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Chapter 9
Time Value of Money
Discussion Questions
9-1. How is the future value (Appendix A) related to the present value of a single
sum (Appendix B)?
The future value represents the expected worth of a single amount, whereas the
present value represents the current worth.
1
FV = PV (1 + I)n future value PV = FV Present va lue
(1 + i )
n
9-2. How is the present value of a single sum (Appendix B) related to the present
value of an annuity (Appendix D)?
The present value of a single amount is the discounted value for one future
payment, whereas the present value of an annuity represents the discounted
value of a series of consecutive future payments of equal amount.
Money has a time value because funds received today can be invested to reach a
greater value in the future. A person would rather receive $1 today than $1 in
ten years, because a dollar received today, invested at 6 percent, is worth
$1.791 after ten years.
9-4. Does inflation have anything to do with making a dollar today worth more than
a dollar tomorrow?
Inflation makes a dollar today worth more than a dollar in the future. Because
inflation tends to erode the purchasing power of money, funds received today
will be worth more than the same amount received in the future.
9-1
Chapter 09: Time Value of Money
9-5. Adjust the annual formula for a future value of a single amount at 12 percent
for 10 years to a semiannual compounding formula. What are the interest
factors (FVIF) before and after? Why are they different?
FV = PV × FVIF ( AppendixA )
i = 12%, n = 10 3.106 Annual
i = 6%, n = 20 3.207 Semiannual
The greater the number of compounding periods, the larger the future value.
The investor should choose daily compounding over monthly or quarterly.
9-8. List five different financial applications of the time value of money.
Chapter 9
Problems
1. Future value (LO2) You invest $2,500 a year for three years at 8 percent.
a. What is the value of your investment after one year? Multiply $2,500 × 1.08.
b. What is the value of your investment after two years? Multiply your answer to part a
by 1.08.
9-2
Chapter 09: Time Value of Money
c. What is the value of your investment after three years? Multiply your answer to part
b by 1.08. This gives your final answer.
d. Confirm that your final answer is correct by going to Appendix A (future value of
$1), and looking up the future value for n = 3, and i = 8 percent. Multiply this tabular
value by $2,500 and compare your answer to the answer in part c. There may be a
slight difference due to rounding.
9-1. Solution:
a. $2,500 × 1.08 = $2,700
b. $2,700 × 1.08 = $2,916
c. $2,916 × 1.08 = $3,149.28
d. Appendix A (8%, 3 periods)
FV = PV × FVIF
$2,500 × 1.260 = $3,150
Solution:
Appendix B
PV = FV × PVIF
a. $ 8,000 × .558 = $4,464
b. $16,000 × .567 = $9,072
c. $25,000 × .315 = $7,875
Solution:
9-3
Chapter 09: Time Value of Money
Appendix B
PV = FV × PVIF (18%, 40 periods)
4. Present Value (LO4) You will receive $4,000 three years from now. The discount rate is
10 percent.
a. What is the value of your investment two years from now? Multiply $4,000 × .909
(one year’s discount rate at 10 percent).
b. What is the value of your investment one year from now? Multiply your answer to
part a by .909 (one year’s discount rate at 10 percent).
c. What is the value of your investment today? Multiply your answer to part b by .909
(one year’s discount rate at 10 percent).
d. Confirm that your answer to part c is correct by going to Appendix B (present value
of $1) for n = 3 and i = 10%. Multiply this tabular value by $4,000 and compare your
answer to part c. There may be a slight difference due to rounding.
9-4. Solution:
a. $4,000 × .909 = $3,636
b. $3,636 × .909 = $3,305.12
c. $3,305.12 × .909 = $3,004.35
d. Appendix B (10%, 3 periods)
FV = FV × PVIF
$4,000 ×.751 = $3,004.00
5. Future value (LO2) If you invest $12,000 today, how much will you have:
a. In 6 years at 7 percent?
b. In 15 years at 12 percent?
c. In 25 years at 10 percent?
d. In 25 years at 10 percent (compounded semiannually)?
9-5. Solution:
Appendix A
FV = PV × FVIF
9-4
Chapter 09: Time Value of Money
6. Present value (LO3) Your aunt offers you a choice of $20,000 in 50 years or $45 today.
If money is discounted at 13 percent, which should you choose?
9-6. Solution:
Appendix B
PV = FV × PVIF (13%, 50 periods)
PV = $20,000 × .002 = $40
Choose $45 today.
