Introduction to the Mathematics of Finance (Problem Set 6 – 9)

Examples
Text: G. D. Prichett & J. C. Saber
Solutions: Muhammad Shamim

Example 61 Sam purchased a piece of property by making a down

payment and signing an agreement to pay the remaining amount,
$5000, by making equal yearend payments of $700 for 10 years. Find
the rate of annually compounded interest that Sam is paying.

Solution: Given Payment per period (R) = $700

Present value of the annuity (P) = $5000
Number of periods (n) = 10 years
Requirement: Interest rate per period (i or IRR) = ?
Using interpolation method, we can see the present value interest factory
annuity (PVIFA) = P/R = 5000/700 = 7.143 at 10 years in the columns
between 6% (7.360) and 7%(7.024).

C Where,
 i (IRR) = A   ( B  A) A = Lower discounting rate
CD
152 B = Higher discounting rate
= 6  ( 7  6) C = NPV at lower discounting rate
152  (83.2)
= (700  7.360  5000)
152
= 6 1 = 152
235.2 D = NPV at higher discounting rate
= 6.64% (approx.) [Ans.] = (700  7.024  5000)
= – 83.2

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Example 62 Mary bought a new sports car for $26000. She was able
to put 10 percent down and wanted to finance the rest with
payments of $500 per month. If she is charged 12 percent interest,
how many payments much she make?

Solution: Given Payment per period (R) = $500

Present value of the annuity (P) = $26000  90%
= $23400
Interest rate per period (i) = 12%/12 = 0.12/12 = 0.01
Requirement: Number of periods (n) = ?
We know,
1  (1  i) n 
P = R 
 i 
1  (1  0.01)  n 
 $23400 = $500 
 0.01 
$23400 1  (1.01)  n 
 =  
$500  0.01 
1  (1.01)  n
 46.8 =
0.01
 46.8  0.01 = 1  (1.01)  n

 0.468 = 1  (1.01)  n
 (1.01)  n = 1 – 0.468
 (1.01)  n = 0.532
 ln (1.01)  n = ln 0.532
 – n ln 1.01 = ln 0.532
ln 0.532
–n =
ln 1.01
0.63111
–n =
0.00995
 – n = – 63.426
 n = 63.426 payments [Ans.]
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 Introduction to the Mathematics of Finance (Problem Set 6 – 9)
Example 63 How much must be deposited at the end of each quarter
for 5 years at 8 percent compounding continuously to accumulate
$10000 at the time of the last deposit?

Solution: Given Future value of the annuity (F) = $10000

Nominal interest rate (j) = 8% = 0.08
Number of compoundings per year (m) = 4 times
Number of years (t) = 5 years
Requirement: Payment per period (R) = ?
We know,
 e j / m  1
R = F jt

 e  1 

 e 0.08 / 4  1 
= $10000 (0.08)(5)

 e  1 

 e 0.02  1
= $10000 0.40

 e  1

 1.02020134  1 
= $10000 
1.491824698  1 

0.02020134 
= $10000 
 .491824698 
0

= $10000(0.041074269)
= $410.74 [Ans.]

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Exercises
Text: G. D. Prichett & J. C. Saber
Solutions: Muhammad Shamim
Exercise 36 At what interest rate, compounded semiannually, will an
ordinary annuity of $100 every 6 months amount to $2500 in 8
years?

Solution: Given Payment per period (R) = $100

Future value of the annuity (F) = $2500
Number of periods (n) = 8 years
= (8)(2) periods
= 16 periods
Requirement: Interest rate per period (i or IRR) = ?
Using interpolation method, we can see the future value interest factory
annuity (FVIFA) = F/R = 2500/100 = 25 at 16 years in the columns
between 5% (23.657) and 6%(25.673).

 C  Where,
i (IRR) = 2 A   (B  A)
 CD  A = Lower discounting rate
B = Higher discounting rate
 134.3  C = NFV at lower discounting rate
= 2 5   (6  5)
 134.3  (67.3)  = (2500  100  23.657)
= 134.3
134.3 
= 2 5   1 D = NFV at higher discounting rate
 201.6 
= (2500  100  25.673)
= 2(5.67%) = – 67.3
= 11.34% (approx.) [Ans.]

