1. Do the following simple numerical exercises.

a. What is the six-year discount factor at a discount rate of 12 percent?

b. The PV of 139 is 125. What is the discount factor?
c. Suppose you invest 100,000 at 6 percent. How much will you have after
eight years?
d. What is the PV of 37,400 to be received in year 9? The cost of capital is 9
percent.
e. What is the PV of nine annual payment of 37,400? The first payment is

2.
3.

4.

5.

next year, and the cost of capital is 9 percent.

f. What is the NPV of an investment that costs HK$2 million and pays
HK$225,000 in perpetuity? The cost of capital is 8.5 percent.
A project produces cash flows of A$432,000 in year 1, A$437,000 in year 2, and
A$330,000 in year 3. What is the projects PV? The cost of capital is 15 percent.
The interest rate is 10 percent.
a. What is the PV of an asset that pays $1 a year in perpetuity?
b. The value of an asset that appreciates at 10 percent per annum approximately
dou-bles in seven years. What is the approximate PV of an asset that pays $1
a year in perpetuity beginning in year 8?
c. What is the approximate PV of an asset that pays $1 a year for each of the
next seven years?
d. A piece of land produces an income that grows by 5 percent per annum. If the
first years income is $10,000,what is the value of the land?
The continuously compounded interest rate is 12 percent.
a. You invest $1,000 at this rate. What is the investment worth after five years?
b. What is the PV of $5 million to be received in eight years?
c. What is the PV of a continuous stream of cash flows , amounting to $2,000
per year , start-ing immediately and continuing for 15 years?
When Samuel Pepys, the British diarist, lent his friend, Lady Sandwich, 100 in

1668,he charged her 6 percent interest. If the loan was due at the end of one year,
how much would Lady Sandwich have had to pay if interest was (a) compounded
annually,(b) compounded semiannually,(c) compounded continuously?
6. Mike Polanski is 30 years of age and his salary next year will be $40,000. Mike
forecasts that his salary will increase at a steady rate of 5 percent per annum until
his retirement at age 60.
a. If the discount rate is 8 percent, what is the PV of these future salary
payments?
b. If Mike saves 5 percent of his salary each year and invests these savings at an
inter-est rate of 8 percent, how much will he have saved by age 60?

c. If Mike plans to spend these savings in even amounts over the subsequent
20 years, how much can he spend each year?
7. Kangaroo Autos is offering free credit on a new $10,000 car. You pay $1,000
down and then $300 a month for the next 30 months. Turtle Motors next door
dose not offer free credit but will give you $1,000 off the list price. If the rate of
interest is 10 percent a year, ( about 0.83 percent a month ) which company is
offering the better deal?
8. What is the value of the following three investments? Each investment generates
four annual cash inflows. The interest rate is 7 percent.
a. Investment P1 pays 10,000 at the end of each year.
b. Investment P2 pays 10,000 at the beginning of each year.
c. Investment P3 pays 10,000 spread evenly over each year.
9. Vernal Pool, a self-employed herpetologist, wants to put aside a fixed fraction of
her an-nual income as savings for retirement. Ms. Pool is now 40 years old and
makes $40,000 a year. She expects her income to increase by 2 percentage points
over inflation (e.g., 4 percent inflation means a 6 percent increase in income). She
wants to accumulate $500,000 in real terms to retire at age 70. What fraction of
her income does she need to set aside? Assume her retirement funds are
conservatively invested at an expected real rate of return of 5 percent a year.
Ignore taxes.
10. If you deposit $10,000 in a bank account that pays 10 percent interest annually,
how much money will be in your account after 5 years?
11. What is the present value of a security that promises to pay you $5,000 in 20 years?
Assume that you can earn 7 percent if you were to invest in other securities of
equal risk.
12. A rookie quarterback is in the process of negotiating his firs contract. The teams
general manager has offered him three possible contracts. Each of the contracts
lasts for 4 years. All of the money is guaranteed and is paid at the end of each year.
The terms of each of the contracts are listed below:
CONTRACT 1
PAYMENTS

