Time Value of Money

Question # 1
You sold a car and accepted a note with the following cash flow stream as your payment. What
was the effective price you received for the car assuming an interest rate of 8%?

Years:

0
|
$0

CFs:

1
|
$1,500

Ans 1.

FV = PV (1 + I)n
PV=FV/

(1 + I)n

PV1=1500/1.08

PV1=$1388.88---------------------1
PV2= 2000/(1.08) 2
PV2=1714.67

$ 2

PV3= 22000/ 1.08 3

PV3=$ 17464.309-----------3
PV4= 2500/(1.08)

PV4= $1837.5-----------------------4
Now

adding all four values of eq 1,2,3 & 4

P(total)= $ 22405.4

2
|
$2,000

3
|
$2,2000

4
|
$2,500

Question # 2
To complete your last year in business school and then go through law school, you will need
$14,000 per year for 4 years, starting next year (that is, you will need to withdraw the first
$14,000 one year from today). Your rich uncle offers to put you through school, and he will
deposit in a bank paying 8.5% interest, compounded annually, a sum of money that is sufficient
to provide the 4 payments of $14,000 each. His deposit will be made today.
a) How large must the deposit be?
b) How much will be in the account immediately after the sthird withdrawal?
Ans2

PV

14000

14000

14000

14000

PVA = PMT [(1 - (1 / (1 + i)n)) / i]1

where
PVA=?
i=8.5%
PMT=$ 14000
n=4
Putting values in eq 1
PV=14000

(1 / (1 + .085)4)) / 0.085]

PVA= $ 45858.35ans to part a

Now for part b amortization table is required

years

Beginning

installment

interest

principle

ending principle

amount

amount

45858.35

----

45858.35

14000

3898

10102

35756.35

35756.35

14000

3039.28

10960.7

24795.789

24795.789

14000

2107.642

11892.35

12903.43

12903.43

14000

1096.57

12903.43

Ans for part b is

-----

------

45858.35

12903.43$

Question # 3
The prize in last weeks Florida lottery was estimated to be worth $10 million. If you were lucky
enough to win, the state will pay you $2 million per year over the next 5 years. Assume that the
first installment is received immediately. If the interest rates are 7 percent, what is the present
value of the prize?
Ans #3

PVA = PMT [(1 - (1 / (1 + i)n)) / i]1

PMT= 2 million
I=7%
N= 5 years
PVA=?
Putting values in eq 1
PVA = 2 [(1 - (1 / (1 + 0.07)5)) / 0.07]
PVA= 8.774 million

Question # 4
An investment pays you $800 at the end of each of the next 3 years. The investment will then
pay you $900 at the end of Year 4, $950 at the end of Year 5, and $990 at the end of Year 6. If
the interest rate earned on the investment is 6 percent, what is its present value? What is its
future value?
Ans #4

Future value

FV = PV (1 + i)n
FV1 = 800 (1 + .06)5
FV2 = 800 (1 + .06)4

= $1070.58
= $1009.98

FV3 = 800 (1 + .06)3 = $952.81

FV4 = 900 (1 + 0.06)2 =$1011.24
FV 5= 950 (1 +0.06 )1= $1007
FV6 = $990
FV (Total)= $ 6041.61

Present value

FV = PV (1 + I)n

PV = FV / (1 + I)n
PV1 = FV / (1 + I)n
PV1 = 800 / (1 + 0.06)1
PV1 = $754
PV2 = 800 / (1 + 0.06)2
PV2 = $711
PV3 = 800 / (1 + 0.06)3
PV3 = $671.69
PV4 = 900 / (1 + 0.06)4
PV4 = $ 712.88
PV5 = 950 / (1 + 0.06)5
PV5 = $ 709.84
PV6 = 990 / (1 + 0.06)6
PV6 = $ 679.91

Question # 5
Your company is planning to borrow $8,000,000 on a 5-year, 11% annual payment fully
amortized term loan. Prepare an amortization table to show the full payments for five years along
with breakdown of each payment into interest and reduction in principal amount.
Ans #5

