Chapter 4 Tutorial Questions

1. Simple Interest versus Compound Interest.   First City Bank pays 6 percent simple interest on its
savings account balances, whereas Second City Bank pays 6 percent interest compounded annually. If
you made a deposit of $7,500 in each bank, how much more money would you earn from your Second
City Bank account at the end of 10 years?

2. Calculating Future Values.   For each of the following, compute the future value:

3. Calculating Present Values.   For each of the following, compute the present value:

4. Calculating Interest Rates.   Solve for the unknown interest rate in each of the following:

5. Calculating the Number of Periods.   Solve for the unknown number of years in each of the
following:

6. Calculating Rates of Return.   Assume the total cost of a college education will be $280,000 when
your child enters college in 18 years. You presently have $45,000 to invest. What annual rate of
interest must you earn on your investment to cover the cost of your child's college education?
7. Calculating the Number of Periods.   At 5 percent interest, how long does it take to double your
money? To quadruple it?
8. Calculating Rates of Return.   In 2011, an 1880-O Morgan silver dollar sold for $13,113. What was
the rate of return on this investment?
 9. Calculating the Number of Periods.   You're trying to save to buy a new $150,000 Ferrari. You have
$35,000 today that can be invested at your bank. The bank pays 3.2 percent annual interest on its
accounts. How long will it be before you have enough to buy the car?
10. Calculating Present Values.   Imprudential, Inc., has an unfunded pension liability of $675 million
that must be paid in 25 years. To assess the value of the firm's stock, financial analysts want to discount
this liability back to the present. If the relevant discount rate is 6 percent, what is the present value of
this liability?
11. Calculating Present Values.   You have just received notification that you have won the $2 million
first prize in the Centennial Lottery. However, the prize will be awarded on your 100th birthday
(assuming you're around to collect), 80 years from now. What is the present value of your windfall if
the appropriate discount rate is 10 percent?
12. Calculating Future Values.   Your coin collection contains 50 1952 silver dollars. If your
grandparents purchased them for their face value when they were new, how much will your collection
be worth when you retire in 2058, assuming they appreciate at annual rate of 6.1 percent?
13. Calculating Growth Rates and Future Values.   In 1895, the first U.S. Open Golf Championship was
held. The winner's prize money was $150. In 2011, the winner's check was $1,440,000. What was the
annual percentage increase in the winner's check over this period? If the winner's prize increases at the
same rate, what will it be in 2045?
14. Calculating Rates of Return.   In 2011, an Action Comics No. 1, featuring the first appearance of
Superman, was sold at auction for $2,161,000. The comic book was originally sold in 1938 for $.10.
What was the annual increase in the value of this comic book?
15. Calculating Rates of Return.   In October 2011, the average house price in the United States was
$242,300. In October 2004, the average price was $289,600. What was the annual change in the
average selling price?

Answers to Tutorial Questions

1. The time line for the cash flows is:

0 10

$7,500 FV

The simple interest per year is:

$7,500 × .06 = $450

So, after 10 years, you will have:

$450 × 10 = $4,500 in interest.

The total balance will be $7,500 + 4,500 = $12,000

With compound interest, we use the future value formula:

FV = PV(1 +r)t
FV = $7,500(1.06)10 = $13,431.36

The difference is:

$13,431.36 – 12,000 = $1,431.36

2. To find the FV of a lump sum, we use:

 FV = PV(1 + r)t

0 6

$3,150 FV

FV = $3,150(1.13)6 = $6,558.15

0 19

$8,453 FV

FV = $8,453(1.07)19 = $30,570.51

0 13

$89,305 FV

FV = $89,305(1.09)13 = $273,791.68

0 21

$227,382 FV

FV = $227,382(1.05)21 = $633,477.75

3. To find the PV of a lump sum, we use:

PV = FV / (1 + r)t

0 15

PV $17,328

PV = $17,328 / (1.04)15 = $9,621.62

0 8

PV $41,517

PV = $41,517 / (1.09)8 = $20,835.98

0 13

PV $790,382

PV = $790,382 / (1.12)13 = $181,135.15

0 25

PV $647,816

PV = $647,816 / (1.11)25 = $47,684.50

4. To answer this question, we can use either the FV or the PV formula. Both will give the same
answer since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV / PV)1 / t – 1

