Solution Chap 4

24Berk/DeMarzo/HarfordFundamentalsofCorporateFinance,SecondEdition
Chapter4
TimeValueofMoney:
ValuingCashFlowStreams
Note: AllproblemsinthischapterareavailableinMyFinanceLab.Anasterisk(*)indicatesproblems
withahigherlevelofdifficulty.
EditorsNote: Aswemoveforwardtomorecomplexfinancialanalysis,thestudentwillnoticethatsome
problemsmaycontainalargeamountofdatafromdifferenttimeperiodsthatrequire
morecomplicatedandintensiveanalysis.Moderninformationtechnologyhasevolvedin
theformoffinancialcalculatorswithbuiltinanalysisfunctionsandTimeValueofMoney
functionsthatarebuiltintocomputerbasedelectronicspreadsheetsoftwaresuchasExcel.
Thesolutionsformanydataandcomputationallyintensiveproblemswillbepresentedin
formulaformwithasolution,aswellaswiththeappropriatefinancialcalculatorcommands
andExcelfunctionstoproducethesamecorrectanswer.Inthisway,itisourexpectation
thatstudentswilldevelopproficiencyinsolvingfinancialanalysisproblemsbymathematical
calculationaswellasbyusingfinancialcalculatorsandelectronicspreadsheets.
1.
0 1 2 3 4 5
4000 1000 1000 1000 1000 1000

Fromthebanksperspective,thetimelineisthesameexceptallthesignsarereversed.
2.
300 300 300 300 300
Fromthebanksperspective,thetimelinewouldbeidenticalexceptwithoppositesigns.
2012PearsonEducation,Inc.PublishingasPrenticeHall
3. Plan:DrawthetimelineandthencomputetheFVofthesetwocashflows.
Execute:
Timeline(sincewearecomputingthefuturevalueoftheaccount,wewilltreatthecashflowsas
positivegoingintotheaccount):
0 1
500 300
FV?
FV500(1.03)300815
Evaluate:
Thetimelinehelpsusorganizeourworksothatwegetthenumberofperiodsofcompounding
correct.Thefirstcashflowwillhave1yearofcompounding,butthesecondcashflowwillbe
depositedattheendofperiod1,soitreceivesnocompounding.
4. EditorsNote:Inseveralpreviousproblemsweusedafinancialcalculatortosolveatimevalue
ofmoneyproblem.ProblemscouldbesolvedquicklyandeasilybymanipulatingtheN,I/Y,
PV,PMT,andFVkeys.Ineachoftheseproblemstherewasaseriesofpayments,ofequal
amount,overtime,i.e.,anannuity.Allyouhadtodotoinputthisserieswasenterthepayment
(PMT)andthenumberofpayment(N).
Manyfinancialanalysisproblemsinvolveaseriesofequalpayments,butothersinvolveaseries
ofunequalpayments.Afinancialcalculatorcanbeusedtoevaluateanunequalseriesofcash
flows(usingthecashflow(CF)key),buttheprocessiscumbersomebecauseeachcashflow
mustbeenteredindividually.IurgeeachstudenttostudytheChapter4Appendix:Usinga
FinancialCalculator,aswellasinstructionalmaterialsthatareproducedbythemanufacturers
ofthefinancialcalculator.
Herewewillsolveaproblemwithunevencashflowsmathematicallyandwithafinancial
calculator.
Plan:Itiswonderfulthatyouwillreceivethiswindfallfromyourinvestmentinyourfriends
business.Sincethecashflowpaymentstoyouareofdifferentamountsandpaidover3years,
therearedifferentwaysinwhichyoucanthinkabouthowmuchmoneyyouarereceiving.
Execute:
10,000 20,000 30,000
PV
1.035 1.0352 1.0353
a.
9662 18,670 27,058
55,390
0 1 2 3
10,000 20,000 30,000
Chapter4TimeValueofMoney:ValuingCashFlowStreams26
TheTexasInstrumentBAIIPLUScalculatorhasacashflowworksheetaccessedwiththe
CFkey.ToclearallpreviousvaluesthatmightbestoredinthecalculatorpresstheCF,
second,andCE/Cbuttons.ThescreenshouldshowCFoaskingforthecashflowattime0,
whichinthisproblemis0.Press0,thenpressenter,andthenthedownkeybutton.The
screenshouldshowCO1askingforthecashflowattime1,whichinthisproblemis10,000.
Input10,000followedbytheenterkey,followedbythedownbutton.Thescreenshould
showFO11.0askingforthefrequencyofthiscashflow.Sinceitoccursonlyonce,itis
correct,andwepressthedownkey.ThescreennowhasCO2askingforthetime2cash
flow,whichis20,000,whichweinput,followedbytheenterkeyandthedownkey.The
screennowhasFO21.0,whichiscorrect.Enterthedownkey,whichasksforthethird
cashflow,whichis30,000.Input30,000,followedbytheenteranddownkeys.Nowpress
theNPVkeyanditwilldisplayIaskingfortheinterestrate,whichis3.5.Input3.5,press
enterkey,andpressthedownkeyandthescreenwilldisplayNPVThenpresstheCPT
buttonandthescreenshoulddisplay55,390.33,theNetPresentValue.
FV 55,390 1.0353
b.
61,412
0 1 2 3
10,000 20,000 30,000
Evaluate:Youmayask:HowmuchbetteroffamIbecauseofthiswindfall?Thereare
severalanswerstothisquestion.Thevaluetoday(i.e.,thepresentvalue)ofthecashyouwill
receiveover3yearsis$55,390.Ifyoudecidetoreinvestthecashflowsasyoureceivethem,
thenin3yearsyouwillhave$61,412(i.e.,futurevalue)fromyourwindfall.
5. Plan:UseEq.4.3tocomputethePVofthisstreamofcashflowsandthenuseEq.4.1tocompute
theFVofthatpresentvalue.Toanswerpart(c),youneedtotrackthenewdepositmadeeach
yearalongwiththeinterestonthedepositsalreadyinthebank.
Execute:
100 100 100
PV 257.71
a.andb. (1.08) (1.08) (1.08)3
2
FV 257.71(1.08)3 324.64
Year1:100
c. Year2:100 1.08 100 208
1
Year3:208(1.08)1 100 324.64
Evaluate:
ByusingthePVandFVtools,weareabletokeeptrackofourbalanceaswellasquickly
calculatethebalanceattheend.Whetherwecomputeitstepbystepasinpart(c)ordirectlyas
inpart(b),theansweristhesame.
6. Plan:First,createatimelinetounderstandwhenthecashflowsareoccurring.
0 1 2 3
1000 1000 1000

