FIN202 - FINANCIAL MANAGEMENT

TIME VALUE OF MONEY

September, 2021

Tutorial Questions
Question 1

You have won first prize in a lottery and have a choice of prizes:

i. $10,000 today
ii. $6,000 today and $6,000 in five years
iii. $13,000 in four years
iv. $3,500 a year for four years, the first payment being in three years
v. $750 for ever, the first payment being today
If your required rate of return is 7.5%, which option would you choose?

Question 1 – ANS.

To choose between options you have to put each option into equivalent dollars.
The obvious one to use is today’s dollars, because of the perpetuity.

i. PV = $10,000

ii. PV = 6,000 + 6,000(1.075)-5 = $10,179

iii, PV = 13,000(1.075)-4 = $ 9,734

iv. PV = 3,500PVIFA(7.5%,4)(1.075)-2 = $10,144

750
v. PV = 750 + 0.075 = $10,750

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 Choose (v) as it has highest value.

(iv) 3500 { [ 1- (1.075)-4 ] / 0.075} (1.075)-2

Question 2

a. Determine how much $1,000 deposited in a savings account paying 8% (compounded annually) will be
worth after 5 years.
a. $5,526
b. $ 784
c. $1,400
d. $1,469
ANS: D
FV  PV 1  i  n
= 1000(1.08)5 from the FVIF tables

= 1000 (1.4693)

=1,469

b. Mr. Moore is 35 years old today and is beginning to plan for his retirement. He wants to set aside
an equal amount at the end of each of the next 25 years so that he can retire at age 60. He expects
to live to the maximum age of 80 and wants to be able to withdraw $25,000 per year from the
account on his 61st through 80th birthdays. The account is expected to earn 10 percent per
annum for the entire period of time. Determine the size of the annual deposits that must be made
by Mr. Moore.
a. $212,850
b. $23,449
c. $2,164
d. $8,514
ANS: C

First find the PV of the annuity of his withdrawal of $25,000 p.a. on his retirement from 61 st to 80th
birthday. This is to find the total amount he should have in his savings.

1−( 1+i )−n

PVannuity = pmt
[ i ]
PV = 25,000 [ 1 – (1.10)-20 / O.10] Refer to PVIFA table

= 25,000 (8.5136) = 212,840

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 After that find the Annuity/deposit he have to make each year to accumulate the total savings when
he retire.

PMT 1  i  n  1
FVA 
i  
$212,840 = PMT [ (1 + 0.10)25 – 1 / 0.10] Refer to FVIFA table

212,840 = PMT ( 98.347)

Pmt = 212,840 / 98.347

Pmt = $2,164.17

c. Air Atlantic (AA) has been offered a 3-year old jet airliner under a 12-year lease arrangement. The lease
requires AA to make annual lease payments of $500,000 at the beginning of each of the next 12 years.
Determine the present value of the lease payments if the opportunity cost of funds is 14 percent.
a. $2,830,000
b. $13,635,500
c. $6,000,000
d. $3,226,200
ANS: D

1−( 1+i )−n

PVannuity = pmt
[ i (1+i)
]
PV = 500,000 [1 – (1+0.14)-12 / 0.14) (1+0.14) Refer to PVIFA Table

= 500,000(5.6603) (1.14)
= $3,226,371

d. If you invest $10,000 in a 4-year certificate of deposit (CD) paying 10 percent interest compounded
annually, determine how much the CD will be worth at the end of 4 years.
a. $13,600
b. $45,730
c. $14,640
d. $15,958
ANS: C

FV  PV 1  i  n
FV = 10,000 (1.10)4

FV = 10,000 (1.4641) = 14,641.

e. BB&C bank has agreed to lend you $30,000 today, but you must repay $42,135 in 3 years. What rate is
the bank charging you?
a. 10%

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b. 11%
c. 12%
d. 13%
ANS: C

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 FV  n
r   1
 PV  = (42,135/30,0001/3) -1

= 12%

Question 3

You wish to take out an interest only loan for $100,000 for one year, and have received the
following quotes:

Bank A: 2.75% per quarter effective

Bank B: 11.5% per annum

Bank C: 11.0% per annum compounded semi-annually

What would be the annual interest charges for each bank on your $100,000 loan?
Which bank would you choose?

