1 Basic Financial Calculations 1.1 Overview This chapter aims to give you some finance basics and their Excel implementa- tion. If you have had a good introductory course in finance, this chapter is likely to be at best a refresher.' This chapter covers: + Net present value (NPV) + Internal rate of return (IRR) + Payment schedules and loan tables + Future value + Pension and accumulation problems + Continuously compounded interest + Time-dated cash flows (Excel functions XNPV and XIRR) Almost all financial problems are centered on finding the value today of a series of cash receipts over time. The cash receipts (or cash flows, as we will call them) may be certain or uncertain. The present value of a cash flow CF, anticipated to be received at time + is Ch. The numerator of this (+r) expression is usually understood to be the expected time t cash flow, and the discount rate rin the denominator is adjusted for the riskiness of this expected cash flow—the higher the risk, the higher the discount rate. The basic concept in present value calculations is the concept of opportunity cost. Opportunity cost is the return which would be required of an investment In the financial to make it a viable alternative to other, similar investments literature there are many synonyms for opportunity cost, among them: discount rate, cost of capital, and interest rate. When applied to risky cash flows, we will sometimes call the opportunity cost the risk-adjusted discount rate (RADR) or the weighted average cost of capital (WACC). It goes without saying that this sted, and much of the standard finance literature discusses how to do this. As illustrated below, when we calculate the net present value, we use the investment’s opportunity cost as a discount rate When we calculate the internal rate of return, we compare the calculated return to the investment’s opportunity cost to judge its value: discount rate should be risk-adj 1. In my book Principles of Finance with Excel (Oxford University Press, 2nd edition, 2008) 1 have discussed many basic Excel/inance topics at greater length,4 Chapter 1 1.2 Present Value and Net Present Value Both of these concepts are related to the value today of a set of future antici- pated cash flows. As an example, suppose we are valuing an investment which promises $100 per year at the end of this and the next 4 years. We suppose that these cash flows are risk free: There is no doubt that this series of 5 pay- ments of $100 each will actually be paid. If a bank pays an annual interest rate of 10% on a 5-year deposit, then this 10% is the investment’s opportunity cost, the alternative benchmark return to which we want to compare the invest- ment, We can calculate the value of the investment by discounting its cash flows using this opportunity cost as a discount rate: rN B c D 4 COMPUTING THE PRESENT VALUE 2 Discount rate 10% 3 Present 4 Year Cashflow value 5 1 100, 90.9091 6 2 100, 82.6446 7 3 100 75.1315 8 4 100 68.3013 o 5 100, 62.0921 10 11 |Net present value 12] Summing cells C5:C9 13] Using Excel's NPV function 14] Using Excel's PV function The present value, 379.08, is the value today of the investment. In a competi- tive market, the present value should correspond to the market price of the cash flows. The spreadsheet illustrates three ways of obtaining this value: + Summing the individual present values in cells C5:C9. To simplify the copying, note the use of “*” to represent the power and the use of both the relative and absolute references; for example: =B5/(1+SBS2)*AS in cell C5. + Using the Excel NPV function. As we show on the next page, Excel’s NPV function is unfortunately misnamed—it actually computes the present value and not the net present value.Basic Financial Calculations + Using the Excel PV function. This function computes the present value of a series of constant payments. PV(B2,5,-100) is the present value of 5 pay- ments of 100 each at the discount rate in cell B2. The PV function returns a negative value for positive cash flows; to prevent this unfortunate occurrence, we have made the cash flows negative ‘The Difference Between Excel’s PV and NPV Functions The above spreadsheet may leave the misimpression that PV and NPV perform exactly the same computation. But this is not tre—whereas NPV can handle any series of cash flows, PV can handle only constant cash flows: A B cl D COMPUTING THE PRESENT VALUE In this example the cash flows are not equal Either discount each cash flow separately or use Excel's NPV function 4 Excel's PV doesn't work for this case 2 [Discount rate 10% 3 Cash Present | Present value 4 Year flow value __of each cash flow 5 1 400 =B5/(1#8B$2)*A5, é 2 200 B6/(1+$BS2)°A6 7 3 300 71(1#8BS2)9A7 g 4 400 (+SBS2)*A8 9 5 500 9/(1+$B82)9A9 40 “1 |Net present value 42] Summing cells C5:C9 4065.26 <-- =SUM(C5:C9) 13] __Using Excel's NPV function _1065.26 <-- =NPV(B2,85:89) Excel’s NPV Function Is Misnamed! In standard finance terminology, the present value of a series of cash flows is, the value today of the future cash flows: a) Present value = ——— fa (1+r) 2. This siange propenty—returming negative values for postive cash flows—is shared by a ‘number of otherwise impeccable Excel functions such as PMT and PV. The somewhat convoluted logic which led Microsoft to write these functions this way is not worth explaining.16 Chapter 1 The net present value is the present value minus the cost of acquiring the asset (the cash flow at time zero): Net present value =>. = yo oh Ser = fe ee ee ed Excel's language about discounted cash flows differs somewhat from the standard finance nomenclature. To calculate the finance net present value of a series of cash flows using Excel, we have to calculate the present value of the future cash flows (using the Excel NPV function), taking into account the time-zero cash flow (this is often the cost of the asset in question) ‘The Net Present Value, NPV ‘Suppose that the above investment is sold for $400. Clearly it would not be worth its purchase price, since—given the alternative return (discount rate) of 10%—the investment is worth only $379.08. The net present value (NPV) is the applicable concept here. Denoting by r the discount rate applicable to the investment, the NPV is calculated as follows: NPV=Chy+)) Gi (ery where CF; is the investments cash flow at time f and CFy is today’s cash flow. Suppose, for example, that the series of 5 cash flows of $100 is sold for $250. Then, as shown below, the NPV = 129.08. x a D 1 COMPUTING THE NET PRESENT VALUE 2 [Discount rate 10% 3 Present 4 Year Cash flow value 5 ° -250 B5/(1¥$BS2)"A5 6 1 100 T 2 100 3 3 100 BI 1¥SBS2)"A8 9 4 100 68.30 <-- =B9/(1+$B$2)*A9 10 5 100 1 12|Net present value 13] Summing cells €5:¢10 18] Using Excel's NPV function7 Basic Financial Calculations ‘The NPV represents the wealth increment of the purchaser of the cash flows, If you buy the series of 5 cash flows of 100 for 250, then you have gained 129.08 in wealth today. In a competitive market the NPV of a series of cash flows ought to be zero: Since the present value should correspond to the market price of the cash flows, the NPV should be zero. In other words, the market price of our 5 cash flows of 100 ought—in a competitive market, assuming that 10% is the correct risk-adjusted discount rate—be 379.08. ‘The Present Value of an Annuity—Some Useful Formulas’ An annuity is a security which pays a constant sum in each period in the future Annuities may have a finite or infinite series of payments. If the annuity is finite, and the appropriate discount rate is r, then the value today of the annuity is its present value: PV of finite annuity If the annuity promises an infinite series of constant future payments, then this formula reduces to: cc c + ed ltr (1+r) r PY of infinite annuity = Both of these formulas can be computed with Excel. Below we compute the value of a finite annuity in three ways: using the formula (cell B6), using Excel's PV function (cell B7), and using Excel’s NPV function: 3, All the formulas in this subsection depend on some well-known but oft-forgotten high school algebra.18 Chapter 1 x 5 c COMPUTING THE VALUE OF A FINITE ANNUITY 4 2 |Periodic payment, C 1,000 3 |Number of future periods paid, n 5 4 [Discount rate, r 12% 5 |Present value of annuity | Using formula 3,604.78 <- =B2"(1-1/(1+B4)9B3)/B4 7| Using Excel's PV function 3,604.78 <~ =PV(B4,B3,-B2) 8 “Annuity 9 Period payment 40 1 1,000.00 <~ =B2 1 2 1,000.00 12 3 1,000.00 13 4 1,000.00 14 5 1,000.00 15. 16 |Present value using Excel's NPV function 3,604.78 <~ =NPV(B4,B10:B14) ‘Computing the value of an infinite annuity is even simpler: A B c 1 COMPUTING THE VALUE OF AN INFINITE ANNUITY 2 [Periodic payment, C 4,000 3 Discount rate, r 12% 4 [Present value of annuity 8,333.33 <- =B2/B3 ‘The Value of a Growing Annuity A growing annuity pays out a sum C, which grows at a periodic growth rate g. If the annuity is finite, its value today is given by: Bente renineeant ee te Tr” (ler) (147) elegy (+r) / ley ltr19 Basic Financial Calculations Taking this formula and letting n + ©, we can compute the value of infinite growing annuity: C_C(l+g) C+) ge erin elecepe aetna COtgy ler (1+r) (1+r) . provided Peal rg +r! These formulas can easily be implemented in Excel. Below we compute the value of a finite growing annuity using the formula above and using Excel's NPV function: A I BT c 4 COMPUTING THE VALUE OF A FINITE GROWING ANNUITY 2 |First payment, C 4,000 3_|Growth rate of payments, g 6% 4 |Number of future periods paid, n 5 5 [Discount rate, r 12% 6 |Present value of annuity T| Using formula 4,010.91 32°(1-((1+B3)/(1+B5))/%B4)/(B5-B3 8 ‘Annuity 8 Period payment 10. 4 4,000.00 <- =B2 11 2 1,060.00 <~- =§B$2"(1+$B$3)A11-1) 12, 3 4,123.60 <~- =$B$2"(1+$BS3)A12-1) 13. 4 4,191.02 <~ =$B$2"(1+$BS3)A13-1) 14. 5 1,262.48 <~ =$B$2"(1+$BS3)A14-1) 15, 16 |Present value using Excel's NPV function 4,010.91 <~- =NPV(B5,B10:814) When the growing annuity has an infinite life: A I B I c 1 COMPUTING THE VALUE OF AN INFINITE GROWING ANNUITY 2 [Periodic payment, C 4,000|<- Starting at date 1 3 |Growth rate of payments, 6% 4 [Discount rate, r 12% 5 [Present value of annuity 16,666.67 <— =B2/(B4-B3)20 Chapter 1 ‘The Gordon Formula The Gordon formula values a stock by discounting its future anticipated dividends at the cost of equity rs. Letting Py be the current stock price, Div the current dividend, and g the growth rate of future dividends, then r=> Divo(1 +s) _ Div (1+g) fa (trey Te-8 Using the formula for an infinite growing annuity, we can write this as Divo(1+ g) neg B provided |¢|<|re| Inverting this formula shows that Div(1+g) OB Ne +g ‘The Gordon formula is used in Financial Modeling’s Chapters 2, 4, 5, and 6 to model the firm’s terminal value and in Chapter 3 to model the firm’s cost of equity 1 1.3. The Internal Rate of Return (IRR) and Loan Tables ‘The internal rate of return (IRR) is defined which makes the NPV equal to zero: the compound rate of return r ~ CF, CRy+ i =9 Lien To illustrate, consider the example given in rows 2-10 below: A project costing 800 in year zero returns a variable series of cash flows at the end of years 1-5. The IRR of the project (cell B10) is 22.16%:21 Basic Financial Calculations A [6 1 c 1 INTERNAL RATE OF RETURN Cash 2 Year flow 3 oO -800, 4 1 200) 5 2 250) 6 3 300) 7 4 360) 3 5 400) 9 10|Intemnal rate of return 22.16% <- =IRR(B3:B8) Note that the Excel IRR function includes as arguments all of the cash flows in this case negative—cash flow of the investment, including the fi of -800. Determining the IRR by Trial and Error There is no simple formula to compute the IRR. Excel’s IRR function uses trial and error, which can be simulated by using trial and error in a spreadsheet as illustrated below: A 5 a 1 INTERNAL RATE OF RETURN 2 [Discount rate 12% 3 4 |Year Cash flow 5 oO -800 6 1 200. 