A B C D E F

1 Tool Kit Chapter 4

2 The Time Value of Money
3
4
The worksheet shown below performs most of the calculations required for Chapter 4, and it was used to create
5 many of the chapter's tables and figures. We pasted in a few dialog boxes for specific Excel functions and features;
6 they are shown off to the right of where they were used. We encourage students to become familiar with Excel
7 functions. It is also useful to learn how Excel models can be used to create tables and graphs that can then be
copied into Word documents, which is the way we prepared the text manuscript for submission to the publisher.
8 That procedure is used often in business (and in business courses) to prepare reports.
9
10
11
Although answers to the Self-Test questions within the chapter are generally quite easy and can be worked with a
12 calculator, we also solved them with Excel as a check and also to provide some information on the solutions for
13 students who might have questions. The tabs at the lower part of this screen take you to the solutions for self-
tests in the various sections of the chapter. Even students who are not familiar with Excel should still be able to
14 see the solution setup and then work the problem with a calculator.
15
16
17 4-2 Future Values
18
19 A dollar in hand today is worth more than a dollar to be received in the future because, if you had it now, you
20 could invest it, earn interest, and end up with more than one dollar in the future. The process of going to future
values (FVs) from present values (PVs) is called compounding.
21
22
23 To illustrate, refer to our 3-year time line in the Figure below and assume that you plan to deposit $100 in a bank
that pays a guaranteed 5% interest each year. How much would you have at the end of Year 3?
24
25
26 To answer this question, we show 4 methods: (1) the step-by-step using a regular calculator; (2) the formula
27 approach using a regular calculator; (3) the financial calculator approach; and (4) the Excel approach.
28
29 Figure 4-1
30 Alternative Procedures for Calculating Future Values
31 INPUTS:
32 Investment = CF0 = PV = −$100.00
33 Interest rate = I = 5%
34 No. of periods = N = 3
35
36 Time Line Periods: 0 1 2
37 Cash flow: −$100.00 0 0
38
39 1. Step-by-Step: Multiply by (1 + I) each step $100.00 → $105.00 → $110.25 →
40
41 2. Formula: FVN = PV(1+I)N FV3 = $100(1.05)3 =
42
43 Inputs: 3 5 −100 0
44 3. Financial Calculator: N I/YR PV PMT
45 Output:
46
47 4. Excel Spreadsheet: FV function: FVN = =FV(I,N,0,PV)
48 Fixed inputs: FVN = =FV(0.05,3,0,−100) =
 A B C D E F
49 Cell references: FVN = =FV(C33,C34,0,C32) =
50 In the Excel formula, the terms are entered in this sequence: interest, periods, 0 to indicate no periodic cash flows,
and then the PV. The data can be entered as fixed numbers or, better yet, as cell references.
51
52
53
54
Figure 4-2 (just below) shows how a $1 investment grows over time at different interest rates. The curves were
55 created by solving for FV at different values for N and I. The graph shows, simultaneously, the effects of time and
56 interest rates. The data table used to create this figure is shown to the right of the figure.
57
58 Figure 4-2
59 Growth of $100 at Various Interest Rates and Time Periods
60
61 FV of $100
62 After N Years
63
64
65 $700.00
66
67
68 $600.00
69
70 $500.00
71
72 $400.00
73
74 $300.00
75
76
$200.00
77
78
79 $100.00
80
81 $0.00
82 0 2 4 6 8 10 12
83 Years
84
85
86 4-3 Present Values
87
88 Mathematically, the present value is the opposite of the future value. Instead of compounding a present value
89 forward to find the FV, you discount the FV back to find the PV. Thus, if you know the PV, you can compound to
find the FV, while if you know the FV, you can discount to find the PV.
90
91
92 To illustrate, refer to the time line below and assume that you will need $115.76 in 3 years. If a bank pays a
guaranteed 5% interest rate each year, how much must you deposit now to have $115.76 in 3 years?
93
94
95 Figure 4-3
 A B C D E F
96 Present value of at Various Interest Rates and Time Periods
97 INPUTS:
98 Future payment = CFN = FV = $115.76
99 Interest rate = I = 5.00%
100 No. of periods = N = 3
101
102 Time Line Periods: 0 1 2
103 Cash flow: PV = ? 0 0
104
105 1. Step-by-Step: $100.00 ← $105.00 ← $110.25
106
107 2. Formula: PVN = FV/(1+I)N PV = $115.76/(1.05)3 =
108
109 Inputs: 3 5 0
110 3. Financial Calculator: N I/YR PV PMT
111 Output: −$100.00
112
113 4. Excel Spreadsheet: PV function: PV = =PV(I,N,0,FV)
114 Fixed inputs: PV = =PV(0.05,3,0,115.76) =
115 Cell references: PV = =PV(C99,C100,0,C98) =
116
In the Excel formula, the terms are entered in this sequence: interest, periods, 0 to indicate no periodic cash flows,
117 and then the FV. The data can be entered as fixed numbers or, better yet, as cell references.
118
119
120 Figure 4-4 shows how the present value of $1 due in the future declines as either the interest rate or the time until
121 receipt increases. The Data Table to the right provides the data used to draw the figure. At 0%, the PV of $1
122 always remains at $1, but at higher rates the value at the end of N years is lower the higher the rate, and at a given
rate, the value declines the larger the value of N.
123
124
125 Figure 4-4
126 Present Value of $100 at Various Interest Rates and Time Periods
127
128 FV of $100
129 After N Years
130
$120.0000
131
132
133 $100.0000
134
135 $80.0000
136
137
138 $60.0000
139
140 $40.0000
141
142
$20.0000

$0.0000
0 5 10 15 20 25 30 35 40 45
Years
 $80.0000

$60.0000

$40.0000

A B C D E F
$20.0000
143
144
145 $0.0000
146 0 5 10 15 20 25 30 35 40 45
147 Years
148
149
150
151 4-4 Finding the Interest Rate, I
152
153 Previously, we solved the basic equation to find FV and PV. However, we could just as easily solve for I or N. For
154 example, suppose we know that a given bond has a cost of $100 and that it will return $150 after 10 years. Thus,
we know PV, FV, and N, and we want to find the rate of return we would earn if we bought the bond.
155
156
157 INPUTS:
158 Present value (PV) -$100.00
159 Future value (FV) $150.00
160 No. of years (N) 10
161
162 OUTPUT:
163
164 Interest rate (I) = RATE(N,0,PV,FV)
165 Interest rate (I) 4.14%
166
167
168 4-5 Finding the Number of Years, N
169
170
Sometimes we need to know how long it will take to accumulate a given sum of money, given our beginning funds
171 and the rate we will earn on those funds. For example, suppose we believe that we could retire comfortably if we
had $1 million, and we want to find how long it will take us to reach that goal, assuming that we now have
172 $500,000 invested at 4.5%.
173
174 INPUTS:
175
176 Present value (PV) -$500,000
177 Future value (FV) $1,000,000
178 Interest rate (I) 4.50%
179
180 OUTPUT:
181
182 No. of years (N) =NPER(I,0,PV,FV)
183 No. of years (N) 15.7473
184
185
186 4-6 Perpetuities
187
188 Perpetuities are securities that promise to make payments forever. The tale below shows how the present value
189 of an ordinary annuity changes as the number of payments increases. Note that we cannot calculate the future
value of a perpetuity because, since payments go on forever, this value would be infinitely large and thus
meaningless.
 Perpetuities are securities that promise to make payments forever. The tale below shows how the present value
of an ordinary
A annuity changes
B as the number
C of payments
D increases. NoteE that we cannotFcalculate the future
value of a perpetuity because, since payments go on forever, this value would be infinitely large and thus
190 meaningless.

