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Tutorial Chapter 3

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40 views3 pages

Tutorial Chapter 3

Uploaded by

nurnakishasyazana
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER 2 TUTORIAL QUESTIONS

1. Understanding the Time Value of Money (TVM)


Question: Explain the concept of the Time Value of Money (TVM) using the example
provided in the text, where an investor is considering three different plans for a RM100
investment over 10 years. Discuss why Plan A is preferred over Plans B and C from the
perspective of TVM.
Answer : The Time Value of Money (TVM) is a fundamental financial concept that states that
a sum of money today is worth more than the same sum in the future, due to its potential
earning capacity or interest-bearing potential. This principle recognizes that a dollar received
today can be invested to earn interest or returns, making it worth more than the same dollar
received in the future. Let's consider the example provided in the text where an investor is
considering three different plans for a RM100 investment over 10 years :

 Plan A : RM100 today, compounded annually at 10% interest.


 Plan B : RM100 today, compounded annually at 8% interest.
 Plan C : RM100 today, compounded annually at 12% interest.

The reason Plan A might be preferred over Plans B and C from the perspective of TVM is
Plan A offers an annual interest rate of 10%, which is higher than Plans B (8%) and C (12%).
According to TVM, higher interest rates lead to higher future values of investments. Thus,
over the 10-year period, the RM100 investment in Plan A would grow more rapidly compared
to Plans B and C. Other than that, all three plans compound annually, ensuring that interest is
earned on both the initial investment and any accrued interest. Since compounding frequency
affects the growth of an investment, having the same compounding frequency allows for a
fair comparison between the plans. Moreover, since all three plans have the same time
horizon of 10 years, the difference in their future values will primarily be driven by the
interest rate offered. Plan A's higher interest rate means that the investment will grow more
quickly over time compared to Plans B and C. Last but not least, by using the TVM formula
for compound interest, one can calculate the future value of each investment after 10 years.
Given the same initial investment, Plan A would likely yield the highest future value due to
its higher interest rate. In summary, Plan A is preferred over Plans B and C because of its
higher interest rate, which leads to a higher future value of the investment over the 10-year
period. This exemplifies the principle of the Time Value of Money, where investments with
higher potential returns are favored over those with lower returns, all else being equal.
2. Calculating Future Value of a Lump Sum
Question: An investor deposits RM1,000 in a bank account that offers a 5% annual interest
rate, compounded annually. Using the future value formula presented, calculate the amount
this investment will grow to at the end of 5 years. Explain how the future value of money is
affected by the interest rate and the time period.
Answer : The future value of an investment can be calculated using the future value formula,
which is FV = PV * (1 + r)^n, where FV is the future value, PV is the present value, r is the
interest rate, and n is the number of periods. In this case, if an investor deposits RM1,000 in a
bank account with a 5% annual interest rate compounded annually, the future value after 5
years can be calculated as follows:

FV = 1000 * (1 + 0.05)^5
FV = 1000 * (1.05)^5
FV = 1000 * 1.27628
FV = 1276.28

Therefore, the investment will grow to RM1,276.28 at the end of 5 years.


The future value of money is affected by both the interest rate and the time period. A higher
interest rate will result in a higher future value, as the investment earns more interest over
time. Similarly, a longer time period will also lead to a higher future value, as the interest has
more time to compound. This illustrates the concept of the time value of money, where the
timing of cash flows impacts their value.
3. Determining Present Value of Future Cash Flows
Question: Consider a real estate investment that is expected to produce RM10,000 in income
annually for 5 years, with a potential sale generating an additional RM100,000 at the end of
the fifth year. Assuming an annual return requirement of 10%, calculate the present value of
this investment. Illustrate how discounting future cash flows to their present value helps in
assessing the worth of long-term investments.
Answer :

4. Application of Excel in Time Value of Money Problems


Question: Describe how Excel can be used to solve Time Value of Money problems, using the
provided template structure involving number of periods (N), periodic interest rate (I),
present value (PV), periodic payment (PMT), and future value (FV). Provide a step-by-step
guide on setting up a simple calculation for either the future value or present value of a given
investment.
Answer :

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