7. Present Value (LO3) Your uncle offers you a choice of $100,000 in 10 years or $45,000
today. If money is discounted at 8 percent, which should you choose?
9-7. Solution:
Appendix B
PV = FV × PVIF (8%, 10 periods)
PV = $100,000 × .463 = $46,300
Choose $100,000 after 10 years.
8. Present Value (LO3) In Problem 7, if you had to wait until 12 years to get the $100,000,
would your answer change? All other factors remain the same.
9-8. Solution:
Appendix B
PV = FV × PVIF (8%, 12 periods)
FV = $100,000 × .397 = $39,700
Choose $45,000 today.
9-5
Chapter 09: Time Value of Money
9. Present Value (LO3) You are going to receive $200,000 in 50 years. What is the
difference in present value between using a discount rate of 15 percent versus 5 percent?
9-9. Solution:
Appendix B
$200,000 $200,000
.001 (15%,50) .187 (5%,50)
$200 $17, 400
The difference is $17,200
$17, 400
− 200
$17, 200
10. Present Value (LO3) How much would you have to invest today to receive:
a. $12,000 in 6 years at 12 percent?
b. $15,000 in 15 years at 8 percent?
c. $5,000 each year for 10 years at 8 percent?
d. $40,000 each year for 40 years at 5 percent?
9-10. Solution:
Appendix B (a and b)
PV = FV × PVIF
a. $12,000 × .507 = $ 6,084
b. $15,000 × .315 = $ 4,725
Appendix D (c and d)
c. $ 5,000 × 6.710 = $ 33,550
d. $40,000 × 17.159 = $686,360
11. Future value (LO2) If you invest $8,000 per period for the following number of periods,
how much would you have?
9-6
Chapter 09: Time Value of Money
a. 7 years at 9 percent.
b. 40 years at 11 percent.
9-11. Solution:
Appendix C
FVA = A × FV IFA
a. $8,000 × 9.20 = $ 73,600
b. $8,000 × 581.83 = $ 4,654,640
12. Future value (LO2) You invest a single amount of $12,000 for 5 years at 10 percent. At
the end of 5 years you take the proceeds and invest them for 12 years at 15 percent. How
much will you have after 17 years?
9-12. Solution:
Appendix A
FV = PV × FVIF (5years, 10%)
$12,000 × 1.629 = $19,548
Appendix A
FV = PV × FVIF (15%, 12 periods)
$19,548 × 5.350 = $104,582
13. Present value (LO3) Mrs. Crawford will receive $6,500 a year for the next 14 years from
her trust. If a 8 percent interest rate is applied, what is the current value of the future
payments?
9-13. Solution:
Appendix D
PVA = A × PVIFA (8%, 14 periods)
= $6,500 × 8.244 = $53,586
14. Present value (LO3) John Longwaite will receive $100,000 in 50 years. His friends are
very jealous of him. If the funds are discounted back at a rate of 14 percent, what is the
present value of his future “pot of gold”?
9-7
Chapter 09: Time Value of Money
9-14. Solution:
Appendix B
PV = FV × PVIF (14%, 50 periods)
= $100,000 × .001 = $100
15. Present Value (LO3) Sherwin Williams will receive $18,000 a year for the next 25 years
as a result of a picture he has painted. If a discount rate of 10 percent is applied, should he
be willing to sell out his future rights now for $160,000?
9-15. Solution:
Appendix D
PVA = A × PVIFA (10%, 25 periods)
PVA = $18,000 × 9.077 = $163,386
No, the present value of the annuity is worth more than $160,000.
16. Present value (LO3) General Mills will receive $27,500 per year for the next 10 years as a
payment for a weapon he invented. If a 12 percent rate is applied, should he be willing to
sell out his future rights now for $160,000?
9-16. Solution:
Appendix D
PVA = A × PVIFA (12%, 10 periods)
PVA = $27,500 × 5.650 = $155,375
Yes, the present value of the annuity is worth less than $160,000.
17. Present value (LO3) The Western Sweepstakes has just informed you that you have won
$1 million. The amount is to be paid out at the rate of $50,000 a year for the next 20 years.
With a discount rate of 12 percent, what is the present value of your winnings?
