Integrated Case

First National Bank

Feb-42 Time Value of Money Analysis You have applied for a job with a local bank. As
part of its evaluation process, you must take an examination on time value of money analysis
covering the following questions.

A Draw time lines for (1) a 100 lump sum cash flow at the end of Year 2, (2) an ordinary annuity
of 100 per year for 3 years, and (3) an uneven cash flow stream of -50, 100, 75, and 50
at the end of Years 0 through 3.

Answer
Lump sum
0 1 2

100
Annuity
0 1 2 3

100 100 100

Uneven cash flow stream

0 1 2 3

-50 100 75 50

B. (1) What’s the future value of 100 after 3 years if it earns 10%, annual compounding?

0 10% 1 2 3

100 FV=?
PV= 100 N= 3
FVN = PV(1 + I)^N
So FV3 = 100(1.10)^3 = 100(1.3310) = 133.10. FV= $133.10
B. (2) What’s the present value of 100 to be received in 3 years if the interest rate is 10%,
annual compounding?

0 10% 1 2 3

PV=? 100

PV = FVn/(1+I)^N FV= 100 I= 10%

PV = 100/(1+.01)^3 N= 3
PV = 75.13 PV= $75.13

C. What annual interest rate would cause 100 to grow to 125.97 in 3 years?

0 10% 1 2 3

100 125.97

100(1 + I)^3 = $125.97. PV= 100

(1+I)^3=125.97/100 FV= 125.97
(1+I)^3=1.2597 N= 3
(1+I)^(3*1/3)=1.2597^1*3 I= ?
41.99 (1+I)=1.0799
0.4199 I=1.0799-1 I= 8%
I=.0799
I=8%

D. If a company’s sales are growing at a rate of 20% annually, how long will it take sales to double?

2 = 1(1 + I)^N Pv= 1

2 = 1(1.20)^N. FV= 2
2/1=(1.20)^N I= 20%
2=(1.20)^N N= ?
ln2=N ln(1.20)
N= ln2/ln(1.20) N= -3.80178
N=3.8

0 20% 1 2 3 3.8

1 2

E. What’s the difference between an ordinary annuity and an annuity due? What type of annuity
 is shown here? How would you change it to the other type of annuity?
0 1 2 3

0 100 100 100

Answer
An ordinary annuity has end-of-period payments,
while an annuity due has beginning-of-period payments.

The annuity shown above is an ordinary annuity. To convert it to an annuity due,

shift each payment to the left.

0 1 2 3

100 100 100 0

F. (1) What is the future value of a 3-year, 100 ordinary annuity if the annual interest rate is 10%?
Answer
0 10% 1 2 3

100 100 100 0

110 1
121 2
331

FVAn = 100(1) + 100(1.10) + 100(1.10)^2

= 100[1 + (1.10) + (1.10)2] = 100(3.3100) = 331.00.

F. (2) What is its present value?

0 10% 1 2 3

100 100 100

1 90.90909
2 82.64463
3 75.13148
248.6852

F. (3) What would the future and present values be if it were an annuity due?
0 10% 1 2 3

100 100 100

 110 1
121 2
133.1 3
364.1

0 10% 1 2 3

0 100 100 100

1 90.90909
2 82.64463
173.5537

G. A 5-year $100 ordinary annuity has an annual interest rate of 10%.

(1) What is its present value?

0 10% 1 2 3

100 100 100

1 90.90909
2 82.64463
3 75.13148
4 68.30135
5 62.09213
379.0787

G. (2) What would the present value be if it was a 10-year annuity?

I= 10%

0 1 2 3 4 5 6 7

100 100 100 100 100 100 100

1 90.90909
2 82.64463
3 75.13148
4 68.30135
5 62.09213
6 56.44739
7 51.31581
8 46.65074
9 42.40976
10 38.55433
614.4567
G. (3) What would the present value be if it was a 25-year annuity?

I= 10%

0 1 2 3 4 5 6 7

100 100 100 100 100 100 100

1 90.90909
2 82.64463
3 75.13148
4 68.30135
5 62.09213
6 56.44739
7 51.31581
8 46.65074
9 42.40976
10 38.55433
11 35.04939
12 31.86308
13 28.96644
14 26.33313
15 23.9392
16 21.76291
17 19.78447
18 17.98588
19 16.3508
20 14.86436
21 13.51306
22 12.2846
23 11.16782
24 10.15256
25 9.2296
907.704

G. (4) What would the present value be if this was a perpetuity?

FV= 100
I= 10%

PV= 1000
H. A 20-year-old student wants to save $3 a day for her retirement. Every day she places $3 in a drawer.
At the end of each year, she invests the accumulated savings ($1,095) in a brokerage account
with an expected annual return of 12%.

