A B C D E F

1 Tool Kit Chapter 4

2 The Time Value of Money
3
4
5 The worksheet shown below performs most of the required calculations, and we used it to create many of the chapter's
tables and figures. We pasted in a few Excel dialog boxes for specific Excel functions and features; they are shown off to the
6 right of where they were used. We encourage students to become familiar with Excel functions. It is also useful to learn
7 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. That procedure is used often in business (and in
8 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 students
13 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 see the solution setup and
14 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 could invest
20 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
24 a guaranteed 5% interest each year. How much would you have at the end of Year 3?
25
26 To answer this question, we show 4 methods: (1) the step-by-step using a regular calculator; (2) the formula approach
27 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
 A B C D E F
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) =
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$100
FV of (just below) shows how a $1 investment grows over time at different interest rates. The curves were created by
solving for FV at different values for N and I. The graph shows, simultaneously, the effects of time and interest rates. The
After N Years
55 data table used to create this figure is shown to the right of the figure.
56
57
58 Figure $700.00
4-2
59 Growth of $100 at Various Interest Rates and Time Periods
60 $600.00
61
62 $500.00
63
64 $400.00
65
66
67 $300.00
68
69 $200.00
70
71 $100.00
72
73 $0.00
74 0 2 4 6 8 10 12
75
Years
76
77
78
79
80
81
82
83
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 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.
 A
Mathematically, the presentBvalue is the opposite
C of the future value.
D Instead of compounding
E F
a present value 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
89 you know the FV, you can discount to find the PV.
90
91
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
92 5% interest rate each year, how much must you deposit now to have $115.76 in 3 years?
93
94
95 Figure 4-3
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: PV = FVN/(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 FV of $100
113 After N Years
4. Excel Spreadsheet: PV function: PV = =PV(I,N,0,FV)
114 Fixed inputs: PV = =PV(0.05,3,0,115.76) =
115 $120.0000 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, and
then the FV. The data can be entered as fixed numbers or, better yet, as cell references.
$100.0000
117
118
119 $80.0000
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 receipt
121 increases. The Data Table to the right provides the data used to draw the figure. At 0%, the PV of $1 always remains at $1,
$60.0000
122 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 $40.0000
125 Figure 4-4
126 Present Value of $100 at Various Interest Rates and Time Periods
$20.0000
127
128
$0.0000
129
0 5 10 15 20 25 30 35 40 45
130
Years
131
132
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133
134
135
136
137
138
139
140
141
142
143
144
145
146
147
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 example,
154 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
171 Sometimes we need to know how long it will take to accumulate a given sum of money, given our beginning funds and the
rate we will earn on those funds. For example, suppose we believe that we could retire comfortably if we had $1 million,
172 and we want to find how long it will take us to reach that goal, assuming that we now have $500,000 invested at 4.5%.
173
174 INPUTS:
175
176 Present value (PV) -$500,000
177 Future value (FV) $1,000,000
 A B C D E F
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 of an
189 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.
190
191
192 Payment (PMT) $25
193 Interest rate (I) 5.2%
194
195 PV of Ordinary
Number of 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 you would
217 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 value of a perpetuity can be
218 found with a simple formula: Value = PMT / I .
219
220
221 Consider a bond that pays a $25 annual payment. If interest rates are currently 2.5%, what is the value of the bond?
 A B C D E F
Consider a bond that pays a $25 annual payment. If interest rates are currently 2.5%, what is the value of the bond?
222
223
224 Payment (PMT) $25 $25
225 Interest rate (I) "= PMT x " ( 〖 "(1+I)" 〗 ^"N"2.5%
〗 ^"N" "-1" )/"I" ) =
/"I" " − " "1" /"I" ) = "PMT x " (" " 3.0%
( 〖 "(1+I)"
226
227 Value (PV): $25 / 0.02.5 = $1,000.00 $833.33
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 must not
233 change.
234
235
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 future
239 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
"PMT x " ( 〖 "(1+I)" 〗 ^"N" /"I" " − "
256 2. Formula: "1" /"I" ) x (1 + I) =
257
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) =
 A B C D E F
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 beginning
274 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
284 Cash flow: −$100 −$100 −$100
285 ↓ ↓ ↓
286 ↓ ↓ └→→ $105.00
287 Multiply each payment by ↓
"= PMT x " ("1" /"I" " − " "1" / └ → → → → → → → → $110.25
288 ("I" 〖 "FVs
(1+I)N-t and sum these (1+I)"
to 〗 ^"N" )) = └→→ →→→→→→→ →→→→→→ $115.76
289 find FVAN: $331.01
290
291 2. Formula:
292
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 the
309 present value of an ordinary annuity are shown below.
310
 A B C D E F
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:
"PMT x " ("1" /"I" "0− " "1" /("I" 〖 " (1+I)"
1 〗 2 3
319 ^"N" ))
Cash flow:x (1 + I) −$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
328 PVAN $272.32
329
330
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 ↓ ↓ ↓
 A B C D E F
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
364 PVAN = = $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
379
380 Fundamentally, this section is no different than previous TVM exercises. When solving for PMT, N, or I, you must be given
381 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 earn a return
385 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 would
399 earn 6%. How long would it take you to reach your $10,000 goal?
400
401 BEGIN MODE
 A B C D E F
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 return
411 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 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 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
425 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
426 Excel, using either the PV or the NPV function. We illustrate the step-by-step and the two Excel approaches below.
427
428
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:
 A B C D E F
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 the first
457 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 the cash flows appear in
458 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 flow: $0.00 $100.00 $300.00 $300.00 $300.00
472 PVs of the CFs: $89.29 $239.16 $213.53 $190.66
473 Sum of PVs = $1,016.35
474
475
476 2. Financial Calculator:
Enter the cash flows into the cash flow register of a financial calculator, enter I/YR, and
477 then press the NPV key to find the answer.

