292 Chapter 8 I Compound Interest: Future Value and Present Value

CONCEPT QUESTIONS
1. What is the meaning of the term discount rate? 5. If the present value of $100 due eight years from
2. Does a smaller discount rate result in a larger or now is $50, what is the present value of $100
a smaller present value? Explain. due 16 years from now? Answer without using
formula (8-2).
3. The process of discounting is the opposite of
doing what? 6. Suppose the future value of $1 after x years is S5,
What is the present value of $1, x years before
4. Why does $100 due one year from now have less
its scheduled payment date? (Assume the same
economic value than $100 has today? What do
interest rate in both cases.)
you need to know before you can determine the

difference between the economic values of the

two payments?

EXERCISE 8.3 Answers to the odd-numbered problems ore ot the end of the book.

Note: In Section 8.4, you will learn how to use special functions on a financial calculator toso/ve
compound-interest problems. Exercise 8.4 will invite you to return to this Exercise to practise
the financial calculator method.

Note: A few problems in some Exercises have been extracted (with permission) from course
materials created by the Canadian Institute of Financial Planning (CIFP) for its program leading
to the Certified Financial Planner (CFP) designation. The CIFP and associated bodies (see
www.ifse.ca) are leading providers of financial services education in Canada. Problems derived
from ClFP materials are identified in our Exercises by the organization's logo placed in the
margin adjacent to the problems.
1. If money can be invested to earn 6.5% compounded annually, how much would have
to be invested today to grow to $10,000 after:
a. 10 years? b. 20 years? c. 30 years?
2. What amount would have to be invested today for the future value to be $10,000 after
20 years if the rate of return is:
a. 5% compounded quarterly? b. 7% compounded quarterly?
c. 9% compounded quarterly?
3. What amount invested today would grow to $10,000 after 25 years, if the investment earns:
a. 8% compounded annually? b. 8% compounded semiannually?
c. 8% compounded quarterly? d. 8% compounded montWy?
4. If money is worth 6% compounded annually, what amount today is equivalent to
$10,000 paid:
a. 12 years from now? b. 24 years from now? c. 36 years from now?
5. What is the present value of $10,000 discounted at 4.5% compounded annually over
ten years?
6. What principal amount will have a maturity value of $5437.52 after 27 months, if it
earns 8.5% compounded quarterly?
7. The maturity value of an investment after 42 months is $9704.61. What was the
original investment, if it earned 7.5% compounded semiannually?
8. What amount today is economically equivalent to $8000 paid 18 months from now, if
money is worth 5% compounded.monthly?
9. If your client's objective is to have $10,000 in four years, how much should he
invest today in a product earning 5.5% compounded annually? (Taken from CIFP
course materials.)
 \ Chapter 8 I Compound Interest Future Value and Present Value 293

