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Time Value of Money

1. John Smith has received a \$1,000,000 gift from his grandmother. Below are two alternatives for investment. Calculate the current value of each. Which investment should John choose and why?

A. Invest in a one year government security yielding 5%.
B. Invest in real estate with some risk. John has found a piece of property for \$1,000,000 that is forecasted to be worth \$1,100,000 after one year.

2. Tom Jones is 65 years of age and has a life expectancy of 12 more years. He wishes to invest \$20,000 in an annuity that will make a level payment at the end of each year until his death. If the interest rate is 8%, what income can Mr. Jones expect to receive each year?

3. Evaluate the three investment opportunities for bonus of \$1,000 you just received. Find the values at 1 year, 5 years, and 20 years. Indicate which opportunity is the best for each of time periods.

A. An account paying 12% interest compounded annually.
B. An account paying 11% interest compounded semi-annually.
C. An investment that will pay you 14% annual interest only at the end of the investment period. of 1 year, 5 years, or 20 years.

Solution Preview

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1. John Smith has received a \$1,000,000 gift from his grandmother. Below are two alternatives for investment. Calculate the current value of each. Which investment should John choose and why?
A. Invest in a one year government security yielding 5%.
Return= 5%

B. Invest in real estate with some risk. John has found a piece of property for \$1,000,000 that is forecasted to be worth \$1,100,000 after one year.

Return= 10% = (\$1,100,000 / \$1,000,000)-1

John can choose either of the two investments depending on his risk tolerance.
If he wants a less risky investment, he can choose a government security that has a lower return.
If he can tolerate risk, he can choose real estate. He will be rewarded by a higher return (10%) for taking this risky investment.

2. Tom Jones is 65 years of age and has ...

Solution Summary

Evaluates investments and calculates the value of annuity.

\$2.19