478
479 3. Excel Spreadsheet:
480 Excel NPV function: =NPV(I,Cash flows)
481 Fixed inputs: =NPV(0.12,100,300,300,300,500)
482 Cell references: =NPV(C467,C471:G471)
483
484 The Excel formula ignores the initial cash flow (in Year 0). When entering a cash flow range, Excel assumes that the first
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
485 value
complete the NPV formula result. Notice too that you can enter cash flows one-by-one, but if the cash flows appear in
486 consecutive cells, you can enter the cell range, as we did here.
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 approach
492 works the same, but unfortunately, Excel does not have a net future value (NFV) function, although financial calculators do
493 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 flow: $0.00 $100.00 $300.00 $300.00 $300.00
504 FVs of the CFs: $157.35 $421.48 $376.32 $336.00
505 Sum of FV's =
506
507
 A B C D E F
508 2. Financial Calculator:

Enter the cash flows into the cash flow register of a financial calculator, enter I/YR, and
509 then press the NFV key to find the answer.

510
511 3. Excel Spreadsheet:
512 Step 1. Find NPV: =NPV(C499,C503:G503)
513 Step 2. Compound NPV to find NFV: =FV(C499,G502,0,-G512)
514
515
516
517 4-14 Solving for I with Irregular Cash Flows
518
519 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.
520 The cost of the bond is $927.90. What rate of return would you earn if you bought the bond?
521
522
523 You could find the rate of return using Excel's IRR (for "internal rate of return") function or its RATE function, as shown
below. The RATE function deals with situations where we have an annuity plus a final lump sum. The IRR function deals
524 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.
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 The IRR function is used to find the rate of return on capital budgeting projects, where the firm makes a capital
538 expenditure and then expects to receive a series of cash inflows. Figure 4-9 illustrates this calculation. Note that the IRR
539 function can be used even if one of the post-investment cash flows is negative. Change the 4th year CF from $300 to -$100
and see the IRR drop to 2.90%. Then change it back to $300.
540
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 and
548 1. Calculator: then press the IRR key to find the answer.

549
 A B C D E F
550 2. Excel IRR Function: Cell references: IRR = =IRR(B546:G546)

551
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 interest rates
556 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 with
559 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

Periodic Effective
568 Frequency of Nominal Annual Number of Periods Interest Rate Annual Rate
Compounding Rate (INOM) per Year (M)a (IPER) (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 The EFF% is calculated as (1 + IPER)M. It can also be calculated using
b

577 an Excel function: =EFF(INOM ,M).

578 c
The Future value is calculated as $100(1 + EFF%).
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(B598:M598) = 1.4313%
601 APR rate: =E600*G592 = 17.1758%
602 EFF%: =(1+E600)^G592-1 = 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
 A B C D E F
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.
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 year. How
639 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%

646 Number of days

in year = 365

647 Number of
months interest
charged = 9
 A B C D E F
648
649 Compounded Interest Results
650 IPER = 0.02740%
651 Number of days interest charged (rounded up) = 274
652 Ending amount = $107.79
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 5 equal
667 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
671 below. It is far easier, and less prone to errors, to construct the amortization table with Excel, as we do 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)