Question 3 – ANS.
Bank A: Interest = [(1.0275)4-1]100,000 = $ 11,462.13

Bank B: Interest = [(1.115)-1]100,000 = $ 11,500.00

Bank C: Interest = [(1+0.11/2)2-1]100,000 = $ 11,302.50

Therefore choose Bank C because it has the lowest interest.

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Question 4

a. If the appropriate interest rate is 5% pa, would you rather receive

i $10,000 today

ii $5,000 today plus $6,000 in 4 years

iii $12,000 in 3 years

iv $600 per year in perpetuity, starting in 5 years

v. a perpetuity which grown at 2% pa, the first payment of $300 will be in 3 years

b. Considering the options above, what factors may influence your choice?

Question 4 – ANS.

a. i PV = $10,000

ii PV = 5000 + 6000(1.05)-4 = $ 9,936

iii PV = 12,000(1.05)-3 = $10,366

600
(1.05 )−4
iv PV = 0.05 = $ 9,872

300
(1.05 )−2
v PV = 0. 05−0.02 = $ 9,070

Choose (iii) as it has highest value, and you should always choose this option.

b. Tax

Future investment outlook

Risk

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Question 5

You take out a 12 year bank loan that has monthly repayments of $2,276.06. The nominal rate
of 9% is compounded monthly

i. What is the size of the loan?

ii Half way through the loan period, the bank increases the interest rate to
12%. If you wish to avoid the increased interest rate, what will be your
payout figure at this time?

iii If you are unable to payout the loan (as in (ii) above) and you do not
want to increase the size of the repayments, how much longer will it
take to repay the loan?

i. n = 12(12) = 144 periods (months)

1−(1.0075 )−144
[
PV T 0 =2 ,276 .06
0. 0075 ] 0.09
¿2 ,276 . 06(87 .87109 ) i = 12 = 0.0075 per period (month)
¿$ 200 ,000 [ $199,999 . 88 ]

−72
1−(1 .0075 ) 144
ii. PV T 72=2 ,276.06 [
0. 0075 ] n = 2 = 72 months
¿2 ,276 . 06(55 .47685 )
¿$ 126 ,268 . 64
iii.
1−(1.01)−n 0.12
126, 268.64=2,276.06 [ 0. 01 ] i = 12 = 0.01 per period (month)

0.55477=1−(1. 01)−n
0.4452=(1.01)−n
ln 0.4452=−n ln1. 01
ln 0. 4452
−n=
ln 1.01
−0.8092
¿
0 .0099503
n=81.32 months

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 Therefore it would take an extra 9.3 months to repay (81.3 - 72)

Question 6

You have decided to set up an education fund so that you will be able to give a needy scholar
$1,000 a year, starting in four years' time. To finance the fund you will deposit three equal
annual deposits starting today. If the required rate of return is 7.5%, what will be the size of the
deposits?

ANSWER:

0 1 2 3 4 5 Time / years

Dep Dep Dep W'drawal W'drawal Cash flows

Using FV

PV T3, DEPOSIT =PVT0, WITHDRAWALS

1,000
¿
0.075
¿ $13 ,333 .33

(1.075 )3 -1
$13,333 .33=D [
0.075 ]( 1.075 )
¿ D(3 .230625 )(1.075)
D=$3,839 .23

Question 7

You wish to buy a house for $750,000 and the bank has agreed to give you a 15 year loan for
80% of the purchase price, at an annual interest rate of 9%, compounded monthly. The loan
will pay off the interest and capital such that there is no debt outstanding at the end of the
loan.
a. What are your monthly repayments, the first being due at the end of the first month?

