FIN_305W_-_Practice_Problems - Practice Problems: Annuities...

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Lukas Roth FIN 305W Practice Problems: Annuities and Perpetuities Problem #1 In 21 years you want to receive $25,000 income annually to perpetuity. What equal annual deposits are required to guarantee that income if you start in one year and make your last payment in 20 years. The interest rate is 10%. Problem #2 You have been offered the life insurance policy “Oh, what a deal.” As part of that policy, you invest $100,000 today and are promised $500,000 in 20 years. Carefully answer the following questions. A. What average annual rate of return is the policy promising? Assume annual compounding. B. Suppose the insurance company can invest your money at 10%. What equal annual fee can it pay itself from the difference between 10% and the rate it is implicitly promising? Problem #3 Suppose the Township of State College wants to subsidize firms that agree to locate here. It is thinking of various alternatives. Assume the annual market rate of interest is 8%. Carefully answer the following questions. A. To induce firms to commit to the local economy, it could give them three equal lump sums of $100,000 every year starting in three years. What would be the current value of the associated subsidy? B. It could give them a five-year, interest-free $2,000,000 loan . What would be the current value of this subsidy? C. It could give them a lump-sum perpetuity of $20,000 starting at the end of year five. What would be the current value of this subsidy? Problem #4 You just turned 40 and will retire at the end of 65. It is therefore time to start planning for your retirement. Based on statistical information you expect to live until the end of 85. You are asking yourself a number of questions, listed in what follows. Carefully answer them by assuming a annual interest rate of 4% (annual compounding). A. Suppose you need an annual income of $100,000 to maintain your life standard. How much money do you have to set aside every year to be able to pay yourself $100,000 per year when you retire? Assume your first contribution is in one year, and the last one at the end of your 65th year (i.e., at the beginning of year 66). Moreover, assume you receive your first payment at the end of year 66 (one year after the last contribution), and the last one at the end of year 85.
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2 B. You want to leave some money to your heirs that they will have a good reason to remember you. How does the answer to (A) change if, in addition to the annual $100,000, you also want a lump sum of $500,000 at the end of 85? C. You anticipate an annual inflation rate of 2% during your retirement years. How does your answer to (B) change if you want the annual payments to grow with inflation? The first payment equals $100,000. Problem #5 Barry and Gary have an Uncle Larry. When Barry was born, Uncle Larry gave him 100 shares of stock in GTX Corp, the price of the stock was $10.00/share, and it has returned 8% annually. Uncle Larry has been giving Gary $100 a year since birth, which he has invested at 6% a year. Barry and Gary are now both 30 years old, and neither of them has saved any other money. Carefully answer the following questions.
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This note was uploaded on 04/06/2010 for the course FIN 305W at Pennsylvania State University, University Park.

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FIN_305W_-_Practice_Problems - Practice Problems: Annuities...

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