TVM Test Bank
TVM Test Bank
True/False
Easy:
(2.2) Compounding Answer: a EASY
1. One potential benefit from starting to invest early for retirement is
that the investor can expect greater benefits from the compounding of
interest.
a. True
b. False
a. True
b. False
a. True
b. False
a. True
b. False
a. True
b. False
a. True
b. False
a. True
b. False
a. True
b. False
a. True
b. False
a. True
b. False
a. True
b. False
a. True
b. False
a. True
b. False
Easy:
(2.1) Time lines Answer: a EASY
14. Which of the following statements is NOT CORRECT?
a. A time line is not meaningful unless all cash flows occur annually.
b. Time lines are useful for visualizing complex problems prior to
doing actual calculations.
c. Time lines cannot be constructed to deal with situations where some
of the cash flows occur annually but others occur quarterly.
d. Time lines can only be constructed for annuities where the payments
occur at the ends of the periods, i.e., for ordinary annuities.
e. Time lines cannot be constructed where some of the payments
constitute an annuity but others are unequal and thus are not part
of the annuity.
a. The cash flows are in the form of a deferred annuity, and they
total to $100,000. You learn that the annuity lasts for only 5
rather than 10 years, hence that each payment is for $20,000 rather
than for $10,000.
b. The discount rate increases.
c. The riskiness of the investments cash flows decreases.
d. The total amount of cash flows remains the same, but more of the
cash flows are received in the earlier years and less are received
in the later years.
e. The discount rate decreases.
a. The cash flows for an ordinary (or deferred) annuity all occur at
the beginning of the periods.
b. If a series of unequal cash flows occurs at regular intervals, such
as once a year, then the series is by definition an annuity.
c. The cash flows for an annuity due must all occur at the ends of the
periods.
d. The cash flows for an annuity must all be equal, and they must
occur at regular intervals, such as once a year or once a month.
e. If some cash flows occur at the beginning of the periods while
others occur at the ends, then we have what the textbook defines as
a variable annuity.
Medium:
(2.14) Solving for I with uneven cash flows Answer: c MEDIUM
18. Which of the following statements is CORRECT?
a. If you have a series of cash flows, all of which are positive, you
can solve for I, where the solution value of I causes the PV of the
cash flows to equal the cash flow at Time 0.
b. If you have a series of cash flows, and CF0 is negative but all of
the other CFs are positive, you can solve for I, but only if the
sum of the undiscounted cash flows exceeds the cost.
c. To solve for I, one must identify the value of I that causes the PV
of the positive CFs to equal the absolute value of the PV of the
negative CFs. This is, essentially, a trial-and-error procedure
that is easy with a computer or financial calculator but quite
difficult otherwise.
d. If you solve for I and get a negative number, then you must have
made a mistake.
e. If CF0 is positive and all the other CFs are negative, then you
cannot solve for I.
a. The remaining balance after three years will be $125,000 less the
total amount of interest paid during the first 36 months.
b. Because it is a fixed-rate mortgage, the monthly loan payments
(that include both interest and principal payments) are constant.
c. Interest payments on the mortgage will steadily decline over time.
d. The proportion of the monthly payment that goes towards repayment of
principal will be higher 10 years from now than it will be the first
year.
e. The outstanding balance gets paid off at a faster rate in the later
years of a loans life.
a. Investment A pays $250 at the beginning of every year for the next
10 years (a total of 10 payments).
b. Investment B pays $125 at the end of every 6-month period for the
next 10 years (a total of 20 payments).
c. Investment C pays $125 at the beginning of every 6-month period for
the next 10 years (a total of 20 payments).
d. Investment D pays $2,500 at the end of 10 years (a total of one
payment).
e. Investment E pays $250 at the end of every year for the next 10
years (a total of 10 payments).
a. A 5-year, $250 annuity due will have a lower present value than a
similar ordinary annuity.
b. A 30-year, $150,000 amortized mortgage will have larger monthly
payments than an otherwise similar 20-year mortgage.
