Time value of money

Decision #1: Which set of Cash Flows is worth more now?

Assume that your grandmother wants to give you generous gift. She wants you to choose which one of the following sets of cash flows you would like to receive:

Option B: Receive a \$1250 gift each year for the next 10 years. The first \$1250 would be
Option C: Receive a one-time gift of \$15,000 10 years from today.

Compute the Present Value of each of these options if you expect the interest rate to be 3% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

Option A would be worth \$__________ today.
Option B would be worth \$__________ today.
Option C would be worth \$__________ today.
Financial theory supports choosing Option _______

Compute the Present Value of each of these options if you expect the interest rate to be 6% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

Option A would be worth \$__________ today.
Option B would be worth \$__________ today.
Option C would be worth \$__________ today.
Financial theory supports choosing Option _______

Compute the Present Value of each of these options if you expect to be able to earn 9% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

Option A would be worth \$__________ today.
Option B would be worth \$__________ today.
Option C would be worth \$__________ today.
Financial theory supports choosing Option _______

Decision #2 begins at the top of page 2!

Decision #2: Planning for Retirement

Luke and Olivia are 22, newly married, and ready to embark on the journey of life. They both plan to retire 45 years from today. Because their budget seems tight right now, they had been thinking that they would wait at least 10 years and then start investing \$1800 per year to prepare for retirement. Olivia just told Luke, though, that she had heard that they would actually have more money the day they retire if they put \$1800 per year away for the next 10 years – and then simply let that money sit for the next 35 years without any additional payments – than they would have if they waited 10 years to start investing for retirement and then made yearly payments for 35 years (as they originally planned to do).

Assume that all payments are made at the end of a year, and that the rate of return on all yearly investments will be 8.4% annually.

a) How much money will Luke and Olivia have in 45 years if they do nothing for the next 10 years, then put \$1800 per year away for the remaining 35 years?

b) How much money will Luke and Olivia have in 10 years if they put \$1800 per year away for the next 10 years?

b2) How much will that amount you just computed grow to if it remains invested for the remaining