191
192 Payment (PMT) $25
193 Interest rate (I) 5.2%
194

195 Number of PV of Ordinary

Periods Annuity
196 1 $23.76
197 2 $46.35
198 3 $67.83
199 4 $88.24
200 5 $107.64
201 10 $191.18
202 15 $256.02
203 20 $306.34
204 25 $345.39
205 30 $375.70
206 40 $417.48
207 50 $442.65
208 60 $457.81
209 70 $466.94
210 80 $472.44
211 90 $475.75
212 100 $477.75
213 200 $480.75
214 500 $480.77
215
216 Notice in the table above that the PV of an ordinary annuity increases as the number of payments increases, as
217 you would expect. However, the PV appears to begin leveling off. This is because the present value of a cash flow
far in the future is very small and approaches zero as the time of the cash flow goes to infinity. In fact, the present
218 value of a perpetuity can be found with a simple formula: Value = PMT / I .
219
220
221 Consider a British consol that pays a $25 annual payment. If interest rates are currently 5.2%, what is the value
222 of the consol?
223
224 Payment (PMT) $25
225 Interest rate (I) 5.2%
226
227 Value (PV): $25 / 0.052 = $480.77
228
229
230 4-7 Annuities
231
232 An annuity is a series of equal cash flows. The cash flows can be at the end of the period or the beginning, but they
233 must not change.
234
235
 A B C D E F
236 4-8 Future Value of an Ordinary Annuity
237
238 An ordinary annuity has regular, periodic payments that occur at the end of each period. Methods for solving the
239 future value of an ordinary annuity are shown below.
240
241 Figure 4-5
242 Summary: Future Value of an Ordinary Annuity
243 INPUTS:
244 Payment amount = PMT = −$100
245 Interest rate = I = 5.00%
246 No. of periods = N = 3
247
248 1. Step-by-Step: Periods: 0 1 2 3
249 Cash flow: −$100 −$100 −$100
250 ↓ ↓ ↓
251 ↓ ↓ $100.00
252 Multiply each payment by ↓ ⤷→→ $105.00
253 (1+I)N-t and sum these FVs to ⤷→→ →→→→→→→ $110.25
254 find FVAN: $315.25
255
256 2. Formula:
257 "= PMT x " ( 〖 "(1+I)" 〗 ^"N"
/"I" " − " "1" /"I" ) =
258 FVAN $315.25
259
260
261 Inputs: 3 5 0 −100
262 3. Financial Calculator: N I/YR PV PMT
263 Output:
264
265 4. Excel Spreadsheet: FV function: FVAN = =FV(I,N,PMT,PV)
266 Fixed inputs: FVAN = =FV(0.05,3,-100,0) =
267 Cell references: FVAN = =FV(C245,C246,C244,0) =
268
269
270
271 4.9 Future Value of an Annuity Due
272
273 An annuity due also has regular, periodic payments, but unlike an ordinary annuity, the payments occur at the
274 beginning of each period.
275
276 Figure Not In Textbook
277 Summary: Future Value of an Annuity Due
278 INPUTS:
279 Payment amount = PMT = −$100
280 Interest rate = I = 5.00%
281 No. of periods = N = 3
282
283 1. Step-by-Step: Periods: 0 1 2 3
 A B C D E F
284 Cash flow: −$100 −$100 −$100
285 ↓ ↓ ↓
286 ↓ ↓ ⤷→→ $105.00
287 Multiply each payment by ↓ ⤷→→ →→→→→→→ $110.25
288 (1+I)N-t and sum these FVs to ⤷→→
→→→→→→→ →→→→→→→ $115.76
289 find FVAN: $331.01
290
291 2. Formula:
"PMT x " ( 〖 "(1+I)" 〗 ^"N" /"I" "
292 − " "1" /"I" ) x (1 + I) =
293 FVAN = $331.01
294
295
296 Inputs: Mode = BEG 3 5 0 −100
297 3. Financial Calculator: N I/YR PV PMT
298 Output:
299
300 4. Excel Spreadsheet: FV function: FVAN = =FV(I,N,PMT,PV,TYPE)
301 Fixed inputs: FVAN = =FV(0.05,3,-100,0,1) =
Cell references: FVAN = =FV(C280,C281,C279,0,1) =
302
303
304
305
306 4-10 Present Value of Ordinary Annuities and Annuities Due
307
308 The present value of an ordinary annuity is the sum of the PVs of the individual cash flows. Methods for solving
309 the present value of an ordinary annuity are shown below.
310
311 Figure 4-6
312 Summary: Present Value of an Ordinary Annuity
313 INPUTS:
314 Payment amount = PMT = −$100
315 Interest rate = I = 5.00%
316 No. of periods = N = 3
317
318 1. Step-By-Step: Periods: 0 1 2 3
319 Cash flow: −$100 −$100 −$100
320 ↓ ↓ ↓
321 $95.24 ←←⤶ ↓ ↓
322 Divide each payment by $90.70 ←←←←←← ←←⤶ ↓
323 (1+I)t and sum these PVs to $86.38 ←←←←←← ←←←←←← ← ← ⤶
324 find PVAN: $272.32
325
326 2. Formula:
327 "= PMT x " ("1" /"I" " − " "1" /
328 PVAN ("I" 〖 " (1+I)" 〗 ^"N" )) = $272.32
329
330
 A B C D E F
331
332 Inputs: 3 5 −100
333 3. Financial Calculator: N I PV PMT
334 Output: 272.32
335
336 4. Excel Spreadsheet: PV function: PVAN = =PV(I,N,PMT,FV)
337 Fixed inputs: PVAN = =PV(0.05,3,-100,0) =
338 Cell references: PVAN = =PV(C315,C316,C314,0) =
339
340
341 PRESENT VALUE OF AN ANNUITY DUE (this table is not in text)
342
343 The difference between the present value of an ordinary annuity and an annuity due is that payments are
received earlier in an annuity due.
344
345
346 Figure Not In Textbook
347 Summary: Present Value of an Annuity Due
348
349 INPUTS:
350 Payment amount = PMT = −$100
351 Interest rate = I = 5.00%
352 No. of periods = N = 3
353
354 1. Step-By-Step: Periods: 0 1 2 3
355 Cash flow: −$100 −$100 −$100
356 ↓ ↓ ↓
357 $100.00 ↓ ↓
358 Divide each payment by $95.24 ←←⤶ ↓
359 (1+I)t and sum these PVs to $90.70 ←←←←←← ←←⤶
360 find PVAN: $285.94
361
362 2. Formula:
363 "PMT x " ("1" /"I" " − " "1" /("I" 〖 " (1+I)" 〗
364 PVAN = ^"N" )) x (1 + I) = $285.94
365
366
367
368 Inputs: Mode = BEG 3 5 −$100
369 3. Financial Calculator: N I PV PMT
370 Output: 285.94
371
372 4. Excel Spreadsheet: PV function: PVAN = =PV(I,N,PMT,FV)
373 Fixed inputs: PVAN = =PV(0.05,3,-100,0,1) =
374 Cell references: PVAN = =PV(C351,C352,C350,0,1) =
375
376
377
378 4-11 Finding Annuity Payments, Periods, and Interest Rates
 A B C D E F
379
380 Fundamentally, this section is no different than previous TVM exercises. When solving for PMT, N, or I, you must
381 be given values for the other variables, and then you solve the problem.
382
383 FINDING PMT
384 Suppose we need to accumulate $10,000 and have it available 5 years from now. Suppose further that we can
385 earn a return of 6% on our savings, which are currently zero. How much must we save in each of the 5 years,
assuming (a) end-of-year payments and (b) beginning-of-year payments?
386
387
388 No. of years (N) 5
389 Interest rate (I) 6%
390 Present value (PV) $0
391 Future value (FV) $10,000
392
393 a. END MODE b. BEGIN MODE
394 Payment (PMT) -$1,773.96 Payment (PMT -$1,673.55
395 =PMT(I,N,PV,FV) =PMT(I,N,PV,FV,Type=1)
396
397 FINDING N
398 Suppose you decide to make end-of-year deposits, but you can only save $1,200 per year. Again assume that you
399 would earn 6%. How long would it take you to reach your $10,000 goal?
400
401 BEGIN MODE
402 Interest rate (I) 6% 6%
403 Present value (PV) $0 $0
404 Payment (PMT) -$1,200 -$1,200
405 Future value (FV) $10,000 $10,000
406
407 No. of years (N) 6.96 6.63
408 =NPER(I,PMT,PV,FV,0) =NPER(I,PMT,PV,FV,1)
409 FINDING I
410 Now suppose you can only save $1,200 annually, but you still want to have the $10,000 in 5 years. What rate of
411 return would enable you to achieve your goal?
412
413 BEGIN MODE
414 No. of years (N) 5 5
415 Present value (PV) $0 $0
416 Payment (PMT) -$1,200 -$1,200
417 Future value (FV) $10,000 $10,000
418
419 Interest rate (I) 25.78% 17.54%
420 =RATE(N,PMT,PV,FV,0) =RATE(N,PMT,PV,FV,1)
421
422 4-12 Uneven, or Irregular, Cash Flows
423
424
425
First, consider a security that pays $100 for 5 years plus a lump sum of $1,000 at the end of the 5th year. We can
426 find the PV in several ways: (1) With a financial calculator using the step-by-step approach, or by finding the PV of
the annuity plus the PV of the final $1,000 and then summing these two values, or by using the calculator's cash
flow register, or (2) with Excel, using either the PV or the NPV function. We illustrate the step-by-step and the two
Excel approaches below.
 First, consider a security that pays $100 for 5 years plus a lump sum of $1,000 at the end of the 5th year. We can
find theA B (1) With a financial
PV in several ways: C D using the step-by-step
calculator E approach,For by finding the PV of
427 the annuity plus the PV of the final $1,000 and then summing these two values, or by using the calculator's cash
flow register, or (2) with Excel, using either the PV or the NPV function. We illustrate the step-by-step and the two
428 Excel approaches below.
429 Figure Not Shown in Textbook
430 Present Value of an Annuity Plus Additional Final Payment
431 INPUTS:
432 Interest rate = I = 12.00%
433 No. of periods = N = 5
434 Payment amount = PMT = $100
435 Future value = FV = $1,000
436
437 1. Step-by-step:
438 Periods: 0 1 2 3 4
439 PMT CFs: $100.00 $100.00 $100.00 $100.00
440 Additional CF:
441 Total CFs: $100.00 $100.00 $100.00 $100.00
442 PVs of the CFs: $89.29 $79.72 $71.18 $63.55
443
444 PV of the CF Stream = Sum of the Individual PVs = $927.90
445
446 2. Financial Calculator:
447 You could enter the cash flows into the cash flow register of a financial calculator,
enter I/YR, and then press the NPV key to find the answer.
448
449
450 3. Excel Spreadsheet: PV Function: PVAN = =PV(I,N,PMT,FV)
451 PV fixed inputs: PVAN = =PV(0.12,5,100,1000) =
452 PV cell references: PVAN = =PV(C432,C433,C434,C435) =
453 NPV Function: NPV = =NPV(I,CFs)
454 NPV fixed inputs: NPV = =NPV(0.12,100,100,100,100,1100) =
455 NPV cell references: NPV = =NPV(C432,C441:G441) =
456 The Excel formula ignores the initial cash flow (in Year 0). When entering a cash flow range, Excel assumes that
457 the first value occurs at the end of the first year. As we will see later, if there is an initial cash flow, it must be
added separately to complete the NPV formula result. Notice too that you can enter cash flows one-by-one, but if
458 the cash flows appear in consecutive cells, you can enter the cell range, as we did here.
459
460
461
462 Now consider an irregular cash flow stream, where the CFs can take on any value.
 A B C D E F
463
464 Figure 4-7
465 Present Value of an Irregular Cash Flow Stream
466 INPUTS:
467 Interest rate = I = 12%
468
469 1. Step-by-step:
470 Periods: 0 1 2 3 4
471 Cash Flows: $0.00 $100.00 $300.00 $300.00 $300.00
472 PVs of the CFs: $89.29 $239.16 $213.53 $190.66
473
474 PV of the Irregular CF Stream = Sum of the Individual PVs = $1,016.35
475
476
You could enter the cash flows into the cash flow register of a financial calculator,
477 2. Calculator: enter I/YR, and then press the NPV key to find the answer.
478
479 3. Excel Spreadsheet: NPV Function: NPV = = NPV(I,CFs)
480 Fixed inputs: NPV = =NPV(0.12,100,300,300,300,500)
481 Cell references: NPV = =NPV(C467,C471:G471)
482
483 The Excel formula ignores the initial cash flow (in Year 0). When entering a cash flow range, Excel assumes that
the first value occurs at the end of the first year. As we will see later, if there is an initial cash flow, it must be
484 added separately to complete the NPV formula result. Notice too that you can enter cash flows one-by-one, but if
485 the cash flows appear in consecutive cells, you can enter the cell range, as we did here.
486
487
488
489 4-13 Future Value of an Uneven Cash Flow Stream
490
491 We find the future value of uneven cash flow streams by compounding rather than discounting. The step-by-step
492 approach works the same, but unfortunately, Excel does not have a net future value (NFV) function, although
493 financial calculators do have this function. One way around this is to solve for the NPV and then find the FV of this
amount at the end of the cash flow stream.
494
495
496 Figure 4-8
497 Future Value of an Irregular Cash Flow Stream
498 INPUTS:
499 Interest rate = I = 12%
500
501 1. Step-by-step:
502 Periods: 0 1 2 3 4
503 Cash flows: $0.00 $100.00 $300.00 $300.00 $300.00
504 FVs of the CFs: $157.35 $421.48 $376.32 $336.00
505
506 FV of the Irregular CF Stream = Sum of the Individual FVs = $1,791.15
507
508
 A B C D E F
You could enter the cash flows into the cash flow register of a financial calculator,
509 2. Calculator:
enter I/YR, and then press the NFV key to find the answer.

