Problems Problem 4-9 Problem 4-10 Problem 4-11 Problem 4-12 Problem 4-19 Problem 4-20 Problem 4-23

Problem 4-24 Problem 4-25 Problem 4-27 Problem 4-29 Problem 4-30 Problem 4-31 Problem 4-38 Problem 4-39

Problem 4-9 You have just received a windfall from an investment you made in a friends business. He will be paying you $10,000 at the end of this year, $20,000 at the end of the following year, and $30,000 at the end of the year after that (three years from today). The interest rate is 3.5% per year. Interest Rate: 3.50% 0 Year 1 2

Cash flow: $10,000.00 $20,000.00 a. What is the present value of your windfall? Present Value Using formulas 55390 Using Excel functions 55390 b. What is the future value of your windfall in three years (on the date of the last payment)? Using formulas Using Excel functions

ou made in a friends s year, $20,000 at the year after that (three

3 $30,000.00

Future Value 61412 61412

Problem 4-10 You have a loan outstanding. It requires making three annual payments at the end of the next three years of $1000 each. Your bank has offered to allow you to skip making the next two payments in lieu of making one large payment at the end of the loans term in three years. If the interest rate on the loan is 5%, what final payment will the bank require you to make so that it is indifferent between the two forms of payment? Interest Rate: 5.00% Year 1

0 Cash flow: Future value

$1,000.00 $1,000.00 $1,000.00 3153

Problem 4-11

You have been offered a unique investment opportunity. If you invest $10,000 today, you w from now, and $10,000 ten years from now. Interest rate NPV 6.00% -2609 Year 0 Cash flow: Discounted value NPV ($10,000.00 -10000 -2609 1 2 3 $0.00 4 $0.00 $500.00 $1,500.00 472 1335

a. What is the NPV of the opportunity if the interest rate is 6% per year? Should you take th At an interest rate of 6.00% the NPV is -2609 so reject the project.

b. What is the NPV of the opportunity if the interest rate is 2% per year? Should you take it At an interest rate of 2.00% the NPV is 135 so accept the project.

The relationship is illustrated by the chart below:

NPV

3,000.00 2,000.00 1,000.00 0.00

NPV

-1,000.00 -2,000.00 -3,000.00 -4,000.00 0.0

0.01

0.02

0.03

0.04

0.05

0.06

-1,000.00 -2,000.00 -3,000.00 -4,000.00 0.0

0.01

0.02

0.03 Discount rate

0.04

0.05

0.06

$10,000 today, you will receive $500 one year from now, $1500 two years

Year 5 $0.00 6 $0.00 7 $0.00 8 $0.00 9 10 $0.00 $10,000.00 5584

ar? Should you take the opportunity?

ar? Should you take it now?

Data for NPV profile: 0% 1% 2% 3% 4% 5% 6% 7% 2,000.00 1,018.36 135.43 -659.73 -1,376.75 -2,024.13 -2,609.36 -3,139.06

NPV

04

0.05

0.06

0.07

04

0.05

0.06

0.07

Problem 4-12 Marian Plunket owns her own business and is considering an investment. If she undertakes the investment, it will pay $4000 at the end of each of the next three years. The opportunity requires an initial investment of $1000 plus an additional investment at the end of the second year of $5000. What is the NPV of this opportunity if the interest rate is 2% per year? Should Marian take it? Interest rate NPV using Excel function 2.00% 5730 0 Cash flow: Discounted cash flow NPV the "long" way Year 1 2 3

($1,000.00 $4,000.00 ($1,000.00 $4,000.00 -1000 3922 -961 3769 5730

Marion should take the investment.

Problem 4-19 Your grandmother has been putting $1000 into a savings account on every birthday since your first (that is, when you turned 1). The account pays an interest rate of 3%. How much money will be in the account on your 18th birthday immediately after your grandmother makes the deposit on that birthday? PMT Rate Years FV $1,000.00 3.00% 18 ###

Problem 4-20 A rich relative has bequeathed you a growing perpetuity. The first payment will occur in a year and will be $1000. Each year after that, you will receive a payment on the anniversary of the last payment that is 8% larger than the last payment. This pattern of payments will go on forever. If the interest rate is 12% per year, a. What is todays value of the bequest? First Payment $1,000.00 Growth Rate 8.00% Interest Rate 12.00% Value $25,000.00 b. What is the value of the bequest immediately after the first payment is made?

