Principles of Finance

# Problems

1 .
Your aunt promises to gift you $1,500 now,$1,700 one year from now, $1,900 two years from now, and$2,500 three years from now. You will deposit all four amounts in an account that bears 3% interest compounded annually. How much will be in the account at the end of the fourth year?
2 .
You believe that you can set aside $1,200 each year for the next four years, starting immediately, in order to buy a small fishing boat for your retirement. Your friend Luis promises that he’ll pay you back$4,900 that he owes you three years from now, so you will add that to the payment you make at the start of year 4. Then, at the start of year 5, you will increase your payment to $1,400; in year 6, to$1,500; and in year 7, to $1,600. Every payment will be deposited in a fund bearing 4% interest compounded annually. How much will you have set aside for your boat at the end of the seventh year? 3 . Assume you win a lottery that will pay you$10,000 immediately, plus $20,000 one year from now,$30,000 two years from now, $40,000 three years from now, and$75,000 four years from now. You’re curious about how much the lottery commission might offer you as an immediate lump sum instead. What is the minimum amount you should consider accepting today instead? Use a 5% annual discount rate. Please remember that we are ignoring taxation and other considerations and basing this only on the math itself.
4 .
Assume you win a lottery, and you are offered the following stream of payments by the lottery commission: $25,000 today,$32,000 one year from now, another $32,000 two years from now, and a final payment of$55,000 three years from now. You accept the offer. If you invest all of these proceeds at 6% compounded annually and extract nothing from the investment, how much will you have at the end of the fourth year?
5 .
You are offered a business partnership that guarantees you cash returns of $150,000 one year from now, nothing at the end of year 2, and$350,000 at the end of year 3. After year 3, the partnership will be dissolved, and there will be no more expected returns on your investment. If you analyze this plan expecting 7% compounded annually, what is this potential deal worth to you today?
6 .
Tony owns a small business that he is attempting to sell. A potential buyer offers him $500,000 today, plus$1,500,000 two years from now and a balance of $1,700,000 three years from now. Tony always analyzes cash flows using a rate of 4% compounded annually. To compare this to other offers, which would be paid in cash immediately, he wants to know the present value of these future cash flows. Show the calculation and solution that you would present to Tony to use in his decision. 7 . Continuing Problem 6 above, assume that as Tony receives each payment from the buyer, he can immediately invest it in a fund that returns a guaranteed 3.5% compounded annually. If he accepts the terms of this offer, how much will he have accumulated in this investment four years from now? 8 . You hire Susan for a three-year term. She has no retirement plan, so you agree to invest money immediately to allow her a stream of three payments beginning one year after her employment term ends. Draw a timeline! The money you invest for the full six years of this arrangement (three years of employment and three years of withdrawals) always earns 4% compounded annually. When Susan receives her third and last payment, the fund will be depleted and equal zero. The three payments she will receive are as follows: • End of year 4:$25,000
• End of year 5: $30,000 • End of year 6:$37,000

Therefore, your goal is to have enough money in this account at the end of Susan’s three-year employment term to assure her of receiving these payments.

How much money must you invest today to accomplish this strategy?

9 .
Abby owns a business that projects two years of strong cash flow, followed by a two-year hiatus while she pursues a graduate degree. She then plans to resume her business and is confident about the following two years of cash flow. At the end of each year, she will invest her profits in a fund that returns 3% compounded annually. Each investment will be made at the end of the year. Her expected investments are as follows:
• Year 1: $50,000 • Year 2:$78,000
• Year 3: 0
• Year 4: 0
• Year 5: $84,000 • Year 6:$89,000

If Abby meets her expectations, how much money will she have in this fund at the end of year 7?