Time Value of Money

Learning Problems

Answer Keys

Time Value of Money Page 1

Problem: Future Value at Hamilton

1. (100,000.00) (1 + .02)3 = 106,120.80 FV = CAD 106,120.80

106,120.80 – 100,000.00 = 6,120.80 Interest = CAD 6,120.80

Note: The original amount invested in the bank deposit is deducted from the future
value to determine the amount of the interest earned.

2. (100,000) (1 + .02)5 = 110,408.08 FV = CAD 110,408.08

110,408.08 – 100,000 = 10,408.08 Interest = CAD 10,408.08

Note: More interest is earned because the term of the investment is longer.

.02 (12 x 3)
3. (100,000) (1 + ) = 106,178.35 FV = CAD 106,178.35
12

106,178.35 – 100,000 = 6,178.35 Interest = CAD 6,178.35

Note: More frequent compounding generates more interest. The interest rate (i) is
calculated for the monthly compounding period by dividing the APR by 12 and the
number of compounding periods is 12 per year times three years.

Time Value of Money Page 2

Problem: Future Value at Sproule

1. (10,000.00) (1 + .0610)3 = 11,943.90 FV = CAD 11,943.90

Note: Sproule will receive the initial loan principal of CAD 10,000 plus interest in
three years.

2.
Compound Interest

11,943.90 – 10,000.00 = 1,943.90 Interest = CAD 1,943.90

Note: The original amount of the loan is deducted from the future value calculated
in Part 1 to determine the interest earned.

Simple Interest

(10,000) (.0610) (3) = 1,830.00 Interest = CAD 1,830.00

Note: The initial principal is multiplied by the annual interest rate and the number
of years in the loan to give the simple interest. This can be done because there is no
compounding or interest on interest at the end of each year.

Additional Interest due to Compounding

1,943.90 – 1,830.00 = 113.90 Additional interest = CAD 113.90

Note: This is the difference between the compound and simple interest. The table
below provides an additional perspective on how the amounts were determined.

Simple Interest Compound Interest

Interest Due to
Year Beginning Interest Beginning Interest
Compounding
Principal (CAD) i = 6.10% Principal (CAD) i = 6.10%
1 10,000.00 610.00 10,000.00 610.00 0.00
2 10,000.00 610.00 10,610.00 647.21 37.21
3 10,000.00 610.00 11.257.21 686.69 76.69
Total interest 1,830.00 Total interest 1,943.90 113.90

.0610 (3 x 2)
3. (10,000.00) (1 + ) = 11,975.34 FV = CAD 11,975.34
2

Note: The interest earned grows with more frequent compounding.

4.

Time Value of Money Page 3

Problem: APR versus EAR at Tyson

1.
8%, compounded monthly

.08 12
(1 + ) – 1 = .0830 or 8.30%
12

Note: The APR is divided by the number of compounding periods per year to
determine the effective interest rate for the period. This rate is then compounded by
the number of compounding periods per year to give the EAR.

8%, compounded quarterly

.08 4
(1 + ) – 1 = .0824 or 8.24%
4

8%, compounded semi-annually

.08 2
(1 + ) – 1 = .0816 or 8.16%
2

8%, compounded annually

.08 1
(1 + ) – 1 = .0800 or 8.00%
1

Note: The EAR is higher the more frequent the compounding.

Time Value of Money Page 4

Problem: Present Value at Tribeca
150,000
1. 3
=139,289.91 PV = CAD 139,289.91
(1+.025)

Note: An amount equal to 150,000 must be accumulated in three years. If Tribeca

invests 139,289.91 and earns interest for three years, it will have the 150,000 needed.

150,000
2. n
=120,000
(1+.025)

1.25 = 1.025n

log 1.25 = n log 1.025

log 1.25
n=
log 1.025

n = 9.04 years

Note: It will take longer to accumulate 150,000 because at the same interest rate
because you have less to invest now. Logarithms is a complex topic that was first
introduced in high school. This is the only application you need to understand for
this module.

150,000
3. 3
=120,000 i = .0772 or 7.72%
(1+i )

Note: A higher interest rate is required if Tribeca only has 120,000 to investment
and must accumulate 150,000 in three years. The interest rate (i) is solved for by:

150,000
=¿ (1+i)3
120,000

150,000 1/ 3
( ) =¿ ( ( 1+i ) ¿¿ 3)1 /3 ¿
120,000
1/ 3
150,000
( ) =¿ (1 + i)
120,000

150,000 1/ 3
( ) −1=¿ i
120,000

i = .0772

Time Value of Money Page 5

Time Value of Money Page 6
Problem: Present Value at Sol

1. Yes, they should investment. The total present value of the future cash inflows at the
end of each of the three years and the sale of the assets at the end of the project’s
life exceeds the initial cost, so the project makes a profit. By expressing all cash
flows in today’s dollars by calculating their PV, the cash flows are comparable.

