Question 1

Your child's orthodontist offers you two alternative payment plans. The first plan requires a $4,000 immediate up- front payment. The second plan requires you to make monthly payments of $137.41, payable at the end of each month for 3 years. What nominal annual interest rate is built into the monthly payment plan?

Accepted Answer

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Question 2

Your sister turned 35 today, and she is planning to save $7,000 per year for retirement, with the first deposit to be made one year from today. She will invest in a mutual fund that's expected to provide a return of 7.5% per year. She plans to retire 30 years from today, when she turns 65, and she expects to live for 25 years after retirement, to age 90. Under these assumptions, how much can she spend each year after she retires? Her first withdrawal will be made at the end of her first retirement year.

Accepted Answer

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Question 3

Pace Co. borrowed $20,000 at a rate of 7.25%, simple interest, with interest paid at the end of each month. The bank uses a 360-day year. How much interest would Pace have to pay in a 30-day month?

Accepted Answer

We can use the simple interest formula to find the interest for a 30-day month:
Interest = Principal x Rate x Time
Since the bank uses a 360-day year, we need to divide the annual rate by 12 and the time by 12 as well:
Interest = $20,000 x 0.0725 x (30/360) = $120.83
Therefore, the correct answer is A) $120.83.

Question 4

Farmers Bank offers to lend you $50,000 at a nominal rate of 5.0%, simple interest, with interest paid quarterly. Merchants Bank offers to lend you the $50,000, but it will charge 6.0%, simple interest, with interest paid at the end of the year. What's the difference in the effective annual rates charged by the two banks?

Accepted Answer

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Question 5

Suppose you borrowed $15,000 at a rate of 8.5% and must repay it in 5 equal installments at the end of each of the next 5 years. By how much would you reduce the amount you owe in the first year?

Accepted Answer

We can use the formula for the present value of an annuity to calculate the amount of each installment payment:

PV = C[(1 - (1 + r)^-n) / r]

where PV is the present value (the amount borrowed), C is the amount of each installment payment, r is the interest rate (in decimal form), and n is the number of periods (in this case, 5).

Plugging in the values we know, we get:

15000 = C[(1 - (1 + 0.085)^-5) / 0.085]

Solving for C, we get:

C = $3,669.72

So each payment will be $3,669.72.

Now we can use the formula for the future value of an annuity to calculate how much will be left to pay after the first year:

FV = C[(1 + r)^n - 1] / r

where FV is the future value (what will be left to pay after the first year), C is the amount of each payment, r is the interest rate (in decimal form), and n is the number of periods (in this case, 4, since we're calculating after the first of the 5 payments has been made).

Plugging in the values we know, we get:

FV = 3669.72[(1 + 0.085)^4 - 1] / 0.085

Solving for FV, we get:

FV = $12,137.23

So after the first payment, there will be $12,137.23 left to pay. To calculate how much the amount owed was reduced, we can subtract this from the original amount borrowed:

$15,000 - $12,137.23 = $2,862.77

So the answer is not one of the choices given. However, we can look at the answer choices and find the one that is closest to our calculated value:

A) $2,404.91
B) $2,531.49
C) $2,658.06
D) $2,790.96
E) $2,930.51

We can see that the closest answer is B, $2,531.49, so that is our choice.

Question 6

Your bank offers to lend you $100,000 at an 8.5% annual interest rate to start your new business. The terms require you to amortize the loan with 10 equal end-of-year payments. How much interest would you be paying in Year 2?

Accepted Answer

To calculate the interest paid in year two, we need to first calculate the annual payment:
PV = $100,000
Annual interest rate = 8.5%
Number of years = 10
Using the formula for calculating an amortization payment, we get:
Annual payment = PV*(r*(1+r)^n) / ((1+r)^n - 1)
= $100,000*(0.085*(1+0.085)^10) / ((1+0.085)^10 - 1)
= $15,735.95
The interest paid in the second year is equal to the outstanding balance at the end of the first year multiplied by the annual interest rate.
Outstanding balance at the end of the first year = PV*(1+r)^(n-1) - annual payment*((1+r)^n - (1+r)^(n-1))/r
= $100,000*(1+0.085)^(1-1) - $15,735.95*((1+0.085)^10 - (1+0.085)^(1-1))/0.085
= $87,064.05
Interest paid in the second year = $87,064.05*0.085 = $7,927.

Question 7

You just deposited $2,500 in a bank account that pays a 4.0% nominal interest rate, compounded quarterly. If you also add another $5,000 to the account one year (4 quarters) from now and another $7,500 to the account two years (8 quarters) from now, how much will be in the account three years (12 quarters) from now?

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Question 8

Suppose you borrowed $12,000 at a rate of 9.0% and must repay it in 4 equal installments at the end of each of the next 4 years. How large would your payments be?

Accepted Answer

This is a problem of calculating the payment for an installment loan, which can be solved using the formula for the annuity payment or an amortization calculator. Given a principal of $12,000, an annual interest rate of 9.0%, and a term of 4 years, the correct payment amount is $3,704.02. This calculation takes into account the interest on the declining balance over the period, ensuring that both the principal and the interest are fully paid off over the 4 years.

Question 9

Suppose you borrowed $15,000 at a rate of 8.5% and must repay it in 5 equal installments at the end of each of the next 5 years. How much would you still owe at the end of the first year, after you have made the first payment?

Accepted Answer

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Question 10

You plan to borrow $35,000 at a 7.5% annual interest rate. The terms require you to amortize the loan with 7 equal end-of-year payments. How much interest would you be paying in Year 2?