PVA = PMT [(1 - (1 / (1 + i)n)) / i].1

PVA= $ 8000000
I= 11%
N=5
So
PMT from eq 1
PMT= $ 2164502.165

Years

Begning
amount

Installment

INTREST

Principal
amount

Ending
amount

8000000

------

------

------

8000000

8000000

2164502.17

880000

1284502.17

6715497.83

6715497.83

2164502.17

738704.76

1425797.41

5289700.42

5289700.42

2164502.17

581867.046

1582635.124

3707065.29

3707065.296

2164502.17

407777.18

1756724.987

1950340.309

1950340.309

2164502.17

214161.86

1950340.309

----nil----

Question # 6
After graduation, you plan to work for a company for 15 years and then start your own business.
You expect to save and deposit $5,000 a year for the first 8 years (t = 1 through t = 8) and $8,000
annually for the following 7 years (t = 9 through t = 15). The first deposit will be made a year
from today. In addition, your grandfather just gave you a $20,000 graduation gift which you will
deposit immediately (t = 0). If the account earns 7% compounded annually, how much will you
have when you start your business 15 years from now?
Ans #6

FV = PV (1 + I)n
as $ 20000 graduation gift at t=0 so future value at t= 15 will be

FV = 20000 (1 + 0.07)15
FV1 = $ 55180.630.1

Deposit pf $ 5000 for 8 years

so PMT= $ 5000
n=8
i=7%

FV(t=1 to t=8) = PMT [((1 + i)n - 1) / i]

FV(t=1 to t=8) = 5000 [((1 + 0.07)8 - 1) / 0.07]
FV(t=1 to t=8) = $ 51299
As the amount will be in account for next 7 more years i.e t= 9 to 15 so
Future value of $ 5000 annuity at 15 years will be

FV = 51299 (1 + 0.07)7
FV (at t=15) = $ 82374.98--------2

Now for PMT= $ 8000 for 7 years future value will be

FVA(t=9 to t=15) = PMT [((1 + i)n - 1) / i]

FVA(t=9 to t=15) = 8000 [((1 + 0.07)7 - 1) / 0.07]

FVA(t=9 to t=15) = $ 69232.168 .3
Now adding three eqs 1,2 and 3
FV total at 15th year will be=
55180.63 + 82374.98+69232.168= $ 206787.7

...........

Question # 7
Your sister turned 32 today, and she is planning to save $12,000 per year for retirement, with the
first deposit to be made one year from today. She will invest in a mutual fund that's expected to
provide a return of 6.5% per year. She plans to retire when she turns 65, and she expects to live
for 20 years after retirement, to age 85. Under these assumptions, how much can she spend each
year after she retires? Her first withdrawal will be made at the end of her first retirement year.
Ans # 7

FVA(t=32 to t=65) = PMT [((1 + i)n - 1) / i]

N= 33
I= 0.065
PMT= $ 12000
FVA(t=32 to t=65) = 12000 [((1 + 0.065)33 - 1) / 0.065]
FVA(at t=65) = $ 1290428.5
Now at t= 65th year my FVA will be my PVA

PVA= $ 1290428.5
PMT= ?
N= 20
I= 7%
PVA = PMT [(1 - (1 / (1 + i)n)) / i]
1290428.5=PMT(11.0185)
PMT=$ 117114.63
She can spend $ 117114.63

Question # 8
You just deposited $6,500 in a bank account that pays a 9% interest rate, compounded quarterly.
If you also add another $8,000 to the account one year (4 quarters) from now and another $9,500
to the account two years (8 quarters) from now, how much will be in the account three years (12
quarters) from now?

I= 9% annually or for quarterly=0.09/4=0.0225

n=3 years or 3x4= 12

FV = PV (1 + I)n
FV(for $ 6500at t=3 years) = 6500 (1 + .0225)12
FV(for $ 6500at t=3 years) = $8489.32
FV( for $ 8000 at 2 year)= 8000 (1 + .0225)8
FV( for $ 8000 at 2 year)= $ 9558.64

FV( for $9500 at 1 year)= 9500 (1 + .0225)4

FV( for $ 8000 at I year)= $ 10384.29
FV
(Total
at
3
years
or
$8489.32+$ 9558.64+$ 10384.29= $ 28432.25

at

12th

quater)=