510
511 3. Excel Spreadsheet Step 1. Find NPV: =NPV(C499,C503:G503)
512 Step 2. Compound NPV to find NFV: =FV(C499,G502,0,-G511)
513
514
515
516 4-14 Solving for I with Irregular Cash Flows
517
518 Assume that a bond will pay $100 at the end of each of the next 5 years, plus an additional $1,000 at the end of the
5th year. The cost of the bond is $927.90. What rate of return would you earn if you bought the bond?
519
520
521
You could find the rate of return using Excel's IRR (for "internal rate of return") function or its RATE function, as
522 shown below. The RATE function deals with situations where we have an annuity plus a final lump sum. The IRR
523 function deals with any cash flow pattern, and it is easier to use. You could enter a guess as to the IRR, but this is
not necessary.
524
525
526 Finding the Interest Rate, Annuity Plus Lump Sum
527 INPUTS:
528 Annuity pmts $100
529 Future lump sum $1,000
530
531 Periods: 0 1 2 3 4
532 Cash Flows: -$927.90 $100 $100 $100 $100
533
534 Excel Function Approach: Cell references: IRR = =IRR(B532:G532)
535 Cell references: RATE = =RATE(G531,B528,B532,B529)
536
537
538 The IRR function is used to find the rate of return on capital budgeting projects, where the firm makes a capital
539 expenditure and then expects to receive a series of cash inflows. Figure 4-9 illustrates this calculation. Note that
the IRR function can be used even if one of the post-investment cash flows is negative. Change the 4th year CF
540 from $300 to -$100 and see the IRR drop to 2.90%. Then change it back to $300.
541
542
543 Figure 4-9
544 IRR of an Uneven Cash Flow Stream
545 Periods: 0 1 2 3 4
546 Cash flows: -$1,000 $100 $300 $300 $300
547
You could enter the cash flows into the cash flow register of a financial calculator
548 1. Calculator: and then press the IRR key to find the answer.

549
550 2. Excel IRR Function: Cell references: IRR = =IRR(B546:G546)
551
 A B C D E F
552
553 4-15 Semiannual and Other Compounding Periods
554
555 If $100 is invested in an account at an annual nominal interest rate of 12% for 1 year, what are the effective
556 interest rates and the future values based on annual, semiannual, quarterly, monthly and daily compounding?
557
558 When you work this problem, recognize that with more compounding periods, you receive interest sooner than
559 with annual compounding, so you will earn more "interest on interest." Therefore, you will end up with more
money, and the effective interest rate will be higher, than with annual compounding.
560
561
562 Nominal annual rate = 12%
563 Amount invested = $100
 A B C D E F
564 Number of years = 1
565
566 Figure 4-10
567 Effect on $100 of Compounding More Frequently than Once a Year

Number of Periodic
568 Frequency of Nominal Periods Interest Rate Effective Annual
Compounding Annual Rate per Year (M)a (IPER) Rate (EFF%)b Future Valuec
569 Annual 12% 1 12.0000% 12.0000% $112.00
570 Semiannual 12% 2 6.0000% 12.3600% $112.36
571 Quarterly 12% 4 3.0000% 12.5509% $112.55
572 Monthly 12% 12 1.0000% 12.6825% $112.68
573 Daily 12% 365 0.0329% 12.7475% $112.75
574
575 a
We used 365 days per year in the calculations.
576 b
The EFF% is calculated as (1 + IPER)M.
577 c
The Future value is calculated as $100(1 + EFF%).
578
579
580
581 ADD-ON INTEREST (Box: Truth in Lending)
582
583 Cost of Credit based on "Add-On" Interest. This table is not in the text, but the
584 procedure is discussed in the "Truth in Lending Box". This procedure is commonly
585 used by retailers, auto dealers, and many other lenders. The calculator solution is
586 explained in the text and also below. The Excel solution is explained just below.
587
588 Amount borrowed = Cost of TV. Disregards the advanced payment, handled separately.
589 Nominal rate
590 Amount of interest = interest rate x Amt borrowed
591 Stated loan size = Amt borrowed + Interest
592 Number of payments
593 Payment/month
594
595 0 1 2 3 4
596 Amt borrowed $3,000.00
597 Monthly Pmts -$270.00 -$270.00 -$270.00 -$270.00 -$270.00
598 CF time line $2,730.00 -$270.00 -$270.00 -$270.00 -$270.00
599
600 IRR = periodic rate: =IRR(B593:M593) = 1.4313%
601 APR rate: =E595*G587 = 17.1758%
602 EFF%: =(1+E595)^G587-1 = 18.5945%
603
604 Before the Truth in Lending Act, auto dealers, TV dealers, and even student loan officers would
605 make add-on loans and just tell customers about the 8% stated rate. After 1968, such lenders were
606 required to also report the much higher APR rate. But lenders are still not required to report the even
607 higher EFF%, which is the "true" rate that borrowers should base decisions on.
 A B C D E F
608
609 We showed the cash flows above as a"horizontal" time line, but it's easier to fit the analysis on the
610 screen using a vertical time line, as shown below. The calculations are identical, but the vertical setup
611 is better from a presentation standpoint if we have more cash flows than can be shown on the screen.
612
613 Periods Borrowed Payments Monthly CFs
614 0 $3,000.00 -$270.00 $2,730.00
615 1 -$270.00 -$270.00
616 2 -$270.00 -$270.00
617 3 -$270.00 -$270.00
618 4 -$270.00 -$270.00
619 5 -$270.00 -$270.00
620 6 -$270.00 -$270.00
621 7 -$270.00 -$270.00
622 8 -$270.00 -$270.00
623 9 -$270.00 -$270.00
624 10 -$270.00 -$270.00
625 11 -$270.00 -$270.00
626 12 $0.00 $0.00
627 IRR = periodic rate: 1.4313%
628 APR rate: 17.176%
629 EFF%: 18.595%
630
631 To solve the problem with a calculator, first set the machine to BEGIN mode, then enter N = 12, PV =
632 3000, and PMT = -270. When you press the I/YR key to get the periodic rate, 1.431313, which you can
633 use to find the APR and EFF% as we did above.
634
635
636 4-16 Fractional Time Periods
637
638 Suppose you deposited $100 in a bank that pays a nominal rate of 10%, compounded daily, based on a 365-day
639 year. How much would you have after 9 months?
640
641 It depends on whether interest is compounded or is simple interest.
642
643 Inputs
644 PV = $100
645 INOM = 10%
Number of days
646 in year = 365

