Chapter 4

Q1: Simple Interest versus compound Interest First City Bank pays 9 percent simple interest on its savings account balances, whereas Second City Bank pays 9 percent interest compounded annually. If you made a $5,000 deposit in each bank, how much more money would you earn from your Second City Bank account at the end of 10 years? A: First City Bank: 5000*(1+10*0.09)=9500

Second City Bank: 5000*(1+0.09)10=11837

11837-9500=2337

So we will earn more $2,337 from Second City Bank account at the end of 10 years.

Q17: Calculating EAR First National Bank charges 10.1 percent compounded monthly on its business loans. First United Bank charges 10.4 percent compounded semiannually. As a potential borrower, to which bank would you go for a new loan? A:First National Bank: EAR=1+0.1011212-1=0.1058

First United Bank: EAR=1+0.10422-1=0.1067

So as a potential borrower, I would like to choose the First National Bank to go for a new loan.

Q23: Calculating Annuities You are planning to save for retirement over the next 30 years. To do this, you will invest $700 a month in a stock account and $300 a month in a bond account. The return of the stock account is expected to be 10 percent, and the bond account will pay 6 percent. When you retire, you will combine your money into an account with an 8 percent return. How much can you withdraw each month from your account assuming a 25-year withdrawal period? A:FVStock=700*(1+0.112)360-10.112=1582341.55

FVbond=300*(1+0.0612)360-10.0612=301354.51

PVA=1582341.55+301354.51=C*1-1(1+0.0812)3000.0812=14538.67

So you can withdraw $14538.67 each month from the account assuming a 25-year withdrawal period.

Q30: Balloon Payments Audrey Sanborn has just arranged to purchase a $450,000 vacation home in the Bahamas with a 20 percent down payment. The mortgage has a 7.5 percent stated annual interest rate, compounded monthly, and calls for equal monthly payments over the next 30 years. Her first payment will be due one month from now. However, the mortgage has an eight-year balloon payment, meaning that the balance of the loan must be paid off at the end of year 8. There were no other transaction costs or finance charges. How much will Audrey’s balloon payment be in eight years? A:The mortgage = 450000*0.8=360000

360000=C*1-1(1+0.07512)3600.07512 =>C=2517.17

Since we have experienced 8 years, so the left month is 264

Loan balance = 2517.17*1-1(1+0.00625)2640.00625=325001.45

So Audrey’s balloon payment will be $325001.45 in eight years.

Q38: Calculating Loan Payments You need a 30-year, fixed-rate mortgage to buy a new home for $250,000. Your mortgage bank will lend you the money at a 6.8 percent APR for this 360-month loan. However, you can only afford monthly payments of $1,200, so you offer to pay off any remaining loan balance at the end of the loan in the form of a single balloon payment. How large will this balloon payment have to be for you to keep your monthly payments at $1,200? A: the monthly payment is 1200, so

Loan=1200*1-1(1+0.06812)3600.06812=184070.20

250000-184070=65930

So the balloon payment is $65930 that you have to be for you to keep the monthly payments at $1200.

Chapter 5

Q20: Comparing Investment Criteria You are a senior manager at Poeing Aircraft and have been authorized to spend up to $400,000 for projects. The three projects you are considering have the following characteristics:

Project A:Initial investment of $280,000. Cash flow of $190,000 at year 1 and $170,000 at year 2. This is a plant expansion project, where the required rate of return is 10 percent.

Project B:Initial investment of $390,000. Cash flow of $270,000 at year 1 and $240,000 at year 2. This is a new product development project, where the required rate of return is 20 percent.

Project C:Initial investment of $230,000. Cash flow of $160,000 at year 1 and $190,000 at year2. This is a market expansion project, where the required...