Ariel S.

Gutierrez
BSA 201A

P5–1
Using a time line The financial manager at Starbuck Industries is
considering an investment that requires an initial outlay of $25,000 and is
expected to result in cash inflows of $3,000 at the end of year 1, $6,000 at the
end of years 2 and 3, $10,000 at the end of year 4, $8,000 at the end of year
5, and $7,000 at the end of year 6.
a. Draw and label a time line depicting the cash flows associated with
Starbuck Industries’ proposed investment.
b. Use arrows to demonstrate, on the time line in part a, how compounding to
find future value can be used to measure all cash flows at the end of year 6.
c. Use arrows to demonstrate, on the time line in part b, how discounting to
find present value can be used to measure all cash flows at time zero.

d. Which of the approaches—future value or present value—do financial

managers rely on most often for decision making? Why?
Because financial managers typically make decisions prior to the start
of a project, at time zero, as does the present value equation, they place
a greater emphasis on present value than future value.

P5–2
Future value calculation Without referring to the preprogrammed function on
your financial calculator, use the basic formula for future value along with the
given interest rate, r, and the number of periods, n, to calculate the future
value of $1 in each of the cases shown in the following table.

Answer:
A. 12% interest, 2 periods
= (1+ 0.12) ^2
= $1.25
B. 6% interest, 3 periods
= (1+ 0.06) ^3
= $1.19
C. 9% interest, 2 periods
= (1+ 0.09) ^2
= $1.19
D. 3% interest, 4 periods
= (1+ 0.03) ^4
= $1.13
P5–3
Future value You have $100 to invest. If you can earn 12% interest, about
how long does it take for your $100 investment to grow to $200? Suppose that
the interest rate is just half that, at 6%. At half the interest rate, does it take
twice as long to double your money? Why or why not? How long does it take?

Answer:
$100*(1+0.12)y = $197.38
y=6
It would take about 6 periods to double the initial $100.
If the interest rate dropped to 6%, it would take twice as long to accrue the
same amount of interest to double the initial investment because you would
be accruing half the interest.
At 6%, it would take 12 interest periods to double the amount.

100*(1+0.06)y = $201.21
y = 12

P5–4
Future values For each of the cases shown in the following table, calculate
the future value of the single cash flow deposited today at the end of the
deposit period if the interest is compounded annually at the rate specified.

A. $200 x (1+ 0.05) ^20

= $530.66
B. $4,500 x (1+ 0.08) ^7
= $7,712.21
C. $10,000 x (1+ 0.09) ^10
= $23,673.64
D. $25,000 x (1+ 0.10) ^12
= $78,460.71
E. $37,000 x (1+ 0.11) ^5
= $62,347.15
F. $40,000 x (1+ 0.12) ^9
= $110,923.15

P5–5
Time value You have $1,500 to invest today at 7% interest compounded
annually.
a. Find how much you will have accumulated in the account at the end of
(1) 3 years, (2) 6 years, and (3) 9 years.

Answer:
1. Three Years
FV = 1500 X (1+.07)^3 = $1,837.56
2. Six Years
FV = 1500 X (1+.07)^6 = $2,251.10
3. Nine Years
FV = 1500 X (1+.07)^9 = $2,757.69

b. Use your findings in part a to calculate the amount of interest earned in (1)
the first 3 years (years 1 to 3), (2) the second 3 years (years 4 to 6), and (3)
the third 3 years (years 7 to 9).

1. The first three years

$1,837.56-$1,500 = $337.56
2. The second three years
$2,251.10-$1,837.56= $413.54
3. The third three years
$2,757.69-$2,251.10=$506.59

c. Compare and contrast your findings in part b. Explain why the amount of
interest earned increases in each succeeding 3-year period.

The reason the interest grows is due to the magic of compounding. The
interest compounded throughout each of the 3 year periods we saw in part (a)
of the problem. Initially, the interest grew only off of $1500 which was the
initial investment. After the first 3 years, the interest was not based off of
$1500, rather it was based off of $1837.56. After 6 years were over, the value
of the investment was $2,251.10, which then grew another 7% to what we see
for the 9 year amount, which is $2,757.69. To put it simply, interest was
earned not only on the principal invested, but also on top of the earned
interest. This is why it is important to invest early and often, so that the
investment has time to grow. Time in market is one of the greatest factors
when it comes to investing. If a person in their 20s invests the same amount
as a person who started in their 50s and have the same principal invested by
the age of 65, the person in his 20s will come out with far greater returns even
though both individuals invested the same amount. Time was on the younger
person's side and the magic of compounding did the rest of the work for him.
Time is literally money.

