Question

1. How might you relate the “time value of money” concept to something in your life? For example, how does it apply to repaying student loans, or to other financial obligations or assets you currently have?

2. If you loan Jack $5,000 at 5% for one year, and the inflation rate is 10%, how much do you lose, or gain, in purchasing power during that year?

3.Jordan Jessup is planning to invest $25,000 in a mutual fund that will provide a return of 8% per year. What will be the value of the investment at the end of 10 years?

4.If the nominal rate of interest is 4.25%, and the expected rate of inflation is 1.75%, what is the real rate of interest?

5.You are in desperate need of cash and you turn to your uncle who has offered to lend you some money. You decide to borrow $1,300 and agree to pay back $1,500 in two years. Alternatively, if you borrow from your bank they will charge 6.5% interest per year. Which is the best plan?

6. Zephre Manufacturing Co. has sales of $1,125 million. They expect sales to grow at the rate of 6.5% annually. How long will it take for sales to double?

7.Calculate the slope or beta where the following facts exist: In Year 1 a share of IBM stock increased 8%, and in Year 2 it increased 10%. At the same time the S&P index increased 5% in Year 1 and 7% in Year 2.

Once calculated, explain what your answer means.

8.The local real estate market is heating up and you have purchased a residential dwelling for $100,000 that you plan to flip in one year. The following are possible future prices and the probabilities: $80,000 at 10%, $110,000 at 30%, $125,000 at 50%, and $130,000 at 10%.

Compute the Expected Rate of Return.

Answer 1

1. Time value of money as the name explains the value of money at a certain specified time, it might be one year earlier, or one year after, or any period specified.

   For eg: If we are to get 10% return for a year, and we need $1,100 at the end of period, then amount to be invested = $1,000. In this manner, if we are to repay student loan by the end of 4^th year of graduation, we will calculate its current value, or amount to be paid at that time by adding interest charges, which explain the time value of money.

2. Provided loan to Jack = $5,000

   Interest rate = 5%, Interest value = $250

   Inflation Rate = 10%, thus value at year end because of inflation = total amount with interest + 10% = $5,250 + 10% = 5,775

   Loss due to inflation = $5,775 - $5,250 = $525

3. Annual return on mutual funds = 8%

   The compounded interest factor for 8% for 10 years = 2.1589

   This can be calculated simply by:

   ((((((((((1+ 8%)+ 8%) + 8%) + 8%) + 8%) + 8%) + 8%) + 8%) + 8%) + 8%) = 2.1589

   Value after 10 years = 25,000 X 2.1589 = $53,972.50

   Note: the return on base amount is on compound basis.

   Value at the end of 10 years = $53,972.50

4. Real rate of interest = Nominal rate – Inflation rate,

   Here, Nominal rate = 4.25%

   Inflation rate = 1.75%

   Therefore, Real rate of interest = 4.25 – 1.75 = 2.50%

   This is because revenue is nominal interest = 4.25% and cost = inflation rate = 1.75% thus, real rate is net of both rates.