Chapter 5, 13

th
E
Time Value of Money
Learning Objective
After reading this chapter, students should be able to:
Explain how the time value of money works and discuss why it is such an important concept in finance.
Calculate the present value and future value of lump sums.
Identify the different types of annuities, calculate the present value and future value of both an ordinary
annuity and an annuity due, and calculate the relevant annuity payments.
Calculate the present value and future value of an uneven cash flow stream. ou will use this
knowledge in later chapters that show how to value common stocks and corporate pro!ects.
Explain the difference between nominal, periodic, and effective interest rates. An understanding of
these concepts is necessary when comparing rates of returns on alternative investments.
"iscuss the basics of loan amorti#ation and develop a loan amorti#ation schedule that you might use
when considering an auto loan or home mortgage loan.
Chapter 5! Time Value of Money Learning Objectives "5
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licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
Lecture -uggetion
$e regard Chapter % as the most important chapter in the book, so we spend a good bit of time on it. $e
approach time value in three ways. &irst, we try to get students to understand the basic concepts by use of
time lines and simple logic. 'econd, we explain how the basic formulas follow the logic set forth in the time
lines. (hird, we show how financial calculators and spreadsheets can be used to solve various time value
problems in an efficient manner. )nce we have been through the basics, we have students work problems
and become proficient with the calculations and also get an idea about the sensitivity of output, such as
present or future value, to changes in input variables, such as the interest rate or number of payments.
'ome instructors prefer to take a strictly analytical approach and have students focus on the
formulas themselves. (he argument is made that students treat their calculators as *black boxes,+ and that
they do not understand where their answers are coming from or what they mean. $e disagree. $e think
that our approach shows students the logic behind the calculations as well as alternative approaches, and
because calculators are so efficient, students can actually see the significance of what they are doing better
if they use a calculator. $e also think it is important to teach students how to use the type of technology
,calculators and spreadsheets- they must use when they venture out into the real world.
In the past, the biggest stumbling block to many of our students has been time value, and the
biggest problem was that they did not know how to use their calculator. 'ince time value is the foundation
for many of the concepts that follow, this chapter is near the beginning of the text. (his gives students more
time to become comfortable with the concepts and the tools ,formulas, calculators, and spreadsheets-
covered in this chapter. (herefore, we strongly encourage students to get a calculator, learn to use it, and
bring it to class so they can work problems with us as we go through the lectures. )ur urging, plus the fact
that we can now provide relatively brief, course.specific manuals for the leading calculators, has reduced if
not eliminated the problem.
)ur research suggests that the best calculator for the money for most students is the /0.123II.
&inance and accounting ma!ors might be better off with a more powerful calculator, such as the /0.143II.
$e recommend these two for people who do not already have a calculator, but we tell them that any
financial calculator that has an I55 function will do.
$e also tell students that it is essential that they work lots of problems, including the end.of.chapter
problems. $e emphasi#e that this chapter is critical, so they should invest the time now to get the material
down. $e stress that they simply cannot do well with the material that follows without having this material
down cold. 3ond and stock valuation, cost of capital, and capital budgeting make little sense, and one
certainly cannot work problems in these areas, without understanding time value of money first.
$e base our lecture on the integrated case. (he case goes systematically through the key points in
the chapter, and within a context that helps students see the real world relevance of the material in the
chapter. $e ask the students to read the chapter, and also to *look over+ the case before class. /owever,
our class consists of about 1,222 students, many of whom view the lecture on (6, so we cannot count on
them to prepare for class. &or this reason, we designed our lectures to be useful to both prepared and
unprepared students.
'ince we have easy access to computer pro!ection e7uipment, we generally use the PowerPoint
slides as the core of our lectures. $e strongly suggest to our students that they print a copy of the
PowerPoint slides for the chapter from the website and bring it to class. (his will provide them with a hard
copy of our lecture, and they can take notes in the space provided. 'tudents can then concentrate on the
lecture rather than on taking notes.
$e do not stick strictly to the slide show8we go to the board fre7uently to present somewhat
different examples, to help answer 7uestions, and the like. $e like the spontaneity and change of pace trips
to the board provide, and, of course, use of the board provides needed flexibility. Also, if we feel that we
have covered a topic ade7uately at the board, we then click 7uickly through one or more slides.
(he lecture notes we take to class consist of our own marked.up copy of the PowerPoint slides,
with notes on the comments we want to say about each slide. If we want to bring up some current event,
provide an additional example, or the like, we use post.it notes attached at the proper spot. (he advantages
of this system are ,1- that we have a carefully structured lecture that is easy for us to prepare ,now that we
have it done- and for students to follow, and ,9- that both we and the students always know exactly where
". Lecture Suggestions Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
we are. (he students also appreciate the fact that our lectures are closely coordinated with both the text
and our exams.
(he slides contain the essence of the solution to each part of the integrated case, but we also
provide more in.depth solutions in this Instructors Manual. It is not essential, but you might find it useful to
read through the detailed solution. Also, we put a copy of the solution on reserve in the library for interested
students, but most find that they do not need it.
&inally, we remind students again, at the start of the lecture on Chapter %, that they should bring a
printout of the PowerPoint slides to class, for otherwise they will find it difficult to take notes. $e also repeat
our re7uest that they get a financial calculator and our brief manual for it that can be found on the website,
and bring the calculator to class so they can work through calculations as we cover them in the lecture.
/'0- O1 C2'3TE(! 4 O5 5. /'0- 65%,minute perio)7
Chapter 5! Time Value of Money Lecture Suggestions ""
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
'n*er to En),of,Chapter 8uetion
5,1 (he opportunity cost is the rate of interest one could earn on an alternative investment with a risk
e7ual to the risk of the investment in 7uestion. (his is the value of I in the (6: e7uations, and it is
shown on the top of a time line, between the first and second tick marks. It is not a single rate8the
opportunity cost rate varies depending on the riskiness and maturity of an investment, and it also
varies from year to year depending on inflationary expectations ,see Chapter ;-.
5,$ (rue. (he second series is an uneven cash flow stream, but it contains an annuity of <=22 for >
years. (he series could also be thought of as a <122 annuity for 12 years plus an additional
payment of <122 in ear 9, plus additional payments of <?22 in ears ? through 12.
5,3 (rue, because of compounding effects8growth on growth. (he following example demonstrates
the point. (he annual growth rate is I in the following e7uation:
<1,1 @ I-
12
A <9.
$e can find I in the e7uation above as follows:
Bsing a financial calculator input C A 12, 06 A .1, 0:( A 2, &6 A 9, and ID5 A E 'olving for ID5
you obtain 4.1>F.
6iewed another way, if earnings had grown at the rate of 12F per year for 12 years, then E0'
would have increased from <1.22 to <9.%G, found as follows: Bsing a financial calculator, input C A
12, ID5 A 12, 06 A .1, 0:( A 2, and &6 A E. 'olving for &6 you obtain <9.%G. (his formulation
recogni#es the *interest on interest+ phenomenon.
5,4 &or the same stated rate, daily compounding is best. ou would earn more *interest on interest.+
5,5 &alse. )ne can find the present value of an embedded annuity and add this 06 to the 06s of the
other individual cash flows to determine the present value of the cash flow stream.
5,. (he concept of a perpetuity implies that payments will be received forever. &6 ,0erpetuity- A 06
,0erpetuity-,1 @ I-

A .
5," (he annual percentage rate ,A05- is the periodic rate times the number of periods per year. It is
also called the nominal, or stated, rate. $ith the *(ruth in Hending+ law, Congress re7uired that
financial institutions disclose the A05 so the rate charged would be more *transparent+ to
consumers. (he A05 is e7ual to the effective annual rate only when compounding occurs annually.
If more fre7uent compounding occurs, the effective rate is always greater than the annual
percentage rate. Cominal rates can be compared with one another, but only if the instruments
being compared use the same number of compounding periods per year. If this is not the case,
then the instruments being compared should be put on an effective annual rate basis for
comparisons.
5,9 A loan amorti#ation schedule is a table showing precisely how a loan will be repaid. It gives the
re7uired payment on each payment date and a breakdown of the payment, showing how much is
interest and how much is repayment of principal. (hese schedules can be used for any loans that
are paid off in installments over time such as automobile loans, home mortgage loans, student
loans, and many business loans.
"9 Answers and Solutions Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
-olution to En),of,Chapter 3roblem
5,1 2 1 9 ? = %
I I I I I I
06 A 12,222 &6% A E
&6% A <12,222,1.12-
%
A <12,222,1.;12%1- A <1;,12%.12.
Alternatively, with a financial calculator enter the following: C A %, ID5 A 12, 06 A .12222, and 0:(
A 2. 'olve for &6 A <1;,12%.12.
5,$ 2 % 12 1% 92
I I I I I
06 A E &692 A %,222
$ith a financial calculator enter the following: C A 92, ID5 A 4, 0:( A 2, and &6 A %222. 'olve for
06 A <1,9G9.12.
5,3 2 1>
I I
06 A 9%2,222 &61> A 1,222,222
$ith a financial calculator enter the following: C A 1>, 06 A .9%2222, 0:( A 2, and &6 A 1222222.
'olve for ID5 A >.21F J >F.
5,4 2 C A E
I I
06 A 1 &6C A 9
<9 A <1,1.2;%-
C
.
$ith a financial calculator enter the following: ID5 A ;.%, 06 A .1, 0:( A 2, and &6 A 9. 'olve for
C A 11.21 J 11 years.
5,5 2 1 9 C K 9 C K 1 C
I I I I I I
06 A =9,1>2.%? %,222 %,222 %,222 %,222 &6 A 9%2,222
Bsing your financial calculator, enter the following data: ID5 A 19L 06 A .=91>2.%?L 0:( A .%222L
&6 A 9%2222L C A E 'olve for C A 11. It will take 11 years to accumulate <9%2,222.
Chapter 5! Time Value of Money Answers and Solutions ":
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
12F
4F
;.%F
19F
ID5 A E
5,. )rdinary annuity:
2 1 9 ? = %
I I I I I I
?22 ?22 ?22 ?22 ?22
&6A% A E
$ith a financial calculator enter the following: C A %, ID5 A 4, 06 A 2, and 0:( A ?22. 'olve for
&6 A <1,49%.99.
Annuity due:
2 1 9 ? = %
I I I I I I
?22 ?22 ?22 ?22 ?22
$ith a financial calculator, switch to *3EM+ and enter the following: C A %, ID5 A 4, 06 A 2, and
0:( A ?22. 'olve for &6 A <1,>=%.GG. "onNt forget to switch back to *EC"+ mode.
5," 2 1 9 ? = % ;
I I I I I I I
122 122 122 922 ?22 %22
06 A E &6 A E
Bsing a financial calculator, enter the following: C&2 A 2L C&1 A 122L C! A ?L C&= A 922 ,Cote
calculator will show C&9 on screen.-L C&% A ?22 ,Cote calculator will show C&? on screen.-L C&; A
%22 ,Cote calculator will show C&= on screen.-L and ID5 A >. 'olve for C06 A <G9?.G>.
(o solve for the &6 of the cash flow stream with a calculator that doesnNt have the C&6 key, do the
following: Enter C A ;, ID5 A >, 06 A .G9?.G>, and 0:( A 2. 'olve for &6 A <1,=;;.9=. ou can
check this as follows:
2 1 9 ? = % ;
I I I I I I I
122 122 122 922 ?22 %22
?9=.22
9??.9>
19%.G4
1?;.2%
1=; .G?
<1,=;; .9?
5,9 Bsing a financial calculator, enter the following: C A ;2, ID5 A 1, 06 A .92222, and &6 A 2. 'olve
for 0:( A <===.>G.
EA5A
:
C):
:
I
1