9-17. Solution:
Appendix D
PVA = A × PVIFA (12%, 20 periods)
PVA = $50,000 × 7.469 = $373,450
9-8
Chapter 09: Time Value of Money
18. Present value (LO3) Rita Gonzales won the $60 million lottery. She is to receive
$1 million a year for the next 50 years plus an additional lump sum payment of $10 million
after 50 years. The discount rate is 10 percent. What is the current value of her winnings?
9-18. Solution:
Appendix D
PVA = A × PVIFA (10%, 50 periods)
PVA = $1,000,000 × 9.915 = $9,915,000
Appendix B
PV = FV × PVIF (10%, 50 periods)
PV = $10,000,000 × .009 = $90,000
$ 9,915,000
90,000
$10,005,000
19. Future value (LO2) Bruce Sutter invests $2,000 in a mint condition Nolan Ryan baseball
card. He expects the card to increase in value 20 percent a year for the next five years.
After that, he anticipates a 15 percent annual increase for the next three years. What is the
projected value of the card after eight years?
9-19. Solution:
Appendix A
FV = PV × FVIF (20%, 5 periods)
= $2,000 × 2.488 = $4,976
FV = PV × FVIF (15%, 3 periods)
= $4,976 × 1.521 = $7,568.50
20. Future value (LO2) Christy Reed has been depositing $1,500 in her savings account every
December since 2001. Her account earns 6 percent compounded annually. How much will
she have in December 2010? (Assume that a deposit is made in December of 2010. Make
sure to count the years carefully.)
9-9
Chapter 09: Time Value of Money
9-20. Solution:
Appendix C
FVA = A × FVIFA (6%, n = 10)
FVA = $1,500 × 13.181 = $19,771.50
21. Future value (LO2) At a growth (interest) rate of 8 percent annually, how long will it take
for a sum to double? To triple? Select the year that is closest to the correct answer.
9-21. Solution:
Appendix A
22. Present value (LO3) If you owe $30,000 payable at the end of five years, what amount
should your creditor accept in payment immediately if she could earn 11 percent on her
money?
9-22. Solution:
Appendix B
PV = FV × PVIF (11%, 5 periods)
PV = $30,000 × .593 = $17,790
23. Present value (LO3) Barney Smith invests in a stock that will pay dividends of $3.00 at
the end of the first year; $3.30 at the end of the second year; and $3.60 at the end of the
third year. Also, he believes that at the end of the third year he will be able to sell the stock
for $50. What is the present value of all future benefits if a discount rate of 11 percent is
applied? (Round all values to two places to the right of the decimal point.)
9-23. Solution:
9-10
Chapter 09: Time Value of Money
Appendix B
PV = FV × PVIF
Discount rate = 11%
24. Present value (LO3) Mr. Flint retired as president of Color Title Company but is currently
on a consulting contract for $45,000 per year for the next 10 years.
a. If Mr. Flint’s opportunity cost (potential return) is 10 percent, what is the present
value of his consulting contract?
b. Assuming that Mr. Flint will not retire for two more years and will not start to receive
his 10 payments until the end of the third year, what would be the value of his
deferred annuity?
Solution:
Using a Two Step Procedure
Appendix D
a. PVA = A × PVIFA (i = 10%, 10 periods)
= $45,000 × 6.145 = $276,525
Appendix B
b. PV = FV × PVIF (i = 10%, 2 periods)
$276,525 × .826 = $228,410
Alternative Solution
Appendix D
a. PVA = A × PVIFA (10%, 10 periods)
PVA = $45,000 × 6.145 = $276,525
9-11
Chapter 09: Time Value of Money
b. Deferred annuity-Appendix D
PVA = $45,000 (6.814 – 1.736) where n = 12; n = 2 and
i = 10%
= $45,000(5.078)
= $228,510 (or use a two step solution)
9-25. Solution:
Appendix A
FV = PV × FVIF (3%, 40 periods)
FV = $100,000 × 3.262 = $326,200
26. Special compounding (LO5) Determine the amount of money in a savings account at the
end of five years, given an initial deposit of $3,000 and a 8 percent annual interest rate
when interest is compounded (a) annually, (b) semiannually, and (c) quarterly.
9-26. Solution:
Appendix A
FV = PV × FVIF
a. $3,000 × 1.469 = $4,407 (n=5; i=8%)
b. $3,000 × 1.480 = $4,440 (n=10; i=4%)
c. $3,000 × 1.486 = $4,458 (n=20; i=2%)
9-12
Chapter 09: Time Value of Money
27. Annuity due (LO4) As stated in the chapter, annuity payments are assumed to come at the
end of each payment period (termed an ordinary annuity). However, an exception occurs
when the annuity payments come at the beginning of each period (termed an annuity due).
