rigtltlY oF BII$IISSS rIrD Egol{omcs

co8FogfiE flIlrrrcE (rnv*. roos)

.&s5rciflMf-Nr fuurt g/2olo

The Problans and p4ge numbers refer to problems in the texf Corporate Finance
Fundamentals, byRWJ, McGraw-Hill, 96 ed. zoto.

la Problern 6-2. (Present Value and Multiple Cash Flows, p.179).

lb. Problem 6-3. (Future Value and Multiple Cash Flows, p.179)
lc. Problem G38 (GrowingAnruity, p.183)
ld. Problem 642. (Calculating Loan Payment with balloon paymen! p.l33)

2u hoblem 6-52. (Calculating hesent Values ofAnnuities, p.l8a)

2b. Problem 6-66, (Annuity Paynents, Part (a) only (Savings Plan) , p.1S6-7)

3a- Problem 6-12 (Calculating EAR given APR, p.180)

3b. Problem 6-13 (CalculatingAPR given EAR, p.180)
3c. Problem 6-51 (Calculating EA& p.18a)

4a. hoblem 6-53 (CalculatingAnnuities Due, p.18a)

4b. Problem 6-55 (Amortization with Equal Payments, p.l8a)
4c. Problem 6-56 (Amortization with Equal Principal Paynents, p.185)

5. Financial Planning, Calculating Annuity Values

David is 30 years old and wants to save to meet 3 objectives:
(1) He would like to retire 30 years from now with retirement income of $35,000 per
'first
month for 20 years, with the paynent received 30 years and I month from now.
(2) He would like to purchase a house in China 10 years from now for about
$600,000.
(3) He would like to accumulate by age 80 an amount of $1,000,000 which he can pass
on to his relatives.
a. He can afford to save $6,000 per month for the next l0 years. Ifhe can earn an 8
percent EAR before he retires and 5 percent EAR after he retires, how much will he
have to save each month in years 11 through 30?
b. Apart from the 3 objectives, what other things has David missed that he should
consider in his retirement planning?
 CHA PTE R6 Discounted Cash Flow Valuation

APR and EAR [LO4] Should lending laws be changed to require lenders to report
EARs instead of APRs? Why or whY not?
Time Value [LOf l On subsidized Stafford loans, a common source of financial aid
for college students, interest does not begin to accme until repayment begins. Who
receives a bigger subsidy, a freshman or a senior? Explain. In words, how'would
you go about valuing the subsidy on a subsidized Stafford loan?
Time Value [LO1] Eligibiliry for a subsidized Stafford loan is based on curent
financial need. However, both subsidized and unsubsidized Stafford loans are repaid
out of future income. Given this, do you see a possible objection to having two types?
10. Time Value [LO1] Aviatical settlement is a lump sum of money given to a
terminally ill individual in exchange for his life insurance policy. When the insured
person dies, the purchaser receives the payout from the life insurance policy. What
factors determine the value of the viatical settlement? Do you think such
settlements are ethical? Why or why not?

Present value and Multiple cash Flows [LOll seaborn co. has identified an BASIC
investment project with the following cash flows. If the discount rate is 10 percent, (Questions 1-28)

what is the present value of these cash flows? What is the present value at
l8 percent? At24 percent?
Year Cash Flow
1 $950
2 1,040
3 1 ,130
4 1,075

' Present Value and Multiple Cash Flows [LO'l] Investment X offers to pay you
Y offers to pay you $8'000 per
::,$6,000 per year for nine years, whereas lnvestment
flow streams has the higher present value if
; year for siryears. Which of these cash
i,iir Aft""*, *." it S percent? If the discount rate is 15 percent?

Future Value and Multiple Cash Flows [LOil Paradise, Inc', has identified an z.
investment project with the following cash flows. If the discount rate is 8 percent,
what is the future value of these cash flows in year 4? What is the future value at a
discountrate of 11 percent? At24 percent?