+ K 1.2
A ,1.21-
19
K 1.2
A 19.;>F.
Alternatively, using a financial calculator, enter the following: C):F A 19 and 0D5 A 19. 'olve
for E&&F A 19.;>9%F. 5emember to change back to 0D5 A 1 on your calculator.
5,: a& 2 1
9% Answers and Solutions Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
4F
>F
>F
4F
,1.2>-
,1.2>-
9
,1.2>-
?
,1.2>-
=
,1.2>-
%
;F
I I <%22,1.2;- A <%?2.22.
.%22 &6 A E
Bsing a financial calculator, enter C A 1, ID5 A ;, 06 A .%22, 0:( A 2, and &6 A E 'olve for
&6 A <%?2.22.
b& 2 1 9
I I I <%22,1.2;-
9
A <%;1.>2.
.%22 &6 A E
Bsing a financial calculator, enter C A 9, ID5 A ;, 06 A .%22, 0:( A 2, and &6 A E 'olve for
&6 A <%;1.>2.
c& 2 1
I I <%22,1D1.2;- A <=41.42.
06 A E %22
Bsing a financial calculator, enter C A 1, ID5 A ;, 0:( A 2, and &6 A %22, and 06 A E 'olve
for 06 A <=41.42.
)& 2 1 9
I I I <%22,1D1.2;-
9
A <==%.22.
06 A E %22
Bsing a financial calculator, enter C A 9, ID5 A ;, 0:( A 2, &6 A %22, and 06 A E 'olve for 06
A <==%.22.
5,1% a& 2 1 9 ? = % ; 4 > G 12
I I I I I I I I I I I <%22,1.2;-
12
A <>G%.=9.
.%22 &6 A E
Bsing a financial calculator, enter C A 12, ID5 A ;, 06 A .%22, 0:( A 2, and &6 A E 'olve for
&6 A <>G%.=9.
b& 2 1 9 ? = % ; 4 > G 12
I I I I I I I I I I I <%22,1.19-
12
A <1,%%9.G9.
.%22 &6 A E
Bsing a financial calculator, enter C A 12, ID5 A 19, 06 A .%22, 0:( A 2, and &6 A E 'olve for
&6 A <1,%%9.G9.
c& 2 1 9 ? = % ; 4 > G 12
I I I I I I I I I I I <%22D,1.2;-
12
A <94G.92.
06 A E %22
Bsing a financial calculator, enter C A 12, ID5 A ;, 0:( A 2, &6 A %22, and 06 A E 'olve for
06 A <94G.92.
Chapter 5! Time Value of Money Answers and Solutions 91
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
;F
;F
;F
;F
;F
19F
)& 2 1 9 ? = % ; 4 > G 12
I I I I I I I I I I I
06 A E 1,%%9.G2
<1,%%9.G2D,1.19-
12
A <=GG.GG.
Bsing a financial calculator, enter C A 12, ID5 A 19, 0:( A 2, &6 A 1%%9.G2, and 06 A E 'olve
for 06 A <=GG.GG.
<1,%%9.G2D,1.2;-
12
A <>;4.1?.
Bsing a financial calculator, enter C A 12, ID5 A ;, 0:( A 2, &6 A 1%%9.G2, and 06 A E 'olve
for 06 A <>;4.1?.
e& (he present value is the value today of a sum of money to be received in the future. &or
example, the value today of <1,%%9.G2 to be received 12 years in the future is about <%22 at an
interest rate of 19F, but it is approximately <>;4 if the interest rate is ;F. (herefore, if you had
<%22 today and invested it at 19F, you would end up with <1,%%9.G2 in 12 years. (he present
value depends on the interest rate because the interest rate determines the amount of interest
you forgo by not having the money today.
5,11 a& 922; 9224 922> 922G 9212 9211
I I I I I I
.; 19 ,in millions-
$ith a calculator, enter C A %, 06 A .;, 0:( A 2, &6 A 19, and then solve for ID5 A 1=.>4F.
b& (he calculation described in the 7uotation fails to consider the compounding effect of interest.
It can be demonstrated to be incorrect as follows:
<;,222,222,1.92-
%
A <;,222,222,9.=>>?9- A <1=,G9G,G92,
which is greater than <19 million. (hus, the annual growth rate is less than 92FL in fact, it is
about 1%F, as shown in 0art a.
5,1$ (hese problems can all be solved using a financial calculator by entering the known values shown
on the time lines and then pressing the ID5 button.
a& 2 1
I I
@422 .4=G
$ith a financial calculator, enter: C A 1, 06 A 422, 0:( A 2, and &6 A .4=G. ID5 A 4F.
b& 2 1
I I
.422 @4=G
$ith a financial calculator, enter: C A 1, 06 A .422, 0:( A 2, and &6 A 4=G. ID5 A 4F.
c& 2 12
I I
@>%,222.921,99G
9$ Answers and Solutions Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
E
19F
ID5 A E
ID5 A E
ID5 A E
$ith a financial calculator, enter: C A 12, 06 A >%222, 0:( A 2, and &6 A .92199G. ID5 A GF.
)& 2 1 9 ? = %
I I I I I I
@G,222 .9,;>=.>2 .9,;>=.>2 .9,;>=.>2 .9,;>=.>2 .9,;>=.>2
$ith a financial calculator, enter: C A %, 06 A G222, 0:( A .9;>=.>2, and &6 A 2. ID5 A 1%F.
5,13 a& E
I I
.922 =22
$ith a financial calculator, enter ID5 A 4, 06 A .922, 0:( A 2, and &6 A =22. (hen press the
C key to find C A 12.9=. )verride ID5 with the other values to find C A 4.94, =.1G, and 1.22.
b& E
I I Enter: ID5 A 12, 06 A .922, 0:( A 2, and &6 A =22.
.922 =22 C A 4.94.
c& E
I I Enter: ID5 A 1>, 06 A .922, 0:( A 2, and &6 A =22.
.922 =22 C A =.1G.
)& E
I I Enter: ID5 A 122, 06 A .922, 0:( A 2, and &6 A =22.
.922 =22 C A 1.22.
5,14 a& 2 1 9 ? = % ; 4 > G 12
I I I I I I I I I I I
=22 =22 =22 =22 =22 =22 =22 =22 =22 =22
&6 A E
$ith a financial calculator, enter C A 12, ID5 A 12, 06 A 2, and 0:( A .=22. (hen press the
&6 key to find &6 A <;,?4=.G4.
b& 2 1 9 ? = %
I I I I I I
922 922 922 922 922
&6 A E
$ith a financial calculator, enter C A %, ID5 A %, 06 A 2, and 0:( A .922. (hen press the &6
key to find &6 A <1,12%.1?.
Chapter 5! Time Value of Money Answers and Solutions 93
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
ID5 A E
4F
12F
1>F
12F
%F
122F
c& 2 1 9 ? = %
I I I I I I
=22 =22 =22 =22 =22
&6 A E
$ith a financial calculator, enter C A %, ID5 A 2, 06 A 2, and 0:( A .=22. (hen press the &6
key to find &6 A <9,222.
)& (o solve 0art d using a financial calculator, repeat the procedures discussed in 0arts a, b, and c,
but first switch the calculator to *3EM+ mode. :ake sure you switch the calculator back to *EC"+
mode after working the problem.
1. 2 1 9 ? = % ; 4 > G 12
I I I I I I I I I I I
=22 =22 =22 =22 =22 =22 =22 =22 =22 =22 &6 A E
$ith a financial calculator on 3EM, enter: C A 12, ID5 A 12, 06 A 2, and 0:( A .=22. &6 A
<4,219.=4.
9. 2 1 9 ? = %
I I I I I I
922 922 922 922 922 &6 A E
$ith a financial calculator on 3EM, enter: C A %, ID5 A %, 06 A 2, and 0:( A .922. &6 A
<1,1;2.?>.
?. 2 1 9 ? = %
I I I I I I
=22 =22 =22 =22 =22 &6 A E
$ith a financial calculator on 3EM, enter: C A %, ID5 A 2, 06 A 2, and 0:( A .=22. &6 A
<9,222.
5,15 a& 2 1 9 ? = % ; 4 > G 12
I I I I I I I I I I I
06 A E =22 =22 =22 =22 =22 =22 =22 =22 =22 =22
$ith a financial calculator, simply enter the known values and then press the key for the
unknown. Enter: C A 12, ID5 A 12, 0:( A .=22, and &6 A 2. 06 A <9,=%4.>?.
b& 2 1 9 ? = %
I I I I I I
06 A E 922 922 922 922 922
$ith a financial calculator, enter: C A %, ID5 A %, 0:( A .922, and &6 A 2. 06 A <>;%.G2.
c& 2 1 9 ? = %
I I I I I I
06 A E =22 =22 =22 =22 =22
$ith a financial calculator, enter: C A %, ID5 A 2, 0:( A .=22, and &6 A 2. 06 A <9,222.22.
)& 1. 2 1 9 ? = % ; 4 > G 12
I I I I I I I I I I I
94 Answers and Solutions Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
2F
12F
%F
2F
12F
%F
2F
12F
=22 =22 =22 =22 =22 =22 =22 =22 =22 =22
06 A E
$ith a financial calculator on 3EM, enter: C A 12, ID5 A 12, 0:( A .=22, and &6 A 2. 06
A <9,42?.;1.
9. 2 1 9 ? = %
I I I I I I
922 922 922 922 922
06 A E
$ith a financial calculator on 3EM, enter: C A %, ID5 A %, 0:( A .922, and &6 A 2. 06 A
<G2G.1G.
?. 2 1 9 ? = %
I I I I I I
=22 =22 =22 =22 =22
06 A E
$ith a financial calculator on 3EM, enter: C A %, ID5 A 2, 0:( A .=22, and &6 A 2. 06 A
<9,222.22.
5,1. 064F A <122D2.24 A <1,=9>.%4. 061=F A <122D2.1= A <41=.9G.
$hen the interest rate is doubled, the 06 of the perpetuity is halved.
5,1" 2 1 9 ? = ?2
I I I I I I
>%,222 .>,94?.%G .>,94?.%G .>,94?.%G .>,94?.%G .>,94?.%G
$ith a calculator, enter C A ?2, 06 A >%222, 0:( A .>94?.%G, &6 A 2, and then solve for ID5 A GF.
5,19 a& Cash 'tream A Cash 'tream 3
2 1 9 ? = % 2 1 9 ? = %
I I I I I I I I I I I I
06 A E 122 =22 =22 =22 ?22 06 A E ?22 =22 =22 =22 122
$ith a financial calculator, simply enter the cash flows ,be sure to enter C&2 A 2-, enter ID5 A
>, and press the C06 key to find C06 A 06 A <1,9%1.9% for the first problem. )verride ID5 A >
with ID5 A 2 to find the next 06 for Cash 'tream A. Enter the cash flows for Cash 'tream 3,
enter ID5 A >, and press the C06 key to find C06 A 06 A <1,?22.?9. )verride ID5 A > with
ID5 A 2 to find the next 06 for Cash 'tream 3.
b& 06A A <122 @ <=22 @ <=22 @ <=22 @ <?22 A <1,;22.
063 A <?22 @ <=22 @ <=22 @ <=22 @ <122 A <1,;22.
Chapter 5! Time Value of Money Answers and Solutions 95
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
ID5 A E
%F
2F
>F >F
5,1: a& 3egin with a time line:
=2 =1 ;= ;%
I I I I
%,222 %,222 %,222
&6 A E
Bsing a financial calculator input the following: C A 9%, ID5 A G, 06 A 2, 0:( A %222, and
solve for &6 A <=9?,%2=.=>.
b& =2 =1 ;G 42
I I I I
%,222 %,222 %,222
&6 A E
Bsing a financial calculator input the following: C A ?2, ID5 A G, 06 A 2, 0:( A %222, and
solve for &6 A <;>1,%?4.;G.
c& 1. ;% ;; ;4 >= >%
I I I I I
=9?,%2=.=> 0:( 0:( 0:( 0:(
Bsing a financial calculator, input the following: C A 92, ID5 A G, 06 A .=9?%2=.=>, &6 A
2, and solve for 0:( A <=;,?G?.=9.
9. 42 41 49 >= >%
I I I I I
;>1,%?4.;G 0:( 0:( 0:( 0:(
Bsing a financial calculator, input the following: C A 1%, ID5 A G, 06 A .;>1%?4.;G, &6 A
2, and solve for 0:( A <>=,%%2.>2.
5,$% Contract 1: 06 A
= ? 9
- 12 . 1 ,
222 , 222 , ? <
- 12 . 1 ,
222 , 222 , ? <
- 12 . 1 ,
222 , 222 , ? <
12 . 1
222 , 222 , ? <
+ + +
A <9,494,949.4? @ <9,=4G,??>.>= @ <9,9%?,G==.=2 @ <9,2=G,2=2.?4
A <G,%2G,%G;.?=.
Bsing your financial calculator, enter the following data: C&2 A 2L C&1.= A ?222222L ID5 A 12L C06 A
E 'olve for C06 A <G,%2G,%G;.?=.
Contract 9: 06 A
= ? 9
- 12 . 1 ,
222 , 222 , % <
- 12 . 1 ,
222 , 222 , = <
- 12 . 1 ,
222 , 222 , ? <
12 . 1
222 , 222 , 9 <
+ + +
A <1,>1>,1>1.>9 @ <9,=4G,??>.>= @ <?,22%,9%G.92 @ <?,=1%,2;4.9>
A <12,414,>=4.1=.
Alternatively, using your financial calculator, enter the following data: C&2 A 2L C&1 A 9222222L C&9
A ?222222L C&? A =222222L C&= A %222222L ID5 A 12L C06 A E 'olve for C06 A <12,414,>=4.1=.
Contract ?: 06A
= ? 9
- 12 . 1 ,
222 , 222 , 1 <
- 12 . 1 ,
222 , 222 , 1 <
- 12 . 1 ,
222 , 222 , 1 <
12 . 1
222 , 222 , 4 <
+ + +
A <;,?;?,;?;.?; @ <>9;,==;.9> @ <4%1,?1=.>2 @ <;>?,21?.=;
A <>,;9=,=12.G2.
9. Answers and Solutions Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
GF
GF
GF
GF
Alternatively, using your financial calculator, enter the following data: C&2 A 2L C&1 A 4222222L C&9
A 1222222L C&? A 1222222L C&= A 1222222L ID5 A 12L C06 A E 'olve for C06 A <>,;9=,=12.G2.
Contract 9 gives the 7uarterback the highest present valueL therefore, he should accept Contract 9.
5,$1 a& If Crissie expects a 4F annual return on her investments:
1 payment 12 payments ?2 payments
C A 12 C A ?2
ID5 A 4 ID5 A 4
0:( A G%22222 0:( A %%22222
&6 A 2 &6 A 2
06 A <;1,222,222 06 A <;;,49=,29% 06 A <;>,9=G,494
Crissie should accept the ?2.year payment option as it carries the highest present value
,<;>,9=G,494-.
b& If Crissie expects an >F annual return on her investments:
1 payment 12 payments ?2 payments
C A 12 C A ?2
ID5 A > ID5 A >
0:( A G%22222 0:( A %%22222
&6 A 2 &6 A 2
06 A <;1,222,222 06 A <;?,4=%,44? 06 A <;1,G14,>2>
Crissie should accept the 12.year payment option as it carries the highest present value
,<;?,4=%,44?-.
c& If Crissie expects a GF annual return on her investments:
1 payment 12 payments ?2 payments
C A 12 C A ?2
ID5 A G ID5 A G
0:( A G%22222 0:( A %%22222
&6 A 2 &6 A 2
06 A <;1,222,222 06 A <;2,G;4,4=> 06 A <%;,%2%,2G4
Crissie should accept the lump.sum payment option as it carries the highest present value
,<;1,222,222-.
)& (he higher the interest rate, the more useful it is to get money rapidly, because it can be
invested at those high rates and earn lots more money. 'o, cash comes fastest with O1,
slowest with O?, so the higher the rate, the more the choice is tilted toward O1. ou can also
think about this another way. (he higher the discount rate, the more distant cash flows are
penali#ed, so again, O? looks worst at high rates, O1 best at high rates.
5,$$ a& (his can be done with a calculator by specifying an interest rate of %F per period for 92 periods
with 1 payment per period.
C A 12 9 A 92, ID5 A 12D9 A %, 06 A .12222, &6 A 2. 'olve for 0:( A <>29.=?.
b& 'et up an amorti#ation table:
3eginning 0ayment of Ending
0eriod 3alance 0ayment Interest 0rincipal 3alance
Chapter 5! Time Value of Money Answers and Solutions 9"
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
1 <12,222.22 <>29.=? <%22.22 <?29.=? <G,;G4.%4
9 G,;G4.%4 >29.=? =>= .>> ?14.%% G,?>2.29
<G>= .>>
3ecause the mortgage balance declines with each payment, the portion of the payment that is
applied to interest declines, while the portion of the payment that is applied to principal
increases. (he total payment remains constant over the life of the mortgage.
c& Pan must report interest of <G>=.>> on 'chedule 3 for the first year. /er interest income will
decline in each successive year for the reason explained in 0art b.
)& Interest is calculated on the beginning balance for each period, as this is the amount the lender
has loaned and the borrower has borrowed. As the loan is amorti#ed ,paid off-, the beginning
balance, hence the interest charge, declines and the repayment of principal increases.
5,$3 a& 2 1 9 ? = %
I I I I I I
.%22 &6 A E
$ith a financial calculator, enter C A %, ID5 A 19, 06 A .%22, and 0:( A 2, and then press &6
to obtain &6 A <>>1.14.
b& 2 1 9 ? = % ; 4 > G 12
I I I I I I I I I I I
.%22 &6 A E
$ith a financial calculator, enter C A 12, ID5 A ;, 06 A .%22, and 0:( A 2, and then press &6
to obtain &6 A <>G%.=9.
Alternatively, &6C A 06
C:
C):
:
I
1