Second,calculatethepresentvalueofthecashflows.
Onceyouknowthepresentvalueofthecashflows,computethefuturevalue(ofthispresent
value)atdate3.
1000 1000 1000
PV
1.05 1.052 1.053
Execute:
952 907 864
2723
N I/Y PV PMT FV ExcelFormula

Given: 3 5.00% 1000 0
SolveforPV: 2723.25 PV(0.05,3,1000,0)
FV3 2723 1.053

3152

Given: 3 5.00% 2723.43 0
SolveforFV: 3152.71 FV(0.05,3,0,2723.43)
Evaluate:Becauseofthebanksoffer,younowhavetwochoicesastohowyouwillrepaythis
loan.Eitheryouwillpaythebank$1000peryearforthenext3yearsasoriginallypromised,or
youcandecidetoskipthethreeannualpaymentsof$1000andpay$3152inyearthree.
Younowhavetheinformationtomakeyourdecision.
7. Plan:Thisscholarshipisaperpetuity.Thecashflowis$10,000andthediscountrateis7%.
WecanuseEq.4.4tosolveforthePV,whichistheamountyouneedtoendow.
Execute:
Timeline:
0 1 2
10,000 10,000
PV10,000/0.07142,857.14
Evaluate:
Withadonationof$142,857.14todayand7%interest,theuniversitycanwithdrawtheinterest
everyyear($10,000)andleavetheendowmentintacttogeneratethenextyears$10,000.Itcan
keepdoingthisforever.
8. Plan:Thisisadeferredperpetuity.Hereisthetimeline:
0 1 2 10 11

