TIA A.1.3. #3

[maurice197]

I thought I was doing this right...

I took bill's loan and discounted it back: 5000(1.1)^-5

Then took Sally's loan and discounted that back: 10000(1.08)^-7

Then combined the loans: 8939.51

Finally, an "Equation of Value" like so...

8939.51 = X [(V.07) ^2 + (V.07^3)] and tried to solve for X

I got 5290.48...the answer should be $5,459.79

Where did I go wrong?

[Bama Gambler]

In this problem, you have to be careful where you setup the equation of value. You can not discount the payment in the consolidated loan to time 0 b/c you don't know the rate during time 0-2 (the loan is taken out at time 2). This problem's equation of value has to be setup at time 2 or time 3, b/c the 7% is only effective b/w time 2 and 3. Does that make sense?

[maurice197]

So I should discount to zero both Bill and Sally, then accumulate to 2. Then use that value for the equation of value for x + xv.07^1???

[Bama Gambler]

Since Bill and Sally have different rates, don't discount to time 0, add, and the accumulate. Simply discount their payments to time 2. In other words, setup your equation of value of time 2 (discount all payments to time 2).

[maurice197]

Thanks!