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b. You believe that immediately after the 24th payment, interest rates will rise to 12% pa.
i. If you decide to pay out the loan at that time to avoid the higher interest rate
charges, what will be the payout amount?
ii. If you are unable to afford to pay out the loan at that time, how much longer will
it take to pay out the loan if you do not adjust the monthly payments?

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Question 7

a. 0 . 09
r= =0 .75 % per month
12 n=12×15 years = 180
-180
1-(1 . 0075)
750 , 000(0 .8 )=Pmt [
0 . 0075 ]
600 , 000=Pmt(98 .5934 )
Pmt=$6,085 .60 per month

1-(1. 0075)-156
b. i. Payout=6,085. 60 [0 . 0075 ] n=12×13 years = 156

¿6 , 085 .60( 91. 7700)

¿$ 558 , 475. 57
ii. 0 . 12
r= =1 . 00 % per month
12
1−(1. 01 )−n
558,475. 57=6,085. 60 [
0 . 01 ]
1−(1 . 01)−n
91. 7700=
0 .01
0 . 91770=1−(1. 01)−n
(1 .01 )−n =0 .08220
−n( ln1.01 )=ln0.08220
ln0. 08220
−n=
ln1. 01
−2. 4974
¿
0 .00995
n=250. 98 months
The original loan period would be extended by 94.98 months (250.98 – 156), that is by:

7 years 11 months

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 Question 8

a. John borrowed $20,000 to finance his college education. If the finance charge on the loan is 6
percent, and he will pay off the loan in 10 equal, annual, end of year payments, how much total
interest will he pay?
a. $7,173.90
b. $2,717.39
c. $12,000.00
d. $25,924.23
ANS: A

USE PVIFA FORMULA

1−( 1+i )−n

PVannuity = pmt
[ i ]
$20,000 = PMT [ 1- (1 + 0.06)-10 / 0.06 ] Refer PVIFA TABLE

$20,000 = PMT ( 7.3601)

PMT = 20,000 / 7.3601 = $2,717.35

Total interest he will pay = ($2,717.35 x 10) - $20,000 = $7,173.50

b. You just purchased a new $25,000 car and agreed to pay for the car in 50 monthly payments. If the
monthly interest rate is 1 percent, what is your total financing cost?
a. $637.82
b. $12,500
c. $574.25
d. $6,891
ANS: D
$25,000 = pmt [ 1 – (1.01)-50 / 0.01]

$25,000 = pmt (39.196)

PMT = 25,000 / 39.196 = $637.82

Total financing cost = ($637.82 x 50) – 25,000 = $6,891

c. The Summer Breeze Hotel borrowed $100,000 from the Meadowlands Bank to pay for a new air
conditioning system. The loan is for a period of 5 years at an interest rate of 10% and requires 5 equal
end-of-year payments that include both principal and interest on the outstanding balance. What will be the
outstanding balance after the third payment?
a. $60,000
b. $20,865
c. $45,788
d. $50,866
ANS: C

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USE PVIFA FORMULA

1−( 1+i )−n

PVannuity = pmt
[ i ]
$100,000 = pmt [ 1 – (1 + 0.10)-5 / 0.10 ]

$100,000 = pmt ( 3.7908 )

Pmt = 100,000 / 3.7908 = $26,380

After the third payment we have another two more payments to make. Therefore outstanding
payments is the PV of the remaining instalments.

PV = 26,380 ( 1.7355 )

= $45,782.49

PART B (sample questions for the mid-term exam)

This paper consists of TWO (2) parts. Part A will consists of 20 multiple choice questions worth 2 marks
each. Part B consist 2 questions covering computations and discussions. All questions are compulsory
and should be attempted.

Question 1

What are the financial decisions facing the managers of firms? How are they related?

Question 2

In six years time you wish to have $10,000 in an account that pays 5% pa.

a. How much do you have to deposit today to achieve this goal?