7 2 250 3 3 300 9 4 350) 70 5 400 1 12 [Net present value (NPV) 240.81 <~ =B5+NPV(B2,86.810) By playing with the discount rate or by using Excel's Goal Seek (found under Data|What-if analysis, see Chapter 31), we can determine that at 22.16% the NPV in cell B12 is zero:2 Chapter 1 A B Cc 1 INTERNAL RATE OF RETURN 2 |Discount rate 22.16% 3 4 |Year Cash flow 5 0 -800 6 1 200 7 2 250 8 3 300 9 4 350 10 5 400 14 12 |Net present value (NPV) 0.00 |<~- =85+NPV(B2,B6:810) Here’s the way the Goal Seek screen looked before we got the correct answer: ———$— A) B c D E 1 INTERNAL RATE OF RETURN 2 Discount rate c 3 Cash 4 Year flow Sgt cell: sesiz 5 0 -800 s ooo ° 7 2 250 By changing celt, | sBs2) 8 3 300 9 4 360 10 5 400 42 [Net present value (NPV)] 240.81 <~ =85+NPV(B2,86:B10)23 Basic Financial Calculations Loan Tables and the Internal Rate of Return The IRR is the compound rate of return paid by the investment. To understand this fully, it helps to make a loan table, which shows the division of the invest- ‘ment’s cash flows between investment income and the return of the investment principal: z [Ls 1 ¢ = 1 INTERNAL RATE OF RETURN 2 Yoar Cash flow 3 0 -800 4 1 200 5 2 250 6 3 300) 7 4 350) 3 5 400 ° 70]intemal rato of rtum 1 12 |USING THE IRR IN A LOAN TABLE Division of cash flow between investment income and return of . EBs BSTOBIS es Investment at beginning of Cash flow Return of 14 Year year atend ofyear_ income _ principal 5 Hi 200.00 200.00 47728 22.72 15-015 16 2 77728 250.00 47225 77.75 17 3 69953 300.00 15502 144.98 18 4 55455 350.00 42288 227.11 19 5 32744 400.00 7256 327.44 20 6 0.00 2] 22 EBISE'S [The remaining investment principal 23 in the year ater the last cash fow is 24 ze, indicating that al he principal 25 has been repac 2524 Chapter 1 The Joan table divides each of the cash flows of the asset into an component and a return-of-principal component. The income component at the end of each year is IRR times the principal balance at the beginning of that year. Notice that the principal at the beginning of the last year (327.44 ii the example) exactly equals the return of principal at the end of that year. We can use the loan table to find the internal rate of return. Consider an investment costing 1,000 today that pays off the cash flows indicated below at the end of years 1, 2, ... 5. At a rate of 15% (cell B2), the principal at the beginning of year 6 is negative, indicating that too little has been paid out i income. Thus the IRR must be larger than 15%: come A B Cc D E F 4 USING A LOAN TABLE TO FIND THE IRR 2 IRR? 15.00% 3 Division of cash flow between investment Income and return of 4 principal Principal Cash flow at beginning at end of 5| Year of year year Income Principal 6| 1 4,000.00 300 150.00 150.00 6-D6 7| 2 850.00 200 127.50 72.50 e| 3 777.50 150 116.63 33.38 o| 4 744.13 600 111.62 488.38 10] 5 255.74 900 38.36 861.64 1] 6 -605.89 12 =sBs2"B6 73] EBEES If the interest rate in cell B3 is indeed the IRR, then cell B11 should be 0. We can use Excel’s Goal Seek (found under Data|What-if analysis) to calculate the IRR:25 Basic Financial Calculations e e D E F 1 USING A LOAN TABLE TO FIND THE IRR Divison of cash flow between investment Income and return of 4 principal eed Income Principal 45000 150.00 <~ =C.06 127507250 118633338 11162 488.38 389888168 Sas As shown below, the IRR is 24.44% A B Cc D E 4 USING A LOAN TABLE TO FIND THE IRR IRR? 24.44% FE Division of cash flow between investment Income and return of 4 principal Principal Cash flow at beginning at end of 5| Year | ofyear year Income _ Principal e| 4 4,000.00 300 244.36 55.64 <- =C6-D6 7| 2 944.36 200 230.76 _-30.76 e| 3 975.13 150 238.28, -88.28 a] 4 4,063.41 600 259.86, 340.14 10] 5 723.26 900 176.74, 723.26 11] 6 0.00 12 =SBS2°66 73] E86626 Chapter 1 The loan table is an effective illustration that the IRR is the interest rate that pays off an investment over its term. Of course, we could have simplified life by just using the IRR function: A B c D 15 Direct calculation of IRR 76| Year | Cash flow 17| 0 ~1,000 18] 4 300) ig] 2 200) 20| 3 150 21] 4 600) 22| 5 900) 23 24 (IRR 24.44% <- =IRR(B17:B22) s Rate Function Excel's Rate function computes the IRR of a series of constant future pay- ments. In the example below, we pay $1,000 today for an annual payment of $100 for the next 30 years. Rate shows that the IRR is 9.307%: x Ts | c USING EXCEL'S RATE FUNCTION TO. COMPUTE THE IRR 4 2 |iniial investment 4,000, 3. [Periodic cash flow 100 4 |Number of payments 30, Sige, 9.307% <= =RATE(B4,83-B2) Note: Rate works much like PMT and PV discussed elsewhere in this chapter; it requires a sign change between the initial investment and the peri- odic cash flow (note that we have used -B2 in cell B5). It also has switches to allow for payments which start today and payments which start one period from now (not shown in the above example).27 Basic Financial Calculations 1.4 Multiple Internal Rates of Return ‘Sometimes a series of cash flows has more than one IRR. In the next example we can tell that the cash flows in cells B6:B11 have two IRRs, since the NPV graph crosses the x-axis twice: A Tos Te Too Te TF Ts TT 4 MULTIPLE INTERNAL RATES OF RETURN 2 [Discountate A SINPV -B.06|== =NPVEZE7BTI}E5 DATA TABLE Discount 4 rate _NPV S| Year [Cash flow! T 2.39] Table header, <= =B3 sf o a 20.0 74 0] 4051 a} 2 0] ti] af 3 0] a2 jo} 00 29 cc ne 275 a7 2 aa] 13 ac 1 Two IRRs teal 15 00 =o. 1 2d 7 aor =4.90 TE) § sop =75 ia] | 5 4027 ZO] F000 zy) § Dicuntrte Note: Fora {now to create data a ‘evo ora dscussion of how oeeat zlly Spr tables in Excel, see Chapter 31 3a 2000 25 — 200 ar 28 23 identifying the two RRS 0st IRR 278% st Second IRR | 96 65% Excel's IRR function allows us to add an extra argument which will help us find both IRRs. Instead of writing =IRR(B6:B11), we write =IRR(B6:B11,guess). The argument guess is a starting point for the algorithm, which Excel uses to find the IRR; by adjusting the guess, we can identify both the IRRs. Cells B30 and B31 give an illustration.28 Chapter 1 There are two things to note about this procedure: + The argument guess merely has to be close to the IRR; it is not unique For example, by setting the guesses equal to 0.1 and 0.5, we will still get the same IRRs A 5 c D 2B [Identifying the two IRRs 30 [First IRR 8.78% <. =IRR(B6:B11,0.1) 31 |Second IRR 26.65% /<- =IRR(B6:811,0.5) + In order to identify the number and the approximate value of the IRRs, it helps greatly to graph (as we did above) the NPV of the investment as a func- tion of various discount rates. The internal rates of return are then the points where the graph crosses the x-axis, and the approximate location of these points should be used as the guesses in the IRR function.