Chapter 4: Time Value of Money 165

a. How much must you deposit 1 year from now to have a balance of $1,000 at
Year 4?
b. If you want to make equal payments at the end of Years 1 through 4 to
accumulate the $1,000, how large must each of the 4 payments be?
c. If your father were to offer either to make the payments calculated in part b
($221.92) or to give you a lump sum of $750 one year from now, which would
you choose?
d. If you will have only $750 at the end of Year 1, what interest rate, compounded
annually, would you have to earn to have the necessary $1,000 at Year 4?
e. Suppose you can deposit only $186.29 each at the end of Years 1 through 4, but
you still need $1,000 at the end of Year 4. What interest rate, with annual
compounding, is required to achieve your goal?
f. To help you reach your $1,000 goal, your father offers to give you $400 one year
from now. You will get a part-time job and make 6 additional deposits of equal
amounts each 6 months thereafter. If all of this money is deposited in a bank that
pays 8%, compounded semiannually, how large must each of the 6 deposits be?
g. What is the effective annual rate being paid by the bank in part f?
(ST–3) Bank A pays 8% interest, compounded quarterly, on its money market account. The
Effective Annual managers of Bank B want its money market account’s effective annual rate to equal
Rates that of Bank A, but Bank B will compound interest on a monthly basis. What nomi-
nal, or quoted, rate must Bank B set?

Problems Answers Appear in Appendix B

EASY PROBLEMS 1–8

(4–1) If you deposit $10,000 in a bank account that pays 10% interest annually, how much
Future Value of a will be in your account after 5 years?
Single Payment
(4–2) What is the present value of a security that will pay $5,000 in 20 years if securities of
Present Value of a equal risk pay 7% annually?
Single Payment
(4–3) Your parents will retire in 18 years. They currently have $250,000, and they think
Interest Rate on a they will need $1 million at retirement. What annual interest rate must they earn to
Single Payment reach their goal, assuming they don’t save any additional funds?
(4–4) If you deposit money today in an account that pays 6.5% annual interest, how long
Number of Periods of a will it take to double your money?
Single Payment
(4–5) You have $42,180.53 in a brokerage account, and you plan to deposit an additional
Number of Periods for $5,000 at the end of every future year until your account totals $250,000. You expect to
an Annuity earn 12% annually on the account. How many years will it take to reach your goal?
(4–6) What is the future value of a 7%, 5-year ordinary annuity that pays $300 each year?
Future Value: Ordinary If this were an annuity due, what would its future value be?
Annuity versus Annuity
Due
(4–7) An investment will pay $100 at the end of each of the next 3 years, $200 at the end of
Present and Future Year 4, $300 at the end of Year 5, and $500 at the end of Year 6. If other investments of
Value of an Uneven equal risk earn 8% annually, what is this investment’s present value? Its future value?
Cash Flow Stream
166 Part 2: Fixed Income Securities

(4–8) You want to buy a car, and a local bank will lend you $20,000. The loan would be
Annuity Payment and fully amortized over 5 years (60 months), and the nominal interest rate would be
EAR 12%, with interest paid monthly. What is the monthly loan payment? What is the
loan’s EFF%?
INTERMEDIATE PROBLEMS
9–29

(4–9) Find the following values, using the equations, and then work the problems using a
Present and Future financial calculator to check your answers. Disregard rounding differences. (Hint:
Values of Single Cash If you are using a financial calculator, you can enter the known values and then
Flows for Different
Periods press the appropriate key to find the unknown variable. Then, without clearing
the TVM register, you can “override” the variable that changes by simply enter-
ing a new value for it and then pressing the key for the unknown variable to ob-
tain the second answer. This procedure can be used in parts b and d, and in
many other situations, to see how changes in input variables affect the output
variable.)
a. An initial $500 compounded for 1 year at 6%
b. An initial $500 compounded for 2 years at 6%
c. The present value of $500 due in 1 year at a discount rate of 6%
d. The present value of $500 due in 2 years at a discount rate of 6%

(4–10) Use both the TVM equations and a financial calculator to find the following values.
Present and Future See the Hint for Problem 4-9.
Values of Single Cash
Flows for Different a. An initial $500 compounded for 10 years at 6%
Interest Rates b. An initial $500 compounded for 10 years at 12%
c. The present value of $500 due in 10 years at a 6% discount rate
d. The present value of $500 due in 10 years at a 12% discount rate