681 Repayment
of Principalb
a
Beginning Amount Payment Interest (2) − (3) = Ending Balance
Year (1) (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
 A B C D E F
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 by the
688 interest rate. Therefore, interest in Year 1 is $100,000(0.06) = $6,000; in Year 2 it is $82,260.36(0.06) =
689 $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
693
694
695
696 Suppose you buy a house and take out a 30-year home mortgage of $250,000 at an annual rate of 6%. What
is the monthly payment? What is the remaining balance after a year? What are the total principal payments
697 and interest payments during the first year? What are the total payments and interest payments over the
698 life of the loan?
699
700
701 INPUTS:
702 Amount borrowed: $250,000
703 Years: 30
704 Rate: 6%
705
706 Monthly Payment
707
708 N= 360
709 I/YR = 0.5%
710 PV = $250,000
711 FV = $0
712
713 PMT (unrounded) = $1,498.8763 Using the PMT function.
714
715 After rounding to cents, the monthly payment is:
716
717 PMT (rounded) = $1,498.88
718
719 Remaining Balance
720
721 What is the remaining balance after the 12th payment?
722
723 You can determine how much balance remains after 12 months using the FV function, with N equal to the number of payments you have mad
724
725
726 Use the FV function as though you have just made 12 months of payments:
727
728 Number of payments made = N = 12
729 I/YR = 0.50%
730 PMT = $1,498.88
 A B C D E F
731 PV = −$250,000.00
732
733 Remaining balance = $246,929.93 Use the FV function
734
735 Total Principal Payments and Interest Paid During the First Year
736
737 Total principal paid in Year 1 = Beginning principal - ending principal
738 = −$496,929.93
739
740 Total interest paid in Year 1 = Total Year-1 payments − Total Year-1 principal payments
741 = (12 x Monthly payment) − Total Year-1 principal payments
742 = $514,916.49
743
744 rcent of interest in Year-1 payments = 2863%
745
746 Total payments in first year = 12 payments x payment amount
747 = $17,986.56
748
749 Total Payments and Interest Paid During the Life of the Loan
750
751 Total payments = Total number of payments x Payment amount
752 = $539,597
753
754 Total interest payments = Total payments − amount borowed
755 = $289,597
756
757 15-Year Mortgage: Total Payments and Interest Paid During the Life of the Loan
758
759 Suppose we consider a 15-year mortgage at the same interest rate. How much interest will the borrower
760 pay over the life of the loan?
761
762 N= 180
763 I/YR = 0.5%
764 PV = $250,000
765 FV = $0
766
767 PMT = −$2,109.6421 Using the PMT function.
768
769 Total payments = $379,735.57
770 Total interest = $129,736
771
772
773 Auto Loans
774
775 Many auto dealers offer to finance car loans. They use amortizing loans, but they do not allocate monthly interest charges based on the
balance at the beginning of the month. Instead, they use a method called the "Rule of 78".
776
 Many auto dealers offer to finance car loans. They use amortizing loans, but they do not allocate monthly interest charges based on the
balanceA
at the beginning ofBthe month. Instead, they
C use a method called
D the "RuleEof 78". F
777
778
779 Here is how the rule of 78 works. First, determine the sum of the payment numbers. For example, with 12 payments, the sum of 1 through 12
is 78, which is how the rule got its name.
780
781
782
783 With 24 payments, the sum of 1 through 24 is equal to 300. (If N is the number of payments, the sum is N(N + 1)/2). The allocation factor for
the first month is equal to 24/300. The second factor is 23/300, and so forth.
784
785
786
787 With 24 payments, the sum of 1 through 24 is equal to 300. (If N is the number of payments, the sum is N(N + 1)/2). The first interest charge
equal to 24/300 multiplied by the total interest to be paid, usually as determined by add-on interest. The second factor is 23/300, and so
788 forth.
789
790
791 For example, suppose you borrow $25,000 from a car dealer using the rule of 78. The annual nominal interest rate is 9%.
792
793
794 Using Rule of Normal
795 78 Amortizing Loan
796 Amount borrowed = $25,000.00
797 Nominal interest rate = 12.00%
798 Number of payments = 48
799 Monthly payment = $658.35
800 mount of interest = (Total payments - Amount borrowed) = $6,600.60
801 Sum of months = 1176
802
803
804
805
Interest allocation Remaining
806 factor using the Balance for Rule
807 Periods rule of 78 Payments Interest Principal of 78
808 0 $25,000.00
809 1 4.08% $658.35 $269.41 $388.93 $24,611.07
810 2 4.00% $658.35 $263.80 $394.55 $24,216.52
811 3 3.91% $658.35 $258.19 $400.16 $23,816.36
812 4 3.83% $658.35 $252.57 $405.77 $23,410.59
813 5 3.74% $658.35 $246.96 $411.38 $22,999.20
814 6 3.66% $658.35 $241.35 $417.00 $22,582.21
815 7 3.57% $658.35 $235.74 $422.61 $22,159.60
816 8 3.49% $658.35 $230.12 $428.22 $21,731.37
817 9 3.40% $658.35 $224.51 $433.84 $21,297.54
818 10 3.32% $658.35 $218.90 $439.45 $20,858.09
819 11 3.23% $658.35 $213.28 $445.06 $20,413.03
820 12 3.15% $658.35 $207.67 $450.67 $19,962.36
821 13 3.06% $658.35 $202.06 $456.29 $19,506.07
