Sep 26, 2014(Friday).

Financial
Management
Submitted to: Maam Fizza Abbas

ASSIGNMENT NO: 1
Numericals Ch#3: Time Value of
Money
Student Name: Tehniat Zafar
Major: BBA (Hons.)
Semester: 5 Sec: B

Problems:
Q.1 The following are exercises in future (terminal) values:
(A) At The end of three years, how much is an initial deposit of $
100 worth, assuming a compound annual interest rate of a) 10
percent? b) 100 percent? c) 0 percent?
Solution:
i) 10 percent
Values: P.V = $100, i = 10 % p.a, n = 3 years
Putting Values:
F.Vn = P.V(1+i)n
F.V3= 100(1+0.10)3
F.V3 = 133.1 Ans.
ii) 100 percent
Values: P.V = $100, i = 100 % p.a, n = 3 years
F.V3 = P.V(1+i)n
F.V3= 100(1+1)3
F.V3 = 800 Ans.
iii) 0 percent
Values: P.V = $100, i = 0 % p.a, n = 3 years
F.V3 = P.V(1+i)n
F.V3= 100(1+0)3
F.V3 = 100 Ans.

(B) At the end of five years, how much is an initial $500 deposit
followed by five year-end, annual $100 payments worth,
assuming a compound annual interest rate of (i) 10 percent? (ii) 5
percent? (iii) 0 percent?
Formula: FVn = P.V0(1 + i)n ; FVAn = R[([1 + i]n 1)/i]
Values: P.V = $500, i = 10%, n = 5
(i) FV5 = $500(1.10)5
= $500(1.611)

= $ 805.50 Ans # 1
Values: R= $100, i= 10%
FVA5 = $100[([1.10]5 1)/(0.10)]
= $100(6.105)
= $610.50 Ans # 2
Adding 1 and 2

$805.50 + $610.50 = $1,416

(ii) FV5 = $500(1.05)5
= $500(1.276)
= $ 638.00 Ans # 1
FVA5 = $100[([1.05]5 1)/(0.05)]
= $100(5.526)
= $552.60 Ans # 2
Adding 1 and 2
$638.00 + $552.60 = $1,190.60
(iii) FV5 = $500(1.0)5
= $500(1)
= $ 500.00 Ans # 1
FVA5 = $100(5)*
= $500.00 Ans # 2
Adding 1 and 2
$500.00 + $500.00 = $1,000.00
*[Note: We had to invoke lHospitals rule in the special case where i =
0; in short, FVIFAn = n when i = 0.]

(C) At the end of six years,how much is an initial $500 deposit

followed by five year-end annual $100 payments worth, assuming
a compound annual interest rate of (i) 10 percent? (ii) 5 percent?
(iii) 0 percent?
Formulas:

FVn = P.V0(1 + i)n

FVADn = R[([1 + i]n 1)/i][1 + i]

Values: PV = 500, i = 10%, n = 6

(i) FV6 = $500 (1.10)6
= $500(1.772)
= $ 886.00 Ans # 1
Values: R= $100, i = 10%, n = 5
FVAD5 = $100 [([1.10]5 1)/(.10)] [1.10]
= $100(6.105)(1.10)
= 671.55 Ans # 2
Adding 1 and 2
$886.00 + $671.55 = $1,557.55

(ii) FV6 = $500(1.05)6

= $500(1.340)
= $ 670.00 Ans # 1
FVAD5 = $100[([1.05]5 1)/(0.05)] [1.05]
= $100(5.526)(1.05)
= $ 580.23 Ans # 2
Adding 1 and 2
$670.00 + $580.23 = $1,250.23

(iii) FV6 = $500(1.0)6

= $500(1) = $ 500.00 Ans # 1
FVAD5 = $100(5) = 500.00 Ans # 2
Adding 1 and 2
$500.00 + $500.00 = $1,000.00

