5.3. Your parents will retire in 18 years.
They currently have $250,000, and they think they will need
$1,000,000 at retirement. What annual interest rate must they earn to reach their goal, assuming
they don’t save any additional funds?
Answer:
Amount in 18 years = 250000 *(1+r) ^ 18
1000000 = 250000 *(1+r) ^ 18
(1+r) ^ 18 = 4
1+r = 1.08
r = 1.08 – 1
r = 0.08 or 8%
5.5. You have $42,180.53 in a brokerage account, and you plan to deposit an additional $5,000 at the
end of every future year until your account totals $250,000. You expect to earn 12% annually on the
account. How many years will it take to reach your goal?
Answer:
FVA = 42180.53*(1+12%)^n + 5000*[(1+12%)^n-1]/12% = 250,000
42180.53*1.12^n + 5000*(1.12^n - 1)/0.12 = 250,000
42180.53*(1.12)^n + 41666.67*(1.12)^n - 41667.67 = 250,000
83847.2*(1.12)^n = 250,000+41666.67 = 291666.67
1.12^n = 291,666.67/83847.2 = 3.478
n = 10.998 = 11 years
5.13. Find the interest rates earned on each of the following:
a. You borrow $700 and promise to pay back $749 at the end of 1 year
PV = $700
N=1
FV = -$749
PMT = 0
I=?
I = 7%
b. You lend $700 and receive a promise to be paid $749 at the end of 1 year
PV = -$700
N=1
FV = $749
PMT = 0
I = 7%
c. You borrow $85,000 and promise to pay back $201,229 at the end of 10 years
PV = $85,000
N = 10
FV = -$201,229
PMT = 0
I = 9%
d. You borrow $9,000 and promise to make payments of $2,684.80 at the end of each the next 5
years.
PV = $9,000
N=5
FV = 0
PMT = $2,684.80
I = 15%
5-17. What is the present value of a $100 perpetuity if the interest rate is 7%? IF interest rated
doubled to 14%, what would its present value be?
The present value of a perpetuity is forced by dividing the cash flow by the discount rate
PV = $100 / O. O7 = $1,428.57
At a discount rate of 14 percent the present value falls.
PV = $100 / 0.14 = $714.29
5-22 PV of a Cash Flow Stream. A rookie quarterback in negotiating his first NFL contract. His
opportunity cost is 10%. He has been offered three possible 4-year contracts. Payments are
guaranteed, and they would be made at the end of each year. Terms of each contract are as follows
Contract 1: PV =$2,727,272.73 + $2,479,338.84 + $2,253,944.40 + $2,049,040.37 = $9,509,596.34
Contract 2: PV = $1,818,181.82 + $2,479,338.84 + $3,005,259.20 + $3,415,067.28 = $10,717,847.14
Contract 3: PV = $6,363,636.36 + $826,446.28 + $ 751,314.80 + $683,013.46 = $8,624,410.90
Contract 2 gives the quarterbacks the highest present value, therefore, he should accept Contract 2.
5-23.Wang Yun just won the lottery and she must choose among three award option. She can elect to
receive a lump sum today of $61 million to receive 10 end-of-year payments of 9.5 million or to
receive 30 end-of-year payments of 5.5 million.
A.) 1. Receive a lump sum today of $61 million
PV = $61,000,000 1/Y= 7% n= 0
FV = PV (1 + r) t
FV = $61,000,000 (1+0.07)0
FV = $61,000,000
2. Receive 10 end-of-year payments of 9.5 million
PV = $9,500,000 1/Y = 7% n= 10
FV = PV(1+ r) t
FV = $9,500,000 (1 + 0.07)0
FV = $18,693,464.47
3. Receive 30 end-of-year payments of $5.5 million
PV = $5,500,000 1/Y = 7% n = 30
FV = PV(1 + r)t
FV = $5,500,000 (1 + 0.07)0
FV = $41,905,187.05
Decision: In this case, It will be better for her to receive a lump sum today of $61 million since she will
get the highest present value
B.) If she expects to earn 8% annually, which is the best choice?
1. Receive a lump sum today of $61 million
PV = $61,000,000 1/Y = 8% n= 0
FV = PV(1 + r)t
FV = $61,000,000 (1 + 0.08)10
FV = $61,000,000
2. Receive 10 end-of-year payments of 9.5 million
PV =$9,500,000 1/Y = 8% n=10
FV = PV(1+ r)t
FV = $9,500,000 (1+ 0.08) 10
FV = $20,515,582.10
3. Receive 30 end-of-year payments of $ 5.5 million.
PV = $5,5000,000 1/Y=8% n= 30
FV = PV(1 +r)t
FV = $5,500,000 (1+0.08)30
FV = $55,389,926.17
Decision: In this case it will be better for her to receive a lump sum today of $61 million since she will get
the highest present value.
