UNIVERSIDAD DEL PACÍFICO

Foundations of Finance
Academic Term: 2019 - I
Instructors: Alexei Alvarez JPs: Carlos Calderón / Juan Raunelli
Juan Manuel de los Ríos José Carlos Cortés / Rodrigo Reyna
Fernando Bresciani Percy Vega / María Alejandra Chumbe
Carlos Arias Renzo Morales / Ariel Pajuelo
Jeferson Carbajal Eduardo Córdova / Gonzalo Vidalón

Question Bank – Topic 2 – Time Value of Money

Future and Present Value

1. Given a 10% interest rate, calculate the present value of the following cash flows

0 t+ 1 t+ 2 t+ 3
-100 50 100 200

2. Given a 12% interest rate, calculate the present value of the following cash flows

0 t+ 1 t+ 2 t+3 t+4 t+5

-500 0 200 0 0 2,000

3. Given an 8% interest rate, which of the following sequence of cash flows has the highest present value?

Year 1 Year 2 Year 3 Year 4

A 110 20 10 5
B 20 -5 20 110
C -100 -100 -100 500

4. Bryan invests $5,000 in a mutual fund offering a 12% annual return. In how many years will Bryan duplicate
his investment?

5. The amount an investor will have in 15 years if $1,000 is invested today at an annual interest rate of 9% will
be closest to:
a) $1,350
b) $3,518
c) $3,642

6. Fifty years ago, an investor bought a share of stock for $10. The stock has paid no dividends during this
period, yet it has returned 20%, compounded annually, over the past 50 years. If this true, the share price is
now closest to:
a) $4,550
b) $45,502
c) $91,004
 7. How much must be invested today, at 8% interest, to accumulate enough to retire a $10,000 debt due seven
years from today? The amount that must be invested today is closest to:
a) $5,835
b) $6,123
c) $8,794

8. An analyst estimates that XYZ’s earnings will grow from $3 to $4.5 per share over the next eight years. The
rate of growth in XYZ’s earnings is closest to:
a) 4.9%
b) 5.2%
c) 6.7%

9. An investment will generate cash flows of US$ 500, US$ 200 and US$ 800 at the end of the next three years.
Find the present value if the discount rate is 5.75%.

10. Answer the following:

a. An investor offers to buy two promissory notes of $200,000 (one in the fourth year and the other one
in the fifth year). If the other best option yields 12% of EAR from the first to the fourth year and 15%
of EAR from the fifth year onwards. What is the price that the investor should offer?

b. How many months should a $ 5,000 accumulation policy, that pays 5% annual cash, be left so that
it becomes $ 14,000?

c. Mr. Vidal plans to buy a television to comfortably watch the World Cup matches. The appliance store
has offered to pay for the TV in three monthly payments of S/ 210, but they inform him that if he pays
it in cash (one payment), it is delivered for S / 500. What is the EAR for the use of credit? On the
other hand, Mr. Vidal, thanks to his network, can obtain a loan from the bank with an effective annual
rate (EAR) of 30%. What is the best decision for Mr. Vidal?

Interest Rates and Capitalization

11. What is the effective annual rate for a credit card that charges 18% compounded monthly?
a) 15.38%
b) 18.81%
c) 19.56%

12. Calculate the EAR for a:

a) 5% interest rate compounded quarterly
b) 3.5% interest rate compounded semiannually
c) 10% interest rate compounded daily

13. Calculate the following:

a) The interest rate compounded monthly that is equivalent to an 8% interest rate compounded semiannually
b) The interest rate compounded quarterly that is equivalent to EAR of 12%
c) The interest rate compounded weekly that is equivalent to a 5% interest rate compounded monthly
14. John is planning to retire in 20 years. For that reason, he wants to make the following deposits throughout
time:
Year 0 $50,000
Year 5 $15,000
Year 10 $12,000
Year 15 $25,000
However, these contributions will return the market interest rates. John knows the current interest rates:

From To Interest rate

Year 0 Year 5 7% (EAR)
Year 0 Year 10 8% (EAR)
Year 0 Year 15 8.5% (Annual rate, compounded monthly)
Year 0 Year 20 9% (Annual rate, compounded quarterly)
John wants to know how much will he have accumulated to the time of his retirement. Please help him with
this issue.

