Chapter 4 Financial Management the Time Value of Money

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Chapter 4 The Time Value of Money 4-1. You have just taken out a five-year loan from a bank to buy an engagement ring. The ring costs $5000. You plan to put down $1000 and borrow $4000. You will need to make annual payments of $1000 at the end of each year. Show the timeline of the loan from your perspective. How would the timeline differ if you created it from the bank’s perspective? 0 1 2 3 4 5 4000 –1000 –1000 –1000 –1000 –1000 From the bank’s perspective, the timeline is the same except all the signs are reversed. 4-2. You currently have a four-year-old mortgage outstanding on your house. You make monthly payments of $1500. You have just made a payment. The mortgage has 26 years to go (i.e., it had an original term of 30 years). Show the timeline from your perspective. How would the timeline differ if you created it from the bank’s perspective? 0 1 2 3 4 312 –1500 –1500 –1500 –1500 –1500 From the bank’s perspective, the timeline would be identical except with opposite signs. 4-3. Calculate the future value of $2000 in a. c. Five years at an interest rate of 5% per year. Five years at an interest rate of 10% per year. b. Ten years at an interest rate of 5% per year. d. Why is the amount of interest earned in part (a) less than half the amount of interest earned in part (b)? a. Timeline: 0 1 2 5 2000 FV5 = 2, 000 × 1.055 = 2, 552.56 FV= ? ©2011 Pearson Education, Inc. Publishing as Prentice Hall Berk/DeMarzo • Corporate Finance, Second Edition b. Timeline: 0 27 1 2 10 2000 FV10 = 2, 000 × 1.0510 = 3, 257.79 FV=? c. Timeline: 0 1 2 5 2000 FV5 = 2, 000 × 1.15 = 3, 221.02 FV= ? d. 4-4. Because in the last 5 years you get interest on the interest earned in the first 5 years as well as interest on the original $2,000. What is the present value of $10,000 received

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