0 0 10,000 10,000
Dothisintwosteps:
1. Calculatethevalueoftheperpetuityinyear9,whenitwillstartinonlyoneyear
(wealreadydidthisinproblem7).
2. Discountthatvaluebacktothepresent.
Execute:
Thevalueinyear9is10,000/0.07142857.14.
142857.14
Thevaluetodayis 77704.82 .
1.079
Evaluate:
Becauseyourendowmentwillhave10yearstoearninterestbeforemakingitsfirstpayment,
youcanendowthescholarshipformuchless.Thevalueofyourendowmentmustreach
$142,857.14theyearbeforeitstarts(in9years).Ifyoudonate$77,704.82today,itwillgrowat
7%interestfor9years,justreaching$142,857.14,oneyearbeforethefirstpayment.
9. Thetimelineforthisinvestmentis:
0 1 2 3
100 100 100
a. Thevalueofthebondisequaltothepresentvalueofthecashflows.Bytheperpetuity
formula,whichassumesthefirstpaymentisatperiod1,thevalueofthebondis:
100
PV
0.04
2500
b. Thevalueofthebondisequaltothepresentvalueofthecashflows.Thefirstpaymentwillbe
receivedattimezero.Thecashflowsaretheperpetuityplusthepaymentthatwillbe
receivedimmediately.
100
PV 100
0.04
2600
10. Plan:Drawthetimelineofthecashflowsfortheinvestmentopportunity.ComputetheNPVof
theinvestmentopportunityat7%interestperyeartodetermineitsvalue.
0 1 2 3 100
1000 1000 1000 1000

Execute:Thecashflowsarea100yearannuity,sobytheannuityformula:
1000 1
PV 1
0.07 1.07100
14,269.25

Given: 100 7.00% 1000 0
SolveforPV: (14,269.25) PV(0.07,100,1000,0)
Evaluate:ThePVof$1000tobepaideveryyearfor100yearsdiscounttothepresentat7%is
$14,269.25.
11. Plan:Prepareatimelineofyourgrandmothersdeposits.
0 1 2 3 18
1000 1000 1000 1000
Thedepositsarean18yearannuity.UseEq.4.6tocalculatethefuturevalueofthedeposits.
1 1
Execute: FV C ((1 r ) N 1) 1000 ((1.03)18 1) 23,414.43
r .03

Given: 18 3.00% 0 1000
SolveforFV: (23,414.43) FV(0.03,18,1000,0)
Atage18youwillhave$23,414.43inyouraccount.
Evaluate:
Theinterestonthedepositsandinterestonthatinterestaddsmorethan$5414totheaccount.
12. a.
0 1 2 3 18
C C C C
First,weneedtocalculatethePVof$160,000in18years.
160,000
PV
(1.08)18
40,039.84

Given: 18 8.00% 0 160,000
SolveforPV: (40,039.84) PV(0.08,18,0,160000)
Inorderfortheparentstohave$160,000inyourcollegeaccountbyyour18thbirthday,
the18yearannuitymusthaveaPVof$40,039.84.Solvingfortheannuitypayments:
40,039.84
C
1 1
1
0.08 1.0818
$4272.33
whichmustbesavedeachyeartoreachthegoal.

Given: 18 8.00% 40,039.84 0
SolveforPMT: (4,272) PMT(0.08,18,40039.84,0)
b. First,weneedtocalculatethePVof$200,000in18years.
200,000
PV
(1.08)18
50,049.81

Given: 18 8.00% 0 200,000
SolveforPV: (50,049.81) PV(0.08,18,0,200000)
Inorderfortheparentstohave$200,000inyourcollegeaccountbyyour18thbirthday,
the18yearannuitymusthaveaPVof$50,049.81.Solvingfortheannuitypayments:
$50,049.81
C
1 1
1
0.08 1.0818
$5340.42
whichmustbesavedeachyeartoreachthegoal.

Given: 18.00 0.08 50,049.81 0.00
5340.4
SolveforPMT: 2 PMT(0.08,18,50049.81,0)
*13. Plan:
a. Drawthetimelineofthecashflowsfortheloan.
1 2 3 4 5
0 1 2 3 4
5000 5000 5000 5000
Topayofftheloanyoumustrepaytheremainingbalance.Theremainingbalanceisequal
tothepresentvalueoftheremainingpayments.Theremainingpaymentsarea4year
annuity,so:
b.
4 5
0 1
5000
Execute:
5000 1
PV 1
a. 0.06 1.06 4
17,325.53

