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5.

1 Future value: Chuck Tomkovick is planning to invest $25,000 today in a mutual


fund that will provide a return of 8 percent each year. What will be the value of the
investment in 10 years?
LO 2
Solution:
0 5 years

PV = $25,000 FV = ?
Amount invested today = PV = $25,000
Return expected from investment = i = 8%
Duration of investment = n = 10 years
Value of investment after 10 years = FV
10
$53,973.12
+
10 n
10
) 08 . 1 ( 000 , 25 $ ) 1 ( PV FV i
5.2 Future value: Ted Rogers is investing $7,500 in a bank CD that pays a 6 percent
annual interest. How much will the CD be worth at the end of five years?
LO 2
Solution:
0 5 years

PV = $7,500 FV = ?
Amount invested today = PV = $7,500
Return expected from investment = i = 6%
Duration of investment = n = 5 years
Value of investment after 5 years = FV
5
$10,036.69
+
5 n
5
) 06 . 1 ( 500 , 7 $ ) 1 ( PV FV i
5.3 Future value: Your aunt is planning to invest in a bank deposit that will pay 7.5
percent interest semiannually. If she has $5,000 to invest, how much will she have at
the end of four years?
LO 2
Solution:
0 4 years

PV = $5,000 FV = ?
Amount invested today = PV = $5,000
Return expected from investment = i = 7.5%
Duration of investment = n = 4 years
Frequency of compounding = m = 2
Value of investment after 4 years = FV
4
$6,712.35

,
_

,
_

8
4 2 mn
4
) 0375 . 1 ( 500 , 7 $
2
075 . 0
1 500 , 7 $
m
1 PV FV
i
5.4 Future value: Kate Eden received a graduation present of $2,000 that she is planning
on investing in a mutual fund that earns 8.5 percent each year. How much money can
she collect in three years?
LO 2
Solution:
0 3 years

PV = $2,000 FV = ?
Amount Kate invested today = PV = $2,000
Return expected from investment = i = 8.5%
Duration of investment = n = 3 years
Value of investment after 3 years = FV
3
$2,554.58
+
3 n
3
) 085 . 1 ( 000 , 2 $ ) 1 ( PV FV i
5.5 Future value: Your bank pays 5 percent interest semiannually on your savings
account. You dont expect the current balance of $2,700 to change over the next four
years. How much money can you expect to have at the end of this period?
LO 2
Solution:
0 4 years

PV = $2,700 FV = ?
Amount invested today = PV = $2,700
Return expected from investment = i = 5%
Duration of investment = n = 4 years
Frequency of compounding = m = 2
Value of investment after 4 years = FV
4
$3,289.69

,
_

,
_

8
4 2 mn
4
) 025 . 1 ( 700 , 2 $
2
05 . 0
1 700 , 2 $
m
1 PV FV
i
5.6 Future value: Your birthday is coming up, and instead of any presents, your parents
promised to give you $1,000 in cash. Since you have a part time job and thus dont
need the cash immediately, you decide to invest the money in a bank CD that pays 5.2
percent quarterly for the next two years. How much money can you expect to gain in
this period of time?
LO 2
Solution:
0 2 years

PV = $1,000 FV = ?
Amount invested today = PV = $1,000
Return expected from investment = i = 5.2%
Duration of investment = n = 2 years
Frequency of compounding = m = 4
Value of investment after 2 years = FV
2
$1,108.86

,
_

,
_

8
2 4 mn
2
) 013 . 1 ( 000 , 1 $
4
052 . 0
1 000 , 1 $
m
1 PV FV
i
5.7 Multiple compounding periods: Find the future value of an investment of $100,000
made today for five years and paying 8.75 percent for the following compounding
periods:
a. Quarterly
b. Monthly
c. Daily
d. Continuous
LO 2
Solution:
0 5 years

PV = $100,000 FV = ?
Amount invested today = PV = $100,000
Return expected from investment = i = 8.75%
Duration of investment = n = 5 years
a. Frequency of compounding = m = 4
Value of investment after 5 years = FV
5
4 $154,154.2

,
_

,
_

20
5 4 mn
5
) 021875 . 1 ( 000 , 100 $
4
0875 . 0
1 000 , 100 $
m
1 PV FV
i
b. Frequency of compounding = m = 12
Value of investment after 5 years = FV
5
7 $154,637.3

,
_

,
_

60
5 12 mn
5
) 00729 . 1 ( 000 , 100 $
12
0875 . 0
1 000 , 100 $
m
1 PV FV
i
c. Frequency of compounding = m = 365
Value of investment after 5 years = FV
5
1 $154,874.9

,
_

,
_

1825
5 365 mn
5
) 00024 . 1 ( 000 , 100 $
365
0875 . 0
1 000 , 100 $
m
1 PV FV
i
d. Frequency of compounding = m = Continuous
Value of investment after 5 years = FV
5
3 $154,883.0


5488303 . 1 000 , 100 $
e 000 , 100 $ e PV FV
5 0875 . 0
5
in
5.8 Growth rates: Matt Murton, an outfielder for the Chicago Cubs, is expected to hit 25
home runs in 2008. If his home run hitting ability is expected to grow by 12 percent
every year for the next five years, how many home runs is he expected to hit in 2013?
LO 4
Solution:
0 5 years

PV = 25 FV = ?
Number of home runs hit in 2008 = PV = 25
Expected annual increase in home runs hit = i = 12%
Growth period = n = 5 years
No. of home runs after 5 years = FV
5
runs home 44
+
5
5
) 12 . 1 ( 25 ) 1 (
n
i PV FV
5.9 Present value: Roy Gross is considering an investment that pays 7.6 percent. How
much will he have to invest today so that the investment will be worth $25,000 in six
years?
LO 3
Solution:
0 6 years

PV = ? FV = $25,000
Value of investment after 6 years = FV
5
= $25,000
Return expected from investment = i = 7.6%
Duration of investment = n = 6 years
Amount to be invested today = PV
$16,108.92

6 n
n
) 076 . 1 (
000 , 25 $
) 1 (
FV
PV
i
5.10 Present value: Maria Addai has been offered a future payment of $750 two years
from now. If her opportunity cost is 6.5 percent compounded annually, what should
she pay for this investment today?
LO 3
Solution:
0 2 years

