Chapter 5

Time Value of Money

ANSWERS TO END-OF-CHAPTER QUESTIONS

5–1
012345

PV = 10,000 FV5 = ?

FV5 = $10,000(1.10)5
= $10,000(1.61051) = $16,105.10.

Alternatively, with a financial calculator enter the following: N = 5,

I = 10, PV = -10000, and PMT = 0. Solve for FV = $16,105.10.

5–2
0 5 10 15 20

PV = ? FV20 = 5,000

With a financial calculator enter the following: N = 20, I = 7, PMT = 0, and FV = 5000. Solve
for PV = $1,292.10.

5–3
0 18

PV = 250,000 FV18 = 1,000,000

With a financial calculator enter the following: N = 18, PV = -250000, PMT = 0, and FV =
1000000. Solve for I = 8.01% ≈ 8%.

5–4
0n=?

PV = 1 FVn = 2

2 = 1(1.065)n.

With a financial calculator enter the following: I = 6.5, PV = -1, PMT = 0, and FV = 2. Solve for
N = 11.01 ≈ 11 years.

5–5
Using your financial calculator, enter the following data: I = 12; PV =
-42180.53; PMT = -5000; FV = 250000; N = ? Solve for N = 11. It will take 11 years for John to
accumulate $250,000.
5–6

012345

300 300 300 300 300

FVA5 = ?

With a financial calculator enter the following: N = 5, I = 7, PV = 0, and PMT = 300. Solve for
FV = $1,725.22.

012345

300 300 300 300 300

With a financial calculator, switch to “BEG” and enter the following: N = 5, I = 7, PV = 0, and
PMT = 300. Solve for FV = $1,845.99. Don’t forget to switch back to “END” mode.

5–7

5–8

0123456

100 100 100 200 300 500

PV = ? FV = ?

Using a financial calculator, enter the following:

CF0 = 0
CF1 = 100, Nj = 3
CF4 = 200 (Note calculator will show CF2 on screen.)
CF5 = 300 (Note calculator will show CF3 on screen.)
CF6 = 500 (Note calculator will show CF4 on screen.)
and I = 8. Solve for NPV = $923.98.

To solve for the FV of the cash flow stream with a calculator that doesn’t have the NFV key,
do the following: Enter N = 6, I = 8, PV = -923.98, and PMT = 0. Solve for FV = $1,466.24. You
can check this as follows:

0123456

100 100 100 200 300 500

324.00
233.28
125.97
136.05
146.93
$1,466.23

5-9
Using a financial calculator, enter the following: N = 60, I = 1, PV =
-20000, and FV = 0. Solve for PMT = $444.89.

EAR = - 1.0
= (1.01)12 - 1.0
= 12.68%.

Alternatively, using a financial calculator, enter the following: NOM% = 12 and P/YR = 12.
Solve for EFF% = 12.6825%. Remember to change back to P/YR = 1 on your calculator.

5 – 10

a. 0 6%1
| | $500(1.06) = $530.00.
-500 FV = ?

b. 0 6%1 2
| | | $500(1.06)2 = $561.80.
-500 FV = ?

c. 0 6%1
| | $500(1/1.06) = $471.70.
PV = ? 500

d. 0 6%1 2
| | | $500(1/1.06)2 = $445.00.
PV = ? 500

5 – 11
6%
a. 0 1 2 3 4 5 6 7 8 9 10 $ 500 ( FVIF 6 %,10 )=
| | | | | | | | | | | $ 500 (1 .7908 )=$ 895 . 40 .
-500 FV = ?
12% $ 500 ( FVIF 12%,10 )=
b. 0 1 2 3 4 5 6 7 8 9 10
| | | | | | | | | | | $ 500 (3 . 1058)=$ 1 , 552. 90 .
-500 FV = ?

c. 0 6%1 2 3 4 5 6 7 8 9 10 $ 500 ( FVIF 6 %,10 )=

| | | | | | | | | | | $ 500 (0 . 5584 )=$ 279 .20 .
 PV = ? 500
12%
d. 0 1 2 3 4 5 6 7 8 9 10
| | | | | | | | | | |
PV = ? 1,552.90

$1,552.90(PVIF12%,10) = $1,552.90(PVIF6%,10) =
$1,552.90(0.3220)= $500.03; i = 6%:$1,552.90(0.5584) = $867.14.