2 ways:
Value This Year Times 1 + Growth Rate $27,000.00 - OR Second Payment $1,080.00 Growth Rate 8.00% Interest Rate 12.00% Value $27,000.00

Problem 4-23 Your oldest daughter is about to start kindergarten at a private school. Tuition is $10,000 per year, payable at the beginning of the school year. You expect to keep your daughter in private school through high school. You expect tuition to increase at a rate of 5% per year over the 13 years of her schooling. What is the present value of the tuition payments if the interest rate is 5% per year? Look at 4-24 for an explanation. In this problem, the difference is that the first payment occurs today. (If you want to look at this like 4-24, change that sheet just a little and you can see it go to zero.) Payment Years Value $10,000.00 13 ###

This is true only because the growth rate equals the interest rate.

Problem 4-24

A rich aunt has promised you $5000 one year from today. In addition, each year after that, she has promised you a payment (on the anniversary of the last payment) that is 5% larger than the last payment. She will continue to show this generosity for 20 years, giving a total of 20 payments. If the interest rate is 5%, what is her promise worth today? Discount rate 5.00% Number of payments 20 Payment amount $5,000.00 PV = 95238 which is equal to the payment amount times the number of periods discounted for one period at. Here's why: In order to have enough to make all her payments to you, auntie would have to deposit that much now. Here's how that would be depleted:
Beginning balance - amount paid out end ending of year balance

+interest

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

5000.00 5250.00 5512.50 5788.13 6077.53 6381.41 6700.48 7035.50 7387.28 7756.64 8144.47 8551.70 8979.28 9428.25 9899.66

95238 100000 99750 99225 98398 97241 95721 93807 91462 88647 85323 81445 76965 71834 65998 59398

4762 4750 4725 4686 4631 4558 4467 4355 4221 4063 3878 3665 3421 3143 2828 2475

5000 5250 5513 5788 6078 6381 6700 7036 7387 7757 8144 8552 8979 9428 9900

100000 99750 99225 98398 97241 95721 93807 91462 88647 85323 81445 76965 71834 65998 59398 51973

16 17 18 19 20

10394.64 10914.37 11460.09 12033.10 12634.75

51973 43657 34380 24066 12635

2079 1637 1146 602

10395 10914 11460 12033 12635

43657 34380 24066 12635

n, each year after payment) that is 5% ty for 20 years, promise worth today?

ent amount times the ed for one period at.

payments to you, now. Here's how that

Amount of principal used for that payment

-250 -525 -827 -1158 -1519 -1914 -2345 -2814 -3324 -3878 -4479 -5131 -5837 -6600 -7425

-8316 -9277 -10314 -11431 -12635

Problem 4-25

You are running a hot Internet company. Analysts predict that its earnings will grow at 30% competition increases, earnings growth is expected to slow to 2% per year and continue at th earnings of $1,000,000. What is the present value of all future earnings if the interest rate is year.) Starting growth rate Number of years of high growth Later growth rate Discount rate 30.00% 5 2.00% 8.00% 0 Cash flow PV(cash flow) PV(infinite cash flows) Value of company 1

Yea $1,000,000.00 $1,300,000.00 $1,203,703.70 51981214

ct that its earnings will grow at 30% per year for the next five years. After that, as ow to 2% per year and continue at that level forever. Your company has just announced future earnings if the interest rate is 8%? (Assume all cash flows occur at the end of the

Year 2 3 4 5 6 $1,690,000.00 $2,197,000.00 $2,856,100.00 $3,712,930.00 $3,787,188.60 $1,448,902.61 $1,744,049.43 $2,099,318.76 $2,526,957.77 42958282