Year Cash Flow

1 $940
2 1,090
3 1,340
q 1,405
:;

ilculatingAnnuity present Value [LOl] An investment offers $5,300 per year

: 15 years" with the first payment occurring one year from now' If the required -
irrn is Z percent, what is the value of the investment? What would the value be if
payments occurred for 40 years? For 75 years? Forever?
tc:ulatingAnnuity cash Flows [Lol] If you put up $34,000 today in exchange
/.65 percent, 15-year annuity, what will the annual cash flow be?

ir.
 PART 3 Valuationof FutureCashFtows

6.carcuratingAnnuitvvarueslt"l."-?:ffi#iJll"f lf:l'ii;:g:;nt#"*"'
a ur present varue or the
my;:"*:rl;.x 3i"T;:H:ffiil'n"
savings?

fi jjff *i11
$t,|-
". L:J,ff fi,fi::fl *"T:jdeposits
varues
7 carcurating Annuitv L?11 11
paymg r-r'r
t"-izo y"ars into an account you have if you make
vou have r *" J"i""r-t io v"Lri no*"r"J
8.Hfl jiltlil,3i''#"i."*'ii':.
years from now' and vou;;3"'"iL*in"tr 6.8 p"r""nt interest, what
'l",il:Annu*y*"":l:?:1,.:"#T$1
account l0 *
the end of each Yll-"o
il" """""t' "
e ffi$Hli:::;lH:::'ia 3'ffi""1#;ff:lffJ[1.;?l?;:;il.;;-
co is
n" Pav Lire Insurance
* ; :*ff*:'"::'ffittii[?"'j "'*0"
tryinsto*ur"',T?i",**;"u*i:l;iii-nli:i*W#ili*':f
'- r
Ji'i ru '
-

on tnrs lnvtrlurvrrr
iJt?o'"u"t' it ttre required return

,,1*nt$il:'ffi
r^'
Jr*.iut" totd yoo the policy
y::"::.ti?#,,'eH"fffi:niJ:"'f;T;"T'J"nT':*:
costs $J /

tfi:;*l*"AR Ftnd the EAR tn each

orthe r:1]o\:::;:;::
rz2. [Lo4]

QuadertY
8o/o
Monthly
16
DailY
12
lnfinite
16
following
rate' in each of the
Find the APR, or shted
1,3. CalculatingAPR[LO41
CASES:

Hutft-t
o r't99 cotggYndol 8.60/o
SemiannuallY 19.8
MonthlY 9.4
WeeklY 16.5
lnfinite

n 14.
;;;,aty on"its business-ntial
uvrrv"Y" which
"
ililfiii"ifi:::[:ffi$ffL'
o"J'*5rra you to for
go a new

semiannually' As a potenuar borrower,

,- ^-^,tir (.orn- wants to earn an effecdve
:
loan?
ls. ili*ruti,,e,q.pl itsrT1]":11ffi::;.i:::I;ffi; ;;. *e b ank use s daly
n ;;;;ffi; consum:1,i"."'T::i'"'ffi;il5il;"quired uv. 11* to report
on
l'ffi"*r ntiur
"" g::ffi;Jlf;fiffi'-t',',
borrowers? Exptatn
wrry u'r r*'- -- *,;;;"rio
an uninrormed

io fot years
in 17
borrower' .r n,rr \xrhqr
I is the future value of $2'100
wha1 tl}t""u"u
values tLo 1