The present value is the value today of a sum of money to be received in the
future. For example, the value today of $1,552.90 to be received 10 years in the
future is about $500 at an interest rate of 12 percent, but it is approximately
$867 if the interest rate is 6 percent. Therefore, if you had $500 today and
invested it at 12 percent, you would end up with $1,552.90 in 10 years. The
present value depends on the interest rate because the interest rate determines
the amount of interest you forgo by not having the money today.

5 – 12

a. 1997 1998 1999 2000 2001 2002

-6 12 (in millions)

With a calculator, enter N = 5, PV = -6, PMT = 0, FV = 12, and then solve for I = 14.87%.

b. The calculation described in the quotation fails to take account of the compounding
effect. It can be demonstrated to be incorrect as follows:

$6,000,000(1.20)5 = $6,000,000(2.4883) = $14,929,800,

which is greater than $12 million. Thus, the annual growth rate is less than 20 percent; in
fact, it is about 15 percent, as shown in Part a.

1997 1998 1999 2000 2001 2002

| | | | | |
-6 12 (in millions)

With a calculator, enter N = 5, PV = -6, PMT = 0, FV = 12, and then solve for I =
14.87%.

5 – 13
These problems can all be solved using a financial calculator by entering the known values
shown on the time lines and then pressing the I button.

a. 0 i=? 1
| |
+700 -749

7 percent: $700 = $749(PVIFi,1); PVIFi,1 = 0.9346.

b. 0 i=? 1
| | 7 percent.
-700 +749

c. 0 i=? 10
| |
+85,000 -201,229

$201,229/$85,000 = 2.3674 = FVIF i,10; i = 9%.

i=?
d. 0 1 2 3 4 5
| | | | | |
+9,000 -2,684.80 -2,684.80 -2,684.80 -2,684.80 -2,684.80

$9,000/$2,684.80 = 3.3522 = PVIFA i,5; i = 15%.

5 – 14
 a. ?
| | $400 = $200(FVIF7%,n)
-200 400 2 = FVIF7%,n
n  10 years.

With a financial calculator, enter I = 7, PV = -200, PMT = 0, and FV = 400. Then

press the N key to find N = 10.24. Override I with the other values to find N =
7.27, 4.19, and 1.00.

b. 10% ?
| | 2 = FVIF10%,n
-200 400 n  7 years.

c. 18% ?
| | 2 = FVIF18%,n
-200 400 n  4 years.

d. 100 ?
| | 2 = FVIF100%,n
-200 400 n = 1 year.

5 – 15

The general formula is FVAn = PMT(FVIFAi,n).

10%
a. 0 1 2 3 4 5 6 7 8 9 10
| | | | | | | | | | |
400 400 400 400 400 400 400 400 400 400
FV = ?

FVA10 = ($400)15.9374 = $6,374.96.

With a financial calculator, enter N = 10, I = 10, PV = 0, and PMT = -400. Then
press the FV key to find FV = $6,374.97.

b. 0 5% 1 2 3 4 5
| | | | | | ($200)5.5256 = $1,105.12.
200 200 200 200 200
FV = ?

With a financial calculator, enter N = 5, I = 5, PV = 0, and PMT =

-200. Then press the FV key to find FV = $1,105.13.
 c. 0 0% 1 2 3 4 5
| | | | | | ($400)5 = $2,000.00.
400 400 400 400 400
FV = ?

With a financial calculator, enter N = 5, I = 0, PV = 0, and PMT =

-400. Then press the FV key to find FV = $2,000.

d. To solve Part d using a financial calculator, repeat the procedures discussed in

Parts a, b, and c, but first switch the calculator to "BEG" mode. Make sure you
switch the calculator back to "END" mode after working the problem.
10%
(1) 0 1 2 3 4 5 6 7 8 9 10
| | | | | | | | | | |
400 400 400 400 400 400 400 400 400 400 FV = ?
FVAn(Annuity due) = PMT(FVIFAi,n)(1 + i). Therefore,
FVA10 = $400(15.9374)(1.10) = $7,012.46.

(2) 0 5% 1 2 3 4 5
| | | | | |
200 200 200 200 200 FV = ?
FVA5 = $200(5.5256)(1.05) = $1,160.38.

(3) 0 0%1 2 3 4 5
| | | | | |
400 400 400 400 400 FV = ?
FVA5 = $400(5)(1.00) = $2,000.00.

