Assignment 2:

Business Finance:

4–1 Using a time line The financial manager at Starbuck Industries is considering
an investment that requires an initial outlay of $25,000 and is expected to result
in cash inflows of $3,000 at the end of year 1, $6,000 at the end of years 2 and
3, $10,000 at the end of year 4, $8,000 at the end of year 5, and $7,000 at the
end of year 6.
a. Draw and label a time line depicting the cash flows associated with Starbuck
Industries’ proposed investment.
b. Use arrows to demonstrate, on the time line in part a, how compounding
to find future value can be used to measure all cash flows at the end of
year 6.
c. Use arrows to demonstrate, on the time line in part b, how discounting to
find present value can be used to measure all cash flows at time zero.
d. Which of the approaches—future value or present value—do financial managers
rely on most often for decision making? Why?
4–2 Future value calculation Without referring to tables or to the preprogrammed
function on your financial calculator, use the basic formula for future value
along with the given interest rate, i, and the number of periods, n, to calculate
the future value interest factor in each of the cases shown in the following table.
Compare the calculated value to the value in Appendix Table A–1.

4–4 Future values For each of the cases shown in the following table, calculate the
future value of the single cash flow deposited today that will be available at the
end of the deposit period if the interest is compounded annually at the rate specified
over the given period.
4–5 Future value You have $1,500 to invest today at 7% interest compounded
annually.
a. Find how much you will have accumulated in the account at the end of
(1) 3 years, (2) 6 years, and (3) 9 years.
b. Use your findings in part a to calculate the amount of interest earned in
(1) the first 3 years (years 1 to 3), (2) the second 3 years (years 4 to 6), and
(3) the third 3 years (years 7 to 9).
c. Compare and contrast your findings in part b. Explain why the amount of
interest earned increases in each succeeding 3-year period.
4–6 Inflation and future value As part of your financial planning, you wish to purchase
a new car exactly 5 years from today. The car you wish to purchase costs
$14,000 today, and your research indicates that its price will increase by 2% to
4% per year over the next 5 years.
a. Estimate the price of the car at the end of 5 years if inflation is (1) 2% per
year, and (2) 4% per year.
b. How much more expensive will the car be if the rate of inflation is 4% rather
than 2%?
4–7 Future value and time You can deposit $10,000 into an account paying 9%
annual interest either today or exactly 10 years from today. How much better
off will you be at the end of 40 years if you decide to make the initial deposit
today rather than 10 years from today?
4–10 Present value calculation Without referring to tables or to the preprogrammed
function on your financial calculator, use the basic formula for present value,
along with the given opportunity cost, i, and the number of periods, n, to calculate
the present value interest factor in each of the cases shown in the accompanying
table. Compare the calculated value to the table value.
4–11 Present values For each of the cases shown in the following table, calculate the
present value of the cash flow, discounting at the rate given and assuming that
the cash flow is received at the end of the period noted.

4–12 Present value concept Answer each of the following questions.

a. What single investment made today, earning 12% annual interest, will be
worth $6,000 at the end of 6 years?
b. What is the present value of $6,000 to be received at the end of 6 years if the
discount rate is 12%?
c. What is the most you would pay today for a promise to repay you $6,000 at
the end of 6 years if your opportunity cost is 12%?
d. Compare, contrast, and discuss your findings in parts a through c.
4–16 Present value comparisons of single amounts In exchange for a $20,000 payment
today, a well-known company will allow you to choose one of the alternatives
shown in the following table. Your opportunity cost is 11%.

a. Find the value today of each alternative.

b. Are all the alternatives acceptable, i.e., worth $20,000 today?
c. Which alternative, if any, will you take?
4–18 Future value of an annuity For each case in the accompanying table, answer
the questions that follow.

a. Calculate the future value of the annuity assuming that it is

(1) an ordinary annuity.
(2) an annuity due.
b. Compare your findings in parts a(1) and a(2). All else being identical, which
type of annuity—ordinary or annuity due—is preferable? Explain why.
4–19 Present value of an annuity Consider the following cases.