+ A <%22
- 9 , %
9
19 . 2
1

+
A <%22,1.2;-
12
A <>G%.=9.
c& 2 = > 19 1; 92
I I I I I I
.%22 &6 A E
$ith a financial calculator, enter C A 92, ID5 A ?, 06 A .%22, and 0:( A 2, and then press &6
to obtain &6 A <G2?.2;.
Alternatively, &6C A <%22

=
2.19
@ 1
- = , %
A <%22,1.2?-
92
A <G2?.2;.
)& 2 19 9= ?; => ;2
I I I I I I
.%22 &6 A E
$ith a financial calculator, enter C A ;2, ID5 A 1, 06 A .%22, and 0:( A 2, and then press &6
to obtain &6 A <G2>.?%.
Alternatively, &6C A <%22

19
2.19
@ 1
- 19 , %
A <%22,1.21-
;2
A <G2>.?%.
99 Answers and Solutions Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
19F
;F
?F
1F
e& 2 ?;% 1,>9%
I I I
.%22 &6 A E
$ith a financial calculator, enter C A 1>9%, ID5 A 19D?;% A 2.2?9>44, 06 A .%22, and 0:( A 2,
and then press &6 to obtain &6 A <G12.G4.
Alternatively, &6C A <%22

?;%
2.19
@ 1
- ?;% , %
A <%22,1.222?9>44-
1,>9%
A <G12.G4.
f& (he &6s increase because as the compounding periods increase, interest is earned on interest
more fre7uently.
5,$4 a& 2 9 = ; > 12
I I I I I I
06 A E %22
$ith a financial calculator, enter C A 12, ID5 A ;, 0:( A 2, and &6 A %22, and then press 06
to obtain 06 A <94G.92.
Alternatively, 06 A &6C

