Managerial Finance

Time Value of Money Supplemental Homework Problems

1.) A client invests $500,000 in a mutual fund investment projected to earn 10% annually.
Estimate the value of her investment after 6 years assuming the projected 10% annual return
is realized. (Calculating FV)

2.) Andrew owns a $10 million portfolio and decides to invest 5% of the $10 million portfolio in
a money market fund projected to earn 3% annually. Estimate the value of this portion of
the portfolio after 12 years. (Calculating FV)

3.) A mother will make her sons first $80,000 college tuition payment 12 years from today. How
much will she need to invest today to meet her first tuition goal, if the investment she selects
earns 8% annually? (Calculating PV)

4.) Sarah has agreed to invest $100,000 one year from today in a business planning to expand,
and she has decided to set aside the funds today in a bank account promising to pay 7%
compounded quarterly. How much should Sarah set aside today to ensure she will have the
$100,000 in one year to make the promised payment? (Calculating PV)

5.) A client can choose between receiving 10 annual $100,000 retirement payments, starting one
year from today (ordinary annuity), or receiving a lump sum today. Knowing that the client
can invest the lump sum today at a rate of 5% annually, he has decided to take the lump sum.
What lump sum today will be equivalent to the future annual payments? (Calculating PV of
annuity)

6.) For liquidity purposes, Ellen keeps $100,000 in a bank account. The bank quotes a stated
annual rate of 7%.
a. With quarterly compounding, how much will Ellen have in her account at the end of one
year, assuming no additions or withdrawals? (Calculating FV)
b. With monthly compounding, how much will she have in her account at the end of one
year, assuming no additions or withdrawals? (Calculating FV)

7.) You are considering investing in two different instruments. If your required rate of return on
these investments is 8% annually, what should you be willing to pay for each instrument?
(Calculating PV)
a. The first investment will pay nothing for 3 years, but then it will pay $20,000 for 4 years.
b. The second instrument will pay $20,000 for three years and then $30,000 in the fourth
year.

8.) You want to double your money in 6 years. Approximately what rate of interest must you
earn?
 Managerial Finance Time Value of Money Problem Set
Time Value of Money Supplemental Homework Problems Solutions

1.) A client invests $500,000 in a mutual fund investment projected to earn 10% annually.
Estimate the value of her investment after 6 years assuming the projected 10% annual return
is realized. (Calculating FV)

Calculate the future value of a lump sum of $500,000 in 6 years:

Draw a time line:

0 1 2 6

500K ?

Formula is FV=PV(1+r)N
PV = - $500,000 FV=$500,000(1.10)6
I/Y = 10 FV=$500,000(1.7715)
N=6 FV=$885,780.50
PMT = 0
CPT FV = $885,780.50

2.) Andrew owns a $10 million portfolio and decides to invest 5% of the $10 million portfolio in
a money market fund projected to earn 3% annually. Estimate the value of this portion of the
portfolio after 12 years. (Calculating FV)

5% of $10,000,000 =$500,000
Calculate the future value of a lump sum of $500,000 in 12 years:
Draw a time line:

0 1 2 12

500K ?

Formula is FV=PV(1+r)N
PV = - $500,000 FV=$500,000(1.03)12
I/Y = 3 FV=$500,000(1.4258)
N = 12 FV=$712,880.44
PMT = 0
CPT FV = $712,880.44

3.) A mother will make her sons first $80,000 college tuition payment 12 years from today. How
much will she need to invest today to meet her first tuition goal, if the investment earns 8%
annually? (Calculating PV)

Calculate the present value of a lump sum of $80,000 to be paid in 12 years:

Draw a time line:

0 1 2 12

? $80K
 FV
Formula is PV =
(1 + r ) N
FV = $80,000
r=8 PV=$80,000(0.3971)
N = 12 PV=$31,769.10
PMT = 0
CPT PV = $31,769.10

4.) Sarah has agreed to invest $100,000 one year from today in a business planning to expand,
and she has decided to set aside the funds today in a bank account promising to pay 7%
compounded quarterly. How much should Sarah set aside today to ensure she will have the
$100,000 in one year to make the promised payment? (Calculating PV)

Calculate the present value of a lump sum of $100,000 to be paid in 1 year:

However, we have quarterly compounding.
Draw a time line:

0 1/4 1/2 3/4 1

? $100K

FV N
Formula is PV =
r
(1 + ) mxN
m
FV = $100,000
I/Y = 7 / 4 = 1.75 PV=$500,000(0.9330)
N=4 PV=$93,295.85
PMT = 0
CPT PV = $93,295.85

5.) A client can choose between receiving 10 annual $100,000 retirement payments, starting one
year from today (ordinary annuity), or receiving a lump sum today. Knowing that the client
can invest the lump sum today at a rate of 5% annually, he has decided to take the lump sum.
What lump sum today will be equivalent to the future annual payments? (Calculating PV of
annuity)

Calculate the present value of a 10-year $100,000 per year annuity:

Draw a time line:
0 1 2 3 4 5 6 7 8 9 10

100K 100K 100K 100K 100K 100K 100K 100K 100K 100K

Using calculator:
PMT = $100,000 N = 10
I/Y = 5 FV = 0 CPT PV = $772,173.49
6.) For liquidity purposes, Ellen keeps $100,000 in a bank account. The bank quotes a stated
annual rate of 7%.
a. With quarterly compounding, how much will Ellen have in her account at the end of one
year, assuming no additions or withdrawals? (Calculating FV)
 Calculate the future value of a lump sum of $100,000 in 1 year, quarterly compounding:
Draw a time line:

0 1/4 1/2 3/4 1

$100K ?

