Exam 5: The Time Value of Money

The higher the interest rate on an investment, the more money that is accumulated for any time period.

Using lower discount rates will:

The future value technique uses discounting to find the future value of each cash flow at the end of the project's life.

Multiple compounding periods (FV): Hector started on his first job last year and plans to save for a down payment on a house in 10 years. He will be able to invest $12,000 today in a money market account that will pay him an interest of 6.25 percent on a monthly basis. How much will he have at the end of 10 years?

Multiple compounding (PV): You need to have $15,000 in five years to pay-off a home equity loan. You can invest in an account that pays 5.75 percent compounded quarterly. How much will you have to invest today to attain your target in five years? (Round to the nearest dollar.)

If Laura has to choose between a loan that charges quarterly interest and a loan that charges monthly interest, she should always choose the one charging quarterly interest.

Time to attain goal: Franklin Foods announced that its sales were $1,233,450 this year. The company forecasts a growth rate of 16 percent for the foreseeable future. How long will it take the company to produce earnings of $3 million? (Round off to the nearest year.)

Compounding: Dat Nguyen is depositing $17,500 in an account paying an annual interest rate of 8.25 percent compounded monthly. What is the interest-on-interest after six years?

Time to attain goal: Elegant Designers have generated sales of $625,000 for the current year. If they can grow their sales at a rate of 12 percent every year, how long will they take to triple their sales? (Round off to the nearest year.)

Present value: Derek's friend, Jack, is asking to borrow today with a promise to repay $7,418.87 in four years. If Derek could earn 5.45 percent annually on the any investment he makes today, how much would he be willing to lend Jackson today? (Round to nearest dollar.)

Multiple compounding periods (FV): Carolyn Botti wants to invest $3,500 today in a money market fund that pays quarterly interest at 5.5 percent. She plans to fund a scholarship with the proceeds at Brisbane University. How much will Carolyn have at the end of seven years? (Round to the nearest dollar.)

Compound interest consists of both simple interest and interest-on-interest.

Using higher interest rates will:

Time value of money is based on the belief that people have a positive time preference for consumption.

The higher the discount rate, the lower the present value of a future cash flow.

The Rule of 72

The value of a dollar invested at positive interest rate grows over time but at an increasingly slower rate further into the future.

Multiple compounding periods (FV): Your brother has asked you to help him with choosing an investment. He has $5,000 to invest today for a period of two years. You identify a bank term deposit that pays an interest rate of 4.25 percent with the interest being paid quarterly. What will be the value of the investment in two years?

Growth rate: Vidmar Agencies is a fast-growing advertising agency. Currently, their sales are at $700,000. They expect their sales to grow at an annual rate of 35 percent in the next two years, followed by an annual rate of 25 percent in years 3 through 7. Finally, their growth rate would slow down to 10 percent in years 8-10. What will be their sales as of year 10? (Round to the nearest dollar.)

Compound interest consists of interest-on-interest.