Ch.

2: Concepts of Value and Return

CHAPTER 2
CONCEPTS OF VALUE AND RETURN
Problem 1
Time preference (discount) rate
(i) A. Investment
B. Period (years)
C. Compound value factor at 9% for 4 years
D. Compound value at the end of 4 years: [A x C]
: 15,000 (1.09)4 = 15,000 x 1.4116

9%
15,000
4
1.4116
21,173.72
Now

(ii)

A. Investment
B. Period (end of year)
C. Compounding periods
D. Compound value factor (lump sum)
E. Compound value [A x D]
: 6,000 (1.09)5 = 6,000 x 1.5386
: 6,000 (1.09)4 = 6,000 x 1.4116

6,000
5
5
1.5386

After 1 year
6,000
5
4
1.4116

9,231.74
8,469.49

(iii) A. Annual investment (end of year)

B. Period (years)
C. Compound value factor (annuity)
D. Compound value at the end of 8 years [A x C]
: 18,000 [(1.09)8 - 1]/0.09 = 18,000 x 11.0285

18,000
8
11.0285
19,8512.53

(iv) A. Annual investment (beginning of year)

B. Periods (years)
C. Compound value factor (annuity due)
D. Compound value at the end of 8 years [A x C]
: 18,000 [{(1.09)8 - 1}/0.09] (1.09) = 18,000 x 12.0210

18,000
8
12.0210
216,378.66
Withdrawal Balance

(v)

A. Annual investment for 4 years

B. Compound value at the end of 4 years:
: 18,000 x [{(1.09)4-1}/0.09]
C. Compound value at the end of 5 years:
: (82,316.32 x 1.09) - 12,000
C. Compound value at the end of 6 years:
: (77,724.79 x 1.09) - 12,000
D. Compound value at the end of 7 years:
: (72,720.02 x 1.09) -12,000
E. Compound value at the end of 8 years:
: (67,264.82 x 1.09) - 0

18,000.00
82,316.32

89,724.79

12,000.00 77,724.79

84,720.02

12,000.00 72,720.02

79,264.82

12,000.00 67,264.82

73,318.66

0.00 7,3318.66

I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

Problem 2
Discount rate
(i) A. Cash flow
B. Period
C. Present value factor
D. Present value (Rs): 2,000/(1.13)0

13%
2,000
0
1
2,000

(ii) A. Cash flow

B. Period
C. Present value factor: 1/(1.13)1
D. Present value (Rs): [A x C]: 2,000/(1.13)1

2,000
1
0.8850
1,769.91

(iii) A. Cash flow

B. Period
C. Present value factor
D. Present value (Rs) [A x C]

2,000
2
0.7831
1,566.29

(iv) A. Cash flow

B. Period
C. Present value factor: 1/(1.13)3
D. Present value (Rs): [A x C]: 4,000/(1.13)3

4,000
3
0.6931
2,772.20

(v) A. Cash flow

B. Period
C. Present value factor: 1/(1.13)3
D. Present value (Rs) [A x C]: 7,000/(1.13)3

7,000
3
0.6931
4,851.35

(vi) A. Cash flow

B. Period
C. Present value factor: 1/(1.13)4
D. Present value (Rs): [A x C]: 3,000/(1.13)4

3,000
4
0.6133
1,839.96

(vii) A. Cash flow

B. Period
C. Present value annuity factor:
[{(1.13)5-1}/{0.13(1.13)5}]
D. Present value (Rs):[A x C]:
5

PV =

(113
. )

4,000
5
3.5172
14068.93

4,000 t

= 4,000 3.5172

t =1

(viii) A. Cash flow

B. Period
C. Present value factor (annuity due)
[{(1.13)5-1}/{0.13(1.13)5}](1.13)
D. Present value (Rs):
4

PV =

(1.13)

4,000 t
t

4,000
5
3.9745

15,897.89
= 4,000 x 3.9745

t =0

Ch. 2: Concepts of Value and Return

Problem 3
Discount rate

14%

Year

A. Cash flows
B. PVF at 14%
C. Present value [A x B]
4

PV =

(114
. )