5 – 16

The general formula is PVAn = PMT(PVIFAi,n).

a. 0 10%1 2 3 4 5 6 7 8 9 10
| | | | | | | | | | |
PV = ? 400 400 400 400 400 400 400 400 400 400

PV = $400 (6.1446) = $2,457.83.

With a financial calculator, simply enter the known values and then press the key
for the unknowns. Except for rounding errors, the answers are as given below.

b. 0 5% 1 2 3 4 5
| | | | | | $200(4.3295) = $865.90.
PV = ? 200 200 200 200 200

c. 0 0% 1 2 3 4 5
| | | | | | $400(5) = $2,000.00.
PV = ? 400 400 400 400 400
 10%
d. (1) 0 1 2 3 4 5 6 7 8 9 10
| | | | | | | | | | |
400 400 400 400 400 400 400 400 400 400 PV = ?

PVAn (Annuity due) = PMT(PVIFAi,n)(1 + i). Therefore,

$400(6.1446)(1.10) = $2,703.62.

(2) 0 5%1 2 3 4 5
| | | | | |
200 200 200 200 200 200

PVAn (Annuity due) = $200(4.3295)(1.05) = $909.20.

(3) 0 0% 1 2 3 4 5
| | | | | |
400 400 400 400 400

PV = ?
PVAn (Annuity due)= $400(5)(1.00) = $2,000.00.

5 – 17

PV = $100/0.07 = $1,428.57. PV = $100/0.14 = $714.29.

When the interest rate is doubled, the PV of the perpetuity is halved.

5 – 18

0 1 2 3 4 30
| | | | |  |
85,000 -8,273.59 -8,273.59 -8,273.59 -8,273.59 -8,273.59

$85,000/$8,273.59 = 10.2737 = PVIFA i,n for a 30-year annuity.

With a calculator, enter N = 30, PV = 85000, PMT = -8273.59, FV = 0, and then solve
for I = 9%.

5 – 19
 a. Cash Stream A Cash Stream B
0 8% 1 2 3 4 5 0 1 8% 2 3 4 5
| | | | | | | | | | | |
PV = ? 100 400 400 400 300 PV = ? 300 400 400 400 100

With a financial calculator, simply enter the cash flows (be sure to enter CF 0 = 0),
enter I = 8, and press the NPV key to find NPV = PV = $1,251.25 for the first problem.
Override I = 8 with I = 0 to find the next PV for Cash Stream A. Repeat for Cash
Stream B to get NPV = PV = $1,300.32.

b. PVA = $100 + $400 + $400 + $400 + $300 = $1,600.

PVB = $300 + $400 + $400 + $400 + $100 = $1,600

5 – 20
a. FV = 423,504.48
b. FV = 681,537.69
c. 1. PMT = 46,393.42
d. 2. PMT = 84,550.80

5 – 21
5 – 22

Contract 2: PV = 10,717,847.14

5 – 23

a. If Crissie expects a 7% annual return upon her investments:

1 payment 10 payments 30 payments

N = 10 N = 30
I=7I=7
PMT = 9500000 PMT = 5500000
FV = 0 FV = 0

PV = 61,000,000 PV = 66,724,025 PV = 68,249,727

Crissie should accept the 30-year payment option as it carries the highest present value
($68,249,727).

b. If Crissie expects an 8% annual return upon her investments:

1 payment 10 payments 30 payments

N = 10 N = 30
I=8I=8
PMT = 9500000 PMT = 5500000
FV = 0 FV = 0

PV = 61,000,000 PV = 63,745,773 PV = 61,917,808

Crissie should accept the 10-year payment option as it carries the highest present value
($63,745,773).

c. If Crissie expects a 9% annual return upon her investments:

1 payment 10 payments 30 payments

N = 10 N = 30
I=9I=9
PMT = 9500000 PMT = 5500000
FV = 0 FV = 0

PV = 61,000,000 PV = 60,967,748 PV = 56,505,097

Crissie should accept the lump-sum payment option as it carries the highest present value
($61,000,000).

5 – 24

This can be done with a calculator by specifying an interest rate of 5% per period for 20
periods with 1 payment per period, or 10% interest, 20 periods, 2 payments per year.
Either way, we get the payment each 6 months:

N = 10  2 = 20.
I = 10%/2 = 5.
PV = -10000.
FV = 0.

