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Time Value

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Time Value

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savithanm2002
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Time Value of Money 2.

31

Solved Problems
P.2.1 An investor deposits Rs 100 in a bank account for 5 years at 8 per cent interest. Find out the amount
which he will have in his account if interest is compounded (a) annually (b) semi-annually (6-monthly), (c)
quarterly and (d) continuously.
Solution E P1 + Vm m= Px FVIF,
(a) Annual compounding (m = 1): F - Rs 10o (1 + 0.08/1)5 = Rs 100 (1.4693) = Rs 146.93
(b) Semi-annual compounding (m = 2): F = Rs 100 (1 + 0.08/2) * 2 = Px FVIE,, = Rs 100(1.4802) =
Rs 148.02
(c) Quarterly compounding (m = 4): F = Rs 100 | + 0.08/4) ×4 = Px FVIF, = Rs 100(1.4859) =
Rs 148.59
(d) Continuous compounding: F. P*e " F = Rs 100 (2.71828y * Rs 100 (2.71828y -
Rs 100 (1.4918) = Rs 149.18
P.2.2 If the discoun/required rate is 10 per cent, compute the present value of the cashflow streams detailed
below: (a) Rs 100 at the end of year 1; (b) Rs 100 at the end of year 4; (c) Rs 100 at the end of (i) year 3 and
(ii) year 5 and (d) Rs 100 for the next 10 years (for years 1 through 10).
Solution P- F|WU +0| - E, x PVIF
(a) Rs 100 at the end of
ne m Rs
I Rs 10O[1/.10)!] Rs 100 x PVIF,, - Rs 100 x 0.9091 Rs 90.91.
(b) Rs 100 at the end of
(c)
100/L10Rs 100 x PVo,4KSRs 100 xx 0.683 = Rs 68.3
100 at the end of () year 3 and (ii) year 5 Rs 100(1/10| + Rs 100(1/1.10)] (Rs 100 x PVIF,, )
+ (Rs 100 x PVIF. ) (Rs 100 x 0.7513) + (Rs 100 x 0.6209) - Rs 75.13 + Rs 62,09 - Rs 137.22.
(d) Rs l00 for the next 10 years (annuity)
P. = Ax PVIFA, Rs 100 x PVIFA, o = Rs 10006.1446) - Rs 614.46.
P.2.3 Compute the presen/discounted value of the following future cash inflows, assuming a required rate of
10 per cent: (a) Rs 100 a year for years 5 through 10 and (b) Rs 100 a year for years 1through 3, nil in years
through 5 and Rs 100 a year for years 6 through 10.
Solution
(a) P= Rs 10OXPVIFA,o )-Rs 100X PVIFA,,) = Rs 1006.1446) - Rs 1003.1699)= Rs 614.46 Rs 316.99
Rs 29747.
(b) P= Rs 100XPVIFA,,)+ [Rs 100(PVIFA,o 1o -Rs 100PVTFAjos )] = (Rs 100 x 2,4869) + ((Rs 100
6) - (Rs 100 x 3.7908) = Rs 248 69 + (R - Rs 379.08) = Rs 248.69 + Rs 235.38
Rs sá 07.
P.2.4 An executive is about to retire at the age of 60. His employer has offered himn two post-retirement
options: (a) Rs 20,00,000 lump sum, (b) Rs 2,50,000 for 10 years. Assuming 10 per cent interest, which is a
better option?
Solution P, AXPVIFA, Po = Rs 2,50,000XPVIFA,o1)Rs 2,50,000(6.1446) = Rs 15,36,150.
Since the lumpsum of Rs 20,00,000 is worth more now, the executive should opt for it.
P.2.5 Compute the present value of a perpetuity of Rs 100 vear if the discount rate is 10 per cent.
Solution Present value of a perpetuity = Wi= Rs 100/0.10 = Rs 1.000.
P.2.6 ABC LId has Rs 10 crore bonds outstanding. Bank deposits eam 10 per cent per annum. The bonds will
be redeemed after 15 years for which purpose ABC Ltd wishes to create a sinking fund. How much amount
should be deposited to the sinking fund each year so that ABC Lud woukd have in the sinking fund Rs 10
crore to retire its entire issue of bonds?