3,000

t =1

7,000
5
. )
(114

3,000.00 3,000.00 3,000.00 3,000.00 7,000.00 1,000.00

0.8772
0.7695
0.6750
0.5921
0.5194
0.4556
12,832.30 2,631.58 2,308.40 2,024.91 1,776.24 3,635.58
455.59
+

1,000
6
. )
(114

= 3,000 2.9138 + 7,000 0.5194 + 1,000 0.4556 = Rs12,832.30

Problem 4
A. Rate of interest
B. Sum received now (Rs)
C. Period (years)
D. Present value factor (annuity) at 15%
E. Capital recovery factor (annuity) at 15%
: [1/D]: 1/5.0188
F. Annual instalment (end of period) [B x E]
10
1

100 =
A
t
(115
. )
t =1
100 = 5.0188A
A = 100 / 5.0188 = Rs19.93
G. Present value factor (annuity due) at 15%:
: 5.0188 x 1.15
H. Capital recovery factor (annuity due) at 15% [1/G]
I. Annual instalment (beginning of period) [B x H]

15%
100
10
5.0188
0.1993
19.93

5.7716
0.1733
17.33

Problem 5
A. Interest rate
B. Debt payable now (Rs)
C. Period of instalments (years)
D. Present value factor (annuity) at 10%
E. Capital recovery factor (annuity) at 10%
F. Annual instalment (end of period): [B x E]
5
1

1,000 =
A
t
(110
. )
t =1
1,000 = A / 3.7908

10%
1,000
5
3.7908
0.2638
263.80

A = 1,000(1 / 3.7908) = Rs263.80

I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

Problem 6
A. Time value of money
B. Payment now (Rs)
C. Period of instalments (years)
D. Present value factor (annuity) at 12%
E. Capital recovery factor (annuity) at 12%: [1/D]
F. Annual instalment (end of period): [B x E], 13,000 x 0.2774
G. Present value factor (annuity due) at 12%: [D x 1.12]
H. Capital recovery factor (annuity due) at 12% [1/G]
I. Annual instalment (beginning of period) (Rs): [B x H], 13,000 x 0.2477

12%
13,000
5
3.6048
0.2774
3,606.33
4.0373
0.2477
3,219.93

Problem 7
A. Discount rate
B. Outlay now
C. Period of instalments (years)
D. Present value factor (annuity) at 11%
E. Capital recovery factor (annuity) at 11% [1/D]
F. Annual instalment (end of period) [B x E or B/D]
G. Present value factor (annuity due) at 11%
H. Capital recovery factor (annuity due) at 11% [1/G]
I. Annual instalment (beginning of period) [B x H]

11%
10,000
5
3.6959
0.2706
2,705.70
4.1024
0.24357
2,437.57

Problem 8
A. Discount rate
B. Annual interest payment
C. Period (years)
D. Present value factor (annuity), 30 periods, 8%
E. Present value of annual interest [B x D]
F. Maturity value at the end of 30 years
G. Present value factor, end of 30 years
H. Present value of maturity value [F x G]
I. Present value of bond [E + H]:
30

PV =

(1.08)
t =1

150 t

8%
150
30
11.2578
1,688.67
1,000
0.0994
99.38
1,788.04

1,000
30
. )
(108

= 150 11.2578 + 1,000 0.0994 = Rs1,788.04

Problem 9
A. Discount rate
B. Annual pension
C. Periods of pension
D. Present value factor, 20 years, 15%
E. Present value of pension at the end of 20 years
F. Present value factor, end of 20 years
G. Present value of pension now [E x F]

15%
10,000
20
6.2593
62,593.31
0.0611
3,824.47

Ch. 2: Concepts of Value and Return

Problem 10
A. Interest rate

10%

B. Year
C. Cash flow
D. Present value factor
E. Present value (Rs) [C x D]
F. Net present value (Rs)

0
1-6
7
8
12
-10,000
2,000 -1,500 1,600
2,500
1.0000 4.3553 0.5132 0.4665
1.4788
-10,000 8,710.52 -769.74 746.41 3,696.91
2,384.11

