Practice

Practice Problems set 1
i. A companys 2005 sales were $100 million. If sales grow at 8% per year, how large will they be 10 yea
rs later, in 2015, in millions?
ii. Suppose a U.S. government bond will pay $1,000 three years from now. If the going interest rate on 3
year government bonds is 4%, how much is the bond worth today?
iii. The U.S. Treasury offers to sell you a bond for $613.81. No payments will be made until the bond m
atures 10 years from now, at which time it will be redeemed for $1,000. What interest rate would y
ou earn if you bought this bond at the offer price?
iv. Addico Corp's 2005 earnings per share were $2, and its growth rate during the prior 5 years was 11.0
% per year. If that growth rate were maintained, how long would it take for Addicos EPS to double?
v. You have a chance to buy an annuity that pays $1,000 at the end of each year for 5 years. You could
earn 6% on your money in other investments with equal risk. What is the most you should pay for t
he annuity?
vi. Suppose you inherited $200,000 and invested it at 6% per year. How much could you withdraw at t
he end of each of the next 15 years?
vii. You are buying your first house for $220,000, and are paying $30,000 as a down payment. You have
arranged to finance the remaining $190,000 30- year mortgage with a 7% nominal interest rate and
monthly payments. What are the equal monthly payments you must make?
viii. Whats the present value of a perpetuity that pays $100 per year if the appropriate interest rate is
6%?
ix. Whats the rate of return you would earn if you paid $1,500 for a perpetuity that pays $105 per year?
x. At a rate of 8%, what is the present value of the following cash flow stream? $0 at Time 0; $100 at the
end of Year 1; $300 at the end of Year 2; $0 at the end of Year 3; and $500 at the end of Year 4?
ANSWERS
i. $215.89
ii. $889.00
iii. 5.00%
iv. 6.64
v. $4,212.36
vi. $20,592.55
vii. $1,264
viii. $1,666.67
ix. 7.00%
x. $717.31

