Chapter 5 2 What The Effective Annual Rate 142 Medium

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Chapter 5: Time Value of Money M/C Problems Page 155
d. $17,754
e. $18,642
93. You want to go to Europe 5 years from now, and you can save $3,100 per
year, beginning one year from today. You plan to deposit the funds in
a mutual fund that you think will return 8.5% per year. Under these
conditions, how much would you have just after you make the 5th
deposit, 5 years from now?
a. $18,369
b. $19,287
c. $20,251
d. $21,264
e. $22,327
94. You want to quit your job and go back to school for a law degree 4
years from now, and you plan to save $3,500 per year, beginning
immediately. You will make 4 deposits in an account that pays 5.7%
interest. Under these assumptions, how much will you have 4 years from
today?
a. $16,112
b. $16,918
c. $17,763
d. $18,652
e. $19,584
95. You want to quit your job and return to school for an MBA degree 3
years from now, and you plan to save $7,000 per year, beginning
immediately. You will make 3 deposits in an account that pays 5.2%
interest. Under these assumptions, how much will you have 3 years from
today?
a. $20,993
b. $22,098
c. $23,261
d. $24,424
e. $25,645
96. What is the PV of an ordinary annuity with 10 payments of $2,700 if the
appropriate interest rate is 5.5%?
a. $16,576
b. $17,449
c. $18,367
d. $19,334
e. $20,352
97. What is the PV of an ordinary annuity with 5 payments of $4,700 if the
appropriate interest rate is 4.5%?
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Page 156 M/C Problems Chapter 5: Time Value of Money
a. $16,806
b. $17,690
c. $18,621
d. $19,601
e. $20,633
98. You have a chance to buy an annuity that pays $2,500 at the end of each
year for 3 years. You could earn 5.5% on your money in other
investments with equal risk. What is the most you should pay for the
annuity?
a. $5,493.71
b. $5,782.85
c. $6,087.21
d. $6,407.59
e. $6,744.83
99. You just inherited some money, and a broker offers to sell you an
annuity that pays $5,000 at the end of each year for 20 years. You
could earn 5% on your money in other investments with equal risk. What
is the most you should pay for the annuity?
a. $50,753
b. $53,424
c. $56,236
d. $59,195
e. $62,311
100. Your aunt is about to retire, and she wants to sell some of her stock
and buy an annuity that will provide her with income of $50,000 per
year for 30 years, beginning a year from today. The going rate on such
annuities is 7.25%. How much would it cost her to buy such an annuity
today?
a. $574,924
b. $605,183
c. $635,442
d. $667,214
e. $700,575
101. What is the PV of an annuity due with 5 payments of $2,500 at an
interest rate of 5.5%?
a. $11,262.88
b. $11,826.02
c. $12,417.32
d. $13,038.19
e. $13,690.10
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Chapter 5: Time Value of Money M/C Problems Page 157
102. What’s the present value of a perpetuity that pays $250 per year if the
appropriate interest rate is 5%?
a. $4,750
b. $5,000
c. $5,250
d. $5,513
e. $5,788
103. What’s the rate of return you would earn if you paid $950 for a
perpetuity that pays $85 per year?
a. 8.95%
b. 9.39%
c. 9.86%
d. 10.36%
e. 10.88%
104. You have a chance to buy an annuity that pays $550 at the beginning of
each year for 3 years. You could earn 5.5% on your money in other
investments with equal risk. What is the most you should pay for the
annuity?
a. $1,412.84
b. $1,487.20
c. $1,565.48
d. $1,643.75
e. $1,725.94
105. You have a chance to buy an annuity that pays $5,000 at the beginning
of each year for 5 years. You could earn 4.5% on your money in other
investments with equal risk. What is the most you should pay for the
annuity?
a. $20,701
b. $21,791
c. $22,938
d. $24,085
e. $25,289
106. Your uncle is about to retire, and he wants to buy an annuity that will
provide him with $75,000 of income a year for 20 years, with the first
payment coming immediately. The going rate on such annuities is 5.25%.