PV = ? FV = $750
Value of investment after 2 years = FV
2
= $750
Return expected from investment = i = 6.5%
Duration of investment = n = 2 years
Amount to be invested today = PV
( )
$661.24

2 n
n
) 065 . 1 (
750 $
1
FV
PV
i
5.11 Present value: Your brother has asked you for a loan and has promised to pay back
$7,750 at the end of three years. If you normally invest to earn 6 percent, how much
will you be willing to lend to your brother?
LO 3
Solution:
0 3 years

PV = ? FV = $7,750
Loan repayment amount after 3 years = FV
3
= $7,750
Return expected from investment = i = 6%
Duration of investment = n = 3 years
Amount to be invested today = PV
( )
$6,507.05

3 n
n
) 06 . 1 (
750 , 7 $
1
FV
PV
i
5.12 Present value: Tracy Chapman is saving to buy a house in five years time. She plans
to put down 20 percent down at that time, and she believes that she will need $35,000
for the down payment. If Tracy can invest in a fund that pays 9.25 percent annually,
how much will she need to invest today?
LO 3
Solution:
0 5 years

PV = ? FV = $35,000
Amount needed for down payment after 5 years = FV
5
= $35,000
Return expected from investment = i = 9.25%
Duration of investment = n = 5 years
Amount to be invested today = PV
( )
$22,488.52

5 n
n
) 0925 . 1 (
000 , 35 $
1
FV
PV
i
5.13 Present value: You want to buy some deep discount bonds that have a value of
$1,000 at the end of seven years. Bonds with similar risk are said to pay 4.5 percent
interest. How much should you pay for them today?
LO 3
Solution:
0 7 years

PV = ? FV = $1,000
Face value of bond at maturity = FV
7
= $1,000
Appropriate discount rate = i = 4.5%
Number of years to maturity = n = 7 years.
Present value of bond = PV
( )
$734.83

7 n
n
) 045 . 1 (
000 , 1 $
1
FV
PV
i
5.14 Present value: Elizabeth Sweeney wants to accumulate $12,000 by the end of 12
years. If the interest rate is 7 percent, how much will she have to invest today to
achieve her goal?
LO 3
Solution:
0 12 years

PV = ? FV = $12,000
Amount Ms. Sweeney wants at end of 12 years = FV
12
= $12,000
Interest rate on investment = i = 7%
Duration of investment = n = 12 years.
Present value of investment = PV
( )
$5,328.14

12 n
n
) 07 . 1 (
000 , 12 $
1
FV
PV
i
5.15 Interest rate: You are in desperate need of cash and turn to your uncle who has
offered to lend you some money. You decide to borrow $1,300 and agree to pay back
$1,500 in two years. Alternatively, you could borrow from your bank that is charging
6.5 percent interest. Should you go with your uncle or the bank?
LO 2
Solution:
0 2 years

PV = $1,300 FV = $1,500
Amount to be borrowed = PV = $1,300
Amount to be paid back after 2 years = FV
2
= $1,500
Interest rate on investment = i = ?
Duration of investment = n = 2 years.
Present value of investment = PV
( )
7.42%

+
+

i
1 1538 . 1
1538 . 1
$1,300
$1,500
) i 1 (
) 1 (
500 , 1 $
300 , 1 $
1
FV
PV
2
2
n
n
i
i
i
You should go with the bank borrowing.
5.16 Time to attain goal: You invest $150 in a mutual fund today that pays 9 percent
interest. How long will it take to double your money?
LO 1,2
Solution:
0 n years

PV = $150 FV = $300
Value of investment today = PV = $150
Interest on investment = n = 9%
Future value of investment = FV = $300
Number of years to double investment = n
years 8



+
) 09 . 1 ln(
) 00 . 2 ln(
) 00 . 2 ln( ) 09 . 1 ln(
00 . 2 150 300 $ ) 09 . 1 (
) 09 . 1 ( 150 $ 300 $
) 1 (
n
n
i PV FV
n
n
n
n
INTERMEDIATE
5.17 Growth rate: Your Finance textbook sold 53,250 copies in its first year. The
publishing company expects the sales to grow at a rate of 20 percent for the next three
years and by 10 percent in the fourth year. Calculate the total number of copies that
the publisher expects to sell in years 3 and 4. Draw a time line to show the sales level
for each of the next four years.
LO 4
Solution:
Number of copies sold in its first year = PV = 53,250
Expected annual growth in the next 3 years = i = 20%
Number of copies sold after 3 years = FV
3
=
copies 92,016

+
3
n
n
) 20 . 1 ( 250 , 53
) 1 ( PV FV i
Number of copies sold in the fourth year = FV
4
copies 101,218
+ ) 10 . 1 ( 016 , 92 ) 1 ( PV FV
n
n
i
0 3 4 years

PV = 53,250 92,016 10,218 copies


5.18 Growth rate: CelebNav, Inc., had sales last year of $700,000, and the analysts are
predicting a good year for the start up, with sales growing 20 percent a year for the
next three years. After that, the sales should grow 11 percent per year for another two
years, at which time the owners are planning on selling the company. What are the
projected sales for the last year of the companys operation?
LO 4
Solution:
0 1 2 3 4 5
years

g
1
= 20% g
2
= 11%
PV = $700,000
FV=?
Sales of CelebNav last year = PV = $700,000
Expected annual growth in the next 3 years = g
1
= 20%
Expected annual growth in years 4 and 5 = g
2
= 11%
Sales in year 5 = FV
5
.16 $1,490,348
+ +
2 3 2
2
3
1 5
) 11 . 1 ( ) 20 . 1 ( 000 , 700 $ ) g 1 ( ) g 1 ( PV FV
5.19 Growth rate: You decide to take advantage of the current online dating craze and
start your own Web site. You know that you have 450 people who will sign up
immediately, and through a careful marketing research and analysis you determine
that membership can grow by 27 percent in the first two years, 22 percent in year 3,
and 18 percent in year 4. How many members do you expect to have at the end of
four years?
LO 4
Solution:
0 1 2 3 4 years

g
1-2
=27% g
3
=22% g
4
=18%
PV = 450 FV = ?
Number of Web site memberships at t = 0 = PV = 450
Expected annual growth in the next 2 years = g
1-2
= 27%
Expected annual growth in years 3 = g
3
= 22%
Expected annual growth in years 4 = g
4
= 18%
Number of members in year 4 = FV
4
members 1,045
+ + + ) 18 . 1 )( 22 . 1 ( ) 27 . 1 ( 450 ) g 1 )( g 1 ( ) g 1 ( PV FV
2
4 3
2
1 4
5.20 Multiple compounding periods: Find the future value of an investment of $2,500
made today for the following rates and periods:
a. 6.25 percent compounded semiannually for 12 years
b. 7.63 percent compounded quarterly for 6 years
c. 8.9 percent compounded monthly for 10 years
d. 10 percent compounded daily for 3 years
e. 8 percent compounded continuously for 2 years
LO 2
Solution:
a.
$5,232.09