15. Calculate the following:

d) The interest rate compounded weekly that is equivalent to an 8% interest rate compounded quarterly
e) The interest rate compounded monthly that is equivalent to EAR of 10%
f) The interest rate compounded semiannually that is equivalent to a 6% interest rate compounded monthly
g) The EAR that is equivalent to a 12% interest rate compounded quarterly

16. Which of the following options gives the highest EAR?

a) An 8% annual rate compounded daily
b) A 7.95% annual rate compounded monthly
c) A 8.05% annual rate compounded quarterly

17. Make the following conversion of rates:

From To
Annual interest rate compounded semiannually of 5% EAR
Semiannual interest rate compounded annually of EAR
10%
Quarterly interest rate compounded annually of 4% Annual interest rate compounded semiannually
EAR 8% Annual interest rate compounded bimonthly
Semiannual effective rate of 5% EAR
Quarterly effective rate of 4.5% Annual interest rate compounded semiannually
Annual interest rate compounded biweekly of 12% Daily effective rate

18. Kelly is thinking about making an investment. With that purpose in mind, she studied the behavior of interest
rates offered by ABC Bank:
From To Interest Rate
Year 0 Year 1 5% (Annual interest rate compounded semiannually)
Year 0 Year 2 8% (EAR)
Year 0 Year 3 4.5% (Semiannual interest rate compounded bimonthly)
 Kelly wants to make a one-year investment, although she wants to agree on the investment in year 0, she
does not want to make the initial payment in year 0. Liliana, who knows a lot about finance topics, tells Kelly
that it is possible to find the effective annual rates from year 1 to year 2 and from year 2 to year 3 given that:
“Investing a sol from year 0 to year t must be exactly the same as investing the same sol from year 0 to year
t-k (k> 0) and reinvest the entire amount obtained from year t-k to year t”.
With this information it is requested to calculate the Effective Annual Rates (EAR) from year 1 to year 2 and
from year 2 to year 3 (both agreed in year 0).

19. The following financial instruments are available which consist of paying an initial value to receive a final
value:

From To
Year 0 -100 Year 10 150
Year 0 -100 Year 30 400
Year 0 -200 Year 40 1500
Year 0 -300 Year 50 4000

Juan is making a 50-year investment plan. He decides to plan and close all the deals today, so he plans to
invest the following cash flows in the following periods:

Year 0 S/. 2000

Year 10 S/. 500
Year 30 S/. 500
Year 40 S/. 500

Juan wants to know the value of his total investment after the 50 years. Remember that if we agree on t = 0:
(i) “Investing a sol from year 0 to year t must be exactly the same as investing that same sol from year 0 to
year t-k (k> 0) and reinvest the entire amount obtained from year t-k to year t”.

20. Juan is making a 50-year investment plan. He decides to plan and close all the deals today, so he plans to
invest the following cash flows in the following periods:

Año 0 S/. 2000

Año 10 S/. 500
Año 30 S/. 500
Año 40 S/. 500

These amounts will be monetized at the corresponding market rates. Juan knows today's market rates:

From To Rate
Year 0 Year 10 7% (EAR)
Year 0 Year 30 8% (EAR)
Year 0 Year 40 1% (Bimonthly interest rate compounded semiannually)
Year 0 Year 50 5% (250 days effective rate)*
* Consider that a year consists in 360 days.
 Juan wants to know the value of his total investment after the 50 years and you will have to calculate it.
Remember that if we agree on t = 0: (i) “Investing a sol from year 0 to year t must be exactly the same as
investing that same sol from year 0 to year t-k (k> 0) and reinvest the entire amount obtained from year t-k to
year t”.