How much would it cost him to buy the annuity today?
a. $ 825,835
b. $ 869,300
c. $ 915,052
d. $ 963,213
e. $1,011,374
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107. Your father is about to retire, and he wants to buy an annuity that
will provide him with $85,000 of income a year for 25 years, with the
first payment coming immediately. The going rate on such annuities is
5.15%. How much would it cost him to buy the annuity today?
a. $1,063,968
b. $1,119,966
c. $1,178,912
d. $1,240,960
e. $1,303,008
(5-9) PV of annuity due C J Answer: b MEDIUM
108. You inherited an oil well that will pay you $25,000 per year for 25
years, with the first payment being made today. If you think a fair
return on the well is 7.5%, how much should you ask for it if you
decide to sell it?
a. $284,595
b. $299,574
c. $314,553
d. $330,281
e. $346,795
109. Sam was injured in an accident, and the insurance company has offered
him the choice of $25,000 per year for 15 years, with the first payment
being made today, or a lump sum. If a fair return is 7.5%, how large
must the lump sum be to leave him as well off financially as with the
annuity?
a. $225,367
b. $237,229
c. $249,090
d. $261,545
e. $274,622
110. What’s the present value of a 4-year ordinary annuity of $2,250 per
year plus an additional $3,000 at the end of Year 4 if the interest
rate is 5%?
a. $ 8,509
b. $ 8,957
c. $ 9,428
d. $ 9,924
e. $10,446
111. Suppose you inherited $275,000 and invested it at 8.25% per year. How
much could you withdraw at the end of each of the next 20 years?
a. $28,532
b. $29,959
c. $31,457
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Chapter 5: Time Value of Money M/C Problems Page 159
d. $33,030
e. $34,681
112. Your uncle has $375,000 and wants to retire. He expects to live for
another 25 years and to earn 7.5% on his invested funds. How much
could he withdraw at the end of each of the next 25 years and end up
with zero in the account?
a. $28,843.38
b. $30,361.46
c. $31,959.43
d. $33,641.50
e. $35,323.58
113. Your uncle has $375,000 and wants to retire. He expects to live for
another 25 years, and he also expects to earn 7.5% on his invested
funds. How much could he withdraw at the beginning of each of the next
25 years and end up with zero in the account?
a. $28,243.21
b. $29,729.70
c. $31,294.42
d. $32,859.14
e. $34,502.10
114. Your grandmother just died and left you $100,000 in a trust fund that
pays 6.5% interest. You must spend the money on your college
education, and you must withdraw the money in 4 equal installments,
beginning immediately. How much could you withdraw today and at the
beginning of each of the next 3 years and end up with zero in the
account?
a. $24,736
b. $26,038
c. $27,409
d. $28,779
e. $30,218
115. Suppose you inherited $275,000 and invested it at 8.25% per year. How
much could you withdraw at the beginning of each of the next 20 years?
a. $22,598.63
b. $23,788.03
c. $25,040.03
d. $26,357.92
e. $27,675.82
116. Your father's employer was just acquired, and he was given a severance
payment of $375,000, which he invested at a 7.5% annual rate. He now
plans to retire, and he wants to withdraw $35,000 at the end of each
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year, starting at the end of this year. How many years will it take to
exhaust his funds, i.e., run the account down to zero?
a. 22.50
b. 23.63
c. 24.81
d. 26.05
e. 27.35
117. Your uncle has $300,000 invested at 7.5%, and he now wants to retire.
He wants to withdraw $35,000 at the end of each year, starting at the
end of this year. He also wants to have $25,000 left to give you when
he ceases to withdraw funds from the account. For how many years can
he make the $35,000 withdrawals and still have $25,000 left in the end?
a. 14.21
b. 14.96
c. 15.71
d. 16.49
e. 17.32
118. Your Aunt Ruth has $500,000 invested at 6.5%, and she plans to retire.
She wants to withdraw $40,000 at the beginning of each year, starting
immediately. How many years will it take to exhaust her funds, i.e.,
run the account down to zero?
a. 18.62
b. 19.60
c. 20.63
d. 21.71
e. 22.86
119. Your aunt has $500,000 invested at 5.5%, and she now wants to retire.
She wants to withdraw $45,000 at the beginning of each year, beginning
immediately. She also wants to have $50,000 left to give you when she
ceases to withdraw funds from the account. For how many years can she
make the $45,000 withdrawals and still have $50,000 left in the end?