822 14 2.98% $658.35 $196.45 $461.90 $19,044.17
823 15 2.89% $658.35 $190.83 $467.51 $18,576.66
824 16 2.81% $658.35 $185.22 $473.12 $18,103.53
 A B C D E F
825 17 2.72% $658.35 $179.61 $478.74 $17,624.79
826 18 2.64% $658.35 $174.00 $484.35 $17,140.44
827 19 2.55% $658.35 $168.38 $489.96 $16,650.48
828 20 2.47% $658.35 $162.77 $495.58 $16,154.91
829 21 2.38% $658.35 $157.16 $501.19 $15,653.72
830 22 2.30% $658.35 $151.54 $506.80 $15,146.92
831 23 2.21% $658.35 $145.93 $512.41 $14,634.50
832 24 2.13% $658.35 $140.32 $518.03 $14,116.47
833 25 2.04% $658.35 $134.71 $523.64 $13,592.83
834 26 1.96% $658.35 $129.09 $529.25 $13,063.58
835 27 1.87% $658.35 $123.48 $534.87 $12,528.72
836 28 1.79% $658.35 $117.87 $540.48 $11,988.24
837 29 1.70% $658.35 $112.26 $546.09 $11,442.15
838 30 1.62% $658.35 $106.64 $551.70 $10,890.44
839 31 1.53% $658.35 $101.03 $557.32 $10,333.13
840 32 1.45% $658.35 $95.42 $562.93 $9,770.20
841 33 1.36% $658.35 $89.80 $568.54 $9,201.66
842 34 1.28% $658.35 $84.19 $574.15 $8,627.50
843 35 1.19% $658.35 $78.58 $579.77 $8,047.74
844 36 1.11% $658.35 $72.97 $585.38 $7,462.36
845 37 1.02% $658.35 $67.35 $590.99 $6,871.36
846 38 0.94% $658.35 $61.74 $596.61 $6,274.76
847 39 0.85% $658.35 $56.13 $602.22 $5,672.54
848 40 0.77% $658.35 $50.51 $607.83 $5,064.71
849 41 0.68% $658.35 $44.90 $613.44 $4,451.26
850 42 0.60% $658.35 $39.29 $619.06 $3,832.21
851 43 0.51% $658.35 $33.68 $624.67 $3,207.54
852 44 0.43% $658.35 $28.06 $630.28 $2,577.26
853 45 0.34% $658.35 $22.45 $635.89 $1,941.36
854 46 0.26% $658.35 $16.84 $641.51 $1,299.85
855 47 0.17% $658.35 $11.23 $647.12 $652.73
856 48 0.09% $658.35 $5.61 $652.73 $0.00
857 1176 100% $31,600.60 $6,600.60 $25,000.00
858
859 4-18 Growing Annuities
860
861 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
862 each year and keep the withdrawals constant in real terms, i.e., growing at the same rate as inflation and thus enabling him
863 or her to maintain a constant standard of living?
864
865
866 Inputs
867 Number of years = 20
868 Nominal interest rate, rNOM = 6%
869 Available to invest = Portfolio = $1,000,000
870 Inflation rate = 3%
 A B C D E F
871 Initial withdrawal (guess) = $50,000
872 Withdrawal at beginning or end? Beginning
873
874 Step 1: Set up an "Amortization Table" to show exactly what's happening. We begin with $1 million. But we immediately
make the first withdrawal, hence have less than $1 million to invest. We don't know how much we can withdraw initially,
875 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
876 6% and thus earns $57,000. The earnings are added to the beginning balance, less the withdrawal, to produce the ending
balance, which is carried forward to create the next beginning balance. This process is continued for 20 years.
877
878
879
880
881 We want to end up with a $0.00 ending balance. With the $50,000 initial withdrawal, we see that the ending balance is
greater than zero. Therefore, we should make a larger initial withdrawal. We could just go through a series of trials and
882 errors until we found an initial withdrawal that produced the zero ending balance. The amount that does the trick is
883 $64,786.87708. Replace the $50,000 with 64786.87708 to prove that this value "works."
884
885
886
887 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 that the
888 withdrawals rise every year with inflation, earnings decline, and the balance declines faster and faster, as the withdrawals
889 increase and the earnings decline.
890
891
892 BOY: Amount Investable
Withdrawal Beginning Balance Withdrawn Funds Earnings Ending Balance
893 1 $1,000,000.00 $64,786.88 $935,213.12 $56,112.79 $991,325.91
894 2 $991,325.91 $66,730.48 $924,595.43 $55,475.73 $980,071.15
895 3 $980,071.15 $68,732.40 $911,338.75 $54,680.33 $966,019.08
896 4 $966,019.08 $70,794.37 $895,224.71 $53,713.48 $948,938.19
897 5 $948,938.19 $72,918.20 $876,019.99 $52,561.20 $928,581.19
898 6 $928,581.19 $75,105.75 $853,475.44 $51,208.53 $904,683.97
899 7 $904,683.97 $77,358.92 $827,325.05 $49,639.50 $876,964.55
900 8 $876,964.55 $79,679.69 $797,284.87 $47,837.09 $845,121.96
901 9 $845,121.96 $82,070.08 $763,051.88 $45,783.11 $808,835.00
902 10 $808,835.00 $84,532.18 $724,302.82 $43,458.17 $767,760.98
903 11 $767,760.98 $87,068.15 $680,692.84 $40,841.57 $721,534.41
904 12 $721,534.41 $89,680.19 $631,854.22 $37,911.25 $669,765.47
905 13 $669,765.47 $92,370.60 $577,394.88 $34,643.69 $612,038.57
906 14 $612,038.57 $95,141.71 $516,896.86 $31,013.81 $547,910.67
907 15 $547,910.67 $97,995.96 $449,914.70 $26,994.88 $476,909.59
908 16 $476,909.59 $100,935.84 $375,973.74 $22,558.42 $398,532.17
909 17 $398,532.17 $103,963.92 $294,568.25 $17,674.09 $312,242.34
910 18 $312,242.34 $107,082.84 $205,159.51 $12,309.57 $217,469.08
911 19 $217,469.08 $110,295.32 $107,173.76 $6,430.43 $113,604.18
912 20 $113,604.18 $113,604.18 $0.00 $0.00 $0.00
913
914 Using Goal Seek: 1. Put the pointer on the orange cell for the Ending Balance after the 20th withdrawal.
 A B C D E F
915 2. Click Data, What-If-Analysis, Goal Seek to get a dialog box, which you then fill out as shown to the right.