,
_

) 0928 . 2 ( 500 , 2 $
2
0625 . 0
1 PV FV
12 2
12
b.
$3,934.48

,
_

) 4768 . 2 ( 500 , 2 $
4
0763 . 0
1 PV FV
6 4
12
c.
$6,067.86

,
_

) 4271 . 2 ( 500 , 2 $
12
089 . 0
1 PV FV
10 12
12
d.
$3,374.51

,
_

) 3498 . 1 ( 500 , 2 $
365
010 . 0
1 PV FV
3 365
12
e.
$2,933.78


1735 . 1 500 , 2 $
e 000 , 3 $ e PV FV
2 08 . 0 in
3
5.21 Growth rates: Xenix Corp had sales of $353,866 in 2008. If it expects its sales to be
at $476,450 in three years, what is the rate at which the companys sales are expected
to grow?
LO 4
Solution:
Sales in 2008 = PV = $353,866
Expected sales three years from now = $476,450
To calculate the expected sales growth rate, we set up the future value equation.
10.42%

+
+
+
1 ) 3464 . 1 ( g
3464 . 1
866 , 353 $
450 , 476 $
) g 1 (
) g 1 ( 866 , 353 $ 450 , 476 $
) g 1 ( PV FV
3
1
3
3
3
3
5.22 Growth rate: Infosys Technologies, Inc., an Indian technology company reported a
net income of $419 million this year. Analysts expect the companys earnings to be
$1.468 billion in five years. What is the companys expected earnings growth rate?
LO 4
Solution:
Earnings in current year = PV = $419,000,000
Expected earnings five years from now = $1,468,000,000
To calculate the expected earnings growth rate, we set up the future value equation.
% 2 5 . 8
1 ) 5036 . 3 ( g
5036 . 3
000 , 000 , 419 $
000 , 000 , 468 , 1 $
) g 1 (
) g 1 ( 000 , 000 , 419 $ 000 , 000 , 468 , 1 $
) g 1 ( PV FV
5
1
5
5
5
5


+
+
+
5.23 Time to attain goal: Zephyr Sales Company has currently reported sales of $1.125
million. If the company expects its sales to grow at 6.5 percent annually, how long
will it be before the company can double its sales? Use a financial calculator to solve
this problem.
LO 1,2
Solution:
Enter
6.5% -$1.125 $2.250
N i% PMT PV FV

Answer: 11 years
5.24 Time to attain goal: You are able to deposit $850 into a bank CD today, and you will
only withdraw the money once the balance is $1,000. If the bank pays 5 percent
interest, how long will it take you to attain your goal?
LO 1,2
Solution:
Amount invested today = PV = $850
Expected amount in the future = FV = $1,000
Interest rate on CD = i = 5%
To calculate the time needed to reach the target FV, we set up the future value
equation.
years 3.3



+
) 05 . 1 ln(
) 1764 . 1 ln(
) 1764 . 1 ln( ) 05 . 1 ln(
1764 . 1
850 $
000 , 1 $
) 05 . 1 (
) 05 . 1 ( 850 $ 000 , 1 $
) 1 ( PV FV
n
n
n
n
n
n
i
5.25 Time to attain goal: Neon Lights Company is a private company with sales of $1.3
million a year. They want to go public but have to wait until the sales reach $2
million. Providing that they are expected to grow at a steady 12 percent annually,
when is the earliest that Neon Lights can start selling their shares?
LO 1,2
Solution:
Current level of sales = PV = $1,300,000
Target sales level in the future = FV = $2,000,000
Projected growth rate = g = 12%
To calculate the time needed to reach the target FV, we set up the future value
equation.
years 3.8



+
) 12 . 1 ln(
) 5385 . 1 ln(
) 5385 . 1 ln( ) 12 . 1 ln(
5385 . 1
00 , 300 , 1 $
000 , 000 , 2 $
) 12 . 1 (
) 12 . 1 ( 000 , 300 , 1 $ 000 , 000 , 2 $
) g 1 ( PV FV
n
n
n
3
n
n
5.26 Present value: Caroline Weslin needs to decide whether to accept a bonus of $1,900
today or wait two years and receive $2,100 then. She can invest at 6 percent. What
should she do?
LO 3
Solution:
0 2 years

PV = $1,900 FV = ?
Amount to be received in 2 years = FV
2
= $2,100
Return expected from investment = i = 6%
Duration of investment = n = 2 years
Present value of amount today PV =
$1,868.99

2 n
2
) 06 . 1 (
100 , 2 $
) 1 (
FV
PV
i
Since the amount to be received today ($1,900) is greater than the present value of the
$2,100 to be received in two years, Ms. Weslin should choose to receive the amount
of $1,900 today
5.27 Multiple compounding periods: Find the present value of $3,500 under each of the
following rates and periods.
a. 8.9% compounded monthly for five years.
b. 6.6% compounded quarterly for eight years.
c. 4.3% compounded daily for four years.
d. 5.7% compounded continuously for three years.
LO 2
Solution:
0 n years

PV = ? FV = $3,500
a. Return expected from investment = i = 8.9%
Duration of investment = n = 5 years
Frequency of compounding = m = 12
Present value of amount = PV
$2,246.57

,
_

,
_


5579 . 1
500 , 3 $
12
089 . 0
1
500 , 3 $
m
1
FV
PV
5 12 mn
5
i
b. Return expected from investment = i = 6.6%
Duration of investment = n = 8 years
Frequency of compounding = m = 4
Present Value of amount = PV
$2,073.16

