CHAPTER 5

INTRODUCTION TO VALUATION: THE

TIME VALUE OF MONEY
Answers to Concepts Review and Critical Thinking Questions

1. The four parts are the present value (PV), the future value (FV), the discount rate (r), and the life
of the investment (t).

2. Compounding refers to the growth of a dollar amount through time via reinvestment of interest
earned. It is also the process of determining the future value of an investment. Discounting is the
process of determining the value today of an amount to be received in the future.

3. Future values grow (assuming a positive rate of return); present values shrink.

4. The future value rises (assuming it’s positive); the present value falls.

5. It would appear to be both deceptive and unethical to run such an ad without a disclaimer or
explanation.

6. It’s a reflection of the time value of money. TMCC gets to use the $24,099. If TMCC uses it
wisely, it will be worth more than $100,000 in 30 years.

7. This will probably make the security less desirable. TMCC will only repurchase the security
prior to maturity if it is to its advantage, i.e., interest rates decline. Given the drop in interest
rates needed to make this viable for TMCC, it is unlikely the company will repurchase the
security. This is an example of a “call” feature. Such features are discussed at length in a later
chapter.

8. The key considerations would be: (1) Is the rate of return implicit in the offer attractive relative
to other, similar risk investments? and (2) How risky is the investment; i.e., how certain are we
that we will actually get the $100,000? Thus, our answer does depend on who is making the
promise to repay.

9. The Treasury security would have a somewhat higher price because the Treasury is the strongest
of all borrowers.

10. The price would be higher because, as time passes, the price of the security will tend to rise
toward $100,000. This rise is just a reflection of the time value of money. As time passes, the
time until receipt of the $100,000 grows shorter, and the present value rises. In 2019, the price
will probably be higher for the same reason. We cannot be sure, however, because interest rates
could be much higher, or TMCC’s financial position could deteriorate. Either event would tend
to depress the security’s price.
Solutions to Questions and Problems

NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require
multiple steps. Due to space and readability constraints, when these intermediate steps are included
in this solutions manual, rounding may appear to have occurred. However, the final answer for each
problem is found without rounding during any step in the problem.

Basic

1. The time line for the cash flows is:

0 8

$8,600 FV

The simple interest per year is:

$8,600 × .075 = $645

So, after 8 years you will have:

$645 × 8 = $5,160 in interest

The total balance will be $8,600 + 5,160 = $13,760

With compound interest we use the future value formula:

FV = PV(1 + r)t
FV = $8,600(1.075)8
FV = $15,337.91

The difference is:

$15,337.91 – 13,760 = $1,577.91

2. To find the FV of a lump sum, we use:

FV = PV(1 + r)t

0 11

$2,597 FV

FV = $2,597(1.13)11 = $9,961.73

0 7

$7,834 FV

FV = $7,834(1.09)7 = $14,320.86
 0 14

$81,286 FV

FV = $81,286(1.12)14 = $397,253.81

0 16

$213,612 FV

FV = $213,612(1.06)16 = $542,649.60

3. To find the PV of a lump sum, we use:

PV = FV/(1 + r)t

0 17

PV $16,832

PV = $16,832/(1.09)17 = $3,889.42

0 9

PV $48,318

PV = $48,318/(1.07)9 = $26,281.79

0 23

PV $886,073

PV = $886,073/(1.13)23 = $53,292.40

0 35

PV $550,164

PV = $550,164/(1.21)35 = $696.63

4. We can use either the FV or the PV formula. Both will give the same answer since they are the
inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV/PV)1/t – 1

0 8

–$181 $317

FV = $317 = $181(1 + r)8 r = ($317/$181)1/8 – 1 = .0726, or 7.26%

0 13
 –$335 $1,080

FV = $1,080 = $335(1 + r)13 r = ($1,080/$335)1/13 – 1 = .0942, or 9.42%

0 11

–$48,000 $185,382

FV = $185,382 = $48,000(1 + r)11 r = ($185,382/$48,000)1/11 – 1 = .1307, or 13.07%

0 25

–$40,353 $531,618

FV = $531,618 = $40,353(1 + r)25 r = ($531,618/$40,353)1/25 – 1 = .1086, or 10.86%

5. We can use either the FV or the PV formula. Both will give the same answer since they are the
inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for t, we get:

t = ln(FV/PV)/ln(1 + r)

0 ?

–$610 $1,389

FV = $1,389 = $610(1.07)t t = ln($1,389/$610)/ln 1.07 = 12.16 years

0 ?

–$940 $1,821

FV = $1,821 = $940(1.08)t t = ln($1,821/$940)/ln 1.08 = 8.59 years

0 ?

–$26,350 $289,715

FV = $289,715 = $26,350(1.09)t t = ln($289,715/$26,350)/ln 1.09 = 27.82 years

0 ?