* From a purely technical point of view, a set of cash flows can have multiple IRRs only if it has at least two changes of sign. Many typical cash flows have only one change of sign. Consider, for example, the cash flows from purchas ing a bond having a 10% coupon, a face value of $1,000, and 8 more years to maturity. If the current market price of the bond is $800, then the stream of cash flows changes signs only once (from negative in year 0 to positive i years 1-8). Thus there is only one IRR: a 1] BOND CASH FLOWS: NPV CROSSES X-AXIS ONLY ONCE, SO THERE IS ONLY ONE IRR Z| Year Cash flow Data table: Effect of 3] 0 800 Aiscount rate on NPV a} 4 100 1,000.00|<- =NPV(E4,B4:811)+B3, table header 5] 2 100 (0% 1,000.00 | 3 100 2% 785.04, NPV of Bond Cash Flows 7| 4 400 4% 603.96 se] 5 100 6% 44839) 3] 6 100 8% 31493) = io] 7 100 40% 200.00) «0 a] 8 | 4.100 12% 100.85 | & «> 1 14% 1445)| * 200 TSIIRR 14.96% <- =IRRBSBI) 16% 6062, o 14 78% 12621) agg RR 15 20% 183.72) “top 16 Discount ate 17 4 Ifyou don’t putin a guess (as we did in the previous section), Excel defaults to a guess of 0.1 Thus, in the current example, IRR(B34:B39) will return 8.78%29 Basic Financial Calculations 1.5 Flat Payment Schedules Another common problem is to compute a “flat” repayment for a loan, For example: You take a loan for $10,000 at an interest rate of 7% per year. The bank wants you to make a series of payments which will pay off the loan and the interest over 10 years. We can use Excel’s PMT function to determine how much each annual payment should be: A 8 c > ews 6 4 1 FLAT PAYMENT SCHEDULES 2 loon principal ‘10,000 3 |nerest rte 7% 4 (Loon tom © < Number of yrs over which an is ropid 5 Amal payment 2.05790, <~ =PHT(63,B4,62) 8 7 a ‘ a 9 ‘0 ) h a 2 «SSI 13 eerie wii sane tet eso ts Kemet a “4 te eset te mg Ne gp 8 8 8 8 2 Notice that we have put “PV"—Excel’s nomenclature for the initial loan principal—with a minus sign. As discussed above, if we do not do this Excel returns a negative payment (a minor irritant). You can confirm that the answer of 2,097.96 is correct by creating a loan table:30 Chapter 1 x Ls [¢ 7] o | & |] fF] 6 1 FLAT PAYMENT SCHEDULES 2 |Loan principal 40,000 3 interest rate 7%. “4_|Loan term 6 < Number of years over which loan is repaid © |Annual payment 2,097.96 |< =PMT(B3,B4,-B2) 6 7 Split payment into: Principal at beginning Payment at Rot 8 Year of year endof year _ Interest , pfincipal 9 1 410,000.00 2,097.96 700,00" 1,307.96 10 2 2.00204 208798 | 60214 | 149882" ~=DEES] 1 a 7.10623 2,097.96 497.44 1,600.52 12 oro 4 5.50570 2097.98 38540 1,712.56 13 5 3,793.15 2,097.98 265.52 1,832.44 14 6 1.96071 2,097.96 | 137.25 1,960.71 15 7 0.00 ‘The zero n cell C15 indicates that the loan is fully repaid over its term of 6 years. You can easily confirm that the present value of the payments over the 6 years is the initial principal of 10,000. 1.6 Future Values and Applications We start with a triviality. Suppose you deposit 1,000 in an account today, leaving it there for 10 years. Suppose the account draws annual interest of 10%. How much will you have at the end of 10 years? The answer, as shown in the following spreadsheet, is 2,593.74:31 Basic Financial Calculations A B c D E 1 SIMPLE FUTURE VALUE 2 interest 10% 3 Account Interest Total in Year, Dalance, earned account, beginning of | ° 4 year during year end year s| 1 1,000.00 400.00 6| 2 4,100.00) 110.00 7] 3 1,210.00 121.00 a| 4 1,331.00 133.10 ; o| 5 1,464.10 146.41, 1,610.51 7 1,610.51 1.05. 1,771.56 | 7 4.71.56 17X16 1,948.72 12| 8 1,948.72 194. 2,143.59 13| 9 2,143.59 214.36\_ 2,357.95 14] 10 2,357.95 235.79 \ 2,593.74 15] 11 2,593.74 =D5 16 171A simpler way 2,598.74 <- =B5*(1+B2)Mo As cell C17 shows, you don’t need all these complicated calculations: The ‘future value of 1,000 in 10 years at 10% per year is given by: FV =1,000*(1+10%)'" = 2,593.74 Now consider the following, slightly more complicated, problem: Again, you intend to open a savings account. Your initial deposit of 1,000 today will be followed by a similar deposit at the beginning of years 1, 2, ... , 9. If the account earns 10% per year, how much will you have in the account at the start of year 10?2 Chapter 1 This problem is easily modeled in Excel: A 5 c D E E 1 FUTURE VALUE WITH ANNUAL DEPOSITS 2 [interest 10% [Annual deposit 4,000 <- Made today and at begining of each of next 9 years 4 [Number of deposits 10 5 poco Deposit at Interest Total in balance, Year pense’ o¢ Pesinning eamed account, 6 ning of “ofyear_ during yearend year 7 1 000 1000 100.00. 1,100.00'<— 8 2 7,109.00, 1,000 210.00 9 3 2.310 4,000 331.00 10 4 3,641.00 \_1,000. 464.10 eee rT 5 5,105.10 (000. 610.51,_6,715.61 12 6 671561, 1 771.56 8,487.17 13 7 8487.17 1,00\\__948.72, 10,495.89 14 8 4049589 1,000 143.59 12,579.48 15 9 1257948 1,000 1,38K95 14,937.42 16 10 44,997.42_1,000__ 1,593. 47,531.17 a7 18 |Future value 417,531.17 _<-- =FV(B2,B4,-B3..1) EET Thus the answer is that we will have 17,531.17 in the account at the end of year 10. This same answer can be represented as a formula that sums the future values of each deposit: Total at beginning of year 10 = 1,000*(1+10%)'° + 1,000*(1+ 10%)? +...+1,000*(1+ 10%)! = ¥1,000*(1+ 10%) An Excel function: Note from cell B18 that Excel has a function FV which gives this sum. The dialog box brought up by FV is the following:33 Basic Financial Calculations Rate oa per 0 Pmt ~1000 fo Tyee “1 = 17531,16706 Return the future value ofan investment based on period, constant payments anda constant terest ate. ‘Type isa vale representing the ting of payment: payment atthe begining of the pered = 1; payment at the end of the pened = 0 or omitted, Formisresut = 17,531.17 tito ths fncton Coo) Gera) We note three things about this function: + For positive deposits FV returns a negative number. This is an irritating property of this function, which it shares with PV and PMT. To avoid negative numbers, we have put the Pmt in as ~1,000. + The line Py in the dialog box refers to a situation wherein the account has some initial value other than 0 when the series of deposits is made. In the above example, this has been left blank, which indicates that the initial account value is zero. + As noted in the picture, “Type” (either 1 or 0) refers to whether the deposit is made at the beginning or the end of each period (in our example the former is the case). 