D: I @ 1
1
C):
C:
A <%22

D9 19 . 2 @ 1
1
- 9 , %
A <%22

1.2;
1
12
A <94G.92.
b& 2 = > 19 1; 92
I I I I I I
06 A E %22
$ith a financial calculator, enter C A 92, ID5 A ?, 0:( A 2, and &6 A %22, and then press 06
to obtain 06 A <94;.>=.
Alternatively, 06 A <%22

D= 19 . 2 @ 1
1
,%- =
A <%22

? 1.2
1
2 9
A <94;.>=.
c& 2 1 9 19
I I I I
06 A E %22
$ith a financial calculator, enter C A 19, ID5 A 1, 0:( A 2, and &6 A %22, and then press 06
to obtain 06 A <==?.49.
Alternatively, 06 A <%22

D19 19 . 2 @ 1
1
- 1 , 19
A <%22

1 1.2
1
19
A <==?.49.
)& (he 06s for 0arts a and b decline as periodsDyear increases. (his occurs because, with more
fre7uent compounding, a smaller initial amount ,06- is re7uired to get to <%22 after % years. &or
0art c, even though there are 19 periodsDyear, compounding occurs over only 1 year, so the 06 is
larger.
5,$5 a& 2 1 9 ? G 12
I I I I I I
Chapter 5! Time Value of Money Answers and Solutions 9:
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
;F
?F
1F
;F
2.2?9GF
.=22 .=22 .=22 .=22 .=22
&6 A E
Enter C A % 9 A 12, ID5 A 19D9 A ;, 06 A 2, 0:( A .=22, and then press &6 to get &6 A
<%,949.?9.
b& Cow the number of periods is calculated as C A % = A 92, ID5 A 19D= A ?, 06 A 2, and 0:( A
.922. (he calculator solution is <%,?4=.24. (he solution assumes that the nominal interest rate
is compounded at the annuity period.
c& (he annuity in 0art b earns more because the money is on deposit for a longer period of time
and thus earns more interest. Also, because compounding is more fre7uent, more interest is
earned on interest.
5,$. Bsing the information given in the problem, you can solve for the maximum car price attainable.
&inanced for => months &inanced for ;2 months
C A => C A ;2
ID5 A 1 ,19FD19 A 1F- ID5 A 1
0:( A .?%2 0:( A .?%2
&6 A 2 &6 A 2
06 A 1?,9G2.>G 06 A 1%,4?=.9;
ou must add the value of the down payment to the present value of the car payments. If financed
for => months, you can afford a car valued up to <14,9G2.>G ,<1?,9G2.>G @ <=,222-. If financing for
;2 months, you can afford a car valued up to <1G,4?=.9; ,<1%,4?=.9; @ <=,222-.
5,$" a& 3ank A: IC): A Effective annual rate A =F.
3ank 3:
Effective annual rate A
?;%
?;%
2?% . 2
1