647 Number of
months interest
charged = 9
648
649 Compounded Interest Results
650 IPER = 0.02740%
651 Number of days interest charged (rounded up) = 274
652 Ending amount = $107.79
 A B C D E F
653 Interest owed = $7.79
654
655 Simple Interest Results
656 Number of days interest charged = 274
657 Number of years interest charged = 0.7506849

658 Method 1: Interest owed= amount borrowed x

annual rate x number of years = $7.51

659 Method 2: Interest owed= amount borrowed x

daily rate x number of days = $7.51
660
661
662 4-17 Amortized Loans
663
664 If a loan is to be repaid in equal amounts on a monthly, quarterly, or annual basis it is called an amortized loan.
665
666 The figure below illustrates the amortization process. A company borrows $100,000, with the loan to be repaid in
667 5 equal payments at the end of each of the next 5 years. The lender charges 6% on the balance at the beginning of
each year.
668
669
670 With a calculator, we solve for the required payment, then we construct an amortization table as shown in The
figure below. It is far easier, and less prone to errors, to construct the amortization table with Excel, as we do
671 here.
672
673 Figure 4-11
674 Loan Amortization Schedule, $100,000 at 6% for 5 Years
675 INPUTS:
676 Amount borrowed: $100,000
677 Years: 5
678 Rate: 6%
679 Intermediate calculation:
680 PMT: $23,739.64 =PMT(C678,C677,−C676)

Beginning Repayment of
681 Amount Payment Interesta Principalb Ending Balance
Year (1) (2) (3) (2) − (3) = (4) (1) − (4) = (5)
682 1 $100,000.00 $23,739.64 $6,000.00 $17,739.64 $82,260.36
683 2 $82,260.36 $23,739.64 $4,935.62 $18,804.02 $63,456.34
684 3 $63,456.34 $23,739.64 $3,807.38 $19,932.26 $43,524.08
685 4 $43,524.08 $23,739.64 $2,611.44 $21,128.20 $22,395.89
686 5 $22,395.89 $23,739.64 $1,343.75 $22,395.89 $0.00
687 a
Interest in each period is calculated by multiplying the loan balance at the beginning of the year
688 by the interest rate. Therefore, interest in Year 1 is $100,000(0.06) = $6,000; in Year 2 it is
689 $82,260.36(0.06) = $4,935.62; and so on.
690
b
Repayment of principal is the $23,739.64 annual payment minus the interest charge for the year,
691 $17,739.64 for Year 1.
692
 A B C D E F
693
694 Consider a 30-year home mortgage of $250,000 at an annual rate of 6%. How much interest will the
695 borrower pay over the life of the loan?
696
697 INPUTS:
698 Amount borrowed: $250,000
699 Years: 30
700 Rate: 6%
701
702 N= 360
703 I/YR = 0.5%
704 PV = $250,000
705 FV = $0
706
707 PMT = −$1,498.8763 Using the PMT function.
708
709 Total payments = $539,595.47
710 Total interest = $289,595
711
712 How much interest does the borrower pay in the first year?
713
714 N= 348
715 I/YR = 0.5%
716 PMT = −$1,498.88 We are rounding to 2 decimal places.
717 FV = $0
718
719 PV = $246,930.58 Using the PMT function and rounding to 2 decimal places.
720
721 Total payments in year = $17,986.56
722 Principal paid in year = $3,069.42
723 Interest paid in year = $14,917.14
724
725 Suppose we consider a 15-year mortgage at the same interest rate. How much interest will the
726 borrower pay over the life of the loan?
727
728 N= 180
729 I/YR = 0.5%
730 PV = $250,000
731 FV = $0
732
733 PMT = −$2,109.6421 Using the PMT function.
734
735 Total payments = $379,735.57
736 Total interest = $129,736
737
738 4-18 Growing Annuities
739
740
Example 1. A 65-year-old retiree expects to live for 20 more years, currently has $1,000,000 of savings, expects to
earn a 6% rate on his or her money, and expects inflation to average 3%. How much can he or she withdraw at
the beginning of each year and keep the withdrawals constant in real terms, i.e., growing at the same rate as
inflation and thus enabling him or her to maintain a constant standard of living?
 A B C D E F
Example 1. A 65-year-old retiree expects to live for 20 more years, currently has $1,000,000 of savings, expects to
741 earn a 6% rate on his or her money, and expects inflation to average 3%. How much can he or she withdraw at
742 the beginning of each year and keep the withdrawals constant in real terms, i.e., growing at the same rate as
inflation and thus enabling him or her to maintain a constant standard of living?
743
744
745 Inputs
746 Number of years = 20
747 Nominal interest rate, rNOM = 6%
748 Available to invest = Portfolio = $1,000,000
749 Inflation rate = 3%
750 Initial withdrawal (guess) = $50,000
751 Withdrawal at beginning or end? Beginning
752
753
754 Step 1: Set up an "Amortization Table" to show exactly what's happening. We begin with $1 million. But we
755 immediately make the first withdrawal, hence have less than $1 million to invest. We don't know how much we
756 can withdraw initially, so we make a "guess" of $50,000. We subtract the $50,000 from the initial portfolio and
get $950,000, which is invested at 6% and thus earns $57,000. The earnings are added to the beginning balance,
757 less the withdrawal, to produce the ending balance, which is carried forward to create the next beginning
758 balance. This process is continued for 20 years.
759
760
We want to end up with a $0.00 ending balance. With the $50,000 initial withdrawal, we see that the ending
761 balance is greater than zero. Therefore, we should make a larger initial withdrawal. We could just go through a
762 series of trials and errors until we found an initial withdrawal that produced the zero ending balance. The
amount that does the trick is $64,786.87708. Replace the $50,000 with 64786.87708 to prove that this value
763 "works."
764
765
766
767 As you might guess, there are two much easier ways to find the initial withdrawal amount: (1) Use Excel's Goal
Seek function, or (2) use an equation. We explain those procedures below, and we also graph the results. We see
768 that the withdrawals rise every year with inflation, earnings decline, and the balance declines faster and faster, as
769 the withdrawals increase and the earnings decline.
770
771 Beginning BOY: Amount Investable
Withdrawal Balance Withdrawn Funds Earnings Ending Balance
772 1 $1,000,000.00 $64,786.88 $935,213.12 $56,112.79 $991,325.91
773 2 $991,325.91 $66,730.48 $924,595.43 $55,475.73 $980,071.15
774 3 $980,071.15 $68,732.40 $911,338.75 $54,680.33 $966,019.08
775 4 $966,019.08 $70,794.37 $895,224.71 $53,713.48 $948,938.19
776 5 $948,938.19 $72,918.20 $876,019.99 $52,561.20 $928,581.19
777 6 $928,581.19 $75,105.75 $853,475.44 $51,208.53 $904,683.97
778 7 $904,683.97 $77,358.92 $827,325.05 $49,639.50 $876,964.55
779 8 $876,964.55 $79,679.69 $797,284.87 $47,837.09 $845,121.96
780 9 $845,121.96 $82,070.08 $763,051.88 $45,783.11 $808,835.00
781 10 $808,835.00 $84,532.18 $724,302.82 $43,458.17 $767,760.98
782 11 $767,760.98 $87,068.15 $680,692.84 $40,841.57 $721,534.41
783 12 $721,534.41 $89,680.19 $631,854.22 $37,911.25 $669,765.47
784 13 $669,765.47 $92,370.60 $577,394.88 $34,643.69 $612,038.57
785 14 $612,038.57 $95,141.71 $516,896.86 $31,013.81 $547,910.67
786 15 $547,910.67 $97,995.96 $449,914.70 $26,994.88 $476,909.59
787 16 $476,909.59 $100,935.84 $375,973.74 $22,558.42 $398,532.17
 A B C D E F
788 17 $398,532.17 $103,963.92 $294,568.25 $17,674.09 $312,242.34
789 18 $312,242.34 $107,082.84 $205,159.51 $12,309.57 $217,469.08
790 19 $217,469.08 $110,295.32 $107,173.76 $6,430.43 $113,604.18
791 20 $113,604.18 $113,604.18 $0.00 $0.00 $0.00
792
793 Using Goal Seek: 1. Put the pointer on the orange cell for the Ending Balance after the 20th withdrawal.
2. Click Data, What-If-Analysis, Goal Seek to get a dialog box, which you then fill out as shown to
794 the right.
795 3. You will be at the "Set cell" because you put the pointer there initially.
796 4. Go down to the "To value to" cell. You want to get 0 as the ending balance, so enter 0 here.
5. Now move down to the "By changing cell" box, then click on the yellow cell with the Year 1
797 withdrawal to select it.

