Mary Mickaella R.
Ventura
BSA 3-A
Chapter 6- p. 182-183 (30-40)
30. Calculating EAR [ LO4] You are looking at an investment that has an effective annual rate of 17
percent. What is the effective semiannual return? The effective quarterly return? The effective monthly
return?
Solution:
EAR = [1 + (APR / m)]m – 1
EAR = .17 = (1 + r)
2 – 1; r = (1.17)1/2 – 1 = .0817 or 8.17% per six months
EAR = .17 = (1 + r)
4 – 1; r = (1.17)1/4 – 1 = .0400 or 4.00% per quarter
EAR = .17 = (1 + r)
12 – 1; r = (1.17)1/12 – 1 = .0132 or 1.32% per month
31. Calculating Interest Expense [LO2] You receive a credit card application from Shady Banks Savings
and Loan offering an introductory rate of 1.5 percent per year, compounded monthly for the first six
months, increasing thereafter to 18 percent compounded monthly. Assuming you transfer the $5,000
balance from your existing credit card and make no subsequent payments, how much interest will you
owe at the end of the first year?
Solution:
FV = $5,000 [1 + (.015/12)]6
= $5,037.62
FV in another six months will be:
FV = $5,037.62[1 + (.18/12)]6
= $5,508.35
Interest accrued is:
Interest = $5,508.35 – 5,000.00 = $508.35
32. Calculating Annuities [LO1] You are planning to save for retirement over the next 30 years. To do
this, you will invest $700 a month in a stock account and $300 a month in a bond account. The return of
the stock account is expected to be 11 percent, and the bond account will pay 6 percent. When you
retire, you will combine your money into an account with a 9 percent return. How much can you
withdraw each month from your account assuming a 25-year withdrawal period?
Solution:
Stock account: FVA = $700[{[1 + (.11/12) ]360 – 1} / (.11/12)] = $1,963,163.82
Bond account: FVA = $300[{[1 + (.06/12) ]360 – 1} / (.06/12)] = $301,354.51
Total amount saved at retirement:
$1,963,163.82 + 301,354.51 = $2,264,518.33
PVA equation:
PVA = $2,264,518.33 = $C[1 – {1 / [1 + (.09/12)]300} / (.09/12)]
C = $2,264,518.33 / 119.1616 = $19,003.763 withdrawal per month
33. Calculating Future Values [LO1] You have an investment that will pay you 1.17 percent per month.
How much will you have per dollar invested in one year? In two years?
Solution:
FV in one year = $1(1.0117)12 = $1.15
FV in two years = $1(1.0117)24 = $1.32
EAR = (1 + .0117)12 – 1 = .1498 or 14.98%
USING EAR METHOD:
FV in one year = $1(1.1498)1
= $1.15
FV in two years = $1(1.1498)2
= $1.32
34. Calculating Annuity Payments [LO1] You want to be a millionaire when you retire in 40 years. How
much do you have to save each month if you can earn a 12 percent annual return? How much do you
have to save if you wait 10 years before you begin your deposits? 20 years?
Solution:
Starting today:
FVA = C[{[1 + (.12/12) ]480 – 1} / (.12/12)]
C = $1,000,000 / 11,764.77 = $85.00
Starting in 10 years:
FVA = C[{[1 + (.12/12) ]360 – 1} / (.12/12)]
C = $1,000,000 / 3,494.96 = $286.13
Starting in 20 years:
FVA = C[{[1 + (.12/12) ]240 – 1} / (.12/12)]
C = $1,000,000 / 989.255 = $1,010.86
35. Calculating Rates of Return [ LO2] Suppose an investment offers to triple your money in 12 months
(don’t believe it). What rate of return per quarter are you being offered?
Solution:
FV = $3 = $1(1 + r)
(12/3)
r = .3161 or 31.61%
36. Comparing Cash Flow Streams [LO1] You’ve just joined the investment banking firm of Dewey,
Cheatum, and Howe. They’ve offered you two different salary arrangements. You can have $95,000 per
year for the next two years, or you can have $70,000 per year for the next two years, along with a
$45,000 signing bonus today. The bonus is paid immediately, and the salary is paid at the end of each
year. If the interest rate is 10 percent compounded monthly, which do you prefer?
Solution:
EAR = [1 + (.10 / 12)]12 – 1 = .104713 or 10.4713%
PVA1 = $95,000 {[1 – (1 / 1.104713)2] / .104713} = $163,839.09
PVA2 = $45,000 + $70,000{[1 – (1/1.104713)2] / .104713} = $165,723.54
37. Growing Annuity [LO1] You have just won the lottery and will receive $1,000,000 in one year. You
will receive payments for 30 years, which will increase 5 percent per year. If the appropriate discount
rate is 8 percent, what is the present value of your winnings?
Solution:
PV = C {[1/(r – g)] – [1/(r – g)] × [(1 + g)/(1 + r)]t}
PV = $1,000,000{[1/(.08 – .05)] – [1/(.08 – .05)] × [(1 + .05)/(1 + .08)]30}
PV = $19,016,563.18
38. Growing Annuity [LO1] Your job pays you only once a year for all the work you did over the previous
12 months. Today, December 31, you just received your salary of $50,000 and you plan to spend all of it.
However, you want to start saving for retirement beginning next year. You have decided that one year
from today you will begin depositing 5 percent of your annual salary in an account that will earn 11
percent per year. Your salary will increase at 4 percent per year throughout your career. How much
money will you have on the date of your retirement 40 years from today?
Solution:
Next year’s salary = $50,000 (1 + .04)
Next year’s salary = $52,000
DEPOSIT:
Next year’s deposit = $52,000(.05)
Next year’s deposit = $2,600
4%
PV = C {[1/(r – g)] – [1/(r – g)] × [(1 + g)/(1 + r)]t}
PV = $2,600{[1/(.11 – .04)] – [1/(.11 – .04)] × [(1 + .04)/(1 + .11)]40}
PV = $34,399.45
Future value in 40 years:
FV = PV(1 + r)t
FV = $34,366.45(1 + .11)40
FV = $2,235,994.31
39. Present Value and Interest Rates [LO1] What is the relationship between the value of an annuity and
the level of interest rates? Suppose you just bought a 15-year annuity of $9,000 per year at the current
interest rate of 10 percent per year. What happens to the value of your investment if interest rates
suddenly drop to 5 percent? What if interest rates suddenly rise to 15 percent?
Solution:
PVA@10% = $9,000{[1 – (1/1.10)15] / .10} = $68,454.72
PVA@5% = $9,000{[1 – (1/1.05)15] / .05} = $93,416.92
PVA@15% = $9,000{[1 – (1/1.15)15] / .15} = $52,626.33
40. Calculating the Number of Payments [LO2] You’re prepared to make monthly payments of $340,
beginning at the end of this month, into an account that pays 6 percent interest compounded monthly.
How many payments will you have made when your account balance reaches $20,000?
Solution:
FVA = $20,000 = $340[{[1 + (.06/12)]t– 1 } / (.06/12)]
1.005t= 1 + [($20,000)/($340)](.06/12)
t = ln 1.294118 / ln 1.005 = 51.69 payments