+ K 1.2 A ,1.2222G;-
?;%
K 1.2
A 1.2?%;1> K 1.2 A 2.2?%;1> A ?.%;1>F.
$ith a financial calculator, you can use the interest rate conversion feature to obtain the same
answer. ou would choose 3ank A because its EA5 is higher.
b& If funds must be left on deposit until the end of the compounding period ,1 year for 3ank A and
1 day for 3ank 3-, and you think there is a high probability that you will make a withdrawal
during the year, then 3ank 3 might be preferable. &or example, if the withdrawal is made after
; months, you would earn nothing on the 3ank A account but ,1.2222G;-
?;%D9
K 1.2 A 1.4;%F on
the 3ank 3 account.
(en or more years ago, most banks were set up as described above, but now virtually all
are computeri#ed and pay interest from the day of deposit to the day of withdrawal, provided at
least <1 is in the account at the end of the period.
5,$9 /ere you want to have an effective annual rate on the credit extended that is 9F more than what
the bank is charging you, so you can cover overhead. &irst, we must find the EA5 A E&&F on the
bank loan. Enter C):F A ;, 0D5 A 19, and press E&&F to get EA5 A ;.1;4>F.
'o, to cover overhead you need to charge customers a nominal rate so that the corresponding
EA5 A >.1;4>F. (o find this nominal rate, enter E&&F A >.1;4>, 0D5 A 19, and press C):F to
get IC): A 4.>441F. ,Customers will be re7uired to pay monthly, so 0D5 A 19.-
:% Answers and Solutions Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
Alternative solution: $e need to find the effective annual rate ,EA5- the bank is charging first.
(hen, we can add 9F to this EA5 to calculate the nominal rate that you should 7uote your
customers.
3ank EA5: EA5 A ,1 @ IC):D:-
:
K 1 A ,1 @ 2.2;D19-
19
K 1 A ;.1;4>F.
'o, the EA5 you want to earn on your receivables is >.1;4>F.
Cominal rate you should 7uote customers:
>.1;4>F A ,1 @ IC):D19-
19
K 1
1.2>1;4> A ,1 @ IC):D19-
19
1.22;%;= A 1 @ IC):D19
IC): A 2.22;%;=,19- A 4.>441F.
5,$: IC): A 19F, daily compounding ?;2.day year.
Cost per day A 2.19D?;2 A 2.222???? A 2.2????F.
CustomersN credit period A G2 days.
If you loaned <1, after G2 days a customer would owe you ,1 @ 2.19D?;2-
G2
<1 A <1.2?2==G. 'o,
the re7uired markup would be ?.2==GF or approximately ?F.
5,3% a& Bsing the information given in the problem, you can solve for the length of time re7uired to
reach <1 million.
Erika: ID5 A ;L 06 A ?2222L 0:( A %222L &6 A .1222222L and then solve for C A ?>.4=91>9.
(herefore, Erika will be 9% @ ?>.4= A ;?.4= years old when she becomes a millionaire.
Qitty: ID5 A 92L 06 A ?2222L 0:( A %222L &6 A .1222222L and then solve for C A 1;.2=?41?.
(herefore, Qitty will be 9% @ 1;.2= A =1.2= years old when she becomes a millionaire.
b& Bsing the 1;.2=?41? year target, you can solve for the re7uired payment:
C A 1;.2=?41?L ID5 A ;L 06 A ?2222L &6 A .1222222L then solve for 0:( A <?%,>9%.??.
If Erika wishes to reach the investment goal at the same time as Qitty, she will need to
contribute <?%,>9%.?? per year.
c& Erika is investing in a relatively safe fund, so there is a good chance that she will achieve her
goal, albeit slowly. Qitty is investing in a very risky fund, so while she might do 7uite well and
become a millionaire shortly, there is also a good chance that she will lose her entire
investment. /igh expected returns in the market are almost always accompanied by a lot of
risk. $e couldnNt say whether Erika is rational or irrational, !ust that she seems to have less
tolerance for risk than Qitty does.
Chapter 5! Time Value of Money Answers and Solutions :1
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
5,31 a& 2 1 9 ? =
I I I I I
06 A E .12,222 .12,222 .12,222 .12,222
$ith a calculator, enter C A =, ID5 A %, 0:( A .12222, and &6 A 2. (hen press 06 to get 06 A
<?%,=%G.%1.
b& At this point, we have a ?.year, %F annuity whose value is <94,9?9.=>. ou can also think of
the problem as follows:
<?%,=%G.%1,1.2%- K <12,222 A <94,9?9.=G.
5,3$ 2 1 9 ? = % ;
I I I I I I I
1,%22 1,%22 1,%22 1,%22 1,%22 E
&6 A 12,222
$ith a financial calculator, get a *ballpark+ estimate of the number of years it will take to reach your
goal, by entering ID5 A >, 06 A 2, 0:( A .1%22, and &6 A 12222, and solving for C A %.%% years.
(his answer assumes that a payment of <1,%22 will be made %%D122th of the way through ear %.
Cow find the &6 of <1,%22 for % years at >F as follows: C A %, ID5 A >, 06 A 2, 0:( A .1%22, and
solve for &6 A <>,4GG.G2. Compound this value for 1 year at >F to obtain the value in the account
after ; years and before the last payment is madeL it is <>,4GG.G2,1.2>- A <G,%2?.>G. (hus, you will
have to make a payment of <12,222 K <G,%2?.>G A <=G;.11 at ear ;.
Alternative solution: <12,222 is needed ; years from today. (he plan is to deposit <1,%22 annually
in an >F interest account, with the first payment to be made one year from today. (he last deposit
will be for less than <1,%22 if less is needed to reali#e <12,222 in ; years.
Calculate how large last payment will be:
C A ;L ID5 A >L 06 A 2L 0:( A .1%22L and solve for &6 A <11,22?.>G.
If the last payment is <1,%22, then the account will contain <11,22?.>G K <12,222 A <1,22?.>G too
much. (hus, the last payment should be reduced by this excess amount:
Hast payment A <1,%22 K <1,22?.>G A <=G;.11.
5,33 3egin with a time line:
2 1 9 ?
I I I I
%,222 %,%22 ;,2%2
&6 A E
Bse a financial calculator to calculate the present value of the cash flows and then determine the
future value of this present value amount:
'tep 1: C&2 A 2, C&1 A %222, C&9 A %%22, C&? A ;2%2, ID5 A 4. 'olve for C06 A <1=,=1%.=1.
'tep 9: Input the following data: C A ?, ID5 A 4, 06 A .1==1%.=1, 0:( A 2, and solve for &6 A
<14,;%G.%2.
:$ Answers and Solutions Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
%F
>F
4F
5,34 a& $ith a financial calculator, enter C A ?, ID5 A 12, 06 A .9%222, and &6 A 2, and solve for 0:(
A <12,2%9.>4. (hen go through the amorti#ation procedure as described in your calculator
manual to get the entries for the amorti#ation table.
3eginning 5epayment 5emaining
ear 3alance 0ayment Interest of 0rincipal 3alance
1 <9%,222.22 <12,2%9.>4 <9,%22.22 <4,%%9.>4 <14,==4.1?
9 14,==4.1? 12,2%9.>4 1,4==.41 >,?2>.1; G,1?>.G4
? G,1?>.G4 12,2%9 .>4 G1? .G2 G,1?> .G4 2
<?2,1%> .;1 <%,1%> .;1 <9%,222 .22
b& F Interest F 0rincipal
ear 1: <9,%22D<12,2%9.>4 A 9=.>4F <4,%%9.>4D<12,2%9.>4 A 4%.1?F
ear 9: <1,4==.41D<12,2%9.>4 A 14.?;F <>,?2>.1;D<12,2%9.>4 A >9.;=F
ear ?: <G1?.G2D<12,2%9.>4 A G.2GF <G,1?>.G4D<12,2%9.>4 A G2.G1F
(hese percentages change over time because, even though the total payment is constant, the
amount of interest paid each year is declining as the balance declines.
5,35 a& Bsing a financial calculator, enter C A ?, ID5 A 4, 06 A .G2222, and &6 A 2, then solve for 0:(
A <?=,9G=.;%.
?.year amorti#ation schedule:
3eginning 0rincipal Ending
0eriod 3alance 0ayment Interest 5epayment 3alance
1 <G2,222.22 <?=,9G=.;% <;,?22.22 <94,GG=.;% <;9,22%.?%
9 ;9,22%.?% ?=,9G=.;% =,?=2.?4 9G,G%=.9> ?9,2%1.24
? ?9,2%1.24 ?=,9G=.;% 9,9=?.%> ?9,2%1.24 2
Co. Each payment would be <?=,9G=.;%, which is significantly larger than the <4,%22 payments
that could be paid ,affordable-.
b& Bsing a financial calculator, enter C A ?2, ID5 A 4, 06 A .G2222, and &6 A 2, then solve for
0:( A <4,9%9.4>.
es. Each payment would now be <4,9%9.4>, which is less than the <4,%22 payment given in
the problem that could be made ,affordable-.
c& ?2.year amorti#ation with balloon payment at end of ear ?:
3eginning 0rincipal Ending
0eriod 3alance 0ayment Interest 5epayment 3alance
1 <G2,222.22 <4,9%9.4> <;,?22.22 < G%9.4> <>G,2=4.99
9 >G,2=4.99 4,9%9.4> ;,9??.?1 1,21G.=4 >>,294.4%
? >>,294.4% 4,9%9.4> ;,1;1.G= 1,2G2.>= >;,G?;.G1
(he loan balance at the end of ear ? is <>;,G?;.G1 and the balloon payment is <>;,G?;.G1 @
<4,9%9.4> A <G=,1>G.;G.
Chapter 5! Time Value of Money Answers and Solutions :3
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
5,3. a& 3egin with a time line:
2 1 9 ? = % ; ;.mos.
2 1 9 ? ears
I I I I I I I
1,222 1,222 1,222 1,222 1,222 &6A A E
'ince the first payment is made ; months from today, we have a %.period ordinary annuity. (he
applicable interest rate is =FD9 A 9F. &irst, we find the &6A of the ordinary annuity in period %
by entering the following data in the financial calculator: C A %, ID5 A =D9 A 9, 06 A 2, and
0:( A .1222. $e find &6A% A <%,92=.2=. Cow, we must compound this amount for 1
semiannual period at 9F.
<%,92=.2=,1.29- A <%,?2>.19.
b& /ereNs the time line:
2 1 9 ? = Rtrs
I I I I I
0:( A E 0:( A E &6 A 12,222
annuity of
value 5e7uired
A <G,>29.G;
'tep 1: "iscount the <12,222 back 9 7uarters to find the re7uired value of the 9.period annuity
at the end of Ruarter 9, so that its &6 at the end of the =
th
7uarter is <12,222.
Bsing a financial calculator enter C A 9, ID5 A 1, 0:( A 2, &6 A 12222, and solve for
06 A <G,>29.G;.
'tep 9: Cow you can determine the re7uired payment of the 9.period annuity with a &6 of
<G,>29.G;.
Bsing a financial calculator, enter C A 9, ID5 A 1, 06 A 2, &6 A G>29.G;, and solve for
0:( A <=,>44.2G.
5,3" a& Bsing the information given in the problem, you can solve for the length of time re7uired to pay
off the card.
ID5 A 1.% ,1>FD19-L 06 A ?%2L 0:( A .12L &6 A 2L and then solve for C A %2 months.
b& If 'imon makes monthly payments of <?2, we can solve for the length of time re7uired before
the account is paid in full.
ID5 A 1.%L 06 A ?%2L 0:( A .?2L &6 A 2L and then solve for C A 19.G91 J 1? months.
$ith <?2 monthly payments, 'imon will only need 1? months to pay off the account.
c& (otal payments S <12.month: %2 <12 A <%22.22
(otal payments S <?2Dmonth: 19.G91 <?2 A ?>4.;9
Extra interest A <119.?>
:4 Answers and Solutions Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
9F
1F
5,39 2 1 9 ?
19D?1D12 19D?1D11 19D?1D19 19D?1D1? 19D?1D1=
I I I I I
?=,222.22 ?%,292.22 ?;,242.;2 ?4,1%9.49 ?>,9;4.?2
122,222.22
92,222 .22
1%%,292.22 0ayment will be made
'tep 1: Calculate salary amounts ,9212.921=-:
9212: <?=,222
9211: <?=,222,1.2?- A <?%,292.22
9219: <?%,292,1.2?- A <?;,242.;2
921?: <?;,242.;2,1.2?- A <?4,1%9.49
921=: <?4,1%9.49,1.2?- A <?>,9;4.?2
'tep 9: Compound back pay, pain and suffering, and legal costs to 19D?1D19 payment date:
<?=,222,1.24-
9
@ <1%%,292,1.24-
1
<?>,G9;.;2 @ <1;%,>41.=2 A <92=,4G>.22.
'tep ?: "iscount future salary back to 19D?1D19 payment date:
<?;,242.;2 @ <?4,1%9.49D,1.24-
1
@ <?>,9;4.?2D,1.24-
9
<?;,242.;2 @ <?=,499.14 @ <??,=9=.1= A <12=,91;.G1.
'tep =: City must write check for <92=,4G>.22 @ <12=,91;.G1 A <?2G,21=.G1 <?2G,21%.
5,3: 1. $ill save for 12 years, then receive payments for 9% years. /ow much must he deposit at the
end of each of the next 12 yearsE
9. $ants payments of <=2,222 per year in todayNs dollars for first payment only. 5eal income will
decline. Inflation will be %F. (herefore, to find the inflated fixed payments, we have this time line:
2 % 12
I I I
=2,222 &6 A E
Enter C A 12, ID5 A %, 06 A .=2222, 0:( A 2, and press &6 to get &6 A <;%,1%%.4G.
?. /e now has <122,222 in an account that pays >F, annual compounding. $e need to find the
&6 of the <122,222 after 12 years. Enter C A 12, ID5 A >, 06 A .122222, 0:( A 2, and solve
for &6 A <91%,>G9.%2.
=. /e wants to withdraw, or have payments of, <;%,1%%.4G per year for 9% years, with the first
payment made at the beginning of the first retirement year. 'o, we have a 9%.year annuity due
with 0:( A ;%,1%%.4G, at an interest rate of >F. 'et the calculator to *3EM+ mode, then enter
C A 9%, ID5 A >, 0:( A ;%1%%.4G, &6 A 2, and solve for 06 A <4%1,1;%.?%. (his amount must
be on hand to make the 9% payments.
%. 'ince the original <122,222, which grows to <91%,>G9.%2, will be available, we must save
enough to accumulate <4%1,1;%.?% . <91%,>G9.%2 A <%?%,949.>%.
'o, the time line looks like this:
5etires
%2 %1 %9 %G ;2 ;1 >? >= >%
I I I I I I I I I
Chapter 5! Time Value of Money Answers and Solutions :5
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
4F
%F
>F
<122,222 0:( 0:( 0:( 0:(
.;%,1%%.4G .;%,1%%.4G .;%,1%%.4G .;%,1%%.4G
@ 91%,>G9.%2
. 4%1,1;% .?% A 06A,due-
Ceed to accumulate .<%?%,949 .>% A &6A12
;. (he <%?%,949.>% is the &6 of a 12.year ordinary annuity. (he payments will be deposited in the
bank and earn >F interest. (herefore, set the calculator to *EC"+ mode and enter C A 12, ID5
A >, 06 A 2, &6 A %?%949.>%, and solve for 0:( A <?;,G=G.;1 <?;,G%2.
5,4% 'tep 1: "etermine the annual cost of college. (he current cost is <1%,222 per year, but that is
escalating at a %F inflation rate:
College Current ears Inflation Cash
ear Cost from Cow Ad!ustment 5e7uired
1 <1%,222 % ,1.2%-
%
<1G,1==.99
9 1%,222 ; ,1.2%-
;
92,121.=?
? 1%,222 4 ,1.2%-
4
91,12;.%1
= 1%,222 > ,1.2%-
>
99,1;1.>?
Cow put these costs on a time line:
1? 1= 1% 1; 14 1> 1G 92 91
I I I I I I I I I
.1G,1== K92,121 K91,124 K99,1;9
/ow much must be accumulated by age 1> to provide these payments at ages 1> through
91 if the funds are invested in an account paying ;F, compounded annuallyE
$ith a financial calculator enter: C&2 A 1G1==, C&1 A 92121, C&9 A 91124, C&? A 991;9,
and ID5 A ;. 'olve for C06 A <4%,%22.22.
(hus, the father must accumulate <4%,%22 by the time his daughter reaches age 1>.
'tep 9: (he daughter has <4,%22 now ,age 1?- to help achieve that goal. &ive years hence, that
<4,%22, when invested at ;F, will be worth <12,2?4: <4,%22,1.2;-
%
A <12,2?;.;G J
<12,2?4.
'tep ?: (he father needs to accumulate only <4%,%22 K <12,2?4 A <;%,=;?. (he key to completing
the problem at this point is to reali#e the series of deposits represent an ordinary annuity
rather than an annuity due, despite the fact the first payment is made at the beginning of
the first year. (he reason it is not an annuity due is there is no interest paid on the last
payment that occurs when the daughter is 1>.
Bsing a financial calculator, C A ;, ID5 A ;, 06 A 2, and &6 A .;%=;?. 0:( A <G,?>=.G% J
<G,?>%.
:. Answers and Solutions Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
Comprehenive;-prea)heet 3roblem
Note to Instructors:
The olution to thi problem i not provi)e) to tu)ent at the bac< of their te+t& =ntructor can
acce the Excel file on the te+tboo<> *ebite or the =ntructor> (eource C/&
5,41 a&
b&
c&
)&
e&
Chapter 5! Time Value of Money ComprehensiveSpreadsheet !roblem :"
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
Inputs: PV = $1,000
I = 10%
N = 5
Formula: FV = PV(1+I)^N = $1,610.51
W!ar" (FV): $1,610.51
#$ars (%11)
1,610.51 $ 0% 5% &0%
0 $1,000.00 $1,000.00 $1,000.00
1 $1,000.00 $1,050.00 $1,&00.00
& $1,000.00 $1,10&.50 $1,''0.00
( $1,000.00 $1,15).6( $1,)&*.00
' $1,000.00 $1,&15.51 $&,0)(.60
5 $1,000.00 $1,&)6.&* $&,'**.(&
Int$r$st +at$ (%10)
Inputs: FV = $1,000
I = 10%
N = 5
Formula: PV = FV,(1+I)^N = 6&0.-& $
W!ar" (PV): 6&0.-& $
Inputs: PV = .$1,000
FV = $&,000
I = /
N = 5
W!ar" (+at$): 1'.*)%
Inputs: PV = .(6.5
FV = )(
I = 0ro1t2 rat$ &%
N = /
W!ar" (NP3+): (5.00 = #$ars to "ou4l$.
f&
g&
h&
i&
j&
:9 ComprehensiveSpreadsheet !roblem Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
Inputs: P56 (1,000) $
N 5
I 15%
PV: 7s$ 8un9ton 1!ar" (PV) PV = $(,(5&.16
FV: 7s$ 8un9ton 1!ar" (FV) FV = $6,)'&.(*
Inputs: N 10
I *%
PV .$1,000
P56: 7s$ 8un9ton 1!ar" (P56) P56 = $1'-.0(
P56 (%u$): 7s$ 8un9ton 1!ar" (P56) P56 = $1().--
#$ar Pa:m$nt
1 100
& &00
( '00
+at$ = *%
6o 8n" t2$ PV, us$ t2$ NPV 8un9ton: PV = $5*1.5-
Part a. FV 1t2 s$mannual 9ompoun"n0: ;r0. Inputs: N$1 Inputs:
Inputs: PV = $1,000 $1,000
I = 10% 5%
N = 5 10
Formula: FV = PV(1+I)^N = 1,610.51 $ 1,6&*.*- $
W!ar" (FV): 1,610.51 $ 1,6&*.*- $
Part 9. PV 1t2 s$mannual 9ompoun"n0: ;r0. Inputs: N$1 Inputs:
Inputs: FV = $1,000 $1,000
I = 10% 5%
N = 5 10
Formula: FV = FV,(1+I)^N = 6&0.-& $ 61(.-1 $
W!ar" (PV): 6&0.-& $ 61(.-1 $
For t2$ PV, $a92 pa:m$nt 1oul" 4$ r$9$<$" on$ p$ro" soon$r, 2$n9$ 1oul" 4$ "s9ount$" 4a9= on$
l$ss :$ar. 62s 1oul" ma=$ t2$ PV lar0$r. W$ 9an 8n" t2$ PV o8 t2$ annut: "u$ 4: 8n"n0 t2$ PV o8
an or"nar: annut: an" t2$n multpl:n0 t 4: (1 + I).
PV annut: "u$ = $(,(5&.16 1.15 = $(,*5'.-*
3>a9tl: t2$ sam$ a"?ustm$nt s ma"$ to 8n" t2$ FV o8 t2$ annut: "u$.
FV annut: "u$ = $6,)'&.(* 1.15 = $),)5(.)'
<&
l&
Chapter 5! Time Value of Money ComprehensiveSpreadsheet !roblem ::
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
;r0nal amount o8 mort0a0$: $15,000
6$rm to maturt:: '
Int$r$st rat$: *%
@nnual pa:m$nt (us$ P56 8un9ton): ($',5&*.*1)
A$0nnn0 3n"n0
#$ar Aalan9$ Pa:m$nt Int$r$st Prn9pal Aalan9$
1 15,000.00 $ ',5&*.*1 $ 1,&00.00 $ $(,(&*.*1 11,6)1.1- $
& 11,6)1.1- $ ',5&*.*1 $ -((.)0 $ $(,5-5.1& *,0)6.0) $
( *,0)6.0) $ ',5&*.*1 $ 6'6.0- $ $(,**&.)( ',1-(.(' $
' ',1-(.(' $ ',5&*.*1 $ ((5.') $ $',1-(.(' 0.00 $
#$ar Pa:m$nt > (1 + I )^(N t) = FV
1 100 1.166' 116.6'
& &00 1.0*00 &16.00
( '00 1.0000 '00.00
Bum o8 FVCs = )(&.6'
@n alt$rnat<$ pro9$"ur$ 8or 8n"n0 t2$ FV 1oul" 4$ to 8n" t2$ PV o8 t2$ s$r$s usn0 t2$ NPV
8un9ton, t2$n 9ompoun" t2at amount 8or ( :$ars at *%, as s "on$ 4$lo1:

PV = $5*1.5-
FV o8 PV = $)(&.6'
(1) @ A D % 3
() 3@+ 6.00% 6.0-% 6.1'% 6.1)% 6.1*%
() %$post $5,000. W2at s FV1/ $5,(00 $5,(05 $5,(0) $5,(0* $5,(0-
() %$post $5,000. W2at s FV&/ $5,61* $5,6&* $5,6(& $5,6(6 $5,6()
(&) Woul" t2$: 4$ $Euall: a4l$ to attra9t 8un"s/ No. P$opl$ 1oul" pr$8$r mor$ 9ompoun"n0 to l$ss.
() W2at nomnal rat$ 1oul" 9aus$ all 4an=s to pro<"$ sam$ 3@+ as Aan= @/
@ A D % 3
I N;5 6.00% 5.-1% 5.*)% 5.*'% 5.*(%
3a92 o8 t2$s$ nomnal rat$s 4as$" on t2$ 8r$Eu$n9: o8 9ompoun"n0 1ll pro<"$ an 3@+ o8 6%.
(() #ou n$$" $5,000 at t2$ $n" o8 t2$ :$ar. Fo1 mu92 "o :ou n$$" to "$post annuall: 8or @,
s$mannuall:, 8or A, $t9. 4$0nnn0 to"a:, to 2a<$ $5,000 at t2$ $n" o8 t2$ :$ar/
@ A D % 3
P56 $',)16.-* $&,(-1.(1 $1,&0'.16 $'0(.(& $1(.&-
(') 3<$n 8 t2$ 4an=s pro<"$" t2$ sam$ 3@+, 1oul" a ratonal n<$stor 4$ n"88$r$nt 4$t1$$n t2$
4an=s/ Pro4a4l: not. @n n<$stor 1oul" pro4a4l: pr$8$r t2$ 4an= t2at 9ompoun"$" mor$
8r$Eu$ntl:.
=ntegrate) Cae
5,4$
5irt 1ational ?an<
"ime #alue o$ %one& Anal&sis
0ou have applie) for a job *ith a local ban<& ' part of it evaluation proce, you
mut ta<e an e+amination on time value of money analyi covering the follo*ing
@uetion&
'& /ra* time line for 617 a A1%% lump um cah flo* at the en) of 0ear $B
6$7 an or)inary annuity of A1%% per year for 3 yearB an) 637 an uneven
cah flo* tream of ,A5%, A1%%, A"5, an) A5% at the en) of 0ear %
through 3&
'1-CE(! D-ho* -5,1 through -5,4 here&E ' time line i a graphical repreentation
that i ue) to ho* the timing of cah flo*& The tic< mar< repreent
en) of perio) 6often year7, o time % i to)ayB Time 1 i the en) of the
firt year, or 1 year from to)ayB an) o on&
% 1 $ 0ear
F F F Lump um
1%% Cah flo*
% 1 $ 3
F F F F 'nnuity
1%% 1%% 1%%
% 1 $ 3
F F F F Gneven cah flo* tream
,5% 1%% "5 5%
' lump um i a ingle flo*B for e+ample, a A1%% inflo* in 0ear $, a
ho*n in the top time line&
'n annuity i a erie of e@ual cah flo* occurring over e@ual
interval, a illutrate) in the mi))le time line&
1%% Integrated Case Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
=;0(H
=;0(H
=;0(H
'n uneven cah flo* tream i an irregular erie of cah flo* that
)o not contitute an annuity, a in the lo*er time line& ,5% repreent a
cah outflo* rather than a receipt or inflo*&
?& 617 Chat> the future value of A1%% after 3 year if it earn 1%H, annual
compoun)ingI
'1-CE(! D-ho* -5,5 through -5," here&E -ho* )ollar correpon)ing to @uetion
mar<, calculate) a follo*!
% 1 $ 3
F F F F
1%% 5V J I
'fter 1 year!
5V1 J 3V K =1 J 3V K 3V6=7 J 3V61 K =7 J A1%%61&1%7 J A11%&%%&
-imilarly!
5V$ J 5V1 K =$ J 5V1 K 5V16=7
J 5V161 K =7 J A11%61&1%7 J A1$1&%%
J 3V61 K =761 K =7 J 3V61 K =7
$
&
5V3 J 5V$ K =3 J 5V$ K 5V$6=7
J 5V$61 K =7 J A1$161&1%7 J A133&1%
J 3V61 K =7
$
61 K =7 J 3V61 K =7
3
&
=n general, *e ee that!
5V1 J 3V61 K =7
1
,
-o 5V3 J A1%%61&1%7
3
J A1%%61&331%7 J A133&1%&
1ote that thi e@uation ha 4 variable! 5V1, 3V, =;0(, an) 1& 2ere, *e
<no* all e+cept 5V1, o *e olve for 5V1& Ce *ill, ho*ever, often olve
for one of the other three variable& ?y far, the eaiet *ay to *or< all
time value problem i *ith a financial calculator& Lut plug in any three
of the four value an) fin) the fourth&
Chapter 5! Time Value of Money Integrated Case 1%1
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
1%H
5in)ing future value 6moving to the right along the time line7 i
calle) compoun)ing& 1ote that there are 3 *ay of fin)ing 5V3!
(egular calculator!
1& A1%%61&1%761&1%761&1%7 J A133&1%&
$& A1%%61&1%7
3
J A133&1%&
5inancial calculator!
Thi i epecially efficient for more comple+ problem, inclu)ing
e+am problem& =nput the follo*ing value! 1 J 3, =;0( J 1%, 3V J
,1%%, 3MT J %, an) olve for 5V J A133&1%&
-prea)heet!
-prea)heet program are i)eally uite) for olving time value of
money problem& The prea)heet can be et up uing the pecific
5V prea)heet function or by entering a 5V formula;e@uation&
?& 6$7 Chat> the preent value of A1%% to be receive) in 3 year if the interet
rate i 1%H, annual compoun)ingI
'n*er! D-ho* -5,9 through -5,1% here&E 5in)ing preent value, or )icounting
6moving to the left along the time line7, i the revere of compoun)ing,
an) the baic preent value e@uation i the reciprocal of the
compoun)ing e@uation!
% 1 $ 3
F F F F
3V J I 1%%
5V1 J 3V61 K =7
1
tranform to!
7 = K 61
5V
J
= K 1
1

