CHAPTER 5

INTRODUCTION TO VALUATION: THE

TIME VALUE OF MONEY
Answers to Concepts Review and Critical Thinking Questions

1. The four parts are the present value (PV), the future value (FV), the discount rate (r), and the life of
the investment (t).

2. Compounding refers to the growth of a dollar amount through time via reinvestment of interest
earned. It is also the process of determining the future value of an investment. Discounting is the
process of determining the value today of an amount to be received in the future.

3. Future values grow (assuming a positive rate of return); present values shrink.

4. The future value rises (assuming it’s positive); the present value falls.

5. It would appear to be both deceptive and unethical to run such an ad without a disclaimer or
explanation.

6. It’s a reflection of the time value of money. TMCC gets to use the $1,163. If TMCC uses it wisely, it
will be worth more than $10,000 in thirty years.

7. This will probably make the security less desirable. TMCC will only repurchase the security prior to
maturity if it is to its advantage, i.e. interest rates decline. Given the drop in interest rates needed to
make this viable for TMCC, it is unlikely the company will repurchase the security. This is an
example of a “call” feature. Such features are discussed at length in a later chapter.

8. The key considerations would be: (1) Is the rate of return implicit in the offer attractive relative to
other, similar risk investments? and (2) How risky is the investment; i.e., how certain are we that we
will actually get the $10,000? Thus, our answer does depend on who is making the promise to repay.

9. The Treasury security would have a somewhat higher price because the Treasury is the strongest of
all borrowers.

10. The price would be higher because, as time passes, the price of the security will tend to rise toward
$10,000. This rise is just a reflection of the time value of money. As time passes, the time until
receipt of the $10,000 grows shorter, and the present value rises. In 2015, the price will probably be
higher for the same reason. We cannot be sure, however, because interest rates could be much
higher, or TMCC’s financial position could deteriorate. Either event would tend to depress the
security’s price.
 CHAPTER 5 B-2

Solutions to Questions and Problems

NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this
solutions manual, rounding may appear to have occurred. However, the final answer for each problem is
found without rounding during any step in the problem.

Basic

1. The simple interest per year is:

$5,000 × .06 = $300

So after 10 years you will have:

$300 × 10 = $3,000 in interest.

The total balance will be $5,000 + 3,000 = $8,000

With compound interest we use the future value formula:

FV = PV(1 +r)t
FV = $5,000(1.06)10 = $8,954.24

The difference is:

$8,954.24 – 8,000 = $954.24

2. To find the FV of a lump sum, we use:

FV = PV(1 + r)t

FV = $2,250(1.10)16 = $ 10,338.69
FV = $8,752(1.08)13 = $ 23,802.15
FV = $76,355(1.17)4 = $143,080.66
FV = $183,796(1.07)12 = $413,943.81

3. To find the PV of a lump sum, we use:

PV = FV / (1 + r)t

PV = $15,451 / (1.04)6 = $12,211.15

PV = $51,557 / (1.11)7 = $24,832.86
PV = $886,073 / (1.20)23 = $13,375.22
PV = $550,164 / (1.13)18 = $60,964.94
 CHAPTER 5 B-3

4. To answer this question, we can use either the FV or the PV formula. Both will give the same answer
since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV / PV)1 / t – 1

FV = $307 = $240(1 + r)2; r = ($307 / $240)1/2 – 1 = 13.10%

FV = $896 = $360(1 + r)10; r = ($896 / $360)1/10 – 1 = 9.55%
FV = $174,384 = $39,000(1 + r)15; r = ($174,384 / $39,000)1/15 – 1 = 10.50%
FV = $483,500 = $38,261(1 + r)30; r = ($483,500 / $38,261)1/30 – 1 = 8.82%

5. To answer this question, we can use either the FV or the PV formula. Both will give the same answer
since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for t, we get:

t = ln(FV / PV) / ln(1 + r)

FV = $1,284 = $560(1.08)t; t = ln($1,284/ $560) / ln 1.08 = 10.78 years

FV = $4,341 = $810(1.09)t; t = ln($4,341/ $810) / ln 1.09 = 19.48 years
FV = $364,518 = $18,400(1.21)t; t = ln($364,518 / $18,400) / ln 1.21 = 15.67 years
FV = $173,439 = $21,500(1.13)t; t = ln($173,439 / $21,500) / ln 1.13 = 17.08 years

