(Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 ANSWERS TO QUESTIONS 1. Simple interest is interest that is paid (earned) on only the original amount, or principal, borrowed (lent) With compound jnterest, Jinterest payments are added to the principal and both then earn interest for subsequent periods Hence interest is compounded. The greater the mumber of periods and the more times a period interest ie paid, the greater the compounding and future value 3. The anewer here will vary according to the individual. Common answers include a savings account and a mortgage loan 4. An annuity is a series of cash receipte of the same amount over a period of time. It is worth less than a lump sum equal to the eum of the annuities to be received because of the time value of money. 5. Interest compounded continuously. It will result in the highest terminal value possible for a given nominal rate of interest 6. Im calculating the future (terminal) value, we need to know the beginning amount, the interest rate, and the number of periods. In calculating the present value, we need to know the future value or cash flow, the interest or discount rate, and the number of peri- ode. Thus, there ic only a switch of two of the four variables Van Home and Wachowice: Fundamentals of Financial Management, 126 26(Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 10 a They facilitate calculations by being able to multiply the cash flow by the appropriate discount factor. Otherwise, it is necessary to raise 1 plus the discount rate to the nt® power and divide. Prior to electronic calculators, the latter was quite laborious. With the advent of calculators, it ic much easier and the advantage of present-value tables is lessened Interest compounded as few times as possible during the five years, Realistically, it ie likely to be at least annually. Compounding more times will result in a lower present value For interest rates likely to be encountered in normal business situations the "Rule of 72" is a pretty accurate money doubling rule. Since it is easy to remember and involves a calculation that can be done in your head, it hae proven useful, Decreases at a decreasing rate. The present value equation, 1/(2 +4)", is such that as you divide 1 by increasing (linearly) amounts of i, present value decreases toward zero, but at a decreasing rate Decreases at a decreasing rate. The denominator of the present value equation increases at an increasing rate with n. Therefore, present value decreases at a decreasing rate. Van Home and Wachowice: Fundamentals of Financial Management, 126 2(Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 12, Alot. Turning to FVIF Table 3-3 in the chapter and tracing down the 3 percent column to 25 years, we see that he will increase his weight by a factor of 2.09 on a compound basic. ‘hie tranclatee into a weight of about 418 pounds at age 60 SOLUTIONS TO PROBLEMS 1. a) FY = Pola + ayP (i) Fv3 = $100(2.0)3 = $100(8) = $800 (44) Fv3 = $200(1.10)3 100 (1.331) = $133.10 (433) F¥3 = $100(1.0)? $1001) $100 D) Vn = Po(d + S)") FWAn = RE((2 + 422 - 19/4] (4) FV5 = $500(1.10)5 = $500(1.612) = $ 905.50 FVAs = $200[({2.10]5 - 1}/(.10)] $100 (6.105) = 610.50 $1,416.00 (44) PVs = $500(1.05)5 = $500(1.276) = $ 638.00 FVAs = $2001([2.05]5 - 1}/(.05)] = $200 (5.526) 552.60 $1,190.60 (Aid) FVs = $500(1.0}5 = $500(1) $ 500.00 Fas = $100(5)* = 500.00 $1,000.00 +[Note: We had to invoke 1'Hospital'e rule in the epecial