Question

Mastery Problem: Time Value of Money

Time value of money

Due to both interest earnings and the fact that money put to good use should generate additional funds above and beyond the original investment, money tomorrow will be worth less than money today.

Simple interest
Ringer Co., a company that you regularly do business with, gives you a $18,000 note. The note is due in three years and pays simple interest of 5% annually. How much will Ringer pay you at the end of that term? Note: Enter the interest rate as a decimal. (i.e. 15% would be entered as .15)

Principal	+	( Principal	x	Rate	x	Time		)	=	Total
$	+	($	x		x		years	)	=	$

Compound interest
With compound interest, the interest is added to principal in the calculation of interest in future periods. This addition of interest to the principal is called compounding. This differs from simple interest, in which interest is computed based upon only the principal. The frequency with which interest is compounded per year will dictate how many interest computations are required (i.e. annually is once, semi-annually is twice, and quarterly is four times).

Imagine that Ringer Co., fearing that you wouldn’t take its deal, decides instead to offer you compound interest on the same $18,000 note. How much will Ringer pay you at the end of three years if interest is compounded annually at a rate of 5%? If required, round your answers to the nearest cent.

	Principal	Annual Amount of	Accumulated Amount at
	Amount at	Interest (Principal at	End of Year (Principal at
	Beginning of	Beginning of Year x	Beginning of Year + Annual
Year	Year	5%)	Amount of Interest)
1	$18,000	$900	$18,900
2	$18,900	$	$
3	$	$	$

If you were given the choice to receive more or less compounding periods, which would you choose in order to maximize your monetary situation? _____________

Answer 1

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