,
_

,
_


6882 . 1
500 , 3 $
4
066 . 0
1
500 , 3 $
m
1
FV
PV
8 4 mn
8
i
c. Return expected from investment = i = 4.3%
Duration of investment = n = 4 years
Frequency of compounding = m = 365
Present Value of amount = PV
$2,946.96

,
_

,
_


1877 . 1
500 , 3 $
365
043 . 0
1
500 , 3 $
m
1
FV
PV
4 365 mn
4
i
d. Return expected from investment = i = 5.7%
Duration of investment = n = 3 years
Frequency of compounding = m = Continuous
Present value of amount = PV
$2,949.88

1865 . 1
500 , 3 $
e
500 , 3 $
e
FV
PV
3 057 . 0
3
in
5.28 Multiple compounding periods: Samantha is looking to invest some money, so that
she can collect $5,500 at the end of three years. Which investment should she make
given the following choices:
a. 4.2% compounded daily
b. 4.9% compounded monthly
c. 5.2% compounded quarterly
d. 5.4% compounded annually
LO 2
Solution:
0 3 years

PV = ? FV = $5,500
a. Return expected from investment = i = 4.2%
Duration of investment = n = 3 years
Frequency of compounding = m = 12
Present value of amount = PV
$4,848.92

,
_

,
_


1343 . 1
500 , 5 $
365
042 . 0
1
500 , 5 $
m
1
FV
PV
3 365 mn
3
i
Samantha should invest $4,848.92 today to reach her target of $5,500 in three years.
b. Return expected from investment = i = 4.9%
Duration of investment = n = 5 years
Frequency of compounding = m = 12
Present value of amount = PV
$4,749.54

,
_

,
_


5579 . 1
500 , 5 $
12
049 . 0
1
500 , 5 $
m
1
FV
PV
3 12 mn
3
i
Samantha should invest $4,749.54 today to reach her target of $5,500 in three years.
c. Return expected from investment = i = 5.2%
Duration of investment = n = 3 years
Frequency of compounding = m = 4
Present Value of amount = PV
$4,710.31

,
_

,
_


1677 . 1
500 , 5 $
4
052 . 0
1
500 , 5 $
m
1
FV
PV
3 4 mn
3
i
Samantha should invest $4,710.31 today to reach her target of $5,500 in three years.
d. Return expected from investment = i = 5.4%
Duration of investment = n = 3 years
Frequency of compounding = m = 1
Present value of amount = PV
$4,697.22
+

3 3
3
) 054 . 1 (
500 , 5 $
) 1 (
FV
PV
i
Samantha should invest $4,697.22 today to reach her target of $5,500 in three years.
Samantha should invest in choice D.
ADVANCED
5.29 You have $2,500 you want to invest in your classmates start-up business. You
believe the business idea to be great and hope to get $3,700 back at the end of three
years. If all goes according to the plan, what will be your return on investment?
LO 2,3
Solution:
0 3 years

PV = $2,500 FV = $3,700
Amount invested in project = PV = $2,500
Expected return three years from now = FV =$3,700
To calculate the expected rate of return, we set up the future value equation.
13.96%

+
+
+
1396 . 0 1 ) 4800 . 1 (
4800 . 1
500 , 2 $
700 , 3 $
) 1 (
) 1 ( 500 , 2 $ 700 , 3 $
) 1 ( PV FV
3
1
3
3
3
3
i
i
i
i
5.30 Patrick Seeley has $2,400 that he is looking to invest. His brother approached him
with an investment opportunity that could double his money in four years. What
interest rate would the investment have to yield in order for Patricks brother to
deliver on his promise?
LO 2,3
Solution:
0 4 years

PV = $2,400 FV = $4,800
Amount invested in project = PV = $2,400
Expected return three years from now = FV =$4,800
Investment period = n = 4 years
To calculate the expected rate of return, we set up the future value equation.
18.92%

+
+
+
1892 . 0 1 ) 000 . 2 (
4800 . 1
400 , 2 $
800 , 4 $
) 1 (
) 1 ( 400 , 2 $ 800 , 4 $
) 1 ( PV FV
4
1
4
4
4
4
i
i
i
i
5.31 You have $12,000 in cash. You can deposit it today in a mutual fund earning 8.2
percent semiannually; or you can wait, enjoy some of it, and invest $11,000 in your
brothers business in two years. Your brother is promising you a return of at least 10
percent on your investment. Whichever alternative you choose, you will need to cash
in at the end of 10 years. Assume your brother is trustworthy and that both
investments carry the same risk. Which one will you choose?
LO 2,3
Solution:
Option A: Invest in account paying 8.2 percent semiannually for 10 years.
0 10 years

PV = $12,000 FV = ?
Amount invested in project = PV = $12,000
Investment period = n = 10 years
Interest earned on investment = i = 8.2%
Frequency of compounding = m = 2
Value of investment after 10 years = FV
10
$26,803.77

,
_

) 23365 . 2 ( 000 , 12 $
2
082 . 0
1 PV FV
10 2
10
Option B: Invest in brothers business to earn 10 percent for eight years.
0 8 years

PV = $11,000 FV = ?
Amount invested in project = PV = $11,000
Investment period = n = 8 years
Interest earned on investment = i = 10%
Frequency of compounding = m = 1
Value of investment after 8 years = FV
10
( )
$23,579.48
+ ) 14359 . 2 ( 000 , 11 $ 10 . 0 1 PV FV
8
8
You are better off investing today in the mutual fund and earn 8.2 percent
semiannually for 10 years.
5.32 When you were born, your parents set up a bank account in your name with an initial
investment of $5,000. You are turning 21 in a few days and will have access to all
your funds. The account was earning 7.3 percent for the first seven years, and then the
rates went down to 5.5 percent for six years. The economy was doing well at the end
of 1990s and your account was earning 8.2 percent for three years in a row.
Unfortunately, the next two years you only earned 4.6 percent. Finally, as the
economy recovered, your return jumped to 7.6 percent for the last three years.
a. How much money was in your account before the rates went down drastically
(end of year 16)?
b. How much money is in your account now, end of year 21?
c. What would be the balance now if your parents made another deposit of
$1,200 at the end of year 7?
LO 2,3
Solution:
0 1 7 13 14 15 16 21 years

