INDIVIDUAL ASSIGNMENT 2 – FINANCIAL MANAGEMENT

1. What is the difference between simple interest and compound interest?

SIMPLE INTEREST COMPOUND INTEREST
Simple interest is the interest paid Compound interest is interest that is
(in the case of borrowed money) paid not only on the principal but
Concept or earned (in the case of invested also on any
money) on the principal only. interest earned but not withdrawn
during earlier periods.
Profit The interest portion is usually The yield will usually be greater than
amount smaller than compound interest. simple interest
The Fixed and unchanged. Continuous change in deposit time.
principal
amount in
the
account
How to Interest is calculated based on the Interest is calculated based on

𝐈=𝐏×𝐢×t 𝐅Vn = 𝐏V(𝟏 + 𝐢)n

calculate principal: principal and accumulated interest:
interest

2. What are the nominal interest rate and effective annual interest rate?
The nominal interest rate (INOM) (or called quoted or stated rate or annual percentage
rate (APR)) is the rate that credit card companies, student loan officers, auto dealers
and so
forth, tell you they are charging on loans.
The effective annual rate (EFF), also called equivalent annual rate (EAR) is the actual
interest rate being earned.

3. How to calculate the present value and future value of single amount, annuities
and mixed flows? Note that explain the terms of formulation
SINGLE PAYMENT
The formulation to find the future value of money is shown below:
𝐅V = 𝐏V(𝟏 + 𝐢)N
FV: Future value, or ending amount, of your account after N periods
PV: Present value, or beginning amount
i: interest rate
N: number of periods
Present value of the money is calculated from the equation

FV: Future value, or ending amount, of your account after N periods

PV: Present value, or beginning amount
i: interest rate
N: number of periods

ANNUITIES
Future value of an Ordinary Annuity

FVA: The future value of ordinary annuity

PMT: payment amount
I: Interest rate
N: Number of periods
Present value of Ordinary Annuity:

PVA: The present value of annuity

PMT: payment amount
I: Interest rate
N: Number of periods

4. Why do financial managers concern about the time value of money?

1. Earning potential: A dollar today is worth more than a dollar tomorrow because it
can be invested and earn a return. Over time, even small returns can compound
significantly, increasing the future value of the money. Financial managers need to
consider this earning potential when making decisions, as choosing one option over
another could significantly impact future wealth.
2. Inflation erodes value: Over time, inflation decreases the purchasing power of
money. A dollar today can buy more goods and services than a dollar tomorrow.
Financial managers need to account for inflation to ensure that their decisions
maintain or increase the real value of their client's money.
3. Comparing future cash flows: Financial decisions often involve comparing cash
flows that occur at different points in time. For example, comparing the cost of buying
a property today versus renting it for several years. The TVM allows managers to
convert these future cash flows into a present value, enabling an accurate comparison
and determining the best option.
4. Discounted cash flow (DCF) analysis: This is a common financial tool used to
evaluate investments by considering the present value of all future cash inflows and
outflows associated with the investment. By understanding the TVM, financial
managers can accurately calculate the present value and assess the profitability of
potential investments.
5. Risk and uncertainty: The further into the future a cash flow occurs, the greater the
uncertainty surrounding it. Financial managers use the TVM to adjust for this risk by
applying a discount rate that reflects the uncertainty and potential return of the
investment.
In summary, understanding the TVM is crucial for financial managers to make
informed decisions that maximize the value of their client's money, accounting for
earning potential, inflation, future cash flows, risk, and uncertainty.

5. Do the problems from 1 to 10 and 13 at the page 65-67 in the text book
 1.
a) At the end of three years, how much is an initial deposit of $100 worth?
(i) 100% annual interest:
Formula: Final amount = $100 * (1 + 100%)^3 = $100 * 8 = $800
(ii) 10% annual interest:

Formula: Final amount = $100 * (1 + 10%)^3 = $100 * 1.331 = $133.10

(iii) 0% interest:
No interest growth: Final amount = $100 * (1 + 0%) = $100

b) At the end of five years, how much is an initial $500 deposit followed by five year-
end, annual $100 payments worth?
(i) 10% annual interest:
Calculate future value (FV) of each payment: $100 * (1 + 10%)^4 = $161.05
Calculate present value (PV) of each payment: $161.05 / (1 + 10%)^4 = $120.62
Total PV of payments: 5 * $120.62 = $603.10
FV of initial deposit: $500 * (1 + 10%)^5 = $814.50
Final amount: $814.50 + $603.10 = $1417.60
(ii) 5% annual interest:
Same steps as above with 5% interest:
FV per payment: $127.63
PV per payment: $105.73
Total PV of payments: $528.65
FV of initial deposit: $628.89
Final amount: $628.89 + $528.65 = $1157.54
(iii) 0% interest:
No interest growth:
Total payments: 5 * $100 = $500
Final amount: $500 + $500 = $1000

c) At the end of six years, how much is an initial $500 deposit followed by five year-end,
annual $100 payments worth?

