Question

a. The NewLife Insurance Company is offering an insurance policy that will give you and your offspring $18,000 per year forever. If you require 6% return on investment the how much would you have to pay for the policy?

b. If in part a. above the cost of the policy was 360,000 what would you expect the interest rate to be for this to be a fail deal?

c. You’re considering to get a loan. Bank A charges 15% annually and Bank B charges 15.25% accrued semi-annually. Which bank has the lower effective rate of interest?

d. Payments are made on a 15 year annuity of $1500 at the end of each month. Calculate the present value if the interest rate is 11% compounded monthly for the first 7 years and 7 percent compounded monthly thereafter.

(SHOW YOUR WORK)

Answer 1

1) Amount to be paid for policy = [18,000 / 6%] = $300,000

2) Interest rate = [18,000 / 360,000] =.05 or 5%

3) Effective interest rate - Bank A = 15%
Effective interest rate - Bank B = [(1+15.25%/2)^2 - 1] = 15.83%
Bank A is better

4) Value of first 7 years:
FV 0; IY = 11/12=.92; PMT = 1,500; N =7*12=84; PV= 87,604.36
Pv 7 years from today:
PMT = 1,500; IY 7/12 = 0.58; FV 0; N = 8*12 = 96; PV= 110,021.35
Value today: FV 110,021.35; PMT 0; N = 84; I = 11/12=.92; PV= 51,120.33
Present value = [PV of annuity for first 7 years + PV of annuity after 7 years]
Present value = [87,604.36 + 51,120.33] = 138,724.69