PV=$10,000
i=10%=0.10
n=5 years
FV=10,000×(1.10)5≈10,000×1.61051≈$16,105
after 5 years, you will have approximately $16,105 in your account.
FV=$5,000
i=7%=0.07 PV= 5000 / (1.07) **20 = 1291
n=20 years
the present value of the security is $1,291
FV=PV×(1+r)**n
FV=$1,000,000, PV=$250,000, and n=18 years.
1,000,000=250,000×(1+r)18
r≈1.08−1=0.08 or 8%
earn an annual interest rate of approximately 8%.
(1+r)n=2
n≈0.6931/0.0630≈11.0 years.
it will take approximately 11 years to double your money
Let x=(1.12)n. Then the equation becomes:
42,180.53x+(5,000(x−1))/0.12=250,000.
42,180.53x+41,666.67(x−1)=250,000.
83,847.20x=291,666.67.
x= 291,666.67/83,847.20≈3.48.
n=ln(3.48)/ln(1.12)
ln(3.48)≈1.247,
ln(1.12)≈0.1133.
Thus,
n≈1.247/0.1133≈11.
It will take approximately 11 years for your brokerage account to reach $250,000.
FV=PMT× ((1+i)** n−1)/i = 1,725.22×1.07≈$1,846.00
PMT=$300
i=7%=0.07
n=5 years
The cash flows are: Let's compute each term: Year 1:
Year 1: $100 Year 1: FV1=100×1.085≈100×1.4693≈146.93
Year 2: $100
Year 3: $100 PV1=1.081100≈1.08100≈92.59 Year 2:
Year 4: $200
Year 5: $300 Year 2: FV2=100×1.084≈100×1.3605≈136.05
Year 6: $500
PV2=1.082100≈1.1664100≈85.73 Year 3:
Year 3: FV3=100×1.083≈100×1.2597≈125.97
PV3=1.083100≈1.2597100≈79.38 Year 4:
Year 4: FV4=200×1.082≈200×1.1664≈233.28
PV4=1.084200≈1.3605200≈146.87 Year 5:
Year 5: FV5=300×1.081≈300×1.08≈324.00
PV5=1.085300≈1.4693300≈204.13 Year 6:
Year 6: FV6=500×1.080=500×1=500.00
FV≈146.93+136.05+125.97+233.28+324.0
PV6=1.086500≈1.5869500≈315.00
PV≈92.59+85.73+79.38+146.87+204.13+31
100×1.4693≈146.93
100×1.3605≈136.05
100×1.2597≈125.97
200×1.1664≈233.28
300×1.08≈324.00
500×1=500.00
05+125.97+233.28+324.00+500.00≈1,46
PMT=P×r/(1−(1+r)**(−n)) EAR=(1+ rnominal/12)**12−1.
EAR≈1.126825−1=0.126825,
where: Effective Annual Rate (EAR): Approximately 12.68%
P=$20,000
r=0.01
n=60 months
Plug in the values:
PMT=$444.44.
mately 12.68%
(a) Future Value for 1 Year at 6%
FV=500×(1+0.06)**1=500×1.06=$530.00
(b) Future Value for 2 Years at 6%
FV≈500×1.1236=$561.80
(c) Present Value of $500 Due in 1 Year at a Discount Rate of 6%
PV=500/1.06≈$471.70
(d) Present Value of $500 Due in 2 Years at a Discount Rate of 6%
PV= 500/(1.06) **2 ≈ 1.1236 ≈$445.01
a. Future Value after 1 year: $530.00
b. Future Value after 2 years: $561.80
c. Present Value of $500 due in 1 year: $471.70
d. Present Value of $500 due in 2 years: $445.01
(a) Calculating the Compound Annual Growth Rate (CAGR):
Sales in 2009 = $6 million
Sales in 2014 = $12 million
Number of years, n=5
CAGR=0.1487,
14.87% per year.
(b) Evaluating the Statement:
The statement claims: “Sales doubled in 5 years. This
represents a growth of 100% in 5 years; so dividing
100% by 5, we find the growth rate to be 20% per year.”
