Universidad Privada Boliviana

Facultad de Ciencias Empresariales y Derecho

FINANZAS I

Práctica 1
(Exercises LSE)

1. An investment advisor tells you that a particular opportunity will generate (certain) cashflows
of $5,000 at the end of each of the next four years. If the annual rate of interest is 7%, what is
the maximum amount that you should be prepared to pay in order to invest in this opportunity?
Should you invest if the advisor wants to charge you $17,000 to participate.

2. Which of the following cashflows would you prefer (assuming that all are certain and you can
only choose one of them)?
A: $26,000 now
B: $30,000 to be received in 2 years
C: $39,000 to be received in 5 years
Assume that the annual interest rate is 8%.

3. An oil pipeline will cost £19,000,000 to install. If installation starts today, it will be complete in
two years and half of the cost must be paid at the end of each year of the installation process.
Once installed, it will allow the oil company installing it to save $3,000,000 per year at the end of
each of the first five years of operation, $2,000,000 per year in the next five years of operation
and zero thereafter. The annual interest rate is 5%. Should the company invest in the pipeline?
Justify your answer.

4. Give a TRUE/FALSE answer for each of the following statements and in each case justify your
answer.
(a) If a standard bank account pays interest at annual rate of 5%, then a deposit of $100 today
will grow to be worth $110 in two years.
(b) One should always choose to receive $110 in one year rather than $100 today.
(c) If the annual interest rate is 6%, paying £53 in one year is preferable to paying £50 today.

6. An investment advisor offers you a product that will deliver cashflows at the end of each of
the next seven years. The first cashflow is £5,000. If the annual interest rate is 2%, what is the
present value of this opportunity?

7. At the end of each of the next eight years, you plan to put £25,000 of your annual salary in the
bank. If the annual interest rate is 3%, what is the present value of this planned savings stream?
What will the balance in your bank account be at the end of the eight year period?
[HINT: once you know the present value of the savings stream, it’s easy to work out the future
value.]

8. You need to borrow £800,000 to buy a house. You borrow the money from a bank via a
mortgage with a 25-year term. The mortgage requires you to make monthly repayments, with
Universidad Privada Boliviana
Facultad de Ciencias Empresariales y Derecho
FINANZAS I

the first payment one month from now. If the monthly interest rate is 0.5%, work out the fair
monthly repayment that you will have to make.

9. Give a TRUE/FALSE answer for each of the following statements

and in each case justify your answer.
(a) A perpetuity paying $2,000 per year is currently valued at $80,000. This implies that the one
year interest rate is 4%.
(b) A perpetuity pays its initial cashflow of C today and then pays a cashflow of C at the end of
every year from now onwards. If the annual interest rate is r, the present value of this perpetuity
is C/r.
(c) The annual interest rate is 5%. A perpetuity with growth has an initial cashflow of £400, to be
paid in one year. Its present value is £10,000. This must mean that the growth rate of the
cashflows is 1%.

11. The quarterly compounded interest rate is 8%. What is the present value of $1,000 to be
received in nine months? What is the future value of $5,000 if it is deposited in a bank account
today and remains there for 15 months?

12. An investment product promises semi-annual cashflows of $3,500 for the next five years. If
the stated interest rate with monthly compounding is equal to 10%, what is the present value of
the cashflows that the investment promises?

13. You take out a loan today to pay for refurbishments to your house. The loan requires you to
make monthly repayments over the next 10 years. The cost of the refurbishments is £20,000. If
the effective annual interest rate is 8%, what will your monthly loan repayment be?

14. Give a TRUE/FALSE answer for each of the following statements and in each case justify your
answer.
(a) Assuming that interest rates are positive, the effective annual interest rate will always be
larger than the quoted six-month APR.
(b) You should always use effective rates to perform compounding and discounting operations,
and never use APRs.
(c) The real rate of interest is exactly equal to the difference between the nominal interest rate
and the inflation rate.

APR = Annual Percentage Rate