Using calculator:
PV = $100,000
I/Y = 7 / 4 = 1.75 FV=$100,000(1.0719)
N=4 FV=$107,185.90
PMT = 0
CPT FV = $107,185.90

b. With monthly compounding, how much will she have in her account at the end of one
year, assuming no additions or withdrawals? (Calculating FV)

Calculate the future value of a lump sum of $100,000 in 1 year, monthly compounding:
Draw a time line:

0 Jan Feb Mar Dec

$100K ?
r mxN
Formula is FV N = PV (1 + )
m
PV = $100,000
I/Y = 7 / 12 = 0.5833 FV=$100,000(1.0723)
N = 12 FV=$107,229.01
PMT = 0
CPT FV = $107,229.01
7.) You are considering investing in two different instruments. If your required rate of return on
these investments is 8% annually, what should you be willing to pay for each instrument?
(Calculating PV)
a. The first investment will pay nothing for 3 years, but then it will pay $20,000 for 4
years.
Draw a time line:

0 1 2 3 4 5 6 7

0 0 0 20K 20K 20K 20K

The present value of the investment can be found by simply by discounting each of the
investments cash flows (CF) back to t=0.
$20,000
PV of CF to be received in year 4: PV = PV = $14,700.60
(1 + 0.08) 4
$20,000
PV of CF to be received in year 5: PV = PV = $13,611.66
(1 + 0.08)5
$20,000
PV of CF to be received in year 6: PV = PV = $12,603.39
(1 + 0.08)6
$20,000
PV of CF to be received in year 7: PV = PV = $11,669.81
(1 + 0.08)7

Total PV of Investment: $52,585 (rounded)

Alternatively, we can use the CF and NPV functionality of the calculator to solve this
problem.

Hit the CF key;

Clear out old data by hitting 2nd Clr Work (bottom left);
C0 = 0 (then down arrow)
C01 = 0 (then down arrow)
F01 = 3 (there are three consecutive $0 values; then down arrow)
C02 = 20,000 (then down arrow)
F01 = 4 (there are four consecutive $20,000 values)

Double-check the data inputs by scrolling back up through the data using the up arrow.
Once confirm all cash flows are correct, hit the NPV key (just to the right of the CF key).

I = 8; (enter the interest rate as whole number, then down arrow)

CPT NPV = $52,585 (rounded)
b. The second instrument will pay $20,000 for three years and then $30,000 in the fourth
year.

Draw a time line:

0 1 2 3 4

20K 20K 20K 30K

The present value of the investment can be found by simply by discounting each of the
investments cash flows (CF) back to t=0.
$20,000
PV of CF to be received in year 1: PV = PV = $18,518.52
(1 + 0.08)1
$20,000
PV of CF to be received in year 2: PV = PV = $17,146.78
(1 + 0.08) 2
$20,000
PV of CF to be received in year 3: PV = PV = $15,876.45
(1 + 0.08)3
$30,000
PV of CF to be received in year 4: PV = PV = $22,050.90
(1 + 0.08) 4

Total PV of Investment: $73,593 (rounded)

Alternatively, we can use the CF and NPV functionality of the calculator to solve this
problem.

Hit the CF key;

Clear out old data by hitting 2nd Clr Work (bottom left);
C0 = 0 (then down arrow)
C01 = 20,000 (then down arrow)
F01 = 3 (there are three consecutive $20,000 values; then down arrow)
C02 = 30,000 (then down arrow)
F01 = 1

Double-check the data inputs by scrolling back up through the data using the up arrow.
Once confirm all cash flows are correct, hit the NPV key (just to the right of the CF key).

I = 8; (enter the interest rate as whole number, then down arrow)

CPT NPV = $73,593 (rounded)
8.) You want to double your money in 6 years. Approximately what rate of interest must you
earn?

Rule of 72 states that an approximate measure (in years) to double your money is to divide 72
by the interest rate of the investment under consideration. The equation for the Rule of 72
can be written as:
Number of years needed to double money = 72/interest rate of investment

The problem gives 8 years to double your money, so solving for the interest rate yields:
6 = 72/r
6r=72
r=12
So, in order to double your money in 6 years, the approximate (not exact) rate of interest
required on your investment is 12% (assumes annual compounding).

Suppose the question asked to double in 8 years:

Rule of 72 states that an approximate measure (in years) to double your money is to divide 72
by the interest rate of the investment under consideration. The equation for the Rule of 72
can be written as:
Number of years needed to double money = 72/interest rate of investment

The problem gives 8 years to double your money, so solving for the interest rate yields:
8 = 72/r
8r=72
r=9
So, in order to double your money in 8 years, the approximate (not exact) rate of interest
required on your investment is 9% (assumes annual compounding).