916 3. You will be at the "Set cell" because you put the pointer there initially.
917 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 withdrawal
918 to select it.

919 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.
920
921
922
923 Calculator: Step 1: Find the real rate of return, r r.
924 rr = (1+rNOM)/(1 + inflation) - 1
925 = (1.06)/(1.03) - 1
926 rr = 2.9126214%
927
928 Step 2: Use the PMT function in Excel or a calculator to find the initial amount to be withdrawn. Be
929 sure to set the calculator to BEGIN mode, and make a similar adjustment to the Excel function.
930 N= 20
931 I= rr = 2.9126214%
932 PV = -1,000,000
933 PMT = $64,786.88 This is consistent with the value found using Goal Seek.
934
935
936 Formula: Here is a formula for the present value of a growing annuity:
937 PVIFGADue = [1 – [(1 + g)/(1 + rNOM)]N] [(1 + rNOM)/(rNOM − g)]
938 PVIFGADue = 15.4352246177632
939 PMT = PV / PVIFGADue = $64,786.88
940
941
942 If the first withdrawal occurs at the end rather than the beginning of the first year, then the amount of investable funds
during each year will be somewhat larger, and the initial withdrawal to leave a zero final balance will also be somewhat
943 larger. We can modify the table by making the first withdrawal at the end of the year and then using Goal Seek to find the
944 initial withdrawal, which is slightly higher than the case of the annuity due because the original funds earned interest for a
year prior to the first withdrawal.
945
946
947
948 Inputs
949 Number of years = 20
950 Nominal interest rate, rNOM = 6%
951 Available to invest = Portfolio = $1,000,000
952 Inflation rate = 3%
953 Initial withdrawal (guess) = $50,000
954 Withdrawal at beginning or end? End
955
956 EOY: Amount Investable
Beginning Balance Withdrawn Funds Earnings Ending Balance
957 1 $1,000,000.00 $68,674.09 $1,000,000.00 $60,000.00 $991,325.91
 A B C D E F
958 2 $991,325.91 $70,734.31 $991,325.91 $59,479.55 $980,071.15
959 3 $980,071.15 $72,856.34 $980,071.15 $58,804.27 $966,019.08
960 4 $966,019.08 $75,042.03 $966,019.08 $57,961.14 $948,938.19
961 5 $948,938.19 $77,293.29 $948,938.19 $56,936.29 $928,581.19
962 6 $928,581.19 $79,612.09 $928,581.19 $55,714.87 $904,683.97
963 7 $904,683.97 $82,000.45 $904,683.97 $54,281.04 $876,964.55
964 8 $876,964.55 $84,460.47 $876,964.55 $52,617.87 $845,121.96
965 9 $845,121.96 $86,994.28 $845,121.96 $50,707.32 $808,835.00
966 10 $808,835.00 $89,604.11 $808,835.00 $48,530.10 $767,760.98
967 11 $767,760.98 $92,292.23 $767,760.98 $46,065.66 $721,534.41
968 12 $721,534.41 $95,061.00 $721,534.41 $43,292.06 $669,765.47
969 13 $669,765.47 $97,912.83 $669,765.47 $40,185.93 $612,038.57
970 14 $612,038.57 $100,850.22 $612,038.57 $36,722.31 $547,910.67
971 15 $547,910.67 $103,875.72 $547,910.67 $32,874.64 $476,909.59
972 16 $476,909.59 $106,991.99 $476,909.59 $28,614.58 $398,532.17
973 17 $398,532.17 $110,201.75 $398,532.17 $23,911.93 $312,242.34
974 18 $312,242.34 $113,507.81 $312,242.34 $18,734.54 $217,469.08
975 19 $217,469.08 $116,913.04 $217,469.08 $13,048.14 $113,604.18
976 20 $113,604.18 $120,420.43 $113,604.18 $6,816.25 $0.00
977
978 A modified version of the formula could also be used to determine the initial withdrawal:
979 rr = (1+rNOM)/(1 + inflation) - 1
980 rr = 2.9126214%
981
982 Now use the PMT function in Excel or a calculator to find the initial amount to be withdrawn, assuming
983 payments at the end of the year.
984 N= 20
985 I= rr = 2.9126214%
986 PV = 1,000,000
987 PMT = $66,673.87
988 Adjusted PMT = $68,674.09 = PMT(1+ Inflation). The adjustment accounts for Year 1 inflation.
989
990 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, but with the
991 deposits increasing at the inflation rate. You expect to earn 6% on your funds, and you expect a 2% inflation rate. How
992 large must your initial deposit be to enable you to reach your $100,000 target?
993
994
995
996 We can set up a table with an arbitrary initial deposit that grows at the inflation rate and is then compounded at the
997 nominal rate for (N - t) years. The sum of the compounded amounts should total to $100,000. With an arbitrary initial
998 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.
999
1000
1001 Inputs:
1002 Years 10
1003 Amount Needed (FV) $100,000
 A B C D E F
1004 Nominal rate earned on account 6.00%
1005 Inflation 2.00%
1006 Beginning or End? Beginning
1007
1008 Use Goal Seek in the following table to determine the initial deposit. Start with any value for BOY payment at time zero,
then use Goal Seek to set the final balance to the target by changing the BOY t=0 payment.
1009
1010
1011
1012 BOY Payment
Compounded
1013 Period (t) Initial(1+I)^t value
1014 0 $6,598.87 $11,817.57
1015 1 $6,730.85 $11,371.62
1016 2 $6,865.46 $10,942.51
1017 3 $7,002.77 $10,529.58
1018 4 $7,142.83 $10,132.24
1019 5 $7,285.68 $9,749.89
1020 6 $7,431.40 $9,381.97
1021 7 $7,580.03 $9,027.93
1022 8 $7,731.63 $8,687.26
1023 9 $7,886.26 $8,359.43
1024 N= 10 $0.00 $100,000.00
1025
1026 Calculator approach:
1027 Find the real rate: rr = (1+rNOM)/(1 + inflation) - 1 = 3.921569%
1028 is our constant dollar future target: Target real FV = (Nominal FV)/(1 +
1029 Inflation)N = $82,034.83
1030
Use a calculator or the Excel PMT function to find the initial payment. The
1031 PV=0, FV=82034.83, rate=3.921569, and set to Beginning mode. $6,598.87
1032
1033 This is consistent with the Goal Seek solution.
 G H I J K L M
1 11/20/2018
y 2
3
4
used it to create many 5 of the chapter's
ons and features; they are shown off to the
6 useful to learn
Excel functions. It is also
d into Word documents,7which is the way
re is used often in business (and in
8
9
10
11
te easy and can be worked with a
12 for students
nformation on the solutions
13in the various
he solutions for self-tests
ll be able to see the solution setup and
14
15
16
17
18
ecause, if you had it now,19you could invest
20 (FVs) from
s of going to future values
21
22
ou plan to deposit $10023 in a bank that pays
ar 3?
24
25
26 approach
r calculator; (2) the formula
el approach. 27
28
29
30
31
32
33
34
35
36 3
37 FV = ?
38
39 $115.76
40
41 $115.76
42
43
44 FV
 G H I J K L M
45 $115.76
46
47
48 $115.76
49 $115.76