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 Introduction to the Mathematics of Finance (Problem Set 6 – 9)
Exercise 36 George buys a chalet in the mountains for $250000. He
puts 20 percent down and finances the balance with payments of
$3000 per month at 15 percent interest.
(a) How many payments does he make?
(b) What is the total amount paid to the nearest dollar?

Solution: Given Payment per period (R) = $3000

Present value of the annuity (P) = $250000  80%
= $200000
Interest rate per period (i) = 15%/12 = 0.15/12 = 0.0125

Requirement: (a) Number of periods (n) = ?

(b) Total payments (TP) = ?
(a) We know,
1  (1  i) n 
P = R 
 i 
1  (1  0.0125)  n 
 $200000 = $3000 
 0.0125 
$200000 1  (1.0125) n 
 =  
$3000  0.0125 
1  (1.0125)  n
 66.6667 =
0.0125
 66.6667  0.0125 = 1  (1.0125)  n
 0.8333 = 1  (1.0125)  n
 (1.0125)  n = 1 – 0.8333
 (1.0125)  n = 0.1667
 ln (1.0125)  n = ln 0.1667
 – n ln 1.0125 = ln 0.1667
ln 0.1667
–n =
ln 1.0125
1.791762172
–n =
0.012421395
 – n = – 144.235
 n = 144.235 payments [Ans.]

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 Bowen, Prichett & Saber’s Mathematics Manual
(b) We know,
Total payments (TP) = R  n
= $3000  144.235
= $432705 [Ans.]

Exercise 37 How much should be deposited now at 6 percent

compounded continuously to provide payments of $2000 at the end
of each 6 months for 8 years?

Solution: Given Payment per period (R) = $2000

Nominal interest rate (j) = 6% = 0.06
Number of compoundings per year (m) = 2 times
Number of years (t) = 8 years

Requirement: Present value of the annuity (P) = ?

We know,
 1  e  jt 
P = R j/ m

 e  1 

1  e (0.06)(8) 
= $2000 0.06 / 2

 e  1 

1  e 0.48 
= $2000 0.03

 e  1 

1  0.618783391
= $2000 
1.030454534  1 
0.381216608 
= $2000 
 0.030454533 
= $2000(12.517565)
= $25035.13 [Ans.]

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 Introduction to the Mathematics of Finance (Problem Set 6 – 9)

Problem Set 6 – 9
Text: G. D. Prichett & J. C. Saber
Solutions: Muhammad Shamim

1 At what rate of interest compounded annually will payments of

$2000 at the end of each year for 8 years amount to $20000?

Solution: Given Payment per period (R) = $2000

Future value of the annuity (F) = $20000
Number of periods (n) = 8 years
= (8)(1) periods
= 8 periods

Requirement: Interest rate per period (i or IRR) = ?

Using interpolation method, we can see the future value interest factory
annuity (FVIFA) = F/R = 20000/2000 = 10 at 16 years in the columns
between 6% (9.897) and 7%(10.260).

C Where,
i (IRR) = A  
 (B  A)
A = Lower discounting rate
 CD 
B = Higher discounting rate
 206  C = NFV at lower discounting rate
= 6   (7  6)
 206  (520)  = (20000  2000  9.897)

206  = 206

= 6   1 D = NFV at higher discounting rate
 726 
= (20000  2000  10.260)
= 6.284% (approx.) [Ans.] = – 520

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 Bowen, Prichett & Saber’s Mathematics Manual
2 At what rate of interest compounded annually will $50000 be
accumulated by payments of $2000 at the end of each year for 15
years?

Solution: Given Payment per period (R) = $2000

Future value of the annuity (F) = $50000
Number of periods (n) = 15 years
= (15)(1) periods
= 15 periods
Requirement: Interest rate per period (i or IRR) = ?