Given: 4 6.00% 5000 0
SolveforPV: (17,325.53) PV(0.06,4,5000,0)
5000
PV
b. 1.06
4716.98
Evaluate:Topayofftheloanafterowningthevehiclefor1yearwillrequire$17,325.53.
Topayofftheloanafterowningthevehiclefor4yearswillrequire$4716.98.
14. Plan:Thisisadeferredannuity.Thecashflowtimelineis:
0 1 17 18 21
0 0 100,000 100,000
Calculatethevalueoftheannuityinyear17,oneperiodbeforeitstartsusingEq.4.5andthen
discountthatvaluebacktothepresentusingEq.4.2.
Thevalueoftheannuityinyear17,oneperiodbeforeitistostartis:
CF 1 100,000 1
PV 1 n
1 4 331,212.68
r (1 r ) 0.08 (1.08)
Togetitsvaluetoday,weneedtodiscountthatlumpsumamountback17yearstothepresent:
331,212.68
$89,516.50
(1.08)17
Evaluate:
Eventhoughthecashflowsarealittleunusual(anannuitystartingwellintothefuture),wecan
stillvaluethembycombiningthePVofannuityandPVofaFVtool.Ifweinvest$89,516.50
todayataninterestrateof8%,itwillgrowtobeenoughtofundanannuityof$100,000peryear
bythetimeitisneededforcollegeexpenses.
15. Plan:Thisisadeferredannuity.Thecashflowtimelineis:
0 1 44 45 60
0 0 40,000 40,000
Calculatethevalueoftheannuityinyear44,oneperiodbeforeitstartsusingEq.4.5andthen
discountthatvaluebacktothepresentusingEq.4.2.
Execute:
Thevalueoftheannuityinyear44,oneperiodbeforeitistostartis:
CF 1 40,000 1
PV 1 n
1 377,865.94
r r (1 r ) 0.07 (1.07) 16
Togetitsvaluetoday,weneedtodiscountthatlumpsumamountback44yearstothepresent:
377,865.94
$19,250.92
(1.07)44
Evaluate:
Eventhoughthecashflowsarealittleunusual(anannuitystartingwellintothefuture),wecan
stillvaluethembycombiningthePVofannuityandPVofaFVtool.Thetotalvaluetoyou
todayofSocialSecurityspromiseislessthan$20,000.
*16. Plan:Clearly,Mr.Rodriguezscontractiscomplex,callingforpaymentsovermanyyears.
AssumethatanappropriatediscountrateforARodtoapplytothecontractpaymentsis
7%peryear.
a. Calculatethetruepromisedpaymentsunderthiscontract,includingthedeferredpayments
withinterest.
b. Drawatimelineofallofthepayments.
c. Calculatethepresentvalueofthecontract.
d. Comparethepresentvalueofthecontracttothequotedvalueof$252million.Whatexplains
thedifference?
Execute:DeterminethePVofeachofthepromisedpaymentsdiscountedtothepresentat7%.
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
$18M 19M 19M 19M 21M 19M 23M 27M 27M 27M
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
6.7196M 5.3757M 4.0317M 4.0317M 4.0317M 4.0317M 4.0317M 4.0317M 4.0317M 4.0317M
ThePVofthepromisedcashflowsis$165.77million.
Evaluate:ThePVofthecontractismuchlessthan$252million.The$252millionvaluedoes
notdiscountthefuturecashflowsoradjustdeferredpaymentsforaccruedinterest.
*17. a.
0 1 2 3 43

5000 5000 5000 5000
Theamountintheretirementaccountin43yearswouldbe:
5000
FV43 ((1.10)43 1)
0.10
$2,962,003.46

Given: 43 10.00% 0.00 5000
SolveforFV: 2,962,003.46 FV(0.1,43,5000,0)
b. Tosolveforthelumpsumamounttoday,findthePVofthe$2,962,003.46.
2,962,003.46
PV
(1.10)43
$49,169.99

Given: 43 10.00% 0 2,962,003
SolveforPV: (49,169.99) PV(0.1,43,0,2962003.46)
c.
0 1 2 3 20

2,962,003.46 C C C C
Solvefortheannuitycashflowthat,after20years,exactlyequalsthestartingvalueofthe
account.
2,962,003.46
C
1 1
1
0.10 1.10 20
347,915.81

Given: 20.00 0.10 2,962,003.46 0.00
SolveforPMT: 347,915.81 PMT(0.1,20,2962003.46,0)
d.
0 1 2 3 N

2,962,003.46 300,000 300,000 300,000 300,000
WewanttosolveforN,whichisthelengthoftimeinwhichthePVofannualpaymentsof
$300,000willequal$2,962,003.46.SettingupthePVofanannuityformulaandsolvingforN:
300,000 1
1 2,962,003.46
0.10 1.10 N
1 1 2,962,003.46 0.10
0.9873345
1.10 N 300,000
1
1 0.9873345 0.0126655
1.10 N
1.10 N 78.95456
Log(78.95456)
N 45.84
Log(1.10)
e. Ifwecanonlyinvest$1000peryear,thensetupthePVformulausing$1millionastheFV
and$1000astheannuitypayment.
1000 1
1 1,000,000
r (1 r )43
Tosolveforr,wecaneitherguessorusetheannuitycalculator.Youcancheckandseethat
r11.74291%solvesthisequation.Sotherequiredrateofreturnmustbe11.74291%.