Problem 11
IRR
( i ) Deposit and receive
( ii ) Borrow and pay
( iii ) Borrow and pay

14% -100 114

12% 100 -112
13% 1,000
0

0 -3,395

The following formula is used to compute IRR:

n

NPV =

(1 + IRR)
NCFt

C0 = 0

t =1

Problem 12
Year
Bank deposit

13% -100

0 300

Problem 13
We can use the following formula in calculating the time period, n, in this problem:

(1 + r ) n = 2
n ln (1 + r ) = ln 2
n = ln 2 / ln (1 + r )
A. Investment
B. Interest rate (annual)
C. Expected amount after n years:
6000(1+r)n = 12,000
D. Compound value factor:(1.06)n
= 12,000/6,000
E. ln (1+r)
F. ln 2
G. n = ln 2/ln (1+r)
H. Interest rate (semi-annual)
I. ln (1+r/2)
J. n (half-years)= ln 2/ln (1+r/2)

6,000
6%

6,000
10%

6,000
20%

6,000
30%

12,000 12,000 12,000 12,000

2
2
2
2
0.0583 0.0953 0.1823 0.2624
0.6931 0.6931 0.6931 0.6931
11.90
7.27
3.80
2.64
0.03
0.05
0.1
0.15
0.0296 0.0488 0.0953 0.1398
23.45 14.21
7.27
4.96

Problem 14
A. Annual earnings in 19X1
B. Period (years)
C. Annual earnings in 19X8
D. (1+g)7
E. 7 ln (1+g)
F. ln (1+g)
G. (1+g)

45,000
7
67,550
1.5011
0.4062
0.0580
1.060

10

I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

H. g (growth): 1.06 - 1
67,550
g=

45,000

0.060

(1/ 7 )

1 = (15011
.
)

(1/ 7 )

1 = 106
. 1 = 0.6 = 6%

Problem 15
A. Land price
B. Instalments
C. Annual instalment
D. Present value annuity factor required:40000/8213
E. From present value of annuity table, r equals 20%. We can
write the formula for IRR ( r ) as follows:
20

40,000 =

(1 + r)

40,000
20
8,213
4.8703
20%

8,213 t
t

t =1

Problem 16
A. Needed future sum after 15 years
B. Period (years)
C. Interest rate
D. Future value factor of an annuity, 15 years, 12%
E. Annuity value [A/D]:
15
(112
. ) 1
= 30,000
A
0.12
37.28 A = 30,000

300,000
15
12%
37.28

8,047.27

A = 30,000 / 37.28 = Rs 8,047.27

Problem 17
A. Needed future sum at the age of 50
B. Period (years)
C. Interest rate
D. Future value factor of an annuity, 30 years, 10%
E. ( a ) Annuity value [A/D]
F. Future value factor of a lump sum, 30 years, 10%
G. ( b ) Lump sum deposited now [A/F]

1,000,000
30
10%
164.49
6,079.25
17.4494
57,308.55

Problem 18
A. Savings today
B. Period (years)
C. Interest rate
D. Future value factor, 10 years, 10%
E. Future value [A x D]
F. Future value of an annuity factor, 10 years, 10%
G. Annual withdrawal [E/F]
H. Present value of annuity factor, 10 years, 10%
I. Annual withdrawal [A / H]

80,000
10
10%
2.5937
207,499.40
15.9374
13,019.63
6.1446
13,019.63

Ch. 2: Concepts of Value and Return

Problem 19
A. Price of house
B. Cash payment
C. Balance
D. Instalment period
E. Interest rate
F. Present value of an annuity factor, 20 years, 12%
G. Annual instalment

500,000
100,000
400,000
20
12%
7.4694
53,551.51

The interest paid and principal repaid each year are as follows:

Years
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

Balance
400,000.00
394,448.49
388,230.79
381,266.98
373,467.50
364,732.09
354,948.43
343,990.73
331,718.11
317,972.77
302,577.99
285,335.83
266,024.62
244,396.06
220,172.08
193,041.22
162,654.65
128,621.70
90,504.79
47,813.85
0.00