10. Ross has just been notified that the combined principal and interest on an amount
that he borrowed 27 months ago at 11 % compounded quarterly is now $2297.78. How
from much of this amount is principal and how much is interest?
10 11. Your client has a choice of either receiving $5000 two years from now or receiving a lump
ing payment today. If your client can earn 5.4% compounded semiannually, what amount
received today is equivalent to $5000 in two years? (Taken from CIFP course materials.)
is $5. 12. You owe $6000 payable three years from now. v\That alternative amount should your
re creditor be willing to accept today if she can earn 4.2% compounded monthly on a
me low-risk investment?
13. v\That amount, It years from now, is equivalent to $7000 due in 8 years, if money can
earn 6.2% compounded semiannually?
14. A payment of $1300 is scheduled for a date 3t years from now. \Vhat would
be an equivalent payment 9 months from now, if money is worth 5.5%
compounded quarterly?
15. v\That amount 15 months ago is equivalent to $2600, It years from now? Assume
olve money can earn 5.4% compounded monthly.
:tise
16. Mustafa can receive a $77 discount if he pays his property taxes early. Alternatively,
he can pay the full amount of $2250 when payment is due in nine months. v\Thich
:trse alternative is to his advantage if he can earn 6% compounded monthly on short-term
ring investments? In current dollars, how much is the advantage?
'see
17. v\That single amount, paid three years from now, would be economically equivalent
ved
to the combination of $1400 due today and $1800 due in five years, if funds can be
invested to earn 6% compounded quarterly?
18. Ramon wishes to replace payments of $900 due today and $500 due in 22 months by a
single equivalent payment 18 months from now. If money is worth 5% compounded
monthly, what should that payment be?
19. Mohinder has financial obligations of $1000 due in 3t years and $2000 due in 5t years.
He wishes to settle the obligations sooner with a single payment one year from now. If
money is worth 7.75% compounded semiannually, what amount should the payee be
willing to accept?
20. v"hat payment 2t years from now would be a fair substitute for the combination of
$1500 due (but not paid) 9 months ago and $2500 due in 4t years, if money can earn
9% compounded quarterly?
21. \Vhat single payment six months from now would be equivalent to payments of $500
due (but not paid) four months ago, and $800 due in 12 months? Assume money can
earn 7.5% compounded monthly.
22. What single payment one year from now would be equivalent to $2500 due
in three months, and another $2500 due in two years? Money is worth 7%
compounded quarterly.
23. A scheduled payment stream consisted of three payments: $2100 due (but not paid)
It years ago, $1300 due today, and $800 due in 2 years. v"hat single payment, 6 months
from now, would be economically equivalent to the payment stream? Money can earn
4.5% compounded monthly.
24. A debtor owing payments of$750 due today, $1000 due in 2 years, and $1250 due
in 4 years requests a payout figure to settle all three obligations by means of a single
economically equivalent paYl1lent 18 months from now. \Vhat is that amount, if the
payee can earn 9.5% compounded semiannually?
294 Chapter 8 I Compound Interest: Future Value and Present Value

25. Alicia is considering two offers-to-purchase that she has received on a residential building
lot she wishes to sell. One is a cash offer of $145,000. The other offer consists of three
payments of $49,000-one now, one in six months, and one in twelve months. vVhich
offer has the larger economic value if Alicia can earn 4.4% compounded quarterly on
\ low-risk investments? How much more (in current dollars) is the better offer worth?
26. A bond pays $1000 interest at the end of every year for the next 30 years. What is the
current economic value of each of the 15th and 30th payments if we discount the
paymen ts at:
a. 5% compounded semiannually? b. 8% compounded semiannually?
027. Joe Superstar has just signed a "four-year, $68-miLlion deal" with the Toronto Blue
Jays. The terms of the contract include a signing bonus of $4.8 million and salaries of
$10 million, $17.2 million, $17.5 million, and $18.5 million in successive years of the
contract. The news media always ignore the time value of money when they report the
"value" of professional athletes' contracts. vVhat is the economic value of Joe's contract
on the date it was signed? Assume that the signing bonus was paid on that date, that
the annual salaries will be paid in lump amounts ~ year, 1~ years, 2t years, and 3t years
later, and that money is worth 5% compounded semiannually. Round the answer to the
nearest $1000.
28. To motivate individuals to start saving at an early age, financial planners will sometimes
present the results of the following type of calculation. How much must a 25-year-old
individual invest five years from now to have the same maturity value at age 55 as an
immediate investment of $1000? Assume that both investments earn 8% compounded
annually.
029. Michelle has just received an inheritance from her grandfather's estate. She will be
entering college in 3~ years, and wants to immediately purchase three compound-
interest investment certificates having the following maturity values and dates:
$4000 at the beginning of her first academic year, $5000 at the start of her second
year, and $6000 at the beginning of her third year. She can obtain interest rates of
5% compounded semiannually for any terms between three and five years, and
5.6% compounded quarterly for terms between five and seven years. What principal
amount should she invest in each certificate?
30. Daniel makes annual payments of $2000 to the former owner of a residential lot that
he purchased a few years ago. At the time of the fourth from last payment, Daniel asks
for a payout figure that would immediately settle the debt. What amount should the
payee be willing to accept instead of the last three payments, if money can earn 8.5%
compounded semiannually?
031. Commercial Finance Co. buys conditional sale contracts from furniture retailers at
discounts that provide a 16.5% compounded monthly rate of return on the purchase
price. What total price should Commercial Finance pay for the following three contract:
$950 due in four months, $780 due in six months, and $1270 due in five months?
032. Teresita has three financial obligations to the same person: $2700 due in 1 year,
$1900 due in 1t years, and S11 00 due in 3 years. She wishes to settle the obligations
with a single payment in 2± years, when her inheritance will be released from her
mother's estate. What amount should the creditor accept if money can earn 6%
compounded quarterly?
033. A $15,000 loan at 11.5% compounded semiannually is advanced today. Two payments
of $4000 are to be made one year an9 three years from now. The balance is to be paid
in five years. What will the third payment be?
034. A $4000 loan at 10% compounded monthly is to be repaid by three equal payments
due 5, 10, and 15 months from the date of the loan. What is the size of the payments?
 Chapter 8 I Compound Interest: Future Value and Present Value 295