case where i = 0; in short, FVIFAn = n when i = 0.] Van Home and Wachowice: Fundamentals of Financial Management, 126 28(Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 a) 2) ) a) ©) FVn = Po(t + 4)%; FVADn = RI((1 + a9 - 4)/il [a + a] (i) FVe = $500(1.10)6 = $500(2.772) = $ 886.00 FVADs = $100[({1.10]5 = 4)/(.10)] x [2.20] = $100(6.105} (1.10) = 671.55 $1,557.55 (44) FVg = $500(1.05) = $500(1.340) = $ 670.00 VADs = $100[({1-05]5 - 1)/(.05)] x [1.05] = $100(5.526} (1.05) = 580.23 $1,250.23 (iii) Fve = $500(1.0)6 = $500(2) = $ 500.00 FVADs = $100(5) = 500.00 $1,000.00 FY = Pvp (2 + [i/m])™ (4) Fv3 = $200(1 + [2/a]}12 = g200(a4.552) = $1,455.20 (44) Pv3 = $200(1 + [.10/4])22 = g100(1.345) = $ 134.50 ‘The more times @ year interest is paid, the greater the future value. It ie particularly important when the inte: et rate ie high, ae evidenced by the difference in coluticne between Parte 1.a) (i) and 1.4) (i} F¥p = PVp(1 + [i/m])™; FVp = Pvg(e) iP (4) $200(2 + [.10/1])20 = $100(2.594) = $259.40 (44) $200(2 + [.10/2])2° = $100(2.653) = $265.30 (444) $200(2 + [.10/4])40 = $100(2.685) = $268.50 (av) $200 (2.72028) = $272.03 Po = FVala/( + 4)" (4) $200(1/(2)7] = $200(.125) = $12.50 (44) $u00[2/(1.10)3] = g$u00(.751) = $75.10 (444) $200[2/(1.0)3] = g100(4) = $100 Van Home and Wachowice: Fundamentals of Financial Management, 126 29(Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 by) PVAn = RE(2 =(2/(1 + 4)™1)/4] (4) $5001(2 [1/12 + .04)71}/,04] = $500(2.775} = $1,387.50 (ii) $500[(2 -[2/(2 + .25)31}/.25] = $500(1.952} = $ 976.00 ©) Po = P¥nlt/(1 + 477] (i) § 00la/(a.04)4] = § 100(.962) = $ 96.20 S00[1/(1.04)71 4,000f1/(4.04)31 $00(.925) = 462.50 1,000(.889) = 889.00 $1,447.70 (44) $ 100[4/(1.25)4) = $ 100(.800) = $ 80.00 s00[2/(1.25)7] 500.540) 1,000(1/(4.25)31 320.00 1,000(.512) = $12.00 $ 912.00 a) (4) $1, 000[1/(1.04)"] = $1,000(.962) = $ 962.00 s00[2/ (1.04) 7] 500(.925) = 462.50 1oo[a/(1.04)3] = — 100(. 889) = 88.90 $1,513.40 (44) $1, 000[1/(1.25)4) = §1,000(.800) = ¢ 800.00 S00 [1/(1.25)7] 500(.640) = 320.00 oo tay (2.25)71 100(.512) 51.20 $1,171.20 ©) The fact that the cash flows are larger in the first period for the sequence in Part (d) results in their having a higher present value, The comparison illustrates the desirability of early cash flows 3. $25,000 = R(PVIFAgS,12) = R(2.384) R = $25,000/8.384 = $2,982 Van Home and Wachowice: Fundamentals of Financial Management, 126 30(Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 4. $50,000 R(FVIFAg$,10) = Ri14.486} R = $50,000/14.486 = $3,452 5. $50,000 = R(FVIFAgS,19) (1 + -08) = R(15.645) R = $50,000/15.645 = $3,196 6. $10,000 $16, 000 (PIF xg, 3) (PVIF<$,3) = $10,000/$16,000 = 0.625 Going to the PVIF table at the back of the book and lccking across the row for n= 3, we find that the discount factor for 17 percent ie 0.624 and that is closest to the number above 7. $10,000 = $3,000 (PVIFAxg, 4) (PVIFAx§ 4) = $10,200/$3,000 = 3.4 Going to the PVIFA table at the back of the book and looking across the row for n = 4, we find that the discount factor for ¢ percent is 3.465, while for 7 percent it is 3.367. Therefore, the note has an implied interest rate of almost 7 percent 8. xear Sales 1 $ 800,000 = $ 800,000(1.2) 2 720,000 = 600, 000(2.2) 2 64,000 = 720,000 (2.2) a 1,036,800 = 864,000 (2.2) 5 1,244,160 = 1,036, @00(1.2) 6 1,492,992 = 1,244, 160(1.2) Van Home and Wachowice: Fundamentals of Financial Management, 126 