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Assignment: Time Value of Money

Due by Oct 28, 2014 3pm in the TA room faculty block III
Please hand it over to Aleesha Mariya
Q.1
You have recently won the super Jackpot in the Illinois state lottery, with a payoff of
$4,960,000.On reading the fine print, you discover that you have the following two
options:
a. You receive $160,000at the beginning of each year for 31 years. The income would
be taxed at an average rate of 28%. Taxes are withheld when the checks are issued.
b. You receive $1,750,000 now, but you do not have access to the full amount
immediately. The $1,750,000 would be taxed at an average rate of 28%. You are
able to take $446,000of the after tax amount now. The remaining $814,000 will be
placed in a 30 year annuity account that pays 4101,055 on a before tax basis at the
end of each year.
Q.2
You have just completed your 30th birthday and have received and accepted a new job
that pays salary once a year. Your salary payment next year (at the end of age 31) is
going to be $75,000. Now you must decide how much money to put into your retirement
plan. You know that your salary will increase by 2 percent a year till your retirement at
the end of age 65. You plan to contribute a fixed percentage of your salary every year till
your retirement. You cannot make withdrawals until you retire at the end of age 65. After
that point you can make withdrawals as you see fit. You estimate that you would live till
the end of age 100 and would like to provide for that. To live comfortably in your
retirement you will need $100,000 per year starting at the end of the first year of
retirement. The plan works as follows: every dollar in the plan earns 7% per year. For
your place in heaven, assume that you make your last withdrawal at the end of age 100
and pay as you go!!
a. What percentage of your income do you need to contribute to the plan every year
to fund the required retirement income?
b. Suppose you learn well at IIMK and it results in an annual increment of 3% a year
(instead of the 2%), how much more can you have per year in your annual
retirement withdrawal?
c. Suppose you only get a 25 annual increment, but you decide to increase the
contribution to your retirement account by an extra 1% how much more can you
have per year in your annual retirement withdrawal?
Q.3
Ms DM has $ 10,000 that she can deposit in any of 3 savings a/cs for a 3 year period.
Bank A compounds interest on an annual basis, Bank B compounds interest twice each
year, Bank C compounds interest each quarter. All 3 banks have a stated annual interest
rate of 4%. What amount would Ms.DM have at the end of the 3 rd year, leaving all
interest paid on deposit, in each bank.

Q.4
You are shopping for a car and read the following advertisement in the news paper: Own
a new Spitfire! No money down. Four annual payments of just $10,000.You have
shopped around and know that you can buy a Spitfire for cash for $32,500. What is the
interest rate the dealer is advertising (what is the IRR of the loan in the advertisement)?
Assume that you must make the annual payments at the end of each year.
Q.5
The mortgage on your house is 5 years old. It required monthly payments of $1402, had
an original term of 30 years, and had an interest rate of 10% (APR). In the intervening 5
years interest rates have fallen and so you have decided to refinance that is, you will
roll over the outstanding balance into a new mortgage. The new mortgage has a 30 year
term, requires monthly payments and has an interest rate of 6.625% (APR).
a. What monthly repayments will be required with the new loan?
b. If you still want to pay off the mortgage in 25 years, what monthly payments should
you make after you refinance?
c. Suppose you are willing to continue making monthly payments of $1402.00, how
long will it take you to payoff the mortgage after refinancing?
d. Suppose you are willing to continue making monthly payments of $1402.00, and
want to payoff the mortgage in 25 years. How much additional cash can you borrow
today as part of the refinancing?
Q.6
Ms. Adam has received a job offer from a large investment bank as an assistant to the vice
president. Her base salary will be $35,000. She will receive her first annual salary
payment one year from the day she begins to work. In addition, she will get an immediate
$10,000 bonus for joining the company. Her salary will grow at 4 percent each year. Each
year she will receive a bonus equal to 10 percent of her salary. Ms. Adams is expected to
work for 25 years. What is the present value of the offer if the appropriate discount rate is
12%?

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