You've been saving up for a new car that you think costs $25,000. You
already have $10,000 and you think that, with interest and additional
savings, the $10,000 will grow to $20,000 in three years. Suddenly, the
phone rings and a voice at the other end of the line tells you that
you've won $5,000. You have the choice of collecting the $5,000
immediately, or collecting it in three years which will give you enough
money to buy the car. What would you do? Assume that the price of the
car stays constant over the three years and that available interest for
bank savings is 3%.
1a. You get the same prize but the choice changes to $5,000 now or $5,250 in three years. What do you do?
1b. You get the same prize but the choice changes to $5,000 now or $5,500 in three years. What do you do?
1c. Explain the time value of money using this scenario as an example.
What is the difference between EAR (effective annual rate) and APR
(annualized percentage rate)? Which one does a better job of measuring
return? Give an example (not from the book!) that illustrates your