PV = $5,000 FV = ?
i
1
= 7.3% i
2
= 5.5% i
3
= 8.2% i
4
= 4.6% i
5
= 7.6%
a. Initial investment = PV = $5,000
Interest rate for first 7 years = i
1
= 7.3%
Interest rate for next 6 years = i
2
= 5.5%
Interest rate for next 3 years = i
3
= 8.2%
Investment value at age 16 years = FV
16
( )
$14,300.55

+
+ + +
) 2667 . 1 ( ) 3788 . 1 ( ) 6376 . 1 ( 000 , 5 $
) 082 . 1 ( ) 055 . 1 ( 073 . 0 1 000 , 5 $
) 1 ( ) 1 ( ) 1 ( PV FV
3 6 7
3
3
6
2
7
1 16
i i i
b. Interest rate for from age 17 to 18 = i
4
= 4.6%
Interest rate for next 3 years = i
5
= 7.6%
Investment at start of 16
th
year = PV = $14,300.55
Investment value at age 21 years = FV
21
( )
$19,492.38

+
+ +
)) 2458 . 1 ( ) 0941 . 1 ( 55 . 300 , 14 $
) 076 . 1 ( 046 . 0 1 55 . 300 , 14 $
) 1 ( ) 1 ( FV FV
3 2
3
5
2
4 16 21
i i
c. Additional investment at start of 8th year = $1,200
Total investment for next 6 years = $8,187.82 + $1,200 = $9,387.82
Interest rate for next 6 years = i
2
= 5.5%
Interest rate for years 13 to 16 = i
3
= 8.2%
Interest rate for from age 17 to 18 = i
4
= 4.6%
Interest rate for next 3 years = i
5
= 7.6%
Investment value at age 21 = FV
21
( )
$22,349.16


+ + + +
) 2458 . 1 ( ) 0941 . 1 ( ) 2667 . 1 ( ) 3788 . 1 ( 82 . 9387 $
) 076 . 1 ( 046 . 1 ) 082 . 1 ( ) 055 . 1 ( 82 . 387 , 9 $
) 1 ( ) 1 ( ) 1 ( ) 1 (
3 2 3 6
3
5
2
4
3
3
6
2 7 21
i i i i FV FV
5.33 Cedric Benson, a top five draft pick of the Chicago Bears, and his agent are
evaluating three contract options. In each case, there is a signing bonus and a series of
payments over the life of the contract. He uses a 10.25 percent rate of return to
evaluate the contracts. Given the cash flows for each of the following options, which
one should he choose?
Year Cash Flow Type Option A Option B Option C
0 Signing Bonus $3,100,000 $4,000,000 $4,250,000
1 Annual Salary $ 650,000 $ 825,000 $ 550,000
2 Annual Salary $ 715,000 $ 850,000 $ 625,000
3 Annual Salary $ 822,250 $ 925,000 $ 800,000
4 Annual Salary $ 975,000 $1,250,000 $ 900,000
5 Annual Salary $1,100,000 $1,000,000
6 Annual Salary $1,250,000
LO 4
Solution:
To decide on the best contract from Mr. Bensons viewpoint, we need to find the
present value of each option. The contract with the highest present value should be the
one chosen.
Option A:
Discount rate to be used = i= 10.25%
Present value of contract = PV
A
647 , 922 , 6 $
047 , 696 $ 305 , 675 $ 918 , 659 $ 576 , 613 $ 232 , 588 $ 569 , 589 $ 000 , 100 , 3 $
) 1025 . 1 (
000 , 250 , 1 $
) 1025 . 1 (
000 , 100 , 1 $
) 1025 . 1 (
000 , 975 $
) 1025 . 1 (
250 , 822 $
) 1025 . 1 (
000 , 715 $
) 1025 . 1 (
000 , 650 $
000 , 100 , 3 $ PV
6 5 4 3 2 1 A

+ + + + + +
+ + + + + +
Option B:
Discount rate to be used = i= 10.25%
Present value of contract = PV
B
894 , 983 , 6 $
049 , 846 $ 249 , 690 $ 297 , 699 $ 299 , 748 $ 000 , 000 , 4 $
) 1025 . 1 (
000 , 250 , 1 $
) 1025 . 1 (
000 , 925 $
) 1025 . 1 (
000 , 850 $
) 1025 . 1 (
000 , 825 $
000 , 000 , 4 $ PV
4 3 2 1 B

+ + + +
+ + + +
Option C:
Discount rate to be used = i= 10.25%
Present value of contract = PV
C
$7,083,096
+ + + + +
+ + + + +
913 , 613 $ 155 , 609 $ 972 , 596 $ 189 , 514 $ 866 , 498 $ 000 , 250 , 4 $
) 1025 . 1 (
000 , 000 , 1 $
) 1025 . 1 (
000 , 900 $
) 1025 . 1 (
000 , 800 $
) 1025 . 1 (
000 , 625 $
) 1025 . 1 (
000 , 550 $
000 , 250 , 4 $ PV
5 4 3 2 1 C
Option C is the best choice for Mr. Benson.
5.34 Surmec, Inc., had sales of $2.1 million last year. The companys primary business line
is manufacturing of nuts and bolts. Since this is a mature industry, the analysts are
certain that the sales will grow at a steady rate of 7 percent a year for as far as they
can tell. The company reports net income that represents 23 percent of sales. The
companys management would like to buy a new fleet of trucks but can do so only
once the profit reaches $620,000 a year. At the end of what year will Surmec be able
to buy the new fleet of trucks? What will the sales and profit be that year?
LO 1,2,3,4
Solution:
Current level of sales for Surmec = PV = $2,100,000
Profit margin = 23%
Net Income for the year = 0.23 x $2,100,000 = $483,000
Target profit level in the future = FV = $620,000
Projected growth rate of sales = g = 7%
To calculate the time needed to reach the target FV, we set up the future value
equation.
years 3.7