(1) If she keeps saving in this manner, how much will she have accumulated at age 65?

PMT= 1095
N= 45
I= 12%
FV= ?

FV= ###

H. (2) If a 40-year-old investor began saving in this manner, how much would he have at age 65?

PMT= 1095
N= 25
I= 12%
FV= ?

FV= ###

H. (3) How much would the 40-year-old investor have to save each year to accumulate the same amount at 65 as t

PMT= ?
N= 25
I= 12%
FV= 1487262

PMT= ###

I. What is the present value of the following uneven cash flow stream? The annual interest rate is 10%.

0 10% 1 2 3

100 300 300

1 90.90909
2 247.9339
 3 225.3944
4 -34.15067
530.0867

J. (1) Will the future value be larger or smaller if we compound an initial amount more often than annually,
for example, semiannually, holding the stated (nominal) rate constant? Why?

Answer
Accounts that pay interest more frequently than once a year,
for example, semiannually, quarterly, or daily, have future values that are higher
because interest is earned on interest more often.

J. (2) Define (a) the stated, or quoted, or nominal, rate,

Answer The quoted, or nominal, rate is merely the quoted percentage rate of return.

(b) the periodic rate,

Answer The periodic rate is the rate charged by a lender or paid by a borrower each period.

(c) the effective annual rate (EAR or EFF%).

Answer The effective annual rate (EAR) is the rate of interest that would provide an identical future dollar value un

J. (3) What is the EAR corresponding to a nominal rate of 10% compounded semiannually? Compounded quarter

Answer
10% compounded semiannually

EAR = (1+(0.10/2))^2-1
0.1025
10.25 %

10% Compounded quarterly

EAR = (1+(0.10/4))^4-1
0.1038129
10.381289 %

10% Compounded daily

EAR = (1+(0.10/360))^360-1
0.1051556
10.515557
J. (4) What is the future value of $100 after 3 years under 10% semiannual compounding? Quarterly compoundin

Answer 10% semiannual compounding

PV= 100
N= 3
I= 10%
M= 2

FV= 100(1+(.01/2))^(2*3)
FV= 134.00956

10% Quarterly compounding

PV= 100
N= 3
I= 10%
M= 4

FV= 100(1+(.01/4))^(4*3)
FV= 134.48888

K. When will the EAR equal the nominal (quoted) rate?

Answer If annual compounding is used, then the nominal rate will be equal to the effective annual rate.

L. (1) What is the value at the end of Year 3 of the following cash flow stream if interest is 10%, compounded sem

0 2 4 6

0 100 100 100

Answer
0 5% 2 4 6

0 100 100 100 0

110.25 2
121.5506 4
331.8006

L. (2) What is the PV?

0 5% 2 4 6

100 100 100

2 90.70295
 4 82.27025
6 74.62154
247.5947

L. (3) What would be wrong with your answer to parts L(1) and L(2) if you used the nominal rate, 10%,
rather than the EAR or the periodic rate, INOM/2 = 10%/2 = 5% to solve them?

M. (1) Construct an amortization schedule for a $1,000, 10% annual interest loan with 3 equal installments.
(2) What is the annual interest expense for the borrower, and the annual interest income for the lender, during Y

Loan Amount= 1000

I= 10%
N= 3
PMT= ?

PMT= 402.1148

Period Beginning Balance Payment Interest Principa Ending Balance

1 1000 402.1148 100 302.1148 697.885196374623
2 697.885196374623 402.1148 69.78852 332.3263 365.558912386708
3 365.558912386708 402.1148 36.55589 365.5589 0
f money analysis

n ordinary annuity

mpounding?
 it take sales to double?

What type of annuity

erest rate is 10%?
4 5

100 100

8 9 10

100 100 100

8 9 10 11 12 13 14 15 16 17

100 100 100 100 100 100 100 100 100 100
he places $3 in a drawer.
rokerage account

ave at age 65?

late the same amount at 65 as the 20-year-old investor?

nual interest rate is 10%.

-50
more often than annually,

identical future dollar value under annual compounding.

annually? Compounded quarterly? Compounded daily?

unding? Quarterly compounding?

fective annual rate.

nterest is 10%, compounded semiannually?

he nominal rate, 10%,

ith 3 equal installments.

income for the lender, during Year 2?

Aproximately = 0
18 19 20 21 22 23 24 25

100 100 100 100 100 100 100 100