21. Given daily compounding, the growth of $5,000 invested for one year at 12% interest will be closest to:
a) $5,600
b) $5,628
c) $5,637

22. In his 25 birthday, Alvaro had US$ 2000 and decided to deposit his money on an AFP. As he was young, he
preferred to put his money in fund #3, which gave a bimonthly interest rate compounded annually of 4.25%.
Twenty years after, he decided to change to fund #2, because it wasn’t as risky as the other. This fund gave
a semiannual interest rate compounded quarterly of 6.34%. He mentions that we will withdraw his money
when it reaches US$ 500 000. ¿How old will Alvaro be in that moment?

Annuity and Perpetuity

23. An investor has just won the lottery and will receive $50,000 per year at the end of each year for the next 20
years. At a 10% interest rate, the present value of the winnings is closest to:
a) $425,678
b) $637,241
c) $2,863,750

24. If $10,000 is invested today in an account that earns interest at a rate of 9.5%, what is the value of the equal
withdrawals that can be taken out of the account at the end of each of the next five years if the investor plans
to deplete the account at the end of the time period?
a) $2,453
b) $2,604
c) $2,750

25. An investor will receive an annuity of $4,000 a year for ten years. The first payment is to be received five years
from today. At a 9% discount rate, this annuity’s worth today is closest to:
a) $16,684
b) $18,186
c) $25,671

26. Assuming a 10% interest rate, calculate the Present Value of the following:
a) An ordinary annuity of $3,000 for 10 years
b) An annuity due of $2,500 for 8 years
c) A perpetuity of $5,000
d) An ordinary annuity of $300 with a constant growth rate of 5% for 7 years

27. The Parks plan to take three cruises, one each year. They will take their first cruise 9 years from today, the
second cruise one year after that, and the third cruise 11 years from today. The type of cruise they will take
currently costs $5,000, but they expect inflation will increase this cost by 3.5% per year on average. They will
contribute to an account to save for these cruises that will earn 8% per year. What equal contributions must
they make today and every year until their first cruise (ten contributions) in order to have saved enough at that
time for all three cruises? They pay for cruises when taken.
28. An investment (a bond) will pay $1,500 at the end of each year for 25 years and on the date of the last payment
will also make a separate payment of $40,000. If your required rate of return on this investment is 4%, how
much would you be willing to pay for the bond today?

29. A client has $202,971.39 in an account that earns 8% per year, compounded monthly. The client's 35th
birthday was yesterday and she will retire when the account value is $1 million.
i) At what age can she retire if she puts no more money in the account?
ii) At what age can she retire if she puts $250 per month into the account every month, beginning one
month from today?

30. Richard has just inherited $10,000,000 from his grandfather, so he is analyzing some investment
opportunities.

A) An insurance company approached him; the sales man told him: ‘You can give us your money, and we
guarantee a 10% annual return for the first 10 years, a 5% return for the next 10 years, and a 3% return
for the last 10 years. Besides, we can provide you with $1,000,000 annually so you can make some minor
payments’
B) A mutual fund promised him a 5% annual return for the time he desired.
C) A hedge fund said they could guarantee an 8% annual return for the first 20 years; afterwards, they could
only give a 5% annual return for the horizon of his investment.

Richard is 25 years old and the horizon of his investment is 40 years. All the withdrawals will be invested in a
bank deposit, which guarantees a 0.5% annual return, no matter the horizon of the investment. Please help
Richard make up his mind.

