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QM – Answer Explanation Re Time Value

  • This topic has 5 replies, 5 voices, and was last updated Apr-17 by GraemeA.
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    • GraemeA
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      Hello everyone,

      May someone please help me with respect to the following question? It is:

      Jack Long, CFA, is evaluating the retirement account of John Smith. Smith currently has $500,000 and will retire in 12 years. Smith plans to contribute $12,700 per year. If Smith needs $2 million at retirement, the return required is closest to:

      a.10%
      b.11%
      c.12%

      It seemed simple but I was not getting any of the answers when doing it with my Texas BAII Plus.

      The answer is B and the calculator entries are: N=12 PV=500,000 PMT=12,700 FV= -2,000,000… solve for I/Y… I was inputting the PV as negative instead of the FV. Why is the FV required to be negative in this instance instead of the PV??

      Thanks in advance,

      Graeme

    • channing_cox
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      bc the fv will be withdrawn from the fund so that John Smith could then use it for retirement.

      look at the calc equation from the perspective of the inflows and outflows of money into the investment, not from the perspective of inflows and outflows to Mr. Smith

    • Gary
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      @Channing_cox has said it already but on those calculation I think of it as a transaction. The PV is what you pay so on a balance sheet its a negative. The FV is your return so on a balance sheet it would be positive.

      From the other side if PV was positive then it would be money you are receiving ie a loan and the FV would be negative because you would have to pay it back with interest.

    • vincentt
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      In my personal opinion, when calculating TVM, it doesn’t really matter whether you have -PV or -FV. That’s just how the calculator works. Just make sure they are not both the same sign, otherwise you’ll get an error.

    • Lagarta
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      putting the PV as positive makes it more intuitive as @Gary stated (thinking as a transaction).

      If you put -PV, you would have to put -PMT as well.

      PV=-500,000, N=12, FV = 2,000,000, PMT= -12,700 solve for I/Y= 10.816 or B

    • GraemeA
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      Thanks Channing, Gary, Vincent and Lagarta. Alot of help there

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