16. ;;;;t"t Future rate of 8'4 percent compo' semiannuallv'r

assuming an interest
 CHAPTER 5 Discounted Cash FtowValuation

37. GrowingAnnuity [LOIJ You have just won the lottery and will receive
$1,000,000 in one year. You will receive payments for 30 years, which will
increase 5 percent per year. If the appropriate discount rate is 8 percent, what is
the present value of your winnings?
38. Growing Annuity [LO1] Your job pays you only once a year for all the work you did
over the previous 12 months. Today, December 31, you just received your salary of
$50,000 and you plan to spend all of it. Howevet you want to start saving for
rethement beginning next year. You have decided that one year from today you will
begin depositing 5 percent ofyour annual salary in an account that will earn 11 percent
per year. Your salary will increase at 4 percent per year throughout your career. How
much money will you have on the date of your retirement 40 years from today?
39. Present Value and Interest Rates [LOIJ What is the relationship between the
value of an annuity and the level of interest rates? Suppose you just bought a
l5-year annuity of $9,000 per year at the current interest rate of 10 percent per year.
What happens to the value of your investment if interest rates suddenly drop to
5 percent? What if interest rates suddenly rise to l5 percent?
40. Calculating the Number of Payments [LO2] You're prepared to make monthly
payments of $340, beginning at the end of this month, into an account that pays
6 percent interest compounded monthly. How many payments will you have made
when your account balance reaches $20,000?
41. CalculatingAnnuity Present Values [LO2J You want to borrow $73,000 from
your local bank to buy a new sailboat. You can afford to make monthly payments of
$1,450, but no more. Assuming monthly compounding, what is the highest rate you
can afford on a 60-month APR loan?
Calculating Loan Payments [LOzl You need a 30-year, fixed-rate mortgage to n
buy a new home for $240,000. Your mortgage bank will lend you the money at a
6.35 percent APR for this 360-month loan. However, you can afford monthly
payments of only $1,150, so you offer to pay off any remaining loan balance at the
end of the loan in the form of a single balloon payment. How large will this balloon
payment have to be for you to keep your monthly payments at $1,150?
Present and Future Values [LO1] The present value of the following cash flow
stream is $6,550 when discounted at l0 percent annually. What is the value of the
missing cash flow?

Year Gash Flow

1 $1,700
2?
3 2,100
4 2,800

':Calculating Present Values [LOl] You just won the TVM Lottery. You will
receive $l milliontoday plus another 10 annual payments that increase by
,000 per year. Thus, in one year, you receive $1.5 million. In two years you
get $2 million, and so on. If the appropriate interest rate is 9 percent, what is the
value of your winnings?
versus APR [LO4] You have just purchased a new warehouse. To finance i2
1,1j
purchase, you've arranged for a 30-year mortgage loan for 80 percent ofthe
),000 purchase price. The monthly payment on this loan will be $15,000.
is the APR on this loan? The EAR?
I

PART 3 Valuationof FutureCashFlows

56.

a 46 ffi Tl!::lt,t#,*-l**::X$],$t{1,"$,'t*g;
j
relevant discount l1'fi;;;;" does the firm
today' Given a
on this asset'l At
frrm make a Profit
*oI
47. Present
"ii"H;"n*'"
at a discount
t::::;;t5;;"ived 25 vears
$4'000 per vear'
8 years rroi
*-* the last
and
, r-u"*
Luy^o annuiry pays $1,500 P"l3"1l:d
.,o' Interest Rates [Lo1]"^.:i-ilH;:'iitri"Li"'""
4s. vu'iunt" 'u*firt'1rffi::ilonthrv
::'*:mffihn!:"T:1T,'"-"T;*'""il17perce
is "t::;;;;;" the present
of
,
thereafter' what vour choice
j"illti{5it}'f"Hll-,''lr"jtr;
1'1TI"jS'"
A is a t:-v1i.i
4e.compu,inicashF,ows"::T:i+ji
accounts. Iivestment p"lcent comej':T'vesrment,
rate;;;'fu atso good ror
p"v*"I. and has an interest Jo*l
r:T,,:B to be wonh
continuornlY::il;;;;"d in today for it
ii i' u" 8 percent to invest
much money lilt"ttt*
15 years' How
A l5 years u*'r,'ri*
""-t
u, *o"tt as investment an
ftOtl Given {tllll1"^?t-. ,
a s0 :ru*#ffi tfffi'"'tt-*##5"T:i:*:-:;"
o"'*"*:*1Tff |"J:*T'IT:"'*"
s 1 i**:;:x ll* ll::T:,i"=.'-onon.":epp,Ty--q::-',;,i1fr
t"".fl'..t';fu"r',iig,1; r;q;:: l";41;"195;""
vou must
t"nlin,ootii,
i+poo'"""uuse
"e*nTl:"?llfi:i",:TJ:l"li#ru;at
or $2,a16'67Gurr,
rate wourd' have ro be quored?