(D) At the end of three years how much is an initial $100 deposit
worth, assuming a quarterly compounded annual interest rate of
(i) 100 percent? (ii) 10 percent?
Formula: FVn = PV0(1 + [i/m])mn
Values: FV= $100, i= 100%, m= 4, n= 3
(i) FV3 = $100(1 + [1/4])12 = $100(14.552) = $1,455.20
Values: FV= $100, i= 10%, m= 4, n= 3
(ii) FV3 = $100(1 + [0.10/4])12 = $100(1.345) = $134.50

(E) Why do your answers from part (D) differ from those to part (A)?
The more times a year interest is paid, the greater the future value. It is particularly
important when the interest rate is high, as evidenced by the difference in solutions
between Parts 1.A. (i) and 1.D. (i).

(F) At the end of 10 years how much is a $100 initial deposit worth, assuming an annual interst
rate of 10 percent compounded (i) annually? (ii) semi-annuallly? (iii) quarterly? (iv)
continuously?
Formulas:

FVn = PV0(1 + [i/m])mn

FVn = PV0(e)in

(i) $100(1 + [0.10/1])10

= $100(2.594) = $259.40
(ii) $100(1 + [0.10/2])20
= $100(2.653) = $265.30
(iii) $100(1 + [0.10/4])40
= $100(2.685) = $268.50
(iv) $100(2.71828)1 = $271.83

Q.2 The following are exercises in present values:

(A) $100 at the end of 3 years is worth how much today, assuming
a discount rate of (i) 100 percent? (ii) 10 percent? (iii) 0 percent?
Formula: P0 = FVn[1/(1 + i)n]
(i) $100[1/(2)3]
= $100(0.125) = $12.50
(ii) $100[1/(1.10)3]
= $100(0.751) = $75.10
(iii) $100[1/(1.0)3]
= $100(1) = $100

(B) What is the aggregate present value of $500 received at the

end of each of the next three years, assuming a discount rate of
(i) 4 percent? (ii) 25 percent?
Formula: PVAn = R[(1 [1/(1 + i)n])/i]
(i) $500[(1 [1/(1 + .04)3])/0.04]
= $500(2.775) = $1,387.50
(ii) $500[(1 [1/(1 + 0.25)3])/0.25]
= $500(1.952) = $ 976.00

(C) $100 is received at the end of one year, $500 received at the
end of two years, and $1,000 at the end of three years, what is
the aggregate present value of these receipts, assuming a
discount rate of (i) 4 percent? (ii) 25 percent?
Formula: P0 = FVn[1/(1 + i)n]

Values: FV=100, i= 4%, n=1, n=2, n=3

(i) $100[1/(1.04)1]
= $100(0.962) = $ 96.20 Ans.1
$500[1/(1.04)2]
= 500(0.925) = $ 462.50 Ans.2
1,000[1/(1.04)3]
= 1,000(0.889) = 889.00 Ans.3
Adding 1, 2 and 3
=$1,447.70
(ii) Values: FV= 100, i= 25%, n=1, n=2, n=3
$100[1/(1.25)1]
= $100(0.800) = $ 80.00 Ans.1
500[1/(1.25)2]
= 500(0.640) = 320.00 Ans. 2
1,000[1/(1.25)3]
= 1,000(0.512) = 512.00 Ans.3
Adding 1, 2 and 3
= $ 912.00

(D) $1,000 is to be received at the end of one year, $500 at the

end of two years, and $100 at the end of three years. What is the
aggregate present value of these receipts assuming a discount
rate of (i) 4 percent? (ii) 25 percent?
Formula: P0 = FVn[1/(1 + i)n]
(i) Values: FV=1000, i= 4%, n= 1
$1,000[1/(1.04)1] = $1,000(0.962) = $ 962.00 Ans.1
Values: FV=500, i= 4%, n= 2
500[1/(1.04)2] = 500(0.925) = 462.50 Ans.2
Values: FV=100, i= 4%, n= 3
100[1/(1.04)3] = 100(0.889) = 88.90 Ans. 3
Adding 1, 2 and 3
= $1,513.40
(ii) Values: FV=1000, i= 25%, n= 1
$1,000[1/(1.25)1] = $1,000(0.800) = $ 800.00 Ans.1
Values: FV=500, i= 25%, n= 2
500[1/(1.25)2] = 500(0.640) = 320.00 Ans. 2
Values: FV=100, i= 25%, n= 3
100[1/(1.25)3] = 100(0.512) = 51.20 Ans.3
Adding 1, 2 and 3

