Financial Decisions Fin 534

Assignment #1 Financial Decisions

January 23, 2011

The principle of finance is money is worth more the sooner it is received. This is true as long as the money earns interest (http://www.investopedia.com/terms/t/timevalueofmoney.asp). Time value of money is the difference between money today and money in the future.

The future value of one hundred dollars for example, has the potential to be worth one hundred and five dollars ($100*1.05) in one year from today assuming it earns five percent interest. The present value of one hundred dollars assuming it earns five percent interest received one year from today is only worth ninety five dollars and twenty four cents today ($100/1.05). Given a fixed interest rate it is possible to calculate the present value and the future value of a dollar (http://www.investopedia.com/terms/t/timevalueofmoney.asp).

The present value is the initial amount of an investment discounted. The present value represents the cash flow back in time. To calculate the present value one must discount the interest rate factor by dividing the initial investment by the interest rate factor (Berk & DeMarzo, 2010).

The future value is the initial amount of an investment compounded. The future value represents the cash flow forward in time. To calculate the future value one must compound the interest rate by multiplying the initial investment by the interest rate factor (Berk & DeMarzo, 2010).

The U.S. Securities and Exchange Commission defines an annuity as a contract between an individual and an insurance company. Under this contract the individual will make a series of payments. In a fixed annuity the individual is guaranteed to earn a minimum rate of interest (http://www.sec.gov/answers/annuity.htm).

Problem thirty-five states the following:

"You are saving for retirement. To live comfortably, you decide you will need to save $2 million by the time you are 65. Today is your 30th birthday, and you decide, starting today and continuing on every birthday up to and including your 65th birthday, that you will put the same amount into a savings account. If the interest rate is 5%, how much must you set aside each year to make sure that you will have $2 million in the account on your 65th birthday (Berk & DeMarzo, 2010)?"

Total number of payments = 36 (starting today 30th birthday and continuing on every birthday up to and including your 65th birthday)

Rate Per Nper Pv Fv Excel Formula

Given 5.00% 1 year 35 0 $2,000,000.00

Solve for PPMT -22,143.41 =PPMT(.05,1,35,2000000.00)

The calculations increase $2 million by 5%. $2 million * 1.05 = $2,100,000

n = 35 r = 5%

PPMT = ($22,143.41)

If the interest rate is 5%, you must set aside $22,143.00 (rounded to the nearest dollar) each year to make sure that you will have $2 million in the account on your 65th birthday.

Problem thirty-six states the following:

"You