o
*ili[T;T'llll'1JH;;;i'","1]A5_yearan*::r.:jfiJ":i"H#il;TlH
valu"t lii"i";,;iil,n:1t.:-po,
sz. galcuratinewittPresent
uegin 8 years
tt;j'i;;;""nt.compounc monthty, what rs m" y{ul
puy**,, years from now,
wt1.
now. lf the- discount:1?Hi*il is the valut rhree
from
*t ""tJtt fi'u" Y?*^ji^o'1""''' --:"^ rtlo ooo o"'i
"t
s3
ix$ffiT*ffi':-;:i}4fi*dffi,'**l'f.;-
,;
*1ffi,'ffii:ilJil:""jJ53:"ffi:"'"*;"*'"
to inn"'t th"
n*n if the paymeno
9'1t^Th;.ny?
;*"'ii
t" - l"
What
*t
b' Suppose
are an ordtnary
;ltr,ii
'oupayments
value if the
ili-.- ordinarv *Tn'
or annuitv *t*j
'-' 'r"o? Whl
,- i1plesent value, rhe
rue?
c' which
" #;;;itn"st future
*1'y:;;;;;"t
lT'*:.T.t'.i3.ii"J'*nt
value? this alwavs be
;w car from ltr'\$'i
has rr A{r vn,, **, ;;;;
the highesttuturt- a new sports "1.t:::"YH
4 :^*riltrU{ni=ffi",1;'::nlH"$m'*
''{'
s

*ru,'.X',1"1'* ;:l'fi
il;tt'l ::.::
Ji'r:"#y; T";.,ff ,il: fji#-.
:#
ss
lffiT*"HJ:ft#$Tqi:'.;1#:J [lhti r: illli,"*''ow 1
lhT*::ll$l?ffi't$[]t:":*' i
 CHAPTER Discounted Cash Flow Va{uation

56. Amortization with Equal Principal Payments ILOAj Rework Problem 55

assuming that the loan agreement calls for a principal reduction of $8,400 every
year instead of equal annual payments.
57. CalculatingAnnuity Values [LO1] Bilbo Baggins wants to save money to meet CHALLENGE
three objectives. First, he would like to be able to retire 30 years from now with (Questions 57-78)
retirement income of $20,000 per month for 25 years, with the first payment
received 30 years and I month from now. Second, he would like to purchase a
cabin in Rivendell in l0 years at an estimated cost of $380,000. Third, after he
passes on at the end of the 25 years of withdrawals, he would like to leave an
inheritance of $900,000 to his nephew Frodo. He can afford to save $2,500 per
month for the next l0 years. Ifhe can earn a l0 percent EAR before he retires and a
7 percent EAR after he retires, how much will he have to save each month in years
1l through 30?
58. Calculating Annuity Yalues [LO1] After deciding to buy a new car, you can
either lease the car or purchase it on a three-year loan. The car you wish to buy
costs $32,000. The dealer has a special leasing arrangement where you pay $99
today and $450 per month for the next three years. Ifyou purchase the car, you will
pay it off in monthly payments over the next three years at a 7 percent APR. You
believe you will be able to sell the car for $23,000 in three years. Should you buy
or lease the car? What break-even resale price in three years would make you
indifferent between buying and leasing?
CalculatingAnnuity Values [LOl] An All-Pro defensive lineman is in contract
negotiations. The team has offered the following salary structure:

Time Salary
0 $7,000,000
1 $4,500,000
2 $5,000,000
3 $6,000,000
4 $6,800,000
5 $7,900,000
6 $8,800,000

