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Time is Money: Time is Money: Personal Finance Applications Personal Finance Applications

of the Time Value of Moneyof the Time Value of Money

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Problem #1

Your first “real” job pays $32,000 a year to start. How much will you need to be earning in 20 years to maintain the same purchasing power if inflation averages

3%?

$57795.56

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Problem #2

• Your grandparents (age 60 and 62) are about to retire next month. They will have a yearly income of $24,000. Assuming an annual inflation rate of 4%, how much will they need in 10 years to equal the purchasing power of today?

$35525.86

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Problem #3

Your rich uncle has promised to give you $25,000. The only “catch” is that you must graduate from college and get a job before he gives it to you. Let’s assume that’s in 4 years. What is the value of his gift today if his money is earning

5%?

$20567.56

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Problem #4

Heather starts a Roth IRA at age 22. She plans to contribute $3,000 at the end of each year until age 67. How much will she have if her IRA investments earn 9% ?

$1,577,576.10

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Problem #5

You quit smoking a pack a day of cigarettes and save $2,550 a year (savings of $7 per pack per day). You are 20. How much would you have if you invested the money in a stock index fund averaging a 10% return and don’t touch it until age 55?

$691,112.22

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Problem #6

You want to invest $2,500 into a CD which pays an APR of 12%. If the CD compounds monthly, what will it be worth in 2 years?

$3,174.34

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Problem #7

• Your savings account earns 8% interest. Assume it is January 1st and you have a balance of $1750 in your account. How much will you have at the end of five years if your account compounds quarterly?

$2600.33

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Two Take-Home Messages:

1. For every decade that you delay saving, the required investment triples (approx.)

2. Compound interest is NOT retroactive!!!

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Define the following in your own words:1. CD

2. Liquidity

3. IRA

4. Rule of 72

5. Simple Interest

6. Compound interest

7. APR and APY

8. IRA

9. Traditional IRA

10. ROTH IRA