Solutions to Present Value Problems

Present Value: Solutions Problem 1 a. Current Savings Needed = $ 500,000/1.110 = b. Annuity Needed = $ 500,000 (APV,10%,10 years) = $ $ 192,772 31,373 Problem 2 Present Value of $ 1,500 growing at 5% a year for next 15 years = Future Value = $ 18093 (1.08^15) = $ $ 18,093 57,394 Problem 3 Annual Percentage Rate = 8% Monthly Rate = 8%/12 = 0.67% Monthly Payment needed for 30 years = $ 200,000(APV,0.67%,360) = $ 1,473 Problem 4 a. Discounted Price Deal Monthly Cost of borrowing $ 18,000 at 9% APR = [A monthly rate of 0.75% is used] b. Special Financing Deal Monthly Cost of borrowing $ 20,000 at 3% APR = The second deal is the better one. $ 373.65 $ 359.37 17.98245614 Problem 5 a. Year-end Annuity Needed to have $ 100 million available in 10 years= [FV = $ 100, r = 9%, n = 10 years] b. Year-beginning Annuity Needed to have $ 100 million in 10 years = Problem 6 Value of 15-year corporate bond; 9% coupon rate; 8 % market interest rate Assuming coupons are paid semi-annually, Value of Bond = 45*(1-1.04^(-30))/.04+1000/1.04^30 = If market interest rates increase to 10%, Value of Bond = 45*(1-1.05^(-30))/.05+1000/1.05^30 = The bonds will trade at par only if the market interest rate = coupon rate. Problem 7 Value of Stock = 1.50 (1.06)/ (.13 - .06) = $ $ 6.58 $ 6.04 $ 1,086.46 $ 923.14 22.71 Problem 8 Value of Dividends during high growth period = $ 1.00 (1.15)(1-1.15^5/1.125^5)/(.125-.15) $ 5.34 $ Expected Dividends in year 6 = $ 1.00 (1.15)^5*1.06*2 = 4.26 Expected Terminal Price = $ 4.26/(.125-.06) = $ 65.54 Value of Stock = $ 5.34 + $ 65.54/1.125^5 = $ 41.70 Problem 9 Expected Rate of Return = (1000/300)^(1/10) - 1 = 12.79% Problem 10 Effective Annualized Interst Rate = (1+.09/52)^52 - 1 = 9.41% Problem 11 Annuity given current savings of $ 250,000 and n=25 = Problem 12 PV of first annuity - $ 20,000 a year for next 10 years = PV of second annuity discounted back 10 years = Sum of the present values of the annuities = If annuities are paid at the start of each period, PV of first annuity - $ 20,000 at beginning of each year= PV of second annuity discounted back 10 years = Sum of the present values of the annuities = $ 17,738.11 $ 128,353.15 $ 81,326.64 $ 209,679.79 $ 148,353.15 $ 88,646.04 $ 236,999.19 Problem 13 PV of deficit reduction can be computed as follows – Deficit Reductio PV Year 1 $ 25.00 $ 23.15 2 $ 30.00 $ 25.72 3 $ 35.00 $ 27.78 4 $ 40.00 $ 29.40 5 $ 45.00 $ 30.63 6 $ 55.00 $ 34.66 7 $ 60.00 $ 35.01 8 $ 65.00 $ 35.12 9 $ 70.00 $ 35.02 10 $ 75.00 $ 34.74 Sum $ 500.00 $ 311.22 The true deficit reduction is $ 311.22 million. Problem 14 a. b. Annuity needed at 6% = 1.89669896 (in billions) Annuity needed at 8% = 1.72573722 (in billions) Savings = 0.17096174 (in billions) This cannot be viewed as real savings, since there will be greater risk associated with the higher-return investments. Problem 15 a. Year Nominal PV $5.50 $5.50 $4.00 $3.74 $4.00 $3.49 $4.00 $3.27 $4.00 $3.05 $7.00 $4.99 $28.50 $24.04 b. Let the sign up bonus be reduced by X. Then the cash flow in year 5 will have to be raised by X + 1.5 million, to get the nominal value of the contract to be equal to $30 million. Since the present value