a(Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 10 a Present Value Year Amount Factor at 148 Present Value 1 $1,200 77 $1,052.40 2 2,000 768 1,538.00 3 2,400 675 1,620.00 4 1,900 592 2,124.80 5 1,600 sas 830.40 Subtotal (a) $6,165.60 1-10 (annuity) 1,400 5.216 $7,302.40 3-5 (annuity) 1,400 3.433 -4,806.20 Subtotal (b) $2,496.20 Total Present Value (a + bi $8,661.80 Amount Present Value Interest Factor ent Value $1,000 1/(1 + .20)20 = 1306 $306 1,000 ays(1 + .028)40 = 372 272 1,000 aye(-20) (20) 368 368 $1,000,000 = $1,000(1 + x%) 100 (a + x8)200 = $1,000,000/$1, 000 = 1,000 Taking the equare root of both sides of the above equation gives (2 + x8)5° = (FVIFAxg,50) = 31-623 Going to the FVIF table at the back of the book and looking across the row for n = 50, we find that the interest factor for 7 percent is 29.457, while for 8 percent it is 46.901. ‘Therefore, the Amplicit interest rate ie elightly more than 7 percent Van Home and Wachowice: Fundamentals of Financial Management, 126 32(Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 a2. a) b) °) Annuity of $10,000 per year for 15 years at 5 percent. The discount factor in the PVIFA table at the end of the book is 10.380 Purchase price = $10,000 x 10.380 = $103,800 Diecount £actor for 10 percent for 15 yeare ie 7.606 Purchase price = $10,000 x 7.606 = $76,060 Ag the ineurance company ie able to earn more on the amount put up, it requires a lower purchase price Annual annuity payment for 5 percent = $20,000/10.380 $2,890 Annual annuity payment for 10 percent = $30,000/7.606 = $3,948 The higher the interest rate embodied in the yield calcula- tions, the higher the annual payments 13. $190,000 = R(PVIFA17s,20) = R(5.628) R = $190,000/5.628 = $33,760 Van Home and Wachowice: Fundamentals of Financial Management, 126 33(Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 14. a) Vg = $8,000 = R(PVIFArt, 36) = RE(L - (4/(4 + .01)38])/(.02)1 = R(30.108) Therefore, R = $8,000/30.108 = $265.71 a (2) (3) cn MONTHLY PRINCIPAL PRINCIPAL ANOUNT END OF INSTALLMENT © INTEREST PAYNENT OWING AT MONTH END MONTH PAYMENT (Q)e-a x -02 (a = (2) ()e-a - (3) ° - $8,000.00 a $ 265.71 § 80.00 § 1es.74 7,814.28 2 265.71 78.14 187.87 7,626.72 3 265.71 16.27 1a9.44 7,437.28 4 265.71 74.37 u91.34 7,245.94 5 265.71 72.46 193.25 7,052.69 6 265.71 70.53 195.18 6,887.51 7 265.71 68.58 197.13 6,660.38 8 265.71 66.60 199.11 6,461.27 9 265.71 64.61 201.10 6,260.17 10 265.71 62.60 203.11 6,057.06 a 265.71 60.57 205.18 5,851.92 42 265.71 58.52 207.19 5,644.73 13 265.71 56.44 208.27 5,435.46 14 265.71 54.35 211.36 5,224.10 a5, 265.71 52.24 213.47 5,010.63 16 265.71 50.11 215.60 4,795.03 a7 265.71 47.95 217.76 4,577.27 1s. 265.72 45.77 219.94 4,357.33 19 265.71 43.57 222.14 4,135.19 20 265.71 41.35 224.36 3,910.83 za 265.71 39.11 226.60 3,684.23 22 265.71 36.84 228.87 3,455.36 23 265.71 34.55 231.16 3,224.20 24 265.71 32.24 233.47 2,990.73 25 265.71 29.91 235.80 2,754.93 26 265.71 27.55 238.16 2,516.77 27 265.72 25.17 240.54 2,276.23 28 265.71 22.76 242.95 2,033.28 29 265.71 20.33 205.38 1,787.90 30 265.71 17.88 247.83 1,540.07 3a 265.71 15.40 250.31 1,289.76 22 265.71 12.90 252.81 1,036.95 33 265.71 10.37 255.34 791.61 24 265.71 Taz 257.89 523.72 35 265.71 5.24 260.47 263.25 26 265.08* 2.63 263.25 0.00 $9,565.73 $1,865.73 $8,000.00 *The last payment is slightly higher due to rounding throughout Van Home and Wachowice: Fundamentals of Financial Management, 126 34(Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 b) Po = $184,000 = R(PVIFAl08,25) = R(9.077) Therefore, R = $184,000/9.077 = $20,271.01 a (2) (3) (a) ANNUAL, PRINCIPAL PRINCIPAL ANOUNT END OF INSTALLMENT ©“ INTEREST. PAYNENT OWING AT YEAR END ‘YRAR PAYHENT (een * 10 @ - @) (@e-a- (3) ° = - -- 184,000.00 1 20,272.01 § 18,400.00 = § 1,872.02 162,128.99 2 20,272.02 18,212.90 2,058.11 190,070.88 3 20,271.01 18,007.09 2,263.92 177,806.96 4 20,271.01 17,780.70 2,490.32. 