ECON430_Solution_ed4 - 1 -

Problem 4-10
A lump-sum loan of $5,000 is needed by Chandra to pay
for college expenses. She has obtained small consumer
loans with 12% interest per year in the past to help pay for
college. But her father has advised Chandra to apply for a
PLUS student loan charging only 8.5% interest per year.
If the loan will be repaid in full in five years, what is the
difference in total interest accumulated by these two types
of student loans? (4.6)
Solution:
Loan @ 12% F=$5,000(F/P, 12%, 5) = $8,811.71
Loan @ 8.5% F=$5,000(F/P, 8.5%, 5) = $7,518.28
Difference = $1,293.42

Problem 4-18
Suppose that you have $10,000 cash today and can invest
it at an interest rate of 10% compounded each year. How
many years will it take you to become a millionaire? (4.6)
Solution:
$1,000,000 = $10,000(F/P, 10%, N)
= $10,000(1+10%)
N
N = ln(100)/ln(1.1) = 48.32 years

Problem 4-23
At a certain state-supported university, annual tuition and
fees have risen dramatically in recent years as shown in
the table below. (4.6)
Year
Tuition and
Fees
Consumer
Price Index
1982-1983 $827 96.5
1987-1988 $1,404 113.6
1993-1994 $2,018 144.5
2003-2004 $4,450 184.0
2005-2006 $5,290 198.1 (est.)
Source: www.b1s.gov
a. If all tuition and fees are paid at the beginning of
each academic year, what is the compound annual
rate of increase from 1982 to 2005?
b. What is the annual rate of increase from 1993 to
2005?
c. How do the increases in Parts (a) and (b) compare
with the CPI for the same period of time?
Solution:
a. $5,290 = $827 (F/P, i, 23)
i = (5,290/827)
1/23
1 = 8.40%
b. $5,290 = $2,018 (F/P, i, 12)
i = (5,290/2,018)
1/12
1 = 8.36%
c. CPI 198.1 = 96.5 (F/P, i, 23)
f = (198.1/96.5)
1/23
1 = 3.18%
CPI 198.1 = 144.5 (F/P, i, 12)
f = (198.1/144.5)
1/12
1 = 2.66%

Problem 4-28
One of lifes great lessons is to start early and save all the
money you can! If you save two dollars today and two
dollars each and every day thereafter until you are 60
years old, how much money will you accumulate (say,
$730 per year for 35 years) if the annual interest rate is
7%? (4.7)
Solution:
F = $730(F/A, 7%, 35) = $100,912.92

Problem 4-33
Automobiles of the future will most likely be
manufactured largely with carbon fibers made from
recycled plastics, wood pulp, and cellulose. Replacing
half the ferrous metals in current automobiles could
reduce a vehicles weight by 60% and fuel consumption
by 30%. One impediment to using carbon fibers in cars is
cost. If the justification for the extra sticker price of
carbon-fiber cars is solely based on fuel savings, how
much extra sticker price can be justified over a six-year
life span if the carbon-fiber car would average 39 miles
per gallon of gasoline compared to a conventional car
averaging 30 miles per gallon? Assume that gasoline
costs $3.00 per gallon, the interest rate is 20% per year,
and 117,000 miles are driven uniformly over six years.
(4.7)
Solution:
Miles driven per year = 117,000/6 = 19,500
Gas needed with conventional car = 650 gallons/yr
Gas needed with carbon-fiber car = 500 gallons/yr
Annual savings = $3.00(650-500) = $450.00
Justification = $450.00(P/A, 20%, 6) = $1,496.48

Problem 4-35
Gerard just won $2,000,000 in his state lottery. He is
informed the payout will be $100,000 per year for 20
years with the first payment occurring one year from now,
or he can accept a lump-sum payment of $1,000,000 right
away. Gerard is disappointed that he will be receiving
less than an immediate lump-sum payout of $2,000,000.
If his opportunity cost of capital (i) is 8% per year, how
much less than $2,000,000 will Gerard be receiving if he
chooses to receive $100,000 per year for 20 years? (4.7)
Solution:
P = $100,000(P/A, 8%, 20) = $981,814.74
Difference = $2,000,000 - $981,814.74 = $1,018, 185.26

Problem 4-44
The Dell Corporation borrowed $10,000,000 at 7%
interest per year, which must be repaid in equal EOY
amounts (including both interest and principal) over the
next six years. How much must Dell repay at the end of
each year? How much of the total amount repaid is
interest? (4.7)
Solution:
Annual Payment = $10,000,000 (A/P, 7%, 6)
= $2,097,958.00
Total Interest = $2,587,747.99

