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    Calculating Present and Future Value of Annuities

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    5-1 How long will it take $ 200 to double if it earns the following rates? Compounding occurs once a year.

    5-2 Find the present values of these ordinary annuities. Discounting occurs once a year.
    a. $ 400 per year for 10 years at 10%
    b. $ 200 per year for 5 years at 5%
    c. $ 400 per year for 5 years at 0%
    d. Rework Parts a, b, and c assuming they are annuities due.

    5-3 PRESENT VALUE OF A PERPETUITY
    What is the present value of a $ 100 perpetuity if the interest rate is 7%? If interest rates doubled to 14%, what would its present value be?

    5-4 EFFECTIVE INTEREST RATE
    You borrow $ 85,000; the annual loan payments are $ 8,273.59 for 30 years. What interest rate are you being charged?

    5-5 Your client is 40 years old; and she wants to begin saving for retirement, with the first payment to come one year from now. She can save $ 5,000 per year; and you advise her to invest it in the stock market, which you expect to provide an average return of 9% in the future.
    a. If she follows your advice, how much money will she have at 65?
    b. How much will she have at 70?
    c. She expects to live for 20 years if she retires at 65 and for 15 years if she retires at 70. If her investments continue to earn the same rate, how much will she be able to withdraw at the end of each year after retirement at each retirement age?

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    Solutions

    5-1 How long will it take $ 200 to double if it earns the following rates? Compounding occurs once a year.

    No interest rate is given, let us assume interest rates as 5%, 10%

    Case 1, i=5%
    Future Value =FV=$400
    Present Value=PV=$200
    We know that
    FV=PV*(1+i)^n
    400=200*(1+5%)^n
    400/200=1.05^n
    2=1.05^n
    Taking ln (natural log) both sides
    ln(2)=n*ln(1.05)
    n=ln(2)/ln(1.05)=14.21 years

    Case 2, i=10%
    Future Value =FV=$400
    Present Value=PV=$200
    We know that
    FV=PV*(1+i)^n
    400=200*(1+10%)^n
    400/200=1.10^n
    2=1.10^n
    Taking ln (natural log) both sides
    ln(2)=n*ln(1.10)
    n=ln(2)/ln(1.10)=7.27 years
    Similarly we can find period for any rate of interest.

    5-2 Find the present values of these ordinary annuities. Discounting occurs once a year.

    a. $ 400 per year for 10 years at 10%
    Annual payments=R=$400
    Interest rate=i=10%
    Number of payments=n=10
    PV of ordinary annuity=R*((1-1/(1+i)^n)/i)
    =400*((1-1/(1+10%)^10)/10%)
    =$2457.83

    b. $ 200 per year for 5 years at 5%
    Annual payments=R=$200
    Interest rate=i=5%
    Number of payments=n=5
    PV of ordinary annuity=R*((1-1/(1+i)^n)/i)
    =200*((1-1/(1+5%)^5)/5%)
    ...

    Solution Summary

    There are 5 problems. Solutions to these problems explain the methodology to calculate PV & FV of annuities and rate of interest.

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