1.7 A Pension Problem—Complicating the Future Value Problem A typical exercise is the following: You are currently 55 years old and intend to retire at age 60. To make your retirement easier, you intend to start a retire- ‘ment account: + At the beginning of each of years 1, 2, 3, 4 (that is, starting today and at the beginning of each of the next four years), you intend to make a deposit into the retirement account. You think that the account will earn 8% per year.a4 Chapter 1 + After retirement at age 60, you anticipate living 8 more years.’ At the begin ning of each of these years you want to withdraw $30,000 from your retirement account. Your account balances will continue to earn 8%. How much should you deposit annually in the account? The following spreadsheet fragment below shows how easily you can go wrong in this kind of problem—in this case, you've calculated that in order to provide $30,000 per year for 8 years, you need to contribute $240,000/5 = $48,000 in each of the first 5 years. As the spreadsheet shows, you'll end up with a lot of money at the end of 8 years! (The reason—you've ignored the powerful effects of compound interest. If you set the interest rate in the spreadsheet equal to 0%, you'll see that you're right.) x [Ts Te [~_» Te J E 4 A RETIREMENT PROBLEM 2 interest 8% 3 Annual deposit 48,000.00 4 |Annual retirement withdrawal | 30,000.00 5 Account Deposit at Interest Total in balance, Year seaming Beginning earned 6 rms ofyear during year 7 1 0.00, 48,000.00 3,840.00" 51,640.00 8 2 51,840.00| 48,000.00 7,987.20] 107,827.20 8 3 407,827.20, 48,000.00 12,466.18) 168,293.38 70, 4 468,293.38 48,000.00 17,303.47, 233,596.85 at 5 233,596.85] 48,000.00 __22'527.75| 304,124.59 72 6 304,124.59) -30,000.00 21,929.87) 296,054.56 13. 7 296,054.56) -30,000.00 21,284.36 267,338.93, 14 8 287,338.93, -30,000.00 20,587.11) 277,926.04 15. 8 277,926.04) -30,000.00 18,834.08] 267,760.12 16. 10 267,760.12 -30,000.00 19,020.81) 256,780.93, a7 1 256,780.93 -30,000.00 _18,142.47| 244,923.41 15, 12 244,923.41) -30,000.00 17,193.87 252,117.28 79 13 232,117.28) -30,000.00 16,169.38 218,286.66 20 Note: This problem has 5 deposits and 8 annual withdrawals, all made atthe beginning of the year. The beginning of year 13 i the last year ofthe retirement pan; ifthe annual deposit is correctly computed, the 2 balance atthe beginning of year 13 after the withdrawal should be zero, 5. Of course you're going to live much longer! And I wish you good health! The dimensions of this problem have been chosen to make it fit nicely on a page.35 Basic Financial Calculations There are several ways to solve this problem. The first involves Excel’s Solver. This can be found on the Data menu.* ew VIEW DEVELOPER Be pon sem ath) ¥ a, Brann son fater © LEAS, EtRemove Sts Aas ia 5 A Poa ° ' f “ 1 A RETIREMENT PROBLEM 2 erst ms > onus epost Faso00 00 1 eal eenent vabdrowed 30000 ; sree] Account pepoattat interest Totalin Year Paienc®, beginning eammed acct 3 Begining “oryear during year epe'Year 7 1 0.00 48.0000 3840.00" s1.240.00 < =07+07487 8 2 5184000 4800000 798720 10782720 ° 3 40782720 4200000 12466.18 168,259.38 0 ‘ 46829338 4200000 1730347 293,596.85 i 5 23358685 4800000 2507.75 308.12459 2] 8 30412459 30,000.00 21,929.97 296,054.56 3 7 29505486 3000000 21.28436 28732893 rH 8 28739885 3000000 20507.11 27792608 is 8 27752604 2000000 1983408 267,760.12 0 257.760.%2 3000000 1902081 256,78093 7 8 25878093 3000000 18,142.47 244.929.) % 2 2easz341 3000000 17:19887_252.117.28 * 8 23211728 3000000 16,169.30 RARE 6. Ifthe Solver doesnot appearon the Tools menu, then you have to load it. Go to File|Options|Add- ins and click Solver Add-In on the list of programs. Note that you could also use the Goal Seek tool to solve this problem. For simple problems such as this one, there is not much difference between the Solver and Goal Seek; the one (not inconsiderable) advantage of the Solver is that it remembers its previous arguments, so that if you bring it up again on the same spreadsheet, you ean see what you did in the previous iteration. In later chapters we will illustrate problems that ceannot be solved by Goal Seek and in which the use of the Solver is a necessity.36 Chapter 1 Clicking on Solver opens a dialog box. Below we've filled it in: Se objective: Te: oe By Changing Variable Celis $033 Subject tothe Constants: ‘tle a Solong Method: Sohing Method Selec the GRG Noninear engine for Sober Problems tht are smooth nonkner. Stet he LP Simplex engine for inear Scher Problems and select the Evolutonary engine for Sole problems that are homamooth37 Basic Financial Calculations If we now click on the Solve box, we get the answer: x | E 4 ARETIREMENT PROBLEM 2 |interest 8% 3 JAnnual deposit 29,386.55 “4 |Annual retirement withdrawal | 30,000.00 5 Deposit at nterest Total in Year balances beginning _eamad ‘ caining ryear during year 7 1 Coo) 290655 2350.92 a 2 Biya7ae) 208055 4990.02 0901095 a a ceoraes 2508658 _7eaa.04 son 0n2s4 ‘0 4 foae2s4| 298655 10 500.53 143.01282 a 5 ‘wo.o1262) 298655 13,701.99" 109,19110 a 8 fstor to, 9000000 ¥2405.29, 9.06.29 3 7 fase639) 2000000 ¥1004.91 149.781 20 ‘a a ‘woyets0 2000000 9582.50 12025221 15 a faageaet| 2000000 7940.10 107 a1291 8 0 forsiast) 2000000 6.1503 B.4av 04 7 u eau7s+ 3000000 427ee4 7.77770 ‘8 2 777776, 2000000 2222.22 0,000.00 3 2 20,000.00, 30,000.00 200 000, ‘Account Solving the Retirement Problem Using Financial Formulas We can solve this problem in a more intelligent fashion if we understand the discounting process. The present value of the whole series