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Chapter 5 Finman

The document contains several multi-step word problems involving calculating present and future values of cash flows with different interest rates and time periods. It provides the calculations and answers for each problem. The problems cover topics like calculating the interest rate needed for retirement savings to reach a goal amount, determining the number of years to reach a savings target with deposits and interest, and evaluating different cash prize options in a lottery based on their present values.

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793 views

Chapter 5 Finman

The document contains several multi-step word problems involving calculating present and future values of cash flows with different interest rates and time periods. It provides the calculations and answers for each problem. The problems cover topics like calculating the interest rate needed for retirement savings to reach a goal amount, determining the number of years to reach a savings target with deposits and interest, and evaluating different cash prize options in a lottery based on their present values.

Uploaded by

Gen Libertad
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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5.3. Your parents will retire in 18 years.

They currently have $250,000, and they think they will need
$1,000,000 at retirement. What annual interest rate must they earn to reach their goal, assuming
they don’t save any additional funds?

Answer:

Amount in 18 years = 250000 *(1+r) ^ 18

1000000 = 250000 *(1+r) ^ 18

(1+r) ^ 18 = 4

1+r = 1.08

r = 1.08 – 1

r = 0.08 or 8%

5.5. You have $42,180.53 in a brokerage account, and you plan to deposit an additional $5,000 at the
end of every future year until your account totals $250,000. You expect to earn 12% annually on the
account. How many years will it take to reach your goal?

Answer:

FVA = 42180.53*(1+12%)^n + 5000*[(1+12%)^n-1]/12% = 250,000


42180.53*1.12^n + 5000*(1.12^n - 1)/0.12 = 250,000
42180.53*(1.12)^n + 41666.67*(1.12)^n - 41667.67 = 250,000
83847.2*(1.12)^n = 250,000+41666.67 = 291666.67
1.12^n = 291,666.67/83847.2 = 3.478
n = 10.998 = 11 years

5.13. Find the interest rates earned on each of the following:

a. You borrow $700 and promise to pay back $749 at the end of 1 year
PV = $700
N=1
FV = -$749
PMT = 0
I=?
I = 7%
b. You lend $700 and receive a promise to be paid $749 at the end of 1 year
PV = -$700

N=1
FV = $749
PMT = 0
I = 7%

c. You borrow $85,000 and promise to pay back $201,229 at the end of 10 years
PV = $85,000
N = 10
FV = -$201,229
PMT = 0
I = 9%

d. You borrow $9,000 and promise to make payments of $2,684.80 at the end of each the next 5
years.
PV = $9,000
N=5
FV = 0
PMT = $2,684.80
I = 15%

5-17. What is the present value of a $100 perpetuity if the interest rate is 7%? IF interest rated
doubled to 14%, what would its present value be?

The present value of a perpetuity is forced by dividing the cash flow by the discount rate
PV = $100 / O. O7 = $1,428.57

At a discount rate of 14 percent the present value falls.


PV = $100 / 0.14 = $714.29

5-22 PV of a Cash Flow Stream. A rookie quarterback in negotiating his first NFL contract. His
opportunity cost is 10%. He has been offered three possible 4-year contracts. Payments are
guaranteed, and they would be made at the end of each year. Terms of each contract are as follows

Contract 1: PV =$2,727,272.73 + $2,479,338.84 + $2,253,944.40 + $2,049,040.37 = $9,509,596.34

Contract 2: PV = $1,818,181.82 + $2,479,338.84 + $3,005,259.20 + $3,415,067.28 = $10,717,847.14

Contract 3: PV = $6,363,636.36 + $826,446.28 + $ 751,314.80 + $683,013.46 = $8,624,410.90


Contract 2 gives the quarterbacks the highest present value, therefore, he should accept Contract 2.

5-23.Wang Yun just won the lottery and she must choose among three award option. She can elect to
receive a lump sum today of $61 million to receive 10 end-of-year payments of 9.5 million or to
receive 30 end-of-year payments of 5.5 million.
A.) 1. Receive a lump sum today of $61 million
PV = $61,000,000 1/Y= 7% n= 0
FV = PV (1 + r) t
FV = $61,000,000 (1+0.07)0
FV = $61,000,000

2. Receive 10 end-of-year payments of 9.5 million


PV = $9,500,000 1/Y = 7% n= 10
FV = PV(1+ r) t
FV = $9,500,000 (1 + 0.07)0
FV = $18,693,464.47

3. Receive 30 end-of-year payments of $5.5 million


PV = $5,500,000 1/Y = 7% n = 30
FV = PV(1 + r)t
FV = $5,500,000 (1 + 0.07)0
FV = $41,905,187.05

Decision: In this case, It will be better for her to receive a lump sum today of $61 million since she will
get the highest present value

B.) If she expects to earn 8% annually, which is the best choice?

1. Receive a lump sum today of $61 million


PV = $61,000,000 1/Y = 8% n= 0
FV = PV(1 + r)t
FV = $61,000,000 (1 + 0.08)10
FV = $61,000,000

2. Receive 10 end-of-year payments of 9.5 million


PV =$9,500,000 1/Y = 8% n=10
FV = PV(1+ r)t
FV = $9,500,000 (1+ 0.08) 10
FV = $20,515,582.10
3. Receive 30 end-of-year payments of $ 5.5 million.
PV = $5,5000,000 1/Y=8% n= 30
FV = PV(1 +r)t
FV = $5,500,000 (1+0.08)30
FV = $55,389,926.17
Decision: In this case it will be better for her to receive a lump sum today of $61 million since she will get
the highest present value.

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