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BFC2140

CORPORATE FINANCE I

TUTORIAL SET 02 - SOLUTIONS


FINANCIAL MATHEMATICS

Important note to students: It is your responsibility to familiarise yourself with


your own personal calculator (hp10bII+). Assistance will be provided with this
calculator in teaching materials. Do not leave learning how to use the calculator
until the last minute.

Ensure that you clear the memory.

Warm up

2-1. If you invested $200,000 today in an investment returning 6% p.a. with


interest compounding 6 monthly, how much would that investment have
grown to at the end of 10 years?

FV = $200,000(1.03)20 = $361,222.25

Using hp10bII+ calculator


Keys Display Description
1.00 Sets the number of
1 payments per year.
20.00 Enters the number of
20
payments.
3.00 Enters interest per year.
3
-200,000.00 Enters the present value.
-200,000 Note that money paid out
is entered as a negative.
361,222.25 Calculates the future value
if paid at end of the period.

2-2. A bank is quoting an interest rate of 8% p.a. compounding monthly. What is


the effective annual interest rate?

12
 0.08 
EAR offered by the bank  1    1  8.30 % (2 decimal places)
 12 
Using hp10bII+ calculator
Keys Display Description
8.00 Enters the nominal rate
8
12.00 Enters payments per year
12
8.29995 Calculates the annual
effective interest rate

2-3 Fancy Nancy has to borrow funds at 10 percent to purchase a necklace. She
has a contract to sell the necklace for $70,000. Payment is to be received in
two years’ time. The necklace cost $60,000 today and could be sold for this
amount. Nancy likes this arrangement as she does not have to give up the
necklace for two years and by then fashions will possibly have changed. What
is the borrowing rate at which she would break even?

FV  C  (1  r ) n
$70,000  $60,000(1  r) 2
(1  r ) 2  1.166666667
r  8.01 %

Using hp10bII+ calculator


Keys Display Description
1.00 Sets the number of
1 payments per year.
2.00 Enters the number of
2
payments.
-60,000.00 Enters the present value if
-60,000 cash flow at end of the
period.
Note that money paid out
is entered as a negative.
70,000.00 Enters the future value.
70,000
8.01 Calculates the interest per
year.

1. Complete the following table.

Present Value ($) Years Interest Rate Future Value ($)


(%)
2,250 30 12 (i) 67409.82
9,310 16 9 (ii) 36,963.55
(iii) 11,877.67 5 4 14,451
(iv) 35,708.65 15 20 550,164
265 3 (v) 5.03 307
360 9 (vi) 8.67 761
(i)
FV  C  (1  r ) n  $2250  (1  0.12 ) 30  $67409.82

Using hp10bII+ calculator


Keys Display Description
1.00 Sets the number of
1 payments per year.
30.00 Enters the number of
30
payments.
12.00 Enters interest per year.
12
-2,250.00 Enters the present value.
-2250 Note that money paid out
is entered as a negative.
67,409.82 Calculates the future value
if paid at end of the period.

(ii) FV  C  (1  r ) n  $9310  (1  0.09 )16  $36963.55


Using hp10bII+ calculator
Keys Display Description
1.00 Sets the number of
1 payments per year.
16.00 Enters the number of
16
payments.
9.00 Enters interest per year.
9
-9,310.00 Enters the present value.
-9310 Note that money paid out
is entered as a negative.
36,963.55 Calculates the future value
if paid at end of the period.
C $14451
(iii) PV    $11,877 .67
(1  r ) n (1  0.04 ) 5
Using hp10bII+ calculator
Keys Display Description
1.00 Sets the number of
1 payments per year.
5.00 Enters the number of
5
payments.
4.00 Enters interest per year.
4
14,451.00 Enters the future value.
14,451
-$11,877.67 Calculates the present
value if cash flow at end of
the period.
Note that money paid out
is entered as a negative.
C $550 ,164
(iv) PV    $35708 .65
(1  r ) n (1  0.20 )15
Using hp10bII+ calculator
Keys Display Description
1.00 Sets the number of
1 payments per year.
15.00 Enters the number of
15
payments.
20.00 Enters interest per year.
20
550,164.00 Enters the future value.
550,164
-$35,708.65 Calculates the present
value if cash flow at end of
the period.
Note that money paid out
is entered as a negative.

(v)
FV  C  (1  r ) n
FV
(1  r ) n 
C
1/ n
 FV 
(1  r )   
 C 
1/ n 1/ 3
 FV   307 
r   1     1  0.0503 or 5.03%
 C   265 
Using hp10bII+ calculator
Keys Display Description
1.00 Sets the number of
1 payments per year.
3.00 Enters the number of
3
payments.
-265.00 Enters the present value if
-265 cash flow at end of the
period.
Note that money paid out
is entered as a negative.
307.00 Enters the future value.
307
5.03 Calculates the interest per
year.
(vi)
FV  C  (1  r ) n
FV
(1  r ) n 
C
1/ n
 FV 
(1  r )   
 C 
1/ n 1/ 9
 FV   761 
r   1     1  0.0867 or 8.67% (nearest integer)
 C   360 
Using hp10bII+ calculator
Keys Display Description
1.00 Sets the number of
1 payments per year.
9.00 Enters the number of
9
payments.
-360.00 Enters the present value if
-360 cash flow at end of the
period.
Note that money paid out
is entered as a negative.
761.00 Enters the future value.
761
8.67 Calculates the interest per
year.

