FINANCIAL MANAGEMENT COVENANT FINANCIAL CONSULTANTS

TIME VALUE OF MONEY

(Examples and Review Questions)

Example 1

Assume that you deposit TShs 1M at an interest rate of 7% for 2 years. How much will you have
in your account at the end of 2 years assuming

a) Using Simple interest-interest from the previous period is not reinvested

b) Using Compound interest- interest from the previous period is reinvested
c) Using annuity table that presumes compound interest

Example 2

How much would have been in your account if your parents had invested 50000 on your birth
say 20 years ago in your fixed deposit account that pays an interest rate of 12% p.a?

Example 3

CFC wants to know how large would their deposit of TZS 100M be at the rate of 10% 5 years
form today…

Example 4

How long does it take to double TZS 5M at a compound interest rate of 12% p.a?

Example 5

Suppose you need TZS 2M in 3 years to pay your college fee. If you can earn 8% on your money,
how much do you need today?

Example 6

Assume that you need 10M in two years. How much do you need today at the discount rate of
7% per annum compounded annually?

Example 7
You have approached a loan shark for a loan to enable meet your studying costs. Your proposal
is to repay the amount using some money that you expect to earn from your part-time businesses.
This will be shs. 1.2M after one year, shs. 1m after two years and shs. 2m after 4 years. The loan
shark tells you that the interest rate on this type of arrangement is 20 percent per annum. How
much should you expect to receive from the loan shark now?
Example 8

Suppose you decide to deposit Shs 1million each month in an account carrying 1% interest rate
per month. How much are you going to have in the account at the end of 4 months if:

a) The deposit is made at the beginning of the month?

b) The deposit is made at the end of the month?

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Example 9

Suppose you received a 10-years, Shs. 70million mortgage from a bank. The bank is charging you
a 6% interest rate per annum for this mortgage. How large your periodic payment need to be for
you to clear the mortgage in the 10 years:

✓ If you make one payment at the end of each year and interest compounds annually?
✓ If you make one payment at the end of each month and interest compounds monthly?

Example 10

Imacris has a TZS 100m fixed deposit at the bank. The interest rate is 6% compounded quarterly
for one year. What is the effective annual interest rate?

Example 11

The credit card company claims to charge 1.5% per month or 18% per year, but is this really
annual effective interest rate that the company is charging?

Example 12

You need 1 M today to finish paying your tuition fee at CFC and other NBAA registration
requirements. Mzee biashara faida lends you the TZS 1M and makes you promise to repay TZS
1.1M in 3 months.

✓ What is the EAR that he is charging you

✓ Should you take the loan from him

REVIEW QUESTIONS ON TVM

1. ABC Inc. just paid a TZS 2000 dividend at the end of the current year (i.e., D 0 = TZS 2000).
After the dividend is paid, the company’s dividends are expected to grow at a 50% annual
rate for each of the following two years, and then settle down to a steady state growth rate of
5% annually. If investor’s required rate of return is 15% on this stock, what should a share
sell for today?

2. For each of the following, compute the future value; if TZS2000=1USD

Present value (TZS) Years Interest rate Future value in USD
2,250 4 18%
9,310 9 6
76,355 15 12
183,796 21 8

3. For each of the following, compute the present value;

Present value (TZS) Years Interest rate Future value USD

6 4% 15,451
8 12 51,557
16 22 886,073
25 20 550,164

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4. Solve for unknown interest rate in each of the following;

Present value TZS Years Interest rate Future value in TZS
221 3 307
425 9 761
25,000 15 136,771
40,200 30 255,810

5. Solve for unknown number of years in each of the following;

Present value Years Interest rate Future value

$ 250 4% $ 1,284
1,941 9 4,341
21,320 23 402,662
32,500 34 173,439

6. You plan to retire 33 years from now. You expect that you will live 27 years after retiring. You
want to have enough money upon reaching retirement age to withdraw TZS 180,000 from the
account at the beginning of each year you expect to live, and yet still have TZS 2,500,000 left
in the account at the time of your expected death (60 years from now). You plan to accumulate
the retirement fund by making equal annual deposits at the end of each year for the next 33
years. You expect that you will be able to earn 12% per year on your deposits. However, you
only expect to earn 6% per year on your investment after you retire since you will choose to
place the money in less risky investments. What equal annual deposits must you make each
year to reach your retirement goal?

