FINANCE 6500 TIME VALUE PROBLEM SET
Please use your calculator to answer the following questions. Write your answer below each question,
including the calculator keystrokes.
The Open Market Committee of the US Federal Reserve System targets inflation as a means of
controlling the economy. They have repeatedly stated their desire to have an annual inflation rate of
2%. Suppose they are able to achieve this year-in and year out. Assume your annual salary is $100,000. If
you plan to retire 35 years from today, how much must your annual salary be 35 years hence to provide
as much purchasing power as you have now? (Ignore taxes and other complications.)
Now suppose that inflation “gets away” from the Fed (as it did in the 1970s). As a result, the annual
inflation over the next 35 years is 4%, rather than 2%. Now how much must your salary be 35 years
hence to provide the same purchasing power you have today?
Gomez Addams invested $10,000 into a portfolio of one-year U.S. Treasury bills on January 1, 1926. He
(and then his descendants) reinvested the proceeds each year until the end of 2017. The average
annually compounded rate of return over the 92-year period was 2.9%. (Note: 2017-1926 = 91, plus the
year 1926 = 92 years overall.) How much was the portfolio worth on December 31, 2017? (Ignore taxes
and transactions costs.)
Refer to the Gomez Addams problem above. Suppose that, instead of U.S. Treasury bills, Gomez had
invested $10,000 in a portfolio of large-cap common stocks on January 1, 1926. (Note: a “large-cap”
company has a market cap greater than $10b. (https://www.investopedia.com/terms/l/large-cap.asp)
The average annually compounded rate of return on large-cap stocks over the period was 9.8%, rather
than 2.9 percent. How much larger would the December 31, 2017 value of his portfolio have been?
In 2016 A Pevely man won the Missouri lottery and was given the choice of receiving $6.8 million in cash
immediately, or 25 annual payments of $400,000 each (also beginning today). At what interest rate
would he be indifferent between the two options? Suppose he believes he could earn 6% annually on
his investments. Which option should he take?
The second half of this Problem Set is to complete the following retirement exercises for yourself.
Please do so with your hand calculator – DO NOT use one of the many online retirement calculators. I
would like to see the keystrokes for each part....