AGRICULTURAL ECONOMICS 330



AGRICULTURAL ECONOMICS 330

Assignment 3

Instructor: Dr. David J. Leatham

Name: Row Number: Section:

NOTE: SHOW A TIME LINE AND THE PRESENT VALUE OR FUTURE VALUE FORMULA USED TO SOLVE EACH PROBLEM. NO POINTS WILL BE GIVEN WITHOUT A TIME LINE AND FACTORS EVEN IF YOU HAVE THE RIGHT ANSWER!

(If your answer does not match the answers given below, check with the instructor. There is always the chance, albeit small, that your answer is correct and there is a typo below.)

1. Cindy's dead-beat brother-in-law owes her $5,000 which he has promised to pay today. He was not able to pay it and the best she has been able to get out of him is a promise to pay $1,000 per year for the next 5 years, with no interest. The first payment will be made 1 year from now.

A. What is the present value of the 5 payments to Cindy assuming that she would invest the money at 10% if she had it now? (Answer = $3,790.79)

B. What would be the present value of the payments if dead-beat would make each payment 1 year earlier? (Answer = $4,169.87)

2. Gary doesn't have enough money to invest now to provide the $10,000 honeymoon in 10 years. He wants to know how much he would need to deposit each year for the next 10 years to accumulate the $10,000, assuming he makes the first deposit one year from now and interest at 10% is compounded annually. (Answer = $627.45)

3. Bill has just graduated from TAMU and is tired of living in a cramped apartment. However, by reducing housing costs while at college he managed to save enough for an $8,000 down payment on a new house he is planning to purchase now that costs $45,000. Unfortunately, Bill didn't major in business management and wants you to calculate what the payments will be, assuming that monthly payments start 1 month from now and the mortgage carries a 14% stated rate with a 30-year maturity. Calculate the monthly payment. (Answer = $438.40)

4. George is thinking about early retirement. Suppose he deposits $100,000 now at 11% interest. How much could he withdraw each year for the next 10 years if the first withdrawal was made one year from now, the account continues to earn interest at 11% compounded annually, and the account is to be entirely depleted at the end of 10 years? (Answer = $16,980.14)

5. Suppose that you are considering the purchase of a bond that matures in 12 years. The bond has a par value of $1,000, it pays a coupon of 10 percent (annually), and the coupon is paid semiannually (10s).

A. Calculate the market value (price) of the bond today if the bond’s market rate (yield) is 7%. (Answer = $1,240.88)

B. Calculate the market value (price) of the bond in five years if the bond’s market rate is 4% (Answer = $1,363.19)

C. Calculate the Net Present Value and the yield on this bond investment if the current market rate on this bond is 7%, you expect the market rate to be 4% in 5 years, you plan to sell the bond in five years, and your required rate of return on this investment is 8% (4% semiannually). Is this an acceptable investment? (hint: use the purchase price in part A, and the sell price in part B) (Answer: NPV = $85.59; Yield = 9.63% annually)

6. Five years ago you incurred a 10-year term loan that required annual payments of $1,150 per year. You have made four payments in previous years and the fifth payment is due today. The note holder proposes that you buy back this note today for $4,359.

A. Would it pay you to borrow the money at the bank at 13% interest rate and buy back this note (hint: calculate the market value of the loan and compare with the price for which the bank is willing to sell you the note)? (Answer = Market Value = $5,194.8 -- Buy Loan back)

B. At what rate of interest would you be indifferent (hint: calculate the yield on the loan based on the bank's price of the note)? (Answer = i = 23.22%)

7. You are considering buying a special livestock trailer for $12,000. It can be financed over three years, with no down payment and equal quarterly payments due at the end of each quarter, including principal and interest at an annual rate of 12% (compounded quarterly). What would be the quarterly payments? (Answer = $1,205.55)

8. You have a debt obligation of $60,000 at an 11% annual interest rate. The maximum annual payment you can make is $6,901.48 per year (interest and principal). How many years will it take to pay the loan off? (Answer = N = 30 years)

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