5V
J
7 = K 61
5V
J 3V
1
1
1
1
1
1

1%$ Integrated Case Chapter 5! Time Value of Money

# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
1%H
Thu!
A"5&13& J 37 A1%%6%&"51 J
1&1%
1
A1%% J 3V
3

The ame metho) 6regular calculator, financial calculator, an)

prea)heet program7 ue) for fin)ing future value are alo ue) to fin)
preent value, *hich i calle) )icounting&
Ging a financial calculator input! 1 J 3, =;0( J 1%, 3MT J %, 5V J
1%%, an) then olve for 3V J A"5&13&
C& Chat annual interet rate *oul) caue A1%% to gro* to A1$5&:" in 3
yearI
'1-CE(! D-ho* -5,11 here&E
% 1 $ 3
F F F F
,1%% 1$5&:"
A1%%61 K =7 A1%%61 K =7
$
A1%%61 K =7
3
5V J A1%%61 K =7
3
J A1$5&:"&
Ging a financial calculatorB enter 1 J 3, 3V J ,1%%, 3MT J %, 5V J 1$5&:",
then pre the =;0( button to fin) =;0( J 9H&
Calculator can fin) interet rate @uite eaily, even *hen perio)
an);or interet rate are not *hole number, an) *hen uneven cah flo*
tream are involve)& 6Cith uneven cah flo*, *e mut ue the MC5jN
calculator <ey, an) the interet rate i calle) the =((, or Minternal rate of
returnBN *e *ill ue thi feature in capital bu)geting&7
/& =f a company> ale are gro*ing at a rate of $%H annually, ho* long *ill
it ta<e ale to )oubleI
'1-CE(! D-ho* -5,1$ here&E Ce have thi ituation in time line format!
% 1 $ 3 3&9 4
F F F F F F
Chapter 5! Time Value of Money Integrated Case 1%3
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
$%H
,1 $
-ay *e *ant to fin) out ho* long it *ill ta<e u to )ouble our money at
an interet rate of $%H& Ce can ue any number, ay A1 an) A$, *ith
thi e@uation!
5V1 J A$ J A161 K =7
1
A$ J A161&$%7
1
&
Ce *oul) plug =;0( J
$%, 3V J ,1, 3MT J %,
an) 5V J $ into our
calculator, an) then
pre the 1 button to
fin) the number of
year it *oul) ta<e A1
6or any other beginning
amount7 to )ouble
*hen gro*th occur at
a $%H rate& The an*er
i 3&9 year, but ome calculator *ill roun) thi value up to the ne+t
highet *hole number& The graph alo ho* *hat i happening&
Optional 8uetion
' farmer can pen) A.%;acre to plant pine tree on ome marginal lan)& The
e+pecte) real rate of return i 4H, an) the e+pecte) inflation rate i .H& Chat i the
e+pecte) value of the timber after $% yearI
'1-CE(! 5V$% J A.%61 K %&%4 K %&%.7
$%
J A.%61&1%7
$%
J A4%3&.5 per acre&
Ce coul) have a<e)! 2o* long *oul) it ta<e A.% to gro* to A4%3&.5,
given the real rate of return of 4H an) an inflation rate of .HI Of coure,
the an*er *oul) be $% year&
1%4 Integrated Case Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
4 3 $ 1 %
1
$
0ear
3&9
5V
4 3 $ 1 %
1
$
0ear
3&9
5V
E& Chat> the )ifference bet*een an or)inary annuity an) an annuity )ueI
Chat type of annuity i ho*n hereI 2o* *oul) you change it to the
other type of annuityI
% 1 $ 3
F F F F
% 1%% 1%% 1%%
'1-CE(! D-ho* -5,13 here&E Thi i an or)inary annuityOit ha it payment at
the en) of each perio)B that i, the firt payment i ma)e 1 perio) from
to)ay& Converely, an annuity )ue ha it firt payment to)ay& =n other
*or), an or)inary annuity ha en),of,perio) payment, *hile an annuity
)ue ha beginning,of,perio) payment&
The annuity ho*n above i an or)inary annuity& To convert it to an
annuity )ue, hift each payment to the left, o you en) up *ith a payment
un)er the % but none un)er the 3 a illutrate) belo*&
% 1 $ 3
F F F F
1%% 1%% 1%%
5& 617 Chat i the future value of a 3,year, A1%% or)inary annuity if the annual
interet rate i 1%HI
'1-CE(! D-ho* -5,14 here&E
% 1 $ 3
F F F F
1%% 1%% 1%%
11%
1$1
A331
Po through the follo*ing )icuion& One approach *oul) be to treat
each annuity flo* a a lump um& 2ere *e have
5V'1 J A1%%617 K A1%%61&1%7 K A1%%61&1%7
$
Chapter 5! Time Value of Money Integrated Case 1%5
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
1%H
J A1%%D1 K 61&1%7 K 61&1%7
$
E J A1%%63&31%%7 J A331&%%&
5uture value of annuitie may be calculate) in 3 *ay! 617 Treat the
payment a lump um& 6$7 Ge a financial calculator& 637 Ge a
prea)heet&
5& 6$7 Chat i it preent valueI
'1-CE(! D-ho* -5,15 here&E
% 1 $ 3
F F F F
1%% 1%% 1%%
:%&:1
9$&.4
"5 &13
$49 &.9
The preent value of the annuity i A$49&.9& 2ere *e ue) the lump um
approach, but the ame reult coul) be obtaine) by uing a calculator&
=nput 1 J 3, =;0( J 1%, 3MT J 1%%, 5V J %, an) pre the 3V button&
5& 637 Chat *oul) the future an) preent value be if it *a an annuity )ueI
'1-CE(! D-ho* -5,1. an) -5,1" here&E =f the annuity *ere an annuity )ue, each
payment *oul) be hifte) to the left, o each payment i compoun)e)
over an a))itional perio) or )icounte) bac< over one le perio)&
=n our ituation, the future value of the annuity )ue i A3.4&1%!
5V'3 /ue J A331&%%61&1%7
1
J A3.4&1%&
Thi ame reult coul) be obtaine) by uing the time line!
A133&1% K A1$1&%% K A11%&%% J A3.4&1%&
The bet *ay to *or< annuity )ue problem i to *itch your
calculator to M?EPN or beginning or M/GEN mo)e, an) go through the
normal proce& 1ote that it> critical to remember to change bac< to
ME1/N mo)e after *or<ing an annuity )ue problem *ith your calculator&
1%. Integrated Case Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
1%H
=n our ituation, the preent value of the annuity )ue i A$"3&55!
3V'3 /ue J A$49&.961&1%7
1
J A$"3&55&
Thi ame reult coul) be obtaine) by uing the time line!
A1%% K A:%&:1 K A9$&.4 J A$"3&55&
P& ' 5,year A1%% or)inary annuity ha an annual interet rate of 1%H&
617 Chat i it preent valueI
Chapter 5! Time Value of Money Integrated Case 1%"
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
'1-CE(! D-ho* -5,19 here&E
% 1 $ 3 4 5
F F F F F F
1%% 1%% 1%% 1%% 1%%
:%&:1
9$&.4
"5&13
.9&3%
.$&%:
3":&%9
The preent value of the annuity i A3":&%9& 2ere *e ue) the lump um
approach, but the ame reult coul) be obtaine) by uing a calculator&
=nput 1 J 5, =;0( J 1%, 3MT J 1%%, 5V J %, an) pre the 3V button&
P& 6$7 Chat *oul) the preent value be if it *a a 1%,year annuityI
'1-CE(! D-ho* -5,1: here&E The preent value of the 1%,year annuity i A.14&4.&
To olve *ith a financial calculator, input 1 J 1%, =;0( J 1%, 3MT J 1%%, 5V
J %, an) pre the 3V button&
P& 637 Chat *oul) the preent value be if it *a a $5,year annuityI
'1-CE(! The preent value of the $5,year annuity i A:%"&"%& To olve *ith a
financial calculator, input 1 J $5, =;0( J 1%, 3MT J 1%%, 5V J %, an) pre
the 3V button&
P& 647 Chat *oul) the preent value be if thi *a a perpetuityI
'1-CE(! The preent value of the A1%% perpetuity i A1,%%%& The 3V i olve) by
)ivi)ing the annual payment by the interet rate! A1%%;%&1% J A1,%%%&
2& ' $%,year,ol) tu)ent *ant to ave A3 a )ay for her retirement& Every
)ay he place A3 in a )ra*er& 't the en) of each year, he invet the
accumulate) aving 6A1,%:57 in a bro<erage account *ith an e+pecte)
annual return of 1$H&
1%9 Integrated Case Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
1%H
617 =f he <eep aving in thi manner, ho* much *ill he have accumulate)
at age .5I
'1-CE(! D-ho* -5,$% an) -5,$1 here&E =f he begin aving to)ay, an) tic< to
her plan, he *ill have ave) A1,49",$.1&9: by the time he reache .5&
Cith a financial calculator, enter the follo*ing input! 1 J 45, =;0( J 1$,
3V J %, 3MT J ,1%:5, then pre the 5V button to olve for A1,49",$.1&9:&
2& 6$7 =f a 4%,year,ol) invetor began aving in thi manner, ho* much *oul)
he have at age .5I
'1-CE(! D-ho* -5,$$ here&E Thi @uetion )emontrate the po*er of compoun)
interet an) the importance of getting tarte) on a regular aving
program at an early age& The 4%,year ol) invetor *ill have ave) only
A14.,%%%&5: by the time he reache .5& Cith a financial calculator, enter
the follo*ing input! 1 J $5, =;0( J 1$, 3V J %, 3MT J ,1%:5, then pre the
5V button to olve for A14.,%%%&5:&
2& 637 2o* much *oul) the 4%,year,ol) invetor have to ave each year to
accumulate the ame amount at .5 a the $%,year,ol) invetorI
'1-CE(! D-ho* -5,$3 here&E 'gain, thi @uetion )emontrate the po*er of
compoun) interet an) the importance of getting tarte) on a regular
aving program at an early age& The 4%,year ol) invetor *ill have to
ave A11,154&4$ every year, or A3%&5. per )ay, in or)er to have a much
ave) a the $%,year ol) invetor by the time he reache .5& Cith a
financial calculator, enter the follo*ing input! 1 J $5, =;0( J 1$, 3V J %,
5V J 149"$.1&9:, then pre the 3MT button to olve for A11,154&4$&
=& Chat i the preent value of the follo*ing uneven cah flo* treamI The
annual interet rate i 1%H&
% 1 $ 3 4 0ear
F F F F F
Chapter 5! Time Value of Money Integrated Case 1%:
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
% 1%% 3%% 3%% ,5%
'1-CE(! D-ho* -5,$4 an) -5,$5 here&E 2ere *e have an uneven cah flo* tream&
The mot traightfor*ar) approach i to fin) the 3V of each cah flo*
an) then um them a ho*n belo*!
% 1 $ 3 4 0ear
F F F F F
% 1%% 3%% 3%% ,5%
:%&:1
$4"&:3
$$5&3:
634 &15 7
53% &%9
1ote that the A5% 0ear 4 outflo* remain an outflo* even *hen
)icounte)& There are numerou *ay of fin)ing the preent value of an
uneven cah flo* tream& ?ut by far the eaiet *ay to )eal *ith
uneven cah flo* tream i *ith a financial calculator& Calculator
have a function that on the 23,1"? i calle) MC5LO,N for Mcah flo*&N
Other calculator coul) ue other )eignation uch a C5% an) C5j, but
they e+plain ho* to ue them in the manual& 'ny*ay, you *oul) input
the cah flo*, o they are in the calculator> memory, then input the
interet rate, =;0(, an) then pre the 13V or 3V button to fin) the
preent value of the cah flo* tream&
L& 617 Cill the future value be larger or maller if *e compoun) an initial
amount more often than annually 6e&g&, emiannually, hol)ing the tate)
6nominal7 rate contant7I ChyI
'1-CE(! D-ho* -5,$. here&E 'ccount that pay interet more fre@uently than once
a year, for e+ample, emiannually, @uarterly, or )aily, have future value
that are higher becaue interet i earne) on interet more often&
Virtually all ban< no* pay interet )aily on paboo< an) money fun)
account, o they ue )aily compoun)ing&
11% Integrated Case Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
1%H
L& 6$7 /efine 6a7 the tate) 6or @uote) or nominal7 rate, 6b7 the perio)ic rate, an)
6c7 the effective annual rate 6E'( or E55H7&
'1-CE(! D-ho* -5,$" an) -5,$9 here&E The @uote), or nominal, rate i merely the
@uote) percentage rate of return, the perio)ic rate i the rate charge) by
a len)er or pai) by a borro*er each perio) 6perio)ic rate J =1OM;M7, an)
the effective annual rate 6E'(7 i the rate of interet that *oul) provi)e
an i)entical future )ollar value un)er annual compoun)ing&
L& 637 Chat i the E'( correpon)ing to a nominal rate of 1%H compoun)e)
emiannuallyI Compoun)e) @uarterlyI Compoun)e) )ailyI
'1-CE(! D-ho* -5,$: through -5,31 here&E The effective annual rate for 1%H
emiannual compoun)ing, i 1%&$5H!
E'( J Effective annual rate J
M
M 1O
M
= K 1

