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Suppose the interest rate is 10 percent. If \(100 is invested at this rate today, how much will it be worth after one year? After two years? After five years? What is the value today of \)100 paid one year from now? Paid two years from now? Paid five years from now?

Short Answer

Expert verified

$100 invested today will be worth $110 after one year, $121 after two years, and $161.05 after five years.

The value of $100 today paid after one year will be $90.91, after two years will be 82.64, and after five years will be $62.09.

Step by step solution

01

Calculating the future value

The future value is the amount an individual will get if invested at a specific interest rate and for a given time.

The future value of the investment is calculated below:

P=$100r=10100=0.1n=1FV=P1+rn=1001+0.11=1001.1=$110

The future value for $100 after one year will be $110.

Similarly, after two years and five years will be:

n=2;FV=P1+rn=1001+0.12=1001.21=$121n=5;FV=P1+rn=1001+0.15=1001.61051=$161.05

The future value for $100 after two years will be $121, and after five years will be $161.05.

02

Calculating the present value

The present value states the worth of an investment today but received at a later time.

The present value of the investment is calculated below:

FV=$100r=10100PV=FV1+r-n=1001+0.1-1=1000.9091=$90.91

The present value for $100 paid after one year will be $90.91.

Similarly, after two years and five years will be:

n=2;PV=FV1+r-n=1001+0.1-2=1000.8264=$82.64n=5;PV=FV1+r-n=1001+0.1-5=1000.6209=$62.09

The present value for $100 paid after two years will be $82.64, and paid after five years will be $62.09.

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Most popular questions from this chapter

You are planning to invest in fine wine. Each case costs \(100, and you know from experience that the value of a case of wine held for t years is 100t1/2. One hundred cases of wine are available for sale, and the interest rate is 10 percent.

  1. How many cases should you buy, how long should you wait to sell them, and how much money will you receive at the time of their sale?
  2. Suppose that at the time of purchase, someone offers you \)130 per case immediately. Should you take the offer?
  3. How would your answers change if the interest rate were only 5 percent?

A consumer faces the following decision: She can buy a computer for \(1000 and \)10 per month for Internet access for three years, or she can receive a \(400 rebate on the computer (so that its cost is \)600) but agree to pay \(25 per month for three years for Internet access. For simplification, assume that the consumer pays the access fees yearly (i.e., \)10 per month = $120 per year).

a. What should the consumer do if the interest rate is 3 percent?

b. What if the interest rate is 17 percent?

c. At what interest rate will the consumer be indifferent between the two options?

The market interest rate is 5 percent and is expected to stay at that level. Consumers can borrow and lend all they want at this rate. Explain your choice in each of the following situations:

  1. Would you prefer a \(500 gift today or a \)540 gift next year?
  2. Would you prefer a \(100 gift now or a \)500 loan without interest for four years?
  3. Would you prefer a \(350 rebate on an \)8000 car or one year of financing for the full price of the car at 0-percent interest?
  4. You have just won a million-dollar lottery and will receive \(50,000 a year for the next 20 years. How much is this worth to you today?
  5. You win the 鈥渉onest million鈥 jackpot. You can have \)1 million today or \(60,000 per year for eternity (a right that can be passed on to your heirs). Which doyou prefer?
  6. In the past, adult children had to pay taxes on gifts of over \)10,000 from their parents, but parents could make interest-free loans to their children. Why did some people call this policy unfair? To whom were the rules unfair?

Suppose your uncle gave you an oil well like the one described in Section 15.8. (Marginal production cost is constant at \(50.) The price of oil is currently \)80 but is controlled by a cartel that accounts for a large fraction of total production. Should you produce and sell all your oil now or wait to produce? Explain your answer.

Suppose the interest rate is 10 percent. What is the value of a coupon bond that pays \(80 per year for each of the next five years and then makes a principal repayment of \)1000 in the sixth year? Repeat for an interest rate of 15 percent.

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