a. Calculate the present value of the annuity assuming that it is

(1) an ordinary due.
(2) an annuity due.
b. Compare your findings in parts a(1) and a(2). All else being identical, which
type of annuity—ordinary or annuity due—is preferable? Explain why.
4–20 Ordinary annuity versus annuity due Marian Kirk wishes to select the better of
two 10-year annuities, C and D. Annuity C is an ordinary annuity of $2,500 per
year for 10 years. Annuity D is an annuity due of $2,200 per year for 10 years.
a. Find the future value of both annuities at the end of year 10, assuming that
Marian can earn (1) 10% annual interest and (2) 20% annual interest.
b. Use your findings in part a to indicate which annuity has the greater future
value at the end of year 10 for both the (1) 10% and (2) 20% interest rates.
c. Find the present value of both annuities, assuming that Marian can earn (1)
10% annual interest and (2) 20% annual interest.
d. Use your findings in part c to indicate which annuity has the greater present
value for both (1) 10% and (2) 20% interest rates.
e. Briefly compare, contrast, and explain any differences between your findings
using the 10% and 20% interest rates in parts b and d.
Business Finance
Assignment:3
4–22 Present value of a retirement annuity An insurance agent is trying to sell you
an immediate-retirement annuity, which for a single amount paid today will provide
you with $12,000 at the end of each year for the next 25 years. You currently
earn 9% on low-risk investments comparable to the retirement annuity.
Ignoring taxes, what is the most you would pay for this annuity?

4–23 Funding your retirement You plan to retire in exactly 20 years. Your goal is to
create a fund that will allow you to receive $20,000 at the end of each year for
the 30 years between retirement and death (a psychic told you would die after
30 years). You know that you will be able to earn 11% per year during the 30-
year retirement period.
a. How large a fund will you need when you retire in 20 years to provide the
30-year, $20,000 retirement annuity?
b. How much will you need today as a single amount to provide the fund calculated
in part a if you earn only 9% per year during the 20 years preceding retirement?
c. What effect would an increase in the rate you can earn both during
and prior to retirement have on the values found in parts a and b?
Explain.

4–24 Present value of an annuity versus a single amount Assume that you just won
the state lottery. Your prize can be taken either in the form of $40,000 at the
end of each of the next 25 years (i.e., $1,000,000 over 25 years) or as a single
amount of $500,000 paid immediately.
a. If you expect to be able to earn 5% annually on your investments over the
next 25 years, ignoring taxes and other considerations, which alternative
should you take? Why?
b. Would your decision in part a change if you could earn 7% rather than 5%
on your investments over the next 25 years? Why?
c. On a strictly economic basis, at approximately what earnings rate would you
be indifferent between the two plans?
4–25 Perpetuities Consider the data in the following table.

Determine, for each of the perpetuities:

a. The appropriate present value interest factor.
b. The present value.
4–27 Future value of a mixed stream For each of the mixed streams of cash flows
shown in the following table, determine the future value at the end of the final
year if deposits are made into an account paying annual interest of 12%, assuming
that no withdrawals are made during the period and that the deposits
are made:
a. At the end of each year.
b. At the beginning of each year.

4–29 Present value—Mixed streams Find the present value of the streams of cash
flows shown in the following table. Assume that the firm’s opportunity cost
is 12%.

4–30 Present value—Mixed streams Consider the mixed streams of cash flows shown in the
following table.
a. Find the present value of each stream using a 15% discount rate.
b. Compare the calculated present values and discuss them in light of the fact that the
undiscounted cash flows total $150,000 in each case.

4–34 Changing compounding frequency Using annual, semiannual, and quarterly

compounding periods, for each of the following: (1) Calculate the future
value if $5,000 is initially deposited, and (2) determine the effective annual
rate (EAR).
a. At 12% annual interest for 5 years.
b. At 16% annual interest for 6 years.
c. At 20% annual interest for 10 years.

4–39 Annuities and compounding Janet Boyle intends to deposit $300 per year in a
credit union for the next 10 years, and the credit union pays an annual interest rate of 8%.
a. Determine the future value that Janet will have at the end of 10 years, given
that end-of-period deposits are made and no interest is withdrawn, if
(1) $300 is deposited annually and the credit union pays interest annually.
(2) $150 is deposited semiannually and the credit union pays interest semiannually.
(3) $75 is deposited quarterly and the credit union pays interest quarterly.
b. Use your finding in part a to discuss the effect of more frequent deposits and
compounding of interest on the future value of an annuity.

4–46 Loan amortization schedule Joan Messineo borrowed $15,000 at a 14%

annual rate of interest to be repaid over 3 years. The loan is amortized into three
equal annual end-of-year payments.
a. Calculate the annual end-of-year loan payment.
b. Prepare a loan amortization schedule showing the interest and principal
breakdown of each of the three loan payments.
c. Explain why the interest portion of each payment declines with the passage
of time.