Problem 4-47
The Golden Gate Bridge in San Francisco was financed
with construction bonds sold for $35 million, in 1931.
These were 40-year bonds, and the $35 million principal
plus almost $39 million in interest were repaid in total in
1971. If interest was repaid as a lump-sum, what interest
rate was paid on the construction bonds? (4.6)
Solution:
$74,000,000 = $35,000,000 (F/P, i, 40)
i = (74/35)
1/40
1 = 1.89%



ECON430_Solution_ed4 - 2 -
Problem 4-56
How much should be deposited each year for 12 years if
you wish to withdraw $309 each year for five years,
beginning at the end of the 14th year? Let i = 8% per
year. (4.9)
Solution:


1 12
14 18

F
14
= $309 (P/A, 8%, 5)
= $309 (3.9927)
= $1,233.75

P
0
= F14 (P/F, 8%, 13)
= $1,233.75 (0.3677)
= $453.65

A = P
0
(A/P, 8%, 12)
= $453.65 (0.1327)
= $60.20

Problem 4-60
Maintenance costs for a small bridge with expected 50-
year life are estimated to be $1,000 each year for the first
5 years, followed by a $10,000 expenditure in the year 15
and a $10,000 expenditure in year 30. If i = 10% per
year, what is the equivalent uniform annual cost over the
entire 50-year-period? (4.10)
Solution:
P
0
= $1000 (P/A, 10%, 5) + $10,000 (P/F, 10%,15)
+ $10,000 (P/F, 10%, 30)
= $1000 (3.7908) + $10,000 (0.239392)
+ $10,000 (0.057309)
= $6,757.79

A = P
0
(A/P, 10%, 50)
= $6,757.79 (0.100859)
= $678.01

Problem 4-67
In recent years, the United States has gone from being a
positive savings nation to a negativesavings nation
(i.e., we spend more money than we earn). Suppose a
typical American household spends $10,000 more than it
makes and it does this for eight consecutive years. If this
debt will be financed at an interest rate of 15% per year,
what annual repayment will be required to repay the debt
over a 10-year period (repayments will start at EOY 9)?
(4.10)
Solution:
F
9
= $10,000 (F/A, 15%, 8) = $137,268.19
A = $137,268.19 (A/P, 15%, 10) = $27,350.97

Problem 4-72
An expenditure of $20,000 is made to modify a material-
handling system in a small job shop. This modification
will result in first-year savings of $2,000, a second-year
savings of $4,000, and a savings of $5,000 per year
thereafter. How many years must the system last if an
18% return on investment is required? The system is
tailor made for this job shop and has no market (salvage)
value at any time. (4.10)
Solution:
$200,000 = $5,000 (P/A, 18%, N) - $3,000 (P/F, 18%, 1)
- $1,000 (P/F, 18, 2)

N~ 11
It takes 11 years to recover the investment.

Problem 4-78
You owe your best friend $2,000. Because you are short
on cash, you offer to repay the loan over 12 months under
the following condition. The first payment will be $100
at the end of month one. The second payment will be
$100 + G at the end of month two. At the end of month
three, youll repay $100 + 2G. This pattern of increasing
G amounts will continue for all remaining months. (4.11)
a. What is the value of G if the interest rate is 0.5% per
month?
b. What is the equivalent uniform monthly payment?
c. Repeat Part (a) when the first payment is $150 (i.e.
determine G).
Solution:
a. $2,000 = $100(P/A, .5%, 12) + G(P/G, .5%, 12)
$2,000 = $100(11.6189) + G(63.214)
G = $13.26
b. A = $2,000(A/P, .5%, 12) = $172.13
c. $2,000 = $150(P/A, .5%, 12) + G(P/G, .5%, 12)
$2,000 = $150(11.6189) + G(63.214)
G = $4.07

Problem 4-85
You are the manager of a large crude-oil refinery. As part
of the refining process, a certain heat exchanger (operated
at high temperatures and with abrasive material flowing
through it) must be replaced every year. The replacement
and downtime cost in the first year is $175,000. This cost
is expected to increase due to inflation at a rate of 8% per
year for five years, at which time this particular heat
exchanger will no longer be needed. If the companys
cost of capital is 18% per year, how much could you
afford to spend for a higher quality heat exchanger so that
these annual replacement and downtime costs could be
eliminated? (4.12)
Solution:

(
(
(
(

+
+

=
(
(
(
(

+
+

=
08 . 18 .
) 18 . 1 (
) 08 . 1 (
1
000 , 175 $
) 1 (
) 1 (
1
5
5
1
g i
i
g
A P
N
N

= $626,050.52

Problem 4-88
A small company heats its building and spends $8,000 per
year on natural gas for this purpose. Cost increases of
natural gas are expected to be 10% per year starting one
year from now (i.e., the first cash flow is $8,800 at EOY
one). Their maintenance on the gas furnace is $345 per
year, and this expense is expected to increase by 15% per
year starting one year from now. If the planning horizon
is 15 years, what is the total annual equivalent expense for
ECON430_Solution_ed4 - 3 -
operating and maintaining the furnace? The interest rate
is 18% per year. (4.12)
Solution:
(
(
(
(

+
+

=
(
(
(
(

+
+

=
10 . 18 .
) 18 . 1 (
) 10 . 1 (
1
800 , 8 $
) 1 (
) 1 (
1
15
15
1
g i
i
g
A P
N
N
NG

= $71,624.61
(
(
(
(

+
+

+ =
(
(
(
(

+
+

=
15 . 18 .
) 18 . 1 (
) 15 . 1 (
1
%) 15 1 ( 345 $
) 1 (
) 1 (
1
15
15
1 . int
g i
i
g
A P
N
N
Ma

= $3,229.21
A = (P
NG
+ P
Maint.
)(A/P, 18%, 15) = $14,701.50

Problem 4-91
An electronic device is available that will reduce this
year's labor costs by $10,000. The equipment is expected
to last for eight years. If labor costs increase at an
average rate of 7% per year and the interest rate is 12%
per year. (4.12)
a. What is the maximum amount that we could justify
spending for the device?
b. What is the uniform annual equivalent value (A) of
labor costs over the eight-year period?
Solution:
a.
(
(
(
(

+
+

=
(
(
(
(

+
+

=
07 . 12 .
) 12 . 1 (
) 07 . 1 (
1
000 , 10 $
) 1 (
) 1 (
1
8
8
1 0
g i
i
g
A P
N
N

= $61,210.68
b. A = P
0
(A/P, 12%, 8) = $12,321.88

Problem 4-101
What extra semiannual expenditure for five years would
be justified for the maintenance of a machine in order to
avoid an overhaul costing $3,000 at the end of five years?
Assume nominal interest at 8%, compounded
semiannually. (4.15)
Solution:
A = $3,000(A/F, 4%, 10) = $249.87

Problem 4-108
Many people get ready for retirement by depositing
money into a monthly or annual savings plan. (4.15)
a. If $200 per month is deposited in a bank account
paying a 6% APR compounded monthly, how much
will be accumulated in the account after 30 years?
b. If inflation is expected to average 2% per year into
the foreseeable future, what is today's equivalent
spending power for your answer to Part (a)?
Solution:
a. F
actual
= $200(F/A, 0.5%, 360) = $200,903.01
b. F
constant
= F
actual
(P/F, 2%, 30) = $110,912.70

Problem 4-111
Suppose you owe $1,100 on your credit card. The annual
percentage rate (APR) is 18%, compounded monthly.
The credit card company says your minimum monthly
payment is $19.80. (4.15)
a. If you make only this minimum payment, how long
will it take for you to repay the $1,100 balance
(assuming no more charges are made)?
b. If you make the minimum payment plus $10 extra
each month (for a total of $29.80), how long will it
take to repay the $1,100 balance?
c. Compare the total interest paid in Part (a) with the
total interest paid in Part (b).
Solution:
a. $1,100 = $19.80(P/A, 1.5%, N) N~120.3 mo.
b. $1,100 = $29.80(P/A, 1.5%, N) N~54.2 mo.
c. Interest (a) = Total Payment Principal = $1,282.82
Interest (a) = Total Payment Principal = $514.72
Difference = $768.09

Problem 4-118
A man deposited $10,000 in a savings account when his
son was born. The nominal interest rate was 8% per year,
compounded continuously. On the sons 18th birthday, the
accumulated sum is withdrawn from the account. How
much will this accumulated amount be? (4.16)
Solution:
i= e
.08
1 = 0.08329
F= $10,000(F/P, .08329, 18) = $42,206.96