Chapter 4 Tutorial Questions

1.

Simple Interest versus Compound Interest. First City Bank pays 6 percent simple interest on its
savings account balances, whereas Second City Bank pays 6 percent interest compounded annually. If
you made a deposit of $7,500 in each bank, how much more money would you earn from your Second
City Bank account at the end of 10 years?

2.

Calculating Future Values. For each of the following, compute the future value:

3.

Calculating Present Values. For each of the following, compute the present value:

4.

Calculating Interest Rates. Solve for the unknown interest rate in each of the following:

5.

Calculating the Number of Periods. Solve for the unknown number of years in each of the
following:

6.

Calculating Rates of Return. Assume the total cost of a college education will be $280,000 when
your child enters college in 18 years. You presently have $45,000 to invest. What annual rate of interest
must you earn on your investment to cover the cost of your child's college education?
Calculating the Number of Periods. At 5 percent interest, how long does it take to double your
money? To quadruple it?
Calculating Rates of Return. In 2011, an 1880-O Morgan silver dollar sold for $13,113. What was
the rate of return on this investment?

7.
8.

9.

10.

11.

12.

13.

14.

15.

Calculating the Number of Periods. You're trying to save to buy a new $150,000 Ferrari. You have
$35,000 today that can be invested at your bank. The bank pays 3.2 percent annual interest on its
accounts. How long will it be before you have enough to buy the car?
Calculating Present Values. Imprudential, Inc., has an unfunded pension liability of $675 million
that must be paid in 25 years. To assess the value of the firm's stock, financial analysts want to discount
this liability back to the present. If the relevant discount rate is 6 percent, what is the present value of
this liability?
Calculating Present Values. You have just received notification that you have won the $2 million
first prize in the Centennial Lottery. However, the prize will be awarded on your 100th birthday
(assuming you're around to collect), 80 years from now. What is the present value of your windfall if
the appropriate discount rate is 10 percent?
Calculating Future Values. Your coin collection contains 50 1952 silver dollars. If your grandparents
purchased them for their face value when they were new, how much will your collection be worth
when you retire in 2058, assuming they appreciate at annual rate of 6.1 percent?
Calculating Growth Rates and Future Values. In 1895, the first U.S. Open Golf Championship was
held. The winner's prize money was $150. In 2011, the winner's check was $1,440,000. What was the
annual percentage increase in the winner's check over this period? If the winner's prize increases at the
same rate, what will it be in 2045?
Calculating Rates of Return. In 2011, an Action Comics No. 1, featuring the first appearance of
Superman, was sold at auction for $2,161,000. The comic book was originally sold in 1938 for $.10.
What was the annual increase in the value of this comic book?
Calculating Rates of Return. In October 2011, the average house price in the United States was
$242,300. In October 2004, the average price was $289,600. What was the annual change in the
average selling price?

Answers to Tutorial Questions

1.

The time line for the cash flows is:

0

$7,5
00

Thesimpleinterestperyearis:
$7,500.06=$450
So,after10years,youwillhave:
$45010=$4,500ininterest.
Thetotalbalancewillbe$7,500+4,500=$12,000
Withcompoundinterest,weusethefuturevalueformula:
FV=PV(1+r)t
FV=$7,500(1.06)10=$13,431.36
Thedifferenceis:
$13,431.3612,000=$1,431.36

10

FV

2.

TofindtheFVofalumpsum,weuse:
FV=PV(1+r)t
0

$3,1
50

FV=$3,150(1.13)6

FV

=$6,558.15

19

$8,4
53

FV=$8,453(1.07)19

=$30,570.51

13

$89,3
05

FV

FV=$89,305(1.09)13

=$273,791.68

21

$227,3
82

FV

FV=$227,382(1.05)21
3.

FV

=$633,477.75

TofindthePVofalumpsum,weuse:
PV=FV/(1+r)t
0

15

PV

$17,3
28

PV=$17,328/(1.04)15

=$9,621.62

PV

$41,5
17

PV=$41,517/(1.09)8

=$20,835.98

13

PV

$790,3
82

PV=$790,382/(1.12)13
0

25

PV

$647,8
16

PV=$647,816/(1.11)25
4.

=$181,135.15

=$47,684.50

Toanswerthisquestion,wecanuseeithertheFVorthePVformula.Bothwillgivethesame
answersincetheyaretheinverseofeachother.WewillusetheFVformula,thatis:
FV=PV(1+r)t
Solvingforr,weget:
r=(FV/PV)1/t1
0

$715

$1,3
81

FV=$1,381=$715(1+r)9
r=($1,381/$715)1/91
r=.0759,or7.59%
0

$905

$1,7
18

FV=$1,718=$905(1+r)6
r=($1,718/$905)1/61
r=.1127,or11.27%
0

21

$15,000

$141,8
32

FV=$141,832=$15,000(1+r)21
r=($141,832/$15,000)1/211
r=.1129,or11.29%
0

18

$70,300

$312,8
15

FV=$312,815=$70,300(1+r)18
r=($312,815/$70,300)1/181
r=.0865,or8.65%

5.