(i) 10% annual interest:

Similar calculations as above, using six years:
Final amount: $1547.59
(ii) 5% annual interest:
Final amount: $1237.42
(iii) 0% interest:
Final amount: $1000

d) At the end of three years, how much is an initial $100 deposit worth, assuming a
quarterly compounded annual interest rate of (i) 100 percent? (ii) 10 percent?
(i) 100% quarterly compounded interest:
Effective quarterly interest rate: (1 + 100%)^(1/4) - 1 ≈ 2.598
Formula: Final amount = $100 * (1 + 2.598)^12 ≈ $835.57
(ii) 10% quarterly compounded interest:
Effective quarterly interest rate: (1 + 10%)^(1/4) - 1 ≈ 0.025
Formula: Final amount = $100 * (1 + 0.025)^12 ≈ $134.99

e) Why do your answers to Part (d) differ from those to Part (a)?
The answers differ because of compounding frequency. Compounding more frequently
(quarterly in Part (d), annually in Part (a)) leads to faster interest growth due to "interest
on interest." At 100% interest, the effect is much more pronounced.
f) At the end of 10 years, how much is a $100 initial deposit worth, assuming an annual
interest rate of 10 percent compounded (i) annually? (ii) semiannually? (iii) quarterly?
(iv) continuously?
(i) Annually:

Final amount = $100 * (1 + 10%)^10 ≈ $259.37

(ii) Semiannually:
Effective semiannual interest rate: (1 + 10%)^(1/2) - 1 ≈ 4.76%
Formula: Final amount = $100 * (1 + 4.76%)^20 ≈ $270.48
(iii) Quarterly:
Effective quarterly interest rate: (1 + 10%)^(1/4) - 1 ≈ 2.50%
Formula: Final amount = $100 * (1 + 2.50%)^40 ≈ $276.12
(iv) Continuously:
Formula: Final amount = $100 * e^(10% * time) = $100 * e^(10% * 10) ≈ $271.81

2.
a. $100 at the end of three years:
(i) 100% discount rate:
Formula: Present Value (PV) = Future Value (FV) / (1 + Discount Rate)
PV = $100 / (1 + 100%) = $0.50 (rounded to two decimals)
(ii) 10% discount rate:
PV = $100 / (1 + 10%)^3 = $75.13
(iii) 0% discount rate:
No discounting: PV = $100

b. Aggregate present value of $500 received at the end of each year for three years:
(i) 4% discount rate:
PV = $500 / (1 + 4%) + $500 / (1 + 4%)^2 + $500 / (1 + 4%)^3 = $1423.72
(ii) 25% discount rate:
PV = $500 / (1 + 25%) + $500 / (1 + 25%)^2 + $500 / (1 + 25%)^3 = $1000

c. Present value of $100 at year 1, $500 at year 2, and $1000 at year 3, with 4% and 25%
discount rates:
(i) 4% discount rate:
PV = $100 / (1 + 4%) + $500 / (1 + 4%)^2 + $1000 / (1 + 4%)^3 = $1499.36
(ii) 25% discount rate:
PV = $100 / (1 + 25%) + $500 / (1 + 25%)^2 + $1000 / (1 + 25%)^3 = $800

d. Present value of $1000 at year 1, $500 at year 2, and $100 at year 3, with 4% and 25%
discount rates:
(i) 4% discount rate:
PV = $1000 / (1 + 4%) + $500 / (1 + 4%)^2 + $100 / (1 + 4%)^3 = $1537.40
(ii) 25% discount rate:
PV = $1000 / (1 + 25%) + $500 / (1 + 25%)^2 + $100 / (1 + 25%)^3 = $640

e. Comparison and Explanation:

Comparing parts (c) and (d), you'll notice the present values are different even though the
total future cash flows are identical ($1600). This difference arises from the timing of the
cash flows.
In part (c), the larger payments ($500 and $1000) are received later, resulting in a higher
present value due to the discounting effect.
In part (d), the larger payment ($1000) is received earlier, leading to a lower present value
despite the total amount being the same.

