Chapter 2 PQ FM

CHAPTER 2
How to Calculate Present Values
Answers to Problem Sets
1. If the discount factor is .507, then .507 x 1.126 = $1.
2. DF x 139 = 125. Therefore, DF =125/139 = .899.
3. PV = 374/(1.09)9 = 172.20.
4. PV = 432/1.15 + 137/(1.152) + 797/(1.153) = 376 + 104 + 524 = $1,003.
5. FV = 100 x 1.158 = $305.90.
6. NPV = −1,548 + 138/.09 = −14.67 (cost today plus the present value of the
perpetuity).
7. PV = 4/(.14 − .04) = $40.
8. a. PV = 1/.10 = $10.
b. Since the perpetuity will be worth $10 in year 7, and since that is roughly
double the present value, the approximate PV equals $5.
You must take the present value of years 1–7 and subtract from the total
present value of the perpetuity:
PV = (1/.10)/(1.10)7 = 10/2= $5 (approximately).
c. A perpetuity paying $1 starting now would be worth $10, whereas a

perpetuity starting in year 8 would be worth roughly $5. The difference
between these cash flows is therefore approximately $5. PV = $10 – $5=
$5 (approximately).
d. PV = C/(r − g) = 10,000/(.10-.05) = $200,000.
9. a. PV = 10,000/(1.055) = $7,835.26 (assuming the cost of the car does not

appreciate over those five years).
b. The six-year annuity factor [(1/0.08) – 1/(0.08 x (1+.08)6)] = 4.623. You

need to set aside (12,000 × six-year annuity factor) = 12,000 × 4.623 =
$55,475.
c. At the end of six years you would have 1.086 × (60,476 - 55,475) =
$7,935.
10. a. FV = 1,000e.12 x 5 = 1,000e.6 = $1,822.12.
b. PV = 5e−.12 x 8 = 5e-.96 = $1.914 million.
c. PV = C (1/r – 1/rert) = 2,000(1/.12 – 1/.12e .12 x15) = $13,912.
11.
a. FV = 10,000,000 x (1.06)4 = 12,624,770.
b. FV = 10,000,000 x (1 + .06/12)(4 x 12) = 12,704,892.
c. FV = 10,000,000 x e(4 x .06) = 12,712,492.
12.
a. PV = $100/1.0110 = $90.53.
b. PV = $100/1.1310 = $29.46.
c. PV = $100/1.2515 = $3.52.
d. PV = $100/1.12 + $100/1.122 + $100/1.123 = $240.18.
1
13. a. DF1 = = 0.905  r1 = 0.1050 = 10.50%.
1+ r1
1 1
b. DF2 = = = 0.819.
(1 + r2 ) 2
(1.105)2
c. AF2 = DF1 + DF2 = 0.905 + 0.819 = 1.724.
d. PV of an annuity = C  [annuity factor at r% for t years].

Here:
$24.65 = $10  [AF3]
AF3 = 2.465
e. AF3 = DF1 + DF2 + DF3 = AF2 + DF3

2.465 = 1.724 + DF3
DF3 = 0.741
14. The present value of the 10-year stream of cash inflows is:
 1 1 
PV = $170,000   − 10 
= $886,739.66
 0.14 0.14  (1.14) 
Thus:
NPV = –$800,000 + $886,739.66 = +$86,739.66
At the end of five years, the factory’s value will be the present value of the five
remaining $170,000 cash flows:
 1 1 
PV = $170,000   − 5 
= $583,623.76
 0.14 0.14  (1.14) 
15.
10
Ct $50,000 $57,000 $75,000 $80,000 $85,000
NPV =  t
= − $380,000 + + + + +
t =0 (1.12) 1.12 1.122 1.123 1.124 1.125
$92,000 $92,000 $80,000 $68,000 $50,000

+ + + + + = $23,696.15
1.126 1.127 1.128 1.129 1.1210
16. a. Let St = salary in year t.