Cash Flows Calculation Present Value

Time
(CAD) i = 7%, compounded annually (CAD)
−75,000
Initial investments -75,000 ¿ -75,000.00
(1+.07 )0
45,000
Cash inflows at end of year 1 45,000 ¿ 42,056.07
(1+.07 )1
45,000
Cash inflows at end of year 2 45,000 ¿ 39,304.74
(1+.07 )2
45,000
Cash inflows at end of year 3 45,000 ¿ 36,733.40
(1+.07 )3
25,000
Sale of assets 25,000 ¿ 20,407.45
(1+.07 )3
Total CAD 63,501.66

or

−75,000 25,000
0 + 45,000 ¿ +
=¿-75,000 + 118,094.22 + 20,407.45 = 63,501.67
( 1+.07 ) ( 1+.07 )3

PV = CAD 63,501.67

Note: In the second component of the above formula, the PVA formula is used
instead of finding the PV of each cash flow individually. Otherwise, the calculations
are the same.

Time Value of Money Page 7

Problem: Future Value of an Annuity at Cartlidge

1.
Option 1

50,000 (1 + .0355)25 = 119,597.63 FV = CAD 119,597.63

Option 2

( ( 1+.0355 ) ¿¿ 25−1)
3,500( ¿ ) = 137,234.77 FVA = CAD 137,234.77
.0355

Option 2 is preferred because the future value is higher.

Note: The FVA formula was used to value Option 2 because Cartlidge would be
making equal payments at the end of each year.

2. No. The future value of Option 2 would be even higher as the investments are made
at the beginning of the year and there is an extra year of compounding.

( ( 1+.0355 ) ¿¿ 25−1)
3,500( ¿ ) (1 + .0355) = 142,106.60 FVAD = CAD 142,106.60
.0355

Note: The FVAD formula is used instead of the FVA formula because the payments
are made at the beginning of the year.

3. It will discipline Cartlidge to invest her inheritance now. Other purchases or

expenses in the future may prevent her from making regular payments over the next
25 years under Option 2.

Time Value of Money Page 8

Problem: Present Value of an Annuity at Edwards

1.
Option 1

500,000 500,000
5 + = 748,745.64 PV = CAD 748,745.64
(1+.04) (1+.04)10

Note: The PV of the two payments must be calculated separately because they are
not in successive years.

Option 2

90,000 ¿ = 729,980.62 PVA = CAD 729,980.62

Note: The PVA formula can be used because the payments are in successive years.

Option 1 has a higher present value.

2.
Option 2

90,000 ¿ = 759,179.84 PVAD = CAD 759,179.84

or
90,000+ 90,000¿ = 759,179.84 PVAD = CAD 759,179.84

Note: Receiving the payments at the beginning of the year makes them more
valuable.

Yes. Option 2 now has a higher present value.

Time Value of Money Page 9

Problem: Present Value of an Annuity at Wellington

1.
Bid 1
20,000 15,000
1
+ 2 + ¿ ¿ = 91,276.31 PV = CAD 91,276.31
(1+.05) (1+.05)

Note: The PV of the first and second components of the formula must be
determined separately because the amounts are different. The third component of
the formula finds the PV of the payments in Years 3 through 10. The PVA formula is
used because the amounts are the same each year. The PVA formula provides the
value of the annuity at the beginning of Year 3 which is the same as the end of Year
2. All PV formulas provide a value at the beginning of the year. This amount needs
to be discounted for two more years to determine its present value today.

Bid 2

12,000 ¿ PVAD = CAD 81,436.48

or
12,000+12,000 ¿ = 81,436.48 PVAD = CAD 81,436.48

Note: The PVAD formula is used because payments are at the beginning of the
year.

Bid 1 is preferred.

Time Value of Money Page 10

Problem: Present Value of an Annuity at Wilson

1.
Option 1

140,000
¿ = 85,947.86 PV = CAD 85,947.86
(1+.05)10

Option 2

¿ 12,000 ¿ = 92,660.82 PVA = CAD 92,660.82

Option 3
¿ 5,000 ¿ + ¿ ¿42 PV = 86,013.42

Option 2 is preferred as it has the highest present value.