175,316.65 5 20,272.02 17,531.67 2,739.34 172,577.31 6 0,272. 02 17,257.73 3,013.28 169,564.03 7 20,271.01 16, 956.40 2,314.61 166,249.42 a 20,271.01 16,624.94 3,646.07 162,603.35 2 20,272.01 16,260.34 4,010.67 158,592.68 10 20,272.01 15,859.27 4,411.74 154,180.94 aa 20,271.01 15,418.09 4,852.92 149,228.02 42 20,271.01 14,932.80 5,338.21 143,989.81 3 20,272.01 14,398.98 5,872.03 138,117.78 a4 20,272.01 33,811.78 6,459.23 131,658.55 4s 20,271.01 13,165.86 7,108.15 124,553.40 a6 20,271.01 12,455.34 7,815.67 116,737.73 a7 20,272.01 4, 673.77 8,597.24 108,140.49 as. 20,272.01 10,814.05 9,456.96 98,683.53 49 20,271.02 9,962.35 10,402.66 28,280.87 20 20,271.01 8,828.09 11,442.92 16,837.95 2a 20,272.02 7,683.80 12,587.22, 64,250.74 22 20,272.01 6,425.07 13,845.94 50,404.80 23 20,271.01 5,040.48 15,230.53 28,174.27 24 20,271.01 3,517.43 16,753.58 18,420.69 25 20,262. 76* 1,842.07 18,420.69 9.00, $506,767.00 $322,767.00 $184,000.00 *The last payment is somewhat lower due to rounding throughout Van Home and Wachowice: Fundamentals of Financial Management, 126 35(Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 45 46 at $14,300 = $3, 000(PVIFAIS$ ,n) (EVIFAIS%,n) = $14,300/$3,000 = 4.757 Going to the PVIFA table at the back of the book and looking down the colum for 4 = 15%, we find that the discount factor for years is 4.487, while the discount factor for 9 years is 4.772 Thus, it will take approximately 9 years of payments before the loan ie retired. a) $5,000,000 = R[1 + (.20/1)]5 = R(2.488) R = $5,000,000/2.488 = $2,009,646 by $5,000,000 = R[1 + (.20/2}]10 = Ri2.594) R = $5,000,000/2.594 = $1,927,525 c) $5,000,000 = R(1 + (.20/4)]20 = R(2.653) R $5,000, 000/2.653 $1,884,659 4) $5,000,000 = R(e) !-20) (5) « (2.71828) (1) R = $5,000,000/2.71828 = $1,839,398 FV of Earl's plan = ($2,000) * (FVIFA7$, 10) * (FVIF7$,35) ($2,000) x (43.816) x (10.677) $295, 027 * FY of Ivana's plan = ($2,000) x (FVIFA73, 35) = ($2,000) x (138.237) $276,474 Barl's investment program is worth ($295,027 - $276,474) = $18,553 more at retirement than Ivana's program Van Home and Wachowice: Fundamentals of Financial Management, 126 36(Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 18, Tip: First find the future value of a $1,000-a-year ordinary annuity that runs for 25 years. Unfortunately, this future value overetates our "true ending balance because three of the accumed $1,000 deposits never occurred. So, we need to then subtract three future values from our "trial" ending balance: 1) the future value of $1,000 compounded for 25 - 5 = 20 years; 2) the future value of $1,000 compounded for 25 - 7 = 18 years; and 3) the future value of $1,000 compounded for 25 - 11 = 14 years. After collecting terme, we get the following FV25 = $1,000[(FVIFAS¢,25) - (FVIFs¢,20) - (FVIF5¢,18) - (FVIFs¢,14)1 = $2,000[ (47.727) = (2.683) = (2.407) = (2.980) J = $1,000[40.687] = $40,687 19, There are many ways to solve this problem correctly. Here are two: Cagh withdravale at the END of year ° 1 2 3 4 5 6 7 8 2 SEE ESE