a. 15.54
b. 16.36
c. 17.22
d. 18.08
e. 18.99
120. Suppose you just won the state lottery, and you have a choice between
receiving $2,550,000 today or a 20-year annuity of $250,000, with the
first payment coming one year from today. What rate of return is built
into the annuity? Disregard taxes.
a. 7.12%
b. 7.49%
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Chapter 5: Time Value of Money M/C Problems Page 161
c. 7.87%
d. 8.26%
e. 8.67%
121. Your girlfriend just won the Florida lottery. She has the choice of
$15,000,000 today or a 20-year annuity of $1,050,000, with the first
payment coming one year from today. What rate of return is built into
the annuity?
a. 3.44%
b. 3.79%
c. 4.17%
d. 4.58%
e. 5.04%
122. Assume that you own an annuity that will pay you $15,000 per year for
12 years, with the first payment being made today. You need money
today to start a new business, and your uncle offers to give you
$120,000 for the annuity. If you sell it, what rate of return would
your uncle earn on his investment?
a. 6.85%
b. 7.21%
c. 7.59%
d. 7.99%
e. 8.41%
123. What annual payment must you receive in order to earn a 6.5% rate of
return on a perpetuity that has a cost of $1,250?
a. $77.19
b. $81.25
c. $85.31
d. $89.58
e. $94.06
124. What is the present value of the following cash flow stream at a rate
of 6.25%?
Years: 0 1 2 3 4
| | | | |
CFs: $0 $75 $225 $0 $300
a. $411.57
b. $433.23
c. $456.03
d. $480.03
e. $505.30
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125. What is the present value of the following cash flow stream at a rate
of 12.0%?
Years: 0 1 2 3 4
| | | | |
CFs: $0 $1,500 $3,000 $4,500 $6,000
a. $ 9,699
b. $10,210
c. $10,747
d. $11,284
e. $11,849
126. What is the present value of the following cash flow stream at a rate
of 8.0%?
Years: 0 1 2 3
| | | |
CFs: $750 $2,450 $3,175 $4,400
a. $7,917
b. $8,333
c. $8,772
d. $9,233
e. $9,695
127. You sold a car and accepted a note with the following cash flow stream
as your payment. What was the effective price you received for the car
assuming an interest rate of 6.0%?
Years: 0 1 2 3 4
| | | | |
CFs: $0 $1,000 $2,000 $2,000 $2,000
a. $5,987
b. $6,286
c. $6,600
d. $6,930
e. $7,277
128. At a rate of 6.5%, what is the future value of the following cash flow
stream?
Years: 0 1 2 3 4
| | | | |
CFs: $0 $75 $225 $0 $300
a. $526.01
b. $553.69
c. $582.83
d. $613.51
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Chapter 5: Time Value of Money M/C Problems Page 163
e. $645.80
129. Your father paid $10,000 (CF at t = 0) for an investment that promises
to pay $750 at the end of each of the next 5 years, then an additional
lump sum payment of $10,000 at the end of the 5th year. What is the
expected rate of return on this investment?
a. 6.77%
b. 7.13%
c. 7.50%
d. 7.88%
e. 8.27%
130. You are offered a chance to buy an asset for $7,250 that is expected to
produce cash flows of $750 at the end of Year 1, $1,000 at the end of
Year 2, $850 at the end of Year 3, and $6,250 at the end of Year 4.
What rate of return would you earn if you bought this asset?
a. 4.93%
b. 5.19%
c. 5.46%
d. 5.75%
e. 6.05%
131. What’s the future value of $1,500 after 5 years if the appropriate
interest rate is 6%, compounded semiannually?
a. $1,819
b. $1,915
c. $2,016
d. $2,117
e. $2,223
132. What’s the present value of $4,500 discounted back 5 years if the
appropriate interest rate is 4.5%, compounded semiannually?
a. $3,089
b. $3,251
c. $3,422
d. $3,602
e. $3,782
133. What’s the future value of $1,200 after 5 years if the appropriate
interest rate is 6%, compounded monthly?
a. $1,537.69
b. $1,618.62
c. $1,699.55
d. $1,784.53
e. $1,873.76
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134. What’s the present value of $1,525 discounted back 5 years if the
appropriate interest rate is 6%, compounded monthly?
