Time Value of Money

a. If the inflation rate is 5% and the real interest rate is 4.25%, what is the nominal rate of
interest?
b. If the inflation rate is 6.25% what is Rs. 2100 receivable 3 years from today worth in terms of
today’s money?
c. SBI offers 5.4% for Fixed Deposits of maturity 5 years and above. Suppose you want to
invest Rs. 250000 for a period of 7 years. What will your FD be worth in 7 years’ time? If the
inflation rate is 5% what is the real rupee returns that you earn?
d. Refer to the same interest rates mentioned in problem c. If you require INR 500 000 in 10
years’ time, how much should you invest today?
e. You have borrowed Rs. 10,000 from a bank with the understanding that you will pay it off
with a lump sum of $12,000 after 3 years. Find the annual rate of interest on this loan.
f. A bank account pays 5.5% annual interest, compounded monthly. How long will it take the
money to double in this account?
g. You brought a piece of land for Rs 17000 in the year 2005. The same land is now worth Rs
120 000. What is the rate of appreciation on a per year basis?
h. The interest rate on risk-free government bonds is 6%. What does risk-free refer to here?
i. You brought a piece of land in the year 2010. For the next three years the inflation rate was
3%, followed by 7% for the next 4 years. Following that the inflation rate was stable at 6% p
a. What will be the price of the land if we consider inflation alone and if it was worth Rs 20
000 at the time of purchase.
j. In case the risk free rate is 5.5% and the risk premium in a particular investment is 4%, what
does it mean in terms of expected return? What does it mean in terms of required return?
k. You will have a huge financial requirement 10 years down the line. To meet this requirement
you want to do a yearly deposit that will help you meet the outflow after 10 years. If the
requirement is 25,00,000 INR and the interest rate is 10% p.a how much should you deposit at
the end of every year for 10 years starting next year?
l. You plan to buy a Jaguar XJ for INR 36 00 000, but you have only 600,000 in cash. The bank
will loan you the rest at the annual interest rate of 12%, with the payments spread over 60
months. Find your monthly payment.
m. Suppose the price of a house that you are interested in buying is INR 5000000 and you have
your 500000 down payment handy. The bank will loan you the remaining at 8% annual
interest for a 25-year term. Find your monthly payment.
n. If you deposit INR 12000 every year for 12 years at 14%, how much will it amount to?
Assume that the first deposit is made at the end of next year.
Practice problems
1. Adams Company bought a piece of land in 1981 for $200,000. By 2005, its value had
increased to $1 million. Find the annual rate of appreciation during this period. 6.936% ♥
2. Ahsan Co bought a piece of land in 1991 for $160,000 which appreciated in value at the
rate of 3% per year for the first three years and then at the rate of 4% for the next four years.
Find its value after 7 years. $204,534 ♥
3. Your employer has promised to give you a $5,000 bonus after you have been working for
him for 5 years. What is the present value of this bonus if the proper discount rate is 8%?