This reasoning is incorrect because it ignores the effect
of compounding. The growth from 100% total increase
over 5 years must be converted to an annual compound
rate, not a simple average. As we calculated, the correct
compound annual growth rate is approximately 14.87%
per year, not 20%.
a. CAGR= (6/12) mũ 1/5 ≈0.1487 or 14.87%
b. The formula above shows that the correct annual growth rate is 14.87%, not 20%.
a. Borrow $700, pay back $749 at the end of 1 year i=(700-749)/700=0.07=7%
b. Lend $700, borrower pays back $749 at the end of 1 year i=(700-749)/700=0.07=7%
c. Borrow $85,000, pay back $201,229 at the end of 10 yearsi=[(201229/85000) mũ 1/10 ] − 1 ≈0.0910=
d. Borrow $9,000, make payments of $2,684.80 at the end of each year for 5 years
PV=9,000
PMT=2,684.80 i≈0.10=10%
n=5
0) mũ 1/10 ] − 1 ≈0.0910=9.10%
t = 72 / interest rate
a. 7%
t=7≈10.29 years
b. 10%
t=72/10=7.2 years
c. 18%
t=72/18=4 years
d. 100%
t=72/100=0.72 years
a. $400 per year for 10 years at 10% (ordinary annuity)
FV=400×15.937≈6,374.80 FVdue=6,374.80×1.10=7,012.28
b. $200 per year for 5 years at 5% (ordinary annuity)
FV=200×5.526=1,105.20 FVdue=1,105.20×1.05=1,160.46
c. $400 per year for 5 years at 0% (ordinary annuity)
FV=400×5=2,000 FVdue=FVordinary×(1+0)=2,000
a. $400 per year for 10 years at 10% (ordinary annuity) Annuity due: $400 per year for 10 years at 1
PV=400×6.145=2,458.00 PVdue=2,458.00×1.10=2,71
b. $200 per year for 5 years at 5% (ordinary annuity) Annuity due: $200 per year for 5 years at 5%
PV=200×4.33=866.00 PVdue=866.00×1.05=909.30
c. $400 per year for 5 years at 0% (ordinary annuity) Annuity due: $400 per year for 5 years at 0%
PV=400×5=2,000 PVdue=2,000 (same as ordin
0 per year for 10 years at 10%
Vdue=2,458.00×1.10=2,713.80
0 per year for 5 years at 5%
Vdue=866.00×1.05=909.30
0 per year for 5 years at 0%
Vdue=2,000 (same as ordinary annuity)
a. Interest rate of 7% PV=100/0.07=1,428.57
b. Interest rate of 14% (doublPV=100/0.14=714.29
PV = 85,000
PMT = 8,273.59 85,000=8,273.59× ((1−(1+i)) mũ (-30))/i
n = 30
a. Present Value at an 8% Discount Rate
Stream A:
Year 0: $0
Year 1: $100 PVA=0+92.59+343.28+317.81+294.93+204.04
Year 2: $400 PVA=1,252.65
Year 3: $400
Year 4: $400 So, the present value of Stream A at an 8% discount rate is $1,252.65.
Year 5: $300
Stream B:
Year 0: $0 PVB=0+277.78+343.28+317.81+294.93+68.05
Year 1: $300
Year 2: $400 PVB=1,301.85
Year 3: $400
Year 4: $400 So, the present value of Stream B at an 8% discount rate is $1,301.85.
Year 5: $100
b.
Stream A:
PVA=0+100+400+400+400+300=1,600 Stream B:
So, the present value of Stream A at a 0% discount rate is $1,600. PVB=0+300+400+400+400+100=1,600
So, the present value of Stream B at a 0% d
count rate is $1,252.65.
count rate is $1,301.85.
0+400+400+100=1,600
lue of Stream B at a 0% discount rate is $1,600.
Annual savings: $5,000
Expected return: 9% per year (0.09 as a decimal)
First payment: 1 year from now
Retirement age: 65 or 70
Client’s current age: 40
a. How much money will she have at age 65?
FV=5,000×84.7=423,500
So, at age 65, she will have $423,500.
b. How much will she have at age 70? n=70−40=30 years
FV=5,000×136.3=681,500
So, at age 70, she will have $681,500.
c. How much will she be able to withdraw at the end of each year after retirement?
423,500=PMT×9.139 PMT=423,500/9.139=46,319.43
So, if she retires at 65, she can withdraw $46,319.43 per year for 20 years.
ii. If she retires at 70 (expects to live 15 years):
681,500=PMT×8.048
PMT=681,500/8.048=84,662.55
So, if she retires at 70, she can withdraw $84,662.55 per year for 15 years.