7. Nerwin, Inc. is a furniture manufacturing company with50 employees. Recently, after a long
negotiation with the local labor union, the company decided to initiate a pension plan as a
part of its compensation plan.
The plan will start on January 1, 2003. Each employee covered by the plan is entitled to a
pension payment each year after retirement. As required by accounting standards, the
controller of the company needs to report the pension obligation (liability).

On the basis of a discussion with the supervisor of the Personnel Department and an
actuary from an insurance company, the controller develops the following information
related to the pension plan. Average length of time to retirement 15 yearsExpected life
duration after retirement 10 years

8. You have just won the CPA-T Best graduate prize of TZS 11,000,000. Your winnings will be
paid to you in 26 equal annual installments with the first payment made immediately. If you
had the money now, you could invest it in an account with a quoted annual interest rate of
9% with monthly compounding of interest. What is the present value of the stream of
payments you will receive?

9. Your sister is twenty years old today and she wishes to accumulate TZS 9,000,000 by her fifty-
fifth birthday so she can retire to her summer place on Lake Tahoe. She wishes to accumulate
the TZS 9,000,000 by making annual deposits on her twentieth through her fifty-fourth
birthdays. What annual deposit must your sister make if the fund will earn 8% interest
compounded annually?

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10. You plan to make a series of deposits in an interest-bearing account. You will deposit $1,000
today, $2,000 in two years, and $8,000 in five years. If you withdraw $3,000 in three years and
$5,000 in seven years, how much will you have after eight years if the interest rate is 9 percent?
What is the future value of these cash flows?

11. You are valuing an investment that will pay you TZS26,000 per year for the first 9 years,
TZS34,000 per year for the next 11 years, and TZS47,000 per year the following 14 years (all
payments are at the end of each year). Another similar risk investment alternative is an
account with a quoted annual interest rate of 9.00% with monthly compounding of interest.
What is the value in today's dollars of the set of cash flows you have been offered?

12. Deryl wishes to save money to provide for his retirement. Beginning one year from now, he
will begin depositing the same fixed amount each year for the next 30 years into a retirement
savings account. Starting one year after making his final deposit, he will withdraw
TZS100,000 annually for each of the following 25 years (i.e. he will make 25 withdrawals in
all). Assume that the retirement fund earns 12% annually over both the period that he is
depositing money and the period he makes withdrawals. In order for Deryl to have sufficient
funds in his account to fund his retirement, how much should he deposit annually (rounded
to the nearest dollar)?

13. You are planning to retire 15 years from now. You have estimated that you will have 25 years
to live after your retirement. Your objective is to set up an individual retirement fund that will
provide shs. 800,000 each month to meet your living costs after retirement. Your investigation
has shown that it is possible to set up the fund by depositing a fixed amount from your salary
in a special retirement account that earn 4.8% p.a. You have also estimated that this interest
rate will remain constant for the first 15 years and then increase to 6% p.a. thereafter. How
large does your monthly deposit needs to be for you to achieve your objective assuming
interest compounds monthly?

14. A bank offers three different accounts which are similar in all respects – including the level of
riskness – except in the interest rates and the way interest compounds.
- CLASSICS Account carries 7.9 percent interest that compounds annually
- ROYAL Account carries 7.8 percent interest that compounds semi-annually, and
- PRINCESS Account carries 7.5 percent interest that compounds monthly.
a) Which account you will recommend to a friend? Why?
b) Will your answer change if the friend has a 20-year investment horizon? Why?

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DRM Software Review