Exam 3: Time Value of Money: The Universal Tool

Suppose an investor invests $2,000 at the beginning of each year. What will be the value of the investment at the end of ten years if he earns ten percent?

JoAnne Morris is deadly set against buying life insurance because she is convinced that most people are "tricked" into buying insurance. How can you explain the theoretical foundations of life insurance as an effective planning tool?

Use the following to answer questions Bob Lower wants to retire in 10 years. At that time he wants to have a lump sum accumulated that would allow him to withdraw $35,000 a year for the next 20 years. Assume that Bob earns an after-tax return of eight percent. Ignore the inflation in these calculations. - How much does Bob need to invest today in order to fulfill his needs?

How do you calculate the present value of perpetuity? Give an example of a situation where this concept would be relevant.

Contrast the future value of a fixed sum concept with the future value of an annuity concept. Give examples of situations where they are used by the financial planner.

Comment on the following statement: "One of the most valuable concepts in financial planning is the internal rate of return."

Jay Brown, a relatively new financial planner, who is a friend of yours, is unable to determine the internal rate of return of an investment which is expected to generate an uneven cash flow for the next 10 years. Can you help him?

Assume that for his retirement an investor invests $2,000 per year for 35 years. If the investor can earn ten percent return, what will be the ending value?

What would an initial investment of $3,000 grow to if it is compounded annually at 10% for 5 years?

Assume that an investor expects to receive the following dividends: year 1: $8, years 2-7: $10, and years 11-12: $12. If the investor's discount rate is 5 percent, what is the present value of this dividend stream?

John Stern, a business executive, is planning to retire in two years when he will turn 65. You are surprised to hear that he would like to have a monthly income of $9,000, three times his current monthly budget. Upon further questioning, you discover that the $9,000 amount is to take care of future inflation. How do you explain to John that he should start with a realistic budget?

What is the effective interest rate on a bank savings account which pays six percent, compounded semi-annually?

Contrast nominal interest rate with effective interest rate. Which one should be used in making financial decisions?