Chapter 6 Problems

[Link] parents are giving you $500 a month for five years while you attend college to earn both
a bachelor's and a master's degree. At a 7 percent discount rate, what are these payments worth to
you when you first enter college?

2. You just won the lottery! As your prize you will receive $1,500 a month for twenty years. If
you can earn 9 percent on your money, what is this prize worth to you today?

3. Angela is able to pay $230 a month for 6 years on a car loan. If the interest rate is 7.9 percent,
how much can she afford to borrow to buy a car?

4. You are the beneficiary of a life insurance policy. The insurance company informs you that
you have two options for receiving the insurance proceeds. You can receive a lump sum of
$150,000 today or receive payments of $1,627.89 a month for 10 years. You can earn 7.5 percent
on your money. Which option should you take and why?

5. Your employer contributes $50 a week to your retirement plan. Assume that you work for
your employer for another 12 years and that the applicable discount rate is 8 percent. Given these
assumptions, what is this employee benefit worth to you today?

[Link] have a sub-contracting job with a local manufacturing firm. Your agreement calls for
annual payments of $82,000 for the next 3 years. At a discount rate of 9.5 percent, what is this
job worth to you today?
7. You need some money today and the only friend you have that has any is your miserly friend.
He agrees to loan you the money you need, if you make payments of $15 a month for the next
nine months. In keeping with his reputation, he requires that the first payment be paid today. He
also charges you 2 percent interest per month. How much money are you borrowing?

8. The Home Improvement Center (HIC) has an employment contract with the newly hired CEO.
The contract requires a lump sum payment of $32.4 million be paid to the CEO upon the
successful completion of her first five years of service. HIC wants to set aside an equal amount
of money at the end of each year to cover this anticipated cash outflow and will earn 7.25 percent
on the funds. How much must HIC set aside each year for this purpose?

9. Pat retires at age 58 and expects to live to age 90. On the day she retires, she has $287,409 in
her retirement savings account. She is conservative and expects to earn 5.25 percent on her
money during her retirement years. How much can she withdraw from her retirement savings
each month if she plans to die on the day she spends her last penny?

[Link] are buying a previously owned car today at a price of $4,950. You are paying $750 down
in cash and financing the balance for 42 months at 8.45 percent. What is the amount of each loan
payment?

11. Your car dealer is willing to lease you a new car for $199 a month for 72 months. Payments
are due on the first day of each month starting with the day you sign the lease contract. If your
cost of money is 5.45 percent, what is the current value of the lease?
12. You just received an insurance settlement offer related to an accident you had four years ago.
The offer gives you a choice of one of the following three offers:

Option A: $6,500 on the first day of each year for 40 years

You can earn 8.75 percent on your investments. You do not care if you personally receive the
funds or if they are paid to your heirs should you die within the settlement period. Which option
should you choose and why.?

13. Priestly Engineers wants to save $145,000 to buy some new equipment two years from now.
The plan is to set aside an equal amount of money on the first day of each quarter starting today.
The firm can earn a 5.5 percent rate of return. How much does the firm have to save each quarter
to achieve their goal?

14. Starting today, Stephen is going to contribute $200 on the first of each month to his
retirement account. His employer will contribute an additional 50 percent of the amount Stephen
contributes. If both Stephen and his employer continue to do this and he can earn a monthly rate
of 0.75 percent, how much will Stephen have in his retirement account 40 years from now?

15. Susan Sunshine has been investing $160,000 a year for the past 9 years into Sunshine in a
Can, Inc. Today, as the sole shareholder, she sold Sunshine in a Can, Inc. for $2.6 million. What
is her rate of return on this investment?

16. Ottawa Manor would like to buy some additional land and build a new assisted living center.
The anticipated total cost is $12.4 million. The CEO of the firm is quite conservative and will
only do this when the company has sufficient funds to pay cash for the entire construction
project. Management has decided to save $235,000 a month for this purpose. The firm earns 7
percent compounded monthly on the funds it saves. How long does the company have to wait
before expanding its operations?
17. Your insurance agent is trying to sell you an annuity that costs $165,000 today. By buying
this annuity, your agent promises that you will receive payments of $775 a month for the next 40
years. What is the rate of return on this investment?

18. You just settled an insurance claim. The settlement calls for increasing payments over a 5-
year period. The first payment will be paid one year from now in the amount of $30,000. The
following payments will increase by 6 percent annually. What is the value of this settlement to
you today if you can earn 8.5 percent on your investments?

19. A wealthy benefactor just donated some money to the local college. This gift was established
to provide scholarships for worthy students. The first scholarships will be granted one year from
now for a total of $50,000. Annually thereafter the scholarship amount will be increased by 5
percent to help offset the effects of inflation. The scholarship fund will last indefinitely. What is
the value of this gift today at a discount rate of 7.5 percent?

20. Stevenson Interiors of Kingston has a $67,500 liability they must pay four years from today.
The company is opening a savings account so that the entire amount will be available when this
debt needs to be paid. The plan is to make an initial deposit today and then deposit an additional
$10,000 a year for the next four years, starting one year from today. The account pays a 5
percent rate of return. How much does the firm need to deposit today?

21. Mrs. Black established a trust fund that provides $65,000 in scholarships each year for needy
students. The trust fund earns a fixed 5.5 percent rate of return. How much money did Mrs.
Black contribute to the fund assuming that only the interest income is distributed?

22. You just paid $425,000 for an insurance annuity that will pay you and your heirs $15,000 a
year forever. What rate of return are you earning on this policy?
23. Your father won a lottery years ago. The value of his winnings at the time was $225,000.
He invested this money such that it will provide annual payments of $12,000 a year to his heirs
forever. What is the rate of return?

24. Your credit card company quotes you a rate of 18.9 percent. Interest is billed monthly. What
is the actual rate of interest you are paying?

25. On the day you enter college you borrow $12,000 from your local bank. The terms of the
loan include an interest rate of 5.45 percent. The terms stipulate that the principle is due in full
one year after you graduate. Interest is to be paid annually at the end of each year. Assume that
you complete college in four years. How much will you pay the bank one year after you
graduate?

26. On the day you enter college you borrow $18,000 from your local bank. The terms of the
loan include an interest rate of 5.75 percent. The terms stipulate that the principle is due in full
one year after you graduate. Interest is to be paid annually at the end of each year. Assume that
you complete college in four years. How much total interest will you pay on this loan?

27. On March 1, you borrow $239,000 to buy a house. The mortgage rate is 7.75 percent. The
loan is to be repaid in equal monthly payments over 20 years. The first payment is due on April
1. How much of the third payment applies to the principal balance? (Assume that each month is
equal to 1/12 of a year.)