TVM : Practice Problems

Q.1 You are planning to purchase a house four years from now, and you will need $12,000 for a
down payment at that time. Suppose you can earn 4.5% per year in a money market fund. How
much do you need to deposit into the fund today, in a single deposit, in order to have $12,000 at
the end of four years?

Q.2 Your broker calls you with a recommendation to purchase a stock which she says will
double in value in four years. a. What annual rate of return does this represent? b. If the stock
actually produced an annual rate of return of 12.5%, how long would it take your original
investment to double in value?

Q.3 An arena football team has signed a new head coach and agreed to pay him a threepart
signing bonus. The coach will be paid $180,000 at the end of the first year, $50,000 at the end of
the second year, and $70,000 at the end of the third year. Assume the appropriate discount rate is
7% per year. a. What is the total present value of all three payments? b. If the team wished
instead to make three equal payments, one at the end of each year, what level payment amount
would equate to the same total present value?
Q.4 Your lottery ticket came up a winner! For your prize, you must choose one of the following
two options: (1) You can receive ten payments of $25,000 each, paid at the beginning of each of
the next 10 years (the first payment will be made today), or (2) you can receive a one-time
payment of $190,000 today. a. If you decide your discount rate, or opportunity cost of funds, is
6% per year, which offer should you take and why?

Q.5 You wish to purchase a lot in Hamilton County as an investment. To finance the purchase,
you need to borrow $80,000 for ten years. Bank A will lend you the $80,000 for ten years at a
quoted rate of 9.0% compounded annually. Bank B will lend you the money at a quoted rate of
8.75% compounded monthly. Bank C will lend you the money at a quoted rate of 8.65%
compounded daily (assume 365 days in one year). Which bank offers the best rate from the
borrower’s perspective? Clearly explain your reasoning in one or two short sentences.

Q.6 Thanks to your most recent raise in pay, you decide you have enough money to buy a Jaguar
convertible. If you can budget $600 per month for car payments, and if the APR (annual
percentage rate) on your 60-month car loan will be 9.6% compounded monthly, how large of a
car loan can you afford?

Q.7 To fund their BVI retirement, your grandparents deposited $8,000 at the end of each year for
the last 30 years into a mutual fund. Assume that this fund had a geometric average annual return
of 11.5%. Now, at the end of that 30-year period, your grandparents take all this money and put
it into a bank account paying 4% interest compounded monthly. They plan to withdraw an equal
amount every month for the next 20 years. How much can they withdraw each month so that this
savings account lasts exactly 20 years?
Q. 8 What is the monthly payment on a 5 year car loan for $14,000 at an annual interest rate of
12%? 3. Which grows to a larger future value, $1000 invested for 2 years at: a. 10 percent each
year b. 5 percent the first year and 15 percent the second year or c. 15 percent the first year and 5
percent the second year? Explain your results. 4. Which grows to a larger future value: a. $4000
invested for 10 years at 5% or b. $2000 invested for 10 years at 10%. 5. Which is worth more at
10 percent, compounded annually: $1000 in hand today or $2,000 due in 5 years?

Q.9 In 1940, your grandmother put $1000 into a special trust to be paid to a future grandchild
(you) 60 years later, in the year 2000. How much will this trust be worth in the year 2000 if it has
been earning 8%? How much if it earns 12%.

Q.10 A lottery jackpot of one million is paid out $25,000 a year for 40 years. At a 10 percent
required return, what is the present value of this payoff? Assume that the first payment is paid
immediately. 11. At an interest rate of 10%, what is present value of $1m to be received in: a. 10
years b. 50 years c. 100 years d. 150 years.

Q.11 Your grandmother decides to climb Mt. Everest and tells you she doesn’t plan to return.
You suspect that she met a Tibetan Monk online and plans to stay in the Himalayas. As a parting
gift, she gives you $250,000 saying, “I always wanted to give you a Million Dollars but this is
the best I can do . You respond that by investing, you will turn that $250,000 into a $1,000,000
in just 20 years. In order to do this, what annualized rate of return that you must obtain to
accomplish this? Assume annual compounding.

Q.13 What is the present value of a monthly perpetuity cash flow of $257 to be received starting
one month from now if the discount rate is 15% compounded monthly?
Q.14 What is the present value of a monthly perpetuity cash flow of $845 to be received starting
5 months from now if the discount rate is 12% compounded monthly?

Q.15 You are considering purchasing a house and have discussed your loan options with the loan
officer at a local bank. The loan officer told you “thousands of dollars can be saved by choosing
a 15-year loan instead of a 30-year loan.” Assume that you will be borrowing $132,000 and that
you will be repaying the loan in monthly installments.

Both loans have an A.P.R. of 7.2%

a) Calculate the difference between the monthly payment on a 30-year loan and the

monthly payment on a 15-year loan.

b) What is the difference in the total amount of dollars that would be paid to the

lender under each loan?

Q.16 You have decided to buy a house for $140,000. You have saved enough money to

make a 20% down payment, but you will need to borrow the remainder. You arrange

for a 20-year mortgage (monthly payments) with a local bank at a stated rate of 6.6%.

a) What is the total amount of interest that you will pay during the first year of the

loan?

b) What will the outstanding loan balance be after you have made one year of

monthly payments?
Q.17 Your Aunt Betsy is planning to retire in 8 years and needs your help in planning for her
retirement. Betsy’s retirement goals are two-fold. First, Betsy plans to give each of her 4 children
a lump sum of $33,000 on the day she retires. Betsy also wants to have enough additional money
stashed away so that she can withdraw $4,000 per month (at the end of each month) for 20 years
following her retirement. If Betsy can earn 0.5% per month on her money and she currently has
$100,000 invested, how much will she need to save each month for the next 8 years to reach her
retirement goal?

Q.18. At the beginning of this year, Lance Stephenson and George Hill signed three-year
contracts with the Indiana Pacers. Lance’s monthly salary in the first year is $180,000. George’s
monthly salary in the first year is $120,000. Lance’s monthly salary will increase by 3% at the
end of the first year and by an additional 3% at the end of the second year. George’s monthly
salary will increase by 5% at the end of the first year and by an additional 5% at the end of the
second year. George also received a one-time signing bonus at the beginning of his contract.
Pacers management announced that after including George’s signing bonus, both deals had the
same present value. Assume that the appropriate discount rate is 6% compounded monthly. What
was George’s signing bonus?