This Exam FM sample reference tests Interest Rate Valuation. An effective discount rate uses annual present-value factor 0.968; discounting six biennial withdrawals and the year-12 residual produces exactly the equation in choice C.
These notes identify the calculation error associated with each wrong letter when that error is reproducible.
AThis uses interest-rate factor 1.032 even though 3.2% is specified as an effective discount rate.
BThis likewise substitutes an interest-rate discount convention for the stated discount-rate factor.
DIts terminal balance is discounted with 1.032 rather than the required factor 0.968.
EMixing 0.968 and reciprocal 1.032 factors does not apply one consistent discount function.
Original practice · fully worked
Original variant: biennial withdrawal under an effective discount rate
An account receives 20,000 today and earns an annual effective discount rate of 4%. Equal withdrawals occur at years 2, 4, and 6. Immediately after the year-6 withdrawal, 5,000 remains. Determine each withdrawal.
A 5,499.17
B 5,899.17
C 6,299.17
D 6,699.17
E 7,099.17
Variant answer in brief
Using annual discount factor 0.96, the three withdrawal present values plus the residual give X = 6,299.17, choice C.
Setup
Setup
The effective discount rate supplies present-value factor 0.96 per year.
20000=X(0.962+0.964+0.966)+5000(0.96)6
Model
Model
Value the three withdrawals and final residual at the initial deposit date.
X=0.962+0.964+0.96620000−5000(0.96)6
Compute
Compute
Solving the linear equation gives 6,299.1673.
X=6299.1673
Answer
Answer
Each biennial withdrawal is 6,299.17, corresponding to choice C.
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