c. A typical investment's nominal interest rate will always be equal
to or less than its effective annual rate.
d. If an investment pays 10% interest, compounded annually, its
effective annual rate will be less than 10%.
e. Banks A and B offer the same nominal annual rate of interest, but A
pays interest quarterly and B pays semiannually. Deposits in Bank
B will have the higher future value if you leave the funds on
deposit.
a. The present value of a 3-year, $150 annuity due will exceed the
present value of a 3-year, $150 ordinary annuity.
b. If a loan has a nominal annual rate of 8%, then the effective rate
can never be less than 8%.
c. If a loan or investment has annual payments, then the effective,
periodic, and nominal rates of interest will all be the same.
d. The proportion of the payment that goes toward interest on a fully
amortized loan declines over time.
e. An investment that has a nominal rate of 6% with semiannual
payments will have an effective rate that is less than 6%.
a. The present value of ORD must exceed the present value of DUE, but
the future value of ORD may be less than the future value of DUE.
b. The present value of DUE exceeds the present value of ORD, while
the future value of DUE is less than the future value of ORD.
c. The present value of ORD exceeds the present value of DUE, and the
future value of ORD also exceeds the future value of DUE.
d. The present value of DUE exceeds the present value of ORD, and the
future value of DUE also exceeds the future value of ORD.
e. If the going rate of interest decreases, say from 10% to 0%, the
difference between the present value of ORD and the present value
of DUE would remain constant.
Hard:
(2.15) Effective annual rates Answer: e HARD
29. You plan to invest some money in a bank account. Which of the following
banks provides you with the highest effective rate of interest?
Easy:
(2.2) FV of a lump sum Answer: d EASY
30. What would the future value of $125 be after 8 years at 8.5% compound
interest?
a. $205.83
b. $216.67
c. $228.07
d. $240.08
e. $252.08
a. $1,781.53
b. $1,870.61
c. $1,964.14
d. $2,062.34
e. $2,165.46
a. $271.74
b. $286.05
c. $301.10
d. $316.16
e. $331.96
a. $12.54
b. $13.20
c. $13.86
d. $14.55
e. $15.28
a. $2,245.08
b. $2,363.24
c. $2,481.41
d. $2,605.48
e. $2,735.75
a. $765.13
b. $803.39
c. $843.56
d. $885.74
e. $930.03
a. $109.51
b. $115.27
c. $121.34
d. $127.72
e. $134.45
a. $1,928.78
b. $2,030.30
c. $2,131.81
d. $2,238.40
e. $2,350.32
a. 4.37%
b. 4.86%
c. 5.40%
d. 6.00%
e. 6.60%
a. 15.17%
b. 15.97%
c. 16.77%
d. 17.61%
e. 18.49%
a. 23.99
b. 25.26
c. 26.58
d. 27.98
e. 29.46
a. 5.86
b. 6.52
c. 7.24
d. 8.04
e. 8.85
a. 4.59
b. 5.10
c. 5.67
d. 6.30
e. 7.00
a. $11,973.07
b. $12,603.23
c. $13,266.56
d. $13,929.88