Toanswerthisquestion,wecanuseeithertheFVorthePVformula.Bothwillgivethesame
answersincetheyaretheinverseofeachother.WewillusetheFVformula,thatis:
FV=PV(1+r)t
Solvingfort,weget:
t=ln(FV/PV)/ln(1+r)
0

$195

$1,1
05

FV=$1,105=$195(1.09)t
t=ln($1,105/$195)/ln1.09
t=20.13years
0

$2,105

$3,7
00

FV=$3,700=$2,105(1.07)t
t=ln($3,700/$2,105)/ln1.07
t=8.34years
0

$47,800

$387,1
20

FV=$387,120=$47,800(1.12)t
t=ln($387,120/$47,800)/ln1.12
t=18.46years
0

$38,650

$198,21
2

FV=$198,212=$38,650(1.19)t
t=ln($198,212/$38,650)/ln1.19
t=9.40years
6.

The time line is:

0

18

$45,00
0

$280,0
00

Toanswerthisquestion,wecanuseeithertheFVorthePVformula.Bothwillgivethesame
answersincetheyaretheinverseofeachother.WewillusetheFVformula,thatis:

FV=PV(1+r)t
Solvingforr,weget:
r=(FV/PV)1/t1
r=($280,000/$45,000)1/181
r=.1069,or10.69%
7.

Tofindthelengthoftimeformoneytodouble,triple,etc.,thepresentvalueandfuturevalueare
irrelevantaslongasthefuturevalueistwicethepresentvaluefordoubling,threetimesaslarge
fortripling,etc.Toanswerthisquestion,wecanuseeithertheFVorthePVformula.Bothwill
givethesameanswersincetheyaretheinverseofeachother.WewillusetheFVformula,that
is:
FV=PV(1+r)t
Solvingfort,weget:
t=ln(FV/PV)/ln(1+r)
Thelengthoftimetodoubleyourmoneyis:
0

$1

$2

FV=$2=$1(1.05)t
t=ln2/ln1.05
t=14.21years
Thelengthoftimetoquadrupleyourmoneyis:
0

$1

$4

FV=$4=$1(1.05)t
t=ln4/ln1.05
t=28.41years
Noticethatthelengthoftimetoquadrupleyourmoneyistwiceaslongasthetimeneededto
double your money (the slight difference in these answers is due to rounding). This is an
importantconceptoftimevalueofmoney.
8.

The time line is:

0

131

$1

$13,11
3

Toanswerthisquestion,wecanuseeithertheFVorthePVformula.Bothwillgivethesame
answersincetheyaretheinverseofeachother.WewillusetheFVformula,thatis:
FV=PV(1+r)t
Solvingforr,weget:
r=(FV/PV)1/t1
r=($13,113/$1)1/1311
r=.0751,or7.51%
9.

The time line is:

0

$35,000

$150,0
00

Toanswerthisquestion,wecanuseeithertheFVorthePVformula.Bothwillgivethesame
answersincetheyaretheinverseofeachother.WewillusetheFVformula,thatis:
FV=PV(1+r)t
Solvingfort,weget:
t=ln(FV/PV)/ln(1+r)
FV=$150,000=$35,000(1.032)t
t=ln($150,000/$35,000)/ln1.032
t=46.20years
10. The time line is:
0

25

PV

$675,000,0
00

TofindthePVofalumpsum,weuse:
PV=FV/(1+r)t
PV=$675,000,000/(1.06)25
PV=$157,274,075.59
11. The time line is:
0

80

PV

$2,000,000

TofindthePVofalumpsum,weuse:
PV=FV/(1+r)t
PV=$2,000,000/(1.10)80

PV=$976.37
12. The time line is:
0

106

50

FV

TofindtheFVofalumpsum,weuse:
FV=PV(1+r)t
FV=$50(1.061)106
FV=$26,595.04

13. The time line is:

0

116

$150

$1,440,0
00

Toanswerthisquestion,wecanuseeithertheFVorthePVformula.Bothwillgivethesame
answersincetheyaretheinverseofeachother.WewillusetheFVformula,thatis:
FV=PV(1+r)t
Solvingforr,weget:
r=(FV/PV)1/t1
r=($1,440,000/$150)1/1161
r=.0823,or8.23%
To find the FV of the first prize in 2045, we use:
0

34

$1,440,0
00

FV

FV=PV(1+r)t
FV=$1,440,000(1.0823)34
FV=$21,163,131.11
14. The time line is:
0

73

$.10

$2,161,0
00

Toanswerthisquestion,wecanuseeithertheFVorthePVformula.Bothwillgivethesame
answersincetheyaretheinverseofeachother.WewillusetheFVformula,thatis:
FV=PV(1+r)t

Solvingforr,weget:
r=(FV/PV)1/t1
r=($2,161,000/$.10)1/731
r=.2603,or26.03%

15. The time line is:

0

$289,600

$242,300

Toanswerthisquestion,wecanuseeithertheFVorthePVformula.Bothwillgivethesame
answersincetheyaretheinverseofeachother.WewillusetheFVformula,thatis:
FV=PV(1+r)t
Solvingforr,weget:
r=(FV/PV)1/t1
r=($242,300/$289,600)1/71
r=.0252,or2.52%