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SOLUTIONS TO EXERCISES
EXERCISE II-7 (25 MINUTES) 1. Use formula (1): Fn = P(1 + r)n = $2,500(1.14)6 The accumulation factor, (1.14) 6, is given in Table I of Appendix A to Chapter 16. It is 2.195. Thus, the calculation is as follows: Fn = $2,500(2.195) = $5,487.50 The future value of your investment will be $5,487.50. 2. Use formula (2): P = Fn
1 n (1 + r ) 1 = $10,000 5 (1.12)
The discount factor, 1/(1.12)5, is given in Table III of Appendix A to Chapter 16. It is . 567. Thus, the calculation is as follows: P = $10,000(.567) = $5,670 The present value of the gift is $5,670. 3. You need to invest an amount, A, each year so that the following equation is satisfied: A(4.375) = $52,500 The number 4.375 is the annuity accumulation factor, from Table II of Appendix A to Chapter 16, for n = 4 and r = .06. Rearranging the equation above, we solve for A as follows: A=
$52,500 4.375
= $12,000
EXERCISE II-7 (CONTINUED) 4. You need an amount, P, now so that the following equation is satisfied. P = (2.487)$13,000 The number 2.487 is the annuity discount factor, from Table IV of Appendix A to Chapter 16, for n = 3 and r = .10. The solution is P = $32,331. You need to invest $32,331 now in order to fund your educational expenses.
EXERCISE II-8 (45 MINUTES) 1. Future value of investment: Time 0 Year 1 Time 1 Year 2 Time 2 Year 3 Time 3 Year 4 Time 4 Year 5 Time 5 Year 6 Time 6 Time * The discrepancy between $5,487.44 and $5,487.50 is due to rounding error. Amount at time 0 $2,500.00
Interest, year 1 (.14 x $2,500.00) 350.00 Amount at time 1 Interest, year 2 (.14 x $2,850.00) Amount at time 2 Interest, year 3 (.14 x $3,249.00) Amount at time 3 Interest, year 4 (.14 x $3,703.86) Amount at time 4 Interest, year 5 (.14 x $4,222.40) Amount at time 5 Interest, year 6 (.14 x $4,813.54) Amount at time 6 $2,850.00 399.00 $3,249.00 454.86 $3,703.86 518.54 $4,222.40 591.14 $4,813.54 673.90 $5,487.44*
EXERCISE II-8 (CONTINUED) 2. Educational expense fund: Time 0 Year 1 Time 1 Year 2 Time 2 Year 3 Time 3 Time Deposit $32,331................................................... Earn interest ($32,331 x .10)............................... Accumulation at time 1....................................... Withdrawal to cover educational expenses...... Amount remaining to earn interest in year 2.... Earn interest (22,564 x .10)................................. Accumulation at time 2....................................... Withdrawal to cover educational expenses...... Amount remaining to earn interest in year 3.... Earn interest ($11,820 x .10)............................... Accumulation at time 3....................................... Withdrawal to cover educational expenses...... Amount remaining.............................................. $32,331 3,233 $35,564 (13,000) $22,564 2,256 $24,820 (13,000) $11,820 1,182 $13,002 (13,000) $ 2*
EXERCISE II-9 (20 MINUTES) 1. To determine the amount you need to accumulate by the time you retire, calculate the present value of a 40-year annuity in the amount of $225,000. (Use Table IV of Appendix A to Chapter 16.) Present value = (annuity discount factor for n = 40, r = .12)($225,000) = (8.244)($225,000) = $1,854,900 Thus, you need to accumulate $1,854,900 in your account by the time you retire. 2. To determine the amount you need to deposit each year for 15 years, calculate the annuity amount that will accumulate to a future value of $1,854,900 in 15 years. (Use Table II of Appendix A to Chapter 16.) Future value = (annuity accumulation factor for n = 15, r = .12)(annuity amount) $1,854,900 = (37.280)(annuity amount)
$1,854,900 37.280
Annuity amount =
= $49,755.90
Thus, you need to deposit $49,755.90 into your account each year from age 25 through age 39. 3. This is both a present-value and a future-value problem. The problem has two parts. Requirement (1) is a present-value problem; requirement (2) is a future-value problem.