lilding 035. A $10,000 loan at 8% compounded semiannually is to be repaid by three equal payments
ee due 2t, 4, and 7 years after the date of the loan. What is the size of each payment?
ich 036. A $6000 loan at 9% compounded quarterly is to be settled by t"vo payments. The first
>n payment is due after nine months and the second payment, half the amount of the first
? payment, is due after Ityears. Determine the size of each payment.
·he 037. A $7500 loan at 9% compounded monthly requires three payments at five-month
intervals after the date of the loan. The second payment is to be twice the size of
(
the first payment, and the third payment is to be double the amount of the second
payment. Calculate the size of the second payment.
038. Three equal payments were made two, four, and six years after the date on which a
of $9000 loan was granted at 10% compounded quarterly. If the balance immediately
le after the third payment was $5169.81, what was the amount of each payment?
the -39. Repeat Problem 31 with the change that each contract accrues interest from today at
ract the rate of 12% compounded monthly.
-40. Repeat Problem 32 with the change that each obligation accrues interest at the rate of 9%
<:Irs
compounded monthly from a date nine months ago when the obligations were incurred.
lthe
-41. If the total interest earned on an investment at 8.2% compounded semiannually for 8t
years was $1175.98, what was the original investment?
mes
Id -42. Peggy has never made any payments on a five-year-old loan from her mother at 6%
compounded annually. The total interest owed is now $845.56. How much did she
1
ed borrow from her mother?

USING FINANCIAL CALCULATORS

L01 The formulas for many compound-interest calculations are permanently programmed
into financial calculators. These calculators allow you to enter the numerical values for the
variables into memory. Then you select the appropriate financial function to automatically
perform the calculation.
Ideally, you should be able to solve compound-interest problems using both the algebraic
method and the financial functions on a calculator. The algebraic approach strengthens your
mathematical skills and provides more flexibility for handling non-standard cases. It helps
prepare you to create spreadsheets for specific applications. Financial calculators make rou-
tine calculations more efficient and reduce the likelihood of making arithmetic errors. Most
of the example problems from this point onward will present both algebraic and financial
calculator solutions.

KEY DEFINITIONS AND CALCULATOR OPERATION

The financial calculator instructions and keystrokes shown in the main body of this text
and in the Student's Solutions Manual are for the Texas Instruments BA II PLUS. General
instructions for two other models are provided in Appendixes 8A and 12A.
The basic financial keys of the Texas Instruments BA II PLUS calculator are in the third
row of its keyboard. The calculator's manual refers to them as the TVM (Time-Value-of-
Money) keys. The definitions for these keys are as follows.
represents the number of compounding periods, n
represents the nominal (annual) interest rate, j
represents the prin~ipal or present value, PV
represents the periodic annuity payment (not used until Chapter 10)
represents the maturity value or future value, FV