Chapter 5:

Warm-up questions 2.1

E5-1

Assume a firm makes a $2,500 deposit into its money market account. If this account is currently paying 0.7% (yes, that’s right, less than 1%!) , what will the account balance be after 1 year?

E5-2

If Bob and Judy combine their savings of $1,260 and $975, respectively, and deposit this amount into an account that pays 2% annual interest, compounded monthly , what will the account balance be after 4 years?

E5-3

Gabrielle just won $2.5 million in the state lottery. She is given the option of receiving a total of $1.3 million now, or she can elect to be paid $100,000 at the end of each of the next 25 years. If Gabrielle can earn 5% annually on her investments, from a strict economic point view which option should she take?

E5-4

Your firm has the option of making an investment in new software that will cost $130,000 today and is estimated to provide the savings shown in the following table over its 5-year life:

Year----------------Savings estimate

1---------------------$35,000

2---------------------$50,000

3---------------------$45,000

4---------------------$25,000

5---------------------$15,000

Should the firm make this investment if it requires a minimum annual return of 9% on all investments?

E5-5

Joseph is a friend of yours. He has plenty of money but little financial sense. He received a gift of $12,000 for his recent graduation and looking for a bank in which to deposit the funds. Partners’ Saving Bank offers an account with an annual interest rate of 3% compounded semiannually, while Selwyn’s offers an account with a 2.75% annually interest rate compounded continuously. Calculate the value of the two accounts at the end of one year, and recommend to Joseph which account he should choose.

E5-6

Jack and Jill have just had their first child. If college is expected to cost $150,000 per year in 18 years, how much should the couple begin depositing annually at the end of each year to accumulate enough funds to pay the first year’s tuition at the beginning of the 19th year? Assume that they can earn a 6% annual rate of return on their investment.

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