0 9

–$715 $1,381

FV = $1,381 = $715(1 + r)9

r = ($1,381 / $715)1/9 – 1
r = .0759, or 7.59%

0 6

–$905 $1,718

FV = $1,718 = $905(1 + r)6

r = ($1,718 / $905)1/6 – 1
r = .1127, or 11.27%

0 21

–$15,000 $141,832

FV = $141,832 = $15,000(1 + r)21

r = ($141,832 / $15,000)1/21 – 1
r = .1129, or 11.29%

0 18

–$70,300 $312,815

FV = $312,815 = $70,300(1 + r)18

r = ($312,815 / $70,300)1/18 – 1
r = .0865, or 8.65%

5. To answer this question, we can use either the FV or the PV formula. Both will give the same
answer since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for t, we get:

t = ln(FV / PV) / ln(1 + r)

0 t

–$195 $1,105

FV = $1,105 = $195 (1.09)t

 t = ln($1,105 / $195) / ln 1.09
t = 20.13 years

0 t

–$2,105 $3,700

FV = $3,700 = $2,105(1.07)t
t = ln($3,700 / $2,105) / ln 1.07
t = 8.34 years

0 t

–$47,800 $387,120

FV = $387,120 = $47,800(1.12)t
t = ln($387,120 / $47,800) / ln 1.12
t = 18.46 years

0 t

–$38,650 $198,21
2

FV = $198,212 = $38,650(1.19)t
t = ln($198,212 / $38,650) / ln 1.19
t = 9.40 years

6. The time line is:

0 18

–$45,000 $280,000

To answer this question, we can use either the FV or the PV formula. Both will give the same
answer since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV / PV)1 / t – 1
r = ($280,000 / $45,000)1/18 – 1
r = .1069, or 10.69%

7. To find the length of time for money to double, triple, etc., the present value and future value are
irrelevant as long as the future value is twice the present value for doubling, three times as large
for tripling, etc. To answer this question, we can use either the FV or the PV formula. Both will
give the same answer since they are the inverse of each other. We will use the FV formula, that
is:

FV = PV(1 + r)t

Solving for t, we get:

 t = ln(FV / PV) / ln(1 + r)

The length of time to double your money is:

0 t

–$1 $2

FV = $2 = $1(1.05)t
t = ln 2 / ln 1.05
t = 14.21 years

The length of time to quadruple your money is:

0 t

–$1 $4

FV = $4 = $1(1.05)t
t = ln 4 / ln 1.05
t = 28.41 years

Notice that the length of time to quadruple your money is twice as long as the time needed to
double your money (the slight difference in these answers is due to rounding). This is an
important concept of time value of money.

8. The time line is:

0 131

–$1 $13,113

To answer this question, we can use either the FV or the PV formula. Both will give the same
answer since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV / PV)1 / t – 1
r = ($13,113 / $1)1/131 – 1
r = .0751, or 7.51%

9. The time line is:

0 t

–$35,000 $150,000

To answer this question, we can use either the FV or the PV formula. Both will give the same
answer since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for t, we get:

 t = ln(FV / PV) / ln(1 + r)

FV = $150,000 = $35,000(1.032)t
t = ln($150,000 / $35,000) / ln 1.032
t = 46.20 years

10. The time line is:

0 25

PV $675,000,000

To find the PV of a lump sum, we use:

PV = FV / (1 + r)t
PV = $675,000,000 / (1.06)25
PV = $157,274,075.59

11. The time line is:

0 80

PV $2,000,000

To find the PV of a lump sum, we use:

PV = FV / (1 + r)t
PV = $2,000,000 / (1.10)80
PV = $976.37

12. The time line is:

0 106

50 FV

To find the FV of a lump sum, we use:

FV = PV(1 + r)t
FV = $50(1.061)106
FV = $26,595.04

13. The time line is:

0 116

$150 $1,440,000

To answer this question, we can use either the FV or the PV formula. Both will give the same
answer since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV / PV)1 / t – 1
 r = ($1,440,000 / $150)1/116 – 1
r = .0823, or 8.23%

To find the FV of the first prize in 2045, we use:

0 34

$1,440,000 FV

FV = PV(1 + r)t
FV = $1,440,000(1.0823)34
FV = $21,163,131.11

14. The time line is:

0 73

–$.10 $2,161,000

To answer this question, we can use either the FV or the PV formula. Both will give the same
answer since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV / PV)1 / t – 1
r = ($2,161,000 / $.10)1/73 – 1
r = .2603, or 26.03%

15. The time line is:

0 7

–$289,600 $242,300

To answer this question, we can use either the FV or the PV formula. Both will give the same
answer since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV / PV)1 / t – 1
r = ($242,300 / $289,600)1/7 – 1
r = –.0252, or –2.52%