Problem
1. Suppose you buy a house today with a price of $25,000 and
you plan to pay it within the next 6 years. If you are going to
make equal annual end-of-year payments to an investment
account that pays 7%, how big do these annual payments
need to be?
Chapter 4
2. If you can earn 12% on your investments, and you would like
Practice Problems – TIME VALUE OF to accumulate $100,000 for your child’s education at the
MONEY APPLICATIONS end of 18 years, how much must you invest annually to
reach your goal?
Problem Problem
3. What is the present value of an annuity of $10,000 to be received at 5. You have just found the perfect home. However, in order to
the end of each year for 10 years given a 10 percent discount rate? buy it, you will need to take out a $300,000, 30-year mortgage at
an annual rate of 6 percent. What will your monthly mortgage
4. Suppose you plan to get a $9,000 loan from a furniture dealer at 18%
annual interest with annual payments that you will pay off in over five
payments be?
years. What will your annual payments be on this loan? Amortized Loans with Monthly Payments
1
Problem Problem
6. What is the present value of a perpetuity of $500 paid annually 8. a. An investment is expected to pay returns that start with
discounted back to the present at 8 percent? 1.000 € in year 1 and later increase by 5 % per year. What is the
present value of that investment assuming a discount rate of
7. What is the present value of stream of payments equal to 10 %?
$90,000 paid annually and discounted back to the present at 9 b. What happens to the present value if the payment of the first
percent return is delayed until year 3?
Problem Problem 10
9. You plan to retire in 40 years and expect to need 800.000 € for Consider a five year investment whose cash flow consequences
living after retirement. are summarized below.
a. How much would you need to save per year to achieve this
Cash Inflows: The investment will bring $300 cash inflow each year, for
goal? Assume an interest rate of 6 %. years 1 - 5.
b. What happens if the interest rate drops to 5 %?
Cash outflows: The initial cost of the investment is a cash outflow of
$800 in year 0, followed by a cost (outflow) of $150 in year 1. There are
no expected costs in years 2 - 5.
When does payback occur?
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Problem 11 Problem 12
Company C is planning to undertake another project requiring Suppose you are looking at a new project and you have estimated the
initial investment of $50 million and is expected to generate $10 following cash flows:
million in Year 1, $13 million in Year 2, $16 million in year 3, $19
Year 0: CF = -165,000
million in Year 4 and $22 million in Year 5. Calculate the payback
value of the project. Year 1: CF = 63,120;
Year 2: CF = 70,800;
Year 3: CF = 91,080;
Your required return for assets of this risk is 12%.
How would you go about deciding whether to accept this
project or not?
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Problem 13 Problem 14
Eastern Express is considering a project with an initial You need to borrow $2,500 quickly and Slimey Joe, the
investment of $218,400. Clyde, the general manager, estimates neighborhood loan shark, will give it to you if you promise to
the project will generate additional revenues of $76,200 a year repay him $300 a month for the next year. Suppose that Joe's
for the next 4 years. How much value will this project add to the cost of funds is 2 percent per month. From Joe's point of view,
firm if the required rate of return is 15.4 percent? what is the net present value of this deal?
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3
Problem 15
California Squeaker is considering creating a new website at a
cost of $526,000. The website will provide the latest news and
gossip from around the state for an annual fee per subscriber of
$8.95 a year. The company expects to collect fees totaling
$44,750 in year 1, $89,500 in year 2, and $304,300 per year for
years 3 through 5. After year 5, the company believes the
website will be worthless due to technological advancements.
What is the potential value to the firm from this project given a
16 percent discount rate?
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