798 6. Now click OK, and the initial withdrawal will change to $64,786.88, and the final balance will
go to $0.00. You could increase the decimals shown to see the extra digits Excel calculated.
799
800
801
802 Calculator: Step 1: Find the real rate of return, r r.
803 rr = (1+rNOM)/(1 + inflation) - 1
804 = (1.06)/(1.03) - 1 = 0.029126213592
805 rr = 2.9126214%
806
807 Step 2: Use the PMT function in Excel or a calculator to find the initial amount to be withdrawn. Be
808 sure to set the calculator to BEGIN mode, and make a similar adjustment to the Excel function.
809 N= 20
810 I= rr = 2.9126214%
811 PV = -1,000,000
812 PMT = $64,786.88 This is consistent with the value found using Goal Seek.
813
814
815
816 If the first withdrawal occurs at the end rather than the beginning of the first year, then the amount of investable
817 funds during each year will be somewhat larger, and the initial withdrawal to leave a zero final balance will also
be somewhat larger. We can modify the table by making the first withdrawal at the end of the year and then using
818 Goal Seek to find the initial withdrawal, which is slightly higher than the case of the annuity due because the
819 original funds earned interest for a year prior to the first withdrawal.
820
821 Inputs
822 Number of years = 20
823 Nominal interest rate, rNOM = 6%
824 Available to invest = Portfolio = $1,000,000
825 Inflation rate = 3%
826 Initial withdrawal (guess) = $50,000
827 Withdrawal at beginning or end? End
828
829 Beginning EOY: Amount Investable
Balance Withdrawn Funds Earnings Ending Balance
830 1 $1,000,000.00 $68,674.09 ### $60,000.00 $991,325.91
831 2 $991,325.91 $70,734.31 $991,325.91 $59,479.55 $980,071.15
832 3 $980,071.15 $72,856.34 $980,071.15 $58,804.27 $966,019.08
 A B C D E F
833 4 $966,019.08 $75,042.03 $966,019.08 $57,961.14 $948,938.19
834 5 $948,938.19 $77,293.29 $948,938.19 $56,936.29 $928,581.19
835 6 $928,581.19 $79,612.09 $928,581.19 $55,714.87 $904,683.97
836 7 $904,683.97 $82,000.45 $904,683.97 $54,281.04 $876,964.55
837 8 $876,964.55 $84,460.47 $876,964.55 $52,617.87 $845,121.96
838 9 $845,121.96 $86,994.28 $845,121.96 $50,707.32 $808,835.00
839 10 $808,835.00 $89,604.11 $808,835.00 $48,530.10 $767,760.98
840 11 $767,760.98 $92,292.23 $767,760.98 $46,065.66 $721,534.41
841 12 $721,534.41 $95,061.00 $721,534.41 $43,292.06 $669,765.47
842 13 $669,765.47 $97,912.83 $669,765.47 $40,185.93 $612,038.57
843 14 $612,038.57 $100,850.22 $612,038.57 $36,722.31 $547,910.67
844 15 $547,910.67 $103,875.72 $547,910.67 $32,874.64 $476,909.59
845 16 $476,909.59 $106,991.99 $476,909.59 $28,614.58 $398,532.17
846 17 $398,532.17 $110,201.75 $398,532.17 $23,911.93 $312,242.34
847 18 $312,242.34 $113,507.81 $312,242.34 $18,734.54 $217,469.08
848 19 $217,469.08 $116,913.04 $217,469.08 $13,048.14 $113,604.18
849 20 $113,604.18 $120,420.43 $113,604.18 $6,816.25 $0.00
850
851 A modified version of the formula could also be used to determine the initial withdrawal:
852 rr = (1+rNOM)/(1 + inflation) - 1
853 rr = 2.9126214%
854
855 Now use the PMT function in Excel or a calculator to find the initial amount to be withdrawn,
856 assuming payments at the end of the year.
857 N= 20
858 I= rr = 2.9126214%
859 PV = 1,000,000
860 PMT = $66,673.87
861 Adjusted PMT = $68,674.09 = PMT(1+ Inflation). The adjustment accounts for Year 1 inflation.
862
863
864
865 Example 2, Growing Annuities: Initial deposit to accumulate a given sum. You need to accumulate $100,000 in 10
years. You plan to make an initial deposit today, then make 9 more deposits at the beginning of the next 9 years,
866 but with the deposits increasing at the inflation rate. You expect to earn 6% on your funds, and you expect a 2%
867 inflation rate. How large must your initial deposit be to enable you to reach your $100,000 target?
868
869 We can set up a table with an arbitrary initial deposit that grows at the inflation rate and is then compounded at
870 the nominal rate for (N - t) years. The sum of the compounded amounts should total to $100,000. With an
871 arbitrary initial amount the ending amount is not likely to be $100,000, so we use goal seek as shown in the
completed dialog box to find the correct initial deposit.
872
873
874 Inputs:
875 Years 10
876 Amount Needed (FV) $100,000
877 Nominal rate earned on account 6.00%
878 Inflation 2.00%
879 Beginning or End? Beginning
880
 A B C D E F
881
882 Use Goal Seek in the following table to determine the initial deposit. Start with any value for BOY payment at time
883 zero, then use Goal Seek to set the final balance to the target by changing the BOY t=0 payment.
884
885 BOY Payment
Compounded
886 Period (t) Initial(1+I)^t
value
887 0 $6,598.87 $11,817.57
888 1 $6,730.85 $11,371.62
889 2 $6,865.46 $10,942.51
890 3 $7,002.77 $10,529.58
891 4 $7,142.83 $10,132.24
892 5 $7,285.68 $9,749.89
893 6 $7,431.40 $9,381.97
894 7 $7,580.03 $9,027.93
895 8 $7,731.63 $8,687.26
896 9 $7,886.26 $8,359.43
897 N= 10 $0.00 $100,000.00
898
899 Calculator approach:
900 Find the real rate: rr = (1+rNOM)/(1 + inflation) - 1 = 3.921569%
901 inflation rate. This is our constant dollar future target: Target
902 real FV = (Nominal FV)/(1 + Inflation) N = $82,034.83
903 payment. The PV=0, FV=82034.83, rate=3.921569, and set to
904 Beginning mode. $6,598.87
905
906 This is consistent with the Goal Seek solution.
 G H I J K L M
1 5/6/2013
2
3
4
for Chapter 4, and it was used to create
5
s for specific Excel functions and features;
6 with Excel
tudents to become familiar
te tables and graphs that7 can then be
nuscript for submission to the publisher.
epare reports. 8
9
10
11
rally quite easy and can be worked with a
some information on the12 solutions for
13
reen take you to the solutions for self-
amiliar with Excel should still be able to
14
15
16
17
18
19 it now, you
uture because, if you had
e future. The process of20going to future
21
22
23 $100 in a bank
e that you plan to deposit
ve at the end of Year 3?
24
25
26the formula
a regular calculator; (2)
27
h; and (4) the Excel approach.
28
29
30
31
32
33
34
35
36 3
37 FV = ?
38
39 $115.76
40
41 $115.76
42
43
44 FV
45 $115.76
46
47
48 $115.76
 G H I J K L M
49 $115.76
50
riods, 0 to indicate no periodic cash flows,
t, as cell references.
51
52
53
54
ifferent interest rates. The curves were
55 of time and
s, simultaneously, the effects
ght of the figure. 56
57
58
59 Future Value of $1
60 Periods (N) Interest Rate (I)
61 115.7625 I = −20% I = 0% I = 5% I = 10% I = 20%
62 0 $100.00 $100.00 $100.00 $100.00 $100.00
63 1 $80.00 $100.00 $105.00 $110.00 $120.00
64 2 $64.00 $100.00 $110.25 $121.00 $144.00
65 3 $51.20 $100.00 $115.76 $133.10 $172.80
66 4 $40.96 $100.00 $121.55 $146.41 $207.36
67 5 $32.77 $100.00 $127.63 $161.05 $248.83
68 6 $26.21 $100.00 $134.01 $177.16 $298.60
69 7 $20.97 $100.00 $140.71 $194.87 $358.32
70 8 $16.78 $100.00 $147.75 $214.36 $429.98
71 9 $13.42 $100.00 $155.13 $235.79 $515.98
72 10 $10.74 $100.00 $162.89 $259.37 $619.17
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
stead of compounding a88 present value
you know the PV, you can89compound to
90
91
$115.76 in 3 years. If a92
bank pays a
to have $115.76 in 3 years?
93
94
95
 G H I J K L M
96
97
98
99
100
101
102 3
103 $115.76
104
105 ← $115.76
106
107 $100.00
108
109 115.76
110 FV
111
112
113
114 −$100.00
115 −$100.00
116
riods, 0 to indicate no periodic cash flows,
, as cell references. 117
118
119
120or the time until
as either the interest rate
draw the figure. At 0%, 121
the PV of $1
s lower the higher the122
rate, and at a given
123
124
125
126
127 Present Value of $1
128 Periods (N) Interest Rate (I)
129 86.3838 I = 0% I = 5% I = 10% I = 20%
130 0 $100.0000 $100.0000 $100.0000 $100.0000
131 4 $100.0000 $82.2702 $68.3013 $48.2253
132 8 $100.0000 $67.6839 $46.6507 $23.2568
133 12 $100.0000 $55.6837 $31.8631 $11.2157
134 16 $100.0000 $45.8112 $21.7629 $5.4088
135 20 $100.0000 $37.6889 $14.8644 $2.6084
136 24 $100.0000 $31.0068 $10.1526 $1.2579
137 28 $100.0000 $25.5094 $6.9343 $0.6066
138 32 $100.0000 $20.9866 $4.7362 $0.2926
139 36 $100.0000 $17.2657 $3.2349 $0.1411
140 40 $100.0000 $14.2046 $2.2095 $0.0680
141
142
 G H I J K L M
143
144
145
146
147
148
149
150
151
152
153for I or N. For
e could just as easily solve
154
it will return $150 after 10 years. Thus,
earn if we bought the bond.
155
156
157
158
159
160
161
162
163
164
165
166
167
168
169
170
sum of money, given our beginning funds
ve that we could retire171
comfortably if we
goal, assuming that we now have
172
173
174
175
176
177
178
179
180
181
182
183
184
185
186
187
tale below shows how188 the present value
ote that we cannot calculate
189 the future
would be infinitely large and thus
 G H I J K L M
190
191
192
193
194

