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BFM 1014 FUNDAMENTALS OF FINANCE

Trimester 2, 2016-2017

CHAPTER 4: TIME VALUE OF MONEY

CRITICAL THINKING AND CONCEPT REVIEW

3. What happens to a future value if you increase the rate? R? What happens to present value?

The future value rises (assuming a positive rate of return); the present value falls.

8. Would you be willing to pay $24,099 today in exchange for $100,000 in 30 years? What would
be the key considerations in answering yes or no? Would your answer depend on who is making
the promise to repay?

The key considerations would be:

(1) Is the rate of return implicit in the offer attractive relative to other, similar risk investments? and

(2) How risky is the investment; i.e., how certain are we that we will actually get the $100,000?

Thus, our answer does depend on who is making the promise to repay.

QUESTIONS AND PROBLEM

2. For each of the following, compute the future value

Present Value Years Interest Rate Future Value


$ 3,150 6 13% $6,558.15
8,453 19 7 $30,570.51
89,305 13 9 $273,791.68
227,382 21 5 $633,477.75

3. For each of the following, compute the Present Value

Present Value Years Interest Rate Future Value


$9,621.62 15 4% $ 17,328
$20,835.98 8 9 41,517
$181,135.15 13 12 790,382
$47,684.50 25 11 647,816

4. For each of the following, compute the Interest Rate

Present Value Years Interest Rate Future Value


$ 715 9 r = .0759, or 7.59% $ 1,381
905 6 r = .1127, or 11.27% 1,718
15,000 21 r = .1129, or 11.29% 141,832
70,300 18 r = .0865, or 8.65% 312,815
1
5. For each of the following, compute the Number of periods.

Present Value Years Interest Rate Future Value


$ 195 t = 20.13 years 9% $ 1,105
2,105 t = 8.34 years 7 3,700
47,800 t = 18.46 years 12 387,120
38,650 t = 9.40 years 19 198,212

6. Assume the total cost of a college education will be $280,000 when your child enters college in
18 years. You presently have $45,000 to invest. What annual rate of interest must you earn on
your investment to cover the cost of your child’s college education?
0 18

–$45,000 $280,000

To answer this question, we can use either the FV or the PV formula. Both will give the same answer
since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV / PV)1 / t – 1
r = ($280,000 / $45,000)1/18 – 1
r = .1069, or 10.69%

12. Your coin collection contains 50 1952 silver dollars. If our grandparents purchased then for
their face value when they were new, how much will collection be worth when you retire in 2058,
assuming they appreciate at a 6.1 % annual rate?

The time line is:

0 106

50 FV

To find the FV of a lump sum, we use:

FV = PV(1 + r)t
FV = $50(1.061)106
FV = $26,595.04

13. In 1895, the first US Open Golf Championship was held. The winner’s prize money was $150. In
2011, the winner’s check was $ 1,440,000. What was the annual percentage increase in the
winner’s check over this period? If the winner’s prize increases at the same rate, what will it be in
2045?

2
The time line is:

0 116

$150 $1,440,000

To answer this question, we can use either the FV or the PV formula. Both will give the same answer
since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV / PV)1 / t – 1
r = ($1,440,000 / $150)1/116 – 1
r = .0823, or 8.23%

To find the FV of the first prize in 2045, we use:

0 34

$1,440,000 FV

FV = PV(1 + r)t
FV = $1,440,000(1.0823)34
FV = $21,163,131.11

18. You have just made your first $5,000 contribution to your individual retirement account.
Assuming you earn a 10.1 % annual rate of return and make no additional contributions, what will
your account worth when you retire in 45 years? What if you wait 10 years before contributing?
(Does this suggest an investment strategy?)

To find the FV of a lump sum, we use:

FV = PV(1 + r)t

0 45

$5,000 FV

FV = $5,000(1.1010)45
FV = $379,663.95

If you wait 10 years, the value of your deposit at your retirement will be:

0 35

$5,000 FV

FV = $5,000(1.1010)35
FV = $145,052.82

Better start early!