CONTRACT 2
PAYMENTS

CONTRACT 2
PAYMENTS

Year 1
$3 million
$2 million
$7 million
Year 2
3 million
3 million
1 million
Year 3
3 million
4 million
1 million
Year 4
3 million
5 million
1 million
The quarterback discounts all cash flows at 10 percent. Which of the three
contracts offers him the most value?
13. Your company is planning to borrow $1,000,000 on a 5-year, 15%, annual

payment, fully amortized term loan. What fraction of the payment made at the end
of the second year will represent repayment of principal?
14. Assume that your father is now 50 years old, that he plans to retire in 10 years,
and that he expects to live for 25 years after he retires, that is until he is 85. He
wants a fixed retirement income that has the same purchasing power at the time he
retires as $40,000 has today (he realizes that the real value of his retirement
income will decline year by year after he retires). His retirement income will
begin the day he retires, 10 years from today, and he will then get 24 additional
annual payments. Inflation is expected to be 5 percent per year from today
forward; he currently has $100,000 saved up; and he expects to earn a return on
his savings of 8 percent per year, annual compounding. To the nearest dollar, how
much must he save during each of the next 10 years (with deposits being made at
the end of each year) to meet his retirement goal?
15. The price in last weeks Florida lottery was estimated to be worth $35 million. If
you were lucky enough to win, the state will pay you $1.75 million per year over
the next 20 years.
Assume that the first installment is received immediately.
a. If interest rates are 8 percent, what is the present value of the prize?
b. If interest rates are 8 percent, what is the future value after 20 years?
c. How would your answers change if the payments were received at the end of
each year?
16. Your client is 40 years old and wants to begin saving for retirement. You advise
the client to put $5,000 a year into the stock market. You estimate that the
markets return will be, on average, 12 percent a year. Assume the investment will
be made at the end of the year.
a. If the client follows your advice, how much money will she have by age 65?
b. How much will she have by age 70?
17. You are serving on a jury. A plaintiff is suing the city for injuries sustained after
falling down an uncovered manhole. In the trial, doctors testified that it will be 5
years before the plaintiff is able to return to work. The jury has already decided in
favor of the plaintiff, and has decided to grant the plaintiff an award to cover the
following items:
(1) Recovery of 2 years of back-pay ($34,000 in 2001, and $36,000 in 2002).
Assume that it is December 31, 2002 ,and that all salary is received at year end.
This recovery should include the time value of money.
(2) The present value of 5 years of future salsry (2003-2007). Assume that the
plaintiffs salary would increase at a rate of 3 percent a year.
(3) $100,000 for pain and suffering.

(4) $20,000 for court costs.

Assume an interest rate of 7 percent. What should be the size of the settlement?
18. You just started your first job, and you want to buy a house within 3 years. You are
currently saving for the down payment. You plan to save $5,000 the first year. You
also anticipate that the amount you save each year will rise by 10 percent a year as
your salary increases over time. Interest rates are assumed to be 7 percent, and all
savings occur at year end. How much money will you have for a down payment in
3 years?
19. A 15-year security has a price of $340.4689. The security pays $50 at the end of
the next 5 years, and then it pays a different fixed cash flow amount at the end of
each of the following 10 years. Interest rates are 9 percent, What is the annual
cash flow amount between Years 6 and 15?
20. Crissie has just won the state lottery and has three award options to choose from.
She can elect to receive a lump sum payment today of $61 million, 10 annual
end-of-year payments of $9.5 million, or 30 annual end-of-year payments of #5.5
million.
a. If she expects to earn a 7 percent annual return on her investments, which
option should she choose?
b. If she expects to earn an 8 percent annual return on her investments, which
option should she choose?
If she expects to earn a 9 percent annual return on her investments, which option
should she choose?
21. Find the future value of the following annuities. The first payment in these
annuities is made at the end of Year 1 ; that is, they are ordinary annuities. (Note:
Seethe hint to Problem 6-34. Also, note that you can leave values in the TVM
register, switch to BEG, press FV, and find the FV of the annuity due.) Assume
that compounding occurs once a year.
a. $400 per year for 10 years at 10 percent.
b. $200 per year for 5 years at 5 percent.
c. $400 per year for 5 years at 0 percent.
d. Now rework parts a, b, and c assuming that payments are made at the beginning
of each year; that is, they are annuities due.
22. Find the present value of the following ordinary annuities (see note to Problem
6-37). Assume that discounting occurs once a year.
a. $400 per year for 10 years at 10 percent.
b. $200 per year for 5 years at 5 percent.
c. $400 per year for 5 years at 0 percent.
d. Now rework parts a, b, and c assuming that payments are made at the beginning

of each year; that is, they are annuities due.