To find the present value of an annuity due, subtract 1 from n and add 1 to the tabular
value. To find the future value of an annuity, add 1 to n and subtract 1 from the tabular
value. For example, to find the future value of a $100 payment at the beginning of each
period for five periods at 10 percent, go to Appendix C for n = 6 and i = 10 percent. Look
up the value of 7.716 and subtract 1 from it for an answer of 6.716 or $671.60 ($100 ×
6.716).
What is the future value of a 10-year annuity of $2,000 per period where payments
come at the beginning of each period? The interest rate is 8 percent.
9-27. Solution:
Appendix C
FVA = A × FVIFA
n = 11, i = 8% 16.645 – 1 = 15.645
FVA = $2,000 × 15.645 = $31,290
28. Annuity due (LO4) Related to the discussion in problem 27, what is the present value of
a 10-year annuity of $3,000 per period in which payments come at the beginning of each
period? The interest rate is 12 percent.
9-28. Solution:
Appendix D
PVA = A × PVIFA
n = 9, i = 12% 5.328 + 1 = 6.328
PVA = $3,000 × 6.328 = $18,984
29. Present value alternative (LO3) Your grandfather has offered you a choice of one of the
three following alternatives: $5,000 now; $1,000 a year for eight years; or $12,000 at the
end of eight years. Assuming you could earn 11 percent annually, which alternative should
you choose? If you could earn 12 percent annually, would you still choose the same
alternative?
9-29. Solution:
9-13
Chapter 09: Time Value of Money
9-29. (Continued)
9-14
Chapter 09: Time Value of Money
PVA = A × PVIFA
= $1,000 × PVIFA (12%, 8 years)
= $1,000 × 4.968
= $4,968
PV = FV×PVIF
= $12,000×PVIF (12%, 8 years)
= $12,000×.404
= $4,848
30. Payment required (LO4) You need $23,956 at the end of nine years, and your only
investment outlet is an 7 percent long-term certificate of deposit (compounded annually).
With the certificate of deposit, you make an initial investment at the beginning of the first
year.
a. What single payment could be made at the beginning of the first year to achieve this
objective?
b. What amount could you pay at the end of each year annually for nine years to achieve
this same objective?
9-30. Solution:
a. Appendix B
PV= FV × PVIF (7%, 9 periods)
PV= $23,956 × .544 = $13,032.06
9-15
Chapter 09: Time Value of Money
b. Appendix C
A = FVA/FVIFA
A = $23,956/11.978 = $2,000 per year
31. Quarterly compounding (LO5) Beverly Hills started a paper route on January 1, 2004.
Every three months, she deposits $300 in her bank account, which earns 8 percent annually
but is compounded quarterly. On December 31, 2007, she used the entire balance in her
bank account to invest in an investment at 12 percent annually. How much will she have on
December 31, 2010?
9-31. Solution:
Appendix C
FVA = A × FVIFA (2%, 16 periods)
FVA = $300 × 18.639 = $5,591.70 after four years
Appendix A
FV = PV × FVIF (12%, 3 periods)
FV = $5,591.70 × 1.405
FV = $7,856.34 after three more years
32. Yield (LO4) Franklin Templeton has just invested $8,760 for her son (age one). This
money will be used for his son’s education 17 years from now. He calculates that he will
need $60,000 by the time the boy goes to school. What rate of return will Mr. Templeton
need in order to achieve this goal?
9-32. Solution:
Appendix B
PV
PVIF = (17 periods)
FV
$8,760
PVIF = = .146 Rate of return =12%
$60,000
Or
9-16
Chapter 09: Time Value of Money
Alternative solution
Appendix A
FV
FVIF = (17 periods)
PV
$60,000
FVIF = = 6.865 Rate of return = 12%
$8,760
33. Yield with interpolation (LO4) On January 1, 2008, Mr. Dow bought 100 shares of stock
at $12 per share. On December 31, 2010, he sold the stock for $18 per share. What is his
annual rate of return? Interpolate to find the answer.
9-33. Solution:
Appendix B
PV
PVIF =
FV
$12
PVIF = = .667 Return is between 14%-15% for 3 years
$18
9-17
Chapter 09: Time Value of Money
34. Yield with interpolation (LO4) C. D. Rom has just given an insurance company $30,000.
In return, he will receive an annuity of $3,200 for 20 years.