–$43,500 $430,258

FV = $430,258 = $43,500(1.11)t t = ln($430,258/$43,500)/ln 1.11 = 21.96 years

6. The time line is:

0 18

–$85,000 $325,000

We can use either the FV or the PV formula. Both will give the same answer since they are the
inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV/PV)1/t – 1
r = ($325,000/$85,000)1/18 – 1
r = .0774, or 7.74%

7. To find the length of time for money to double, triple, etc., the present value and future value are
irrelevant as long as the future value is twice the present value for doubling, three times as large
for tripling, etc. We can use either the FV or the PV formula. Both will give the same answer
since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for t, we get:

t = ln(FV/PV)/ln(1 + r)

The length of time to double your money is:

0 ?

–$1 $2

FV = $2 = $1(1.043)t
t = ln 2/ln 1.043 = 16.46 years

The length of time to quadruple your money is:

0 ?

–$1 $4

FV = $4 = $1(1.043)t
t = ln 4/ln 1.043 = 32.93 years

Notice that the length of time to quadruple your money is twice as long as the time needed to
double your money (the slight difference in these answers is due to rounding). This is an
important concept of time value of money.
8. The time line is:

0 19

–$197,700 $368,600

We can use either the FV or the PV formula. Both will give the same answer since they are the
inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV/PV)1/t – 1
r = ($368,600/$197,700)1/19 – 1
r = .0333, or 3.33%

9. The time line is:

0 ?

–$50,000 $275,000

We can use either the FV or the PV formula. Both will give the same answer since they are the
inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for t, we get:

t = ln (FV/PV)/ln (1 + r)
t = ln ($275,000/$50,000)/ln 1.048
t = 36.36 years

10. The time line is:

0 20

PV $450,000,000

To find the PV of a lump sum, we use:

PV = FV/(1 + r)t
PV = $450,000,000/(1.052)20
PV = $163,266,738.60
11. The time line is:

0 80

PV $2,000,000

To find the PV of a lump sum, we use:

PV = FV/(1 + r)t
PV = $2,000,000/(1.091)80
PV = $1,883.87

12. The time line is:

0 115

$50 FV

To find the FV of a lump sum, we use:

FV = PV(1 + r)t
FV = $50(1.043)115
FV = $6,333.82

13. The time line is:

0 124

–$150 $2,250,000

We can use either the FV or the PV formula. Both will give the same answer since they are the
inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV/PV)1/t – 1
r = ($2,250,000/$150)1/124 – 1
r = .0806, or 8.06%

To find the FV of the first prize in 2044, we use:

0 25

$2,250,000 FV

FV = PV(1 + r)t
FV = $2,250,000(1.0806)25
FV = $15,636,386.65
14. The time line is:

0 4

–$12,377,500 $10,311,500

We can use either the FV or the PV formula. Both will give the same answer since they are the
inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV/PV)1/t – 1
r = ($10,311,500/$12,377,500)1/4 – 1
r = –4.46%

Notice that the interest rate is negative. This occurs when the FV is less than the PV.

Intermediate

15. The time line from minting to the first sale is:

0 192

–$15 $430,000

We can use either the FV or the PV formula. Both will give the same answer since they are the
inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV/PV)1/t – 1
r = ($430,000/$15)1/192 – 1
r = .0549, or 5.49%

The time line from the first sale to the second sale is:

0 39

–$430,000 $5,500,000

We can use either the FV or the PV formula. Both will give the same answer since they are the
inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t
 Solving for r, we get:

r = (FV/PV)1/t – 1
r = ($5,500,000/$430,000)1/39 – 1
r = .0675, or 6.75%

The time line from minting to the second sale is:

0 231

–$15 $5,500,000

To answer this question, we can use either the FV or the PV formula. Both will give the same
answer since they are the inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV/PV)1/t – 1
r = ($5,500,000/$15)1/231 – 1
r = .0570, or 5.70%

16. We can use either the FV or the PV formula. Both will give the same answer since they are the
inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for r, we get:

r = (FV/PV)1/t – 1

a. The time line is:

0 20

–$50 $100

r = (FV/PV)1/t – 1
r = ($100/$50)1/20 – 1
r = .0353, or 3.53%

b. The time line is:

0 10

–$50 FV

FV = PV(1 + r)t
FV = $50(1 + .001)10
FV = $50.50
 c. The time line is:
0 10

–$50.50 $100

r = (FV/PV)1/t – 1
r = ($100/$50.50)1/10 – 1
r = .0707, or 7.07%

17. The time line is:

0 9

PV $275,000

To find the PV of a lump sum, we use:

PV = FV/(1 + r)t
PV = $275,000/(1.112)9
PV = $105,776.60

18. To find the FV of a lump sum, we use:

FV = PV(1 + r)t

0 45

$5,500 FV

FV = $5,500(1.10)45
FV = $400,897.66

0 35

$5,500 FV

FV = $5,500(1.10)35
FV = $154,563.40

Better start early!