Solve for PMT = $802.43. Set up amortization table:

Pmt of
Period Beg Bal Payment Interest Principal End Bal
1 $10,000.00 $802.43 $500.00 $302.43 $9,697.57
2 9,697.57 802.43 484.88
$984.88

You can also work the problem with a calculator having an amortization function.
Find the interest in each 6-month period, sum them, and you have the answer. Even
simpler, with some calculators such as the HP-17B, just input 2 for periods and press
INT to get the interest during the first year, $984.88. The HP-10B does the same
thing.
5 – 25

5 – 26
a. 0 12% 1 2 3 4 5
| | | | | |
-500 FV = ?

With a financial calculator, enter N = 5, I = 12, PV = -500, and PMT = 0, and then
press FV to obtain FV = $881.17. With a regular calculator, proceed as follows:

Fvn = PV(1 + i)n = $500(1.12)5 = $500(1.7623) = $881.15.

b. 06% 1 2 3 4 5 6 7 8 9 10
| | | | | | | | | | |
-500 FV = ?

Enter the time line values into a financial calculator to obtain FV = $895.42, or

mn
i
PVn= PV
( ) 1+
m
2( 5)
0. 12
= $500
( 1+
2 ) = $500(1.06)10
= $500(FVIF6%, 10) = $500(1.7908) = $895.40.

c. 0 3% 4 8 12 16 20
| | | | | |
-500 FV = ?

Enter the time line values into a financial calculator to obtain FV = $903.06, or

4(5 )
0. 12
FVn = $500
( 1+
4 ) = $500(1.03)20 = $500(1.8061) = $903.05.

d. 0 1% 12 24 36 48 60
| | | | | |
-500 ?

Enter the time line values into a financial calculator to obtain FV = $908.35, or

12 (5 )
0. 12
FVn = $500
( 1+
12 ) = $500(1.01)60 = $500(1.8167) = $908.35.

5 – 27
5 – 28

a. 0 1 2 3 9 10
•••
-400 -400 -400 -400 -400
FV = ?

Enter N = 5  2 = 10, I = 12/2 = 6, PV = 0, PMT = -400, and then press FV to get FV =

$5,272.32.

b. Now the number of periods is calculated as N = 5  4 = 20, I = 12/4 = 3, PV = 0, and PMT =

-200. The calculator solution is $5,374.07. The solution assumes that the nominal interest
rate is compounded at the annuity period.

c. The annuity in Part b earns more because some of the money is on deposit for a longer
period of time and thus earns more interest. Also, because compounding is more frequent,
more interest is earned on interest.

5 – 29

Using the information given in the problem, you can solve for the maximum car price
attainable.

Financed for 48 months Financed for 60 months

N = 48 N = 60
I = 1 (12%/12 = 1%) I = 1
PMT = 350 PMT = 350
FV = 0 FV = 0

PV = 13,290.89 PV = 15,734.26

You must add the value of the down payment to the present value of the car payments. If
financed for 48 months, Jarrett can afford a car valued up to $17,290.89 ($13,290.89 +
$4,000). If financing for 60 months, Jarrett can afford a car valued up to 19,734.26
($15,734.26 + $4,000).

5 – 30

a. E = 63.74 Years; K=41.04 Years

b. 35,825.33

a. First City Bank: Effective rate = 7%.

Second City Bank:

Effective rate = - 1.0 = (1.015)4 – 1.0

= 1.0614 – 1.0 = 0.0614 = 6.14%.

With a financial calculator, you can use the interest rate conversion feature to obtain the
same answer. You would choose the First City Bank.
b. If funds must be left on deposit until the end of the com¬pounding period (1 year for First
City and 1 quarter for Second City), and you think there is a high probability that you will
make a withdrawal during the year, the Second City account might be preferable. For
example, if the withdrawal is made after 10 months, you would earn nothing on the First
City account but (1.015)3 – 1.0 = 4.57% on the Second City account.
Ten or more years ago, most banks and S&Ls were set up as described above, but now
virtually all are computerized and pay interest from the day of deposit to the day of
withdrawal, provided at least $1 is in the account at the end of the period.

5 – 31

5 – 32

3.0449%

5 – 33
5 – 34

a. PV = 35,459.51
b. 35,459.51 (1.05) – 10,000 = 27,232.49

5 – 35
5 – 36

Begin with a time line:

0123

5,000 5,500 6,050

FV = ?

Use a financial calculator to calculate the present value of the cash flows and then
determine the future value of this present value amount:

Step 1: CF0 = 0
CF1 = 5000
CF2 = 5500
CF3 = 6050
I=7
Solve for NPV = $14,415.41.