of payments, dis- counted at 8%, must be zero: $4 Initial deposit _¥ 30,000 x (1.08)' oa = Initial deposit=} > a [3 a 7 30,000 ___1_ 5 30,000 ~ (1.08) (1.08)* 4 (1.08) PMT functions to solve the problem: Rewrite We can now use Excel's PV andChapter 1 A T_s__T c 4 A RETIREMENT PROBLEM 2 interest 8% 3 |Annual retirement withdrawal 30,000.00 4 [Years of withdrawal 8 5 |Years of deposit 5 6 |Present value of withdrawals 117,331.98 <~ =-PV(B2,B4,B3)/(1+B2)"B5 7 [Annual deposit 29,386.55 <— =PMT(B2,B5,-B6) 18 Continuous Compounding Suppose you deposit $1,000 in a bank account which pays 5% per year. This ‘means that at the end of the year you will have $1,000*(1.05) = $1,050. Now suppose that the bank interprets “5% per year” to mean that it pays you 2.5% interest twice a year. Thus after 6 months you'll have $1,025, and 0.05 after 1 year you will have $1. oo0*(1+ ) =$1,050.625.. By this logic, 2 if you get paid interest m times per year, y four accretion at the end of the 0.05)" year will be s1,000%(1+2%5) As n increases this amount gets larger, n converging (rather quickly, as you will soon see) to €. written as the function Exp. When n is infinite, we refer to this as continuous compounding. (By typing Exp(1) in a spreadsheet cell, you can see that e = 2.7182818285. ...) As you can see in the next display, $1,000 continuously compounded for 1 year at 5% grows to $1,000%e"* = $1,051.271 at the end of the year. Continu- ously compounded for t years, it will grow to $1,000*e"°", where r need not be a whole number (for example, when t =: é°**?5 measures the growth of the initial investment at 5% annually, ously compounded for 4 years and 3 months). , which in Excel is 25 then the accumulation factor -ontinu-39 Basic Financial Calculations A a c 4 MULTIPLE COMPOUNDING PERIODS 2 [initial deposit 7,000) 3 interest rate 5% |Number of compounding periods per year 2 3 interest per compounding period 2.500% <= =B3/B4 6 |Accretion in one year 1,050.625|<-- =B2"(1+B5)"B4 7 [Continuous compounding with Exp 1.051.271 |< =B2°EXP(@3) 3] 9 Effect of Multiple Compounding Periods 70 41,051.40 — 1051.20 43] | § 1051.00 14 5 1,050.20 15 s 2 ® 1,050.60 a7. & 1,050.40 18] | B 1,050.20 19 20 po Number of compounding intervals 3 1,049.80 2 1 10 100 1000 23 ing perk End-year 24] Compounding periods per year | ENS-¥ear 25 1 1,050,000 [== =$B52°(1+ SBSAIA25)"A25 26 2 7,050,625 |<~ =$BS2"(1+SB$3/A26)"A26 2 10 7.051.140 25 20 7,051,206 29 50 7,051,245 30 00 7,051,258 31 150 [1.051.262 32 300 4.051.267 33 00 1,051,269 The conclusion: More compounding periods increase the future value, though there over f years, this value a clear asymptotic value; as we will see below, for accretion é Back to Finance—Continuous Discounting If the accretion factor for continuous compounding at interest r over t years is e", then the discount factor for the same period is €". Thus a cash flow C, occurring in year ¢ and di worth Ce today. This is illustrated below: ‘ounted at continuously compounded rate r will be40 Chapter 1 A B c D 4 CONTINUOUS DISCOUNTING 2 interest 8% 3 Continously discounted 4| Year Cash flow 5] 4 400 5" EXP(-$BS2°A5) 6| 2 200) 16° EXP(-$BS2°AG) 7| 3 300, 235.988 e| 4 400, 290.460 o| 5 500, 335.160 10 71 [Present value UM(C5:C8) Calculating the Continuous y Compounded Return from Price Data Suppose at time 0 you had $1,000 in the bank and suppose that 1 year later you had $1,200. What was your percentage return? Although the answer may appear obvious, it actually depends on the compounding method. If the bank paid interest only once a year, then the return would be 20% seeD} 1,000 20% However, if the bank paid interest twice a year, you would need to solve the following equation to calculate the ret 1,000+(1+) 5445% ao (2%) - 2 1,000 The annual percentage ret 2*9.5445% = 19.089%. In general, if there are n compounding periods per year, you have to solve dau (Fo n when interest is paid twice a year is therefore ) —1and then multiply the result appropriately. If is very large, 1 00) 1,000 n 18.2322 %: this converges to r= infBasic Financial Calculations A B GC 1 CALCULATING RETURNS FROM PRICES 2 |initial deposit 1,000) 3 |End-of-year value 1,200) ‘4 |Number of compounding periods 2 5 implied annual interest rate 19.09% |< =((B3/B2)"(1/B4)-1)"B4 6 7 |Continuous return 18.23% |< =LN(B3/B2) 8 9 |Implied annual interest rate with n compounding periods 70 | Number of compounding periods| Rate 4 19.09% |< =BS, data table header 12, 1 20.00% 13, 2 19.09% 14 4 18.65% 15 8 18.44% 16. 20 18.32% 7 1,000 18.23%, Why Use Continuous Compounding? Alll of this may seem somewhat esoteric. However, continuous compounding/ discounting is often used in financial calculations. In this book, it is used to calculate portfolio returns (Chapters 8-13) and in practically all of the options calculations (Chapters 15-19). ‘There’s another reason to use continuous compounding—its ease of calcula- tion. Suppose, for example, that your $1,000 grew to $1,500 in 1 year and 9 months. What's the a st consistent—way to do this is to calculate the continuously compounded annual nualized rate of return? The easiest—and most return, Since | year and 9 months equals 1.75 years, this return is: si) 1,000 23.1694% 1,000explr.75]=1,500— r==t-In| 17542 Chapter 1 1.9 Discounting Using Dated Cash Flows ‘Most of the computations in this chapter consider cash flows which occur at fixed periodic intervals. Typically we look at cash flows which occur on dates 0, 1, ... ,, where the period indicates an annual, semi-annual, or other fixed interval. Two Excel functions, XIRR and XNPY, allow us to do computations on cash flows which occur on specific dates that need not be at even intervals.” In the following example we compute the IRR of an investment of $1,000 made on 1 January 2014 with payments on specific dates: A B c USING XIRR TO COMPUTE THE ANNUALIZED INTERNAL RATE OF 1 RETURN 2 Date Cash flow 3 | 01-Jan-14 -1,000 4 | 03-Mar-14 150 5 04-Jul-14 100 6 12-Oct-14 50 7 | 25-Dec-14 1,000. 