Problem 4-27 You are thinking of purchasing a house. The house costs $350,000. You have $50,000 in cash that you can use as a down payment on the house, but you need to borrow the rest of the purchase price. The bank is offering a 30-year mortgage that requires annual payments and has an interest rate of 7% per year. What will your annual payment be if you sign up for this mortgage? Cost of House Down Payment Number of Years Interest Rate Annual Payment Amount $350,000.00 $50,000.00 30 7.00% -24176

Problem 4-29 You would like to buy the house and take the mortgage described in Problem 4.27. You can afford to pay only $23,500 per year. The bank agrees to allow you to pay this amount each year, yet still borrow $300,000. At the end of the mortgage (in 30 years), you must make a balloon payment; that is, you must repay the remaining balance on the mortgage. How much will this balloon payment be? Payment Cost Term Rate Balloon PV of Payments PV of difference FV of difference $23,500.00 $300,000.00 30 7.00% 63848 - OR -291612 8388 63848

Problem 4-30

You are saving for retirement. To live comfortably, you decide you will need to save $2 million by the time you are 65. Today is your 30th birthday, and you decide, starting today and continuing on every birthday up to and including your 65th birthday, that you will put the same amount into a savings account. If the interest rate is 5%, how much must you set aside each year to make sure that you will have $2 million in the account on your 65th birthday?

Your age Payment 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53

Cumulative value of account (end of year)

-20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869

-21912 -44920 -69079 -94445 -121080 -149046 -178411 -209244 -241618 -275611 -311304 -348782 -388133 -429452 -472837 -518391 -566223 -616447 -669182 -724553 -782693 -843740 -907839 -975144

Number of payments Interest rate Future value Payment amount You'll get the same answer if you calculate the payment that will accumulate to 2 million and then multiply it by 1.05.

54 55 56 57 58 59 60 61 62 63 64 65

-20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869 -20869

-1045813 -1120016 -1197930 -1279738 -1365638 -1455832 -1550536 -1649975 -1754386 -1864018 -1979131 -2000000

decide you will need to 0th birthday, and you up to and including your savings account. If the ear to make sure that you y?

36 5.00% $2,000,000.00 -20869

e same answer if you payment that will o 2 million and then y 1.05.

Problem 4-31

You realize that the plan in Problem 4.30 has a flaw. Because your income will increase lifetime, it would be more realistic to save less now and more later. Instead of putting amount aside each year, you decide to let the amount that you set aside grow by 7% per y this plan, how much will you put into the account today? (Recall that you are planning to first contribution to the account today.)
Cumulative value of account (end of year)

Your age Payment -7102 30 -7599 31 -8131 32 -8700 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55

-9309 -9961 -10658 -11404 -12203 -13057 -13971 -14949 -15995 -17115 -18313 -19595 -20967 -22434 -24005 -25685 -27483 -29407 -31465 -33668 -36025 -38546

-7457 -15809 -25138 -35530 -47081 -59894 -74080 -89759 -107060 -126123 -147098 -170150 -195452 -223196 -253584 -286838 -323195 -362910 -406261 -453543 -505077 -561208 -622307 -688774 -761038 -839564

Number of payments Interest rate Present value Growth rate PV interest factor (formula) Payment

56 57 58 59 60 61 62 63 64 65

-41244 -44132 -47221 -50526 -54063 -57848 -61897 -66230 -70866 -75826

-924849 -1017429 -1117882 -1226829 -1344937 -1472924 -1611562 -1761681 -1924174 -2000000

income will increase over your er. Instead of putting the same de grow by 7% per year. Under t you are planning to make the

36 5.00% -345315 7.00% 48.621416 -7102

Problem 4-37

You are thinking of making an investment in a new plant. The plant will generate revenu per year for as long as you maintain it. You expect that the maintenance cost will start at and will increase 5% per year thereafter. Assume that all revenue and maintenance costs of the year. You intend to run the plant as long as it continues to make a positive cash flo cash generated by the plant exceeds the maintenance costs). The plant can be built and b immediately. If the plant costs $10 million to build, and the interest rate is 6% per year, in the plant?