Using interpolation method, we can see the future value interest factory
annuity (FVIFA) = F/R = 50000/2000 = 25 at 15 periods in the columns
between 6% (23.276) and 7%(25.129).

C Where,
i (IRR) = A  
 (B  A)
 CD  A = Lower discounting rate
B = Higher discounting rate
 3448  C = NFV at lower discounting rate
= 6   (7  6)
 3448  (258)  = (50000  2000  23.276)
= 3448
3448 
= 6   1 D = NFV at higher discounting rate
 3706 
= (50000  2000  25.129)
= 6.93% (approx.) [Ans.] = – 258

3 At what rate of interest will a principal of $20000 provide

payments of $2000 at the end of each year for 20 years?

Solution: Given Payment per period (R) = 2000

Present value of the annuity (P) = $20000
Number of periods (n) = 20 years

Requirement: Interest rate per period (i or IRR) = ?

Using interpolation method, we can see the present value interest factory
annuity (PVIFA) = P/R = 20000/2000 = 10 at 20 years in the columns
between 7% (10.594) and 8%(9.818).

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 Introduction to the Mathematics of Finance (Problem Set 6 – 9)
C Where,
 i (IRR) = A   ( B  A)
CD A = Lower discounting rate
B = Higher discounting rate
1188
= 7  (7  6) C = NPV at lower discounting rate
1188  (364)
= (2000  10.594  20000)
1188 = 1188
= 7 1
1552 D = NPV at higher discounting rate
= 7.76% (approx.) [Ans.] = (2000  9.818  20000)
= – 364

4 At what rate of interest compounded annually will $5000 payments

at the end of each year for 11 years be provided by a principal
investment now of $40000?
Solution: Given Payment per period (R) = 5000
Present value of the annuity (P) = $40000
Number of periods (n) = 11 years
Requirement: Interest rate per period (i or IRR) = ?

Using interpolation method, we can see the present value interest factory
annuity (PVIFA) = P/R = 40000/5000 = 8 at 11 years in the columns
between 5% (8.306) and 6%(7.887).

C Where,
 i (IRR) = A   ( B  A)
A = Lower discounting rate
CD
B = Higher discounting rate
1530
= 5  (6  5) C = NPV at lower discounting rate
1530  (565) = (5000  8.306  40000)
1530 = 1530
= 5 1 D = NPV at higher discounting rate
2095
= (5000  7.887  40000)
= 5.73% (approx.) [Ans.] = – 565

5 Joan deposits $500 in her savings account at the end of every 6

months until she has $5800. If she is getting 12 percent interest
compounded semiannually, how many deposits will she make? What
will be the amount of her last deposit?

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 Bowen, Prichett & Saber’s Mathematics Manual

Solution: Given Payment per period (R) = $500

Future value of the annuity (F) = $5800
Interest rate per period (i) = 12%/2 = 0.12/2 = 0.06
Requirement: (a) Number of periods (n) = ?
(b) Amount of last payment (LP) = ?
(a) We know,
 (1  i) n  1 
F = R 
 i 

 (1  0.06) n  1 
 $5800 = $500 
 0.06 

$5800  (1.06) n  1
 =  
$500  0.06 

(1.06) n  1
 11.6 =
0.06

 11.6  0.06 = (1.06) n  1

 0.696 = (1.06) n  1

 (1.06) n  1 = 0.696

 (1.06) n = 0.696 + 1

 (1.06) n = 1.696

 ln (1.06) n = ln 1.696

 n ln 1.06 = ln 1.696
ln 1.696
 n =
ln 1.06
0.528272537
 n =
0.058268908
 n = 9.06611
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 Introduction to the Mathematics of Finance (Problem Set 6 – 9)
 n = 10 payments [Ans.]
(b) We know,
Amount of last payment (LP) = R  n – [R  (n – 1 )]
= ($500  10) – [R  (10 – 1 )]
= ($500  9.06611) – ($500  9)
= $4533 – $4500
= $33 [Ans.]

6 Chris wants to accumulate $10000 and is able to put $300 into his
credit union monthly. If he is getting 15 percent interest
compounded monthly, how long will it take him? What is his last
contribution?