= $1,171.20

(E) Compare your solutions in part C with those in part D and

explain the reason for the differences.
The fact that the cash flows are larger in the first period for the sequence in Part (D)
results in their having a higher present value. The comparison illustrates the desirability
of early cash flows.

Q.3 Joe Hernandez has inherited $ 25000 and wishes to purchase

an annuity that will provide him with a steady income over the
next 12 years. He has heard that the local saving and loan
association is currently paying 6 percent compounded interest on
an annual basis. If he were to deposit his funds, what year -end
equal dollar amount ( to the nearest dollar ) would he able to
withdraw annually such that he would have a zero valance after
his last withdrawal 12 years from now?
$25,000 = R(PVIFA6%,12) = R(8.384)
R = $25,000/8.384 = $2,982 Ans.

Q.4 You need to have $50,000 at the end of 10 year. To

accumulate this sum, you have decided to save a certain amount
at the end of each year of next 10 years and deposit it in the
bank. The bank pay 8 % interest compounded annually for longterm deposits. How much will you have to save each year (to the
nearest dollar)?
$50,000 = R(FVIFA8%,10) = R(14.486)
R = $50,000/14.486 = $3,452 Ans.

Q.5 Same as Problem 4 above, except that you deposit a certain

amount at the beginning of each of the next 10 years. Now, how
much will you have to save each year (to the nearest dollar)?
$50,000 = R(FVIFA8%,10)(1 + 0.08) = R(15.645)
R = $50,000/15.645 = $3,196 Ans.

Q.6 Vernal Equinox wishes to borrow $ 10,000 for three years. A

group of individuals agree to lend him this amount if he contracts
to pay them $ 16000 at the end of the three years. What is the
implicit compound annual interest rate implied by this contract
( to the nearest whole percent)?
(PVIFx%, 3) = $10,000/$16,000 = 0.625 Ans.
Going to the PVIF table at the back of the book and looking across the row for n = 3, we
find that the discount factor for 17 percent is 0.624 and that is closest to the number above.

Q.7 You have been offered a note with four years to maturity,
which will pay $3,000 at the end of each of the four years. The
price of the note to you is $10,200. What is the implicit compound
annual interest rate you will receive (to the nearest whole
percent)?
$10,000 = $3,000(PVIFAx%,4)(PVIFAx%,4)
= $10,200/$3,000 = 3.4
*Going to the PVIFA table at the back of the book and looking across the row for n = 4, we find that
the discount factor for 6 percent is 3.465, while for 7 percent it is 3.387. Therefore, the note has an
implied interest rate of almost 7 percent.

Q.8 Sales of the P.J. Cramer company were $500000 this year,
and they are expected to grow at a compound rate of 20 % for
next 6 years. What will be the sales figure at the end of each of
the next six year?
Year

Sales

1.

600,000

500,000(1.2)

2.

720,000

600,000(1.2)

3.

864,000

720,000(1.2)

4.

1,036,800

864,000(1.2)

5.

1,244,160

1,036,800(1.2)

6.

1,492,992

1,244,160(1.2)

Q.9 The H & L Bark Company is considering the purchase of a

debarking machine that is expected to provide cash flows as
follows:

Cash flow

Cash flow

1
$1,200

6
$1,400

2
$2,000

END OF YEAR
3
$2,400

4
$1,900

5
$1,600

7
$1,400

END OF YEAR
8
$1,400

9
$1,400

10
$1,400

Ans:

Year
1
2
3
4
5

Amount
$1,200
2,000
2,400
1,900
1,600

Present Value
Factor at 14% Present Value
0.877
$1,052.40
0.769
1,538.00
0.675
1,620.00
0.592
1,124.80
0.519
830.40

Subtotal (a) ................................. $6,165.60

110 (annuity) 1,400
15 (annuity) 1,400

5.216
3.433

$7,302.40
4,806.20

Subtotal (b) ................................. $2,496.20

Total Present Value (a + b) ................................. $8,661.80

Q.10 Suppose you were to receive $1000 at the end of 10 years.