e. $14,626.38
a. $18,368.66
b. $19,287.09
c. $20,251.44
d. $21,264.02
e. $22,327.22
a. $13,956.42
b. $14,654.24
c. $15,386.95
d. $16,156.30
e. $16,964.11
a. $17,986.82
b. $18,933.49
c. $19,929.99
d. $20,926.49
e. $21,972.82
a. $15,809.44
b. $16,641.51
c. $17,517.38
d. $18,439.35
e. $19,409.84
a. $2,636.98
b. $2,775.77
c. $2,921.86
d. $3,075.64
e. $3,237.52
a. $770,963.15
b. $811,540.16
c. $852,117.17
d. $894,723.02
e. $939,459.18
a. $20,671.48
b. $21,705.06
c. $22,790.31
d. $23,929.82
e. $25,126.31
a. $1,412.84
b. $1,487.20
c. $1,565.48
d. $1,643.75
e. $1,725.94
a. $739,281.38
b. $778,190.93
c. $819,148.35
d. $862,261.42
e. $905,374.49
a. $202,893
b. $213,572
c. $224,250
d. $235,463
e. $247,236
a. $8,508.74
b. $8,956.56
c. $9,427.96
d. $9,924.17
e. $10,446.50
a. $28,532.45
b. $29,959.08
c. $31,457.03
d. $33,029.88
e. $34,681.37
a. $28,843.38
b. $30,361.46
c. $31,959.43
d. $33,641.50
e. $35,323.58
a. $28,243.21
b. $29,729.70
c. $31,294.42
d. $32,859.14
e. $34,502.10
a. $22,598.63
b. $23,788.03
c. $25,040.03
d. $26,357.92
e. $27,675.82
a. 22.50
b. 23.63
c. 24.81
d. 26.05
e. 27.35
a. 23.16
b. 24.38
c. 25.66
d. 27.01
e. 28.44
a. 6.72%
b. 7.07%
c. 7.43%
d. 7.80%
e. 8.19%
a. 2.79%
b. 3.10%
c. 3.44%
d. 3.79%
e. 4.17%
a. 6.85%
b. 7.21%
c. 7.59%
d. 7.99%
e. 8.41%
a. $4,750.00
b. $5,000.00
c. $5,250.00
d. $5,512.50
e. $5,788.13
a. 6.52%
b. 7.25%
c. 8.05%
d. 8.95%
e. 9.84%
a. $411.57
b. $433.23
c. $456.03
d. $480.03
e. $505.30
a. $9,699.16
b. $10,209.64
c. $10,746.99
d. $11,284.34
e. $11,848.55
a. $7,916.51
b. $8,333.17
c. $8,771.76
d. $9,233.43
e. $9,695.10
a. $5,986.81
b. $6,286.16
c. $6,600.46
d. $6,930.49
e. $7,277.01
a. $1,819.33
b. $1,915.08
c. $2,015.87
d. $2,116.67
e. $2,222.50
a. $956.95
b. $1,007.32
c. $1,060.33
d. $1,116.14
e. $1,171.95
a. 14.21
b. 14.96
c. 15.71
d. 16.49
e. 17.32
a. 11.98
b. 12.61
c. 13.27
d. 13.94
e. 14.63
a. 7.62%
b. 8.00%
c. 8.40%
d. 8.82%
e. 9.26%
a. $89.06
b. $93.75
c. $98.44
d. $103.36
e. $108.53
a. $526.01
b. $553.69
c. $582.83
d. $613.51
e. $645.80
a. 6.77%
b. 7.13%
c. 7.50%
d. 7.88%
e. 8.27%
a. 4.93%
b. 5.19%
c. 5.46%
d. 5.75%
e. 6.05%
a. $1,922.11
b. $2,023.28
c. $2,124.44
d. $2,230.66
e. $2,342.19
a. $969.34
b. $1,020.36
c. $1,074.06
d. $1,130.59
e. $1,187.12
a. 18.58%
b. 19.56%
c. 20.54%
d. 21.57%
e. 22.65%
(2.15) Comparing the effective cost of two bank loans Answer: d MEDIUM
82. East Coast Bank offers to lend you $25,000 at a nominal rate of 7.5%,
compounded monthly. The loan (principal plus interest) must be repaid
at the end of the year. Midwest Bank also offers to lend you the
$25,000, but it will charge an annual rate of 8.3%, with no interest due
until the end of the year. What is the difference in the effective
annual rates charged by the two banks?
