Lahore School of Economics

Financial Management I
Chapter 5
Time Value of Money - 3
Assignment 4

Examples

1. What’s the present value of a perpetuity that pays $1,000 per year beginning one year from now if the
appropriate interest rate is 5%? What would the value be if payments on the annuity began immediately?

2. What is the rate of return present in an investment costing $5,000 today and paying $50 annually forever?

3. Find the effective rate for the following situations:

a) 10% nominal rate, semiannual compounding
b) 6% APR, quarterly compounding
c) 5% nominal rate, daily compounding

4. Find the amount to which $500 will grow under each of these conditions:
a) 12% compounded annually for 5 years
b) 13% compounded semiannually for 5 years
c) 14% compounded quarterly for 5 years
d) 15% compounded monthly for 5 years
e) 16% compounded daily for 5 years

5. Find the present value of $500 due in the future under each of these conditions:
a) 12% nominal rate, semiannual compounding, discounted back 5 years
b) 11% nominal rate, quarterly compounding, discounted back 5 years
c) 10% nominal rate, monthly compounding, discounted back 1 year

6. As a jewelry store manager, you want to offer credit, with interest on outstanding balances paid monthly. To
carry receivables, you must borrow funds from your bank at a nominal 6%, monthly compounding. To offset your
overhead, you want to charge your customers an EAR (or EFF%) that is 2% more than the bank is charging you.
What APR rate should you charge your customers?

Problems for Assignment

1. What is the PV of a British consol bond paying $250 in interest every year in perpetuity? Assume interest rate
of 2.5%. What will the value be if payments on the annuity begin immediately?

2. If you deposit $10,000 in a bank that pays 8% compounded quarterly, how much will be in your account after 6
years?

3. What is the present value of a security that will pay $5,000 in 10 years if securities of equal risk pay 6%
monthly?

4. Bank A pays 4% interest compounded annually on deposits, while Bank B pays 3.5% compounded daily. Based
on the EAR (or EFF%), which bank should you use?
5. Credit card issuers must by law print their annual percentage rate on their monthly statements. A common APR
is 18%, with interest paid monthly. What is the EFF% on such a loan?