All salaries are to be paid in lump sums. The player has asked you as his agent to
renegotiate the terms. He wants a $9 million signing bonus payable today and a
value increase of $1,400,fi)0. He also wants an equal salary paid every
trhree months, with the first paycheck three months from now. If the interest rate is
.5 percent compounded daily, what is the amount of bis quarterly check? Assume
days in a year.
lnterest Loans [LOal This question illustrates what is known as
interest.Imagine you are discussing a loan with a somewhat unscrupulous
. You want to borrow $25,000 for one year. The interest rate is 15 percent.
and the lender agree that the interest on the loan will be .15 X $25,000 =
750. So the lender deducts this interest amount from the loan up front and gives
r'$21,250. ln this case, we say that the discount is $3,750. What's wrong here?
Annuity Values [LO1] You :ue serving on a jury. A plaintiff is suing
bity for injuries sustained after a freak street sweeper accident. In the trial,
testified that it will be five years before the plaintiff is able to return to
 Cash Flows
PA RT ] Valuation of Future

t?i'***"
workrhe juryn*"o:".1,^:;"ii::J}t#il"T,illi#i5;I"u",n""ff
iii:iilffifip60;d
*,n1rue1runn:::Jlli:f*""ta.n"""#;
;n'rne-nlif i*'sannual
$5b'000' respectivelv'
salarv for *" *'ot"^the salarv will be
(b) The present '*t"*i'"i'
;;;;;i;"" v"tt' ru** 'urulv'
Yoo

month
Assume that the ,ui*v puv*.r,' *::Tf;,*i$irj
$55,000n*,"*.iiiiidb'odor".p^**o*,utr"'ing.(d)$20,000forcourtcosts.
f n: ll::iF:t
**mt?::fl':Tffi#inT'Ti'i'ii'-*;ut'igt'"'orrower
interest rate? t^^lrinc at a olle-Y€?f loan of
62f
ii:#tTf;J*,:#T:"",HiHti:'i:'iiiitsi:'*i";;";:r"-1"*
p"r"Jnt p"r"-ntug" t"t"'t;t thaloan
*lit^3t"tes similar to
in this
is simply t 1o"" interest rate quotadon
with home *otgu;""' The and repav
this one
example
are common
."quir"i,ii i",,"*y, ,o
-n1r.$;
** ;:
P: ti1ll
up rront

loan is
theloanlaterwithSpercent**":..y;;i.ut"*outoyouactualiybepayinghere?
rate on a one-vear
63. Calculating ;; ffi;oto t'ool^The interest
quoted""'ni"""t;;;tI"q;*d4n"'^t-"t"*ni"ot"m;'wtratistheEAR?

oi pJ*"'ianf cfars! i;;t"* ryp1t:f:llfi"tt""Tlilt"*

644.'#il*'il"tffi";ltl*:f*m:ry"*19:1,"i'$240'000
monsages
", tt | re
Bank and Trust rs
the applicatio;;#*"; iyt^1"* .".
appricarion,,u""iJ,*i:'."":*::#*tt"lX;*;t$fl :,T"il"J:ffi
is no'[
;-i* ggR bu'l 'lhis
ru;**'":ffi:{i3ii:i"i:n'"'J;i;"* *
;:ff;fi; iltr'"t" two loans? *out
required*'*".*.i*oablefeestp,"**"urvbecauserefundablefeesarepart.l.
a fee)'what
of the loan
'J"itt'un '

This problem illustrates "

Hf#;* with Add'on rnterest [Loa] that vou see
6s. or q""'i"e interest
"AR tlt"' 1{'Ja ' u-* ii1'*tlj1:ttn"
deceptive wav
anadvertisem"^';;i;;Judy's'stereo-iltytrt*readssomethingtikethis:
somebody has
..$1,000Instantcl"uiiiiu,ii*pr"rn.","",.idJ.i.l'*P-aylLow,Low'..:..:,
*." *i* all th]s
P"*:,*d
Monthly puv-"o,'.?'v*;r" "",-"**rrv utt ttt" manager t-"t-,^*".
APR on the loan """;;';oo
spilled ink over the ,,
:ffi;il. at 14 percent rnterest',in
,c
. you borrow $1'000 for three years
rr
Judy explains that
three Years You will owe:
I
$t'000 X 1'41854:
$1'481"54 '