a. 0.93%
b. 0.77%
c. 0.64%
d. 0.54%
e. 0.43%
a. 6.99%
b. 7.76%
c. 8.63%
d. 9.59%
e. 10.65%
a. 8.46%
b. 8.90%
c. 9.37%
d. 9.86%
e. 10.38%
a. 3.01%
b. 3.35%
c. 3.72%
d. 4.13%
e. 4.59%
a. 15.27%
b. 16.08%
c. 16.88%
d. 17.72%
e. 18.61%
a. $136.32
b. $143.49
c. $151.04
d. $158.59
e. $166.52
a. $5,178.09
b. $5,436.99
c. $5,708.84
d. $5,994.28
e. $6,294.00
a. $3,704.02
b. $3,889.23
c. $4,083.69
d. $4,287.87
e. $4,502.26
a. $1,083.84
b. $1,140.88
c. $1,200.93
d. $1,260.98
e. $1,324.02
a. $925.97
b. $974.70
c. $1,026.00
d. $1,080.00
e. $1,134.00
a. $1,548.79
b. $1,630.30
c. $1,716.11
d. $1,806.43
e. $1,896.75
a. $4,395.19
b. $4,626.52
c. $4,870.02
d. $5,113.52
e. $5,369.19
a. $131.06
b. $137.96
c. $145.22
d. $152.86
e. $160.91
a. 1.98%
b. 2.20%
c. 2.44%
d. 2.68%
e. 2.95%
a. $66,154.58
b. $69,636.40
c. $73,301.47
d. $77,159.45
e. $81,220.47
a. 23
b. 27
c. 32
d. 38
e. 44
a. 33
b. 37
c. 41
d. 45
e. 49
a. 12.31%
b. 12.96%
c. 13.64%
d. 14.36%
e. 15.08%
a. 7
b. 8
c. 9
d. 11
e. 13
a. $17,422.59
b. $18,339.57
c. $19,256.55
d. $20,219.37
e. $21,230.34
a. 1.49%
b. 1.24%
c. 1.04%
d. 0.86%
e. 0.69%
a. $2,492.82
b. $2,624.02
c. $2,755.23
d. $2,892.99
e. $3,037.64
a. $7,636.79
b. $8,038.73
c. $8,461.82
d. $8,907.18
e. $9,375.98
a. $47,888
b. $50,408
c. $53,061
d. $55,714
e. $58,500
Hard:
(2.17) Loan amort: int rate, % of pmt toward principal Answer: e HARD
106. Your company has just taken out a 1-year installment loan for $72,500. The
nominal rate is 12.0%, but with equal end-of-month payments. What percentage
of the 2nd monthly payment will go toward the repayment of principal?
a. 73.01%
b. 76.85%
c. 80.89%
d. 85.15%
e. 89.63%
a. 81.34%
b. 85.62%
c. 89.90%
d. 94.40%
e. 99.12%
a. $68,139.22
b. $71,725.49
c. $75,500.52
d. $79,474.23
e. $83,657.08
a. $10,216.60
b. $10,754.31
c. $11,320.33
d. $11,886.35
e. $12,480.66
a. $8,718.90
b. $9,154.84
c. $9,612.58
d. $10,093.21
e. $10,597.87
Until now, the grandfather has been disappointed with Ed, hence has not
given him anything. However, they recently reconciled, and the
grandfather decided to make an equivalent provision for Ed. He will
make the first payment to a trust for Ed later today, and he has
instructed his trustee to make additional equal annual payments each
year until Ed turns 65, when the 41st and final payment will be made.
If both trusts earn an annual return of 8%, how much must the
grandfather put into Ed's trust today and each subsequent year to enable
him to have the same retirement nest egg as Steve after the last payment
is made on their 65th birthday?
a. $3,726
b. $3,912
c. $4,107
d. $4,313
e. $4,528
a. $238,176
b. $250,712
c. $263,907
d. $277,797
e. $291,687
a. $4,271.67
b. $4,496.49
c. $4,733.15
d. $4,969.81
e. $5,218.30
a. $777.96
b. $818.91
c. $862.01
d. $907.38
e. $955.13
One could make up an example and see that the statement is true. Alternatively, one could simply
recognize that the PV of an annuity declines as the discount rate increases and recognize that more frequent
compounding increases the effective rate.
There is no reason to think that this statement would be true. Each portion of the payment representing interest
declines, while each portion representing principal repayment increases. Therefore, the statement is clearly false.