23. a. Find the present valued of the following cash flow streams. The appropriate
interest rate is 8 percent, compounded annually.(Hint: It is fairly easy to work this
problem dealing with the individual cash flows. However, if you have a financial
calculator, read the section of the manual that describes how to enter cash flows
such as the ones in this problem. This will take a little time, but the investment
will pay huge dividends throughout the course. Note that if you do work with the
cash flow register, you must enter CF 0 = 0.)
YEAR
CASH STREAM A
CASH STREAM B
1

$100

$300

2
400
400
3
400
400
4
400
400
5
300
100
b. What is the value of each flow stream at a 0 percent interest rate, compounded
annually?
24. a. Set up an amortization schedule for a $25,000 loan to be repaid in equal
installments at the end of each of the next 5 years. The interest rate is 10 percent,
compounded annually.
b. How large must each annual payment be if the loan is for $50,000? Assume that
the interest rate remains at 10 percent, compounded annually, and that the loan is
paid off over 5 years.
c. How large must each payment be if the loan is for $50,000, the interest rate is
10 percent, compounded annually, and the loan is paid off in equal installments at
the end of each of the next 10 years? This loan is for the same amount as the loan
in part b, but the payments are spread out over twice as many periods. Why are
these payments not half as large as the payments on the loan in part b?
25. The Jackson family is interested in buying a home. The family is applying for a
$125,000, 30-year mortgage. Under the terms of the mortgage, they will receive
$125,000 today to help purchase their home. The loan will be fully amortized over
the next 30 years. Current mortgage rates are 8 percent. Interest is compounded
monthly and all payments are due at the end of the month.
a. What is the monthly mortgage payment?
b. What portion of the mortgage payments made during the first year will go
toward interest?
c. What will be the remaining balance on the mortgage after 5 years?
d. How much could the Jacksons borrow today if they were willing to have a
$1,200 monthly mortgage payment? (Assume that the interest rate and the

length of the loan remain the same)

26. A father is planning a savings program to put his daughter though college. His
daughter is now 13 years old. She plans to enroll at the university in 5 years, and it
should take her 4 years to complete her education. Currently, the cost per year (for
everythingfood, clothing, tuition, books, transportation, and so forth) is $12,500,
but a 5 percent annual inflation rate in these costs is forecasted. The daughter
recently received $7,500 from her grandfathers estate; this money, which is
invested in a bank account paying 8 percent interest, compounded annually, will
be used to help meet the costs of the daughters education. The remaining costs
will be met by money the father will deposit in the savings account. He will make
6 equal deposits to the account, one deposit in each year from now until his
daughter starts college. These deposits will begin today and will also earn 8
percent interest, compounded annually.
a. What will be the present value of the cost of 4 years of education at the time
the aughter becomes 18? [Hint: Calculate the future value of the cost (at 5%)
for each year of her education, then discount 3 of these costs back (at 8%) to
the year in which she turns 18,then sum the 4 costs.
b. What will be the value of the $7,500 that the daughter received from her
grandfathers estate when she starts college at age 18? (Hint: Compound for 5
years at an 8 percent annual rate.)
c. If the father is planning to make the first of 6 deposits today, how large must
each deposit be for him to be able to put his daughter through college? (Hint:
An annuity due assumes interest is earned on all deposits; however, the 6th
deposit earns no interesttherefore, the deposits are an ordinary annuity.)
27. Juna Garza invested $200,000 10 year ago at 12 percent, compounded quarterly.
How much has he accumulated?
28. Your rich godfather has offered you a choice of one of the three following
alternatives: $10,000 now; $2,000 a year for eight years; or $24,000 at the end of
eight years. Assuming you could earn 11 percent annually, which alternative
should you choose ? If you could earn 12 percent annually, would you still
choose the same alternative?
29. You need $28,974 at the end of 10 years, and your only investment outlet is an 8
percent long-term certificate of deposit (compounded annually). With the
certificate of deposit, you make an initial investment at the beginning of the first
year.
30. Del Monty will receive the following payments at the end of the next three years:
$2,000,$3,500,and $4,500. Then from the end of the fourth through the end of the
tenth year, he will receive an annuity of $5,000 per year. At a discount rate of 9

percent, what is the percent value of all three future benefits?

