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# TIME VALUE OF MONEY 1.

An insurance agent is trying to sell you an immediate- retirement annuity, which for a single amount paid today will provide you with TK.12,000 at the end of each year for the next 25 years. You currently earn 9% on low-risk investments comparable to the retirement annuity. Ignoring taxes, what is the most you would pay for this annuity? 2. You plan to retire in exactly 20 years. Your goal is to create a fund that will allow you to receive TK.20,000 at the end of each year for the 30 years between retirement and death (a psychic told you would die exactly 30 years after you retire). You know that you will be able to earn 11% per year during the 30-year retirement period. a. How large a fund will you need when you retire in 20 years to provide the 30-year, TK.20,000 retirement annuity? b. How much will you need today as a single amount to provide the fund calculated in part a if you earn only 9% per year during the 20 years preceding retirement? c. What effect would an increase in the rate you can earn both during and prior to retirement have on the values found in parts a and b? Explain. d. Now assume that you will earn 10% from now through the end of your retirement. You want to make 20 end-of-year deposits into your retirement account that will fund the 30-year stream of TK.20,000 annual annuity payments. How large do your annual deposits have to be? 3. Assume that you just won the state lottery.Your prize can be taken either in the form of TK.40,000 at the end of each of the next 25 years (that is, TK.1,000,000 over 25 years) or as a single amount of TK.500,000 paid immediately. a. If you expect to be able to earn 5% annually on your investments over the next 25 years, ignoring taxes and other considerations, which alternative should you take? Why? b. Would your decision in part a change if you could earn 7% rather than 5% on your investments over the next 25 years? Why? 4. Find the present value of the streams of cash flows shown in the following table. Assume that the firms opportunity cost is 12%.
Year 1 2 3 4 5 A Cash flow -TK.2,000 3,000 4,000 6,000 8,000 Year 1 25 6 B Cash flow TK.10,000 5,000/yr 7,000 Year 1-5 610 C Cash flow TK.10,000/yr 8,000/yr

4. On September 1, 1998, Susan Chao bought a motorcycle for TK.10,000. She paid TK.1,000 down and financed the balance with a five-year loan at a stated annual interest rate of 9.6 percent, compounded monthly. She started the monthly payment exactly one month after the purchase, i.e., October, 1998. In the middle of October, 2000, she got a new job and decided to pay off the loan. If the bank charges her 1 percent prepayment penalty based on the loan balance, how much should she pay the bank on November 1, 2000?
5. You are saving for the college education of your two children. They are two years apart in age;

one will begin college in 15 years, the other will begin in 17 years. You estimate your childrens college expenses to be TK.21,000 per year per child. The annual interest rate is 15 percent. How much money must you deposit in an account each year to fund your childrens education? You will begin payments one year from today. You will make your last deposit when your oldest child enters college.
6. When Marilyn Monroe died, ex-husband Joe DiMaggio vowed to place fresh flowers on her

grave every Sunday as long as he lived. A bunch of fresh flowers that the former baseball player thought appropriate for the star cost about TK.5 when she died in 1962. Based on actuarial tables, Joltin Joe could expect to live for 30 years after the actress died. Assume that the stated annual interest rate, compounded weekly, is 10.4 percent. Also, assume that the rate of inflation is 3.9 percent per year, when expressed as a stated annual inflation rate, compounded weekly. Assuming that each year has exactly 52 weeks, what is the present value of this commitment?
7. Your younger brother has come to you for advice. He is about to enter college and has two

options open to him. His first option is to study engineering. If he does this, his undergraduate degree would cost him TK.12,000 a year for four years. Having obtained this, he would need to gain two years of practical experience: in the first year he would earn TK.20,000, in the second year he would earn TK.25,000. He would then need to obtain his masters degree, which will cost TK.15,000 a year for two years. After that he will be fully qualified and can earn TK.40,000 per year for 25 years. His other alternative is to study accounting. If he does this, he would pay TK.13,000 a year for four years and then he would earn TK.31,000 per year for 30 years. The effort involved in the two careers is the same, so he is only interested in the earnings the jobs provide. All earnings and costs are paid at the end of the year. What advice would you give him if the market interest rate is 5 percent? A day later he comes back and says he took your advice, but in fact, the market interest rate was 6 percent. Has your brother made the right choice?