6. To answer this question, we can use either the FV or the PV formula. Both will give the same answer
since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV / PV)1 / t – 1
r = ($280,000 / $50,000)1/18 – 1 = 10.04%
 CHAPTER 5 B-4

7. To find the length of time for money to double, triple, etc., the present value and future value are
irrelevant as long as the future value is twice the present value for doubling, three times as large for
tripling, etc. To answer this question, we can use either the FV or the PV formula. Both will give the
same answer since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for t, we get:

t = ln(FV / PV) / ln(1 + r)

The length of time to double your money is:

FV = $2 = $1(1.09)t
t = ln 2 / ln 1.09 = 8.04 years

The length of time to quadruple your money is:

FV = $4 = $1(1.09)t
t = ln 4 / ln 1.09 = 16.09 years

Notice that the length of time to quadruple your money is twice as long as the time needed to double
your money (the difference in these answers is due to rounding). This is an important concept of time
value of money.

8. To answer this question, we can use either the FV or the PV formula. Both will give the same answer
since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV / PV)1 / t – 1
r = ($27,958 / $21,608)1/7 – 1 = 3.75%

9. To answer this question, we can use either the FV or the PV formula. Both will give the same answer
since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for t, we get:

t = ln(FV / PV) / ln(1 + r)

t = ln ($170,000 / $40,000) / ln 1.062 = 24.05 years

10. To find the PV of a lump sum, we use:

PV = FV / (1 + r)t
PV = $700,000,000 / (1.085)20 = $136,931,471.85
 CHAPTER 5 B-5

11. To find the PV of a lump sum, we use:

PV = FV / (1 + r)t
PV = $1,000,000 / (1.09)80 = $1,013.63

12. To find the FV of a lump sum, we use:

FV = PV(1 + r)t
FV = $50(1.045)102 = $4,454.84

13. To answer this question, we can use either the FV or the PV formula. Both will give the same answer
since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV / PV)1 / t – 1
r = ($1,170,000 / $150)1/111 – 1 = 8.41%

To find the FV of the first prize, we use:

FV = PV(1 + r)t
FV = $1,170,000(1.0841)34 = $18,212,056.26

14. To find the PV of a lump sum, we use:

PV = FV / (1 + r)t

PV = $485,000 / (1.2590)67 = $0.10

15. To answer this question, we can use either the FV or the PV formula. Both will give the same answer
since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV / PV)1 / t – 1
r = ($10,311,500 / $12,377,500)1/4 – 1 = – 4.46%

Notice that the interest rate is negative. This occurs when the FV is less than the PV.
 CHAPTER 5 B-6

Intermediate

16. To answer this question, we can use either the FV or the PV formula. Both will give the same answer
since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV / PV)1 / t – 1

a. PV = $10,000 / (1 + r)30 = $500

r = ($10,000 / $1,163)1/30 – 1 = 7.44%

b. PV = $2,500 / (1 + r)9 = $1,163

r = ($2,500 / $1,163)1/9 – 1 = 8.88%

c. PV = $10,000 / (1 + r)21 = $2,500

r = ($10,000 / $2,500)1/21 – 1 = 6.82%

17. To find the PV of a lump sum, we use:

PV = FV / (1 + r)t
PV = $170,000 / (1.11)10 = $59,871.36

18. To find the FV of a lump sum, we use:

FV = PV(1 + r)t

FV = $2,000 (1.12)45 = $327,975.21

FV = $2,000 (1.12)35 = $105,599.24

Better start early!

19. We need to find the FV of a lump sum. However, the money will only be invested for six years, so
the number of periods is six.