Solution: Given Payment per period (R) = $300

Future value of the annuity (F) = $10000
Interest rate per period (i) = 15%/12 = 0.15/12 = 0.0125

Requirement: (a) Number of periods (n) = ?

(b) Total payments (TP) = ?

(a) We know,
 (1  i) n  1 
F = R 
 i 

 (1  0.0125) n  1 
 $10000 = $300 
 0.0125 

$10000  (1.0125) n  1
 =  
$300  0.0125 

(1.0125) n  1
 33.3333 =
0.0125

 33.3333  0.0125 = (1.0125) n  1

 0.416667 = (1.0125) n  1

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 Bowen, Prichett & Saber’s Mathematics Manual
 (1.0125) n  1 = 0.416667

 (1.0125) n = 0.416667 + 1

 (1.0125) n = 1.416667

 ln (1.0125) n = ln 1.416667

 n ln 1.0125 = ln 1.416667
ln 1.416667
 n =
ln 1.0125
0.348306929
 n =
0.012026342
 n = 28.962 payments [Ans.]
 n = 29 payments [Ans.]

(b) We know,
Amount of last payment (LP) = R  n – [R  (n – 1 )]
= ($500  10) – [R  (10 – 1 )]
= ($300  29) – ($300  28.962)
= $8700 – $8688.6
= $11.40 [Ans.]

7 Nick has a chance to buy a new power boat for $14000. His uncle,
who owns the boat, has agreed to allow Nick to pay $600 per month
and will charge him 10 percent interest compounded monthly. How
many payments will Nick make? What is the total amount paid to
the nearest dollar?

Solution: Given Payment per period (R) = $600

Present value of the annuity (P) = $14000
Interest rate per period (i) = 10%/12 = 0.10/12

Requirement: (a) Number of periods (n) = ?

(b) Total payments (TP) = ?
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 Introduction to the Mathematics of Finance (Problem Set 6 – 9)
(a) We know,
1  (1  i) n 
P = R 
 i 

1  (1  0.10 / 12) n 
 $14000 = $600 
 0.10 / 12 

$14000 1  (1  0.10 / 12)  n 

 =  
$600  0.10 / 12 

1  (1  0.10 / 12)  n
 23.3333 =
0.10 / 12

 23.3333  0.10/12 = 1  (1  0.10 / 12)  n

 0.194444 = 1  (1.0083333)  n

 (1.0083333)  n = 1 – 0.194444

 (1.0083333)  n = 0.805556

 ln (1.0083333)  n = ln 0.805556

 – n ln 1.0083333 = ln 0.805556
ln 0.805556
–n =
ln 1.0083333
0.216222556
–n =
0.008298769
 – n = – 26.05477
 n = 27 payments [Ans.]

(b) We know,
Total payments (TP) = R  n
= $600  26.05477
= $15633 [Ans.]

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8 Rita wants to buy a vacation condominium for $75000. She is able
to put 10 percent down and wants to pay $800 per month to
amortize the balance. If she is charged 11 percent interest
compounded monthly, how many payments will she make? What is
the total amount paid to the nearest dollar?

Solution: Given Payment per period (R) = $800

Present value of the annuity (P) = $75000  90% = $67500
Interest rate per period (i) = 11%/12 = 0.11/12

Requirement: (a) Number of periods (n) = ?

(b) Total payments (TP) = ?
(a) We know,
1  (1  i) n 
P = R 
 i 
1  (1  0.11 / 12)  n 
 $67500 = $800 
 0.11 / 12 

$67500 1  (1  0.11 / 12)  n 

 =  
$800  0.11 / 12 
1  (1  0.11 / 12)  n
 84.375 =
0.11 / 12
 84.375  0.11/12 = 1  (1  0.11 / 12)  n
 0.7734375 = 1  (1.0091667)  n
 (1.0091667)  n = 1 – 0.7734375
 (1.0091667)  n = 0.2265625
 ln (1.0091667)  n = ln 0.2265625
 – n ln 1.0091667 = ln 0.2265625
ln 0.2265625
–n =
ln 1.0091667
1.484734434
–n =
0.00912494
 – n = – 162.712
 n = 163 payments [Ans.]
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 Introduction to the Mathematics of Finance (Problem Set 6 – 9)
(b) We know,
Total payments (TP) = R  n
= $800  162.712
= $130170 [Ans.]