+
) 12 . 1 ln(
) 2836 . 1 ln(
) 2836 . 1 ln( ) 07 . 1 ln(
2836 . 1
00 , 483 $
000 , 620 $
) 07 . 1 (
) 07 . 1 ( 000 , 483 $ 000 , 620 $
) g 1 ( PV FV
n
n
n
n
n
n
The company achieves its profit target during the fourth year.
Sales level at end of year 4 = FV
4
.62 $2,752,671
+
4
n
n
) 07 . 1 ( 000 , 100 , 2 $
) g 1 ( PV FV
Profit for the year = $2,752,671.62 x 0.23 = $633,114.47
5.35 You are graduating in two years and you start thinking about your future. You know
that you will want to buy a house five years after you graduate and that you will want
to put down $60,000. As of right now, you have $8,000 in your savings account. You
are also fairly certain that once you graduate, you can work in the family business and
earn $32,000 a year, with a 5 percent raise every year. You plan to live with your
parents for the first two years after graduation, which will enable you to minimize
your expenses and put away $10,000 each year. The next three years, you will have to
live out on your own, as your younger sister will be graduating from college and has
already announced her plan to move back into the family house. Thus, you will only
be able to save 13 percent of your annual salary. Assume that you will be able to
invest savings from your salary at 7.2 percent. What is the interest rate at which you
need to invest the current savings account balance in order to achieve your goal?
Hint: Draw a time line that shows all the cash flows for years 0 through 7.
Remember, you want to buy a house seven years from now and your first salary will
be in year 3.
LO 1,2,3,4
Solution:
0 1 2 3 4 5 6 7

$10,000 $10,000
Starting salary in year 3 = $32,000
Annual pay increase = 5%
Savings in first 2 years = $10,000
Savings rate for years 3 to 7 = 13%
Year 1 2 3 4 5 6 7
Salary $0 $0 $32,000 $33,600 $35,280 $37,044 $38,896
Savings $0 $0 $10,000 $10,000 $4,586.40 $4,815.72 $5,056.48
Investment rate = i = 7.2%
Future value of savings from salary = FV
7
28 . 012 , 41 $
48 . 056 , 5 $ 45 . 162 , 5 $ 86 . 267 , 5 $ 25 . 319 , 12 $ 24 . 206 , 13 $
) 072 . 1 ( 48 . 056 , 5 $ ) 072 . 1 ( 72 . 815 , 4 $
) 072 . 1 ( 40 . 586 , 4 $ ) 072 . 1 ( 000 , 10 $ ) 072 . 1 ( 000 , 10 $ 0 $ 0 $ FV
0 1
2 3 4
7

+ + + +
+ +
+ + + +
Target down payment = $60,000
Amount needed to reach target = $60,000 - $41,012.28 = FV = $18,987.72
Current savings balance = PV $8,000
Time to achieve target = n = 7 years.
To solve for the investment rate needed to achieve target, we need to set up the future
value equation:
13.14%


+
+
+
1 1314 . 1
1 ) 3735 . 2 (
3735 . 2
000 , 8 $
72 . 987 , 18 $
) 1 (
) 1 ( 000 , 8 $ 72 . 987 , 18 $
) 1 ( PV FV
7 1
7
7
7
i
i
i
i
Sample Test Problems
5.1 Santiago Hernandez is planning to invest $25,000 in a money market account for two
years. The account pays an interest of 5.75 percent compounded on a monthly basis.
How much will Santiago Hernandez have at the end of two years?
LO 2
Solution:
0 2 years

PV = $25,000 FV = ?
Amount invested today = PV = $25,000
Return expected from investment = i = 5.75%
Duration of investment = n = 2 years
Frequency of compounding = m = 12
Value of investment after 2 years = FV
2
$28,039.13

,
_

,
_

24
2 12 mn
2
) 1216 . 1 ( 000 , 25 $
12
0575 . 0
1 000 , 25 $
m
1 PV FV
i
5.2 Michael Carter is expecting an inheritance of $1.25 million in four years. If he had the
money today, he could earn interest at an annual rate of 7.35 percent. What is the
present value of this inheritance?
LO 3
Solution:
0 4 years

PV = ? FV = $1,250,000
Amount needed for down payment after 4 years = FV
4
= $1,250,000
Return expected from investment = i = 7.35%
Duration of investment = n = 4 years
Amount to be invested today = PV
( )
3 $941,243.1

4 n
n
) 0735 . 1 (
000 , 250 , 1 $
1
FV
PV
i
5.3 What is the future value of an investment of $3,000 for three years compounded at the
following rates and frequencies?
a. 8.75% compounded monthly.
b. 8.625% compounded daily.
c. 8.5% compounded continuously.
LO 2
Solution:
a. Interest rate on investment = i = 8.75%
Frequency of compounding = m = 12
Value of investment after 3 years = FV
3
$3,896.82

,
_

+
,
_

36
3 12
3
) 00729 . 1 ( 000 , 3 $
12
0875 . 0
1 000 , 3 $ 1
mn
m
i
PV FV
b. Frequency of compounding = m = 365
Value of investment after 3 years = FV
3
$3,885.81

,
_

,
_

1095
3 365 mn
3
) 000236 . 1 ( 000 , 3 $
365
08625 . 0
1 000 , 3 $
m
1 PV FV
i
c. Frequency of compounding = m = Continuous
Value of investment after 3 years = FV
3
$3,871.38


29046 . 1 000 , 3 $
e 000 , 3 $ e PV FV
3 085 . 0
3
in
5.4. Twenty-five years ago, Amanda Cortez invested $10,000 in an account paying an
annual interest rate of 5.75 percent. What is the value of the investment today? What
is the interest-on-interest earned on this investment?
LO 2,3
Solution:
0 25 years

PV = $10,000 FV = ?
Amount invested today = PV = $10,000
Return expected from investment = i = 5.75%
Duration of investment = n = 25 years
Frequency of compounding = m = 1
Value of investment after 25 years = FV
25
46 . 458 , 40 $
) 0575 . 1 ( 000 , 10 $ ) 1 ( PV FV
25 25
25

+ i
Simple interest on investment = $10,000 x 0.0575 x 25
= $1,150
Interest-on-interest = $40,458.46 $1,150 = $39,308.46
5.5 You just bought a corporate bond at $863.75 today. In five years the bond will mature
and you will receive $1,000. What is the rate of return on this bond?
LO 2,4
Solution:
0 5 years