Solution A- S/EVIFA, - S,, = Rs 10 crore/FVIFA,. - Rs 10 crore/31.772 - Rs 3.14,742.54.


P.2.7 ABC LId has borrowed Rs 30,00,000 from Canbank Home Finance Lid to finance the purchase of a house
for 15 years. The rate of interest on such loans is 24 per cent per annum. Compute the amount of annual
payment/instalment.

2.32 Financial Management

Solution P,Ax PVIFA, .


A= P/PVIFA, = P,, = Rs 30,00,000/PVIFA,..,. = Rs 30,00,000/4.0013 = Rs 7.49,756.32.
P.2.8 XYZ Ltd has borrowed Rs 5,00,000 to be repaid in fival equal annual payments (interest and principal
both). The rate of interest is 16 per cernt. Compute the amount of each payment.
Soution A- P/PVIFA, = P./PVIFA,s = Rs 5,00,000/3.2743 = Rs 1,52,704.39
P.2.9 Assume the rate of interest is 12 per cent. Compute the annual percentage/effective rate (AP/ER) if
interest is paid (a) annually, (b) semi-annually, (c) quarterty and (d) monthly. What are the implications of
more frequent payments of interest?
Solution AP/ER = (1 + rm)" 1.0
(a) Interest paid at the end of the year (m = 1):
AP/ER = (1 + 0.12/1) 10 = 1.12 10 = 0.12 = 12 perer cent
(b) Interest paid at the end of each 6-month period (m = 2):
AP/ER = (1 + 0.12/2) - 1.0 = (1.06- 10 = 1.1236 10 = 0.1236 = 12.36 per cent.
(c) Interest paid+01224
at the end of1oeach quarter (m:
= 1125- 10= 0.1255 = 1255 per cent.
TER =
(d) Interest paid at the end of eaCh monu
onth u 12}
(mn=

AP/ER = (1 + 0.12/12)12 1.0 = (1.01)2 10 = l1268 - L0 = 0. 1268 = 12.68 per cent.


Implications: More frequent payments increase the effective annual cost (AP/ER) paid by the
borrower-company.
P.2.10 The earmings of Fairgrowth Lid were Rs 3 per share in year 1. They increased over a 10-year period to
Rs 4.02. Compute the rate of growth or compound annual rate of growth of the earnings per share
Solution
F, = Px FVIF,.
FVIF,, - F/P
FVIEE" Rs 4.02/Rs 3 = 1340
Accordins
ing to Table-1 (Appendix), an FVIF of 1340 at 10 years is at 3 per cent interest. The ompound
annual rate of growth in earnings per share is, therefore, 3 per cent
P.2.11 X has Rs 1,00,000 to deposit in a bnk account for 3 years. Assuming (i) annual compounding.
(ii) semi-annual compounding and (iüi) quarterty compounding at a stated annual interest rate of 4 per cent,
compute (a) the amount he would have at the end of the third year, leaving all interest paid on deposits in
the bank, (b) the effective rate of interest he would eam on each alternative, and (c) which plan should he
choose?
Solution
(a) () Compound/future value (FV,) = Rs 1,00,000 x FVIFA (4,3)
Rs 1,00,000 x 1.125 Rs 1,12,500
(a) (ii) FV, Rs 1,00,000 x FVIFA (4/2, 2 x 3) = Rs 1,00,000 x VIFA (2,6)
- Rs 1,00,000 x 1.126 - Rs 1.12,600
(a) (iii) FV, Rs 1,00,000 x FVIFA (4/4,3) = Rs 1,00,000 x PVIFA (1,12)
Rs 1,00,000 x 1.127 = Rs 1,12,700
(b) (i) Effective rate of interest (1 + 49%1) - I = (1.0)'- 1
= 1,04 -| = 0.04= 4 per cent
(b) (ii) =(|+49o/2) -1 = (1.02 -I= 10404 - 1
-0.0-404 4.04 per cent
(b) (ii) - (| + 4%/4) - l- (| + 0.01)* -l = L0406 - I = 0.0106 = 4.06 per cent.
(c) Mr. X should choose alternative (ii). The quarterly compounding of interest has resulted in the highest
future value as a result of the corresponding highest effective rate of interest.

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