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b. Instead of paying a single sum into the account today, you decide to achieve your goal
by making deposits every six months (= 12 deposits), the first one being today. How
much are the deposits?

ANS:

0 1 2 3 4 5 6 Years

 Cashflow (a)

            Cashflows (b)

a. PV =FV (1+r )−n

¿ 10 , 000(1. 05 )−6
¿ 10 , 000(0 .7462)
¿ $7,462 . 15

b. (1+r )n−1
FV =Dep
r [ ]
(1. 025)12−1
10 , 000=Dep [
0. 025 ]
( 1 . 025)

¿ Dep(13 . 7956 )(1 .025)

¿ Dep(14 .1404 )
Dep=$707 .19

Question 3

Innes Smith bought an $80,000 Italian sports car with a 20% down payment, and financed the
rest with a four year loan at 8% pa, compounded monthly.

a. What is his monthly payment if he starts the payments one month after purchase?

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b. Immediately after the 12th payment, the interest rate rises to 10%pa.

i. If he decides to pay out the loan to avoid the higher interest rate, what is the
payout amount?
ii. If he adjusts his monthly payments so that the loan is still paid out in the original
time, what are the new monthly payments?

ANS:

a. 1−(1+r)−n where: 0 . 08
PV =CF [ r ] i=
12
=0 . 67 % per month
1−(1. 0067 )−48
80 , 000(1−0. 2)=Pmt [
0. 0067 ]
64 , 000=Pmt ( 40. 9619 )
Pmt=$1562 . 43 per month

b. (i) PV 12=1562. 43PVIFA(0 .67%,36) Where: there are 36 outstanding

¿1562.43(31.9118) payments to be made
¿$49,859 .87

(ii) 49 ,859. 87=PmtPVIFA (0. 833 %,36 ) Where: 0 .10

i=
=Pmt (30 .9912 ) 12
Pmt=$1,608 . 84 per month =0 . 833 % per month

Question 4

Can our goal of maximizing the value of the shares conflict with other goals such as avoiding
unethical or illegal behaviour? In particular, do you think issues like customer and employee
safety, the environment, and the general good of society fit into this framework, or are they
essentially ignored? Support your views with specific examples.

Question 5

With regard to finance, consider the agency problem.

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- Describe the conflicts that can arise between equity holders and managers.
- How may they be controlled?
- How do they affect the appropriateness of market value maximisation as the goal of the
corporation’s financial decision making?

Question 6

Firms often involve themselves in projects that do not result directly in profits, for example by
sponsorship of sporting events of the opera or other entertainment. Do these projects
contradict the goal of maximization of shareholder wealth? Why or why not?

Question 7

a. Discuss reasons why cash flow during a period is not necessarily the same as net income
during that period.
b. In trying to judge whether a company has too much debt, what financial ratios would you
use and for what purpose?
Question 8

b.

i.
You wish to borrow $100,000 for one year and have had the following offers from two different
financial institutions. Which one would you choose?

 Bank A: 9.0% pa compounded quarterly

 Bank B: 8.5% pa compounded monthly

ii.
If Bank B charged you an upfront fee of 1% of the loan, would this change your decision?
SOLUTION:

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b. i.

Bank A:

4
0 .09
EAR A= 1+ (4 )
−1=9. 308 %

∴ owe $109,308 after 1 year

Bank B:

12
0 .085
EAR B= 1+ (
12 ) −1=8 . 839 %
∴ owe $108,839 after 1 year

Choose Bank B as lowest cost

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 ii.

Bank B:

$ 108 ,839=( $ 100 , 000−$ 1 ,000 )(1+r)12

r=0. 7927%= effective monthly rate
EAR=(1. 007927 )12−1
¿ 9 . 938%

Now choose Bank A as lowest cost

Question 9

i. What is the purpose of financial markets? How can this purpose be accomplished
efficiently?
ii. Discuss the functions of financial intermediaries.

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