If your opportunity rate is 10 percent, what is the present value
of this amount if interest is compounded (a) annually? (b)
quarterly? (c) continuously?

Ans:-

Amount
$1,000
1,000
1,000

Present Value Interest Factor

1/(1 + .10)10 = 0.386
1/(1 + .025)40 = 0.372
1/e(.10)(10) = 0.368

Present Value
$386
372
368

Q.11 In connection with the United States Bicentennial, the

Treasury once contemplated offering a savings bond for $1,000
that would be worth $1 million in 100 years. Approximately what
compound annual interest rate is implied by this terms?
ANS:-

$1,000,000 = $1,000(1 + x%)100

(1 + x%)100 = $1,000,000/$1,000 = 1,000

Taking the square root of both sides of the above equation gives
(1 + x%)50 = (FVIFAx%, 50) = 31.623
*Going to the FVIF table at the back of the book and looking across the
row for n = 50, we
find that the interest factor for 7 percent is 29.457, while for 8 percent it is
46.901.
Therefore, the implicit interest rate is slightly more than 7 percent.

Q.12 Selyn cohen is 63 years oldand recently retired he wishes

to produce retirement income for himself and is considering an
annuity contract with the Philo Life insurance company. Such a
contract pays him an equal-dollar amount each year that he lives.
For this cash-flow stream he must put a specific amount of money
at the beginning. According to actuary tables, his life expectancy
is 15 years, and that is the duration on which the insurance
company bases its calculations regardless of how long he actually
lives.
(a) If Philo life uses a compound annual interest rate of 5% in its
calculations, what must Cohen pay at the outset for an annuity to
provide him with $10,000 per year? (Assume that the expected
annual payments are at the end of each of the 15 years.)
ANS:-

Annuity of $10,000 per year for 15 years at 5 percent.

The discount factor in the PVIFA table at the end of the book is 10.380.
Purchase price = $10,000 10.380 = $103,800
(b) what would be the purchase price if the compound annual
interest rate is 10 percent?
ANS:-

Discount factor for 10 percent for 15 years is 7.606

Purchase price = $10,000 7.606 = $76,060
As the insurance company is able to earn more on the amount put up, it
requires a lower
purchase price.
(c) Cohen had $30,000 to put into an annuity, How much would he
receive each year if the insurance company uses a 5% annual

compound interst rate in its calculations? A 10 % annual

compound interest rate?
ANS:-

Annual annuity payment for 5 percent = $30,000/10.380 = $2,890

Annual annuity payment for 10 percent = $30,000/7.606 = $3,944
The higher the interest rate embodied in the yield calculations, the higher
the annual
payments.

Q.13 The happy hand build company is purchasing a building and

has obtained a $190,000 mortgage loan for 20 years, the loan
bears a compound annual interest rate of 17% and calls for equal
intallment payments at the end of each of 20 years. What is the
amount of the annual payment?
ANS:-

$190,000 = R(PVIFA17%, 20) = R(5.628)

R = $190,000/5.628 = $33,760

Q.14 Establish loan amortization schedule for the following loans

to the nearest cent if:- (a) 36 month loan of $8000 with equal
instalments payments at the end of each months. The interest
rate is 1 % per month?
ANS:- (a) PV0 = $8,000 = R(PVIFA1%,36)
= R[(1 [1/(1 + .01)36])/(0.01)] = R(30.108)
Therefore, R = $8,000/30.108 = $265.71
OR
No. of months = 36
P.V = $8000
r = 1 % per month
P.V of annuity = P[1-(1+r)-n/r]
P.V = $ 265.71
End of
Month