a. $ 969
b. $1,020
c. $1,074
d. $1,131
e. $1,187
135. Master Card and other credit card issuers must by law print the Annual
Percentage Rate (APR) on their monthly statements. If the APR is
stated to be 18.00%, with interest paid monthly, what is the card's
EFF%?
a. 18.58%
b. 19.56%
c. 20.54%
d. 21.57%
e. 22.65%
136. Riverside Bank offers to lend you $50,000 at a nominal rate of 6.5%,
compounded monthly. The loan (principal plus interest) must be repaid
at the end of the year. Midwest Bank also offers to lend you the
$50,000, but it will charge an annual rate of 7.0%, with no interest
due until the end of the year. How much higher or lower is the
effective annual rate charged by Midwest versus the rate charged by
Riverside?
a. 0.52%
b. 0.44%
c. 0.36%
d. 0.30%
e. 0.24%
137. Suppose Community Bank offers to lend you $10,000 for one year at a
nominal annual rate of 8.00%, but you must make interest payments at
the end of each quarter and then pay off the $10,000 principal amount
at the end of the year. What is the effective annual rate on the loan?
a. 8.24%
b. 8.45%
c. 8.66%
d. 8.88%
e. 9.10%
138. Suppose a bank offers to lend you $10,000 for 1 year on a loan contract
that calls for you to make interest payments of $250.00 at the end of
each quarter and then pay off the principal amount at the end of the
year. What is the effective annual rate on the loan?
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Chapter 5: Time Value of Money M/C Problems Page 165
a. 8.46%
b. 8.90%
c. 9.37%
d. 9.86%
e. 10.38%
139. Charter Bank pays a 4.50% nominal rate on deposits, with monthly
compounding. What effective annual rate (EFF%) does the bank pay?
a. 3.72%
b. 4.13%
c. 4.59%
d. 5.05%
e. 5.56%
140. Suppose your credit card issuer states that it charges a 15.00% nominal
annual rate, but you must make monthly payments, which amounts to
monthly compounding. What is the effective annual rate?
a. 15.27%
b. 16.08%
c. 16.88%
d. 17.72%
e. 18.61%
141. Pace Co. borrowed $20,000 at a rate of 7.25%, simple interest, with
interest paid at the end of each month. The bank uses a 360-day year.
How much interest would Pace have to pay in a 30-day month?
a. $120.83
b. $126.88
c. $133.22
d. $139.88
e. $146.87
142. Suppose you deposited $5,000 in a bank account that pays 5.25% with
daily compounding based on a 360-day year. How much would be in the
account after 8 months, assuming each month has 30 days?
a. $5,178.09
b. $5,436.99
c. $5,708.84
d. $5,994.28
e. $6,294.00
143. Suppose you borrowed $12,000 at a rate of 9.0% and must repay it in 4
equal installments at the end of each of the next 4 years. How large
would your payments be?
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a. $3,704.02
b. $3,889.23
c. $4,083.69
d. $4,287.87
e. $4,502.26
144. Suppose you are buying your first condo for $145,000, and you will make
a $15,000 down payment. You have arranged to finance the remainder
with a 30-year, monthly payment, amortized mortgage at a 6.5% nominal
interest rate, with the first payment due in one month. What will your
monthly payments be?
a. $741.57
b. $780.60
c. $821.69
d. $862.77
e. $905.91
145. Your uncle will sell you his bicycle shop for $250,000, with "seller
financing," at a 6.0% nominal annual rate. The terms of the loan would
require you to make 12 equal end-of-month payments per year for 4
years, and then make an additional final (balloon) payment of $50,000
at the end of the last month. What would your equal monthly payments
be?
a. $4,029.37
b. $4,241.44
c. $4,464.67
d. $4,699.66
e. $4,947.01
146. Suppose you borrowed $14,000 at a rate of 10.0% and must repay it in 5
equal installments at the end of each of the next 5 years. How much
interest would you have to pay in the first year?
a. $1,200.33
b. $1,263.50
c. $1,330.00
d. $1,400.00
e. $1,470.00
147. You plan to borrow $35,000 at a 7.5% annual interest rate. The terms
require you to amortize the loan with 7 equal end-of-year payments.