(4–11) To the closest year, how long will it take $200 to double if it is deposited and
Time for a Lump Sum earns the following rates? [Notes: (1) See the Hint for Problem 4-9. (2) This
to Double problem cannot be solved exactly with some financial calculators. For example, if
you enter PV = –200, PMT = 0, FV = 400, and I = 7 in an HP-12C and then
press the N key, you will get 11 years for part a. The correct answer is 10.2448
years, which rounds to 10, but the calculator rounds up. However, the HP-10B
gives the exact answer.]
a. 7%
b. 10%
c. 18%
d. 100%

(4–12) Find the future value of the following annuities. The first payment in these annuities
Future Value of an is made at the end of Year 1, so they are ordinary annuities. (Notes: See the Hint to
Annuity Problem 4-9. Also, note that you can leave values in the TVM register, switch to Be-
gin Mode, press FV, and find the FV of the annuity due.)
a. $400 per year for 10 years at 10%
b. $200 per year for 5 years at 5%
c. $400 per year for 5 years at 0%
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.
 Chapter 4: Time Value of Money 167

(4–13) Find the present value of the following ordinary annuities (see the Notes to Problem 4-12).
Present Value of an
Annuity a. $400 per year for 10 years at 10%
b. $200 per year for 5 years at 5%
c. $400 per year for 5 years at 0%
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.

(4–14) Find the present values of the following cash flow streams. The appropriate interest
Uneven Cash Flow rate is 8%. (Hint: It is fairly easy to work this problem dealing with the individual
Stream 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, when working with the calculator’s cash flow register, you must enter CF0 = 0.
Note also that it is quite easy to work the problem with Excel, using procedures de-
scribed in the Chapter 4 Tool Kit.)

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 cash flow stream at a 0% interest rate?

(4–15) Find the interest rate (or rates of return) in each of the following situations.
Effective Rate of
Interest a. You borrow $700 and promise to pay back $749 at the end of 1 year.
b. You lend $700 and receive a promise to be paid $749 at the end of 1 year.
c. You borrow $85,000 and promise to pay back $201,229 at the end of 10 years.
d. You borrow $9,000 and promise to make payments of $2,684.80 at the end of
each of the next 5 years.

(4–16) Find the amount to which $500 will grow under each of the following conditions.
Future Value for
Various Compounding a. 12% compounded annually for 5 years
Periods b. 12% compounded semiannually for 5 years
c. 12% compounded quarterly for 5 years
d. 12% compounded monthly for 5 years

(4–17) Find the present value of $500 due in the future under each of the following conditions.
Present Value for
Various Compounding a. 12% nominal rate, semiannual compounding, discounted back 5 years
Periods b. 12% nominal rate, quarterly compounding, discounted back 5 years
c. 12% nominal rate, monthly compounding, discounted back 1 year

(4–18) Find the future values of the following ordinary annuities.

Future Value of an
Annuity for Various a. FV of $400 each 6 months for 5 years at a nominal rate of 12%, compounded
Compounding Periods semiannually
b. FV of $200 each 3 months for 5 years at a nominal rate of 12%, compounded
quarterly
168 Part 2: Fixed Income Securities

c. The annuities described in parts a and b have the same total amount of money
paid into them during the 5-year period, and both earn interest at the same
nominal rate, yet the annuity in part b earns $101.75 more than the one in part a
over the 5 years. Why does this occur?

(4–19) Universal Bank pays 7% interest, compounded annually, on time deposits. Regional
Effective versus Nomi- Bank pays 6% interest, compounded quarterly.
nal Interest Rates
a. Based on effective interest rates, in which bank would you prefer to deposit your
money?
b. Could your choice of banks be influenced by the fact that you might want to
withdraw your funds during the year as opposed to at the end of the year? In
answering this question, assume that funds must be left on deposit during an
entire compounding period in order for you to receive any interest.

(4–20) a. Set up an amortization schedule for a $25,000 loan to be repaid in equal install-
Amortization Schedule ments at the end of each of the next 5 years. The interest rate is 10%.
b. How large must each annual payment be if the loan is for $50,000? Assume that
the interest rate remains at 10% and that the loan is still paid off over 5 years.
c. How large must each payment be if the loan is for $50,000, the interest rate is
10%, 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 pay-
ments 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?

(4–21) Sales for Hanebury Corporation’s just-ended year were $12 million. Sales were
Growth Rates $6 million 5 years earlier.
a. At what rate did sales grow?
b. Suppose someone calculated the sales growth for Hanebury in part a as follows:
“Sales doubled in 5 years. This represents a growth of 100% in 5 years; dividing
100% by 5 results in an estimated growth rate of 20% per year.” Explain what is
wrong with this calculation.

