Chapter 4 (PART 2)

1.You are saving for retirement. To live comfortably, you decide to save RM3.5 million by
the time you reach 65 years old. Today is your birthday aged 25 and you decide to start
today and continue on every birthday up to 65th birthday, that you will put the same amount
into a savings account. If the interest rate is 6%,

a. How much must you set aside each year to make sure that you will have RM3.5
million in the account on your 65th birthday?

FV = 3.5 million
N = (65 – 25) + 1 = 41
I/Y = 6
PMT = ?

PMT = RM 21,206

b. You realise that the plan has a problem. Due to the fact, your income will increase
over a lifetime, it would be more realistic to save less now and more later. Instead of
putting the same amount aside each year, you decide to let the amount that you set
aside grow by 3% per year. Under this plan, how much will put into the first
payment, so that subsequent payment will grow by 3%.

2. You have received a windfall from an investment you made in a friend's business. He
will be paying RM10,000 every year until the 5th year, RM22,000 from the 6th year to the
10th year, and RM26,000 from 11th year to 15th year. What is the future value of the
windfall in the 15th year? Assuming the prevailing rate is at 6%.

Mixed cash flow:

CFj =

0 = RM 0
1st – 5th year: RM 10,000 (5 years)
6th year – 10th year: RM 22,000 (5 years)
11th year – 15th year: RM 26,000 (5 years)

I/Y = 6

NPV = ?

NPV = RM 172,529.76

FV = RM 413,477.61
3. You are thinking of investing in a new plant. The plant will generate revenues of
RM2.5million per year for as long as you maintain it. You expect that the maintenance cost
will start at RM50,000 per year and will increase 6% per year thereafter. Assume that all
revenue and maintenance costs occur at the end of the year. You intend to run the plant as
long as it continues to make a positive cash flow. The plant can be built and becomes
operational immediately. If the plant cost RM12 million to build and interest is 8% per year,
should you invest in the plant?

1)

PMT
Perpetuity (PV )=
i

2.5 million
Revenue ( PV )= =RM 31,250,000
0.08

2)

C
Perpetuity( PV )=
(r −g)

50,000
Maintenance costs ( PV )= =RM 2,500,000
(0.08−0.06)

3)

Profit = 31,250,000 – 2,500,000 = RM 28,750,000

VS

Cost = RM 12 million

Hence,

Net Present Value = 28,750,000 - 12 million = RM 16,750,000

Conclusion: Yes, we should invest in the plant because it will be profitable.

4.You have an outstanding loan payment. The bank gives the option for you to make the
payment. Either you pay the 1st, 2nd,and 3rd year, RM4,000, RM5,000,and RM6,000,
respectively to settle the payment or you pay RM6,000 in the first, skip the 2 nd year and you
pay the 3rd year.

If you are indifferent between those 2 types of payment, how much for the 2 nd option the 3rd
year, you need to pay, assuming the current interest rate is at 6%.

Option 1:

CRj:
0 =0
st
1 year = RM 4,000
2nd year = RM 5,000
3rd year = RM 6,000

I/Y = 6%

NPV = RM 13,261.28

N=3

FV = RM 15,794.40

Option 2:

1st year = RM 6,000

2nd year = Skip
3rd year =

6,000(1 + 0.06)^2 + x = 15,794.40

X = RM 9,052.80
5.Your grandmother bought an annuity from JD Enterprise Insurance for RM300,000 when
she retired. In exchange for the RM300,000, JD Enterprise will pay her RM35,000 per year
until she dies. The interest rate is 8%. How long must she live after the day she retired to
come out ahead (worthwhile)

PMT = 35,000
I/Y = 8
FV = 300,000

N = 15.04 ~ 16 YEARS