Question

When the effective interest rate is 9% per annum, what is the present value of a series of 50 annual payments that start at $1000 at the end of the first year and increase by $10 each subsequent year?

Answer 1

Answer:

$1,109.62

Step-by-step explanation:

Let's first compute the future value FV.  

In order to see the rule of formation, let's see the value (in $) for the first few years

End of year 0

1,000

End of year 1(capital + interest + new deposit)

1,000*(1.09)+10  

End of year 2 (capital + interest + new deposit)

(1,000*(1.09)+10)*1.09 +10 =

$\bf 1,000*(1.09)^2+10(1+1.09)$

End of year 3 (capital + interest + new deposit)

$\bf (1,000*(1.09)^2+10(1+1.09))(1.09)+10=\\1,000*(1.09)^3+10(1+1.09+1.09^2)$

and we can see that at the end of year 50, the future value is

$\bf FV=1,000*(1.09)^{50}+10(1+1.09+(1.09)^2+...+(1.09)^{49}$

The sum  

$\bf 1+1.09+(1.09)^2+...+(1.09)^{49}$

is the sum of a geometric sequence with common ratio 1.09 and is equal to

$\bf \frac{(1.09)^{50}-1}{1.09-1}=815.08356$

and the future value is then

$\bf FV=1,000*(1.09)^{50}+10*815.08356=82,508.35564$

The present value PV is

$\bf PV=\frac{FV}{(1.09)^{50}}=\frac{82508.35564}{74.35572}=1,109.616829\approx \ 1,109.62$

rounded to the nearest hundredth.