cannot change, X - (X+1.5)/1.075 = 0 X (1.075 - 1) = 1.5 0 1 2 3 4 5 X = 1.5/ (1.075 -1) = $3.73 million The sign up bonus has to be reduced by $3.73 million and the final year's cash flow has to be increased by $5.23 million, to arrive at a contract with a nominal value of $30 million and a present value of $24.04 million. Problem 16 Chatham South Orange Mortgage $300,000 $200,000 Monthly Payme $2,201 $1,468 Annual Paymen $26,416 $17,610 Property Tax $6,000 $12,000 Total Payment $32,416 $29,610 b. Mortgage payments will end after 30 years. Property taxes are not only a perpetuity; they are a growing perpetuity. Therefore, they are likely to be more onerous. c. If property taxes are expected to grow at 3% annually forever, PV of property taxes = Property tax * (1 +g) / (r -g) For Chatham, PV of property tax = $6000 *1.03/(.08-.03) = $123,600 For South Orange, PV of property tax = $12,000 *1.03/(.08-.03) = $247,200 To make the comparison, add these to the house prices, Cost of the Chatham house = $400,000 + $123,600 = $523,600 Cost of the South Orange house = $300,000 + $247,200 = $547,200 The Chatham house is cheaper. Problem 17 a. Monthly Payments at 10% on current loan = $ b. Monthly Payments at 9% on refinanced mortgage = $ Monthly Savings from refinancing = $ c. Present Value of Savings at 8% for 60 months = $ Refinancing Cost = 3% of $ 200,000 = d. Annual Savings needed to cover $ 6000 in refinancing cost= $ Monthly Payment with Savings = $ 1755.14 - $ 121.66 = $ Interest Rate at which Monthly Payment is $ 1633.48 = 1,755.14 1,609.25 145.90 7,195.56 $6,000 121.66 1,633.48 9.17% Problem 18 a. Present Value of Cash Outflows after age 65 = $ 300,000 + PV of $ 35,000 each year for 35 years = $ 707,909.89 b. FV of Current Savings of $ 50,000 = $ 503,132.84 Shortfall at the end of the 30th year = $ 204,777.16 Annuity needed each year for next 30 years for FV of $ 204777 = $ 1,807.66 c. Without the current savings, Annuity needed each year for 25 years for FV of $ 707910 = $ 9,683.34 Problem 19 a. Estimated Funds at end of 10 years: FV of $ 5 million at end of 10th year = FV of inflows of $ 2 million each year for next 5 years = - FV of outflows of $ 3 million each year for years 6-10 = = Funds at end of the 10th year = b. Perpetuity that can be paid out of these funds = $ 10.43 (.08) = $ $ $ $ $ 10.79 (in millions) 17.24 17.60 10.43 0.83 Problem 20 a. Amount needed in the bank to withdraw $ 80,000 each year for 25 years = b. Future Value of Existing Savings in the Bank = Shortfall in Savings = $ 1127516 - $ 407224 = Annual Savings needed to get FV of $ 720,292 = c. If interest rates drop to 4% after the 10th year, Annuity based upon interest rate of 4% and PV of $ 1,127,516 = Problem 21 Year 1 2 3 4 5 6 7 8 9 10 Coupon Face Value PV $ 50.00 $ $ 50.00 $ $ 50.00 $ $ 50.00 $ $ 50.00 $ $ 60.00 $ $ 70.00 $ $ 80.00 $ $ 90.00 $ $ 100.00 $ 1,000.00 $ Sum = $ 46.30 42.87 39.69 36.75 34.03 37.81 40.84 43.22 45.02 509.51 876.05 Problem 22 a. Value of Store = $ 100,000 (1.05)/(.10-.05) = b. Growth rate needed to justify a value of $ 2.5 million, 100000(1+g)/(.10-g) = 2500000 Solving for g, g = 5.77% $ 2,100,000 $ 1,127,516 $ 407,224 $ 720,292 $ 57,267 $ 72,174.48