eee eee R R R R R R Alt. #2 Thie above pattern is equivalent to R R R R R R R R R vagy er eee ee eee eee eee eee fee eee eee Seep ee Prag 11 _J PVAs - PVA $100, 000 R(PVIFA.os,9) - RIPVIFA,05,3) = $100,000 R(7.108) = -R(2.723) = $200,000 R(4.385) = $200,000 R = §100,000/(4.385) = $22,805.02 Van Home and Wachowice: Fundamentals of Financial Management, 126 37Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 Cash withdrawals at the END of year ° 1 2 3 4 5 6 7 8 2 R R R R R R Alt. #2 This above pattern is equivalent to R R R R R R es $100,000 ———4 PVAS x (PVEF. 05,3) $100,000 R(PVIFA,o5,6) (PVIF, 95,3) = $100,000 R(S.076) x (864) $100,000 R(4.386) = $100,000 R = $100,000/(4.326) $22,799.82 NOTE: Anewers to Alt. #1 and Alt. #2 differ slightly due to rounding in the table 20. E€fective annual interest rate = (1 + [i/m])™- 4 a (annually) = (14 [.096/1))2- 1 = .0860 b, (semiannually) = (1+ (096/21)? - 4 = 0983 e (quarterly) = (2+ [o96/a}#- 1 = 0995 a (monthly) = (1+ [.096/12])4? - 1 = .1003 e (daily) (1 + [.096/365]}365 - 1007 Effective annual interest rate with continuous compounding = (e)4 - 1 £ (continuous) = (2.71828) 996 - 2 = 1008 Van Home and Wachowice: Fundamentals of Financial Management, 126 38(Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 21. (Note: You are faced with determining the present value of an annuity due. And, (PVIFAg¢,40) can be found in Table IV at the end of the textbook, while (PVIFAgg,39) is not listed in the table.) Alt. 1: PVADgg = (1 + .08) ($25,000) (PVIFAgS, 40) = (2,08) ($25,000) (11.925) = $321,975 Alt. 2: PVAD4o = ($25,000) (PVIFAgg, 39) + $25,000 = ($25,000) [(1 - [1/(4 + .08)39])/.08] + $25,000 = ($25,000) (1.879) + $25,000 = $321,950 NOTE: Answers to Alt. 1 and Alt. 2 differ slightly due to rounding. 22. For approximate anewere, we can make uge of the "Rule of 72" ae follows i) 72/14 = 5.14 or 5 percent (to the nearest whole percent) Li) 72/8 = 9 percent ii) 72/2 = 36 percent For greater accuracy, we proceed as follows: ) a+ atee ae 4a) ae iia) + ae ay a) i} i} a) 2i/14 . 2.07143 © 4 0508 5 percent (to the nearest whole percent} 2 2/8 = 2-125 = 1.0905 9 percent (to the nearest whole percent) 2 2l/2 2 25 = 1.4142 = 41 percent (to the nearest whole percent} Notice how the "Rule of 72" does not work quite eo well for high rates of growth such as that seen in situation (iii) Van Home and Wachowice: Fundamentals of Financial Management, 126 39Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 SOLUTIONS TO SELF-CORRECTION PROBLEMS 4. a, Future (terminal) value of each cash flow and total future value of each stream are as follows (using Table I in the end-of-book Appendix) : FUs FOR INDIVIDUAL CASH FLOWS RECRIVED AT TOTAL CASH-FLOW END OF YRAR FUTURE STREAM 1 2 3 4 5 VALUE w $1a6.a0 $266.20 $242. $330 § «300 $1,284.60 x 878.400 ~~ ee 878.40 y - -- 1,200 1,200.00 z 202.8000 =~ 300° «2,297.80 b. Present value of each cash flow and total present value of each stream (using Table IT in the end-of-book appendix) Vo FOR INDIVIDUAL CASH FLOWS RECRIVED AT TOTAL CASH-FLOW END OF YEAR PRESENT STREAM 1 2 3 4 5 VALUE Ww $87.70 $153.80 $135.00 $177.60 $155.70 $709.80 x 526.20 = - 526.20 ¥ = - 622.80 622.80 z 475.49 = 155.70 668.60 a Plan 1 = $500(FVIFA3.5$,20) = $500([(2 + .035)?