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Class Discussion 04 - TVM 2

The document discusses time value of money concepts including compound interest, loan amortization schedules, and net present value calculations. Several examples are provided to illustrate how to calculate future and present values over different time periods and compounding intervals using formulas and financial calculators.

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Sharmila Bala
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42 views3 pages

Class Discussion 04 - TVM 2

The document discusses time value of money concepts including compound interest, loan amortization schedules, and net present value calculations. Several examples are provided to illustrate how to calculate future and present values over different time periods and compounding intervals using formulas and financial calculators.

Uploaded by

Sharmila Bala
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Class Discussion 4 – Time Value of Money - 2

1. Find the amount to which $10,000 will grow under each of these conditions:
(a) 12 percent compounded annually for 15 years.
Sample solution
Using formula:
FV = PV (1+r)t = 10,000 (1+0.12)15 = $54,735.66

--------------------------------------------
Using financial calculator:
PV = 10000
I/YR = 12%
N = 15
FV = $54,735.66

(b) 12 percent compounded semiannually for 15 years.


Using formula:
FV = PV (1+r)t = 10,000 (1+ 0.12/2)15x2 = $57,434.91

--------------------------------------------
Using financial calculator:
PV = 10000
I/YR = 12%/2 = 6%
N = 15 x 2 = 30
FV = ??

(c) 12 percent compounded quarterly for 15 years.


Using formula:
FV = PV (1+r)t = 10,000 (1+ 0.12/4)15x4 = $58,916.03

(d) 12 percent compounded monthly for 15 years.


Using formula:
FV = PV (1+r)t = 10,000 (1+ 0.12/12)15x12 = $59,958.02

(e) 12 percent compounded daily for 15 years.


Using formula:
FV = PV (1+r)t = 10,000 (1+ 0.12/365)15x365 = $60,478.58

2. You want to buy an equipment, and a local bank will lend you $200,000. The loan
would be fully amortised over 7 years (84 months), and the nominal interest rate
would be 6%, with interest paid monthly (compounded monthly). What would be the
monthly loan payment? What would be the loan’s effective annual rate? What would
be the total interest paid?

N = 84
Monthly loan payment = PMT = $2921.71

Effective annual rate = (1+0.06/12)1x12 – 1 = 0.0617 = 6.17% p.a.


Total interest in 7 years = total payments – principal
= (2921.71 x 7 x 12) - 200000 = ??

3. Josh borrowed RM70,000 at an 8% annual rate of interest to be repaid over 3 years.


The loan is amortized into three equal, annual, end-of-year payments. Prepare a loan
amortization schedule showing the interest and principal breakdown of each of the
three loan payments.

Sample solution
Borrow at Year 0, PV = RM 70000
Interest rate, I/YR = 8% per year
Repay N times in N years; N = 3 years
Each repayment, PMT = 27,162.35

Year Beginning Annual Interest Principal Ending


balance payment payment payment balance
(1) (PMT) (4) = (2)-(3)
(2) (3) = 8% x (1) (5) = (1) – (4)

0 - - - - 70,000

1 70,000 27,162.35 0.08 x 70,000 27,162.35 – 70,000 -


= 5,600 5,600 21,562.35
=21,562.35 = 48,437.65
2 48,437.65 27,162.35 0.08 x 27,162.35 – 48,437.65 –
48,437.65 3,875.01 23,287.34
= 3,875.01 =23,287.34 =25,150.31
3 25,150.31 27,162.35 0.08 x 27,162.35 – 25,150.31 -
25,150.31 2,012.02 25,150.33
= 2,012.02 =25,150.33 = -0.02 ≈ 0

4. You plan to buy a machine and need to borrow RM100,000 from a bank. Interest
rate offered by is 7.2% nominal rate and your term loan is 9 years. Your installment
will be monthly installment. How much total interest do you need to pay in the first 4
months?

Borrow at Year 0, PV = 100000


Interest rate, I/YR = 7.2/12 = 0.6% per month (note: monthly installment)
Repay N times in 9 years; N = 9x12 = 108 months
PMT = ?? per month

Fill up the amortisation table below using Question 3 as an example

Month Beginning Monthly Interest Principal Ending


balance payment payment payment balance
(1) (PMT) (3) = 0.6% x (4) = (2)-(3)
(2) (1) (5) = (1) – (4)

0 - - - -
1
2
3
4

Therefore, total interest you need to pay in the first 4 months = ??

5. An investment will pay $500 at the end of each of the next 3 years, $1000 at the end
of year 4, $5000 at the end of year 5, and $3000 at the end of year 6. If other
investments of equal risk earn 9% annually, what is its present value? Its future value?

Sample solution (we will discuss this)


CF0 = 0
CF1 = 500
CF2 = 500
CF3 = 500
CF4 = 1000
CF5 = 5000
CF6 = 3000
I/YR = 9%
Present value = NPV = $7,012.53
Future value = 7012.53 (1+0.09)6 = $11,760.71

6. James is now 38 years old and plans to continue working until he is 60. Recently, he
saw the vacation home of his dreams and it was listed with a sale price of RM
800,000. He is willing to invest a fixed amount at the end of each of the next 22
years to fund the cash purchase of such a house when he retires. He believes that
prices generally increase at the overall rate of inflation and he can earn 9% annually
after taxes on his investment. Inflation is expected to average 5% per year. Calculate
how much James should invest at the end of each of the next 22 years to have the
cash purchase price of the house when he retires.

Try out this question: (we will discuss this)


Hint: first, estimate the house price after 22 years.

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