Instalment
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51
53,551.51

Interest
48000.00
47333.82
46587.70
45752.04
44816.10
43767.85
42,593.81
41,278.89
39,806.17
38,156.73
36,309.36
34,240.30
31,922.95
29,327.53
26,420.65
23,164.95
19,518.56
15,434.60
10,860.57
5,737.66

Principal
repaid
5551.51
6217.69
6963.82
7799.47
8735.41
9783.66
10,957.70
12,272.62
13,745.34
15,394.78
17,242.15
19,311.21
21,628.56
24,223.98
27,130.86
30,386.57
34,032.95
38,116.91
42,690.94
47,813.85

Problem 20
A. Price of flat
B. Down payment
C. Loan processing fee
D. Net amount of loan
E. Period of mortgage loan (years)
F. Loan instalment
G. Required factor [D/F]
H. Present value of an annuity factor at trial rate 14%, 12 years
I. Present value of an annuity factor at trial rate 16%, 12 years
J. Rate of return:
5.660 5.421
14% + 1%
= 14.52%
5.660 5.197

200,000
40,000
5,000
155,000
12
28,593
5.421
5.660
5.197
15%
(approx.)

I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

Problem 21
Required rate

13%

End
Year Cash flow
0
1
2
3
4
5
6
7

0
2000
2000
2000
1000
1000
1000
1000

PVF

Beginning
PV Cash flow

1.0000
0.0
0.8850 1769.9
0.7831 1566.3
0.6931 1386.1
0.6133 613.3
0.5428 542.8
0.4803 480.3
0.4251 425.1
6783.8

PV

2000
2000
2000 1769.9
2000 1566.3
1000 693.1
1000 613.3
1000 542.8
1000 480.3
0
7665.7

Problem 22
A. Payment now
B. Annuity
C. Expected period for annuity (years)
D. Interest rate
E. Annuity factor
F. Present value of annuity

200,000
25,000
20
0.12
7.4694
186,736

Sundaram should prefer Rs 200,000 now.

Problem 23
A. Time value of money
B. 30-year annuity
C. PVAF, 10%, 30 year
D. Present value of 30-year annuity
E. 20-year annuity
F. PVAF, 10%, 20 year
G. Present value of 20-year annuity
H. Cash right now

10%
5,000
9.4269
47,134.6
6,600
8.5136
56,189.52
50,000

You should choose 20-year annuity of Rs 6,600 as it has highest

PV.

Problem 24
Interest rate
( i ) Amount now or
10-year annuity
PVAF, 8%, 10 year
Present value of 10-year annuity [14,000 6.7101]

8%
80,000
14,000
6.7101
93,941

Ms Punam should choose 10-year annuity offering higher PV.

Ch. 2: Concepts of Value and Return

( ii ) Amount now or
20-year annuity
PVAF, 8%, 20 year
Present value of 20-year annuity [14,000 x 9.8181]

150,000
14,000
9.8181
137,454

Ms Punam should choose to have Rs 150,000

(iii) Amount now or
15-year annuity
PVAF, 8%, 15 year
Present value of 15-year annuity [14,000 8.5595]

120,000
14,000
8.5595
119,833

Both alternatives are almost the same.

Problem 25
Required rate of return
End
Cash flow PVF
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
PV

0
2,000
2,000
2,000
2,000
2,000
3,000
3,000
3000
3,000
6,000
6,000
6,000
6,000
6,000
6,000

1.0000
0.8772
0.7695
0.6750
0.5921
0.5194
0.4556
0.3996
0.3506
0.3075
0.2697
0.2366
0.2076
0.1821
0.1597
0.1401

14%
Beginning
Cash flow

PV
0
1,754
1,539
1,350
1,184
1,039
1,367
1,199
1,052
923
1,618
1,420
1,245
1,092
958
841
18,581

PV

2,000
2,000
2,000
2,000
2,000
3,000
3,000
3,000
3,000
6,000
6,000
6,000
6,000
6,000
6000
0