30
40,000 (1.05)t −1
PV = 
t =1 (1.08)t
 1 (1.05)30 
= 40,000   − 30 
= $760,662.53
 (.08 - .05) (.08 - .05) (1.08) 
b. PV(salary) x 0.05 = $38,033.13

Future value = $38,033.13 x (1.08)30 = $382,714.30
c.
1 1 
PV = C   − t 
 r r  (1+ r) 
 1 1 
$382,714.30 = C   − 20 
 0.08 0.08  (1.08) 
 1 1 
C = $382,714.30  −  = $38,980.30
 0.08 0.08  (1.08)20 
17.
Period Present Value
0 −400,000.00
1 +100,000/1.12 = +89,285.71
2 +200,000/1.122 = +159,438.78
3 +300,000/1.123 = +213,534.07
Total = NPV = $62,258.56
18. We can break this down into several different cash flows, such that the sum of
these separate cash flows is the total cash flow. Then, the sum of the present
values of the separate cash flows is the present value of the entire project. (All
dollar figures are in millions.)
▪ Cost of the ship is $8 million
PV = −$8 million
▪ Revenue is $5 million per year, and operating expenses are $4 million.
Thus, operating cash flow is $1 million per year for 15 years.
 1 1 
PV = $1 million   − 15 
= $8.559 million.
 0.08 0.08  (1.08) 
▪ Major refits cost $2 million each and will occur at times t = 5 and t = 10.
PV = (−$2 million)/1.085 + (−$2 million)/1.0810 = −$2.288 million.
▪ Sale for scrap brings in revenue of $1.5 million at t = 15.
PV = $1.5 million/1.0815 = $0.473 million.
Adding these present values gives the present value of the entire project:
NPV = −$8 million + $8.559 million − $2.288 million + $0.473 million
NPV = −$1.256 million
19. a. PV = $100,000.
b. PV = $180,000/1.125 = $102,136.83.
c. PV = $11,400/0.12 = $95,000.
 1 1 
d. PV = $19,000   − 10 
= $107,354.24.
 0.12 0.12  (1.12) 
e. PV = $6,500/(0.12 − 0.05) = $92,857.14.

Prize (d) is the most valuable because it has the highest present value.
20. Mr. Basset is buying a security worth $20,000 now, which is its present value.
The unknown is the annual payment. Using the present value of an annuity
formula, we have:
1 1 
PV = C   − t 
 r r  (1 + r) 
 1 1 
$20,000 = C   − 12 
 0.08 0.08  (1.08) 
 1 1 
C = $20,000  −  = $2,653.90
 0.08 0.08  (1.08)12 

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CHAPTER 2

How to Calculate Present Values

Answers to Problem Sets

1. If the discount factor is .507, then .507 x 1.126 = $1.

2. DF x 139 = 125. Therefore, DF =125/139 = .899.

4. PV = 432/1.15 + 137/(1.152) + 797/(1.153) = 376 + 104 + 524 = $1,003.

5. FV = 100 x 1.158 = $305.90.

7. PV = 4/(.14 − .04) = $40.

PV = (1/.10)/(1.10)7 = 10/2= $5 (approximately).

c. A perpetuity paying $1 starting now would be worth $10, whereas a

d. PV = C/(r − g) = 10,000/(.10-.05) = $200,000.

9. a. PV = 10,000/(1.055) = $7,835.26 (assuming the cost of the car does not

b. The six-year annuity factor [(1/0.08) – 1/(0.08 x (1+.08)6)] = 4.623. You

10. a. FV = 1,000e.12 x 5 = 1,000e.6 = $1,822.12.

b. PV = 5e−.12 x 8 = 5e-.96 = $1.914 million.

c. PV = C (1/r – 1/rert) = 2,000(1/.12 – 1/.12e .12 x15) = $13,912.

b. FV = 10,000,000 x (1 + .06/12)(4 x 12) = 12,704,892.

c. FV = 10,000,000 x e(4 x .06) = 12,712,492.

d. PV = $100/1.12 + $100/1.122 + $100/1.123 = $240.18.

c. AF2 = DF1 + DF2 = 0.905 + 0.819 = 1.724.

d. PV of an annuity = C  [annuity factor at r% for t years].

e. AF3 = DF1 + DF2 + DF3 = AF2 + DF3

$92,000 $92,000 $80,000 $68,000 $50,000

16. a. Let St = salary in year t.

b. PV(salary) x 0.05 = $38,033.13

e. PV = $6,500/(0.12 − 0.05) = $92,857.14.

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