Time Value of Money Page 11

Problem: Present Value of an Annuity at Harte

1.
Offer 1: Innovative Products
30,000 25,000
= 1
+ 2 + ¿¿ PV = CAD 157,781.68
(1+.04) ( 1+ .04)

Offer 2: Morden Industries

PV = CAD 145,000

Offer 1 is preferred as it has the highest present value.

Time Value of Money Page 12

Problem: Present Value of a Perpetuity at Wexler

1.
5.20
4
= 104.00 PVP = CAD 104.00
.05
4

Note: This is the present value of a perpetuity formula. The inputs were modified
to give a quarterly payment (÷ 4) and a quarterly interest rate (÷ 4) but notice that it
did not matter as the 4’s cancelled out. Remember a perpetuity is a string of
payments that goes on forever and is commonly used in valuing common and
preferred shares.

Time Value of Money Page 13

Problem: Present Value of a Perpetuity with Growth at Jenkins

1.
( 5.20 ) (1+.03)
= 267.80 PVPG = CAD 267.80
.05−.03

Note: This is the present value of a perpetuity with growth formula. The dividend is
currently CAD 5.20 paid out annually. By the end of the first year it will be 3.0%
higher with growth hence (5.20)(1 + .03). Deducting .03 in the denominator allows
for growth in the numerator over time.

2.
1 2 3( 5.20 ) ( 1+.08 )3 (1+.03)
( 5.20 ) (1+.08) ( 5.20 ) (1+.08) ( 5.20 ) (1+.08)
1
+ 2
+ 3
+ (.05−.03) = 5.35 + 5.50 + 5.66
(1+.05) (1+.05) (1+.05) 3
(1+.05)
+ 291.42 = 307.93

PV = CAD 307.93

Note: The growth rate in the first three years was different than the subsequent
years, so the present values of the first three payments were calculated separately.
The PVPG formula was used for all remaining payments that go on forever with
growth. This value is at the beginning of Year 4 or end of Year 3, so the amount was
discounted back another three years to today’s value.

Time Value of Money Page 14

Problem: Present Value of an Annuity with Growth at Harrison

1. Yes, Harrison should undertake the project because the PV of the future cash inflows
exceeds the initial cost.

-250,000 + (
65,000
.06 – .05
¿ (
(1 – )
1+, 05 5
1+.06
) = 50,873.12 PVAG = CAD 50,873.12

Note: This is the present value of an annuity with growth formula. It is used when
the cash flows are expected to increase over the life of a project which is normal.
The initial investment is not discounted because it occurs immediately.

Time Value of Money Page 15

Problem: Calculating a Loan Payment at Jones

1.
.045 −(20 x 12)
1−(1+ )
12
(450,000) (1 - .20) = P ( )
.045
12
Payment = 2,277.54

Note: Jones had to make a 20% down payment, so the loan is only for 80% of
450,000. Blended, equal monthly loan payments are an annuity since the same
payment occurs at the end of each month for the life of the loan so the PVA formula
is used. When you take the PV of loan payments, it removes the interest from the
payments leaving only the principal which must total to the value of the loan. The
interest rate and compounding period must be for one month since the payments
are monthly. The number of periods is the number of payments or months in the
loan.

2.
Amortization Table
Beginning Interest Ending
Period Principal
Principal (.045 ÷ 12) Principal
1 360,000.001 1,350.002 927.543 359,072.464
2 359,072.465 1,346.526 931.027 358,141.448

1
(450,000) (1 - .20)
2
(360,000) (.045 / 12)
3
2,277.54 – 1,350.00
4
360,000 – 927.54
5
Ending principal of the period before
6
(359,072.46) ( .045 / 12)
7
2,277.54 – 1,346.52 = 931.02
8
359,072.46 – 931.02 = 358,141.44

Note: An amortization table provides the break down of interest and principal in
loan payments over the life of the loan. Interest falls as the loan is paid down and
principal rises as more of the payment is devoted to paying down the loan. The
ending principal of one period is the beginning principal of the next period. By the
end of the loan’s life in 240 months, the ending principal will be zero.

Time Value of Money Page 16

Problem: Interest Rate at Wilson

1.
−(25 x12)
1−(1+i)
250,000 = 1,700 ( )
i

i = .005481 (solved using Goal Seek in Excel)

Note: Analysts frequently know the loan’s principal and the amount and number of
payments, but do not know what interest rate (i) is implied by these amounts. The
same formula can be used, analysts simply solve for a different unknown.

