EXERCISE 1. Joel starts the year with $0. Each year Joel is able to earn $5,000

Question

EXERCISE 1. Joel starts the year with $0. Each year Joel is able to earn $5,000 during the year so that at the beginning of the next year he has another $5,000. Joel is contemplating two options for his money: Joel simply places his money in a box under his bed Joel places the money at the beginning of each year in the bank and earns 5% interest on that money during that year He does not remove the money, and whatever interest he earns in the first year gets added to his initial deposit for that years. With this second option, he plans to keep his money in for five years. Joel has asked you to provide a numerical calculation of the value of these two options to him at the end of five years.

Explanation / Answer

Under the first option. There is no interest provided by keeping money under the bed. For five years (beginning at the end of this year or start of next year), there will be each $5000 for next five years so the total money accumulated is $5000x5 = $25000

When there is an interest rate of 5%, the interest is added in the deposit and interest is calculated on interest also. So this is compound interest and future value at the end of five years is

5000(F/A, 5%, 5) = 5000*5.5256 =$27628

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