Q 1&%&
=f =1OM J 1%H an) interet i compoun)e) emiannually, then!
E'(J
$
%&1%
K 1
$

Q 1&% J 61&%57
$
Q 1&%
J 1&1%$5 Q 1&% J %&1%$5 J 1%&$5H&
5or @uarterly compoun)ing, the effective annual rate i 1%&39H!
61&%$57
4
Q 1&% J 1&1%39 Q 1&% J %&1%39 J 1%&39H&
/aily compoun)ing *oul) pro)uce an effective annual rate of 1%&5$H&
L& 647 Chat i the future value of A1%% after 3 year un)er 1%H emiannual
compoun)ingI 8uarterly compoun)ingI
'1-CE(! D-ho* -5,3$ here&E Gn)er emiannual compoun)ing, the A1%% i
compoun)e) over . emiannual perio) at a 5&%H perio)ic rate!
=1OM J 1%H&
Chapter 5! Time Value of Money Integrated Case 111
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
5V1 J
M1
1OM
M
=
K 1

J A1%%
7 3 6 $
$
1% & %
K 1

J A1%%61&%57
.
J A134&%1&
8uarterly! 5V1 J A1%%61&%$57
1$
J A134&4:&
The return *hen uing @uarterly compoun)ing i clearly higher&
'nother approach here *oul) be to ue the effective annual rate
an) compoun) over annual perio)!
-emiannually! A1%%61&1%$57
3
J A134&%1&
8uarterly! A1%%61&1%397
3
J A134&4:&
R& Chen *ill the E'( e@ual the nominal 6@uote)7 rateI
'1-CE(! D-ho* -5,33 here&E =f annual compoun)ing i ue), then the nominal rate
*ill be e@ual to the effective annual rate& =f more fre@uent compoun)ing
i ue), the effective annual rate *ill be above the nominal rate&
L& 617 Chat i the value at the en) of 0ear 3 of the follo*ing cah flo* tream if
interet i 1%H compoun)e) emiannuallyI 62int! 0ou can ue the E'(
an) treat the cah flo* a an or)inary annuity or ue the perio)ic rate
an) compoun) the cah flo* in)ivi)ually&7
% $ 4 . 3erio)
F F F F F F F
% 1%% 1%% 1%%
'1-CE(! D-ho* -5,34 through -5,3. here&E
% $ 4 . 3erio)
F F F F F F F
1%% 1%% 1%%&%%
11%&$5 J A1%%61&%57
$
1$1 &55 J A1%%61&%57
4
A331 &9%
11$ Integrated Case Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
5H
2ere *e have a )ifferent ituation& The payment occur annually, but
compoun)ing occur each . month& Thu, *e cannot ue normal
annuity valuation techni@ue&
L& 6$7 Chat i the 3VI
'1-CE(! D-ho* -5,3" here&E
% $ 4 . 3erio)
F F F F F F F
1%% 1%% 1%%
A :%&"%
9$&$" 3V J 1%%61&%57
,4
"4 &.$
A$4" &5:
To ue a financial calculator, input 1 J 3, =;0( J 1%&$5, 3MT J 1%%, 5V J %,
an) then pre the 3V <ey to fin) 3V J A$4"&5:&
L& 637 Chat *oul) be *rong *ith your an*er to 3art L617 an) L6$7 if you ue)
the nominal rate, 1%H, rather than the E'( or the perio)ic rate, =1OM;$ J
1%H;$ J 5H to olve the problemI
'1-CE(! =1OM can be ue) in the calculation only *hen annual compoun)ing
occur& =f the nominal rate of 1%H *ere ue) to )icount the payment
tream, the preent value *oul) be overtate) by A$"$&3$ Q A$4"&5: J
A$4&"3&
M& 617 Contruct an amortiSation che)ule for a A1,%%%, 1%H annual interet
loan *ith three e@ual intallment&
6$7 Chat i the annual interet e+pene for the borro*er an) the annual
interet income for the len)er )uring 0ear $I
'1-CE(! D-ho* -5,39 through -5,44 here&E To begin, note that the face amount of
the loan, A1,%%%, i the preent value of a 3,year annuity at a 1%H rate!
Chapter 5! Time Value of Money Integrated Case 113
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
5H
% 1 $ 3
F F F F
,1,%%% 3MT 3MT 3MT
3V'3 J 3MT

= K 1
1
1
K 3MT

= K 1
1
$
K 3MT

= K 1
1
3
A1,%%% J 3MT61 K =7
,1
K 3MT61 K =7
,$
K 3MT61 K =7
,3
&
Ce have an e@uation *ith only one un<no*n, o *e can olve it to fin)
3MT& The eay *ay i *ith a financial calculator& =nput 1 J 3, =;0( J 1%,
3V J ,1%%%, 5V J %, an) then pre the 3MT button to get 3MT J
4%$&1149%3., roun)e) to A4%$&11&
'mortiSation -che)ule!
?eginning 3ayment of En)ing
3erio) ?alance 3ayment =nteret 3rincipal ?alance
1 A1,%%%&%% A4%$&11 A1%%&%% A3%$&11 A.:"&9:
$ .:"&9: 4%$&11 .:&": 33$&3$ 3.5&5"
3 3.5&5" 4%$&13T 3.&5. 3.5&5" %&%%
T/ue to roun)ing, the thir) payment *a increae) by A%&%$ to caue the en)ing balance
after the thir) year to e@ual A%&
1o* ma<e the follo*ing point regar)ing the amortiSation che)ule!
The A4%$&11 annual payment inclu)e both interet an) principal&
=nteret in the firt year i calculate) a follo*!
1t year interet J = ?eginning balance J %&1 A1,%%% J A1%%&
The repayment of principal i the )ifference bet*een the A4%$&11
annual payment an) the interet payment!
1t year principal repayment J A4%$&11 Q A1%% J A3%$&11&
The loan balance at the en) of the firt year i!
1t year en)ing balance J ?eginning balance Q 3rincipal repayment
J A1,%%% Q A3%$&11 J A.:"&9:&
114 Integrated Case Chapter 5! Time Value of Money
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&
1%H
Ce *oul) continue thee tep in the follo*ing year&
1otice that the interet each year )ecline becaue the beginning loan
balance i )eclining& -ince the payment i contant, but the interet
component i )eclining, the principal repayment portion i increaing
each year&
The interet component i an e+pene that i )e)uctible to a buine
or a homeo*ner, an) it i ta+able income to the len)er& =f you buy a
houe, you *ill get a che)ule contructe) li<e our, but longer, *ith
3% 1$ J 3.% monthly payment if you get a 3%,year, fi+e),rate
mortgage&
The payment may have to be increae) by a fe* cent in the final year
to ta<e care of roun)ing error an) ma<e the final payment pro)uce a
Sero en)ing balance&
The len)er receive) a 1%H rate of interet on the average amount of
money that *a invete) each year, an) the A1,%%% loan *a pai) off&
Thi i *hat amortiSation che)ule are )eigne) to )o&
Mot financial calculator have built,in amortiSation function&
Chapter 5! Time Value of Money Integrated Case 115
# $%13 Cengage Learning& 'll (ight (eerve)& May not be copie), canne), or )uplicate), in *hole or in part, e+cept for ue a permitte) in a
licene )itribute) *ith a certain pro)uct or ervice or other*ie on a pa*or),protecte) *ebite for claroom ue&