195

196
197
198
199
200
201
202
203
204
205
206
207
208
209
210
211
212
213
214
215
the number of payments 216increases, as
217 of a cash flow
because the present value
h flow goes to infinity. In fact, the present
I. 218
219
220
es are currently 5.2%,221what is the value
222
223
224
225
226
227
228
229
230
231
nd of the period or the232
beginning, but they
233
234
235
 G H I J K L M
236
237
238 for solving the
d of each period. Methods
239
240
241
242
243
244
245
246
247
248
249
250
251
252
253
254
255
256
257
258
259
260
261
262 FV
263 $315.25
264
265
266 $315.25
267 $315.25
268
269
270
271
272
273 occur at the
ary annuity, the payments
274
275
276
277
278
279
280
281
282
283
 G H I J K L M
284
285
286
287
288
289
290
291
292
293
294
295
296
297 FV
298 $331.01
299
300
301 $331.01
$331.01
302
303
304
305
306
307
ividual cash flows. 308 for solving
Methods
309
310
311
312
313
314
315
316
317
318
319
320
321
322
323
324
325
326
327
328
329
330
 G H I J K L M
331
332 0
333 FV
334
335
336
337 $272.32
338 $272.32
339
340
341
342
343 are
annuity due is that payments
344
345
346
347
348
349
350
351
352
353
354
355
356
357
358
359
360
361
362
363
364
365
366
367
368 0
369 FV
370
371
372
373 $285.94
374 $285.94
375
376
377
378
 G H I J K L M
379
When solving for PMT,380N, or I, you must
381
382
383
om now. Suppose further384that we can
must we save in each385
of the 5 years,
?
386
387
388
389
390
391
392
393
394
395
396
397
$1,200 per year. Again398assume that you
399
400
401
402
403
404
405
406
407
408
409
410
ve the $10,000 in 5 years. What rate of
411
412
413
414
415
416
417
418
419
420
421
422
423
424
425
1,000 at the end of the 5th year. We can
-by-step approach, or426
by finding the PV of
values, or by using the calculator's cash
We illustrate the step-by-step and the two
 G H I J K L M
427
428
429
430
431
432
433
434
435
436
437
438 5
439 $100.00
440 ###
441 ###
442 $624.17
443
444
445
446
447 $927.90
448
449
450
451 −$927.90
452 −$927.90
453
454 $927.90
455 $927.90
456
ng a cash flow range, Excel assumes that
457 it must be
here is an initial cash flow,
u can enter cash flows one-by-one, but if
as we did here. 458
459
460
461
any value. 462
 G H I J K L M
463
464
465
466
467
468
469
470 5
471 $500.00
472 $283.71
473
474
475
476
477 $1,016.35

478
479
480 $1,016.35
481 $1,016.35
482
483assumes that
ng a cash flow range, Excel
here is an initial cash flow, it must be
u can enter cash flows484one-by-one, but if
as we did here. 485
486
487
488
489
490
ather than discounting. 491The step-by-step
492 although
uture value (NFV) function,
ve for the NPV and then493find the FV of this
494
495
496
497
498
499
500
501
502 5
503 $500.00
504 $500.00
505
506
507
508
 G H I J K L M

509 $1,791.15

510
511 $1,016.35
512 $1,791.15
513
514
515
516
517
plus an additional $1,000518at the end of the
earn if you bought the bond?
519
520
521
eturn") function or its RATE function, as
522 sum. The IRR
n annuity plus a final lump
uld enter a guess as to523
the IRR, but this is

524
525
526
527
528
529
530
531 5
532 $1,100
533
534 12.00%
535 12.00%
536
537
rojects, where the firm 538
makes a capital
539
4-9 illustrates this calculation. Note that
ws is negative. Change the 4th year CF
o $300. 540
541
542
543
544
545 5
546 $500
547

548 12.55%

549
550 12.55%
551
 G H I J K L M
552
553
554
555
% for 1 year, what are the effective
erly, monthly and daily556
compounding?
557
558 sooner than
eriods, you receive interest
559
Therefore, you will end up with more
mpounding.
560
561
562
563
 G H I J K L M
564
565
566
567

568 Percentage
Increase in FV
569
570 0.32%
571 0.17%
572 0.12%
573 0.06%
574
575
576
577
578
579
580
581
582
583
584
585
586
587
588 $3,000.00
589 8.00%
590 $240.00
591 $3,240.00
592 12
593 -$270.00
594
595 5 6 7 8 9 10 11
596
597 -$270.00 -$270.00 -$270.00 -$270.00 -$270.00 -$270.00 -$270.00
598 -$270.00 -$270.00 -$270.00 -$270.00 -$270.00 -$270.00 -$270.00
599
600
601
602
603
604
605
ot required to report 606
the even
607
 G H I J K L M
608
609
610
dentical, but the vertical setup
n can be shown on the 611
screen.
612
613
614
615
616
617
618
619
620
621
622
623
624
625
626
627
628
629
630
631
632can
ate, 1.431313, which you
633
634
635
636
637
compounded daily, based638on a 365-day
639
640
641
642
643
644
645
646

647

648
649
650
651
652
 G H I J K L M
653
654
655
656
657

658

659

660
661
662
663
664
nual basis it is called an amortized loan.
665
ws $100,000, with the666 loan to be repaid in
rges 6% on the balance 667
at the beginning of
668
669
an amortization table670as shown in The
mortization table with Excel, as we do
671
672
673
674
675
676
677
678
679
680