31. Assuming a 15% interest rate, calculate the present value of the following:
a) An ordinary annuity of $4,000 for 8 years
b) An annuity due of $3,500 for 5 years
c) A perpetuity of $5,000
d) A perpetuity of $8,000 with a constant growth rate of 5%
e) An ordinary annuity of $4500 with a constant growth rate of 6% for 5 years

32. Assuming a 12% interest rate, calculate the future value of the following:
a) An ordinary annuity of $4,000 for 8 years
b) An annuity due of $3,500 for 5 years with a constant growth rate of 5%
c) An ordinary annuity of $4500 with a constant growth rate of 6% for 5 years

33. Steve is planning to take a Master’s Degree in 10 years. For this purpose, he will save 40% of his salary,
which is currently $5,000. However, his salary will increase at the inflation rate (1.5% annually), but the
percentage he saves will remain the same. Steve also knows that the tuition fee for his studies is $180,000,
and this payment will be made in 3 equal parts. The first one is made six months before the program starts;
the second one the first day of classes; and the third six months later. Steve also knows that he will make a
unique spent for the housing, which will be around $10,000, and will be paid on the first day of classes. Finally,
one friend told him that the average monthly expense regarding food and other minor expenses is around
$1,200. Considering the mastership program Steve is willing to take lasts 12 months, and the relevant interest
rate is 10% compounded quarterly, please help Steve to find out how much would he need to borrow in order
to fulfill his payments (He will not work while he is studying).

34. Sam is 30 years old. He has just made a deposit of $10 million. He is planning to retire when he accumulates
$20 million. Consider a 5% annual rate with quarterly compounding,
 a) At what age will he retire if he does not make any additional contributions?
b) If Sam decides to also make annual deposits of $300,000, at what age will he retire?
c) If Sam decides to also make monthly contributions of $1,500, at what age will he retire?

35. Which of the following options has the highest present value, considering a 10% discount rate:
a) An annuity due of $2,000 for 5 years
b) An ordinary annuity of $3,000 for 3 years
c) An ordinary annuity of $2,350 for 4 years with a constant growth rate of 8%

36. Joe is 25 years old. He has just made a deposit of $5 million. He is planning to retire when he accumulates
$8 million. Considering a 5% annual rate with monthly compounding, at what age will he retire?
a) 33
b) 34
c) 36

37. Following the previous question, If Joe decides to also make annual deposits of $500,000, at what age will he
retire?
a) 26
b) 28
c) 30

38. Roger’s dad has just passed away and his sons are deciding where to invest their inheritance. They were
provided with the following alternatives:
A. Requires a deposit of $50 million now, and a contribution of $5 million every 5 years up to the 20th year.
B. Requires a deposit of $60 million now, and a unique contribution of $10 million in the 10th year.
C. Requires an investment of $70 million now.

Also, Roger’s siblings know the current interest rates are as follows:

From To Interest rate

Year 0 Year 5 5% (Annual rate, compounded monthly)
Year 0 Year 10 5.8% (EAR)
Year 0 Year 15 6% (Annual rate, compounded weekly)
Year 0 Year 20 6.5% (Annual rate, compounded quarterly)
Year 0 Year 25 6.8% (EAR)
Year 0 Year 30 7.25% (EAR)

Assuming an investment horizon of 30 years and that no withdrawals are allowed once the money is invested,
please help Roger decide the most adequate alternative.

39. Sam is thinking of travelling around Europe the following year. The duration of his journey would be 12 months.
For this purpose, he is willing to invest in a mutual fund $10,000. Besides, he plans to make a weekly deposit
of $50. He has been required to make a unique payment of $10,000 for the plane tickets, which will be done
the day his adventure starts. He has also been informed that the monthly cost of living is around $200. Please
help Sam to find the maximum amount he could pay for souvenirs, assuming this payment is done at the end
of his journey. The relevant interest rate is 8% annual compounded quarterly.
40. It is proposed to replace a machine within 4 months, the price of which is estimated to be S/. 5,000 on that
date. What constant end-of-month amount should be deposited during that period in a bank that pays a 5%
effective monthly rate (EMR) to buy the machine?