$1,000 X 1'14r = "l

a strzun'
all at once might be
Now, Judy recognizes.that coming oq yith $l'481'54
l's+rti = *t
rets vou make
rowmontnr::'t"T?*;*:ii:
mautv"tow' ::
so she lets l";;
;;;;;"okkeeping^work
for her'
though'hl't':i:,:.:::5:t"'::t
;;;, "";14 percent roan? Why or why'not'/lrunatt:#:fr
ffi-i,,n"epn on this roan?
Is this a sarrr probrem A
think thls ls
gnnf Why
i,is ,t"
the EAR? t"'Li""iliio"::,
whv do you :1,:T-::*::":*".ent
is a classic'"tt'1T1,
nt problern. ,

12 66. calculating A"d;;"*""".*: t'o;;;, *u*

youl il Jhisis celebrating n"t j]tiil;I"il* u"_
1,^ ir.
time rine *lr n"rii,i
roiuing frie:d
and wants * ';;;;i;i;' T":':iTl,Ty,:il"1#:::;;'#;;;i9 ry
fr i:;'ru'*T,Ji3:fl'*:"#'if 'il#'ilffiilont'eroombirthdavYour
 CHAPTER 6 DiscountedCash FlowValuation

intends to invest her money in the local credit union, which offers 7 percent
per year. She wants to make equal annual payments on each birthday into
account established at the credit union for her retirement fund.
If making these deposits on her 36th birthday and continues to make
she starts
deposits until she is 65 (the last deposit will be on her 65th birthday), what
amount must she deposit annually to be able to make the desired withdrawals at
iretirement?
;i Suppose your friend has just inherited a large sum of money. Rather than making
il equat annual payments, she has decided to make one lump sum payment on her
35th birthday to cover her retirement needs. What amount does she have to
deposit?
i Suppose your friend's employer will contribute $1,500 to the accorrnt every year
part of the company's profit-sharing plan. In addition, your friend expects a
i,i as
$150,000 distribution from a family trust fund on her 55th birthday, which she
will also put into the retirement account. What amount must she deposit
ir annually now to be able to make the desired withdrawals at retirement?
the Number of Periods [LO2] Your Christmas ski vacation was
but it unfortunately ran a bit over budget. AII is not lost: Youjust received an
in the mail to transfer your $10,000 balance from your current credit card,
ich charges an annual rate of 19.8 percent, to a new credit card charging a rate of
2 percent. How much fastercould you pay the loan off by making your planned
payments of $200 with the new card? What if there was a2 percent fee
on any balances transferred?
Value and Multiple Cash Flows [LO1] An insurance company is offering
new policy to its customers. Typically, the policy is bought by a parent or
:andparent for a child at the child's birth. The details of the policy are as follows:
purchaser (say, the parent) makes the following six payments to the insurance
v:
First birthday: $ 900
Second birthday: $ 900
Third birthday: $1 ,000
Fourth birthday: $1,000
Fifth birthday: $1 ,100
Sixth birthday: $1 ,100

After the child's sixth birthday, no more payments are made. When the child
ieaches'age 65, he or she receives $500,000. If the relevant interest rate is
12 percent for the first six years and 8 percent for all subsequent years, is the
policy worth buying?
r-Calculating a Balloon Payment You have just atranged for a $750,000
[LO2]
.'mortgagetofinancethepurchaseofalargetractofland.Themortgagehasan
8.1 pirient APR, and it calls for monthly payments over the next 30 years'
However, the loan has an eight-year balloon payment, meaning that the loan must
be paid off then. How big *iU m" balloon payment be?
,Calculating Intertst Rates [LO4l A financial planning service offers a college A'
v savings program. The plan calls for you to make six annual payments of $9,000
e
each, with the first payment occurring today, your child's 12th birthday. Beginning
rrs:
on your child's l8th birthday, the plan will provide $20,000 per year for four years.
What return is this investment offering?