Section__1_Time_Value_Solutions

Section__1_Time_Value_Solutions - Section #1 Solutions Time...

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Section #1 Solutions Time Value Exercises September 3rd, 2008 Copyright 2008 by Rich Curtis
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1. Michelle and “The Time Value of Money” a. After agents’ fees and taxes, Michelle will have $5.28 M: $10 M - Agent's Fees - Tax = $10 M - .04($10 M) - .45(Taxable Income) = $10 M - .04($10 M) - .45($10 M - .04($10 M)) = [$10 M - .04($10 M)] [1-.45] = [$10 M] [1-.04] [1-.45] = $5.28 M
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If Michelle can invest to earn 5.5% annually after-tax for 25 years, the $5.28 million will become $20.13 million: FV = PV1+r N = $5.28 M 1.055 25 = ($5.28 M) (3.81339) = $20.1347 M Is this consistent with the Rule of 72? 72 5.5 = 13.09 Note :
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b. If we consider the cash flows at times 0, 1, 2, 3, and 4, her total Time 25 future value could be calculated as follows: $5.28 M (1.055) 25 + $5.28 M (1.055) 24 + $5.28 M (1.055) 23 + $5.28 M (1.055) 22 + $5.28 M (1.055) 21 = $90.710 M
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Time 0 1 2 3 4 25 $5.28 M $5.28 M $5.28 M $5.28 M $5.28 M
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Is there a more elegant way to get the same answer?
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One could also use the formula for the future value of an annuity to get the Time 4 value of the annuity: FV t=4 = $5.28 M 1.055 5 - 1 .055 = $29.4682 M Remember that the formula for the future value of an annuity gives you the value as of the date of the final cash flow, Time 4. Then use the formula for the future value of a single cash flow to find the Time 25 future value of the annuity: FV t=25 = $29.4682 M 1.055 21 = $90.710 M
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Time 0 1 2 3 4 25 $5.28 M $5.28 M $5.28 M $5.28 M $5.28 M (1.055) 21 29.5 M 90.7 M
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One could also a) PV the Time 0 cash flow and b) add the PV of the Time 1-4 annuity, if one was very careful: PV t=0 = $5.28 M + $5.28 M 1 - 1 1.055 ( ) 4 .055 = $23.7872 M
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Section__1_Time_Value_Solutions - Section #1 Solutions Time...

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