27a. How much money must John invest to achieve his goal?

Construct a timeline to help

visualise the details of this investment plan.

Present value of ordinary annuity:

40000 1
= ( ) × [1 − (1+0.1)25]
0.1

= $363081.60

Present value: FV/(1+r)n

= $363081.60/(1+0.1)14

= $95610.73

He needs to deposit $95610,73 at 50 years old to achieve the value at 65 years old.

50 65 66 Withdrawal of $40000 a year 90

Deposit of Accumulated money Remaining money

John
$363081.60 $0
$95610.73

b. John realises that once he retires, he will want to invest only in less risky assets, like
government securities that will earn a slightly lower rate of return- 5%. So, he will earn 10%
until age 64, and the 5% per annum from age 65 to 90. How much money does he need to set
aside now to achieve his retirement goal.

40000 1
= ( ) × [1 − (1+0.5)25]
0.5

= $536757.78
Present value: FV/(1+r)n

= $536757.78/(1+0.1)14

= $148455

c. Suppose John has changed his mind and invests the entire inheritance into the account
earning 10%. After making his last withdrawal at age 90, he wants to leave the remaining
money to his niece. How much would his niece receive when John withdraws the last annual
instalment of $40000?

Future value: PV (1+r)n

= (150000-95610.73)(1+0.1) 40

= $2461617.87
37. Value of a Mixed Stream

Neil Tyson has developed a prototype of an armoured fabric that is very light but is capable of
stopping projectiles as efficiently as a traditional bullet-proof jacket. A military supplier is
considering the technology and has offered to pay Neil $30000 in year 1,2,and 3; and $40000
in years 4 to 6. All payments will be made at the end of each year.

a. Lay out the cash flows involved in the offer on a timeline.

0 1 2 3 4 5 6

30000 30000 30000 40000 40000 40000

b. If Neil applies a required rate of return of 10% to them, what is the present value of this
series of payments?
$149341.91 (financial calculator)

c. Another company has made an offer of a one-time payment of $275000 for the fabric.
Which offer should Neil accepts?

Neil should accept the one-time payment of $275000 for the fabric because it has a higher
present value than the series of payment offered by the military supplier.
39. Relationship between future value and present value: Mixed Stream. (A,B OK; C,D X)

Using the information in the accompanying table, answer the questions that follow. Assume all
transactions take place at the end of the year.

a. Using a discount rate of 7%, determine the present value of the cash flows.
$24725.98 (financial calculator)
b. Suppose you had a lump sum equal to your answer in part a. You invested this sum in an
account earning a 7% return each year. How much would you have after six years.
Future value: PV (1+r)n
= (24725.98)(1+0.07) 6
= $37107.03
c. Calculate the future value of cash flows six years from now and compare it to your answer
in part b.
Year Future value at 7%
1 (3000)(1+0.07) 6-1 = 4207.66
2 0
3 (4000)(1+0.07) 6-3 = 4900.17
4 (8000)(1+0.07) 6-4 = 9159.20
5 (12000)(1+0.07) 6-5 = 12840
6 6000

Future value: 4207.66+4900.17+9159.20+12840+6000

= $37107.03
d. How much would you be willing to pay for this, assuming that you can earn 7% on your
investments?
Paying up to $24725.98 for this, because it equals the present value at a 7% discount rate.
50. Inflation, time value and annual deposits:

Sadiq Ansari wants to support his daughter’s education by paying for her MBA degree from
premier university in Britain Research indicates that the fees for one-year MBA course at any
good British university will cost $35000 now. His daughter is three years old and he expects
that he will need to pay her fees in 20 years. He wishes to invest a fixed amount at the end of
each of the next 20 years to fund her degree. He is also aware that, on average, the fees are
likely to increase by 4% annually. (A OK; B X; CX)

a. What is the expected fees for an MBA degree in 20 years, when Sadiq will have to pay for
his daughter’s course?
Future value: PV (1+r)n
= (35000)(1+0.04) 20
= $76689.31

b. How much Sadiq invest at the end of each of the next 20 years if his investments pay 8%
every year?

[(1+0.08)20 −1]
= 76689.31 ÷ 0.08

= $1675.83

c. Is Sadiq invest at the beginning instead of at the end of each year, how much must he invest
every year if his investments pay the same 8% per year?

[(1+0.08) 20 −1]
76689.31 = CF0 × × (1+0.08)
0.08

CF0 = $1551.70
52. Loan amortisation schedule

Han Xiao just closed a $50000 business loan that she must repay her brother, who has agreed
to lend it at 5% annual interest. Han must repay the loan over the next five years, in five equal,
end-of-year payments. (A OK, Ch B,C)

a. How much does Han have to pay every year if she has to repay the loan by the fifth end-
of-year instalments?

𝐶𝐹 1
50000 = (0.05)×[1- (1+0.05)5 ]

CF= 11548.74

b. Prepare an amortisation schedule showing the interest and principal breakdown of each
loan payments.
 Year Beginning-of- Loan payment Interest Principal End-of-year
year principal (2) (3) (4) principal
(1) (5)
1 $50000 $11548.74 2500 9048.74 $40951.26
2 40951.26 11548.74 2047.56 9501.18 31450.08
3 31450.08 11548.74 1572.50 9976.24 21473.84
4 21473.84 11548.74 1073.69 10475.05 10998.80
5 10998.80 11548.74 549.94 10998.80 0

c. Explain why the interest expense of each subsequent payment declines over time.

The interest expense of each payment is calculated on the remaining loan balance. When paying
off the principal, the balance of principal decreases, leading to a lower interest charge. This
means that each subsequent payment goes towards reducing the principal, rather than interest.
Thus, the loan is repaid more quickly.