We could also work out some numbers to prove this point. Here's an example for a 3-year loan at a 10% annual
interest rate. The interest component is never equal to the principal repayment component.
18. (2.14) Solving for I with uneven cash flows Answer: c MEDIUM
By inspection, we can see that e dominates a and b, and that c dominates d because, with the same interest
rate, the account with the most frequent compounding has the highest EFF%. Thus, the correct answer
must be either e or c. Moreover, we can see by inspection that since c and e have the same compounding
frequency yet e has the higher nominal rate, e must have the higher EFF%. You could also prove that e is
the correct choice by calculating the EFF%s:
a. 8.300% = (1+0.08/12)12 1
b. 8.000% = (1+0.08/1)1 1
c. 7.250% = (1+0.07/365)365 1
d. 7.229% = (1+0.07/12)12 1
e. 8.328% = (1+0.08/365)365 1
a, d, and e can be ruled out as incorrect by simple reasoning. b is incorrect because interest in the first year
would be Loan amount * interest rate regardless of the life of the loan. That makes c the "logical guess." It
is also logical that the percentage of interest in each payment would be higher if the interest rate were
higher. Think about the situation where r = 0%, so interest would be zero. One could also set up an
amortization schedule and change the numbers to confirm that only c is correct.
a is not correct because we would subtract principal repaid, not interest paid. Thus a is the correct response
to this question. b is correct by definition. c is correct because the outstanding loan balance is declining. d
is clearly correct, as is e. One could also set up an amortization schedule to prove that the above statements
are correct.
b is correct. a is clearly wrong, as are c and d. It is not obvious whether e is correct or not, but we could
set up an example to see:
By inspection, we can see that e dominates b, c, and d because, with the same interest rate, the account with
the most frequent compounding has the highest EFF%. Thus, the correct answer must be either a or e.
However, we can cannot tell by inspection whether a or e provides the higher EFF%. We know that with
one compounding period an EFF% is 6.1%, so we can calculate e's EFF%. It is 6.183%, so e is the correct
answer.
a. = (1+0.061/12)12 1 = 6.100%
e. = (1+0.06/365)365 1 = 6.183%
N 8
I/YR 8.5%
PV $125
PMT $0
FV $240.08
N 5
I/YR 3.5%
PV $1,500
PMT $0
FV $1,781.53
N 5
N 75
I/YR 3.5%
PV $1.00
PMT $0.00
FV $13.20
N 25
I/YR 3.5%
PV $1,000
PMT $0
FV $2,363.24
N 5
I/YR 5.5%
PMT $0
FV $1,000.00
PV $765.13
N 50
I/YR 7.5%
PMT $0
FV $5,000
PV $134.45
N 5
I/YR 4.25%
PMT $0
FV $2,500.00
PV $2,030.30
N 5
Page 52 Answers Chapter 2: Time Value
PV $747.25
PMT $0
FV $1,000.00
I/YR 6.00%
N 10
PV $0.50
PMT $0
FV $2.20
I/YR 15.97%
I/YR 3.8%
PV $50.00
PMT $0
FV $150.00
N 29.46
I/YR 9.0%
PV $2.50
PMT $0
FV $5.00
N 8.04
I/YR 9.0%