At what rate of return must the insurance company invest this $30,000 in order to make
the annual payments? Interpolate.
9-34. Solution:
Appendix D
PVIFA = PVA / A (20 periods)
= $30,000 / $3,200
= 9.375 is between 8% and 9% for 20 periods
PVIFA at 8% 9.818
PVIFA at 9% −9.129
.689
PVIFA at 8% 9.818
PVIFA computed −9.375
.443
8% + (.443/.689) (1%)
8% + .643 (1%) = 8.64%
35. Solving for an annuity (LO4) Alex Bell has just retired from the telephone company. His
total pension funds have an accumulated value of $200,000, and his life expectancy is 16
more years. His pension fund manager assumes he can earn a 12 percent return on his
assets.
What will be his yearly annuity for the next 16 years?
9-35. Solution:
Appendix D
A = PVA / PVIFA (12%,16 periods)
= $200,000 / 6.974
= $28,677.95
9-18
Chapter 09: Time Value of Money
36. Solving for an annuity (LO4) Dr. Oats, a nutrition professor, invests $80,000 in a piece of
land that is expected to increase in value by 14 percent per year for the next five years. She
will then take the proceeds and provide herself with a 10-year annuity. Assuming a 14
percent interest rate for the annuity, how much will this annuity be?
9-36. Solution:
Appendix A
FV = PV × FVIF (14%, 5 periods)
FV = $80,000 × 1.925 = $154,000
Appendix D
A = PVA/PVIFA (14%, 10 periods)
A = $154,000/5.216 = $29,524.54
37. Solving for an annuity (LO4) You wish to retire in 20 years, at which time you want to
have accumulated enough money to receive an annual annuity of $12,000 for 25 years after
retirement. During the period before retirement you can earn 8 percent annually, while
after retirement you can earn 10 percent on your money.
What annual contributions to the retirement fund will allow you to receive the $12,000
annuity?
9-37. Solution:
Determine the present value of an annuity during retirement:
Appendix D
PVA = A × PVIFA (10%, 25 years)
= $12,000 × 9.077 = $108,924
9-19
Chapter 09: Time Value of Money
9-38. Solution:
First find the present value of the first three payments.
This value at the beginning of year four (end of year three) must
now be discounted back for three years to get the present value of
the deferred annuity. Use Appendix B.
9-20
Chapter 09: Time Value of Money
PV = FV × PVIFA (10%,3periods)
= $48,680 × .751 = $36.559
Take the PVIFA for 10 years at 10% and subtract the PVIFA for 3
years at 10% to end up with the 7 year deferred annuity.
9-39. Solution:
First find the present value of the first five payments.
PV = FV × PVIF (Appendix B) i = 13%
9-21
Chapter 09: Time Value of Money
This value at the beginning of year six (end of year five) must
now be discounted back for five years to get the present value of
the deferred annuity. Use Appendix B.
PV = FV × PVIF (13%, 5periods)
= $48,834 ×.543 = $26,517
9-39. (Continued)
Next, find the total present value of all future payments.
9-22
Chapter 09: Time Value of Money
40. Deferred annuity (LO3) Kay Mart has purchased an annuity to begin payment at the end
of 2113 (the date of the first payment). Assume it is now the beginning of 2011. The
annuity is for $12,000 per year and is designed to last eight years.
If the discount rate for the calculation is 11 percent, what is the most she should have paid
for the annuity?
9-40. Solution:
Appendix D will give a factor for an 8 year annuity when the
appropriate discount rate is 11 percent (5.146). The value of the
annuity at the beginning of the year it starts (2113) is:
41. Yield (LO4) If you borrow $9,725 and are required to pay back the loan in five equal
annual installments of $2,500, what is the interest rate associated with the loan?
9-41. Solution:
Appendix D
9-23
Chapter 09: Time Value of Money
42. Loan repayment (LO4) Tom Busby owes $20,000 now. A lender will carry the debt for
four more years at 8 percent interest. That is, in this particular case, the amount owed will
go up by 8 percent per year for four years. The lender then will require Busby to pay off the
loan over 12 years at 11 percent interest. What will his annual payment be?