31. Bridget Jones has a contract in which she will receive the following payments for
the next five years: $1,000,$2,000,$3,000,$4,000,and $5,000. She will then
receive an annuity of $8,500 a year from the end of the 6th through the end of the
15th year. The appropriate discount rate is 14 percent. If she is offered $30,000 to
cancel the contract, should she do it?
32. Mark Ventura has just purchased an annuity to begin payment at the end of
2007(that is the date of the first payment). Assume it is now the beginning of the
year 2005. The annuity is for $8,000 per year and is designed to last 10 years. If
the interest rate for this problem calculation is 13 percent, what is the most he
should have paid for the annuity?
33. If you borrow $15,618 and are required to pay back the loan in seven equal annual
installments of $3,000, what is the interest rate associated with the loan?
34. Cal Lury owes $10,000 now. A lender will carry the debt for five more years at 10
percent interest. That is, in this particular case, the amount owed will go up by 10
percent per year for five years. The lender then will require that Cal pay off the
loan over the next 12 years at 11 percent interest. What will his annual payment
be?
35. If your uncle borrows $60,000 from the bank at 10 percent interest over the
seven-year life of the loan, what equal annual payments must be made to
discharge the loan, plus pay the bank its required rate of interest (round to the
nearest dollar)?How much of his first payment will be applied to interest? To
principal? How much of his second payment will be applied to each?
36. Larry Davis borrows $80,000 at 14 percent interest toward the purchase of a home.
His mortgage is for 25 years.
a. How much will his annual payments be? (Although home payments are
usually on a monthly basis, we shall do our analysis on an annual basis for
ease of computation. We will get a reasonably accurate answer.)
b. How much interest will he pay over the life of the loan?
c. How much should he be willing to pay to get out of a 14 percent mortgage
and into a 10 percent mortgage with 25 years remaining on the mortgage?
Assume current interest rates are 10 percent. Carefully consider the time
value of money. Disregard taxes.
37. You are chairperson of the investment fund for the Eastern Football League. You
are asked to set up a fund of semiannual payments to be compounded
semiannually to accumulate a sum of $100,000 after 10 years at an 8 percent
annual rate(20 payments).The first payment into the fund is to occur six months
from today, and the last payment is to take place at the end of the 10th year.

a. Determine how much the semiannual payment should be.(Round to whole

numbers.)
On the day after the fourth payment is made (the beginning of the third year)
the interest rate will go up to a 10 percent annual rate, and you can earn a 10
percent annual rate on funds that have been accumulated as well as all future
payments into the fund. Interest is to be compounded semiannually on all
funds.
b. Determine how much the revised semiannual payments should be after this
rate change ( there are 16 payments and compounding dates). The next
payment will be in the middle of the third year.(Round all values to whole
numbers.)
38. Your younger sister, Linda, will start college in five years. She has just informed
your parents that she wants to go to Hampton University, which will cost $17,000
per year for four years (cost assumed to come at the end of each year).
Anticipating Lindas ambitions, your parents started investing $2,000 per year five
years ago and will continue to do so for five more years. How much more will
your parents have to invest each year for the next five years to have the necessary
funds for Lindas education? Use 10 percent as the appropriate interest rate
throughout this problem (for discounting or compounding).
39. Dr. Harold Wolf of Medical Research Corporation (MRC) was thrilled with the
re-sponse he had received from drug companies for his latest discovery, a unique
elec-tronic stimulator that reduces the pain from arthritis. The process had yet to
pass rigorous Federal Drug Administration (FDA) testing and was still in the early
stages of development, but the interest was intense. He received the three offers
described below this paragraph.( A 10 percent interest rate should be used
throughout this analysis un-less otherwise specified.)
Offer I $100 million in cumulative sales by the end of year 15, he would receive
an ad-ditional $3,000,000. Dr. Wolf thought there was a 70 percent probability this
would happen.
Offer II Thirty percent of the buyers gross profit on the product for the next four
years. Zbay Pharmaceutical. Zbays gross profit margin was 60 percent. Sales in
year one were projected to be $2 million and then expected to grow by 40 percent
per year.
Offer III A trust fund would be set up for the next 8 years. At the end of that
period, Dr. Wolf would receive the proceeds (and discount them back to the
present at 10 per-cent). The trust fund called for semiannual payments for the next
8 years of $200,000(a total of $400,000 per year).
The payments would start immediately. Since the payments are coming at the

begin-ning of each period instead of the end, this is an annuity due. To look up the
future value of an annuity due in the tables, add 1 to n (161) and subtract 1 from
the value in the table. Assume the annual interest rate on this annuity is 10 percent
annually ( 5 percent semiannually). Determine the present value of the trust funds
final value.
40. Corens 9% 12,000
1,500
41.
4 3 50
4 1,050 900
8%

42. a. 1 1 6 100 5
12% 10

b.10 1,432.02
5 12%

43. 40 55 75
5
6%()

1.
2.

3. 200

4. 20,000

44. 300 4,000

3%
A128.7 B137.3 C232.4 D248.7
45. 500

A6,400 B7,200 C8,000 D8,800

46. 80 500
7%

 3%

A850 B880 C910 D940

47. 40 500 60
6%

A1,150 B1,348 C1,513 D1,604