$3402.92 ♥
4. The U.S. government fixed the price of gold at $35 an oz in 1934. In 2005, the price of the
yellow metal was $480 an oz. Calculate the price appreciation of gold as percent per year,
compounded annually. 3.757% ♥
5. You expect to receive $10,000 as a bonus after 6 years. You have calculated the present
value of this bonus and the answer is $7000. What interest rate did you use in your
calculation? 6.125% ♥
6. A downtown bank is advertising that if you deposit $1,000 with them, and leave it there for
65 months, you can get $2,000 back at the end of this period. Assuming monthly
compounding, what is the monthly rate of interest paid by the bank? 1.072% ♥
7. You decide to put $10,000 in a money market fund that pays interest at the annual rate of
7.2%, compounding it monthly. You plan to take the money out after one year and pay the
income tax on the interest earned. You are in the 25% tax bracket. Find the total amount
available to you after taxes. $10,558.18 ♥
8. Suppose you have decided to put $200 at the beginning of every month in a savings
account that credits interest at the annual rate of 6%, but compounds it monthly. Find the
amount in this account after 30 years. $201,907.52 ♥
9. Antioch Company is adding $25,000 per month to a pension fund. The fund will earn
interest at the rate of 6% per year, compounded monthly. Find the amount available
in this fund after 20 years. $11.609 million ♥
10. Cincinnati Company has decided to put $30,000 per quarter in a pension fund. The fund
will earn interest at the rate of 6% per year, compounded quarterly. Find the amount available
in this fund after 10 years. $1,652,457 ♥
11. Suppose you put $250 at the beginning of every month in a savings account that credits
interest at the annual rate of 6%, but compounds it monthly. Find the amount in this account
after 25 years. $174,114.73 ♥
12. Suppose you deposit $125 on the first of every month for 240 months, and the bank
credits interest at the end of every month at the annual rate of 6%. How much money do you
have in your account at the end of 20 years? $58,043.89 ♥
13. You have decided to put $130 in a savings account at the end of each month. The savings
account credits interest monthly, at the annual rate of 6%. How much money is in your
account after 6 years? $11,233.15 ♥
14. Fred Abbott has just opened an IRA in which he plans to deposit $150 at the end of every
month. The account will compound interest monthly at the annual rate of 9%. How much
money will Fred have after 25 years in this account? $168,168.29 ♥
15. You have started a job with an annual salary of $48,000. You will get the paycheck at the
end of each month, and your deductions for taxes will be 34%. Using a discount rate of 0.8%
per month, find the present value of the take home pay for the whole year. $30,092.34 ♥
16. Suppose you want to accumulate $10,000 for a down payment for a house. You will
deposit $400 at the beginning of every month in an account that credits interest
monthly at the rate of 0.6% per month. How long will it take you to achieve your goal? 24
months. ♥
17. James Earl has decided to save a million dollars by depositing $50,000 at the beginning of
each year in an account that pays interest at the rate of 10%, compounded annually. How long
will it take him to reach his objective? 11 years ♥
18. Suppose you want to accumulate $25,000 as down payment on a house and the best you
can do is to put aside $200 a month. If you deposit this amount at the beginning of each
month in an account that credits 0.75% interest monthly, how long will it take you to attain
your goal? 88 months ♥
19. Suppose you deposit $300 at the beginning of each month in a savings account that pays
interest at the rate of 6% per year, with monthly compounding. How long will it take you to
accumulate $25,000 in this account? 5 years, 10 months ♥
Emily Dickinson would like to accumulate $12,000 for a down payment on a house by
depositing $400 on the first of every month in a savings account that pays 6% annual
interest, compounded monthly. How long will it take her to reach her goal? 28 months ♥
20. Suppose you deposit $70.97 at the beginning of every month in an account that pays 9%
interest per year, compounding it monthly. You would like to accumulate
$10,000 in this account. How long do you have to wait before you reach your goal? 8 years ♥
21. Suppose you are a property owner and you are collecting rent for an apartment. The tenant
has signed a one-year lease with $600 a month rent, payable in advance. Find the present
value of the lease contract if the discount rate is 12% per year. $6820.58 ♥
22. Republic of Zimbabwe has borrowed $50 million from the World Bank at an interest rate
of 3% per year. Zimbabwe will repay the loan over the next 30 years in equal annual