Accepted Answer

First, we need to calculate the annual payment using the amortization formula:
PMT = r * PV / (1 - (1 + r)^(-n))
where
PMT = annual payment
r = annual interest rate
PV = present value of the loan
n = number of payments

Plugging in the given values:
PMT = 0.075 * 35,000 / (1 - (1 + 0.075)^(-7))
PMT = $6,188.01

In the second year, we need to calculate the interest portion of the second payment. To do this, we first need to find the principal portion of the first payment, which we can do using the formula:
Principal = PMT - r * PV
where
Principal = principal portion of the payment
PMT = payment amount
r = annual interest rate
PV = present value of the loan

Plugging in the given values:
Principal = $6,188.01 - 0.075 * $35,000
Principal = $3,758.51

Since the loan is being amortized, the principal portion of each payment will increase and the interest portion will decrease. In the second year, the principal portion will be higher and the interest portion will be lower than in the first year. To find the interest portion of the second payment, we need to subtract the principal portion of the first payment from the total interest paid over the first two payments:

Total interest paid over first two payments = r * PV + r * (PV - Principal)
Total interest paid over first two payments = 0.075 * $35,000 + 0.075 * ($35,000 - $3,758.51)
Total interest paid over first two payments = $5,371.49

Interest portion of second payment = Total interest paid over first two payments - Interest portion of first payment
Interest portion of second payment = $5,371.49 - ($6,188.01 - $3,758.51)
Interest portion of second payment = $2,326.27

Therefore, the answer is D) $2,326.27.

Question 11

Your brother's business obtained a 30-year amortized mortgage loan for $250,000 at a nominal annual rate of 7.0%, with 360 end-of-month payments. The firm can deduct the interest paid for tax purposes. What will the interest tax deduction be for Year 1?

Accepted Answer

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Question 12

You are considering investing in a bank account that pays a nominal annual rate of 7%, compounded monthly. If you invest $3,000 at the end of each month, how many months will it take for your account to grow to $150,000?

Accepted Answer

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Question 13

Suppose you deposited $5,000 in a bank account that pays 5.25% with daily compounding based on a 360-day year. How much would be in the account after 8 months, assuming each month has 30 days?

Accepted Answer

The formula for compound interest is A = P(1 + r/n)^(nt), where A is the amount of money accumulated after n years, including interest, P is the principal amount (the initial amount of money), r is the annual interest rate (decimal), n is the number of times that interest is compounded per year, and t is the time the money is invested for in years. In this case, P = $5,000, r = 5.25% or 0.0525, n = 360 (daily compounding), and t = 8/12 years (since 8 months is 8/12 of a year). Plugging these values into the formula gives A = 5000(1 + 0.0525/360)^(360*(8/12)), which calculates to approximately $5,178.09.

Question 14

Your company has just taken out a 1-year installment loan for $72,500 at a nominal rate of 11.0% but with equal end-of-month payments. What percentage of the 2nd monthly payment will go toward the repayment of principal?

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Question 15

Your subscription to Investing Wisely Weekly is about to expire. You plan to subscribe to the magazine for the rest of your life, and you can renew it by paying $85 annually, beginning immediately, or you can get a lifetime subscription for $850, also payable immediately. Assuming that you can earn 6.0% on your funds and that the annual renewal rate will remain constant, how many years must you live to make the lifetime subscription the better buy?

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Question 16

Your uncle will sell you his bicycle shop for $250,000, with "seller financing," at a 6.0% nominal annual rate. The terms of the loan would require you to make 12 equal end-of-month payments per year for 4 years, and then make an additional final (balloon) payment of $50,000 at the end of the last month. What would your equal monthly payments be?

Accepted Answer

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Question 17

Suppose you are buying your first condo for $145,000, and you will make a $15,000 down payment. You have arranged to finance the remainder with a 30-year, monthly payment, amortized mortgage at a 6.5% nominal interest rate, with the first payment due in one month. What will your monthly payments be?

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Question 18

Suppose you borrowed $14,000 at a rate of 10.0% and must repay it in 5 equal installments at the end of each of the next 5 years. How much interest would you have to pay in the first year?

Accepted Answer

The interest for the first year is calculated simply as 10% of the initial loan amount, which is 10% of $14,000 = $1,400.

Question 19

You agree to make 24 deposits of $500 at the beginning of each month into a bank account. At the end of the 24th month, you will have $13,000 in your account. If the bank compounds interest monthly, what nominal annual interest rate will you be earning?

Accepted Answer

BEGIN Mode
 $\begin{array}{lr}
\text { N } & 24 \
\text { PV } & \$ 0 \
\text { PMT } & \$ 500 \
\text { FV } & \$ 13,000 \
\text { I/MO } & 0.63 \% \
\text { I/YR } & 7.62 \%
\end{array}$

Question 20

You are considering an investment in a Third World bank account that pays a nominal annual rate of 18%, compounded monthly. If you invest $5,000 at the beginning of each month, how many months would it take for your account to grow to $250,000? Round fractional months up.

Accepted Answer

We can use the formula for the future value of an annuity to solve this problem:

FV = PMT * [((1 + r/n)^nt - 1) / (r/n)]

where FV is the future value, PMT is the payment, r is the nominal annual rate, n is the number of times compounded per year, and t is the number of years.

In this case, PMT = $5,000, r = 18%, n = 12 (compounded monthly), and we want to solve for t when FV = $250,000.

$250,000 = $5,000 * [((1 + 0.18/12)^(12t) - 1) / (0.18/12)]

Simplifying and solving for t, we get:

t = 37.95

Rounding up to the nearest whole number, we get t = 38 months, which is answer choice D.

Quiz 5: The Value of Money