Case Study 1

Financial Planning: Time Value of Money

Submitted to:
Dr. Julius Ong Buendia
College of Business
De La Salle University

In partial fulfilment
of the Course Requirements for
Financial Management
(FNC535M)

Submitted by:

Robert Antonio
Jeffrey James Gi
Justa Faith Jarabe
Talna Lenna Leonor
Kimberly Ann Lim
Mary Anelle Lopez

Date:
January 19, 2019
Answers to Guide Questions

1. Morton notes that the $55,000.00 invested in the single-premium life insurance
policy would grow to $176,392.00 in 20 years for a return of 6 percent a year.
Explain how this return was calculated.

The amount of $176,392.00 is the Future Value of the $55,000.00 after 20 years
provided that the investment earns 6% interest annually. This is computed by
adding the 6% interest to the principal amount of $55,000.00 then compound this
amount annually for 20 years. The computation of the return for 20 years period is
as follows:

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 Alternatively, the return can also be computed as shown below:
FVn = PV (1+r) n
Whereas: FVn = Future Value
PV = Present Value
R = Interest Rate
n = Number of Periods
FVn = PV (1+r) n
= 55,000.00 (1+6%) 20
FVn = 176,392.00

Interest / Return = 176,392.00 – 55,000.00

Interest / Return = 121,392.00

2. In order to reposition the equity in his home, Studebaker would have to take out
a 30-year, $75,000 mortgage at 9 percent. Explain how the yearly mortgage
payments on this loan were obtained

The yearly mortgage of Studebraker in obtaining the loan at 9% interest rate will be
$7,300.00 computed using the following formula:

PVAN =PMT [ 1/I - 1/I(1+I)N]

Where: PMT = Payment Amount
I = Interest
N = No. of Periods

Thereby deriving te following formula

PMT = PV of loan / [ 1/I - 1/I(1+I)N] or PV factor of an annuity at 9% for 3N
= $75,000.00 / 10.274
= $7,299.98 or $7,300.00

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 3. For the 9 percent mortgage in Exhibit 4, find the loan balance at the end of years
19 and 20.

The loan balance on the year 19 and 20 are computed as follows:

Year Initial Loan Interest Payment Outstanding
1 75,000.00 6,750.00 7,300.00 74,450.00
2 6,700.50 7,300.00 73,850.50
3 6,646.55 7,300.00 73,197.05
4 6,587.73 7,300.00 72,484.78
5 6,523.63 7,300.00 71,708.41
6 6,453.76 7,300.00 70,862.17
7 6,377.59 7,300.00 69,939.76
8 6,294.58 7,300.00 68,934.34
9 6,204.09 7,300.00 67,838.43
10 6,105.46 7,300.00 66,643.89
11 5,997.95 7,300.00 65,341.84
12 5,880.77 7,300.00 63,922.60
13 5,753.03 7,300.00 62,375.64
14 5,613.81 7,300.00 60,689.45
15 5,462.05 7,300.00 58,851.50
16 5,296.63 7,300.00 56,848.13
17 5,116.33 7,300.00 54,664.46
18 4,919.80 7,300.00 52,284.26
19 4,705.58 7,300.00 49,689.85 Loan balance at the end of
20 4,472.09 7,300.00 46,861.93 Year 19 and 20
21 4,217.57 7,300.00 43,779.51
22 3,940.16 7,300.00 40,419.66
23 3,637.77 7,300.00 36,757.43
24 3,308.17 7,300.00 32,765.60
25 2,948.90 7,300.00 28,414.51
26 2,557.31 7,300.00 23,671.81
27 2,130.46 7,300.00 18,502.28
28 1,665.20 7,300.00 12,867.48
29 1,158.07 7,300.00 6,725.55
30 605.30 7,300.00 30.85

Note: Difference is due to rounding off

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 4. Exhibit 3 indicates that $176,392.00 will be accumulated after 20 years in the
life insurance policy. Is this really true? (Hint: if Studebaker were to make this
investment, what would his debt position look like in year 20?)

Yes, the initial investment of $55,000.00 will be accumulated to $176,392.00 after

20 years given a 6% percent interest rate or rate of return. However, Studebaker at
that time still had an outstanding balance on its mortgage loan amounting to
$46,894.08. But still, the amount of loan can be recovered from the total income
generated by the life insurance investment that has debt to asset ratio of 3.76
($176,392.00 / $46,894.08).

5. A. If the excess $30,000.00 were invested in a long-term asset yielding 8 percent

a year, how much would be accumulated after 20 years?

Future value of $30,000.00 after 20 years given an 8% percent yield rate is

computed using the following given and formula:
Given: Present Value (PV) = $30,000.00
Interest (i) = 8%
Period (n) = 20
𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑉) = 𝑃𝑉 ∗ (1 + 𝑖)𝑛
= $30,000 ∗ (1 + 0.08
= $𝟏𝟑𝟗, 𝟖𝟐𝟖. 𝟕𝟏

Therefore, after 20 years of investing the $30,000 at 8%, $139,828.71 will be

accumulated.
B. Suppose Studebaker placed $3,052 a year into a long-term investment paying
8 percent a year. How much would be accumulated after 20 years (amounts
invested at the end of each year)?