1) Jim makes a deposit of $12,000 in a bank account. The deposit is to earn interest annually at the rate
of 9 percent for seven years.
a) How much will Jim have on deposit at the end of seven years?
FV = $21,936.47
b) Assuming the deposit earned a 9 percent rate of interest compounded quarterly, how much would he
have at the end of seven years?
FV = $22,374.54
c) In comparing parts (a) and (b), what are the respective effective annual yields? Which alternative is
better?
EARA = 9%.
EARB = 9.31%.
2) John is considering the purchase of a lot. He can buy the lot today and expects the price to rise to
$15,000 at the end of 10 years. He believes that he should earn an investment yield of 10 percent annually
on this investment. The asking price for the lot is $7,000. Should he buy it? What is the annual yield
(internal rate of return) of the investment if John purchases the property for $7,000 and is able to sell it
10 years later for $15,000?
PV = $5,783.15.
3) An investor can make an investment in a real estate development and receive an expected cash return
of $45,000 after six years. Based on a careful study of other investment alternatives, she believes that an
18 percent annual return compounded quarterly is a reasonable return to earn on this investment. How
much should she pay for it today?
PV = $15,646.66.
4) Suppose you have the opportunity to make an investment in a real estate venture that expects to pay
investors $750 at the end of each month for the next eight years. You believe that a reasonable return
on your investment should be 17 percent compounded monthly.
a) How much should you pay for the investment?
$39,222.96.
b) What will be the total sum of cash you will receive over the next eight years?
$72,000.
5) Walt is evaluating an investment that will provide the following returns at the end of each of the
following years: year 1, $12,500; year 2, $10,000; year 3, $7,500; year 4, $5,000; year 5, $2,500; year 6,
$0; and year 7, $12,500. Walt believes that he should earn an annual rate of 9 percent on this investment.
How much should he pay for this investment?
NPV = $37,681.
6) A loan of $50,000 is due 10 years from today. The borrower wants to make annual payments at the
end of each year into a sinking fund that will earn interest at an annual rate of 10 percent. What will the
annual payments have to be? Suppose that the borrower will make monthly payments that earn 10
percent interest, compounded monthly. How much will he pay annually into the fund?
With annual compounding: PMT = $3,137.27.
With monthly compounding: PMT = 244.09. The total annual payment will be $2,929.04.
7) The Dallas Development Corporation is considering the purchase of an apartment project for $100,000.
They estimate that they will receive $15,000 at the end of each year for the next 10 years. At the end of
the 10th year, the apartment project will be worth nothing. If Dallas purchases the project, what will be
its internal rate of return? If the company insists on a 9 percent return compounded annually on its
investment, is this a good investment?
PV = $96,264.87.
IRR = 8.14%.
8) Suppose you deposit $5,000 into an account earning 4 percent interest, compounded monthly.
a) How many years will it take for your account to be worth $7,500?
N = 121.84, or 10.15 years.
b) Suppose in addition to the initial $5,000 deposit, you will make monthly contributions of $50. How
many years will it take for the account to grow to $7,500 in this case?
N = 35.39 or 2.95 years.
c) How does your answer change if you make quarterly deposits of $150 rather than monthly
contributions of $50? Explain the reason for any difference in your answer from part b. Maintain the
assumption that interest compounds monthly.
N = 11.83 or 2.96 years.
9) Consider an investment that will pay $680 per month for the next 15 years and will be worth $28,000
at the end of that time. How much is this investment worth to you today at a 5.25 percent discount rate?
PV = 97,351.34.
10) You currently owe $18,000 on a car loan at 9.5 percent interest. If you make monthly payments of
$576.59 per month, how long will it take you to fully repay the loan?
N = 36
11) You have just borrowed $10,000 and will be required to make monthly payments of $227.53 for the
next five years in order to fully repay the loan. What is the implicit interest rate on this loan?
I = 13%
12) Your uncle has given you a bond that will pay $500 at the end of each year forever into the future. If
the market yield on this bond is 8.25 percent, how much is it worth today?
PV = 6,060.61.
13) Suppose you have an investment that is expected to generate a $20,000 cash flow next year and that
this is expected to increase by 5 percent per year forever into the future.
a) If your required rate of return on this investment is 18 percent, how much is it worth to you today?
15 . 846 , 15
b) Suppose now that you do not know how fast the cash flows will grow in the future, but that you expect
them to grow at a constant rate. Suppose also that this investment is currently priced at $200,000. If the
required rate of return is still 18 percent, how fast does the market expect the annual cash flows to grow?
g=8%
14) You are considering the purchase of an investment that is expected to generate cash flows of $15,000
per year for the next five years. After that, cash flows are expected in increase at the rate of 5 percent
per year for the indefinite future. Thus, in year 6 the cash flow will be $15,750, etc. How much is this
investment worth to you today if your required return is 15 percent?
PV = 128,587.66.

1. What is the future value of $3,500 deposited for 12 years at 5 percent interest, compounded annually?
A. $6,285.50
B. $3,679.07
C. $55,709.94
D. $6,369.47
2. What is the internal rate of return on an investment that costs $2,000 and returns $32 per month for
the next 15 years?
A. The IRR cannot be calculated for this investment
B. 1.48%
C. 17.86%
D. 14.13%
3. What is the internal rate of return of an investment with the following cash flows?
n
(1,000)
300
300
300
200
100

B. 10.00%
C. 15.23%
D. 7.48%
4. If your discount rate is 12%, what is the NPV of the investment from the last question?
A. $0.00
B. ($55.25)
C. $200.00
D. ($95.60)
5. How much should you pay for an investment that pays $1,500 per year for the next three years and
then $2,000 per year for the following two years? Assume a discount rate of 15% per year?
A. $8,500.00
B. $5,562.70
C. $6,338.15
D. $10,000.00
6. Consider an eight-year investment costing $55,000. It is expected to pay $3,000 per year in each of
the next five years and $15,000 per year in the last three years. If the required discount rate is 12 percent,
what is the net present value of this investment?
A. $86,257.28
B. ($23,742.72)
C. $5,000
D. $60,000.00
7. What is the internal rate of return of the investment in the last question?
B. 1.47%
C. 14.7%
D. 12.0%
8. What is the annual debt service on a $1.2 million 30-year mortgage at 6.75%
interest with monthly payments?
A. $40,518
B. $7,783
C. $94,286.59
D. $93,398

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Practice Problems set 1

Practice Problems set 2

Practice Problems set 3

A. The IRR cannot be calculated for this investment

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