° - 1]/[.035]} = $14,139.84 b. FV9 Plan 2 = $1,000(FVIFA7.5%,10) = $1,000([(1 + .075)20 - a3/[.075]) = $14,147.09 Van Home and Wachowice: Fundamentals of Financial Management, 126 40(Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 $7.28. ©. Plan 2 would be preferred by a slight margin a. FV Plan 2 = $1,000(FVIFA7$,10) = $1,000({1 + .07)2° - 11/f.071) = $13,816.45 Now, Plan 1 would be preferred by a nontrivial $323.37 margin, 3. Indifference implies that you could reinvest the $25,000 receipt for 6 years at X$ to provide an equivalent $50,000 cash flow in year 12. In short, $25,000 would double in 6 years. Using the "Rule of 72," 72/6 = 12 percent Alternatively, note that $50,000 = §25,000(FVIFxt,6). Therefore, (FVIFxs,6) = $50,000/$25,000 = 2, In Table I in the Appendix at the end of the book, the interest factor for 6 years at 12 percent is 1.974 and that for 13 percent is 2.082. Interpolating, we have 2.000 - 1.974 saa. 2a, 2.082 - 1.974 Res 12+ as the interest rate implied in the contract For an even more accurate answer, recognize that FVIFyg,¢ can aleo be written ae (1+ i}®. Then we can solve directly for i (and X% = 1(100)) as follows (a+ ae2 (1+ ap = 20/6 22-1667 2 4 4225 A = 01225 or X¥ = 12.258 4. a. PVo = $7,000 (PVIFAgs, 20} = $7,000(11.470} = $80,290 b. PV $68,726 $7,000 (PVIFAg§, 29) = $7,000(19.818) 5. a, PVo = $10,000 = R(PVIFA, 43,4) = R(2.914) Therefore, R = $10,000/2.914 = $3,432 (to the nearest dollar) Van Home and Wachowice: Fundamentals of Financial Management, 126 a(Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 b, a (2) (3) ch ANNUAL, PRINCIPAL PRINCIPAL ANOUNT END OF INSTALLMENT INTEREST PAYNENT OWING AT YEAR END ‘YEAR PAYMENT (@e-a x 14 @ = @ (ena - (3) ° -- - - $10,000 1 $3,432 $1,400 § 2,032 7,968 2 3,432 2,116 2,316 5,652 3 3,432 91 2,642 3,012 4 3,432 421 3,012 ° $13,728 $3,728 $10,000 6. When we draw a picture of the problem, we get $1,000 at the end of every even-numbered year for years 1 through 20 ° 1 2 20 jesse easiest mest ef tt $2,000 $1,000 $1,000 TIP: Convert $1,000 every 2 yeare into an equivalent annual annuity (i.e., an annuity that would provide an equivalent present or future value to the actual cash flows) pattern. Solving for a 2- year annuity that ie equivalent to a future $1,000 to be received at the end of year 2, we get FvAg = $1,000 = R(FVIFA104,2) = R(2.100) Therefore, R = $1,000/2.100 = $476.18. Replacing every $1,000 with an equivalent two-year annuity gives us $476.19 for 20 years ° 1 2 3 20 jo pi $476.19 $476.19 $476.19 $476.19 $476.18 $476.19 PVAgo = $476.19(PVEFAL0$,20) = $476.19(8.514) = $4,054.28 Van Home and Wachowice: Fundamentals of Financial Management, 126 42(Chapter 3: The Time Value of Money ‘© Pearson Education Limited 2005 7. BEfective annual interest rate = (1 + [i/m))™ -1 = (1 + [.0706/4] - 1 = 07249 (approx. 7.25%) Therefore, we have quarterly compounding. And, investing $10,000 at 7.06% compounded quarterly for 7 months (Note: 7 months equals 2 and 1/3 quarter perieds), we get $10,000(1 + [.0706/4]}?-33 = $10,000(1.041669) = $10,416.69 @. FVAgs = $1,220(FVIFAs$,65) = $1,230[({1 + .05]©5 - 4)/(.08)] = $1,230(456.798) = $561,861.54 Our “penny saver" would have been better off by ($561,861.54 $80,000) = $481,861.54 -- or 48,186,154 penni: => by depositing the pennies saved each year into a savings account earning 5 percent compound annual interest 9. a. $50,000.08) = $4,000 interest payment $7,451.47 - $4,000 = $3,451.47 principal payment b. Total installment payments - total principal payments = total interest payments $74,514.70 - $50,000 = $24,514.70 Van Home and Wachowice: Fundamentals of Financial Management, 126