Financial Modelling 1/5

ASB4416 Financial Modelling

Time Value of Money: Answers

Gwion Williams

Bangor Business School

 Financial Modelling 2/5

Questions

1. If I deposit £10,000 for 5 years, how much will I receive back at maturity if
the interest rate of 5
simple £10, 000 × (1 + (5% × 5)) = £12, 500

compounded annually £10, 000 × (1 + 5%)5 = £12, 762.82

compounded monthly £10, 000 × (1 + 5%/12)60 = £12, 833.59

compounded continuously £10, 000 × e 5%×5 = £12, 840.25

2. I need to pay a bill of £1500 in 12 months’ time. How much do I need to
set aside now at a monthly compounded rate of 4% so as to receive back
the £1500 I need in 12 months’ time?

PV × (1 + 4%/12)12 = £1500
⇒ PV = £1441.28
 Financial Modelling 3/5

Time Value of Money

3. An investment promises to pay me annual income for a period of 20 years.

The first payment, due in a year from now, will be £1000 and payments
will increase by 4% per annum. How much should I expect to have to
invest today if the interest rate is a) 5% per annum (annual compounding)

value of growing perpetuity is £1000/(5% − 4%) = £100, 000.

We only want 20 years’ of payments so take away value of the same

perpetuity in 20 years’ time (which will have a first payment of
£1000 × (1.04)20 = £2191.12 occurring 21 years from now)

£100, 000 × (1.04)20

£100, 000 − = £100, 000 − £82, 581.13
(5% − 4%)(1.05)20
= £17, 418.87
 Financial Modelling 4/5

Time Value of Money

4. An investment promises to pay me annual income for a period of 20 years.

The first payment, due in a year from now, will be £1000 and payments
will increase by 4% per annum. How much should I expect to have to
invest today if the interest rate is b) 3% per annum?

 The growing perpetuity formula doesn’t work!

 There are formulae for growing annuities but in general, easiest to do

the calculation the long way (Excel makes this very simple)

 first few PVs are £970.87, £980.30, £989.82, £999.43

 notice they are growing (as the growth rate > the discount rate)

 Total PV £21,317.18
 Financial Modelling 5/5

Supplementary Question

 Preparation for the next Session:

 Consider a loan with an interest rate of 10

 The balance at the start of year 1 (i.e. at t=0) is £5,000

 first few PVs are £970.87, £980.30, £989.82, £999.43

 At the end of the first year (at t=1), interest is charged on the
starting balance for the year (in this case 10% of £5,000) and I make
a payment of £1,201.80

 Required

 Set out a table showing the starting balance each year, the interest
charged and the closing balance after taking into account the payment

 How many years will it take to clear the loan?