2,000
1,754
1,539
1,350
1,184
1,558
1,367
1,199
1,052
1,845
1,618
1,420
1,245
1,092
958
21,182

Problem 26
Borrowing
Interest rate
Annuity factor, 10%, 5 year
Annual payment: 50,000/3.7908
Year Outstanding
0
1
2
3
4
5

50,000
41,810
32,801
22,892
11,991
0

Instalment
0
13,190
13,190
13,190
13,190
13,190

50,000
10%
3.7908
13190
Interest
0
5,000
4,181
3,280
2,289
1,199

Repayment
8,190
9,009
9,910
10,901
11,991

I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

Problem 27
Nominal rate of interest
Period
Effective interest rate: annual compounding
Half-yearly compounding:
Compounding period
Half-yearly rate [12%/2]
Effective (annual) interest rate [(1.06)2-1]
Quarterly compounding:
Compounding period
Quarterly rate [12%/4]
Effective (annual) interest rate [(1.03)4-1]
Monthly compounding:
Compounding period
Monthly rate [12%/12]
Effective (annual) interest rate [(1.01)12-1]

12%
1
12%
2
6%
12.36%
4
3%
12.55%
12
1%
12.68%

Problem 28
A. Face value of debenture
B. Current yield (annual)
C. Half-yearly yield [18%/2]
D. Period (years)
E. Compounding periods [10 x 2]
F. Half-yearly interest amount

1,000
18%
9%
10
20
75

G. PVAF, 9%, 20 periods

H. Present value of 20-period annuity of Rs 75 [F x G]
I. PVF of a lump sum, 9%, 20 periods
J. PV of maturity value of Rs 1000 [1,000 x 0.1784]
K. Present value of the debenture [H + J]
20

Value of bond =

(1.09)
t =1

75 t

9.1285
684.64
0.17843
178.43

1,000

863.07

(1.09) 20

Problem 29
A. Initial deposit
B. Interest rate (annual)
C. Compounding period in a year
D. Quarterly rate [12%/4]
E. Period
F. Total compounding periods [C x E]
G. FVF, 3%, 30 periods
H. Future value [A x G]: [(1.03)30 x 1,000]

1,000
12%
4
3%
7.5
30
2.42726
2,427.26

10

Ch. 2: Concepts of Value and Return

Problem 30
A. Half-yearly interest
B. Maturity (years)
C. Maturity value (at par)
D. Maturity value (at premium)
E. Required rate of return
F. Present value annuity factor, 6%, 14 periods
G. Present value factor, 6%, 14 periods
H. Value of the bond (redeemed at par):
(a) Value of interest [A x F]
(b) Present value of maturity value [C x G]
I. Value of bond (redeemed at premium):
(a) Value of interest [A x F]
(b) Present value of maturity value [D x G]

50
7
1,000
1,100
12%
9.2950
0.4423
907.05
464.75
442.30
951.28
464.75
486.53

Problem 31
Current deposit (Rs)
10000
Montly withdrawal
100
Annual interest rate
8%
Quarterly rate
2%
Monthly interest rate
0.006667
The present value of your deposit is Rs 10,000 and you want to withdraw Rs 100 every month. Thus

1
1
10,000 = 100

12n
0.00667 0.00667 (1.00667 )

1
100 = 150
12n
0.00667 (1.00667 )

(1.00667 )12n

= (150 100) 0.00667 = 0.333

1.0066712n = 3.0
12n ln 1.00667 = ln 3 = 12n 0.00665 = 1.0986
1.0986
n=
= 13.8
12 0.00665

You will be able to completely withdraw your deposit in about 14 years.