9 Sam deposits $500 at the end of each 6 months for 10 years in an

account earning 6 percent. How much will be in the account after
the last payment?

Solution: Given Payment per period (R) = $500

Number of periods (n) = 10  2 = 20
Interest rate per period (i) = 6%/2 = 0.06/2 = 0.03

Requirement: Future value of the annuity (F) = ?

We know,
 (1  i) n  1 
F = R 
 i 

 (1  0.03) 20  1 
= $500 
 0.03 

= $500(26.87038)
= $13435.19 [Ans.]

10 Bill wants to accumulate $5000 to buy a boat 5 years from now by

making deposits at the end of each quarter to an account earning 8
percent. How much should Bill deposit each quarter?

Solution: Given Future value of the annuity (F) = $5000

Number of periods (n) = 5  4 = 20
Interest rate per period (i) = 8%/4 = 0.08/4 = 0.02

Requirement: Payment per period (R) = ?

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 Bowen, Prichett & Saber’s Mathematics Manual
We know,
 i 
R = F n 
 (1  i)  1 

 0.02 
= $5000 20 
 (1  0.02)  1 

= $5000(0.041156)

= $205.78 [Ans.]

11 George has $100 deducted from his salary at the end of each
month and invested in an employees’ fund that earns 12 percent
interest. How much will he have after the last payment 10 years
from now?

Solution: Given Payment per period (R) = $100

Number of periods (n) = 10  12 = 120
Interest rate per period (i) = 12%/12 = 0.12/12 = 0.01
Requirement: Future value of the annuity (F) = ?

We know,
 (1  i) n  1 
F = R 
 i 

 (1  0.01)120  1
= $100 
 0.01 

 (1  0.01)120  1
= $100 
 0.01 

= $100(230.0387)
= $23003.87 [Ans.]

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 Introduction to the Mathematics of Finance (Problem Set 6 – 9)
12 A company wants to accumulate $15000 to replace a machine 5
years from now. To do this, equal payments are to be made at the
end of each 6-month period to an account earning 10 percent
interest. Find the periodic payment.

Solution: Given Future value of the annuity (F) = $15000

Number of periods (n) = 5  2 = 10
Interest rate per period (i) = 10%/2 = 0.10/2 = 0.05

Requirement: Payment per period (R) = ?

We know,
 i 
R = F n 
 (1  i)  1 

 0.05 
= $15000 10 
 (1  0.05)  1
= $15000(0.079504)
= $1192.57 [Ans.]

13 Fran has an opportunity to lend a growing company a sum of

money and earn 10 percent interest. The company will discharge its
debt to Fran by sending her equal amounts every 6 months for 5
years. How much should Fran lend if she wants to receive $2000
every 6 months?

Solution: Given Payment per period (R) = $2000

Number of periods (n) = 5  2 = 10
Interest rate per period (i) = 10%/2 = 0.10/2 = 0.05
Requirement: Present value of the annuity (P) = ?

We know,
1  (1  i)  n 
P = R 
 i 

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1  (1  0.05) 10 
= $2000 
 0.05 
= $2000(7.721735)
= $15443.47 [Ans.]

14 How much invested now at 8 percent will provide an income of

$1000 per quarter for the next 7 years?

Solution: Given Payment per period (R) = $1000

Number of periods (n) = 7  4 = 28
Interest rate per period (i) = 8%/4 = 0.08/4 = 0.02

Requirement: Future value of the annuity (F) = ?

We know,
1  (1  i)  n 
P = R 
 i 

1  (1  0.02) 28 
= $1000 
 0.02 
= $1000(21.28127)
= $21281.27 [Ans.]