8 9 |IRR 37.19% <—- =XIRR(B3:B7,A3:A7) ‘The function XIRR outputs an annualized return. It works by computing the daily IRR and annualizing it, X/RR = (1+ daily IRR)" -1 XNPV computes the net present value of a series of cash flows occurring ‘on specific dates: 7. If you do not see these functions, add them in by going to Tools|Add-ins on the toolbar and checking Analysis ToolPak.a Basic Financial Calculations x B o USING XNPV TO COMPUTE THE NET Fl PRESENT VALUE 2] Annual iscountrate | 12% 3 4 Date Cash flow S]_ otvan-14 “4,000 | 03-Mar-15 100 T] 04 uults 195 B] 10616 350 @]25.Dec-17 300 70 TT |Net present value 16.80 < =XNPV(B2.85:80,A5:A8) 2 Note that XNPV has a diferent syntax rom NPV! IxNPV require allthe cash flows, including the ina cashflow, lwhereas NPV assumes thatthe frst cash flow occurs one period 13 hence. Fixing Bugs in XNPV and XIRR Both XNPV and XIRR have bugs, which Microsoft has not fixed in several versions of Excel. The file with this chapter includes functions that fix these bugs, called NXNPV and NXIRR.* + XNPV doesn’t work with zero or negative interest rates. + XIRR does not identify multiple intemal rates of return. The XNPYV relates to the failure of this function to correctly deal with zero or negative discount rates 8, These bug fixes were developed by my colleague Benjam Coacakes.44 Chapter 1 nN Ts T Cc PROBLEM WITH XNPV 1 XNPV does not work with zero or negative discount rates 2 [Discount rate -3.00% 3 |Net present value | #NUM! << =XNPV(B2,B7:B13,A7:A13) 4 ~194.87 <~ =nXNPV(B2,87:B13,A7-A13) 5 é Date Cash flow 7] 30-Jun-14 -500 S| 14-Feb-15 4100 a | 14-Feb-16 300 40] 14-Feb-17 400 11] 14-Feb-18 600 12] 14-Feb-19 800 43] 14-Feb-20 =1,800 ‘The NXNPV function fixes this problem. ‘The bug in XIRR is that the Guess switch on XIRR doesn’t work. Consider the following problem: aT z os z i PROBLEMS WITH XIRR Net present val | 6 9106|== @XNPVZEDBISATATS) RR SNUME <= =XIRRIBESSAGATS) no Guess 5 SNUME “= *KIRR(GEBISATATS 35%), Gus = 35% @ SNUME “== =XIRR(BEBISABATS 58), Guess = 5% ll eo XNPV ag Function of Discount Rate paceaiemsras45 Basic Financial Calculations From the data table, it is evident that there are two internal rates of return (around 5% and around 39%). But the XIRR function does not identify either see cells B4:B6). ‘The function NXIRR fixes this bug: x a c 1 NXIRR FIXES THE XIRR BUG 2 [Discountrate | _-3.00% SRR 5.06% <= =nXIRR(SS:B14 ABA) _no Guess 4 98.77% <= =nXIRR(B8:B 14,A6:A14,35%), Guess = 35% 5 5.00% <= =nXIRR(B6:514,A8:A14,5%) , Guess = 5% 6 7 Date [Cash flow] 30-Jun-14 500] a] 14-Feb-15 09] 0] 14-Feb-16 300 11] 14-Feb-17 400 12] 14-Feb-te 600 1a] 14-Feb-19 800 14] 14-Feb-20 =809] Exercises 1. You are offered an asset costing $600 that has cash flaws of $100 at the end of each of the next 10 years 1. Ifthe appropriate discount rate for the asset is 8%, should you purchase it? b, What is the IRR of the asset? 2. You just took a $10,000, 5-year loan. Payments at the end of each year are flat (equal in every year) at an interest rate of 15%. Calculate the appropriate loan table, showing the breakdown in each year between principal and interest. 3. You are offered an investment with the following conditions: + The cost of the investment is 1,000. + The investment pays out a sum X at the end of the frst year; this payout grows at the rate of 10% per year for 11 years. If your discount rate is 15%, calculate the smallest X which would entice you to purchase the asset. For example, as you can see inthe following display, X= $100 is too small—the NPV is negative:Chapter 1 A B c 7 [Discount rate 15% Z inital payment 129.2852 3 NPV 226.52 <-- =B6+NPV(B1,B7:817) 4 5 Year Cash flow 6 0 1,000.00 7 1 100.00 3 2 110.00 9 3 421.00 10 4 133.10 ct 5 146.41 12 6 161.05 3 7 177.16 14 8 494.87 15 9 214.36 16 10 235.79 7 rt 259.37 4. The following cash-flow pater has two IRRs. Use Excel to draw a graph of the NPV of these cash flows asa function ofthe discount rate. Then use the IRR function to identify the two IRRs. Would you invest inthis project if the opportunity cost were 20%? A B 4 Year __ Cash flow 5 0 -500 6 1 600 7 2 300 8 3 300 9 4 200 10. 5 -1,000 5. Inthis exercise we solve iteratively forthe intemal rate of return. Consider an investment Which costs 800 and has cash flows of 300, 200, 150, 122, 133 in years 1-5. Setting up the loan table below shows that 10% is greater than the IRR (since the return of principal atthe end of year Sis less than the principal at the beginning of the year)47 Basic Financial Calculations A 5 c D E FE c H T|IRR? 70.00% Division of payment 2 LOAN TABLE between: Principal Payment Year Cash flow Year at beginning at end of Interest Principal Pi of year year [a] 0 -800 1 800.00 | 300.00 80.00, 220.00) 5] 1 300 2 80.00 200.00 58,00, 142.00 6] 2 200 3 438.00 | 150.00 43,80, 106.20] 73 150 4 331.80 | 122.00 33.18 88.82 a] 4 122 5 242.98 133.00 24.30| 108.70) ol 5 133 6 434,28 |< Should be zero for IRR Setting the IRR? cell equal to 3% shows that 39 is less than the IRR, since the return of principal at the end of year 5 is greater than the principal atthe beginning of year 5. By changing the IRR? cel, find the internal rate of return of the investment. a c D E F c a 7 IRR? 3.00% Division of payment 2 LOAN TABLE between: Principal Payment Year Cash flow Year at beginning at end of Interest Principal Pl of year year 4] 0 -800 1 800.00 | 300.00 24.00| 276.00) s| 1 300 2 24.00 | 200.00 15.72, 184.28| 6] 2 200 3 339.72 | 150.00 10.19, 139.81 7| 3 150 4 199.91 122.00 6.00, 116.00] a] 4 122 5 83.91 133.00 2.52, 130.48| ol 5 133 6 -46.57 __< Should be zero for IRR 6. _Analternative definition of the IRR is the rate which makes the principal at the beginning of year 6 equal to zero.’ This is shown in the printout above, in which cell E9 gives the principal atthe beginning of year 6. Using the Goal Seek function of Excel, find this rate (below we illustrate how the screen should look). 