Problem 32
A. Preference share capital
B. Maturity period (years)
C. Required return
D. Compound value annuity factor, 12%, 8 years
E. Sinking fund factor, 12%, 8 years [1/D]
F. Annual contribution in SF (end of the year) [A x E]
G. Compound value annuity factor (annuity due), 12%, 8
years
H. Sinking fund factor (annuity due), 12%, 8 years [1/G]
I. Annual contribution in SF(beg. of the year) [A x H]

800,000
8
12%
12.2997
0.0813
65,042.27
13.7757
0.0726
58,073.46

11

I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

Problem 33
A. Face (and maturity) value of bond
B. Interest rate (half yearly)
C. Half yearly interest
D. Remaining life of bond (half years)
E. Required rate of return (half yearly)
F. Present value annuity factor, 6%, 8 years
G. Present value factor, 6%, 8 years
H. Value of bond:
(a) Present value of interest [C x F]
(b) Present value of maturity value [A x G]

1,000
7%
70
8
6%
6.2098
0.62741
1,062.10
434.69
627.41

Problem 34
A. Annual payments
B. Period (years)
C. Principal
D. Internal rate of return:
4

NPV =

(1 + r)

3,800
t

3,800
4
10,000

10,000 = 0

19.14%

t =1

By trial & error IRR is approx. 19%

Problem 35
A. Loan amount
B. Period (years)
C. Interest rate
D. Annual repayment
E. Internal rate of return:
8

NPV =

(1 + r)

2,013
8

10,000
8
12%
2,013

10,000 = 0

12%

t =1

Interest rate charged by the bank and the internal rate of return are the same. 12% is the true rate of interest.
Loan amortisation schedule
Beg.
Year balance Instalment
0
1
2
3
4
5
6
7
8

10,000
9,187
8,276
7,257
6,114
4,835
3,402
1,798
0

2,013
2,013
2,013
2,013
2,013
2,013
2,013
2,013

Repayment
End
Interest
Principal balance
1,200
1,102
993
871
734
580
408
216

813
911
1,020
1,142
1,279
1,433
1,605
1,797

9,187
8,276
7,257
6,114
4,835
3,402
1,798
0

12

Ch. 2: Concepts of Value and Return

Problem 36
A. Amount deposited
1,000
B. Interest rate for years 1-5 (5 years)
10%
C. Interest rate for years 6-13 (8 years)
13%
D. Compound value for 13-year period:
[1,000(1.10)5 x (1.13)8]
4,281.45
E. Compound rate of interest:
[(4,281.45/1,000)1/13 - 1]
11.84%

13

I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

CASE
Case 2.1: Divya Handtools Private Limited (DHPL)
This case is intended to discuss concepts of value. The students will get practice in computing present value under
different situations. The instructor should use this case to ensure that students understand the logic and concepts of
time value of money.

Capacity expansion
Year
NCF
PVF
PV, 14%
0
-250
1.000
-250.0
1
45
0.877
39.5
2
45
0.769
34.6
3
45
0.675
30.4
4
68
0.592
40.3
5
68
0.519
35.3
6
68
0.456
31.0
7
68
0.400
27.2
8
68
0.351
23.8
9
30
0.308
9.2
10
85
0.270
22.9
NPV
44.2
Year 10 cash flows include salvage value.
Minimum savings each year from replacement
Cash outlay (Rs million)
Life (years)
PVFA 14%, 10
Annuity (annual savings, Rs million)
This is a case of capital recovery

Annual instalment of SBI loan

Amount (Rs million)
Interest rate
Period (years)
PVFA 14%, 10
Annual instalment (Rs mn.)

Payment at maturity - SBI loan

Amount (Rs million)
Interest rate
Period (years)
Future value factor
Single payment (future value)

50
10

5.2161
9.6

200
14%
10
5.2161
38.3

200
14%
10
3.7072
741.4

Quarterly instalment - FI loan

Amount (Rs million)
Annual interest rate
Quarterly rate
Quarterly periods

200
13.50%
3.375%
40

PVFA 3.375%, 40
Quarterly instalment (Rs mn)

21.7754
9.2

The company should borrow from FI since the annual interest rate is lower.

14

Ch. 2: Concepts of Value and Return

Lease
Amount (Rs million)
Period (years)
Lease rental (beginning of the year)
PVFA of annuity due (13.5%)
Value of lease rentals

300
10
52
6.038
314.0

The value of lease rentals is higher than the amount of borrowing (Rs 300 million). Hence, borrowing is heaper than
leasing.

15