o indicate no periodic 50
cash flows, and
rences.
51
52
53
nterest rates. The curves
54 were created by
he effects of time and interest rates. The
55
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
compounding a present 88
value forward to
u can compound to find the FV, while if
 G H I J K L M
89
90
91
in 3 years. If a bank pays a guaranteed
3 years? 92
93
94
95
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

o indicate no periodic116
cash flows, and
rences.
117
118
119
120
the interest rate or the time until receipt
121 remains at $1,
At 0%, the PV of $1 always
d at a given rate, the value
122 declines the
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
 G H I J K L M
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
143
144
145
146
147
148
149
150
151
152
ust as easily solve for I153
or N. For example,
0 after 10 years. Thus,154
we know PV, FV,
d.
155
156
157
158
159
160
161
162
163
164
165
166
167
168
169
170
money, given our beginning
171 funds and the
retire comfortably if we had $1 million,
172 at 4.5%.
now have $500,000 invested
173
174
175
176
177
 G H I J K L M
178
179
180
181
182
183
184
185
186
187
188
ow shows how the present value of an
189
nnot calculate the future value of a
large and thus meaningless.
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
216
mber of payments increases, as you would
217
t value of a cash flow far in the future is
ct, the present value of a perpetuity can be
218
219
220
221
2.5%, what is the value of the bond?
 G H I J K L M
2.5%, what is the value of the bond?
222
223
224 $25
225 2.0%
226
227 $1,250.00
228
229
230
231
232but they must not
period or the beginning,
233
234
235
236
237
h period. Methods for 238
solving the future
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
 G H I J K L M
267 $315.25
268
269
270
271
272
273
uity, the payments occur at the beginning
274
275
276
277
278
279
280
281
282
283
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
308
ash flows. Methods for solving the
309
310
 G H I J K L M
311
312
313
314
315
316
317
318
319
320
321
322
323
324
325
326
327
328
329
330
331
332 0
333 FV
334
335
336
337 $272.32
338 $272.32
339
340
341
342
343received earlier
due is that payments are
344
345
346
347
348
349
350
351
352
353
354
355
356
 G H I J K L M
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
379
olving for PMT, N, or I,380
you must be given
381
382
383
Suppose further that384 we can earn a return
of the 5 years, assuming385 (a) end-of-year
386
387
388
389
390
391
392
393
394
395
396
397
per year. Again assume 398that you would
399
400
401
 G H I J K L M
402
403
404
405
406
407
408
409
410
10,000 in 5 years. What rate of return
411
412
413
414
415
416
417
418
419
420
421
422
423
424
the end of the 5th year. We can find the
ch, or by finding the PV of the annuity plus
425 or (2) with
culator's cash flow register,
426 below.
the two Excel approaches
427
428
429
430
431
432
433
434
435
436
437
438 5
439 $100.00
440 $1,000.00
441 $1,100.00
442 $624.17
443
444
445
446
 G H I J K L M
447
$927.90
448
449
450
451 −$927.90
452 −$927.90
453
454 $927.90
455 $927.90
456
flow range, Excel assumes that the first
457 separately to
cash flow, it must be added
y-one, but if the cash flows appear in
458
459
460
461
e. 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 $1,016.35
483
484 that the first
flow range, Excel assumes
cash flow, it must be added separately to
485 appear in
y-one, but if the cash flows
486
487
488
489
490
491
an discounting. The step-by-step approach
492 calculators do
function, although financial
FV of this amount at the end of the cash
493
494
495
496
497
498
499
500
501
502 5
503 $500.00
504 $500.00
505 $1,791.15
506
507
 G H I J K L M
508

509 $1,791.15

510
511
512 $1,016.35
513 $1,791.15
514
515
516
517
518
dditional $1,000 at the519
end of the 5th year.
ht the bond?
520
521
522
523 as shown
function or its RATE function,
final lump sum. The IRR function deals