PV = $863.75 FV = $1,000
Amount to be borrowed = PV = $863.75
Amount to be paid back after 5 years = FV
5
= $1,000
Years to maturity = n = 5 years.
Interest rate on investment = i
Present value of investment = PV
( )
2.97% i

+
+

1 ) 1577 . 1 (
1577 . 1
$863.75
$1,000
) 1 (
) 1 (
000 , 1 $
75 . 863 $
1
FV
PV
5 1
5
5
n
n
i
i
i
i
The rate of return on this bond is 2.97 percent
CHAPTER SIX
6.1 Future value with multiple cash flows: Konerko, Inc., expects to earn cash flows of
$13,227, $15,611, $18,970, and $19,114 over the next four years. If the company uses
an 8 percent discount rate, what is the future value of these cash flows at the end of
year 4?
Solution:
0 8% 1 2 3 4

$13,227 $15,611 $18,970 $19,114


6.2 Future value with multiple cash flows: Ben Woolmer has an investment that will
pay him the following cash flows over the next five years: $2,350, $2,725, $3,128,
$3,366, and $3,695. If his investments typically earn 7.65 percent, what is the future
value of the investments cash flows at the end of five years?
Solution:
0 7.65% 1 2 3 4 5

$2,350 $2,725 $3,128 $3,366 $3,695


$17,498.75
+ + + +
+ + + +
695 , 3 $ 50 . 623 , 3 $ 89 . 624 , 3 $ 45 . 399 , 3 $ 91 . 155 , 3 $
695 , 3 $ ) 0765 . 1 ( 366 , 3 $ ) 0765 . 1 ( 128 , 3 $ ) 0765 . 1 ( 725 , 2 $ ) 0765 . 1 ( 350 , 2 $ FV
1 2 3 4
5
$74,472.48
+ + +
+ + +
114 , 19 $ 60 . 487 , 20 $ 67 . 208 , 18 $ 21 . 662 , 16 $
114 , 19 $ ) 08 . 1 ( 970 , 18 $ ) 08 . 1 ( 611 , 15 $ ) 08 . 1 ( 227 , 13 $ FV
1 2 3
4
6.3 Future value with multiple cash flows: You are a freshman in college and are
planning a trip to Europe when you graduate from college at the end of four years.
You plan to save the following amounts starting today: $625, $700, $700, and $750.
If the account pays 5.75 percent annually, how much will you have at the end of four
years?
Solution:
0 5.75% 1 2 3 4

$625 $700 $700 $750


$3,185.40
+ + +
+ + +
13 . 793 81 . 782 $ 83 . 827 $ 63 . 781 $
) 0575 . 1 ( 750 $ ) 0575 . 1 ( 700 $ ) 0575 . 1 ( 700 $ ) 0575 . 1 ( 625 $ FV
2 3 4
4
6.4 Present value with multiple cash flows: Saul Cervantes has just purchased some
equipment for his landscaping business. He plans to pay the following amounts at the
end of the next five years: $10,450, $8,500, $9,675, $12,500, and $11,635. If he uses
a discount rate of 10.875 percent, what is the cost of the equipment he purchased
today?
Solution:
0 10.875% 1 2 3 4 5

$10,450 $8,500 $9,675 $12,500 $11,635


$38,652.76
+ + + +
+ + + +
82 . 943 , 6 $ 33 . 271 , 8 23 . 098 , 7 $ 35 . 914 , 6 $ 03 . 425 , 9 $
) 10875 . 1 (
635 , 11 $
) 10875 . 1 (
500 , 12 $
) 10875 . 1 (
675 , 9 $
) 10875 . 1 (
500 , 8 $
) 10875 . 1 (
450 , 10 $
PV
5 4 3 2
6.5 Present value with multiple cash flows: Jeremy Fenloch borrowed from his friend a
certain amount and promised to repay him the amounts of $1,225, $1,350, $1,500,
$1,600, and $1,600 over the next five years. If the friend normally discounts
investments at 8 percent annually, how much did Jeremy borrow?
Solution:
0 8% 1 2 3 4 5

$1,225 $1,350 $1,500 $1,600 $1,600


$5,747.40
+ + + +
+ + + +
93 . 088 , 1 $ 05 . 176 , 1 $ 75 . 190 , 1 $ 41 . 157 , 1 $ 26 . 134 , 1 $
) 08 . 1 (
600 , 1 $
) 08 . 1 (
600 , 1 $
) 08 . 1 (
500 , 1 $
) 08 . 1 (
350 , 1 $
) 08 . 1 (
225 , 1 $
PV
5 4 3 2
6.6 Present value with multiple cash flows: Biogenesis, Inc., expects the following cash
flow stream over the next five years. The company discounts all cash flows at a 23
percent discount rate. What is the present value of this cash flow stream?
Solution:
0 23%
1 2 3 4 5

1 2 3 4 5
-$1,133,676 -$978,452 $275,455 $878,326 $1,835,444
-$1,133,676 -$978,452 $275,455 $878,326 $1,835,444
2 $384,711.7
+ + +
+ + +

94 . 951 , 651 $ . 43 . 738 , 383 $ 09 . 025 , 148 $ 37 . 739 , 646 $ 80 . 687 , 921 $
) 23 . 1 (
444 , 835 , 1 $
) 23 . 1 (
326 , 878 $
) 23 . 1 (
455 , 275 $
) 23 . 1 (
452 , 978 $
) 23 . 1 (
676 , 133 , 1 $
PV
5 4 3 2
6.7 Present value of an ordinary annuity: An investment opportunity requires a
payment of $750 for 12 years, starting a year from today. If your required rate of
return is 8 percent, what is the value of the investment today?
Solution:
0 8% 1 2 3 11 12

$750 $750 $750 $750 $750


Annual payment = PMT = $750
No. of payments = n = 12
Required rate of return = 8%
Present value of investment = PVA
12
$5,652.06


1
1
1
1
]
1


5361 . 7 750 $
08 . 0
) 08 . 1 (
1
1
750 $
) 1 (
1
1
PMT PVA
12
n
n
i
i
6.8 Present value of an ordinary annuity: Dynamics Telecommunications Corp. has
made an investment in another company that will guarantee it a cash flow of $22,500
each year for the next five years. If the company uses a discount rate of 15 percent on
its investments, what is the present value of this investment?
Solution:
0 15% 1 2 3 4 5