Given: 43 0.00 1000 1,000,000
SolveforRate: 11.74291% RATE(43,1000,0,1000000)
18. Plan:Thebequestisaperpetuitygrowingataconstantrate.Thebequestisidenticaltoafirm
thatpaysadividendthatgrowsforeverataconstantrate.Wecanusetheconstantdividend
growthmodeltodeterminethevalueofthebequest.
Execute:
a.
0 1 2 3
1000 1000(1.08) 1000(1.08)2
UsingtheformulaforthePVofagrowingperpetuitygives
1000
PV
0.12 0.08
25,000
whichisthevaluetodayofthebequest.
b.
1 2 3 4
0 1 2 3
1000(1.08) 1000(1.08)2 1000(1.08)3
UsingtheformulaforthePVofagrowingperpetuitygives:
1000(1.08)
PV
0.12 0.08
27,000
whichisthevalueofthebequestafterthefirstpaymentismade.
Evaluate:Thebequestisworth$25,000todayandwillbeworth$27,000in1yearstime.
*19. Plan:Themachinewillproduceaseriesofsavingsthataregrowingataconstantrate.Therate
ofgrowthisnegative,buttheconstantgrowthmodelcanstillbeused.
Execute:Thetimelineforthesavingwouldlookasfollows:
0 1 2 3
1000 1000(10.02) 1000(10.02)2
Wemustvalueagrowingperpetuitywithanegativegrowthrateof0.02:
1000
PV
0.05 ( 0.02)
$14,285.71
Evaluate:Thevalueofthesavingsproducedbythemachineisworth$14,285.71today.
20. Plan:Nobelsbequestisaperpetuity.Thetotalamountis5$45,000$225,000.Withacash
flowof$225,000andaninterestrateof7%peryear,wecanuseEq.4.4tosolveforthetotal
amounthewouldneedtousetoendowtheprizes.Inpart(b),wewillneedtousetheformula
foragrowingperpetuity(Eq.4.7)tofindthenewvaluehewouldneedtoleave.Finally,inpart
(c),wecanusetheFVequation(Eq.4.1)tosolveforthefuturevaluehisdescendantswould
havehadiftheyhadkeptthemoneyandinvesteditat7%peryear.
a. Inordertoendowaperpetuityof$225,000peryearwitha7%interestrateperyear,he
wouldneedtoleave$225,000/0.07$3,214,285.71.
b. Inordertoendowagrowingperpetuitywithaninterestrateof7%andagrowthrateof4%
andaninitialcashflowof$225,000,hewouldhavetoleave:
CF1 225,000
PV 7,500,000
r g 0.07 0.04
c. FVPV(1r)n7,500,000(1.07)118$21,996,168,112
Evaluate:
TheprizesthatbearNobelsnamewereveryexpensivetoendow$3millionwasanenormous
sumin1896.However,Nobelsendowmenthasbeenabletogenerateenoughinteresteachyear
tofundtheprizes,whichnowhaveacashawardofapproximately$1,500,000each!
21. Plan:Thedrugwillproduce17yearsofcashflowsthatwillgrowat5%annually.Thevalueof
thisstreamofcashflowstodaymustbedetermined.Wecanusetheformulaforagrowing
annuity(Eq.4.8)orExceltosolvethis.C2,r0.10,g0.05,N17
1 1.05
17
Execute: PV 2 1 21.86
0.10 0.05 1.10

Sincethecashflowsfromthisinvestmentwillcontinuefor17years,wedecidedtosolveforthe
NetPresentValuebyusingtheNPVfunctioninExcel.Thisisshownbelow.The17cashflows
arepresentedincolumnsC,D,S.Theinitialcashflowof$2MispresentedincellC8and
eachsubsequentcashflowgrowsat5%until$4.365749Mispresentedinyear17incellS8.
(NotethatcolumnsGthroughQarenotpresented.)TheNPVoftheprojectiscalculatedusing
theNPVformula NPV(C3,C8:S8)incellB10.TheNPVofthefuturecashflowsis$21.86M.
A B C D E F R S
1
2 1+g 1.05
3 r 0.1
4
5
6 T 0 1 2 3 4 16 17
7
8 2 2.1 2.205 2.31525 4.157856 4.365749
9
10 NPV $21.86
11
12 EXCELNPVFORMULANPV(C3,C8:S8)
13
Evaluate:Thevaluetodayofthecashflowsproducedbythedrugoverthenext17yearsis
$21.86million.Becausethecashflowsareexpectedtogrowataconstantrate,wecanusethe
growingannuityformulaasashortcut.
22. Plan:Yourrichauntispromisingyouaseriesofcashflowsoverthenext20years.Youmust
determinethevalueofthosecashflowstoday.ThisisagrowingannuityandwecanuseEq.4.8
tosolveit,orwecanalsosolveitinExcel.C5,r0.03,g0.05andN20
1 1.03
20
Execute: PV 5 1
1.05 79.82