Future value of $3,052.00 placed yearly for 20 years given an 8% percent yield rate
is computed using the following given and formula:
Given: Cash investment at the end of each year (C) = $3,052
Interest (i) = 8%
Period (n) = 20
𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑉) = 𝐶 ∗ [((1 + 𝑖)𝑛 − 1)/𝑖]
= $3,052 ∗ [((1 + 0.08)20 − 1)/0.08]
= $𝟏𝟑𝟗, 𝟔𝟔𝟓. 𝟓𝟎

Therefore, the amount that will be accumulated is $139.665.5 after 20 years of

investing $3,052 a year at 8%.

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 6. Repeat problem 5 but assume a 7 percent return can be earned.
A. If the excess $30,000.00 were invested in a long-term asset yielding 7 percent
a year, how much would be accumulated after 20 years?

Given: Present Value (PV) = $30,000

Interest (i) = 7%
Period (n) = 20
𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑉) = 𝑃𝑉 ∗ (1 + 𝑖)𝑛
= $30,000 ∗ (1 + 0.07)20
= $𝟏𝟏𝟔, 𝟎𝟗𝟎. 𝟓𝟎

Therefore, after 20 years of investing the $30,000 at 7%, $116,090.5 will be

accumulated.

B. Suppose Studebaker placed $3,052 a year into a long-term investment paying

7 percent a year. How much would be accumulated after 20 years (amounts
invested at the end of each year)?

Given: Cash investment at the end of each year (C) = $3,052

Interest (i) = 7%
Period (n) = 20
𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑉) = 𝐶 ∗ [((1 + 𝑖)𝑛 − 1)/𝑖]
= $3,052 ∗ [((1 + 0.07)20 − 1)/0.07]
= $𝟏𝟐𝟓, 𝟏𝟏𝟖. 𝟐𝟎

Therefore, the amount that will be accumulated is $125,118.2 after 20 years of

investing $3,052 a year at 7%.

7. Comer’s criticisms implied that the single-premium life insurance policy is an

unattractive investment for Studebaker. What do your previous answers
suggest?

To check if Comer’s criticism that the single-premium life insurance policy is an

unattractive investment, computation of the correct amount of benefit of life
insurance and the possible benefits of investing amount to a long-term investment
of similar risk are necessary.

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 The future value of the $55,000 investment after 20 years yielding a 6% interest
rate will be $176,392. However, Studebaker should pay $3,000 for closing cost on
new mortgage and $2,000 for other costs totaling to $5,000 with a future value of
$16,035.50. Thus, the net future benefit of having the life insurance will amount to
$160,356.50.

On the other hand, using the amount of $30,000 from the money market mutual
fund into a long-term investment for 20 years at 7% interest rate will have a future
value of $116,091. Not availing the new mortgage, Studebaker will also have an
amount of $3,052 annually for 20 years available to be invested in a long-term
investment yielding 7% interest rate that will have a future value of $125,116.74.
Accordingly, Studebaker will have a total of $241,207.74 in investing in a long-term
investment.

As a conclusion, Comer’s criticism is correct as investing to a long-term investment

have an incremental benefit of $80,851.24 than the life insurance.

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 8. A. Suppose Studebacker’s goal is to accumulate $400,000 in 20 years. Assumed
$30,000 invested at 8% interest. How much will he have to save in equal amount
at the end of each year of the next 20 years if he can earn 8% of any investment?

Given: Investment $ 30,000

FV $ 400,000
Interest (i) : 8%
Period (n): 20 years

Applying this ($ 30,000 investment at 8%)

$30,000 X 4.661 (FV Factor) = FA $139,830

The remaining balance to accumulate $400,000 should have a savings each year is as
follows:
= $ 260,170 / 45.762 (FV Factor of annuity at 8% for 20 periods)
= $ 5,685.28

We conclude that Studebacker should save at the end of each year amounting to $
5,685.28 to be able to accumulate $ 400,000 in 20 years including interest earned
from $30,000 investment at 8%.

B. Repeat part (a) but assume he will not be able to save any money in years 13
to 20. This is, he will save an equal amount at the end of years 1 to 12 and
nothing thereafter.

The remaining balance to accumulate $400,000 should have a savings each year is as
follows:
= $260,170 / 18.977 (FV Factor of annuity at 8% for 12 periods)
= $ 13,709.75

Since Studebacker would not be able to save money in years 13 to 20. He should
save at the end of each year amounting to $13,714.81 to be able to accumulate $
400,000.

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 9. The yearly payment on the new 30-year, $75,000.00 mortgage is $7,300.00. This
assumes one payment is made at the end of each of the next 30 years. Suppose
that payments must be made at the end of each month. Would 12 of these
monthly payments be equal to one of the yearly payments? Explain.

No because the period is different. There will be a difference in interest when you
pay monthly, quarterly or annually. In the case of Studebaker, if he will pay the loan
monthly, there will be lower interest expenses due to the deduction of the loan in a
monthly rather the on a yearly basis.

10. Exhibit 3 suggests that the annual cost of the life insurance policy is $3,052.00.
With the adjustments mentioned in the case, Corner calculated the cost to be
$5,152.00 in year 1 and $18,632.00 by year 20 assuming a 7 percent annual
return. Explain how these were determined.

The $5,152.00 adjusted cost in Year 1 is derived by adding the annual cost of life
insurance policy amounting to $3,052.00 and the opportunity cost amounting to
$2,100.00 (assuming that excess $30,000 is invested in a 7% bearing long-term
investment).

The $18,632.00 total cost by year 20 is computed using an amortization schedule

for the adjusted cost mentioned above which is $5,152.00 with an annual interest
rate of 7%.

Table for computation is as follows:

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