41. Find the present value of the following alternatives:

a) An ordinary annuity of S /. 3000 for 10 years.
b) An annuity due of S /. 2500 for 8 years.
c) An ordinary annuity of S /. 500 to infinity.
d) An annuity due of S /. 300 with a constant growth rate of 5% to infinity.
e) An ordinary annuity of S /. 2000 every two years for 10 years. (The first payment is from year 2)

If you have a present value of 10000, what would be the value of a perpetuity that is equivalent if:
a) Constant perpetuity.
b) Perpetuity grows 5%.

The opportunity cost of capital is 15% per year.

42. Jose Luis decided to save 10% of his salary in a BBWA bank account. He deposits this money at the end of
each month during the last 4 years. If you know that in the first 3 years his monthly salary was S/. 4,500.00
and then he began earning a salary of S / .7,550.00. How much does José Luis have today, a moment after
making his deposit number 48? BBWA bank gives him an 8% annual rate compounded daily.

43. An investor decided to create a fund for the students of his alma mater. His plan is for the fund to be able to
make $ 25,000 a year in perpetuity. The first scholarship should be given 4 years from today. The funds will
be deposited into an account immediately and they will grow at a nominal annual rate of 4% compounded
semi-annually for the first 2 years; and at a nominal annual rate of 3.5% compounded quarterly over the next
2 years. Finally, from year 4 the accumulated fund will be deposited in a term deposit and will yield 5%. How
much money will you have to donate today to create such fund?

44. Lucía is happy because she has won a prize from “La Brinka”, which pays S/ 50,000 annually for 20 years.
Lucía will receive her first payment within a year. “La Brinka” calls the prize as “The Million soles Lottery” just
because 1,000,000=50,000*20.
a. Is it correct to call it “The Million soles Lottery”? Discuss
b. If the EAR is 8%, what is the present value of the lottery?

45. Raul Ruidiaz would like to set up a foundation that will pay a scholarship to one deserving student every year.
The first such scholarship will pay USD 10,500 (in nominal terms) and is to be awarded in seven years from
now. A scholarship will be awarded in perpetuity every year after that (even after Ruidiaz’s death), but will be
indexed at 5% a year to account for inflation. How much money should Raul put in the foundation’s account,
if that account earns 15% a year?

46. Patricio is a former banker that wants to save money to move to his favorite city: San Diego. Given his good
reputation, he is currently working as a consultant for various banks at the Latin America and the Caribbean
region, and he is making US$ 35,000 a month, including a bonus of US$ 50,000 at the end of each year.
Additionally, his monthly expenses including rent, food and leisure time total US$ 8,000. He is going to save
in a deposits account that has an EAR of 4%. Today is December 31st of 2018. He is planning to buy the
house by taking a mortgage at an effective monthly interest rate of 1%, in March 31st of 2022 (payments are
 monthly, the first payment is made at the end of April and the last saving would be made in March 31st). The
mortgage lasts after 10 years. What is the maximum value of the property that he can afford if the house is
80% financed by debt? Use the discount rate of the 4% EAR deposits account for all the periods.

47. At retirement nine years from now, a client will have the option of receiving a lump sum of £400,000 or 20
annual payments of £40,000, with the first payment made at retirement. What is the annual rate the client
would need to earn on a retirement investment to be indifferent between the two choices?

48. Your friend Miguelon is trying to decide the best deposit account to save his money. He knows that
in the following 3 years (at the end of the year) he will receive USD 3,800 annually, and his investment
plan is the following:
a. First year wage: He is going to deposit the money at Skotia, at a semiannual nominal rate
compounded quarterly of 8%.
b. Second year wage: He is going to deposit the money at VCB at a three-year EAR of 10%.
c. Third year wage: He is going to deposit the money at VVBA at an annual nominal rate compounded
semiannual of 5%.
We know that he realized the following bank movements in his accounts

Bank Operation Amount Period

Skotia Withdrawal 2000 Year 3
VCP Withdrawal 1560 Semester 7
VVBA Deposit 3100 Year 1

How much will he save in total at year 6?