he IRR, but this is not 524
necessary.
525
526
527
528
529
530
531 5
532 $1,100
533
534 12.00%
535 12.00%
536
537
where the firm makes a capital
trates this calculation.538
Note that the IRR
hange the 4th year CF from $300 to -$100
539
540
541
542
543
544
545 5
546 $500
547

548 12.55%

549
 G H I J K L M
550 12.55%

551
552
553
554
555
year, what are the effective interest rates
y compounding? 556
557
558 than with
ou receive interest sooner
559
ou will end up with more money, and the
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
 G H I J K L M
606
607
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
nded daily, based on a638
365-day year. How
639
640
641
642
643
644
645
646

647
 G H I J K L M
648
649
650
651
652
653
654
655
656
657

658

659

660
661
662
663
664 loan.
is it is called an amortized
665
666
,000, with the loan to be repaid in 5 equal
alance at the beginning667
of each year.
668
669
tization table as shown670
in The figure
ble with Excel, as we do671
here.
672
673
674
675
676
677
678
679
680

681

682
683
684
 G H I J K L M
685
686
687
688
689
690
691
692
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
723number of payments you have made.
ction, with N equal to the
724
725
726
727
728
729
730
 G H I J K L M
731
732
733
734
735
736
737
738
739
740
741
742
743
744
745
746
747
748
749
750
751
752
753
754
755
756
757
758
759
760
761
762
763
764
765
766
767
768
769
770
771
772
773
774
775interest charges based on the
do not allocate monthly
e of 78".
776
 G H I J K L M
777
778
ers. For example, with779
12 payments, the sum of 1 through 12
780
781
782
payments, the sum is783N(N + 1)/2). The allocation factor for
784
785
786
payments, the sum is787N(N + 1)/2). The first interest charge is
d by add-on interest. The second factor is 23/300, and so
788
789
790
. The annual nominal 791
interest rate is 9%.
792
793
794
795
796
797
798
799
800
801
802
803
804
805 Remaining Remaining
Balance for Balance:
806 Normal Normal minus
807 Amortizing Loan Rule of 78
808 $25,000.00
809 $24,591.65 $19.41
810 $24,179.22 $37.30
811 $23,762.67 $53.69
812 $23,341.95 $68.64
813 $22,917.03 $82.18
814 $22,487.85 $94.36
815 $22,054.38 $105.21
816 $21,616.58 $114.79
817 $21,174.40 $123.14
818 $20,727.80 $130.29
819 $20,276.73 $136.30
820 $19,821.15 $141.20
821 $19,361.02 $145.05
822 $18,896.28 $147.89
823 $18,426.90 $149.76
824 $17,952.82 $150.71
 G H I J K L M
825 $17,474.00 $150.79
826 $16,990.40 $150.05
827 $16,501.96 $148.52
828 $16,008.63 $146.28
829 $15,510.37 $143.35
830 $15,007.13 $139.79
831 $14,498.85 $135.65
832 $13,985.50 $130.98
833 $13,467.01 $125.83
834 $12,943.33 $120.25
835 $12,414.42 $114.30
836 $11,880.22 $108.02
837 $11,340.67 $101.48
838 $10,795.73 $94.71
839 $10,245.34 $87.78
840 $9,689.45 $80.75
841 $9,128.00 $73.66
842 $8,560.93 $66.57
843 $7,988.20 $59.54
844 $7,409.73 $52.62
845 $6,825.49 $45.88
846 $6,235.39 $39.36
847 $5,639.40 $33.14
848 $5,037.45 $27.26
849 $4,429.48 $21.78
850 $3,815.43 $16.78
851 $3,195.24 $12.30
852 $2,568.84 $8.41
853 $1,936.19 $5.18
854 $1,297.20 $2.65
855 $651.83 $0.91
856 $0.00 $0.00
857
858
859
860
861
$1,000,000 of savings, expects to earn a
n he or she withdraw at the beginning of
862
ame rate as inflation and thus enabling him
863
864
865
866
867
868
869
870
 G H I J K L M
871
872
873
gin with $1 million. But874we immediately
ow how much we can withdraw initially,
875
olio and get $950,000, which is invested at
876
ss the withdrawal, to produce the ending
cess is continued for 20 years.
877
878
879
880
881 balance is
awal, we see that the ending
uld just go through a series of trials and
ce. The amount that does882the trick is
works." 883
884
885
886
887Goal Seek
l amount: (1) Use Excel's
o graph the results. We see that the
lines faster and faster,888
as the withdrawals
889
890
891
892
893
894
895
896
897
898
899
900
901
902
903
904
905
906
907
908
909
910
911
912
913
914
 G H I J K L M
915
hich you then fill out as shown to the right.