PV $5,000.00
PMT $0
FV $9,140.20
N 7.00
N 3
I/YR 5.2%
PV $0.00
PMT $4,200
FV $13,266.56
N 5
I/YR 8.5%
Chapter 2: Time Value Answers Page 53
PV $0.00
PMT $3,100
FV $18,368.66
N 3
I/YR 5.2%
PV $0.00
PMT $4,200
FV $13,956.42
N 5
I/YR 8.5%
PV $0.00
PMT $3,100
FV $19,929.99
N 10
I/YR 6.5%
PMT $2,700
FV $0.00
PV $19,409.84
N 3
I/YR 5.5%
PMT $1,200
FV $0.00
PV $3,237.52
N 25
I/YR 6.25%
PMT $65,000
FV $0.00
PV $811,540.16
N 10
I/YR 6.5%
PMT $2,700
Page 54 Answers Chapter 2: Time Value
FV $0.00
PV $20,671.48
N 3
I/YR 5.5%
PMT $550
FV $0.00
PV $1,565.48
N 25
I/YR 6.25%
PMT $65,000
FV $0.00
PV $862,261.42
N 10
I/YR 8.5%
PMT $30,000
FV $0.00
PV $213,572
N 4
I/YR 5.0%
PMT $2,250
FV $3,000
PV $10,446.50
N 20
I/YR 8.25%
PV $275,000
FV $0.00
PMT $28,532.45
N 25
I/YR 7.5%
PV $375,000
FV $0.00
Chapter 2: Time Value Answers Page 55
PMT $33,641.50
N 25
I/YR 7.5%
PV $375,000
FV $0.00
PMT $31,294.42
N 20
I/YR 8.25%
PV $275,000
FV $0.00
PMT $26,357.92
I/YR 7.5%
PV $375,000
PMT $35,000
FV $0.00
N 22.50
I/YR 7.5%
PV $500,000
PMT $40,000
FV $0.00
N 28.44
N 10
PV $3,500,000
PMT $500,000
FV $0.00
I/YR 7.07%
N 20
PV $15,000,000
PMT $1,050,000
FV $0.00
I/YR 3.44%
Page 56 Answers Chapter 2: Time Value
63. (2.10) Interest rate implicit in an annuity due Answer: e EASY
N 12
PV $120,000
PMT $15,000
FV $0.00
I/YR 8.41%
I/YR 5.0%
PMT $250
PV $5,000.00
I/YR = 6.25%
0 1 2 3 4
CFs: $0 $75 $225 $0 $300
PV of CFs: $0 $71 $199 $0 $235
PV = $505.30 Find the individual PVs and sum them. Automate the
PV = $505.30 process using Excel or a calculator, by inputting the
data into the cash flow register and pressing the NPV key.
I/YR = 12.0%
0 1 2 3 4
CFs: $0 $1,500 $3,000 $4,500 $6,000
PV of CFs: $0 $1,339 $2,392 $3,203 $3,813
I/YR = 8.0%
0 1 2 3
CFs: $750 $2,450 $3,175 $4,400
PV of CFs: $750 $2,269 $2,722 $3,493
I/YR = 6.0%
0 1 2 3 4
CFs: $0 $1,000 $2,000 $2,000 $2,000
PV of CFs: $0 $943 $1,780 $1,679 $1,584
Years 5
Periods/Yr 2
Nom. I/YR 6.0%
N = Periods 10
PMT $0
I = I/Period 3.0%
PV $1,500 Could be found using a calculator, the equation, or Excel.
FV $2,015.87 Note that we must first convert to periods and rate per period.
Years 5
Periods/Yr 2
Nom. I/YR 6.0%
FV $1,500
N = Periods 10
PMT $0
I = I/Period 3.0% Could be found using a calculator, the equation, or Excel.
PV $1,116.14 Note that we must first convert to periods and rate per period.
I/YR 7.50%
PV $300,000
PMT $35,000
FV $25,000
N 14.96
N 24
PV $0
PMT $500
FV $13,000
I/YR 7.62%
I/YR = 6.5%
0 1 2 3 4
CFs: $0 $75 $225 $0 $300
FV of CFs: $0 $91 $255 $0 $300
77. (2.14) Interest rate built into uneven CF stream Answer: c MEDIUM
0 1 2 3 4 5
CFs: -$1,000 $75 $75 $75 $75 $75
$1,000
-$1,000 $75 $75 $75 $75 $1,075
I/YR 7.50% I is the discount rate that causes the PV of the inflows
to equal the initial negative CF, and is found with
Excel's IRR function or by inputting the CFs into a
calculator and pressing` the IRR key.