(4–22) Washington-Pacific invested $4 million to buy a tract of land and plant some young
Expected Rate of pine trees. The trees can be harvested in 10 years, at which time W-P plans to sell
return the forest at an expected price of $8 million. What is W-P’s expected rate of return?
(4–23) A mortgage company offers to lend you $85,000; the loan calls for payments of
Effective Rate of $8,273.59 at the end of each year for 30 years. What interest rate is the mortgage
Interest company charging you?
(4–24) To complete your last year in business school and then go through law school, you
Required Lump-Sum will need $10,000 per year for 4 years, starting next year (that is, you will need to
Payment withdraw the first $10,000 one year from today). Your rich uncle offers to put you
through school, and he will deposit in a bank paying 7% interest a sum of money
that is sufficient to provide the 4 payments of $10,000 each. His deposit will be made
today.
a. How large must the deposit be?
b. How much will be in the account immediately after you make the first with-
drawal? After the last withdrawal?
 Chapter 4: Time Value of Money 169

(4–25) While Mary Corens was a student at the University of Tennessee, she borrowed
Repaying a Loan $12,000 in student loans at an annual interest rate of 9%. If Mary repays $1,500 per
year, then how long (to the nearest year) will it take her to repay the loan?
(4–26) You need to accumulate $10,000. To do so, you plan to make deposits of $1,250 per
Reaching a Financial year—with the first payment being made a year from today—into a bank account
Goal that pays 12% annual interest. Your last deposit will be less than $1,250 if less is
needed to round out to $10,000. How many years will it take you to reach your
$10,000 goal, and how large will the last deposit be?
(4–27) What is the present value of a perpetuity of $100 per year if the appropriate discount
Present Value of a rate is 7%? If interest rates in general were to double and the appropriate discount
Perpetuity rate rose to 14%, what would happen to the present value of the perpetuity?
(4–28) Assume that you inherited some money. A friend of yours is working as an unpaid
PV and Effective intern at a local brokerage firm, and her boss is selling securities that call for 4 pay-
Annual Rate ments of $50 (1 payment at the end of each of the next 4 years) plus an extra pay-
ment of $1,000 at the end of Year 4. Your friend says she can get you some of
these securities at a cost of $900 each. Your money is now invested in a bank that
pays an 8% nominal (quoted) interest rate but with quarterly compounding. You re-
gard the securities as being just as safe, and as liquid, as your bank deposit, so your
required effective annual rate of return on the securities is the same as that on your
bank deposit. You must calculate the value of the securities to decide whether they
are a good investment. What is their present value to you?
(4–29) Assume that your aunt sold her house on December 31, and to help close the sale she
Loan Amortization took a second mortgage in the amount of $10,000 as part of the payment. The mort-
gage has a quoted (or nominal) interest rate of 10%; it calls for payments every 6
months, beginning on June 30, and is to be amortized over 10 years. Now, 1 year
later, your aunt must inform the IRS and the person who bought the house about
the interest that was included in the two payments made during the year. (This inter-
est will be income to your aunt and a deduction to the buyer of the house.) To the
closest dollar, what is the total amount of interest that was paid during the first year?
CHALLENGING PROBLEMS
30–34

(4–30) Your company is planning to borrow $1 million on a 5-year, 15%, annual payment,
Loan Amortization fully amortized term loan. What fraction of the payment made at the end of the sec-
ond year will represent repayment of principal?
(4–31) a. It is now January 1. You plan to make a total of 5 deposits of $100 each, one
Nonannual every 6 months, with the first payment being made today. The bank pays a
Compounding nominal interest rate of 12% but uses semiannual compounding. You plan to
leave the money in the bank for 10 years. How much will be in your account
after 10 years?
b. You must make a payment of $1,432.02 in 10 years. To get the money for this
payment, you will make 5 equal deposits, beginning today and for the following
4 quarters, in a bank that pays a nominal interest rate of 12% with quarterly
compounding. How large must each of the 5 payments be?

(4–32) Anne Lockwood, manager of Oaks Mall Jewelry, wants to sell on credit, giving cus-
Nominal Rate of return tomers 3 months to pay. However, Anne will have to borrow from her bank to carry
the accounts receivable. The bank will charge a nominal rate of 15% and will