How much interest would you be paying in Year 2?
a. $1,994.49
b. $2,099.46
c. $2,209.96
d. $2,326.27
e. $2,442.59
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Chapter 5: Time Value of Money M/C Problems Page 167
148. Your bank offers to lend you $100,000 at an 8.5% annual interest rate
to start your new business. The terms require you to amortize the loan
with 10 equal end-of-year payments. How much interest would you be
paying in Year 2?
a. $7,531
b. $7,927
c. $8,323
d. $8,740
e. $9,177
149. You are considering an investment in a Third World bank account that
pays a nominal annual rate of 18%, compounded monthly. If you invest
$5,000 at the beginning of each month, how many months would it take
for your account to grow to $250,000? Round fractional months up.
a. 23
b. 27
c. 32
d. 38
e. 44
150. You are considering investing in a bank account that pays a nominal
annual rate of 7%, compounded monthly. If you invest $3,000 at the end
of each month, how many months will it take for your account to grow to
$150,000?
a. 39.60
b. 44.00
c. 48.40
d. 53.24
e. 58.57
151. Your child’s orthodontist offers you two alternative payment plans.
The first plan requires a $4,000 immediate up-front payment. The
second plan requires you to make monthly payments of $137.41, payable
at the end of each month for 3 years. What nominal annual interest
rate is built into the monthly payment plan?
a. 12.31%
b. 12.96%
c. 13.64%
d. 14.36%
e. 15.08%
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152. Your subscription to Investing Wisely Weekly is about to expire. You
plan to subscribe to the magazine for the rest of your life, and you
can renew it by paying $85 annually, beginning immediately, or you can
get a lifetime subscription for $850, also payable immediately.
Assuming that you can earn 6.0% on your funds and that the annual
renewal rate will remain constant, how many years must you live to make
the lifetime subscription the better buy?
a. 7.48
b. 8.80
c. 10.35
d. 12.18
e. 14.33
153. You just deposited $2,500 in a bank account that pays a 4.0% nominal
interest rate, compounded quarterly. If you also add another $5,000 to
the account one year (4 quarters) from now and another $7,500 to the
account two years (8 quarters) from now, how much will be in the
account three years (12 quarters) from now?
a. $15,234.08
b. $16,035.87
c. $16,837.67
d. $17,679.55
e. $18,563.53
154. Farmers Bank offers to lend you $50,000 at a nominal rate of 5.0%,
simple interest, with interest paid quarterly. Merchants Bank offers
to lend you the $50,000, but it will charge 6.0%, simple interest, with
interest paid at the end of the year. What's the difference in the
effective annual rates charged by the two banks?
a. 1.56%
b. 1.30%
c. 1.09%
d. 0.91%
e. 0.72%
155. Suppose you borrowed $15,000 at a rate of 8.5% and must repay it in 5
equal installments at the end of each of the next 5 years. By how much
would you reduce the amount you owe in the first year?
a. $2,404.91
b. $2,531.49
c. $2,658.06
d. $2,790.96
e. $2,930.51
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Chapter 5: Time Value of Money M/C Problems Page 169
156. Suppose you borrowed $15,000 at a rate of 8.5% and must repay it in 5
equal installments at the end of each of the next 5 years. How much
would you still owe at the end of the first year, after you have made
the first payment?
a. $10,155.68
b. $10,690.19
c. $11,252.83
d. $11,845.09
e. $12,468.51
(Comp.) Retirement planning C J Answer: c MEDIUM/HARD
157. Your sister turned 35 today, and she is planning to save $7,000 per
year for retirement, with the first deposit to be made one year from
today. She will invest in a mutual fund that's expected to provide a
return of 7.5% per year. She plans to retire 30 years from today, when
she turns 65, and she expects to live for 25 years after retirement, to
age 90. Under these assumptions, how much can she spend each year
after she retires? Her first withdrawal will be made at the end of her
first retirement year.
a. $58,601
b. $61,686
c. $64,932
d. $68,179
e. $71,588
158. You agree to make 24 deposits of $500 at the beginning of each month
into a bank account. At the end of the 24th month, you will have
$13,000 in your account. If the bank compounds interest monthly, what
nominal annual interest rate will you be earning?
a. 7.62%
b. 8.00%
c. 8.40%
d. 8.82%
e. 9.26%
159. Your company has just taken out a 1-year installment loan for $72,500
at a nominal rate of 11.0% but with equal end-of-month payments. What
percentage of the 2nd monthly payment will go toward the repayment of
principal?
