Chapter 4.docx - Chapter 4 Questions and Problems...

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Chapter 4 - Questions and Problems BASIC (Questions 1−20) 1 Simple Interest versus Compound Interest First City Bank pays 7.5 percent simple interest on its savings account balances, whereas Second City Bank pays 7.5 percent interest compounded annually. If you made a $7,000 deposit in each bank, how much more money would you earn from your Second City Bank account at the end of 10 years? Page 124 1 Calculating Future Values Compute the future value of $1,000 compounded annually for a 10 years at 6 percent. a 10 years at 12 percent. a 20 years at 6 percent. a Why is the interest earned in part (c) not twice the amount earned in part (a)? 1 Calculating Present Values For each of the following, compute the present value: Present Value Years Interest Rate Future Value 8 7% $ 13,827 13 15 43,852 17 11 725,380 26 18 590,710 1 Calculating Interest Rates Solve for the unknown interest rate in each of the following: Present Value Years Interest Rate Future Value $ 242 4 $ 345 410 8 927 51,700 16 152,184 18,750 27 538,600 1 Calculating the Number of Periods Solve for the unknown number of years in each of the following: Present Value Years Interest Rate Future Value $ 625 7% $ 1,284 810 12 4,341 16,500 17 402,662
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21,500 8 147,350 1 Calculating the Number of Periods At 6.5 percent interest, how long does it take to double your money? To quadruple it? 1 Calculating Present Values Imprudential, Inc., has an unfunded pension liability of $550 million that must be paid in 20 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 6.4 percent, what is the present value of this liability? 1 Calculating Rates of Return Although appealing to more refined tastes, art as a collectible has not always performed so profitably. During 2010, Deutscher-Menzies sold Arkie under the Shower, a painting by renowned Australian painter Brett Whiteley, at auction for a price of $1,100,000. Unfortunately for the previous owner, he had purchased it three years earlier at a price of $1,680,000. What was his annual rate of return on this painting? 1 Perpetuities An investor purchasing a British consol is entitled to receive annual payments from the British government forever. What is the price of a consol that pays $125 annually if the next payment occurs one year from today? The market interest rate is 3.9 percent. Page 125 1 Continuous Compounding Compute the future value of $1,900 continuously compounded for a 9 years at an APR of 12 percent. a 5 years at an APR of 8 percent. a 17 years at an APR of 5 percent. a 10 years at an APR of 9 percent. 1 Present Value and Multiple Cash Flows Wilkinson Co. has identified an investment project with the following cash flows. If the discount rate is 10 percent, what is the present value of these cash flows? What is the present value at 18 percent? At 24 percent? Year Cash Flow 1 $ 675 2 880 3 985 4 1,530 1 Present Value and Multiple Cash Flows Investment X offers to pay you $3,900 per year for nine years, whereas Investment Y offers to pay you $6,100 per year for five years. Which of these
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cash flow streams has the higher present value if the discount rate is 5 percent? If the discount rate is 22 percent?
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