9-42. Solution:
Appendix A
FV = PV × FVIFA (8%, 4 periods)
FV = $20,000 × 1.360
= $27, 200 Amount owed at end of 4 periods
Appendix D
A = PVA /PVIFA (11%, 12 periods)
= $27,200/6.492
= $4,189.77 Annual payment required
43. Loan repayment (LO4) If your aunt borrows $50,000 from the bank at 10 percent interest
over the eight-year life of the loan, what equal annual payments must be made to discharge
the loan, plus pay the bank its required rate of interest (round to the nearest dollar)? How
much of his first payment will be applied to interest? To principal? How much of her
second payment will be applied to each?
9-43. Solution:
9-24
Chapter 09: Time Value of Money
Appendix D
A = PVA / PVIFA (10%, 8periods)
= $50,000 / 5.335
= $9,372.07 Annual payments
First payment:
$50,000 × .10 = $5,000 first year interest
$9,372.07 – $5,000 = $4,372.07 applied to principal
44. Loan repayment (LO4) Jim Thorpe borrows $70,000 toward the purchase of a home at 12
percent interest. His mortgage is for 30 years.
a. How much will his annual payments be? (Although home payments are usually on a
monthly basis, we shall do our analysis on an annual basis for ease of computation.
We will get a reasonably accurate answer.)
b. How much interest will he pay over the life of the loan?
c. How much should he be willing to pay to get out of a 12 percent mortgage and into a
10 percent mortgage with 30 years remaining on the mortgage? Suggestion: Find the
annual savings and then discount them back to the present at the current interest rate
(10 percent).
9-44. Solution:
Appendix D
a. A = PVA / PVIFA (12%, 30 periods)
= $70, 000 / 8.055
= $8, 690.25
9-25
Chapter 09: Time Value of Money
Appendix D
c. New payments at 10%
9-44. (Continued)
Difference between old and new payments
9-26
Chapter 09: Time Value of Money
45. Annuity with changing interest rates (LO4) You are chairperson of the investment fund
for the Continental Soccer League. You are asked to set up a fund of semiannual payments
to be compounded semiannually to accumulate a sum of $200,000 after 10 years at an 8
percent annual rate (20 payments). The first payment into the fund is to take place six
months from today, and the last payment is to take place at the end of the 10th year.
a. Determine how much the semiannual payment should be. (Round to whole numbers.)
On the day after the sixth payment is made (the beginning of the fourth year) the interest
rate goes up to a 10 percent annual rate, and you can earn a 10 percent annual rate on funds
that have been accumulated as well as all future payments into the fund. Interest is to be
compounded semiannually on all funds.
b. Determine how much the revised semiannual payments should be after this rate
change (there are 14 payments and compounding dates). The next payment will be in
the middle of the fourth year. (Round all values to whole numbers.)
9-45. Solution:
Appendix C
a. A = FVA / FVIFA
= $200,000 / 29.778(4%, 20 periods)
= $6,716
b. First determine how much the old payments are equal to after
6 periods at 4%. Appendix C.
Appendix A
FV = PV × FVIF (5%, 14 periods)
= $44,547 × 1.980
= $88, 203
9-27
Chapter 09: Time Value of Money
9-45. (Continued)
Subtract this value from $200,000 to determine how much you
need to accumulate on the next 14 payments.
$200, 000
− 88, 203
$111, 797
Appendix C
A = FVA/FVIFA
A = $111,797/19.599
A = $5,704
46. Annuity consideration (LO4) Your younger sister, Brittany, will start college in five
years. She has just informed your parents that she wants to go to Eastern State U., which
will cost $30,000 per year for four years (cost assumed to come at the end of each year).
Anticipating Brittany’s ambitions, your parents started investing $5,000 per year five years
ago and will continue to do so for five more years.
How much more will your parents have to invest each year for the next five years to
have the necessary funds for Brittany’s education? Use 10 percent as the appropriate
interest rate throughout this problem (for discounting or compounding). Round all values to
whole numbers.
9-46. Solution:
Present value of college costs
Appendix D
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Chapter 09: Time Value of Money
Appendix C
FVA = A × FVIFA (10%, 10 periods)
= $5, 000 × 15.937
= $79, 685
Additional funds required 5 years from now when Brittany starts
college.
9-46. (Continued)
Appendix C
A = FVA / FVIFA (10%, 5 periods)
= $15, 415 / 6.105
= $2,525
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Chapter 09: Time Value of Money
47. Special consideration of annuities and time periods (LO4) Brittany (from problem 46) is
now 18 years old (five years have passed), and she wants to get married instead of going to
college. Your parents have accumulated the necessary funds for her education.