15 Jan has lent a new company $10000 at 12 percent. The company

will discharge its debt by sending Jan checks of equal amounts, one
each month, for 6 years. How much will Jan receive each month?

Solution: Given Present value of the annuity (F) = $10000

Number of periods (n) = 6  12 = 72
Interest rate per period (i) = 12%/12 = 0.12/12 = 0.01

Requirement: Payment per period (R) = ?

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 Introduction to the Mathematics of Finance (Problem Set 6 – 9)
We know,
 i 
R = P n 
1  (1  i) 

 0.01 
= $10000 72 
1  (1  0.01) 

= $10000(0.019550)
= $195.50 [Ans.]

16 Bill has borrowed $5000 at 24 percent to purchase a car. He will

discharge the debt by equal end-of-the-month payments for 3 years.
Find the payment.

Solution: Given Present value of the annuity (F) = $5000

Number of periods (n) = 2  12 = 36
Interest rate per period (i) = 24%/12 = 0.24/12 = 0.02
Requirement: Payment per period (R) = ?
We know,
 i 
R = P n 
1  (1  i) 

 0.02 
= $5000 36 
1  (1  0.02) 
= $5000(0.039232)
= $196.16 [Ans.]

17 Fran deposits $150 at the end of each month for 6 years in an

account earning 7.2 percent compounded continuously. What will be
the amount in the account after the last deposit?

Solution: Given Payment per period (R) = $150

Nominal interest rate (j) = 7.2% = 0.072
Number of compoundings per year (m) = 12 times
Number of years (t) = 6 years

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 Bowen, Prichett & Saber’s Mathematics Manual
Requirement: Future value of the annuity (F) = ?

We know,
 e jt  1 
F = R j/ m

 e  1

 e ( 0.072)(6)  1 
= $150 0.072 / 12

 e  1 

 e 0.432  1 
= $150 0.006

 e  1 

= $150(89.78596)
= $13467.89 [Ans.]

18 How much should be deposited at the end of each month for 10

years to accumulate $20000 if the account earns 8 percent
compounded continuously?

Solution: Given Future value of the annuity (F) = $20000

Nominal interest rate (j) = 8% = 0.08
Number of compoundings per year (m) = 12 times
Number of years (t) = 10 years
Requirement: Payment per period (R) = ?
We know,
 e j / m  1
R = F jt

 e  1 

 e 0.08 / 12  1 
= $20000 (0.08)(10)

 e  1 

 e 0.006667  1 
= $20000 0.80

 e  1 

= $20000(0.005458)
= $109.16 [Ans.]

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 Introduction to the Mathematics of Finance (Problem Set 6 – 9)
19 What sum of money deposited at 7.5 percent compounded
continuously will yield an income of $1500 at the end of each month
for 6 years?

Solution: Given Payment per period (R) = $1500

Nominal interest rate (j) = 7.5% = 0.075
Number of compoundings per year (m) = 12 times
Number of years (t) = 6 years

Requirement: Present value of the annuity (P) = ?

We know,
 1  e  jt 
P = R j/ m

 e  1 

1  e (0.075)(6) 
= $1500 0.075 / 12

 e  1 

 1  e 0.45 
= $1500 0.00625

 e  1 

 1  e 0.45 
= $1500 0.00625

 e  1 

= $1500(57.7985)
= $86697.75 [Ans.]

20 Bill borrowed $6000 at 18 percent compounded continuously to

buy a car. He will discharge the debt by equal end-of-the-month
payments for 3 years. Find the amount of the payment.

Solution: Given Present value of the annuity (P) = $6000

Nominal interest rate (j) = 18% = 0.18
Number of compoundings per year (m) = 12 times
Number of years (t) = 3 years

Requirement: Payment per period (R) = ?

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 Bowen, Prichett & Saber’s Mathematics Manual
We know,
 e j / m  1
R = P  jt

 1  e 
 e 0.18 / 12  1 
= $6000  (0.18)(3)

1  e 
 e 0.015  1 
= $6000  0.54

1  e 
= $6000(0.03622)
= $217.32 [Ans.]

612