Foundations of Corporate Finance

Solutions to end-of-chapters Problems

Chapter 4: Time Value of Money

Problems 1-7: Solved in tutorial 4

Problem 8: Calculate the present value (PV) for each set of cash flows to
determine which plan is better. Answer is: Plan B.

Problem 9: To be able to compare the two options solve for the interest rate that
Westshore Lending Corp. is offering and compare it to the bank’s offer. Answer:
The bank’s offer is better.

Problem 10: Use the FV formula to calculate the answer. Answer is: $194,287

Problem 11:

a) Apply the PV of an annuity formula to calculate the PV of the cash outflows.

Answer: It is cheaper to Lease (Lease present value is $38,132)
b) Apply the PV of an annuity due (Lease payments are paid at the beginning
of the year instead of the end of the year). Answer: It is cheaper to buy the
truck. (Lease present value is $40,802)

Problem 12: Convert the posted annual rate into a per period (pp) rate: 𝑝𝑝 =
𝐴𝑃𝑅
𝑚
.
Compute the effective annual rate EAR using the EAR formula:
𝐸𝐴𝑅 = (1 + 𝑝𝑝)𝑚 − 1,
where 𝑚 is the number of compounding periods within the year. Answer: First
National Bank offers a higher EAR. (EAR (First Bank) 6.3% vs. EAR Second Bank
6.1%).
Problem 13:

a) Using the future value formula: 𝐹𝑉 = 𝑃𝑉 × (1 + 𝑟)𝑛 , calculate the present

value given the details provided to you. Compare this number to the
purchase price and decide whether the investment is attractive or not.
Answer is: $2.72 million and is lower than the purchase price.
b) Use the present value of an annuity formula to calculate the present value of
the rent. Add that value to the PV of the property excluding the value of the
rent. Compare the new value with the purchase price. Answer: Yes. Value
including rental income is: $3.52 million (higher than the purchase price).

Problem 14: Using the pp formula, 𝑝𝑝 =

𝐴𝑃𝑅
𝑚
. compute APR. Answer is: 28.8%.
Since 𝐸𝐴𝑅 = (1 + 𝑝𝑝)𝑚 − 1, compute EAR. Answer is: 32.9%, you will end up
paying $329.23 in interest on the borrowed $1,000.