Instead of her schooling, your parents are paying $10,000 for her current wedding and
plan to take year-end vacations costing $3,000 per year for the next three years.
How much money will your parents have at the end of three years to help you with
graduate school, which you will start then? You plan to work on a master’s and perhaps a
PhD. If graduate school costs $32,600 per year, approximately how long will you be able to
stay in school based on these funds? Use 10 percent as the appropriate interest rate
throughout this problem. (Round all values to whole numbers.
9-47. Solution:
Funds available after the wedding
Appendix D
PVA = A × PVIFA (10%, 3 periods)
= $3, 000 × 2.487 = $7, 461
$85,100
– 7,461
$77,639 Remaining funds for graduate school
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Chapter 09: Time Value of Money
9-47. (Continued)
Appendix A
FV = × PVIF (10%, 3 periods)
= $77, 639 × 1.331
= $103,338 Funds available for starting graduate school
Appendix D
PVA
PVIFA = (10%)
A
$103,338
= = 3.170 (rounded)
$32, 600
COMPREHENSIVE PROBLEM
Modern Weapons, Inc. (Comprehensive time value of money) Mr. Rambo, President of
Modern Weapons, Inc., was pleased to hear that he had three offers from major defense
companies for his latest missile firing automatic ejector. He will use a discount rate of 12 percent
to evaluate each offer.
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Chapter 09: Time Value of Money
Offer I $500,000 now plus $120,000 from the end of years 6 through 15. Also if the product
goes over $50 million in cumulative sales by the end of year 15, he will receive an
additional $1,500,000. Rambo thought there was a 75 percent probability this would
happen.
Offer II Twenty-five percent of the buyer’s gross margin for the next four years. The buyer
in this case is Air Defense, Inc. (ADI). Its gross margin is 65 percent. Sales for year
1 are projected to be $1 million and then grow by 40 percent per year. This amount
is paid today and is not discounted.
Offer III A trust fund would be set up for the next nine years. At the end of that period,
Rambo would receive the proceeds (and discount them back to the present at
12 percent). The trust fund called for semiannual payments for the next nine years of
$80,000 (a total of $160,000 per year). The payments would start immediately. Since
the payments are coming at the beginning of each period instead of the end, this is
an annuity due. To look up the future value of the annuity due in the tables, add 1 to
n (18 + 1) and subtract 1 from the value in the table. Assume the annual interest rate
on this annuity is 12 percent annually (6 percent semiannually). Determine the
present value of the trust fund’s final value.
Required: Find the present value of each of the three offers and then indicate which
one has the highest present value.
CP 9-1. Solution:
Modern Weapons, Inc.
Offer I
$500,000 now plus:
$120,000 from year six through fifteen (deferred annuity)
$1,500,000 75% potential bonus if sales pass $50 million
Appendix D
PVA = A × PVIFA (12%, 10 years)
= $120,000 × 5.650
= $678,000 (present value at the beginning of
year 6, i.e., the end of year 5)
Appendix B
PV = FV × PVIF (12%, 5 years)
= $678,000 × .567 = $384,426
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Chapter 09: Time Value of Money
Appendix B
PV = FV × PVIF (12%, n = 15)
= $1,125,000 × .183 = $205,875
CP 9-1. (Continued)
Offer II
Sales Gross Profit Payment 25%
Year (40% Growth) (65% of Sales) of Gross Profit
1 $1,000,000 $ 650,000 $162,500
2 1,400,000 910,000 227,500
3 1,960,000 1,274,000 318,500
4 2,744,000 1,783,600 445,900
$1,154,400
Offer III
Future value of an annuity due (Appendix C)
9 years – semiannually
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Chapter 09: Time Value of Money
N = 18 + 1 = 19
I = 12%/2 = 6%
FVIFA = 33.760 – 1 = 32.760 (using Appendix C)
FVA = A × FVIFA
= $80,000 × 32.760
= $2,620,800 Value of trust fund after 9 years
Present value of trust fund (Appendix B)
PV = FV × PVIF (12%, 9 years)
= $2,620,800 × .361 = $946,109
CP 9-1. (Continued)
Summary
Value of Offer I $1,090,301
Value of Offer II $1,154,250
Value of Offer III $ 946,109
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