681

682
683
684
685
686
687
688
689
690
691
692
 G H I J K L M
693
694
695
696
697
698
699
700
701
702
703
704
705
706
707
708
709
710
711
712
713
714
715
716
717
718
719
720
721
722
723
724
725
726
727
728
729
730
731
732
733
734
735
736
737
738
739
740
ently has $1,000,000 of savings, expects to
. How much can he or she withdraw at
ms, i.e., growing at the same rate as
f living?
 G H I J K L M
741
742
743
744
745
746
747
748
749
750
751
752
753
754
. We begin with $1 million. But we
755how much we
to invest. We don't know
756portfolio and
e $50,000 from the initial
nings are added to the beginning balance,
ward to create the next757
beginning
758
759
760
withdrawal, we see that the ending
withdrawal. We could761 just go through a
uced the zero ending balance.
762 The
4786.87708 to prove that this value
763
764
765
766
thdrawal amount: (1)767Use Excel's Goal
w, and we also graph the results. We see
768
d the balance declines faster and faster, as
769
770
771
772
773
774
775
776
777
778
779
780
781
782
783
784
785
786
787
 G H I J K L M
788
789
790
791
792
793
ance after the 20th withdrawal.
g box, which you then fill out as shown to
794
795
as the ending balance,796
so enter 0 here.
click on the yellow cell with the Year 1
797

e to $64,786.88, and the798

final balance will
see the extra digits Excel calculated.
799
800
801
802
803 Here is a formula for the present value of a growing annuity:
804 PVIFGADue = [1 – [(1 + g)/(1 + rNOM)]N] [(1 + rNOM)/(rNOM − g)]
805 PVIFGADue = 15.435225
806 PMT = PV / PVIFGADue = $64,786.88
o find the initial amount807
to be withdrawn. Be
imilar adjustment to the808Excel function.
809
810
811
h the value found using 812
Goal Seek.
813
814
815
816 of investable
first year, then the amount
wal to leave a zero final817
balance will also
awal at the end of the year and then using
case of the annuity due818
because the
819
820
821
822
823
824
825
826
827
828
829
830
831
832
 G H I J K L M
833
834
835
836
837
838
839
840
841
842
843
844
845
846
847
848
849
850
851
852
853
854
855
856
857
858
859
860
861
accounts for Year 1 inflation.
862
863
864
865$100,000 in 10
m. You need to accumulate
osits at the beginning of the next 9 years,
6% on your funds, and866 you expect a 2%
867
ach your $100,000 target?
868
869
nflation rate and is then compounded at
870With an
should total to $100,000.
so we use goal seek as871
shown in the
872
873
874
875
876
877
878
879
880
 G H I J K L M
881
882payment at time
rt with any value for BOY
g the BOY t=0 payment.883
884
885
886
887
888
889
890
891
892
893
894
895
896
897
898
899
900
901
902
903
904
905
906
 N O P Q
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
 N O P Q
96
97
98
99
100
101
102
103
104
105
106
107
108
109
110
111
112
113
114
115
116
117
118
119
120
121
122
123
124
125
126
127
128
129
130
131
132
133
134
135
136
137
138
139
140
141
142
 N O P Q
143
144
145
146
147
148
149
150
151
152
153
154
155
156
157
158
159
160
161
162
163
164
165
166
167
168
169
170
171
172
173
174
175
176
177
178
179
180
181
182
183
184
185
186
187
188
189
 N O P Q
236
237
238
239
240
241
242
243
244
245
246
247
248
249
250
251
252
253
254
255
256
257
258
259
260
261
262
263
264
265
266
267
268
269
270
271
272
273
274
275
276
277
278
279
280
281
282
283
 N O P Q
284
285
286
287
288
289
290
291
292
293
294
295
296
297
298
299
300
301
302
303
304
305
306
307
308
309
310
311
312
313
314
315
316
317
318
319
320
321
322
323
324
325
326
327
328
329
330
 N O P Q
331
332
333
334
335
336
337
338
339
340
341
342
343
344
345
346
347
348
349
350
351
352
353
354
355
356
357
358
359
360
361
362
363
364
365
366
367
368
369
370
371
372
373
374
375
376
377
378
 N O P Q
463
464
465
466
467
468
469
470
471
472
473
474
475
476
477
478
479
480
481
482
483
484
485
486
487
488
489
490
491
492
493
494
495
496
497
498
499
500
501
502
503
504
505
506
507
508
 N O P Q
564
565
566
567

568

569
570
571
572
573
574
575
576
577
578
579
580
581
582
583
584
585
586
587
588
589
590
591
592
593
594
595 12
596
597
598 $0.00
599
600
601
602
603
604
605
606
607
 N O P Q
608
609
610
611
612
613
614
615
616
617
618
619
620
621
622
623
624
625
626
627
628
629
630
631
632
633
634
635
636
637
638
639
640
641
642
643
644
645
646

647

648
649
650
651
652
 SECTION 4-2
SOLUTIONS TO SELF-TEST
What would the future value of $100 be after 5 years at 10% compound
interest?

N 5
I 10%
PV $100
PMT $0 FV $161.05

Suppose you currently have $2,000 and plan to purchase a 3-year certificate
of deposit (CD) that pays 4% interest compounded annually. How much will
you have when the CD matures?

N 3
I 4%
PV $2,000
PMT $0 FV $2,249.73

How would your answer change if the interest rate were 5%, or 6%, or 20%?

Interest rate$2,249.73
5% $2,315.25
6% $2,382.03
20% $3,456.00
A company’s sales in 2009 were $100 million. If sales grow at 8%, what will
they be 10 years later?

N 10
I 8%
PV ($M) $100
PMT $0 FV ($M) $215.89

What would they be if they decline by 8% per year for 10 years?

N 10
I -8%
PV ($M) $100
PMT $0 FV ($M) $43.44

How much would $1, growing at 5% per year, be worth after 100 years?

N 100
I 5%
PV $1
PMT $0 FV $131.50

What would FV be if the growth rate were 10%?

N 100
 I 10%
PV $1
PMT $0 FV $13,780.61
SECTION 4-3
SOLUTIONS TO SELF-TEST

Suppose a risk-free bond promises to pay $2,249.73 in 3 years. If the going

risk-free interest rate is 4%, how much is the bond worth today?

N 3
I 4%
PMT $0
FV $2,249.73 PV $2,000.00

How would your answer change if the bond matured in 5 rather than 3 years?

N 5
I 4%
PMT $0
FV $2,249.73 PV $1,849.11

If the risk-free interest rate is 6% rather than 4%, how much is the 5-year bond
worth today?

N 5
I 6%
PMT $0
FV $2,249.73 PV $1,681.13
How much would $1,000,000 due in 100 years be worth today if the discount
rate were 5%?

N 100
I 5%
PMT $0
FV $1,000,000 PV $7,604.49

What if the discount rate were 20%?

N 100
I 20%
PMT $0
FV $1,000,000 PV $0.0121
SECTION 4-4
SOLUTIONS TO SELF-TEST
Suppose you can buy a U.S. Treasury bond which makes no
payments until the bond matures 10 years from now, at which time it
will pay you $1,000. What interest rate would you earn if you bought
this bond for $585.43?

N 10
PMT $0
PV $585.43
FV $1,000 I= 5.50%

What rate would you earn if you could buy the bond for $550?

N 10
PMT $0
PV $550.00
FV $1,000 I= 6.16%

For $600?

N 10
PMT $0
PV $600.00
FV $1,000 I= 5.24%
2011, it earned $2.75. What was the growth rate in Microsoft’s
earnings per share (EPS) over the 14-year period?

N 14
PMT $0
PV $0.33
FV $2.75 I= 16.35%
If EPS in 2011 had been $2.00 rather than $2.75 what would the
growth rate have been?

N 14
PMT $0
PV $0.33
FV $2.00 I= 13.73%
SECTION 4-5
SOLUTIONS TO SELF-TEST

How long would it take $1,000 to double if it were invested in a

bank that pays 6% per year?

I 6%
PMT $0
PV $1,000
FV $2,000 N 11.90

How long would it take if the rate were 10%?

I 10%
PMT $0
PV $1,000
FV $2,000 N 7.27
A company's 2013 earnings per share were $2.75, and its growth
rate during the prior 10 years was 16.35% per year. If that
growth rate were maintained, how long would it take for EPS to
double?

I 16.35%
PMT $0
PV $2.75
FV $5.50 N 4.58
SECTION 4-6
SOLUTIONS TO SELF-TEST

What is the present value of a perpetuity that pays ₤1,000 per year,
beginning one year from now, if the appropriate interest rate is 5%?

PMT £1,000 ₤
I 5% PV £20,000
What would the value be if the perpetuity began its payments
immediately?
payments 1 through
PMT £1,000 infinity. If a payment is
I 5% PV £21,000 to be received
immediately, it must be
added to the formula
result.
SECTION 4-8
SOLUTIONS TO SELF-TEST

For an ordinary annuity with 5 annual payments of $100 and a 10% interest
rate, for how many years will the 1st payment earn interest, and what is the
compounded value of this payment at the end?

1st
Annuit Payme
y Data nt Data
N 5 4
I 10% 10% Years of int 4
PMT -$100 $0
PV $0 -$100 Payment FV $146.41

Answer this same question for the 5th payment.

5th
Annuit Payme
y Data nt Data
N 5 0
I 10% 10% Years of int 0
PMT -$100 0
PV $0 -$100 Payment FV $100.00

Assume that you plan to buy a condo 5 years from now, and you estimate
that you can save $2,500 per year to get a down payment. You plan to
deposit the money in a bank that pays 4% interest, and you will make the first
deposit at the end of this year. How much will you have after 5 years?

N 5
I 4%
PMT -$2,500
PV $0 FV $13,540.81

How would your answer change if the bank's interest rate were increased to
6%, or decreased to 3%?

N 5
I 6%
PMT -$2,500
PV $0 FV $14,092.73

N 5
I 3%
PMT -$2,500
PV $0 FV $13,272.84
SECTION 4-9
SOLUTIONS TO SELF-TEST

Assume that you plan to buy a condo 5 years from now, and you
need to save for a down payment. You plan to save $2,500 per year,
with the first payment being made immediately and deposited in a
bank that pays 4%. How much will you have after 5 years?
BEGIN MODE
N 5
I 4%
PV $0
PMT -$2,500 FV $14,082.44
How much would you have if you made the deposits at the end of
each year?