.05 .03
Sincethecashflowsfromthisinvestmentwillcontinuefor20years,wedecidedtosolveforthe
NetPresentValuebyusingtheNPVfunctioninExcel.Thisisshownbelow.The20cashflows
arepresentedincolumnsC,D,V.Theinitialcashflowof$5000ispresentedincellC8and
eachsubsequentcashflowgrowsat3%until$8767.53ispresentedinyear20incellV8.(Note
thatcolumnsGthroughRarenotpresented.)TheNPVoftheprojectiscalculatedusingthe
NPVformula NPV(C3,C8:V8)incellB10.TheNPVofthefuturecashflowsis$79,824.
A B C D E S T U V
1
2 1+g 1.03
3 r 0.05
4
5
6 T 0 1 2 3 17 18 19 20
7
8.51216
8 5 5.15 5.3045 8.023532 8.264238 5 8.76753
9
10 NPV $79.82
11
12 EXCELNPVFORMULANPV(C3,C8:V8)
13
Evaluate:Becauseyourauntwillbeincreasinghergiveeachyearataconstantrate,wecanuse
thegrowingperpetuityformulaasashortcuttovaluethestreamofcashflows.Hergiftisquite
generous:itisequivalenttogivingyoualmost$80,000today!
23. Plan:Thisproblemisaskingustosolvefortherateofreturn(r).Becausetherearenorecurring
payments,wecanuseEq.4.1torepresenttheproblemandthenjustsolvealgebraicallyforr.
WehaveFV100,PV50,n10.
Execute:
FVPV(1r)n
1
100 10
10050(1r) ,so r
10
1 0.072,or7.2%
50
Evaluate:
Theimplicitreturnweearnedonthesavingsbondwas7.2%.Ourmoneydoubledin10years,
whichbytheruleof72meantthatweearnedabout72/10=7.2%andourcalculationconfirmed
that.
24. Plan:Thisproblemisagainaskingustosolveforr.Wewillrepresenttheinvestmentwith
Eq.4.1andsolveforr.WehavePV1000,FV5000,n10.Thesecondpartoftheproblem
asksustochangetherateofreturngoingforwardandcalculatetheFVinanother10years.
Execute:
a. FV=PV(1+r)n
1
5000 10
50001000(1r) ,so r
10
1 0.1746,or17.46%
1000
b. FV5000(1.15)10$20,227.79
25. Plan:DrawatimelineanddeterminetheIRRoftheinvestment.
Execute:
0 1
5000 6000
IRRistherthatsolves:
6000 6000
5000 1 20%
1 r 5000
Evaluate:Youaremakinga20%IRRonthisinvestment.
26. Plan:Drawatimelinetodemonstratewhenthecashflowswilloccur.Thensolvetheproblem
todeterminethepaymentsyouwillreceive.
Execute:
0 1 2 3
1000 C C C
C
P C P r 1000 0.05 $50
r
Evaluate:Youwillreceive$50peryearintoperpetuity.
27. Plan:Drawatimelinetodeterminewhenthecashflowsoccur.Solvetheproblemtodetermine
theannualpayments.
Timeline(fromtheperspectiveofthebank):
Execute:
0 1 2 3 30

300,000 C C C C
300,000
C $24,176
1 1
1
0.07 1.0730
whichistheannualpayment.

Given: 30 7.00% 300,000.00 0
SolveforPMT: $24,175.92 PMT(0.07,30,300000,0)
Evaluate:Youwillhavetopaythebank$24,176peryearfor30yearsinmortgagepayments.
*28. Plan:Drawatimelinetodemonstratewhenthecashflowswilloccur.Determinetheannual
payments.
Execute:
0 2 4 6 20
0 1 2 3 10

500,00 C C C C
Thiscashflowstreamisanannuity.First,calculatethe2yearinterestrate:The1yearrateis
4%,and$1todaywillbeworth(1.04)21.0816in2years,sothe2yearinterestrateis8.16%.
Usingtheequationforanannuitypayment:
50,000
C
1 1
1 10
0.0816 (1.0816)
$7505.34
whichisthepaymentyoumustmakeevery2years.