9. In general, of course, the IRR is the rate of return that makes the principal inthe yeat following the last payment equal to zero,48 Chapter 1 a Sows] Dmsion of payment E LOAN TABLE etween Principal Payment Vern Year atbeginning atend Interest Principal of yea a 300 4 @0000 song 1 300 2 52400 29 2 200 3 3072 ‘siecle 3 150 2 ‘ 12 5 a 1 5 33 6 | sr IRR 5.07% This uses the Excel lomula “RRGLBO) (Of course you should check your calculations by using the Excel IRR function.) Calculate the flat annual payment requited to pay off a 136, 5-year loan of $100,000. 8. You have just taken a car loan of $15,000. The loan is for 48 months at an annual interest rate of 15% (which the bank translates t0 a monthly rate of 15%/12 = 1.25%). The 48 payments ((o be made at the end of each of the next 48 months) are all equal. a Caleulate the monthly payment on the loan, b, In a loan table calculate, for each month: the principal remaining on the loan at the beginning of the month ‘and the split of that month's payment between interest and repayment of principal . Show that the principal at the beginning of each month is the present value of the remaining loan payments at the loan interest rate (use either NPV or the PV functions. 9. You ate considering buying a car from a local auto dealer. The dealer offers you one of two payment options: + You can pay $30,000 eash, + The “deferred payment plan”: You ean pay the dealer $5,000 cash today and a payment ‘of $1,050 at the end of each of the next 30 months. As an alternative to the dealer financing, you have approached a local bank, which is willing to give you a car loan of $25,000 at the rate of 1.25% per month.49. Basic Financial Calculations ‘a Assuming that 1.25% is the opportunity cost, calculate the present value of all the payments on the dealer's deferred payment plan 'b, What is the effective interest rate being charged by the dealer? Do this calculation by preparing a spreadsheet like this (only patt of the spreadsheet is shown—you have to do this calculation for all 30 months) D E i S H Payment under i Month Cash payment ja"! Difference payment plan 30,000 5,000 1,050 1,050 1,050 1,050 1,050 1,050 1,050 1,050 25,000 o]co|sJo]or]afosfro lo oan ensio =|5] Now calculate the IRR of the difference column; this is the monthly effective interest rate fon the deferred payment plan, 10, You are considering a savings plan which calls for a deposit of $15,000 at the end of each ofthe next 5 years. Ifthe plan offers an interest rate of 10%, how much will you accumulate at the end of year 5? Do this calculation by completing the following spreadsheet, This spreadsheet does the calculation twice—onee using the FV function and once using a simple table which shows the accumulation at the beginning of each year A B c D 7 [Annual payment 75,000 2 interest rate 10% 3. |Number of years 5 4 {Total value $91,576.50 <~ =FV(B2,B3,-B1,,0) 5 Accumulation Year at beginning of Paymentat Annual a aa end of year interest 7 1 0 16,000, 0.00 8 2 15,000 16,000 1,500.00 9 3 31,500 10 4 11 5 12 650. Chapter 1 11, Redo the previous calculation, this time assuming that you make 5 deposits atthe begin- ning ofthis year and the following 4 years. How much will you accumulate by the end of year 5? 12, A mutual fund has been advertising that, had you deposited $250 per month in the fund for the last 10 years, you would now have accumulated $85,000. Assuming that these deposits were made atthe beginning of each month for a period of 120 months, calculate the effective annual return fund investors got. Hint: Set up the following spreadsheet and then use Goal Seek. A B ie Monthly payment 250 Number of months 120 Effective monthly return? [Accumulation Jen] oo} ] =FV(B4,B2,-B1,,1) ‘The effective annual return can then be calculated in one of two ways: + (1+ monthly return = 1: This is the compound annual return, which is preferable, since it makes allowance for the reinvestment of each month's eat + 12¢monthly return: This method is often used by banks. 13. You have just turned 35, and you intend to start saving for your retirement. Once you retire in 30 years (When you tun 65), you would like to have an income of $100,000 per yes for the next 20 years, Calculate how much you would have to save between now and age 65 in order to finance your retirement income, Make the following assumptions: + All savings draw compound interest of 10% per yea + You make the frst payment today and the last payment on the day you tum 64 (30 payments) + You make the frst withdrawal when you turn 65 and the last withdrawal when you turn 84 (20 payments), 14, You currently have $25,000 in the bank, in a savings account that draws 5% interest. Your ‘business needs $25,000, and you are considering two options: (a) Use the money in your savings account (b) Borrow the money from the bank at 6%, leaving the money in the savings account.sl Basic Financial Calculations Your finan ial analyst suggests that solution (b) above is better. His logic: The sum of the interest paid on the 6% loan is lower than the interest earned at the same time on the $25,000 deposit. His calculations at illustrated below. S You think about it, it couldn't be preferable to take a 6% loan when you are getting 5% ow that this logie is wrong. (If interest from the bank. However, the explanation for this may not be ixivial.) x [ss fi EXERCISE 14, financial analyst's calculations z 3% s o% fn epost 75000 =PUTISBS3.2-$884) 6 THE 6% LOAN Principal at Payment at pag Repayment , sad beginning of year endot yeas AMF" Pald of rncipal = 42500000 #385502 4.50000 1.13592 < =cs-D8 = 2. igaetos 1363502 ‘771. 8H 1286408 a Totalinterest paid 22ri ss at 2 Savings Account Insavings—Endyear Year sccountat intrest 2accountat Fs beginning ofyear eared “1 42500000 280.00 8.25000 5 2 desoco 13280 2756250 a 2.58250 15, Use XIRR to compute the internal rate of return of the following investment: A B 1] Date Cash flow 2 | 30-Jun-07 -899| 3 | 14-Feb-08 70| 4 |14-Feb-09 70| 5 | 14-Feb-10 70| 6 | 14-Feb-11 70| 7 |14-Feb-12 70| 8 |14-Feb-13 1,070}Chapter 1 16, Use XNPV to value the following investment. Assume that the annual discount rate is 13% A B 4 Date Cash flow 5 30-Jun-07 -500] 6 14-Feb-08 100) 7 14-Feb-09 300 8 14-Feb-10 400| 9 14-Feb-11 600 10 14-Feb-12 800 ci 14-Feb-13 -1,800| 17. Identify the two internal rates of return of the investment in exercise 16.