N 5
I 4%
PV $0
PMT -$2,500 FV $13,540.81
SECTION 4-10
SOLUTIONS TO SELF-TEST

What is the PVA of an ordinary annuity with 10 payments of $100 if the

appropriate interest rate is 10%?

N 10
I 10%
PMT -$100
FV $0 PV $614.46

What would the PVA be if the interest rate were 4%?

N 10
I 4%
PMT -$100
FV $0 PV $811.09

What if the interest rate were 0%?

N 10
I 0%
PMT -$100
FV $0 PV $1,000.00

What would the PVAs be if we were dealing with annuities due?

Part a Part b Part c

BEGIN MODE BEGIN MODE BEGIN MODE
N 10 N 10 N 10
I 10% I 4% I 0%
PMT -$100 PMT -$100 PMT -$100
FV $0 FV $0 FV $0
PV $675.90 PV $843.53 PV $1,000.00
Assume that you are offered an annuity that pays $100 at the end of each year
for 10 years. You could earn 8% on your money in other equally risky
investments. What is the most you should pay for the annuity?

N 10
I 8%
PMT -$100
FV $0 PV $671.01
If the payments began immediately, then how much would the annuity be
worth?
BEGIN MODE
N 10
I 8%
PMT -$100
FV $0 PV $724.69
SECTION 4-11
SOLUTIONS TO SELF-TEST

Suppose you inherited $100,000 and invested it at 7% per year. How large of
a withdrawal could you make at the end of each of the next 10 years and end
up with zero?

N 10
I 7%
PV $100,000
FV $0 PMT -$14,237.75
How would your answer change if you made withdrawals at the beginning of
each year?
BEGIN MODE
N 10
I 7%
PV $100,000
FV $0 PMT -$13,306.31

If you had $100,000 that was invested at 7% and you wanted to withdraw
$10,000 at the end of each year, how long would your funds last?

I 7.0%
PV $100,000
PMT -$10,000
FV $0 N 17.8

How long would they last if you earned 0%?

I 0.0%
PV $100,000
PMT -$10,000
FV $0 N 10.0

How long would they last if you earned the 7% but limited your withdrawals
to $7,000 per year?

I 7.0%
with $7,000
PV $100,000
withdrawals, you would
PMT -$7,000 never exhaust the
FV $0 N #NUM! funds.

Your rich uncle named you as the beneficiary of his life insurance policy.
The insurance company gives you a choice of $100,000 today or a 12-year
annuity of $12,000 at the end of each year. What rate of return is the
insurance company offering?

N 12
PMT -$12,000
PV $100,000
 FV $0 I 6.11%

Assume that you just inherited an annuity that will pay you $10,000 per year
for 10 years, with the first payment being made today. A friend of your
mother offers to give you $60,000 for the annuity. If you sell it to him, what
rate of return will your mother’s friend earn on the investment?

BEGIN MODE
N 10
PMT -$10,000
PV $60,000
FV $0 I 13.70%
If you think a “fair” rate of return would be 6%, how much should you ask for
the annuity?
BEGIN MODE
N 10
I 6%
PMT -$10,000
FV $0 PV $78,016.92
 SECTION 4-12
SOLUTIONS TO SELF-TEST

What is the present value of a 5-year ordinary annuity of $100 plus an

additional $500 at the end of Year 5 if the interest rate is 6%?

Interest 6%

Year 0 1 2 3 4 5
Ann Pmt $0 $100 $100 $100 $100 $100
Lump Sum $500
Total CFs $0 $100 $100 $100 $100 $600

NPV $794.87

How would the PV change if the $100 payments occurred in Years 1

through 10 and the $500 came at the end of Year 10?

Interest 6%

Year 0 1 2 3 4 5 6 7 8 9 10
Ann Pmt $0 $100 $100 $100 $100 $100 $100 $100 $100 $100 $100
Lump Sum $500
Total CFs $0 $100 $100 $100 $100 $100 $100 $100 $100 $100 $600

NPV $1,015.21

What is the present value of the following uneven cash flow stream: $0
at Time 0, $100 at the end of Year 1 (or at Time 1), $200 at the end of
Year 2, $0 at the end of Year 3, and $400 at the end of Year 4, assuming
the interest rate is 8%?

Interest 8%
Year 0 1 2 3 4
CFs $0 $100 $200 $0 $400

NPV $558.07
SECTION 4-13
SOLUTIONS TO SELF-TEST

What is the future value of this cash flow stream: $100 at the end of 1 year, $150
after 2 years, and $300 after 3 years, assuming the appropriate interest rate is
15%?

Interest ra 15%

Year 0 1 2 3
CFs $0 $100 $150 $300

FV of CFs $0.00 $132.25 $172.50 $300.00

NFV $604.75
SECTION 4-14
SOLUTIONS TO SELF-TEST

An investment costs $465 now and is expected to produce cash flows of $100 at the
end of each of the next 4 years, plus an extra lump sum payment of $200 at the end
of the 4th year. What is the expected rate of return on this investment?

Year 0 1 2 3 4
Ann Pmt -$465 $100 $100 $100 $100
Lump Sum $200
Total CFs -$465 $100 $100 $100 $300

IRR 9.05%

An investment costs $465 and is expected to produce cash flows of $100 at the end
Year 1, $200 at the end of Year 2, and $300 at the end of Year 3. What is the expected
rate of return on this investment?

Year 0 1 2 3
CFs -$465 $100 $200 $300

IRR 11.71%
SECTION 4-15
SOLUTIONS TO SELF-TEST
What is the future value of $100 after 3 years if the appropriate interest rate is
8%, compounded annually?

N 3
I 8%
PV -$100
PMT $0 FV $125.97

Compounded monthly?

N 36
I 0.67%
PV -$100
PMT $0 FV $127.02
What is the present value of $100 due in 3 years if the appropriate interest rate
is 8%, compounded annually?

N 3
I 8%
PMT $0
FV $100 PV $79.38

Compounded monthly?

N 36
I 0.67%
PMT $0
FV $100 PV $78.73

monthly statements. A common APR is 18%, with interest paid monthly. What
is the EFF% on such a loan?

Nominal rate 18%

Comp/year 12

Effective rate 19.56% =(1+B35/B36)^B36-1

19.56% =EFFECT(B35,B36)
SECTION 4-16
SOLUTIONS TO SELF-TEST

Suppose a company borrowed $1 million at a rate of 9%, simple interest, with

interest paid at the end of each month. The bank uses a 360-day year. How much
interest would the firm have to pay in a 30-day month?

Loan $1,000,000
Interest rate 9%
Days/year 360
Interest pd (da 30

Interest paid $7,500

What would the interest be if the bank used a 365-day year?

Loan $1,000,000
Interest rate 9%
Days/year 365
Interest pd (da 30

Interest paid $7,397.26

Suppose you deposited $1,000 in a credit union that pays 7% with daily
compounding and a 365-day year. What is the EFF%, and how much could you
withdraw after 7/12 of a year?

Loan $1,000
Interest rate 7%
Comp/year 365 Time period (mo 7

Effective rate 7.250098% Account value $1,041.67

SECTION 4-17
SOLUTIONS TO SELF-TEST

Consider again the example in Figure 28-11. If the loan were amortized over 5 years with 60
monthly payments, how much would each payment be, and how would the first payment be
divided between interest and principal?

Years 5
Months = N 60
Nom. I 6%
Periodic I 0.5000%
PV $100,000
FV $0
PMT $1,933.28

First payment interest: $500.00 =B10*B11

First payment principal: $1,433.28 =B13-C15

Suppose you borrowed $30,000 on a student loan at a rate of 8% and now must repay it in 3
equal installments at the end of each of the next 3 years. How large would your payments
be, how much of the first payment would represent interest and how much would be
principal, and what would your ending balance be after the first year?

N 3
I 8%
PV $30,000
FV $0

PMT -$11,641.01

Loan Amortization Schedule, $30,000 at 8% for 3 Years

Amount borrowed: $30,000
Years: 3
Rate: 8%
PMT: -$11,641.01

Repayment
Beginning Payment Interest of PrincipalEnding
Year Amount (1) (2) (3) (4) Balance (5)
1 $30,000.00 $11,641.01 $2,400.00 $9,241.01 $20,758.99
2 $20,758.99 $11,641.01 $1,660.72 $9,980.29 $10,778.71
3 $10,778.71 $11,641.01 $862.30 $10,778.71 $0.00

Rather than focus on Year 1 data, we just constructed the full amortization schedule.
SECTION 4-18
SOLUTIONS TO SELF-TEST

If the nominal interest rate is 10% and the expected inflation rate is 5%, what is the
expected real rate of return?

rNOM 10%
Inflation 5%

rr =((1+B6)/(1+B7))-1 = 4.7619%