Given: 10 8.16% 50,000.00 0
SolveforPMT: $7,505.34 PMT(0.0816,10,50000,0)
Evaluate:Youmustpaytheartdealer$7505.34every2yearsfor20years.
*29. Plan:Drawatimelinetodeterminewhenthecashflowsoccur.Timeline(whereXistheballoon
payment):
0 1 2 3 30

300,000 23,500 23,500 23,500 23,500X
NotethatthePVoftheloanpaymentsmustbeequaltotheamountborrowed.
Execute:
23,500 1 X
300,000 1 30

0.07 1.07 (1.07)30
SolvingforX:
23,500 1
X 300,000 1 (1.07)
30
0.07 1.0730
$63,848

Given: 30 7.00% 23,500 0
SolveforPV: 291,612.47 PV(0.07,30,23500,0)
Thepresentvalueoftheannuityis$291,612.47,whichis$8387.53lessthanthe$300,000.00.
Tomakeupforthisshortfallwithaballoonpaymentinyear30wouldrequireapaymentof
$63,848.02.

Given: 30 7.00% 8387.53 0
SolveforFV: (63,848.02) FV(0.07,30,0,8387.53)
Evaluate:Attheendof30yearsyouwouldhavetomakea$63,848single(balloon)paymentto
thebank.
*30. Plan:Drawatimelinetodemonstratewhenthecashflowsoccur.Weknowthatyouintendto
fundyourretirementwithaseriesofannuitypaymentsandthefuturevalueofthatannuityis
$2million.
22 23 24 25 65
0 1 2 3 43

C C C C C
Execute:FV$2million.
ThePVofthecashflowsmustequalthePVof$2millionin43years.Thecashflowsconsistof
a43yearannuity,plusthecontributiontoday,sothePVis:
C 1
PV 1 C
0.05 1.05 43
ThePVof$2millionin43yearsis:
2,000,000
$245,408.80
(1.05)43

Given: 43 5.00% 0 2,000,000
SolveforPV: (245,408.80) PV(0.05,43,0,2000000)
Settingtheseequalgives
C 1
1 C 245,408.80
0.05 (1.05)43
245,408.80
C $13,232.50
1 1
1 1
0.05 (1.05)43
Weneed$245,408.80todaytohave$2,000,000in43years.Ifwedonothave$245,408.80
today,butwishtomake44equalpayments(thefirstpaymentistoday,makingthepayments
anannuitydue)thentherelevantExcelcommandis:
PMT(rate,nper,pv,(fv),typePMT(.05,44,245,408.80,0,1)13,232.50
Typeissetequalto1foranannuitydueasopposedtoanordinaryannuity.
Evaluate:Youwouldhavetoputaside$13,232.50annuallytohavethe$2millionyouwishto
haveinretirement.
31. Plan:Thisproblemisaskingyoutosolveforn.Youcandothismathematicallyusinglogs,or
withafinancialcalculatororExcel.Becausetheproblemhappenstobeaskinghowlongitwill
takeourmoneytodouble,wecanestimatetheanswerusingtheruleof72:72/107.2,sothe
answerwillbeapproximately7.2years.
20000
ln
Execute: 10000
N 7.27
ln 1.10
UsingafinancialcalculatororExcel:
10 10000 0 20000
7.27
ExcelFormula:NPER(RATE,PMT,PV,FV)
NPER(0.10,0,10000,20000)
Evaluate:
Ifyoucanearn10%peryearonthe$10,000,itwilldoubleto$20,000in7.27years.
32. Plan:Drawthetimelineanddeterminetheinterestratethebankispayingyou.
Execute:
0 1 2 3
1000 100 100 100
100
Thepaymentsareaperpetuity,so PV .
r
SettingtheNPVofthecashflowstreamequalto0andsolvingforrgivestheIRR:
100 100
NPV 0 1000 r 10%
r 1000
SotheIRRis10%.
Evaluate:Thebankispayingyou10%onyourdeposit.
*33. Plan:Drawatimelinetoshowwhenthecashflowsoccur.Thendeterminehowlongtheplant
willbeinproduction.AlsoestimatetheNPVoftheprojectandhencewhetherornotitshould
bebuilt.
Execute:
0 1 2 N