916
nding balance, so enter917
0 here.
the yellow cell with the Year 1 withdrawal
918
919 will go to
786.88, and the final balance
digits Excel calculated.
920
921
922
923
924
925
926
927
928
e initial amount to be withdrawn. Be
djustment to the Excel929function.
930
931
932
933Goal Seek.
ith the value found using
934
935
936
937
938
939
940
941
ar, then the amount of 942
investable funds
ero final balance will also be somewhat
943
year and then using Goal Seek to find the
use the original funds 944
earned interest for a
945
946
947
948
949
950
951
952
953
954
955
956
957
 G H I J K L M
958
959
960
961
962
963
964
965
966
967
968
969
970
971
972
973
974
975
976
977
978
979
980
981
982
983
984
985
986
987
988
989
990 in 10 years.
ed to accumulate $100,000
nning of the next 9 years, but with the
991 rate. How
nd you expect a 2% inflation
992
993
994
995
996
rate and is then compounded at the
to $100,000. With an997
arbitrary initial
own in the completed998dialog box to find
999
1000
1001
1002
1003
 G H I J K L M
1004
1005
1006
1007
1008at time zero,
ny value for BOY payment
payment.
1009
1010
1011
1012
1013
1014
1015
1016
1017
1018
1019
1020
1021
1022
1023
1024
1025
1026
1027
1028
1029
1030
1031
1032
1033
 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
 N O P Q
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
 N O P Q
89
90
91
92
93
94
95
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
 N O P Q
133
134
135
136
137
138
139
140
141
142
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
 N O P Q
178
179
180
181
182
183
184
185
186
187
188
189
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
216
217
218
219
220
221
 N O P Q
222
223
224
225
226
227
228
229
230
231
232
233
234
235
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
 N O P Q
267
268
269
270
271
272
273
274
275
276
277
278
279
280
281
282
283
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
 N O P Q
311
312
313
314
315
316
317
318
319
320
321
322
323
324
325
326
327
328
329
330
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
 N O P Q
357
358
359
360
361
362
363
364
365
366
367
368
369
370
371
372
373
374
375
376
377
378
379
380
381
382
383
384
385
386
387
388
389
390
391
392
393
394
395
396
397
398
399
400
401
 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
 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
 N O P Q
606
607
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
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%

What rate would you earn if you could buy the bond for $600?

N 10
PMT $0
PV $600.00
FV $1,000 I= 5.24%

Microsoft earned $0.33 per share in 1997. Fourteen years later, in 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
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?

Annuity 1st Payment

Data 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.

Annuity 5th Payment

Data 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%
PV $100,000
* This result means that with $7,000
PMT -$7,000
withdrawals, you would 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 rate 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 rate 6%

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

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

NPV $558.07
 10
$100
$500
$600
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 rate 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

Credit card issuers must by law print their annual percentage rate (APR) on their 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 (days) 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 (days) 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 (months) 7

Effective rate 7.250098% Account value $1,041.67

SECTION 4-17
SOLUTIONS TO SELF-TEST

Consider again the example in Figure 4-11. 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

Beginning Amount Repayment of Ending Balance

Year (1) Payment (2) Interest (3) Principal (4) (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+rNOM)/(1+Inflation))-1 = 4.7619%