2. At 6 percent interest, how long does it take to double your money? To


quadruple it?
FV  C  (1  r ) n
FV
(1  r ) n 
C
 FV 
n  log( 1  r )  log  
 C 
 FV 
n  log   log( 1  r )  log 2 log( 1  0.06 )  11 .90
 C 
By the rule of 72, 72/r  72/6  12 years.
Using hp10bII+ calculator
Keys Display Description
1.00 Sets the number of
1 payments per year.
6.00 Enters the interest per
6
year.
-1.00 Enters the present value if
-1 cash flow at end of the
period.
Note that money paid out
is entered as a negative.
2.00 Enters the future value.
2
11.90 Calculates the number of
payments.
FV  C  (1  r ) n
FV
(1  r ) n 
C
 FV 
n  log( 1  r )  log  
 C 
 FV 
n  log   log( 1  r )  log 4 / log( 1  0.06 )  23 .79
 C 
Using hp10bII+ calculator
Keys Display Description
1.00 Sets the number of
1 payments per year.
6.00 Enters the interest per
6
year.
-1.00 Enters the present value if
-1 cash flow at end of the
period.
Note that money paid out
is entered as a negative.
4.00 Enters the future value.
4
23.79 Calculates the number of
payments.

3. A) You are offered an investment that requires you to put up $3,000 today in
exchange for $10,000 15 years from now. What is the annual rate of return on
this investment?

FV  C  (1  r ) n
$10000  $3000  (1  r )15
10000
(1  r )15 
3000
1 / 15
 10000 
r    1  8.36 %
 3000 
Using hp10bII+ calculator
Keys Display Description
1.00 Sets the number of
1 payments per year.
15.00 Enters the number of
15
payments.
-3000.00 Enters the present value if
-3000 cash flow at end of the
period.
Note that money paid out
is entered as a negative.
10000.00 Enters the future value.
10000
8.36 Calculates the interest per
year.

B) A bank offers you an interest rate of 8 percent, compounded quarterly.


Which one will you choose (taking the above investment opportunity or
investing at this bank)?

4
 0.08 
EAR offeredby the bank  1    1  8.24% (2 decimal places)
 4 
Therefore, you should take the investment opportunity (a) as it has a higher
rate of return.
Using hp10bII+ calculator
Keys Display Description
8.00 Enters the nominal rate
8
4.00 Enters payments per year
4
8.24 Calculates the annual
effective interest rate

4. An investment has the following cash flows. If the discount rate is 8 per cent;
what is the present value of these flows at t=0? What is the net future value
of these flows at t=3?

YEAR CASH FLOW


1 $300
2 $600
3 $900

$300 $600 $900


PV     $1506 .63
1.08 1.08 2 1.08 3

FV  C  (1  r ) n  $300 (1.08) 2  600 (1.08)1  900  $1,897 .92

Using hp10bII+ calculator


Keys Display Description
CFLO CLR Clears the cash flow
Note: The message flashes memory
and then disappears
1.00 Sets the number of
1 payments per year.
8.00 Enters the interest per
8
year.
0.00 Enters cash flow at t=0
0
(CF0 flashes and then
disappears)
300.00 Enters cash flow at t=1
300
(CF1 flashes and then
disappears)
600.00 Enters cash flow at t=2
600
(CF2 flashes and then
disappears)
900.00 Enters cash flow at t=3
900
(CF3 flashes and then
disappears)
1,506.63 Calculate the PV at t=0
1,897.92 Calculate the Net Future
Value at t=3

5. It is presently July 1, 2016, and you need to raise $10,000 by July 1, 2021.
You can invest money in your bank to earn an 8% return compounded
annually.

A) Calculate the amount of a deposit made on July 1, 2016, to give a balance


of $10,000 on July 1, 2021.

SOLUTION

Timeline

2016 2017 2018 2019 2020 2021


n=0 n=1 n=2 n=3 n=4 n=5
PV =?
FV5=$10,000

FV $10,000
PV    $6,805 .83
(1  r ) n (1.08) 5

Using hp10bII+ calculator


Keys Display Description
1.00 Sets the number of
1 payments per year.
5.00 Enters the number of
5
payments.
8.00 Enters interest per year.
8
10,000.00 Enters the future value.
10,000
-$6,805.83 Calculates the present
value if cash flow at end of
the period.
Note that money paid out
is entered as a negative.

B) Independent of A), if you receive $7,500 from your father on July 1 2017,
calculate the rate of return you must earn to reach the $10,000 required
by July 1, 2021.

SOLUTION

FV = C(1+r)n
$10,000 = $7,500(1+r)4
1
 $10 ,000  4
r =  1 = 7.46%
 $7,500 

Using hp10bII+ calculator


Keys Display Description
1.00 Sets the number of
1 payments per year.
4.00 Enters the number of
4
payments.
-7,500.00 Enters the present value if
-7500 cash flow at end of the
period.
Note that money paid out
is entered as a negative.
10,000.00 Enters the future value.
10000
7.46 Calculates the interest per
year.