10,000,000 1,000,000 1,000,000 1,000,000
50,000 50,000(1.05) 50,000(1.05)N1
Theplantwillshutdownwhen:
1,000,000 50,000(1.05) N 1 0
1,000,000
(1.05) N 1 20
50,000
( N 1) log(1.05) log(20)
log(20)
N 1 62.4
log(1.05)
Sothelastyearofproductionwillbeinyear62.
WenowbuildanExcelspreadsheetwiththecashflowstothe62years.
A B C D E F G BJ BK BL
1
2 G 1.05
3 R 0.06
4
5
6T 0 1 2 3 4 5 60 61 62
7
8 10000000 1000000 1000000 1000000 1000000 1000000 1000000 1000000 1000000
9 50000 52500 55125 57881.3 60775.3 889485 933959 980657
10 ($10,000,000.00) 950000 947500 944875 942118.8 939224.7 110515 66040.71 19342.74
11
12 NP $3,995,073.97
V
13 EXCELNPVFORMULAB10NPV(C3,C11:BL11)
TheNetPresentValueoftheprojectiscomputedincellB12.
Evaluate:So, theNPV 13,995,074 10,000 $3,995,074, andyoushouldbuildit.
*34. Plan:Drawatimelinetoshowwhenthecashflowswilloccur.Thendeterminehowmuchyou
willhavetoputintotheretirementplanannuallytomeetyourgoal.
Execute:
22 23 24 65 66 67 100
0 1 2 43 44 45 78
C C C 100 100 100
ThePVofthecostsmustequalthePVofthebenefits,sobeginbydividingtheproblemintotwo
parts:thecostsandthebenefits.
Costs:Thecostsarethecontributions,a43yearannuitywiththefirstpaymentin1year:
C 1
PVcosts 1
0.07 (1.07)43
Benefits:Thebenefitsarethepayoutsafterretirement,a35yearannuitypaying$100,000
peryearwiththefirstpayment44yearsfromtoday.Thevalueofthisannuityinyear43is:
100,000 1
PV43 1
0.07 (1.07)35

Given: 35 7.00% 100000 0
SolveforPV: (1,294,767.23) PV(0.07,35,100000,0)
Thevaluetodayisjustthediscountedvaluein43years:
PV43
PVbenefits
(1.07)43
100,000 1
43
1
0.07(1.07) (1.07)35
70,581.24
SincethePVofthecostsmustequalthePVofthebenefits(orequivalently,theNPVofthecash
flowmustbezero):
C 1
70,581.24 1
0.07 (1.07)43

Given: 43 7.00% 0 1,294,767
SolveforPV: (70,581.24) PV(0.07,43,0,1294767.23)
SolvingforCgives
70,581.24 0.07
C
1
1
(1.07)43
5225.55

Given: 43 7.00% 70,581.24 0
SolveforPMT: (5,226) PMT(0.07,43,70581.24,0)
Evaluate:Youwillhavetoinvest$5225.55annuallyintotheretirementplantomeetyourgoal.

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24Berk/DeMarzo/HarfordFundamentalsofCorporateFinance,SecondEdition

4000 1000 1000 1000 1000 1000

300 300 300 300 300

10,000 20,000 30,000

10,000 20,000 30,000

Year3:208(1.08)1 100 324.64

1000 1000 1000

N I/Y PV PMT FV ExcelFormula

FV3 2723 1.053

N I/Y PV PMT FV ExcelFormula

100 100 100

1000 1000 1000 1000

N I/Y PV PMT FV ExcelFormula

1000 1000 1000 1000

N I/Y PV PMT FV ExcelFormula

N I/Y PV PMT FV ExcelFormula

N I/Y PV PMT FV ExcelFormula

N I/Y PV PMT FV ExcelFormula

N I/Y PV PMT FV ExcelFormula

5000 5000 5000 5000

N I/Y PV PMT FV ExcelFormula

N I/Y PV PMT FV ExcelFormula

N I/Y PV PMT FV ExcelFormula

N I/Y PV PMT FV ExcelFormula

N I/Y PV PMT FV ExcelFormula

1000 1000(1.08) 1000(1.08)2

1000 1000(10.02) 1000(10.02)2

N I/Y PV PMT FV ExcelFormula

N I/Y PV PMT FV ExcelFormula

N I/Y PV PMT FV ExcelFormula

N I/Y PV PMT FV ExcelFormula

N I/Y PV PMT FV ExcelFormula

1000 100 100 100

Evaluate:So, theNPV 13,995,074 10,000 $3,995,074, andyoushouldbuildit.

C C C 100 100 100

N I/Y PV PMT FV ExcelFormula

N I/Y PV PMT FV ExcelFormula

N I/Y PV PMT FV ExcelFormula

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