0
1

(1)
Installment
Payment

-$ 265.71

(2)
Monthly
Interest
(4) t1 0.01
-$ 80.00

(3)
Principal
Payment
(1) (2)
-$ 185.71

(4)
Principal Amount
Owing At Month
(4)t1 (3)
$8,000.00
7,814.29

2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36

265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.71
265.88*

78.14
76.27
74.37
72.46
70.53
68.58
66.60
64.61
62.60
60.57
58.52
56.44
54.35
52.24
50.11
47.95
45.77
43.57
41.35
39.11
36.84
34.55
32.24
29.91
27.55
25.17
22.76
20.33
17.88
15.40
12.90
10.37
7.82
5.24
2.63

187.57
189.44
191.34
193.25
195.18
197.13
199.11
201.10
203.11
205.14
207.19
209.27
211.36
213.47
215.60
217.76
219.94
222.14
224.36
226.60
228.87
231.16
233.47
235.80
238.16
240.54
242.95
245.38
247.83
250.31
252.81
255.34
257.89
260.47
263.25

7,626.72
7,437.28
7,245.94
7,052.69
6,857.51
6,660.38
6,461.27
6,260.17
6,057.06
5,851.92
5,644.73
5,435.46
5,224.10
5,010.63
4,795.03
4,577.27
4,357.33
4,135.19
3,910.83
3,684.23
3,455.36
3,224.20
2,990.73
2,754.93
2,516.77
2,276.23
2,033.28
1,787.90
1,540.07
1,289.76
1,036.95
781.61
523.72
263.25
0.00

$9,565.73
$1,565.73
$8,000.00
*The last payment is slightly higher due to rounding throughout.

Q.14 (b) A 25 year mortgage loan of $184,000 at a 10% annual

compound intrest rate, with equal installment payments at the
end of each year.
ANS:- PV0 = $184,000 = R(PVIFA10%, 25)
= R(9.077)
Therefore, R = $184,000/9.077 = $20,271.01
End of
Year

(1)
Installment
Payment

(2)
Annual
Interest
(4)t1 0.10

(3)
Principal
Payment
(1) (2)

(4)
Principal Amount
Owing At Year End
(4) t1 (3)

0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25

-$ 20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,271.01
20,262.76*
$506,767.00

-$18,400.00
18,212.90
18,007.09
17,780.70
17,531.67
17,257.73
16,956.40
16,624.94
16,260.34
15,859.27
15,418.09
14,932.80
14,398.98
13,811.78
13,165.86
12,455.34
11,673.77
10,814.05
9,868.35
8,828.09
7,683.80
6,425.07
5,040.48
3,517.43
1,842.07
$322,767.00

-$ 1,871.01
2,058.11
2,263.92
2,490.31
2,739.34
3,013.28
3,314.61
3,646.07
4,010.67
4,411.74
4,852.92
5,338.21
5,872.03
6,459.23
7,105.15
7,815.67
8,597.24
9,456.96
10,402.66
11,442.92
12,587.21
13,845.94
15,230.53
16,753.58
18,420.69

$ 184,000.00
182,128.99
180,070.88
177,806.96
175,316.65
172,577.31
169,564.03
166,249.42
162,603.35
158,592.68
154,180.94
149,328.02
143,989.81
138,117.78
131,658.55
124,553.40
116,737.73
108,140.49
98,683.53
88,280.87
76,837.95
64,250.74
50,404.80
35,174.27
18,420.69
0.00

$184,000.00

Q.15 You have borrowed $ 14300 at a compound annual interest

rate of 15%. You feel that you will be able to make annual
payments of $3000 per year on your loan. (Payments include both
principal and interest.)How long will it be before the loan is
entirely paid off(to the nearest year)?
Ans:-

$14,300 = $3,000(PVIFA15% ,n)

(PVIFA15%,n) = $14,300/$3,000 = 4.767

Going to the PVIFA table at the back of the book and looking down the
column for i = 15%,
we find that the discount factor for 8 years is 4.487, while the discount
factor for 9 years is
4.772. Thus, it will take approximately 9 years of payments before the
loan is retired.

