FINMAN ENCLASS

EXERCISES ON TIME VALUE OF MONEY:

1. You have been hired as a financial advisor to Stephen Curry. He has received two offers for
playing professional basketball and wants to select the best offer, based on considerations
of money only. Offer A is a $10m offer for $2m a year for 5 years. Offer B is a $11m offer
of $1m a year for four years and $7m in year 5. What is your advice? (Hint: compare the
present value of each contract by assuming a range of interest rate, say 8% - 14%)

Rate
Y
R 1 2 3 4 5 8% 9% 10% 11% 12% 13% 14%

A 2.00 2.00 2.00 2.00 2.00 7.99 7.78 7.58 7.39 7.21 7.03 6.87

B 1.00 1.00 1.00 1.00 7.00 8.08 7.79 7.52 7.26 7.01 6.77 6.55

Choice

B B A A A A A

2. It is now December 31, 2011 (t=0), and a jury just found in favor of a woman who sued the
city for injuries sustained in a January 2010 accident. She requested recovery of lost wages
plus $100,000 for pain and suffering plus $20,000 for legal expenses. Her doctor testified
that she has been unable to work since the accident and that she will not be able to work
in the future. She is now 62 and the jury decided that she would have worked for another
3 years. She was scheduled to have $34,000 in 2010. (To simplify this problem, assume
that the entire annual salary amount would have been received on December 31, 2010.)
Her employer testified that she probably would have received raises of 3% per year. The
actual payment for the jury award will be made on December 31, 2012. The judge
stipulated that all dollar amounts are to be adjusted to a present value basis on December
31, 2012, using a 7% annual interest rate and using compound, not simple interest.
Furthermore, he stipulated that the pain and suffering and legal expenses should be based
on a December 31, 2011, date? How large a check must the city write on December 1,
2012?
 12/31/20
12/31/2010 12/31/2011 12/31/2012 12/31/2013 14

38267.29
34000 35020 36070.6 37152.718 954
date which
100000 payment
20000 shall be made
155020

step 1
Calculate for the salary amount from year 2010-2014
growth rate 3%

2010 34,000.00

2011 35,020.00

2012 36,070.60

2013 37,152.72

2014 38,267.30

step 2
Compound or discount the salaries, pain and suffering fees to the date of payment
given:
rate 7%
present value of all cf
at yr 3 309,014.91

or

37,152.
cf 34,000.00 155,020.00 36,070.60 72 38,267.30
npv $252,248.21
npv compounded
at year 3 309,014.91
3. You are planning for retirement 34 years from now. You plan to invest $4,200 per year
for the first 7 years, $6,900 per year for the next 11 years, and $14,500 per year for the
following 16 years (assume all cash flows occur at the end of each year). If you believe
you will earn an effective annual rate of return of 9.7%, what will your retirement
investment be worth 34 years from now?

SOLUTION

4. You plan to retire 33 years from now. You expect that you will live 27 years after retiring.
You want to have enough money upon reaching retirement age to withdraw $180,000
from the account at the beginning of each year you expect to live, and yet still have
$2,500,000 left in the account at the time of your expected death (60 years from now).
You plan to accumulate the retirement fund by making equal annual deposits at the end
of each year for the next 33 years. You expect that you will be able to earn 12% per year
on your deposits. However, you only expect to earn 6% per year on your investment after
 you retire since you will choose to place the money in less risky investments. What equal
annual deposits must you make each year to reach your retirement goal?
12% 6%

annual deposits at end of each year for 33 withdrawals of $180,000 at the beg of each year for the next 27
years years

0 33 60
$2,500,000

1 solve for PV of the withdrawals

BEGINNING
n 27
r 6%
pmt 180,000.00
fv 2,500,000.00
pv ?

PV ($3,038,989.79)

2 PV of the withdrawals will be the fv of the retirement plan

3 solve for the pmt of the retirment plan

END
n 33
r 12%
fv $3,038,989.79
pv 0

pmt ($8,874.79)

5. Susan is currently forty-five years old and is looking for retirement ten years from now.
She aims to have a retirement plan that allows her to withdraw P 150,000.00 at the
beginning of each year for the next fifteen years and still have a remaining balance of P
500,000.00 in the account. However, she only expects to earn 8% per year on her
investment after she retire since she will choose to place the money in less risky
investments. She currently has P 300,000.00 in an account which earns 10% annually. Her
plan is to deposit 40% of her salary to the account at the end of the next 10 years
(assuming she retires after receiving her salary for the tenth year). Her current salary is P
80,000.00 (40% of which she hasn’t deposited yet) and she expects an increase of 3% for
the first 3 years, 5% for the next 5 years, and 2% for the remaining 2 years. The
company’s policy allows managers, who worked with the company for twenty-five years,
to receive a retirement bonus in case the person decides to step down from his/her
position. At present, Susan has been working for the company for fifteen years.
a. How much should Susan receive as a retirement bonus to achieve her retirement
plan?

b. Suppose at this time Susan has only worked for the company for 10 years, how much
should she deposit today in order to reach her retirement plan?
6. Evan Spiegel, one of the youngest billionaires in the world, is planning for an early
retirement. He plans to retire 10 years from now to live a carefree world and in order to
do so he determined that he needs an amount equal to $ 3,500,000.00 today each year
that will continue indefinitely when he retires (assume withdrawn at the end of the year).
His current investment is $ 70,000,000.00 and is earning 6% annually. Inflation rates are as
follows:
 2018 1.90%
2019 1.90%
2020 1.90%
2021 1.90%
2022 2.50%
2023 2.50%
2024 2.50%
2025 3.00%
2026 3.00%
2027 3.00%

What equal annual deposit must he make each year to reach his retirement goal?

SOLUTION