19. The time line is:

0 2 8

$20,000 FV
 We need to find the FV of a lump sum. However, the money will only be invested for six years,
so the number of periods is six.

FV = PV(1 + r)t
FV = $20,000(1.068)6
FV = $29,679.56

20. The time line is:

0 2 ?

–$10,000 $60,000

We can use either the FV or the PV formula. Both will give the same answer since they are the
inverse of each other. We will use the FV formula, that is:

FV = PV(1 + r)t

Solving for t, we get:

t = ln(FV/PV)/ln(1 + r)
t = ln ($60,000/$10,000)/ln 1.11
t = 17.17

So, the money must be invested for 17.17 years. However, you will not receive the money for
another two years. From now, you’ll wait:

2 years + 17.17 years = 19.17 years

Calculator Solutions

1.
Enter 8 7.5% $8,600
N I/Y PV PMT FV
Solve for $15,337.91

$15,337.91 – 13,760 = $1,577.91

2.
Enter 11 13% $2,597
N I/Y PV PMT FV
Solve for $9,961.73

Enter 7 9% $7,834
N I/Y PV PMT FV
Solve for $14,320.86

Enter 14 12% $81,286

N I/Y PV PMT FV
Solve for $397,253.81

Enter 16 6% $213,612
N I/Y PV PMT FV
Solve for $542,649.60

3.
Enter 17 9% $16,832
N I/Y PV PMT FV
Solve for $3,889.42

Enter 9 7% $48,318
N I/Y PV PMT FV
Solve for $26,281.79

Enter 23 13% $886,073

N I/Y PV PMT FV
Solve for $53,292.40

Enter 35 21% $550,164

N I/Y PV PMT FV
Solve for $696.63
4.
Enter 8 $181 $317
N I/Y PV PMT FV
Solve for 7.26%

Enter 13 $335 $1,080

N I/Y PV PMT FV
Solve for 9.42%

Enter 11 $48,000 $185,382

N I/Y PV PMT FV
Solve for 13.07%

Enter 25 $40,353 $531,618

N I/Y PV PMT FV
Solve for 10.86%

5.
Enter 7% $610 $1,389
N I/Y PV PMT FV
Solve for 12.16

Enter 8% $940 $1,821

N I/Y PV PMT FV
Solve for 8.59

Enter 9% $26,350 $289,715

N I/Y PV PMT FV
Solve for 27.82

Enter 11% $43,500 $430,258

N I/Y PV PMT FV
Solve for 21.96

6.
Enter 18 $85,000 $325,000
N I/Y PV PMT FV
Solve for 7.74%

7.
Enter 4.3% $1 $2
N I/Y PV PMT FV
Solve for 16.46

Enter 4.3% $1 $4

N I/Y PV PMT FV
Solve for 32.93

8.
Enter 19 $197,700 $368,600
N I/Y PV PMT FV
Solve for 3.33%

9.
Enter 4.8% $50,000 $275,000
N I/Y PV PMT FV
Solve for 36.36

10.
Enter 20 5.2% $450,000,000
N I/Y PV PMT FV
Solve for $163,266,738.60

11.
Enter 80 9.1% $2,000,000
N I/Y PV PMT FV
Solve for $1,883.87

12.
Enter 115 4.3% $50
N I/Y PV PMT FV
Solve for $6,333.82

13.
Enter 124 $150 $2,250,000
N I/Y PV PMT FV
Solve for 8.06%

Enter 25 8.06% $2,250,000

N I/Y PV PMT FV
Solve for $15,636,386.65

14.
Enter 4 $12,377,500 $10,311,500
N I/Y PV PMT FV
Solve for –4.46%

15.
Enter 192 $15 $430,000
N I/Y PV PMT FV
Solve for 5.49%

Enter 39 $430,000 $5,500,000

N I/Y PV PMT FV
Solve for 6.75%

Enter 231 $15 $5,500,000

N I/Y PV PMT FV
Solve for 5.70%

16. a.
Enter 20 $50 $100
N I/Y PV PMT FV
Solve for 3.53%

b.
Enter 10 .10% $50
N I/Y PV PMT FV
Solve for $50.50

c.
Enter 10 $50.50 $100
N I/Y PV PMT FV
Solve for 7.07%

17.
Enter 9 11.2% $275,000
N I/Y PV PMT FV
Solve for $105,776.60

18.
Enter 45 10% $5,500
N I/Y PV PMT FV
Solve for $400,897.66

Enter 35 10% $5,500

N I/Y PV PMT FV
Solve for $154,563.40

19.
Enter 6 6.8% $20,000
N I/Y PV PMT FV
Solve for $29,679.56
20.
Enter 11% $10,000 $60,000
N I/Y PV PMT FV
Solve for 17.17

From now, you’ll wait 2 + 17.17 = 19.17 years.