Q.16 Lost Dutchman Mines, inc., is considering investing in Peru.

It makes a bid to the government to participate in the
development of a mine, the profit of which will be realized at the
end of five years. The mine is expected to produce $ 500000 in

cash to Lost Dutchman Mines at that time. Other than the bid at
the outset, no other cash flows will occur, as the government will
reimburse the company for all costs. If Lost Dutchman requires a
nominal annual return of 20 %(ignoring any tax consequences) ,
what is the maximum bid it should make for the participation
right of interest is compounded(a) annually ?(b) semi annually?(c)
Quarterly? (d)countinuously?
Ans:-

(a). $5,000,000 = R[1 + (0.20/1)]5 = R(2.488)

R = $5,000,000/2.488 = $2,009,646

(b) $5,000,000 = R[1 + (0.20/2)]10 = R(2.594)

R = $5,000,000/2.594 = $1,927,525
(c) $5,000,000 = R[1 + (0.20/4)]20 = R(2.653)
R = $5,000,000/2.653 = $1,884,659
(d) $5,000,000 = R(e)(0.20) (5) = R(2.71828)(1)
R = $5,000,000/2.71828 = $1,839,398

Q.17 Earl E. Bird has decided to start saving for his retirement.
Beginning on his twenty-first birthday, Earl plans to invest $2,000
each birthday into a savings investment earning a 7 percent
compound annual rate of interest. He will continue this savings
program for a total of 10 years and then stop making payments.
But his savings will continue to compound at 7 percent for 35
more years, until Earl retires at age 65. Ivana Waite also plans to
invest $2,000 a year, on each birthday, at 7 percent, and will do
so for a total of 35 years. However, she will not begin her
contributions until her thirty-first birthday. How much will Earl's
and Ivana's savings programs be worth at the retirement age of
65? Who is better off financially at retirement, and by how much?
ANS:-

FV of Earls plan = ($2,000) (FVIFA7%,10) (FVIF7%,35)

= ($2,000) (13.816) (10.677)
= $295,027
FV of Ivanas plan = ($2,000) (FVIFA7%, 35)
= ($2,000) (138.237)
= $276,474

Earls investment program is worth ($295,027 $276,474) = $18,553

more at retirement
than Ivanas program.

Q.18 When you were born, your dear old Aunt Minnie promised
to deposit $1,000 into a savings account earning a 5%
compounded annual rate on each birthday, beginning with your
first. You have just turned 25 and want the cash. How much
should be in the savings account? However, it turns out that dear
old (forgetful) Aunt Minnie made no deposits on your fifth,
seventh and eleventh birthdays. How much is in the account right
now on your 25th birthday?
ANS:- First find the future value of a $1,000-a-year ordinary annuity that
runs for 25 years.
Unfortunately, this future value overstates our true ending balance
because three of the
assumed $1,000 deposits never occurred.
So, we need to then subtract three future values from our trial ending
balance:
(1) the future value of $1,000 compounded for 25 5 = 20 years;
(2) the future value of $1,000 compounded for 25 7 = 18 years; and
(3) the future value of $1,000 compounded for 25 11 = 14 years.
After collecting terms, we get the following:
FV25 = $1,000[(FVIFA5%, 25) (FVIF5%, 20) (FVIF5%, 18) (FVIF5%,14)]
= $1,000[(47.727) (2.653) (2.407) (1.980)]
= $1,000[40.687] = $40,687

Q.19 Assume that you will be opening a savings account by

today by depositing $100,000. The savings account pays
5%coumpund annual interest and this rate is assumed to remain
in effect for all future periods, four years from today you will
withdraw R dollars. You will continue to make additional annual
withdrawals of R dollars for a while longer- making your last
withdrawals of R dollars for a while longer- making your last
withdrawal at the end of year 9- to achieve the following pattern
of cash flows over time. (Note: Today is time period zero; one year
from today is the end of time period 1; etc. )
0

