Practice Questions Set 2
Theme: Time value of Money
Q1. The Mutual Assurance and Life Company is offering an Insurance Policy under either of the
following two terms:
(a) Make a series of twelve $1,200 payments at the beginning of each of the next 12 years (the
first payment being made today).
(b) Make a single lump-sum payment today of $10,000 and receive coverage of the next 12 years.
If you had an investment opportunity offering an 8% annual return, which alternative would you
prefer?
Q2. A firm purchases 100 acres of land for $200,000 and agrees to remit 20 equal annual end-of-year
instalments of $41,067/- each. What is the true annual interest rate on this loan?
Q3. Two investment opportunities are open to you: Investment 1 and Investment 2. Each has an initial
cost of $10000. If you desire a 10% return on your initial investment, compute the present values of
the cash inflows and evaluate their relative attractiveness.
Investment 1 Investment 2
Year Cash Flows Year Cash Flows
1 $5000 1 $8000
2 $6000 2 $7000
3 $7000 3 $6000
4 $8000 4 $5000
Q4. An investment promises to pay $6000 at the end of each year for the next five years and $4000 at
the end of each year for years 6 through 10. If you require a 12% rate of return on this investment,
what is the maximum amount you would pay for this investment?
Q5. An investment offers the following year-end cash flows:
End of the Year Cash Flows
1 $20,000
2 $30,000
3 $15,000
Using a 15% interest rate, convert this series of irregular cash flows to an equivalent (in present value
terms) 3-year annuity.
Q6. IRA Investments develops retirement programs for individuals. You are 30 years old and plan to
retire on your 60th birthday. You want to establish a plan with IRA that will require a series of equal
payments, annual, end-of-year deposits into the retirement account. The first deposit will be made
one year from today on your 31st birthday. The final payment on the account will be made on your
60th birthday. The retirement plan will allow you to withdraw $120000 per year for 15 years, with the
first withdrawal on 61st birthday. Also, at the end of the 15th year, you wish to withdraw an additional
$250,000. The retirement account promises to earn 12% annually. What periodic payment must be
made into the account to achieve your retirement objective?
Q7. Torbet Fish Packing Company wants to accumulate enough money over the next 10 years to pay
for the expected replacement of its digitalized, automated scaling machine. The new machine is
expected to cost $200,000 in 10 years. Torbet currently has $10,000 that it plans to invest over the
next 10 years to help pay for the new machine. Torbet wants to put away an equal, end-of-yea amount
into a sinking fund investment account at the end of each of the next 10 years. Earnings on all of the
investments are expected to be 7 percent for the first five years and 9 percent thereafter. What equal,
end-of-year amount must Torbet save each other over the next 10 years to meet these needs?
Q8. Crab State Bank has offered you a $1,000,000 five-year loan at an interest rate of 11.25%, requiring
equal annual end-of-year payments that include both principal and interest on the unpaid balance.
Develop an amortization schedule for this loan.
Q9. While Mary Corens was a student at the University of Tennessee, she borrowed $12,000 in student
loans at an annual interest rate at 9%. If Mary repays $1500 per year, then how long (to the nearest
year) will it take her to pay the loan?
Q10. What is the present value of a perpetuity of $100 per year if the appropriate discount rate is 7%.
If interest rates in general were to double and the appropriate discount rate rose to 14%, what would
happen to the present value of perpetuity?