The question is, how long will it $50,000.00 to equal take for

$1,000,000.00

You can solve this using logarithms, by solving the following equation for n: 1000000 = 50000 * divide both sides by 50,000.00 105.00% ^(n-1) =

$20.00

(n-1)* ln(1.05) = (n-1)* 0.05 = Divide both sides by Or you can use the Excel function: 62 0.05

ln(20) 3 and add 1 to get

nt will generate revenues of $1 million enance cost will start at $50,000 per year and maintenance costs occur at the end make a positive cash flow (as long as the plant can be built and become operational st rate is 6% per year, should you invest

if it grows at

5.00% per year?

ation for n: 105.00% ^(n-1)

62

Problem 4-38

You have just turned 30 years old, have just received your MBA, and have accepted your fir Now you must decide how much money to put into your retirement plan. The plan works as follows: Every dollar in the plan earns 7% per year. You cannot make withdrawals until you on your sixty-fifth birthday. After that point, you can make withdrawals as you see fit. You that you will plan to live to 100 and work until you turn 65. You estimate that to live comfor in retirement, you will need $100,000 per year starting at the end of the first year of retireme ending on your one hundredth birthday. You will contribute the same amount to the plan at t of every year that you work. How much do you need to contribute each year to fund your retirement?

Interest rate assumption You will need PV as of age 65 =

7.00% $100,000.00 per year for -1294767 35 years by paying

You can accumulate this amount in

Note: The above uses future value of an annuity.

You can also calculate this using PV of an annuity, by figuring the PV of the FV and computing the annuity implied by that. PV as of age 30 = PMT 121272 9366

BA, and have accepted your first job. ment plan. The plan works as ot make withdrawals until you retire thdrawals as you see fit. You decide ou estimate that to live comfortably nd of the first year of retirement and he same amount to the plan at the end bute each year to fund your

35 years

9366 per year.

figuring the PV of the FV and

Problem 4-39

Problem 4.38 is not very realistic because most retirement plans do not allow you to specify amount to contribute every year. Instead, you are required to specify a fixed percentage salary that you want to contribute. Assume that your starting salary is $75,000 per year an grow 2% per year until you retire. Assuming everything else stays the same as in Proble what percentage of your income do you need to contribute to the plan every year to fund t retirement income? Interest rate assumption You will need PV as of age 65= PV as of age 30= Your contributions will grow at an annual rate of Starting salary PV interest factor You can accumulate this amount in 7.00% $100,000.00 per year for -1294767 -121272

35

2.00% $75,000.00 16.253689 35 years by paying or

Age Contribution Balance $7,461.18 $7,461.18 31 $7,610.40 $15,593.87 32 $7,762.61 $24,448.05 33 $7,917.86 $34,077.28 34 $8,076.22 $44,538.91 35 $8,237.75 $55,894.38 36 $8,402.50 $68,209.48 37 $8,570.55 $81,554.70 38 $8,741.96 $96,005.49 39 $8,916.80 $111,642.67 40 $9,095.14 $128,552.80 41 $9,277.04 $146,828.53 42

7461 9.95%

43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65

$9,462.58 $9,651.83 $9,844.87 $10,041.77 $10,242.60 $10,447.45 $10,656.40 $10,869.53 $11,086.92 $11,308.66 $11,534.83 $11,765.53 $12,000.84 $12,240.86 $12,485.67 $12,735.39 $12,990.10 $13,249.90 $13,514.90 $13,785.19 $14,060.90 $14,342.11 $14,628.96

$166,569.11 $187,880.78 $210,877.30 $235,680.48 $262,420.72 $291,237.62 $322,280.66 $355,709.83 $391,696.44 $430,423.85 $472,088.36 $516,900.07 $565,083.92 $616,880.65 $672,547.97 $732,361.71 $796,617.13 $865,630.22 $939,739.23 $1,019,306.17 $1,104,718.50 $1,196,390.91 $1,294,767.23

allow you to specify a fixed y a fixed percentage of your $75,000 per year and it will he same as in Problem 4.38, every year to fund the same

years

per year. of your annual income.