January

FUNDAMENTAL OF FINANCIAL MANAGEMENT

1, 2015
TUTORIAL: TIME VALUE OF MONEY
Part 1:

Textbook: Chapter 5 (page 155-159):

5, 6, 9, 10, 11, 13, 18, 20, 22, 25, 28, 29, 30, 36, 37, 41, 43, 45, 49, 50, 51, 62.

Part 2: Handout

1. . Suppose you make an investment of $1,000 now. This first two years the
investment returns 12%, the third year it returns 6%, and the fourth and fifth year
it returns 8%. How much would this investment be worth at the end of the fifth
year, assuming no withdrawals are made in between?

2. A wealthy relative gives Barney $5,000 to help provide for his new born child’s
university fee. He decides to invest this money at 10% p.a. until his child is ready
to go to university. How much will be in the account 18 years from now?

3. Barney wants to provide $20,000 for his new born child’s education, which will
begin 18 years from today. How much should Barney invest now, if the interest
rate is 10% p.a.?

4. Barney lends $100,000 to John, his cousin for a total of 10 years at 5% p.a.

a. How much does John have to pay after 10 years (if using simple interest
rate)?

b. How much does John have to pay after 10 years (if using compounded
interest rate)?

c. Assume that Barney lends $100,000 to John, using simple interest rate,
but wants to receive the payment which is equal to that if using compounded interest.
What should the interest rate be?

5. How long will it take certain investment to double in size when invested at the
rate of 8% per year? How long for triple in size?

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6. How long will it take for a $3,000 investment to grow to $10,000 if invested at 5%
interest

a. compounded annually?

b. compounded quarterly?

7. You borrow money on your credit card at 17.5% p.a., compounding quarterly.
What is the effective annual interest rate?

8. The following interest rates are being offered by three competing banks: 4%
compounded monthly; 4.1% compounded quarterly; 4.15% compounded
annually. Which one is the most attractive?

9. On a contract, you have a choice of receiving $25,000 six years from now or
$50,000 twelve years from now. At what implied compound annual interest rate
should you be indifferent between the two contracts?

10. You have just won the prize in the State lottery. A recent innovation is to offer
prize winners a choice of payoffs. You must choose one of the following prizes:

a. $1,000,000 paid immediately

b. $600,000 paid exactly one year from today, and another $600,000 paid
exactly 3 years from today

c. $70,000 payment at the end of each year forever (first payment occurs
exactly 1 year from today)

d. An immediate payment of $600,000, then beginning exactly 5 years from

today, an annual payment of $50,000 forever

e. An annual payment of $200,000 for the next 7 years (first payment occurs
exactly 1 year from today)

You believe that 8% p.a. compounded annually is an appropriate discount rate.

Assuming you wish to maximize your current wealth, which is the best prize?

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11. Your company anticipates the introduction of environmental protection laws 3

years from now. Under these laws, you will have to pay an environment tax of
$5,000 at the end of each year. If the rate is 6% p.a., how much money does
your company need to put aside today to sponsor your company’s obligation
under this law?

12. Joe Hernandez has inherited $25,000 and wishes to purchase an annuity that will
provide him with a steady income over the next 12 years. He has heard that the
local bank is currently paying 6% p.a. (compounding annually). If he were to
deposit his fund, what is the equal amount would he be able to withdraw at the
end of each year for 12 years?

13. After graduation, you plan to work for your local bank for 12 years and then start
your own business. You expect to save and deposit $7,500 a year for the first 6
years and $15,000 annually for the following 6 years. The first deposit will be
made a year from today. In addition, your grandfather just gave you a $25,000
graduation gift which you will deposit immediately. If the account earns 9%
compounded annually, how much will you have when you start your business 12
years from now?

14. Muffin Megabucks is considering two different savings plans in 10 years. The first
plan would have her deposit $500 every six months, and she would receive an
interest rate at 7% p.a. (compounding semi-annually). Under the second plan she
could deposit $1,000 every year with the rate of interest of 7.5% p.a.
(compounding annually). Which plan should Muffin use? (Assuming that the
initial deposit of Plan 1 would be made 6 months from now, and with Plan 2, one
year from now).

15. Kate’s financial advisor tells her that she will need $2 million to fund her
retirement. She plans to work for another 30 years before retiring. She will make
30 contributions to a pension plan. How much will each contribution be, if the
interest rate is 9% p.a.?

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16. Mary has just retired and has $1 million in her retirement account. Her bank
offers an arrangement whereby the bank takes her $1 million now and pays her
$110,000 at the end of each year for the next 20 years. Is it a fair deal, if the
offered rate is 10% p.a.?

17. Mr. Doody, at age 70, is expected to live for 15 years. If he can invest at 12% per
annum compounded monthly, how much does he need now to guarantee himself
$300 every month for the next 15 years?

18. Daryl wishes to save money to provide for his retirement. Beginning one month from
now, he will deposit a fixed amount into a retirement savings account that will earn 12%
p.a. compounded monthly for 30 years. Then, one year after making his final deposit, he
will withdraw $100,000 annually for 25 years. How much should Daryl deposit for the
first 30 years to meet his objective if the fund earns the interest rate of 12.68% p.a.,
compounded annually during the last 25 years?

19. The Happy Hang Glide Company is purchasing a building and has obtained a
$190,000 mortgage loan for 20 years. The loan bears a compound interest rate of 17%
p.a. and calls for equal annual installment payments at the end of each of 20 years.
What is the amount of annual payment?

20. A home buyer is purchasing a $140,000 house. The down payment will be 20% of
the price of the house, and the remainder will be financed by a 30-year mortgage at a
rate of 9.8% interest compounded monthly. What will the monthly payment be?
Compare the monthly payments and the amounts of interest paid if a 15-year mortgage
is chosen instead of a 30-year mortgage.

21. Ann obtains a $150,000, 20-year mortgage with a bank at 9% p.a., compounded
monthly.

a. What is her monthly repayment?

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b. Suppose that after 5 years, Ann plans to repay the loan by making an
additional payment each month along with her regular payment. How much must Ann
pay each month if she wishes to pay off the loan in 10 years?

22. Mark wants to buy a new car for his wife and agrees with a 1.5-year, $12,000 loan.
The financial institution quotes this loan at 10.5%, compounded monthly. Six months
later, Mark is offered an optional loan from another financial institution. The new loan is
quoted at 9.25% and Mark asks that the number of payments be set to 12. A 1% fee will
be added to the remaining loan balance for the principal of the new loan. What was the
first loan monthly payment and what is the amount Mark is going to pay for the new
one? Is it a good idea to change?

23. Mary enters into a loan agreement to borrow $90,000 to help finance the purchase
of her new home.

a. The agreement specifies the term of 20 years with monthly repayment at

the fixed rate of 9% p.a. (compounded monthly). What is her monthly payment?

b. Five years has passed. A rival lender offers to refinance Mary’s loan at the
fixed rate of 8% p.a. (compounded monthly). The cost associated with this refinancing is
$1,500. Should she refinance?

c. Suppose 9 years have passed since Mary enters the original loan. She’s
considering making an extra payment of $10,000 off her loan. If she plans to keep the
term of the loan the same, how much will her monthly repayment reduce?