3. Joe Hernandez's Annuity:

Formula: Future Value (FV) = Present Value (PV) * (1 + Interest Rate)^Number of
Periods
Solution:
PV = $25,000
Interest Rate = 6% = 0.06
Number of Periods = 12 years
We want to find the equal-dollar amount (FV) that will deplete the balance to zero after
12 years. So, after the last withdrawal, FV = $0.
0 = $25,000 * (1 + 0.06)^12 - FV
Solving for FV:
FV = $25,000 * (1 - (1 + 0.06)^(-12))
FV ≈ $10,653.79
Therefore, Joe can withdraw $10,654 (rounded to the nearest dollar) at the end of each
year for 12 years, leaving him with $0 at the end.

4. Saving for $50,000 with Annual Deposits:

Formula: Future Value (FV) = Payment * ((1 + Interest Rate)^Number of Periods - 1) /
Interest Rate
Solution:
FV = $50,000
Interest Rate = 8% = 0.08
Number of Periods = 10 years
FV = Payment * ((1 + 0.08)^10 - 1) / 0.08
Solving for Payment:
Payment ≈ $2,947.67
Therefore, you need to save $2,948 (rounded to the nearest dollar) at the end of each year.

5. Saving for $50,000 with Beginning-of-Period Deposits:

Formula: Future Value (FV) = Payment * ((1 + Interest Rate)^Number of Periods) /
(Interest Rate + 1)
Solution:
FV = $50,000
Interest Rate = 8% = 0.08
Number of Periods = 10 years
FV = Payment * ((1 + 0.08)^10) / (0.08 + 1)
Solving for Payment:
Payment ≈ $3,199.51
Therefore, you need to save $3,200 (rounded to the nearest dollar) at the beginning of
each year.

6. Vernal Equinox's Loan:

Formula: Future Value (FV) = Present Value (PV) * (1 + Interest Rate)^Number of
Periods
Solution:
PV = $10,000
FV = $16,000
Number of Periods = 3 years
16,000 = 10,000 * (1 + Interest Rate)^3
Solving for Interest Rate:
(1 + Interest Rate)^3 = 1.6
Interest Rate ≈ 0.259 = 25.9% (rounded to the nearest whole percent)
Therefore, the implicit annual interest rate is 26%.

7. Implicit Interest Rate on Note:

Formula: Present Value (PV) = Future Value (FV) / (1 + Interest Rate)^Number of
Periods
Solution:
PV = $10,200
FV (each year) = $3,000
Number of Periods = 4 years
10,200 = 3,000 * (1 + Interest Rate)^(-4)
Solving for Interest Rate:
(1 + Interest Rate)^(-4) = 3.4
Interest Rate ≈ 0.291 = 29.1% (rounded to the nearest whole percent)
Therefore, the implicit annual interest rate you will receive is 29%.

8. PJ Cramer Company Sales Projection:

Formula: Future Value (FV) = Present Value (PV) * (1 + Growth Rate)^Number of
Periods
Solution:
PV = $500,000
Growth Rate = 20% = 0.2
Number of Periods = 6 years

Year Sales Figure (FV)

1 500,000 * (1 + 0.2)^1 ≈ $600,000
2 600,000 * (1 + 0.2)^1 ≈ $720,000
3 720,000 * (1 + 0.2)^1 ≈ $864,000
4 864,000 * (1 + 0.2)^1 ≈ $1,036,800
5 1,036,800 * (1 + 0.2)^1 ≈ $1,244,160
6 1,244,160 * (1 + 0.2)^1 ≈ $1,492,992

10.
(a) Annually:
Formula: Present Value (PV) = Future Value (FV) / (1 + Interest Rate)^Number of
Periods
PV = $1,000 / (1 + 0.10)^10 ≈ $385.54
(b) Quarterly:

Effective quarterly interest rate: (1 + 0.10)^(1/4) - 1 ≈ 0.025

Formula: PV = FV / (1 + Effective Rate)^Number of Periods
PV = $1,000 / (1 + 0.025)^40 ≈ $396.51
(c) Continuously:
Formula: PV = FV * e^(-Interest Rate * Time)
PV = $1,000 * e^(-0.10 * 10) ≈ $399.17

13. 1. Define variables:

Loan amount (PV) = $190,000
Interest rate (i) = 17% = 0.17
Number of periods (n) = 20 years
2. Choose the appropriate formula:
Since the loan requires equal annual payments at the end of each period, we can use the
loan payment formula:
Payment = (PV * i * (1 + i)^n) / ((1 + i)^n - 1)
3. Substitute values and calculate:
Payment = ($190,000 * 0.17 * (1 + 0.17)^20) / ((1 + 0.17)^20 - 1)
Payment ≈ $23,202.09
Therefore, the annual payment for the Happy Hang Glide Company's mortgage is
approximately $23,202.09.
6. Discuss with your good friend in the group about above questions