TIME VALUE OF MONEY
Please show all work, or inputs on the financial or graphing calculator, to receive credit for your answers. No credit will be given for answers without calculations or inputs. You must include a timeline with each problem
1. You would like to buy a house, and have researched the mortgage market. Your maximum monthly payment, which will be made at the beginning of each month, is $1,900. The mortgage you will apply for is a 25-year, 6.25% loan with monthly compounding. You will put down a 20% deposit.
a. (10 pts.) What is the total amount you can borrow on this mortgage?
b. (5 pts.) What is the total value of the house you can buy?
c. (10 pts.) You will buy your house in four years, and you will make a payment to your savings account at the end of each of the four years. Your funds are deposited in a savings account earning 5.5% compounded annually.
2. The U.S. Treasury guarantees that EE Savings Bond will double in value in 20 years.
a. (7 pts.) What is the minimum interest rate you will earn on the bond? Interest compounds semiannually.
b. (6 pts.) What is the effective interest rate on the bond if the bond
c. (7 pts.) If the bond were paying 4.75% interest compounded semiannually, how many years would it take for the bond to double in value?
3. You are leaving the company you work for and have to choose the following options: You can accept a lump sum distribution of $500,000, or begin drawing a pension of $4,000 per month at the beginning of each month.
a. (10 pts.) If your life expectancy is 30 years, and you would expect to earn an 8% return on your investments, compounded monthly, which option should you choose?
b. (10 pts.) If you only live 20 years, did you make the right decision?
4. You are saving for retirement, and you have decided that every year when you receive your year-end bonus on December 31, you will deposit $3,500 in an IRA. These funds will be invested in a junk bond fund that earns 12% and compounds quarterly.
a. (10 pts.) If you retire in 33 years, how much will you have accumulated in your IRA?
b. (10 pts.) If you had invested the funds at the beginning of each year, how much would your IRA be worth at retirement?
5. (15 pts.) Your friend has offered you a chance to become an investor in her startup company. If you invest $20,000 today in her new business, she will pay you nothing for two years, then $5,000 in year 3, $5,500 in year 4, $6,000 in year 5, and a payment of $7,000 in each of the years 6 to 9 (four $7000 payments total.) All payments will be made at the end of the year. You believe in your friend's sincerity, but know that the odds against a new company succeeding are great. You would require a 20% return to accept this proposition. Does your friend get the money?
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