Chapter 2: Time Value Answers Page 59
78. (2.14) Interest rate built into uneven CF stream Answer: e MEDIUM
0 1 2 3 4
CFs: -$725 $75 $100 $85 $625
I/YR 6.05% I is the discount rate that causes the PV of the positive
inflows to equal the initial negative CF. I can be found
using Excel's IRR function or by inputting the CFs into a
calculator and pressing the IRR key.
Years 5
Periods/Yr 12
Nom. I/YR 6.0%
N = Periods 60
PMT $0
I/Period 0.5%
PV $1,500
FV $2,023.28 Could be found using a calculator, the equation, or Excel.
Note that we must first convert to periods and rate per period.
Years 5
Periods/Yr 12
Nom. I/YR 6.0%
N = Periods 60
PMT $0
I/Period 0.5%
FV $1,525
PV $1,130.59 Could be found using a calculator, the equation, or Excel.
Note that we must first convert to periods and rate per period.
APR 18.00%
Periods/yr 12
EFF% 19.56%
82. (2.15) Comparing the effective cost of two bank loans Answer: d MEDIUM
This problem can be worked most easily using the interest conversion feature of a calculator. It could also
be worked using the conversion formula. We used the conversion formula.
Then find the IRR as a quarterly rate and convert to an annual rate. This procedure is obviously longer.
0 1 2 3 4
CFs: 10,000.00 -256.25 -256.25 -256.25 -256.25
-10,000.00
10,000.00 -256.25 -256.25 -256.25 -10,256.25
0 1 2 3 4
CFs: 10,000.00 -250.00 -250.00 -250.00 -250.00
-10,000.00
10,000.00 -250.00 -250.00 -250.00 -10,250.00
I/YR 9.0%
Years 4
Amount borrowed $12,000
Payments $3,704.02 Found with a calculator, as the PMT.
Years 30 Payments/year 12
N 360 Nominal rate 6.50%
Periodic rate 0.54% Purchase price $210,000
PV $190,000 Down payment $20,000
FV $0.00
PMT $1,200.93
I/YR 9.0%
Years 4
Amount borrowed $12,000
Interest in Year 1 $1,080.00 Simply multiply the rate times the amount borrowed.
95. (2.18) Growing annuity: calculating the real rate Answer: c MEDIUM
rNOM 5.00%
Inflation 2.50%
rr = [(1 + rNOM)/(1 + Inflation)] 1
rr = 2.44%
96. (2.18) Growing annuity due: withdraw constant real amt Answer: e MEDIUM
I/YR 18.0%
I/MO 1.5% Monthly annuity due, so interest must be calculated on monthly basis
PV $0
PMT $5,000
FV $250,000
N 37.16 Rounded up 38
I/YR 6.0%
I/MO 0.5% Monthly annuity, so interest must be calculated on monthly basis
PV $0
PMT $5,000
99. (Comp: 2.10,2.15) Int rate, annuity, mos compounding Answer: d MEDIUM
N 36
PV $4,000
PMT $137.41
FV $0
I/MO 1.20% Monthly annuity, so interest must be calculated on monthly basis
I/YR 14.36%
Find N for an annuity due with the indicated terms to determine how long you must
live to make the lifetime subscription worthwhile.
Interest rate 5.5%
Annual cost $75
Lifetime subscription cost $750
Number of payments made 13.76 Rounded up: 14
Recall that we used BEGIN mode (because it is an annuity due), so it takes 14 payments to make the
lifetime subscription better. Since the 1st payment occurs today, the 14th payment occurs at t = 13, which
is 13 years from now.
102. (2.15) Compare effective cost of two bank loans Answer: d MEDIUM/HARD
Students must understand that "simple interest with interest paid quarterly" means that the bank gets the
interest at the end of each quarter, hence it can invest it, presumably at the same nominal rate. This results
in the same effective rate as if it were stated as "6%, quarterly compounding."