P5–6
Time value As part of your financial planning, you wish to purchase a new car
exactly 5 years from today. The car you wish to purchase costs $14,000
today, and your research indicates that its price will increase by 2% to 4% per
year over the next 5 years.
a. Estimate the price of the car at the end of 5 years if inflation is (1) 2% per
year and (2) 4% per year.

FV5=$14000*(1+.02)^5
=14000*1.10408
=$15,457.12

FV5=$14000*(1+.04)^5
=$14000*1.2166529
=$17,033.14

b. How much more expensive will the car be if the rate of inflation is 4% rather
than 2%?
=$17,033.14-$15,457.12=$1,576.01

c. Estimate the price of the car if inflation is 2% for the next 2 years and 4%
for 3 years after that.
14000(1+.02)^2
=14000*1.0404
=$14,565.60

14565.6(1+.04)^3
=14565.6*1.124864
=$16,384.32

P5–7
Time value You can deposit $10,000 into an account paying 9% annual
interest either today or exactly 10 years from today. How much better off will
you be at the end of 40 years if you decide to make the initial deposit today
rather than 10 years
from today?

Deposit Now:
40 years, 9% interest, deposit $10,000 = $314,094.20

Deposit in 10 Years:
30 years, 9% interest, deposit $10,000 = $132,676.78

You would make $181,417 more by investing the $10,000 now instead of
waiting 10 years.

P5–8
Time value Peter just got his driver’s license, and he wants to buy a new
sports car for $70,000. He has $3,000 to invest as a lump sum today. Peter is
a conservative investor and he only invests in safe products. After
approaching different banks, he is offered the following investment
opportunities: How long will it take for Peter to accumulate enough money to
buy the car in each of the above three cases?

(1) River Bank’s savings account with an interest rate of 10.8% compounded
monthly.
River bank's savings account
$70,000= $3,000 x ( 1 + (0.108/12))¹²ⁿ
$70,000= $3,000 x (1.009)¹²ⁿ
$23.333
= (1.009)¹²ⁿ
log23.333 = log (1.009¹²ⁿ)
log23.333 = (12n)(log1.009)
log23.333= 12n log1.009
351.55799 = 12n
n = 29.3 years

(2) First State Bank’s savings account with an interest rate of 11.5%
compounded annually.
First state bank's savings account
$70,000= $3,000 x ( 1 + 0.115)ⁿ
$70,000= $3,000 x (1.115)ⁿ
$23.333= (1.115)ⁿ
log23.333 = log (1.115ⁿ)
log23.333 = (n) (log1.115)
log23.333= n
log1.115
n= 28.94 years

(3) Union Bank’s saving account with an interest rate of 9.3% compounded
weekly.
Union bank's savings account
$70,000= $3,000 x ( 1 + (0.093/52))⁵²ⁿ
$70,000= $3,000 x (1.001788462)⁵²ⁿ
$23.333= (1.001788462)⁵²ⁿ
log23.333 = log (1.001788462⁵²ⁿ)
log23.333 = (52n)(log1.001788462)
log23.333= 52n
log1.001788462
1762.7909 = 52n
n = 33.9 years

P5–9
Single-payment loan repayment A person borrows $200 to be repaid in 8
years with 14% annually compounded interest. The loan may be repaid at the
end of any earlier year with no prepayment penalty.
a. What amount will be due if the loan is repaid at the end of year 1?
b. What is the repayment at the end of year 4?
c. What amount is due at the end of the eighth year?
a. N = 1, I = 14%, PV = $200
=200 x 1.14^1
= $228

b. N = 4, I = 14%, PV = $200
=200 x 1.14^4
= $337.79

c. N = 8, I = 14%, PV = $200
=200 x 1.14^8
= $570.52

P5–10
Present value calculation Without referring to the preprogrammed function on
your financial calculator, use the basic formula for present value, along with
the given opportunity cost, r, and the number of periods, n, to calculate the
present value of $1 in each of the cases shown in the following table.

A 2% interest, 4 periods =1+.02^4

=$1.08
B 10% interest, 2 periods=1+.1^2
=$1.21
C 5% interest, 3 periods=1+.05^3
=$1.16
D.13% interest, 2 periods=1+.13^2
=S1.27