$22,500 $22,500 $22,500 $22,500 $22,500


Annual payment = PMT = $22,500
No. of payments = n = 5
Required rate of return = 15%
Present value of investment = PVA
5
$75,423.49


1
1
1
1
]
1


3522 . 3 500 , 22 $
15 . 0
) 15 . 1 (
1
1
500 , 22 $
) 1 (
1
1
PMT PVA
5
n
n
i
i
6.9 Future value of an ordinary annuity: Robert Hobbes plans to invest $25,000 a year
for the next seven years in an investment that will pay him a rate of return of 11.4
percent. He will invest at the end of each year. What is the amount that Mr. Hobbes
will have at the end of seven years?
Solution:
0 11.4% 1 2 3 6 7

$25,000 $25,000 $25,000 $25,000 $25,000


Annual investment = PMT = $25,000
No. of payments = n = 7
Investment rate of return = 11.4%
Future value of investment = FVA
7
5 $247,609.9


1
]
1

+

9044 . 9 000 , 25 $
114 . 0
1 ) 114 . 1 (
000 , 25 $
1 ) 1 (
PMT FVA
7
n
n
i
i
6.10 Future value of an ordinary annuity: Cecelia Thomas is a sales executive at a
Baltimore firm. She is 25 years old and plans to invest $3,000 every year in an IRA
account, beginning at the end of this year until she turns 65 years old. If the IRA
investment will earn 9.75 percent annually, how much will she have in 40 years when
she turns 65 years old?
Solution:
0 9.75% 1 2 3 39 40

$3,000 $3,000 $3,000 $3,000 $3,000


Annual investment = PMT = $3,000
No. of payments = n = 40
Investment rate of return = 9.75%
Future value of investment = FVA
40
.41 $1,240,676


1
]
1

+

5588 . 413 000 , 3 $
0975 . 0
1 ) 0975 . 1 (
000 , 3 $
1 ) 1 (
PMT FVA
40
n
n
i
i
6.11 Future value of an annuity. Refer to Problem 6.10. If Cecelia Thomas starts saving
at the beginning of each year, how much will she have at age 65?
Solution:
0 9.75% 1 2 3 39 40

$3,000 $3,000 $3,000 $3,000 $3,000


Annual investment = PMT = $3,000
No. of payments = n = 40
Type of annuity = Annuity due
Investment rate of return = 9.75%
Future value of investment = FVA
40
.36 $1,361,642

1
]
1



+
1
]
1

+

0975 . 1 5588 . 413 000 , 3 $ ) 0975 . 1 (
0975 . 0
1 ) 0975 . 1 (
000 , 3 $
) 1 (
1 ) 1 (
PMT FVA
40
n
n
i
i
i
6.12 Computing annuity payment: Kevin Winthrop is saving for an Australian vacation
in three years. He estimates that he will need $5,000 to cover his airfare and all other
expenses for a week-long holiday in Australia. If he can invest his money in an S&P
500 equity index fund that is expected to earn an average return of 10.3 percent over
the next three years, how much will he have to save every year, starting at the end of
this year?
Solution:
0 10.3% 1 2 3

PMT PMT PMT


FVA
n
= $5,000
Future value of annuity = FVA = $5,000
Return on investment = i = 10.3%
Payment required to meet target = PMT
Using the FVA equation:
$1,506.20


1
]
1

+

3196 . 3
000 , 5 $
103 . 0
1 ) 103 . 1 (
000 , 5 $
PMT
103 . 0
1 ) 103 . 1 (
PMT 000 , 5 $
1 ) 1 (
PMT FVA
3
3
n
n
i
i
Kevin has to save $1,506.20 every year for the next three years to reach his target of
$5,000.
6.13 Computing annuity payment: The Elkridge Bar & Grill has a seven-year loan of
$23,500 with Bank of America. It plans to repay the loan by paying in seven equal
installments starting today. If the rate of interest is 8.4 percent, how much will each
payment be worth?
0 1 2 3 6 7

PMT PMT PMT PMT PMT PMT


PVA
n
= $23,500 n = 7; i = 8.4%
Present value of annuity = PVA = $23,500
Return on investment = i = 8.4%
Payment required to meet target = PMT
Type of annuity = Annuity due
Using the PVA equation:
$4,221.07

1
1
1
1
]
1

+
1
1
1
1
]
1


084 . 1 1359 . 5
500 , 23 $
) 084 . 1 (
084 . 0
) 084 . 1 (
1
1
500 , 23 $
PMT
) 1 (
) 1 (
1
1
PMT PVA
7
n
n
i
i
i
Each payment made by Elkridge Bar & Grill will be $4,221.07, starting today.
6.14 Perpetuity: Your grandfather is retiring at the end of next year. Heould like to
receive a payment of $10,000 a year forever, starting when he retires. If he can invest
at 6.5 percent, how much does need to invest to receive the desired cash flow?
Solution:
Annual payment needed = PMT = $10,000
Investment rate of return = i = 6.5%
Term of payment = Perpetuity
Present value of investment needed = PV
5 $153,846.1

065 . 0
000 , 10 $ PMT
y Perpetuit of PV
i
6.15 Perpetuity: Calculate the perpetuity payments for each of the following cases:
a. $250,000 invested at 6%
b. $50,000 invested at 12%
c. $100,000 invested at 10%
Solution:
a. Annual payment = PMT
Investment rate of return = i = 6%
Term of payment = Perpetuity
Present value of investment needed = PV = $250,000
$15,000

0.06 $250,000 PV PMT


PMT
y Perpetuit of PV
i
i
b. Annual payment = PMT
Investment rate of return = i = 12%
Term of payment = Perpetuity
Present value of investment needed = PV = $50,000
$6,000

0.12 $50,000 PV PMT


PMT
y Perpetuit of PV
i
i
c. Annual payment = PMT
Investment rate of return = i = 10%
Term of payment = Perpetuity
Present value of investment needed = PV = $100,000
$10,000

0.10 $100,000 PV PMT


PMT
y Perpetuit of PV
i
i