PROBLEM SOLVING 1

4A.1 The accompanying table shows a series of transactions in a savings account. The account
pays 6% simple interest, and the account owner withdraws interest as soon as it is paid. Create a
new table that shows (a) the account balance at the end of each year and (b) the interest earned
each year. What is the true rate of interest that the investor earns in this account?

Date Deposit (Withdrawal) Date Deposit (Withdrawal)

1/1/17 $ 5,000 1/1/19 $2,000
1/1/17 $(4,000) 1/1/20 $3,000

P 4A.2 Using a financial calculator or spreadsheet, calculate the following:

a. The future value of a $223 deposit left in an account paying 7% annual interest for eight years.
b. The future value at the end of eight years of a $300 annual end-of-year deposit into an account
paying 6% annual interest.

P 4A.3 For each of the following initial investment amounts, calculate the future value at the end
of the investment period if interest compounds annually.

Investment Investment Amount Rate of Return Investment Period (yr)

A $ 200 5% 20
B $ 4,500 8% 7
C $10,000 9% 10
D $25,000 10% 12
E 37,000 11% 11

P 4A.4 Using a financial calculator or spreadsheet, calculate the future value in four years of
$15,000 invested today in an account that pays a stated annual interest rate of 10%, compounded
monthly.

P 4A.5 The following table describes the characteristics of five annuities. Calculate the future
value of each annuity given its characteristics.

Deposit Annual Annuity Payment Interest Rate Annuity Length (yr)

A $ 2,500 8% 10
B $ 500 12% 6
C $ 1,000 20% 5
D $12,000 16% 8
E $ 4,000 14% 30
P 4A.6 If you deposit $1,000 into an account at the end of each of the next three years and the
account pays an annual interest rate of 4%, how much will be in the account after three years?

P 4A.7 Assume you can earn 9% on the investments described below. How much money would
each investment provide for you after six years?
a. Invest $5,000 as a lump sum today.
b. Invest $2,000 at the end of each of the next six years.
c. Invest a lump sum of $3,000 today and $1,000 at the end of each of the next six years.
d. Invest $900 at the end of years 1, 3, and 5.

P4A.8 The following table lists the lump sum payout, the timing of that payout, and the discount
rate associated with five different investments. Calculate the present value of each investment.

Investment Future Sum Sum Discount Rate Payout at End of

Year
A $ 7,000 7% 4
B $ 28,000 3% 20
C $ 10,000 9% 12
D $150,000 6% 6
E $ 45,000 8% 8

P 4A.9 A Florida state savings bond can be converted to $1,000 at maturity five years from
purchase. If the state bonds are to be competitive wih U.S. savings bonds, which pay 1% interest
compounded annually, at what price will the state bonds sell, assuming they make no cash
payments prior to maturity?

P4A.10 Referring to Problem 4A.9, at what price would the bond sell if U.S. savings bonds were
paying 1.5% interest compounded annually? Compare your answer to that of the preceding
problem.

P4A.11 How much should you be willing to pay for a lump sum of $10,000 five years from now
if you can earn 3% every six months on other similar investments?

P4A.12 Find the present value of each of the following streams of income, assuming a 12%
discount rate.

A B C
End of Year Income End of Year Income End of Year Income
1 $2,200 1 $10,000 1-5 $10,000/yr
2 $3,000 2-5 $5,000 6-10 $ 8,000/yr
3 $4,000 6 $7,000
4 $6,000
5 $8,000
P4A.13 Consider the streams of income given in the following table.
a. Find the present value of each income stream, using a 1% discount rate. Then repeat those
calculations using an 8% discount rate.
b. Compare the present values and discuss them in light of the fact that the undiscounted total
income amounts to $10,000 in each case.

Income Stream
End of Year A B
1 $ 4,000 $ 1,000
2 $ 3,000 $ 2,000
3 $ 2,000 $ 3,000
4 $ 1,000 $ 4,000
Total $10,000 $10,000

P4A.14 For each of the investments below, calculate the present value of the annual end-of-year
payments at the specified discount rate over the given period.

Investment Annual Payments Discount Rate Period (yr)

A $ 1,200 7% 3
B $ 5,500 12% 15
C $ 700 20% 9
D $14,000 5% 7
E $ 2,200 10% 5

P4A.15 Congratulations! You have won the lottery! Would you rather have $2 million at the end
of each of the next 10 years or $10 million today? (Assume a 10% discount rate.)

P4A.16 Using a financial calculator or an Excel spreadsheet, calculate the following.

a. The present value of $500 to be received four years from now, using an 11% discount rate.
b. The present value of the following end-of-year income streams, using a 9% discount rate and
assuming it is now the beginning of 2018.

End of Year Income Stream A Income Stream B

2018 $80 $140
2019 $80 $120
2020 $80 $100
2021 $80 $80
2022 $80 $60
2023 $80 $40
2024 $80 $20