CFtis the cash flow at time t
i is the discount rate (0.10, or 10%)
t is the year (1 to 4)
Contract 1
Payments:
Year 1: $3,000,000
Year 2: $3,000,000
Year 3: $3,000,000 PV1=2,727,273+2,479,340+2,255,274+2,048,084=9,509,970
Year 4: $3,000,000
Contract 2
Payments:
Year 1: $2,000,000
Year 2: $3,000,000
Year 3: $4,000,000 PV2=1,818,182+2,479,340+3,004,511+3,419,952=10,721,985
Year 4: $5,000,000
Contract 3
Payments:
Year 1: $7,000,000
Year 2: $1,000,000
Year 3: $1,000,000 PV3=6,363,636+826,446+751,315+683,013=8,624,410
Year 4: $1,000,000
084=9,509,970
952=10,721,985
a. If she earns 7% annually: c. If she earns 9% annu
10-year annuity ($9.5M for 10 years at 7%) 10-year annuity ($9.5M
PV=9.5×(1−(1.07)101)÷0.07 PV≈9.5×7.0236=66.72 million PV≈9.5×6.4177=60.97 m
30-year annuity ($5.5M for 30 years at 7%) 30-year annuity ($5.5M
PV=5.5×(1−(1.07)301)÷0.07 PV≈5.5×12.4090=68.25 million PV≈5.5×10.2740=56.51
Best choice at 7%: 30-year annuity ($68.25M) Best choice at 9%: Lump
b. If she earns 8% annually: d. How interest rates af
10-year annuity ($9.5M for 10 years at 8%)
PV≈9.5×6.7101=63.75 million Higher interest rates redu
30-year annuity ($5.5M for 30 years at 8%)
PV≈5.5×11.2577=61.92 million At lower rates (7%), the
At moderate rates (8%),
Best choice at 8%: 10-year annuity ($63.75M) At higher rates (9%), the
If she earns 9% annually:
-year annuity ($9.5M for 10 years at 9%)
V≈9.5×6.4177=60.97 million
-year annuity ($5.5M for 30 years at 9%)
V≈5.5×10.2740=56.51 million
est choice at 9%: Lump sum ($61M)
How interest rates affect the choice:
gher interest rates reduce the present value of annuities because future payments are discounted more heavily.
lower rates (7%), the 30-year annuity is best because future payments hold more value.
moderate rates (8%), the 10-year annuity is best because it balances value and duration.
higher rates (9%), the lump sum is best because she can invest it at a higher return.
counted more heavily.
a. Determine the Amount of Each Payment
PMT=(10,000×0.05)/1−(1.05)^-20
PMT=500-(1−0.3769)=802.43
b. Determine the Interest and Principal Portions of Each Payment
First payment (June 30):
Interest = 10,000×0.05=500 USD
Principal = 802.43−500=302.43 USD
Second payment (December 31):
New loan balance = 10,000−302.43=9,697.57 USD
Interest = 9,697.57×0.05=484.88 USD
Principal = 802.43−484.88=317.55 USD
c. Determine the Total Interest Jan Must Report on Schedule B
Jan receives two payments in the first year, with the following interest portions:
500+484.88=984.88 USD
Thus, Jan must report $984.88 as interest income on Schedule B of IRS Form 1040 for the first year
The interest income will decrease next year as the remaining loan balance declines
d. Why Does Interest Income Change Over Time?
Even though each semiannual payment is fixed at $802.43, the proportion of interest and principal r
Interest is calculated on the remaining loan balance, so the interest portion decreases with each paym
The portion of the payment going toward principal repayment increases, reducing the loan balance m
By the end of the loan term, most of the payment goes toward principal, while interest becomes a sm
This pattern is a characteristic of an amortized loan, where the interest paid decreases as the loan ba
1040 for the first year.
interest and principal repayment changes over time:
creases with each payment.
cing the loan balance more quickly.
e interest becomes a smaller fraction of the total payment.
ecreases as the loan balance is gradually repaid.
a. 12% Compounded Annually
b. 12% Compounded Semiannually
c. 12% Compounded Quarterly
d. 12% Compounded Monthly
e. 12% Compounded Daily
f. Why Does the Future Value Increase with More Frequent Compounding?
The observed pattern occurs because more frequent compounding means interest is applied more of
With annual compounding, interest is added once per year.
With semiannual, quarterly, and monthly compounding, interest is added multiple times per year, ac
With daily compounding, the effect is maximized within practical limits.
