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Exam 4: Time Value of Money

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Question 1

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Your Aunt Elsa has $500,000 invested at 6.5%, and she plans to retire. She wants to withdraw $40,000 at the beginning of each year, starting immediately. What is the maximum number of whole payments that can be withdrawn before the account is exhausted, i.e., before the account balance would become negative? (Hint: Round down to the nearest whole number.)

A) 18
B) 19
C) 20
D) 21
E) 22

F) A) and D)
G) C) and D)

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Question 2

Multiple Choice

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Scott and Linda have been saving to pay for their daughter Casie's college education. Casie just turned 10 at (t = 0) , and she will be entering college 8 years from now (at t = 8) . College tuition and expenses at State U. are currently $14,500 a year, but they are expected to increase at a rate of 3.5% a year. Ellen should graduate in 4 years⎯if she takes longer or wants to go to graduate school, she will be on her own. Tuition and other costs will be due at the beginning of each school year (at t = 8, 9, 10, and 11) . So far, Scott and Linda have accumulated $15,000 in their college savings account (at t = 0) . Their long-run financial plan is to add an additional $5,000 in each of the next 4 years (at t = 1, 2, 3, and 4) . Then they plan to make 3 equal annual contributions in each of the following years, t = 5, 6, and 7. They expect their investment account to earn 9%. How large must the annual payments at t = 5, 6, and 7 be to cover Casie's anticipated college costs?

A) $1,965.21
B) $2,068.64
C) $2,177.51
D) $2,292.12
E) $2,412.76

F) A) and E)
G) A) and B)

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Question 3

Multiple Choice

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On January 1, 2016, your sister's pet supplies business obtained a 30-year amortized mortgage loan for $250,000 at a nominal annual rate of 7.0%, with 360 end-of-month payments. The firm can deduct the interest paid for tax purposes. What will the interest tax deduction be for 2016?

Billy Thornton borrowed $20,000 at a rate of 7.25%, simple interest, with interest paid at the end of each month. The bank uses a 360-day year. How much interest would Billy have to pay in a 30-day month?

A "growing annuity" is a cash flow stream that grows at a constant rate for a specified number of periods.

All other things held constant, the present value of a given annual annuity decreases as the number of periods per year increases.

Midway through the life of an amortized loan, the percentage of the payment that represents interest could be equal to, less than, or greater than to the percentage that represents repayment of principal. The proportions depend on the original life of the loan and the interest rate.

Your business has just taken out a 1-year installment loan for $72,500 at a nominal rate of 11.0% but with equal end-of-month payments. What percentage of the 2nd monthly payment will go toward the repayment of principal?

You are considering investing in a bank account that pays a nominal annual rate of 7%, compounded monthly. If you invest $3,000 at the end of each month, how many months will it take for your account to grow to $150,000?

You plan to invest some money in a bank account. Which of the following banks provides you with the highest effective rate of interest?

Suppose a Google.com bond will pay $4,500 ten years from now. If the going interest rate on safe 10-year bonds is 4.25%, how much is the bond worth today?

Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?

How much would $20,000 due in 50 years be worth today if the discount rate were 7.5%?

Suppose you just won the state lottery, and you have a choice between receiving $2,550,000 today or a 20-year annuity of $250,000, with the first payment coming one year from today. What rate of return is built into the annuity? Disregard taxes.

You were left $100,000 in a trust fund set up by your grandfather. The fund pays 6.5% interest. You must spend the money on your college education, and you must withdraw the money in 4 equal installments, beginning immediately. How much could you withdraw today and at the beginning of each of the next 3 years and end up with zero in the account?

Your aunt wants to retire and has $375,000. She expects to live for another 25 years, and she also expects to earn 7.5% on her invested funds. How much could she withdraw at the beginning of each of the next 25 years and end up with zero in the account?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the nominal rate on the deposit (or loan).

Your investment account pays 8.0%, compounded annually. If you invest $5,000 today, how many years will it take for your investment to grow to $9,140.20?