Step 2: Input the following data:

N = 3, I = 7, PV = -14415.41, PMT = 0, and solve for FV = $17,659.50.
5 – 37
a. With a financial calculator, enter N = 5, I = 10, PV = -25000, and FV = 0, and then
press the PMT key to get PMT = $6,594.94. Then go through the amortization
procedure as described in your calculator manual to get the entries for the
amortization table.

Repayment Remaining
Year Payment Interest of Principal Balance
1 $ 6,594.94 $2,500.00 $ 4,094.94 $20,905.06
2 6,594.94 2,090.51 4,504.43 16,400.63
3 6,594.94 1,640.06 4,954.88 11,445.75
4 6,594.94 1,144.58 5,450.36 5,995.39
5 6,594.93* 599.54 5,995.39 0
$32,974.69 $7,974.69 $25,000.00

*The last payment must be smaller to force the ending balance to zero.

5 – 38

a. PMT = 34,294.65; No > 7500

b. PMT = 7,252.78; Yes > 7500
c. Loan Balance = 86,936.91
d. Baloon Payment = 86,936.91 + 7,252.78 = 94,189.69

5 – 39
5 – 40

a. N = 55 Months
b. N = 11.689 Months
c. Total Payments @$10/month. 55 x $10 = 550. Total Payments @35. 11.689 x 35 =
409.12. Extra Interest = 140.88

5 – 41

Begin with a time line:

012345
12/31/01 12/31/02 12/31/03 12/31/04 12/31/05 12/31/06 01/01/07

34,000 36,000 37,080 38,192.40 39,338.17 40,518.32 41,733.87

100,000
20,000
PV = ?
Step 1: Calculate the PV of the lost back pay:
$34,000(1.07) + $36,000 = $72,380.

Step 2: Calculate the PV of future salary (2003 - 2007):

CF0 = 0
CF1 = 36,000(1.03) = 37080.00
CF2 = 36,000(1.03)2 = 38192.40
CF3 = 36,000(1.03)3 = 39338.17
CF4 = 36,000(1.03)4 = 40518.32
CF5 = 36,000(1.03)5 = 41733.87
I=7
Solve for NPV = $160,791.50.

Step 3: Because the costs for pain and suffering and court costs are already on a present
value basis, just add to the PV of costs found in Steps 1 and 2.

PV = $72,380 + $160,791.50 + $100,000 + $20,000 = $353,171.50.

5 – 42

The $535,272.85 is the FV of a 10-year ordinary annuity. The payments will be deposited in
the bank and earn 8 percent interest. Therefore, set the calculator to "END" mode and
enter N = 10, I = 8, PV = 0, FV = 535272.85, and press PMT to find PMT = $36,949.61.

5 - 43
a. First, determine the annual cost of college. The current cost is $12,500 per year, but that
is escalating at a 5 percent inflation rate:

College Current Years Inflation Cash

Year Cost from Now Adjustment Required
1 $12,500 5 (1.05)5 $15,954
2 12,500 6 (1.05)6 16,751
3 12,500 7 (1.05)7 17,589
4 12,500 8 (1.05)8 18,468

Now put these costs on a time line:

13 14 15 16 17 18 19 20 21

-15,954 –16,751 –17,589 –18,468

How much must be accumulated by age 18 to provide these payments at ages 18 through
21 if the funds are invested in an account paying
8 percent, compounded annually?

With a financial calculator enter: CF0 = 15954, CF1 = 16751, CF2 = 17589, CF3 = 18468, and I
= 8. Solve for NPV = $61,204.41.
Thus, the father must accumulate $61,204 by the time his daughter reaches age 18.
b. She has $7,500 now (age 13) to help achieve that goal. Five years hence, that $7,500,
when invested at 8 percent, will be worth $11,020:

$7,500(1.08)5 = $11,020.

c. The father needs to accumulate only $61,204 - $11,020 = $50,184. The key to completing
the problem at this point is to realize the series of deposits represent an ordinary annuity
rather than an annuity due, despite the fact the first payment is made at the beginning of
the first year. The reason it is not an annuity due is there is no interest paid on the last
payment that occurs when the daughter is 18.

Using a financial calculator, N = 6, I = 8, PV = 0, and FV = -50184. PMT = $6,840.85 ≈ $6,841.