Although increasing compounding frequency raises the future value, the increase becomes smaller a
FV=P×ert=500×e(0.12×5) FV=500×e0.6=500×1.8221=911.05
This confirms that daily compounding is very close to continuous compounding, showing diminishi
rest is applied more often, leading to interest on interest (compounding effect).
tiple times per year, accelerating growth.
ease becomes smaller as compounding frequency approaches continuous compounding. The theoretical maxim
ng, showing diminishing returns in FV as compounding frequency increases.
The theoretical maximum future value is found using continuous compounding:
a. 12% Nominal Rate, Semiannual Compounding, Discounted Back 5 Years
b. 12% Nominal Rate, Quarterly Compounding, Discounted Back 5 Years
c. 12% Nominal Rate, Monthly Compounding, Discounted Back 1 Year
d. Why Do the Differences in PVs Occur?
The present value decreases as the compounding frequency increases. This happens because:
More frequent compounding results in higher effective interest rates, which means the future amoun
The longer the time period, the greater the discounting effect.
The monthly compounding for only 1 year results in a much higher PV because the discounting peri
In summary, the more frequently interest is compounded and the longer the discounting period, the
ppens because:
means the future amount is discounted more heavily to get the present value.
se the discounting period is shorter compared to 5 years.
iscounting period, the lower the present value.
a. FV of $400 paid every 6 months for 5 years at 12% compounded semiannually
b. FV of $200 paid every 3 months for 5 years at 12% compounded quarterly
c. Why is the annuity in part b larger than in part a, even though they receive the same total cash?
Both annuities receive the same total cash over 5 years:
Annuity A: $400 × 2 × 5 = $4,000$
Annuity B: $200 × 4 × 5 = $4,000$
However, the quarterly annuity (part b) has a larger future value because the more frequent the paym
the same total cash?
more frequent the payments, the faster the money compounds.
Financing for 48 Months
Total car price = Loan Amount + Down Payment
13,289.50+4,000=17,289.50
Financing for 60 Months
Total car price = Loan Amount + Down Payment
15,855.00+4,000=19,855.00
a. Calculate the EAR for each bank
Bank A (4% Compounded Annually)
r=4%=0.04
n=1 (compounded annually)
EARA=(1+0.04/1)^1−1
EARA=(1.04)^1−1=0.04=4.00%
Bank B (3.5% Compounded Daily)
r=3.5%=0.035
n=365 (compounded daily)
EARB=(1+0.035/365)^365−1
EARB=1.035616−1=0.035616=3.56%
Since Bank A offers a higher EAR (4.00% vs. 3.56%), it is the better choice if you plan to leave the
b. What if you might withdraw funds during the year?
If you might withdraw money before the end of the year, your choice depends on how each bank ap
Bank A (Annual Compounding): If you withdraw before a full year, you get no interest because inte
Bank B (Daily Compounding): Since interest is compounded daily, you will earn some interest even
f you plan to leave the money for a full year.
s on how each bank applies interest:
no interest because interest is only applied once per year.
earn some interest even if you withdraw mid-year, as long as you leave funds for full daily compounding perio
ily compounding periods.
EARbank=(1+0.06/12)^12−1
EARbank=1.06168−1=0.06168=6.17%
Your desired EAR is 6.17% + 2% = 8.17%.
r=n×((1+EAR)^(1/n)−1)
r=12×((1.0817)^(1/12)−1)
r=12×0.006567=0.0788=7.88%
To achieve an EAR of 8.17%, you should charge an APR of 7.88% with monthly compounding.
thly compounding.
The company allows a 90-day credit period.
The bank charges a 12% nominal interest rate (compounded daily, 360 days/year).
Formula: FV=PV×e^(rt)
FV= PV×e^(0.12×90/360) =PV×1.0304
Required price increase: (1.0304−1)×100%=3%
Conclusion: Increase price by 3% to cover interest costs.
0 days/year).
(a) When will Erika and Kitty reach $1,000,000?
Future Value of an Annuity Formula: FV=PMT×r(1+r)N−1
Erika (6% return) → N≈39.2 years → Age 64
Kitty (20% return) → N≈19.5 years → Age 44
(b) How much must Erika save per year to reach $1M in 19.5 years?
PMT=(1.06)19.5−11,000,000×0.06≈15,000
-> Erika must save $15,000/year
(c) Should Erika invest in bonds or stocks?
Bonds are safer but offer lower returns.
Stocks are riskier but can provide higher returns.
Depends on her risk tolerance.
Withdraw $10,000 annually for 4 years at 5% interest.
PV=PMT×{[1−(1+r)^(−N)]}/r
PV≈35,460
Answer: Deposit $35,460 initially.