See the Excel spreadsheet Answer Keys – Interest Rate at Wilson Company to see
how Goal Seek was used in this question.

APR

(.005481) (12) = .065772

6.58%, compounded monthly

Note: APR expresses the interest rate annually without the effect of compounding,
so the monthly effective interest rate is multiplied by twelve months.

EAR

(1 + .005481)12 – 1 = .067791

6.78%, compounded annually

Note: EAR expresses the interest rate annually including the effect of compounding,
so the monthly effective rate must be compounded 12 times. This formula can be
expressed as investing CAD 1 and earning interest on a compounded basis for
twelve months and then paying back the CAD 1 leaving just the interest. Because
CAD 1 or 100 cents was used, the interest rate can be quickly converted to per cent
form as the base is 100.

Time Value of Money Page 17

Problem: Number of Payments at Allison

1.
1−(1+.035 /12)−n
350,000 = 1,500 ( )
.035 /12

1−(1.002917)−n
350,000 = 1,500 ( )
.002917

.680633 = 1−(1.002917)−n

1.002917-n = .319367

-n log 1.002917 = log .319367

log .319367
n=- = 391.87 months
log 1.002917

Note: Logarithms must be used solve for an unknown when it is an exponent.

Time Value of Money Page 18

Problem: Customized Loan Schedule at Hastings

1.
Interest Principal Total Ending
Paid Paid Payment Principal
September 30, 20181 110,000 0 110,000 5,500,000
December 31, 20181 110,000 0 110,000 5,500,000
March 31, 20191 110,000 500,000 610,000 5,000,000
June 30, 20192 100,000 500,000 600,000 4,500,000
September 30, 20193 90,000 500,000 590,000 4,000,000
December 31, 20194 80,000 500,000 580,000 3,500,000
March 31, 20205 70,000 750,000 820,000 2,750,000
June 30, 20206 55,000 750,000 805,000 2,000,000
September 30, 20207 40,000 750,000 790,000 1,250,000
December 31, 2020,8 25,000 1,250,0009 1,275,000 0

1
(5,500,000) (.08/4) = 110,000
2
(5,500,000 – 500,000 (1)) (.08/4) = 100,000
3
(5,500,000 – 500,000 (2)) (.08/4) = 90,000
4
(5,500,000 – 500,000 (3)) (.08/4) = 80,000
5
(5,500,000 – 500,000 (4)) (.08/4) = 70,000
6
(5,500,000 – 500,000 (4) − 750,000 (1)) (.08/4) = 55,000
7
(5,500,000 – 500,000 (4) – 750,000 (2)) (.08/4) = 40,000
8
(5,500,000 – 500,000 (4) – 750,000 (3)) (.08/4) = 25,000
9
(5,500,000 – 500,000 (4) – 750,000 (3))

2.
I/O – Only interest was paid during the first two quarters.

Straight-line – An equal amount of principal was paid in 2019 and 2020.

Stepped – Principal payment increased from CAD 0 in 2018 to CAD 500,000 in 2019
to CAD 750,000 in 2020.

Balloon – Principal payments were deferred, and a large principal payment was
made in the final quarter.

Note: Customized loan repayment schedules may be negotiated that result in lower
total payments initially when a new company or project is generating a limited
amount of cash. As the company or project becomes more successful, the principal
payments increase, and the loan is eventually paid off.

Time Value of Money Page 19

Problem: Time Value of Money Applications

1.
45,000
PV = = 39,672.88
( 1+.032 )4
2.
5,500
PVP = = 137,500.00
.04
3.
( 8,000 ) ( 1+.0325 )3−8,000=805.62

4.
(8) (5,500) (.038) = 1,672.00

5.
( 1+.0325 )6−1
FVAD = 3,500 ( ¿ (1 + .0325) = 23,522.43
.0325
6.
45,000
PV =
( )
12
.08 = 41,551.27
1+
12
7.
4,350
=
PVPG = .08 – .03
87,000.00

8.
1−( 1+.0365 )−5
4,200 ( )=
PVA = .0365
9. 18,882.93
EAR = 2.71828.035−1 = .0356 or
3.56%

10.
EAR= 1+ ( .06 4
4 )
- 1 = .0614 or 6.14%

Time Value of Money Page 20

Problem: Predefined FV and PV Functions in Excel

1. See Excel spreadsheet provided.

Time Value of Money Page 21

Problem: Calculating a Loan Payment at Flynn

1. See Excel spreadsheet provided.

2. See Excel spreadsheet provided.

Time Value of Money Page 22