Step 1: Find the amount at age 65; use the FV function $566,416
Step 2: Find the PMT for a 25-year ordinary annuity using that FV as the PV $53,061
106. (2.17) Loan amort: int rate, % of pmt toward principal Answer: e HARD
N 12
rNOM 12.0%
Periodic r 1.0%
PV $72,500
PMT $6,442
FV $0 % paid toward prin. = 89.63%
107. (2.17) Loan amort: pmt and % of pmt toward interest Answer: b HARD
Chapter 2: Time Value Answers Page 65
Years 30 Periods/yr 12
Nominal r 6.50% N (12 mo.) 360
PV $150,000 I 0.54%
FV $0 Total pmts $2,844.31
PMT $948.10 Interest $2,435.29
% interest 85.62%
108. (2.18) Growing annuity: withdrawing constant real amt Answer: e HARD
Step 1. Calculate the purchasing power of $1,500,000 in 30 years at an inflation rate of 4%:
N 30
I/YR 4.0%
PMT $0.00
FV $1,500,000
PV $462,478.00
rNOM 6.0%
Inflation 4.0%
rr = [(1 + rNOM)/(1 + Inflation)] 1
rr = 1.92308%
Step 3. Calculate the required initial payment of the growing annuity by using inputs converted to "real"
terms:
Step 1. Calculate the purchasing power of $2,500,000 in 35 years at an inflation rate of 2%:
N 35
I/YR 2.0%
PMT $0.00
FV $2,500,000
PV $1,250,069.03
rNOM 9.0%
Inflation 2.0%
rr = [(1 + rNOM)/(1 + Inflation)] 1
rr = 6.86275%
Step 3. Calculate the required initial payment of the growing annuity by using inputs converted to "real"
terms:
N 35
I/YR 6.86275%
PV $0.00
FV 1,250,069.03
PMT $8,718.90
There are 3 cash flow streams: the gift and the two annuities. The gift will grow for 12 years. Then there is
a 6-year annuity that will compound for an additional 6 years. Finally, there is a second 6-year annuity. The
sum of the compounded values of those three sets of cash flows is the final amount.
Amount Amount
at Year at Year
6 12
Chapter 2: Time Value Answers Page 67
Interest rate 9.0%
1st annuity $7,500 $56,425 $94,630
2nd annuity $15,000 NA $112,850
Gift $25,000 NA $70,317
Total years 12
Annuity years 6 Final amt: $277,797
This is a relatively easy problem to work with Excel, but it is quite difficult to work it with a calculator
because it is hard to conceptualize how to set it up for an efficient calculator solution. We would not use it
for a regular classroom exam, but it might be appropriate for a take-home or online exam.
I = 8%
0 1 2 3 4 5 6 7
-$25,000 $2,500 $5,000 $7,500 X X X X
Calculator solution:
Step 1. Use the CF register to find the NPV of the 4 known cash flows, CF0 to CF3: -$12,444.75
Step 2. Find the FV of this NPV at the end of period 3, i.e., compound the NPV for 3 years. -$15,676.80
Step 3. Now find the PMT for a 4-year annuity with this PV. $4,733.15
Excel solution:
Set the problem up as shown below. Put a guesswe initially guessed $5,000in the boxed cell under the
first X. The IRR initially is greater than 8%, so lower the guess, and keep iterating until IRR = 8%. This
value of X is the required payment for the investment to provide the 8% rate of return. The problem can be
worked faster if you use Goal Seek. Here you would highlight the cell with the IRR, then tell Excel to
0 1 2 3 4 5 6 7
-$25,000 $2,500 $5,000 $7,500 $4,733.15 $4,733.15 $4,733.15 $4,733.15
IRR = 8.00%
The PV (at t = 8) of all college costs is: 70,786.26. This is what they need at t = 8.
After the first 4 payments, the college account will have (at t = 3): $42,291.08
5 more contributions are left in order to get the required funds for college costs.
N 5
I 9.0%
This problem can also be solved with Excel using Goal Seek:
Use Goal Seek to set blue pmt such that we get zero for the pink sum. Note that the Goal Seek solution
step must be repeated again if input values change. It doesn't change automatically with input changes.