a. 73.67%
b. 77.55%
c. 81.63%
d. 85.93%
e. 90.45%
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160. On January 1, 2009, your brother's business obtained a 30-year
amortized mortgage loan for $250,000 at a nominal annual rate of 7.0%,
with 360 end-of-month payments. The firm can deduct the interest paid
for tax purposes. What will the interest tax deduction be for 2009?
a. $17,419.55
b. $17,593.75
c. $17,769.68
d. $17,947.38
e. $18,126.85
161. Steve and Ed are cousins who were both born on the same day, and both
turned 25 today. Their grandfather began putting $2,500 per year into
a trust fund for Steve on his 20th birthday, and he just made a 6th
payment into the fund. The grandfather (or his estate's trustee) will
make 40 more $2,500 payments until a 46th and final payment is made on
Steve's 65th birthday. The grandfather set things up this way because
he wants Steve to work, not be a "trust fund baby," but he also wants
to ensure that Steve is provided for in his old age.
Until now, the grandfather has been disappointed with Ed, hence
has not given him anything. However, they recently reconciled, and the
grandfather decided to make an equivalent provision for Ed. He will
make the first payment to a trust for Ed today, and he has instructed
his trustee to make 40 additional equal annual payments until Ed turns
65, when the 41st and final payment will be made. If both trusts earn
an annual return of 8%, how much must the grandfather put into Ed's
trust today and each subsequent year to enable him to have the same
retirement nest egg as Steve after the last payment is made on their
65th birthday?
a. $3,726
b. $3,912
c. $4,107
d. $4,313
e. $4,528
162. After graduation, you plan to work for Dynamo Corporation for 12 years
and then start your own business. You expect to save and deposit
$7,500 a year for the first 6 years (t = 1 through t = 6) and $15,000
annually for the following 6 years (t = 7 through t = 12). The first
deposit will be made a year from today. In addition, your grandfather
just gave you a $25,000 graduation gift which you will deposit
immediately (t = 0). If the account earns 9% compounded annually, how
much will you have when you start your business 12 years from now?
a. $238,176
b. $250,712
c. $263,907
d. $277,797
e. $291,687
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Chapter 5: Time Value of Money M/C Problems Page 171
163. You are negotiating to make a 7-year loan of $25,000 to Breck Inc. To
repay you, Breck will pay $2,500 at the end of Year 1, $5,000 at the
end of Year 2, and $7,500 at the end of Year 3, plus a fixed but
currently unspecified cash flow, X, at the end of each year from Year 4
through Year 7. Breck is essentially riskless, so you are confident
the payments will be made. You regard 8% as an appropriate rate of
return on a low risk but illiquid 7-year loan. What cash flow must the
investment provide at the end of each of the final 4 years, that is,
what is X?
a. $4,271.67
b. $4,496.49
c. $4,733.15
d. $4,969.81
e. $5,218.30
164. John and Daphne are saving for their daughter Ellen's college
education. Ellen just turned 10 (at t = 0), and she will be entering
college 8 years from now (at t = 8). College tuition and expenses at
State U. are currently $14,500 a year, but they are expected to
increase at a rate of 3.5% a year. Ellen should graduate in 4 years--
if she takes longer or wants to go to graduate school, she will be on
her own. Tuition and other costs will be due at the beginning of each
school year (at t = 8, 9, 10, and 11).
So far, John and Daphne have accumulated $15,000 in their college
savings account (at t = 0). Their long-run financial plan is to add an
additional $5,000 in each of the next 4 years (at t = 1, 2, 3, and 4).
Then they plan to make 3 equal annual contributions in each of the
following years, t = 5, 6, and 7. They expect their investment account
to earn 9%. How large must the annual payments at t = 5, 6, and 7 be
to cover Ellen's anticipated college costs?
a. $1,965.21
b. $2,068.64
c. $2,177.51
d. $2,292.12
e. $2,412.76
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Page 172 Answers Chapter 5: Time Value of Money
CHAPTER 5
ANSWERS AND SOLUTIONS
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Chapter 5: Time Value of Money Answers Page 173
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Page 174 Answers Chapter 5: Time Value of Money

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