payments. Find the annual installment. $2.551 million ♥
23. West Bank gives consumer loans at the annual interest rate of 8.25%. Suppose you take
out a $5,200 loan for 36 months, what will your monthly payment be? $163.55 ♥
24. Easton Bank gives 6% annual interest, compounded monthly, on its savings deposits.
Suppose you deposit $100 on the first of every month in the bank, how long willit take you to
accumulate $10,000? 81 months ♥
25. You want to buy a $120,000 house, and you apply for a mortgage loan. The bank requires
a 20% down payment. It will give you a 25-year loan at 8.75% annual interest rate, payable in
monthly installments. How much is your monthly payment? $789.26 ♥
26. Adana Corporation is interested in buying a building for $500,000 in cash, or it may pay
for it in 50 monthly installments of $12,000 each. If the proper discount rate for Adana is 9%,
which method should it use? PV(installments) = $498,797.36, better ♥
27. Alhambra Corporation borrowed $1 million from Anaheim Bank with the understanding
that Alhambra will pay the loan back in 6 monthly installments of
$175,000 each. Find the annual rate of interest charged by the bank. 16.94% ♥
28. Akron Corporation has borrowed $1 million from Canton Bank with the understanding
that Akron will pay the loan back in 12 monthly installments of $90,000
each. Find the annual rate of interest charged by the bank. 14.45% ♥
29. Armes Corporation has the opportunity to receive $20,000 right now, or, $3254.91 per
year for the next ten years. The first payment will be available after one year. For what rate of
interest would the two options be of equal value? 10% ♥
30. Auckland Corporation has borrowed $700,000 from a bank. Auckland will repay the loan
in ten annual installments of $100,000 each. The first installment will be paid a year from
now. Find the rate of interest charged by the bank. 7.07% ♥
31. Suppose you buy a machine and you have the option of paying the full price, $40,000,
now; or $10,000 at the end of each of the next five years. What is the cost of capital, or the
implied interest rate, for the two methods to be equivalent? 7.93% ♥
32. You have bought a car. The car dealer offers two payment plans: (A) Make 48 monthly
payments of $130 each, or (B) Make 36 payments of $165 each. If the time
value of money is 12% per year, which plan is cheaper for you? (A) by about $31 ♥
33. Bennington Company has borrowed a certain amount from the bank that it will repay in
24 monthly installments. The bank charges 6% interest annually on this loan and the monthly
payment is $6000. Find the amount of loan. $135,377.20 ♥
36. You want to buy a piece of land and the owner would sell it to you for $20,000 cash.
Alternatively, he would let you pay for it with five annual installments of $5,000 each, the
first one due right now. What is the implied interest rate here? 12.59% ♥
37. Karl has borrowed $400 from his friend Bill and he will pay him back in four monthly
installments of $105 each. Find the monthly rate of interest charged by Bill.
1.98% ♥
38. Dickens Corp wants to buy a 100-acre tract of land. The owner will sell it for a cash price
of $175,000, but Dickens offered to pay for the land in five annual installments of $40,000
each, the first one is due at the end of one year. Find the cost of capital for Dickens the two
prices to be equivalent. 4.62% ♥
39. Edinburgh Corporation has the choice of paying for a piece of land $5 million in cash
now. Or, after making a down payment of $1 million, it may pay the balance may in 6 equal
annual payments of $1 million. Find the implied rate of interest in the second
option. 12.98% ♥
40. Suppose you have borrowed $12,000 from a bank with the interest rate of 11.5%. Your
monthly installments are $313.07. How long will it take you to pay the loan?
48 months ♥
41. You have borrowed $10,000 from a bank at the interest rate of 1% per month. Your
monthly payment is $554.15. Find the time required to repay the loan. 20 months ♥
42. Allegheny Company has borrowed $100,000 from a bank with the understanding that the
company will pay $2,000 per month to repay the loan. The bank will charge .75% interest per
month on the unpaid balance. How long will it take Allegheny to amortize the loan? 63
months ♥
43. Ames Corporation has borrowed $5 million from a bank with the understanding that it
will pay the loan in monthly installments of $100,000 each. The bank charges
interest at the rate of 0.8% per month. Find the time required to pay the loan. 65 months ♥
44. Louis Trichardt would like to save $15,000 to use as a down payment on a house. He will
deposit $500 a month in a savings account that pays interest at the rate of 6% per year,
compounded monthly. How long will it take him to accomplish his objective? 28 months ♥
45. Durban Corporation is interested in acquiring a machine that it can buy for $140,000 in
cash. Alternatively, Durban can make five equal payments of $40,000 each,
the first one due after one year, to purchase the same machine. Find the implied interest rate
in the second option. 13.20% ♥