difference in the two cash flows is 054... : +3,764.1+ ( 0+6,546..1, this must be the present value of the future resale price of the car. The breaHMeven resale price of the car is'

91

Fnter Dolve for %1! "LO1# Fnter Dolve for

57 ;

6/ * +4 <7=

0+6,546..1 '>

'/T

:> 04+,575..+

2.2./ ;O/

3:: 2.72/

572 C7=

C:o 06,...,... C,1 03,2..,... :,1 + C,2 02,...,... :,2 + C,3 02,7..,... :,3 + C,4 07,8..,... :,4 + C,$ 06,1..,... :,$ + C,% 08,8..,... :,% + " ( 2.72/ @PV OPT 058,46+,54..86 @ew contract value ( 058,46+,54..86 , +,3..,... ( 051,76+,54..86 PV of payments ( 051,76+,54..86 : 1,...,... ( 05.,76+,54..86 Fffective quarterly rate ( ;+ , (..22*572)<1+.42 : + ( ..+583 or +.583/ Fnter Dolve for %3! "LO4# Fnter Dolve for %4! "LO1# Fnter Dolve for Fnter Dolve for Fnter + ; 8/ <7= 038,711.4. '> ;O/ 6.64/ +4 ; + ; 04+,42. '> 43 ; +.583/ <7= 05.,76+,54..86 '> '/T 0+,2+.,626.88 :>

<7= +6.72/ 8/ 3::

'/T

042,... :>

+4 C7=

6.64/ * +4 <7=

'>

036,... * +4 '/T

:> 038,711.51

'/T

:>

92

Dolve for

024,212.53

93

Fnter Dolve for Fnter Dolve for

+4 ;

6.64/ * +4 <7=

'>

02.,... * +4 '/T

:> 02+,8.6.77

7. ;

6.64/ * +4 <7=

'> 0446,251.+3

022,... * +4 '/T

:>

ward ( 024212.+3 , 2+,8.6.77 , 446,251.+3 , +..,... , 4.,... ( 032+,137.33 %%! "LO4# Gefundable fee' Aith the 045.. application fee, you will need to borrow 0434,5.. to have 043.,... after deductin! the fee. Dolve for the payment under these circumstances. Fnter Dolve for 5. +4 ; 7.8./ * +4 <7= 0434,5.. '>

'/T 0+,261.7+

:>

Fnter

<7= Dolve for ..263372+/ PG ( .. 263372+/ +4 ( 7.8157/ Fnter Dolve for 7.8157/ ;O/

5. +4 ;

043.,... '>

0+,261.7+ '/T

:>

3:: 6.+4/

+4 C7=

Aithout refundable fee' PG ( 7.8./ Fnter Dolve for 7.8./ ;O/ 3:: 6..4/ +4 C7=

94

%%! "LO4# Fnter Dolve for

57 ;

<7= 4.5/

0+,... '>

03+.+2 '/T

:>

PG ( 4.5/ +4 ( 46.7./ Fnter Dolve for %)! "LO1# Fnter Dolve for a. Fnter Dolve for b. Fnter Dolve for c. Fnter Dolve for t 72, she is short' 0+,++4,56+.2.: 412,.64.6.( 08+6,418.8. Fnter Dolve for 5. ; 6/ <7= '> '/T 08,724.42 V08+6,418.8. :> +. ; 6/ <7= 5. ; 6/ <7= 5. ; 6/ <7= 46.6./ ;O/ 3:: 5+.51/ +4 C7=

Ahat she needs at a!e 72' 4. ; 6/ <7= '> 0+,++4,56+.2. 0+.2,... '/T :>

'>

'/T 0++,667..+

0+,++4,56+.2. :>

'> 0+37,+41..3 0+2.,... '>

'/T

0+,++4,56+.2. :>

'/T

:> 0412,.64.6.

Her employer will contribute 0+,2.. per year, so she must contribute' 08,724.42: +,2.. ( 06,+24,42 per year %*! "LO2# Fnter Dolve for ; +.7.2 Aithout fee' +1.8/ * +4 <7= 0+.,... '> 04.. '/T

:>

95

Fnter Dolve for Aith fee' Fnter Dolve for %+! "LO1# Fnter Dolve for Fnter Dolve for Fnter Dolve for Fnter Dolve for Fnter Dolve for + ; 4 ; 5 ; 3 ; ; 21.52 Value at ?ear 7' 2 ; ; 26.11

7.4/ * +4 <7=

0+.,... '>

04.. '/T

:>

7.4/ * +4 <7=

0+.,4.. '>

04.. '/T

:>

+4/ <7=

01.. '>

'/T

:> 0+,287.++

+4/ <7=

01.. '>

'/T

:> 0+3+7.+6

+4/ <7=

0+... '>

'/T

:> 0+,3.3.15

+4/ <7=

+... '>

'/T

:> 0+,423.3.

+4/ <7=

0+,+.. '>

'/T

:> 0+,454

Do, at ?ear 2, the value is' 0+,287.++, +,3+7.+6 , +,3.3.15 , +,423.3. , +,454 , +,+.. ( 06,115.7+ t ?ear 72, the value is' Fnter '/T :> Dolve for 0631,325.44 The policy is not worth buyin!L the future value of the deposits is 0631,325.44but the policy contract will pay off 02..,.... 21 ; 8/ <7= 06,115.7+ '>

96

),! "LO2# Fnter Dolve for Fnter Dolve for )1! "LO4#

5. +4 ;

6.176/ * +4 <7=

062.,... '>

'/T 02,382.68 02382.68 '/T

:>

44 +4 ;

6.176/ * +4 <7=

'> 0784,464.83

:>

C:o C,1 :,1 C,2 :,2 "GG OPT 8..6/

01,... 01,... 2 04.,... 3

)%! "LO4# a. A'R 4 )5 $2 4 3%45 Fnter Dolve for b. Fnter Dolve for + ; 573/ ;O/ 3:: 5,464.25/ 24 C7=

<7= 6.246/

01.5. '>

'/T

0+.... :>

PG ( 6.246/ 24 ( 51+.518/ Fnter Dolve for c. Fnter Dolve for 3 ; 51+.518/ ;O/ 3:: 3425.18/ 24 C7=

<7= +7.62/

078.14 '>

042 '/T

:>

PG ( +7.62/ 24 ( 86+.../ Fnter Dolve for 86+.../ ;O/ 3:: 5+3,4+2.64/ 24 C7=

97