Textbook Question 3

Use what you have learned about the time value of money toanalyze each of the following decisions:

Decision #1:   Which set of Cash Flows isworth more now?

Assume that your grandmother wants to give you generousgift. She wants you to choose which one of the following sets ofcash flows you would like to receive:

Option A: Receive a one-time gift of $ 10,000 today.  

Option B: Receive a $1500 gifteach year for the next 10 years. The first $1500 wouldbe

    received 1 year from today.                

Option C: Receive a one-time gift of $18,000 10 yearsfrom today.

Compute the Present Value of each of these optionsif you expect the interest rate to be 3% annually for the next 10years.    Which of these options does financialtheory suggest you should choose?

       Option A would be worth$__________ today.

      Option B would be worth$__________ today.

       Option C would be worth$__________ today.

       Financial theory supportschoosing Option _______

       

Compute the Present Value of each of these optionsif you expect the interest rate to be 6% annually for the next 10years. Which of these options does financial theory suggest youshould choose?

       Option Awould be worth $__________ today.

       Option B would be worth$__________ today.

       Option C would be worth$__________ today.

      Financial theory supportschoosing Option _______

Compute the Present Value of each of these optionsif you expect to be able to earn 9% annually for the next 10 years.Which of these options does financial theory suggest you shouldchoose?

       Option Awould be worth $__________ today.

       Option B would be worth$__________ today.

       Option C would be worth$__________ today.

       Financial theory supportschoosing Option _______

Decision #2: Planning forRetirement

Erich and Mallory are 22, newly married, and ready to embark onthe journey of life.   They both plan to retire 45 yearsfrom today. Because their budget seems tight right now, they hadbeen thinking that they would wait at least 10 years and then startinvesting $3000 per year to prepare for retirement. Mallory justtold Erich, though, that she had heard that they would actuallyhave more money the day they retire if they put $3000 per year awayfor the next 10 years - and then simply let that money sit for thenext 35 years without any additional payments – then they wouldhave MORE when they retired than if they waited 10 years to startinvesting for retirement and then made yearly payments for 35 years(as they originally planned to do).   Please helpErich and Mallory make an informeddecision:   

Assume that all payments are made at the END a year(or month), and that the rate of return on all yearly investmentswill be 7.2% annually.  

(Please do NOT ROUND when entering “Rates” for any ofthe questions below)

1. How much money will Erich and Mallory have in 45 years if theydo nothing for the next 10 years, then put $3000 per yearaway for the remaining 35 years?

1. How much money will Erich and Mallory have in 10 years if theyput $3000 per year away for the next 10 years?

b2) How much will the amount you just computed grow to if itremains invested for the remaining

35 years, but without any additional yearly deposits beingmade?

1. How much money will Erich and Mallory have in 45 years if theyput $3000 per year away for each of the next 45 years?

How much money will Erich and Malloryhave in 45 years if they put away $250

1. per MONTH at the end of each monthfor the next 45 years? (Remember to adjust 7.2% annualrate to a Rate per month!)

1. If Erich and Mallory wait 25 years (after the kids are raised!)before they put anything away for retirement, how much will theyhave to put away at the end of eachyear for 20 years in order to have $1,000,000 savedup on the first day of their retirement 45 years from today?