Goal: $10,000 in 6 years.
Saving $1,500 per year at 8% interest.
FV=PMT×[(1+r)^N-1]/r
FV≈8,800
Remaining amount needed: 10,000−8,800=1,200
Answer: Final contribution required = $1,200.
Period Cash flow End of year 3
Year 1 5,000.00 5,724.50
Year 2 5,500.00 5,885.00
Year 3 6,050.00 6,050.00
Total: 17,659.50
a.
PMT=(25,000*0.1)/1−(1.10)^3 = 10,051.77
Year Beginning Balance Payment Interest (10%) Principal
1 25,000.00 10,051.77 2,500.00 7,551.77
2 17,448.23 10,051.77 1,744.82 8,306.95
3 9,141.28 10,051.77 914.13 9,137.64
b.
Year Interest (%) Principal (%)
1 (2,500/10,051.77)×100=24.88% 75.12%
2 (1,744.82/10,051.77)×100=17.37% 82.63%
3 (914.13/10,051.77)×100=9.10% 90.90%
At the beginning, the loan balance is high, so the interest component is large.
As the loan is gradually repaid, the remaining balance decreases.
Since interest is charged on the remaining balance, the interest portion of each payment declines over time.
Conversely, the principal repayment increases, meaning a larger portion of each payment goes toward reducing the
Ending Balance
17,448.23
9,141.28
0.00
each payment declines over time.
f each payment goes toward reducing the loan balance.
a. 3 years loan term
PMT=(90,000*0,07)/1−(1.07)^3 = 34,288.05
So, the annual payment would be $34,288.05, which is much higher than the maximum affordable $7,500.
You cannot afford these payments.
b.
PMT=(90,000*0,07)/1−(1.07)^30
So, the annual payment would be=$7,253.24,
7,253.24 which is slightly below the maximum affordable $7,500.
You can afford these payments.
c. The remaining balance of a loan after 3 years
B3=90,000×(1.07)^3−(7,253.24/0.07)*((1,07)^3-1) = 86,945.49
The balloon payment at the end of Year 3
Balloon Payment=B3+PMT=86,945.49+7,253.24=94,198.73
You must pay $94,198.73 at the end of Year 3, which includes the remaining balance and the final regular payment
Since you expect to inherit $100,000, you can afford this balloon payment.
ffordable $7,500.
ble $7,500.
the final regular payment.
a.
the future value of an ordinary annuity
FV=1,000×((1.02)5−1)/0.02 =5,204
FV final =5,204×1.02=5,308.08
b.
future value of two deposits
FV=P(1.01)^3+P(1.01)^2 = 4,878.05
r=18%/12=0.015
PMT (The minimum payment on the card) = $10/
PV = $372.71
a. Numbers of month = [log(PMT / PMT- r x PV)
If Simon only makes the minimum payment of $10
b. If Simon pays $35 per month, he will need app
=> The total amount Simon will pay under the $1
ent on the card) = $10/month
g(PMT / PMT- r x PV) / log(1 + r) = 55
nimum payment of $10 per month, he will need approximately 55 months to pay off the debt.
month, he will need approximately 12 months to pay it off.
will pay under the $10-per-month plan is $130 more than under the $35-per-month plan.
- Legal expenses ($20,000): Discounted to December 31, 2015, from December 31, 2014.
Total amount: $210,646.02
er 31, 2014.
where:
PV=40,000 (today’s value),
r=5%=0.05 (annual inflation rate),
N=10 (years until retirement).
This will give us the required amount of money your father must have saved by retirement (Year 10
To meet his retirement goal, your father must save $33,108.68 per year for the next 10 years.
With his current savings of $100,000, he must contribute $33,108.68 annually for 10 years to r
by retirement (Year 10)
e next 10 years.
ually for 10 years to reach this goal.
The current annual cost is $15,000, and it increases by 5% per year. The daughter will start college i
We calculate the inflated costs for each of those 4 years.
We will compute the total present value of these costs as of the day she enters college, discounting a
The sum of these discounted values gives the total amount needed at the start of college.
N=5.
The difference between the required amount at the start of college and the future value of current savings must be funded throu
These payments form an annuity with 6 deposits, growing at 6% per year.
The father must make six equal annual deposits of $9,385.00 to meet the goal.
hter will start college in 5 years and pay for 4 years.
college, discounting at 6%.
of college.
avings must be funded through 6 equal annual payments.