ANS:-

PVA9 PVA3 = $100,000

R(PVIFA.05, 9) R(PVIFA.05, 3) = $100,000
R(7.108) R(2.723) = $100,000
R(4.385) = $100,000
R= $100,000/(4.385) = $22,805.02

PVA6 (PVIF.05, 3) = $100,000

R(PVIFA.05, 6) (PVIF.05, 3) = $100,000
R(5.076) (.864) = $100,000
R(4.386) = $100,000
R = $100,000/(4.386) = $22,799.82

Q.20 Suppose that an investment promises to pay a nominal 9.6

percent annual rate of interest. What is the effective annual
interest rate on this investment assuming that interest is
compounded (a) annually? (b) semiannually? (c) quarterly? (d)
monthly? (e) daily (365 days)? (f) continuously? (Note: Report
your answers accurate to four decimal places - e.g., 0.0987 or
9.87%.)
ANS:-

Effective annual interest rate = (1 + [i/m])m 1

a. (annually)
b. (semiannually)
c. (quarterly)
d. (monthly)
e. (daily)

=
=
=
=
=

(1 + [0.096/1])1 1
(1 + [0.096/2])2 1
(1 + [0.096/4])4 1
(1 + [0.096/12])12 1
(1 + [0.096/365])365 1

Effective annual interest

rate with continuous compounding
f. (continuous)
= (2.71828).096 1

= 0.0960
= 0.0983
= 0.0995
= 0.1003
= 0.1007
= (e)i 1
= 0.1008

Q.21 "Want to win a million dollars? here's how.... One winner

chosen at random from all entries, will win a $1,000,000 annuity.
That was the statement accouncing a contest on the World Wide
Web. The contest rules described the million-dollar-prize in
greater detail: 40 annual payments of $25,000 each, which will
result in a total payment of $1,000,000. The first payment will be
made Januray 1; subsequent payments will be made each January
thereafter. Using a compound annual interest rate of 8%, what is
the present value of this million-dollar-prize as of the first
installment on January 1?
ANS:You are faced with determining the present value of an annuity due. And,
(PVIFA8%, 40) can be found in Table IV at the end of the textbook, while
(PVIFA8%, 39) is not listed in the table.
Solutions:1: PVAD40 = (1 + 0.08)($25,000)(PVIFA8%, 40)
= (1.08)($25,000)(11.925)

= $321,975
2: PVAD40 = ($25,000)(PVIFA8%, 39) + $25,000
= ($25,000)[(1 [1/(1 + 0.08)39])/0.08] + $25,000
= ($25,000)(11.879) + $25,000 = $321,950
NOTE: Answers to 1 and 2 differ slightly due to rounding.

Q.22

It took roughly 14 years for the Dow Jones Average of

30 Industrial Stocks to go from 1,000 to 2,000. To double from
2,000 to 4,000 took only 8 years, and to go from 4,000 to 8,000
required roughly 2 years. To the nearest whole percent, what
compound annual growth rates are implicit in these three indexdoubling milestones?
ANS:For approximate answers, we can make use of the Rule of 72 as follows:
(i) 72/14 = 5.14 or 5% (to the nearest whole percent)
(ii) 72/8 = 9%
(iii) 72/2 = 36%
For greater accuracy, we proceed as follows:
(i) (1+ i)14 = 2
(1 + i) = 21/14 = 2.07143 = 1.0508
i = 5% (to the nearest whole percent)
(ii) (1 + i)8 = 2
(1 + i) = 2 1/8 = 2.125 = 1.0905
i = 9% (to the nearest whole percent)
(iii) (1 + i)2 = 2
(1 + i) = 21/2 = 2.5 = 1.4142
i = 41% (to the nearest whole percent)
Observe how the Rule of 72 does not work quite so well for high rates of
growth such as that seen in situation (iii).

THE END