FV = PV(1 + r)t
FV = $25,000(1.079)6 = $35,451.97
 CHAPTER 5 B-7

20. To answer this question, we can use either the FV or the PV formula. Both will give the same answer
since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for t, we get:

t = ln(FV / PV) / ln(1 + r)

t = ln($100,000 / $10,000) / ln(1.11) = 22.06

So, the money must be invested for 22.06 years. However, you will not receive the money for
another two years. From now, you’ll wait:

2 years + 22.06 years = 24.06 years

Calculator Solutions

1.
Enter 10 6% $5,000
N I/Y PV PMT FV
Solve for $8,954.24

$8,954.24 – 8,000 = $954.24

2.
Enter 16 10% $2,250
N I/Y PV PMT FV
Solve for $10,338.69

Enter 13 8% $8,752
N I/Y PV PMT FV
Solve for $23,802.15

Enter 4 17% $76,355

N I/Y PV PMT FV
Solve for $143,080.66

Enter 12 7% $183,796
N I/Y PV PMT FV
Solve for $413,943.81

3.
Enter 6 4% $15,451
N I/Y PV PMT FV
Solve for $12,211.15
 CHAPTER 5 B-8

Enter 7 11% $51,557

N I/Y PV PMT FV
Solve for $24,832.86

Enter 23 20% $886,073

N I/Y PV PMT FV
Solve for $13,375.22

Enter 18 13% $550,164

N I/Y PV PMT FV
Solve for $60,964.94

4.
Enter 2 $240 ±$307
N I/Y PV PMT FV
Solve for 13.10%

Enter 10 $360 ±$896

N I/Y PV PMT FV
Solve for 9.55%

Enter 15 $39,000 ±$174,384

N I/Y PV PMT FV
Solve for 10.50%

Enter 30 $38,261 ±$483,500

N I/Y PV PMT FV
Solve for 8.82%

5.
Enter 8% $560 ±$1,284
N I/Y PV PMT FV
Solve for 10.78

Enter 9% $810 ±$4,341

N I/Y PV PMT FV
Solve for 19.48

Enter 21% $18,400 ±$364,518

N I/Y PV PMT FV
Solve for 15.67
 CHAPTER 5 B-9

Enter 13% $21,500 ±$173,439

N I/Y PV PMT FV
Solve for 17.08

6.
Enter 18 $50,000 ±$280,000
N I/Y PV PMT FV
Solve for 10.04%

7.
Enter 9% $1 ±$2
N I/Y PV PMT FV
Solve for 8.04

Enter 8% $1 ±$4
N I/Y PV PMT FV
Solve for 16.09

8.
Enter 7 $21,608 ±$27,958
N I/Y PV PMT FV
Solve for 3.75%

9.
Enter 6.20% $40,000 ±$170,000
N I/Y PV PMT FV
Solve for 24.05

10.
Enter 20 8.5% $700,000,000
N I/Y PV PMT FV
Solve for $136,931,471.85

11.
Enter 80 9% $1,000,000
N I/Y PV PMT FV
Solve for $1,013.63

12.
Enter 102 4.50% $50
N I/Y PV PMT FV
Solve for $4,454.84
 CHAPTER 5 B-10

13.
Enter 111 ±$150 $1,170,000
N I/Y PV PMT FV
Solve for 8.41%

Enter 34 8.41% $1,170,000

N I/Y PV PMT FV
Solve for $18,212,056.26

14.
Enter 67 25.90% $485,000
N I/Y PV PMT FV
Solve for $0.10

15.
Enter 4 ±$12,377,500 $10,311,500
N I/Y PV PMT FV
Solve for –4.46%

16. a.
Enter 30 ±$1,163 $10,000
N I/Y PV PMT FV
Solve for 7.44%

16. b.
Enter 9 ±$1,163 $2,500
N I/Y PV PMT FV
Solve for 8.88%

16. c.
Enter 21 ±$2,500 $10,000
N I/Y PV PMT FV
Solve for 6.82%

17.
Enter 10 11% $170,000
N I/Y PV PMT FV
Solve for $59,871.36

18.
Enter 45 12% $2,000
N I/Y PV PMT FV
Solve for $327,975.21

Enter 35 12% $2,000

N I/Y PV PMT FV
Solve for $105,599.24
 CHAPTER 5 B-11

19.
Enter 6 7.90% $25,000
N I/Y PV PMT FV
Solve for $39,451.97

20.
Enter 11% ±$10,000 $100,000
N I/Y PV PMT FV
Solve for 22.06

From now, you’ll wait 2 + 22.06 = 24.06 years

CHAPTER 5 B-12