ECN Note - Goody

Table of Contents
Day of Class Test (Jan 31, 2024)
Compound Interest
Simple Interest
Compound Interest
Changes in Interest Rate
Frequency Of Compounding Interest
SNAP TEST
Q1. What compound interest rate would be required to obtain N350,000 after 10
years with an initial principal of N250,000?
Q2: How long would it take a sum of money to triple itself at 12% compound
interest?
Q3: How much would N600,000 amount in 4 years If interest rate is 16% p.a.
compounded quarterly.
Q4. Calculate the sum of money that will need to be invested now at 9%
compounded interest to yield N320,000 at the end of 8 years.
No Light(Feb 02, 2024)
Discounting
Capital Expenditure Appraisal
Net Present Value(NPV)
Internal Rate of return(IRR)
Annuity
Annuity in Perpetuity(continuous)
Sinking Funds

Day of Class Test (Jan 31, 2024)

Compound Interest
Compound interest addresses the issue of how interest is calculated on an original capital
that is inverted. As the
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Simple Interest
NO, THANKS
In simple interest setting, GET THE
interest is only APP
calculated on the original capital that is invested.
Hence, total interest over the period of investment will be P.R.N ie. Principal x Rate x Number
of Years.

Terminal value available to an investor will be

Example
Example
How much will an investor have after 6 years if he invests N20,000 at 12% simple interest per
annum.

Compound Interest
Compound interest is applicable where interest is calculated on original principal invested
plus accumulated interest to date. It is usually calculated as

Where is the terminal value available to an investor after n years.

Example
What will be the terminal value of N10,000 if invested at 10% compound interest for 3 years

Changes in Interest Rate

It is possible for interest payable on a principal sum invested to change over the period of
investment. In this case, the basic compounding formula will be:

Where:
= Interest rate applicable for x years
= interest applicable for the next period of y years
= Interest applicable for balanced period

Example
An item of cost, N32000 now, If the rate of inflation is predicted as 10% for the first 2 years, 12%
for the 3rd year, 15% for the 4th and 5th years, and 20% for the 6th year. How much will the
equipment be worth after 6 years from now?

Frequency Of Compounding Interest

The effective annual interest rate on an investment, where interest is credited at shorter
interval of time than a year can be calculated as

A Quarter
Example
What is the effective final interest rate of an investment that pays an interest of 4% every
quarter?

SNAP TEST
 SNAP TEST

Q1. What compound interest rate would be required to obtain N350,000 after 10 years
with an initial principal of N250,000?
Solution

Q2: How long would it take a sum of money to triple itself at 12% compound interest?
Solution

Q3: How much would N600,000 amount in 4 years If interest rate is 16% p.a.
compounded quarterly.
Solution

Q4. Calculate the sum of money that will need to be invested now at 9% compounded
interest to yield N320,000 at the end of 8 years.
Solution
No Light(
Light(Feb 02, 2024)
Adding to the sum invested
An investor may decide to keep adding a given constant sum to the original sum invested
from year to year. Whether this is applicable, there terminal value available to the investor
can be calculated using

where a is additional sum invested from year to year

r- rate of interest
n - investment period

Example
What is the terminal value of 5k invested for 3 years at 12% compound interest, if additional
N20,000 is invested from year to year.
Solution
Principal - 5k, rate - 12%, n - 3, interest - 2k

Discounting
This is the reverse of compounding, while compounding is futuristic, that addresses the
terminal value that the Principal sum will be given, on the other hand discounting addresses
the present on what the future value is in the present.

Example
What is the present value of 120k to be received after 6 years at an interest rate of 15%.
Solution

Capital Expenditure Appraisal

The knowledge of discounting can be applied in the decision on whether to accept or reject
the capital expenditure or investment proposal. This can be done by calculaTING either net
present value of the project(NPV) or internal rate of return of the project(IRR).

Net Present Value(

Value(NPV)
A project will be considered profitable if NPV > 0. If NPV < 0, . if NPV == 0, Breakeven
NPV is calculated using discounting method
Where:
C = Original capital invested in the project
, = Net cash in flow in respective years

Internal Rate of return(

return(IRR)
The internal rate of return is the intrinsic return which a particular project or investment is
able to yield on the capital invested in order to decide whether to accept or reject a project.
The project is acceptable as long as IRR is greater or equal to cost of capital. If IRR is less
than cost of capital, then the project is not profitable.

Where:
= interest rate yielding +ve NPV, P2
= interest rate yielding -ve NPV, P2

Generally, when the rate of interest is decreasing, the discounting factor will be increasing,
so also the NPV, and vice versa.
Example
A company is considering a project that will yield the following cash flow
Y1 - 10k, Y2 - 16K, Y3 - 22k, Y4 - 22.5K. The company requires a 20% return on investment and
the cost of the project is 50k.
1. Calculate NPV. Thereby advice on the worthiness of that project
2. Calculate the IRR and interpret it to how it affects the investment or the investor.
Solution

1.
(Loss)

2.

Example
If a financial group can make an investment of N200 mill now and receive N400 mill in 5
years time. Estimate the internal rate of return for that financial group.
Solution

Annuity
This is an annual payment usually made to an individual. It is usually provided for individual
to withdraw a given constant sum of money each year for a given number of years by
which that time, the original capital invested plus interest accrued will be exactly exhausted
which that time, the original capital invested plus interest accrued will be exactly exhausted

Where:
= present value of annuity amount
R = rate of interest(%)
a = annuity amount
n = number of years of which annuity is to be received

Example
What is the present value of an annuity of N15,000 per annum for 15 years if the interest rate
applicable is 12%.
Solution

Annuity in Perpetuity(continuous)
If the present value of an annuity is to be received perpetually. Then,

Example
If xy is considering a project which will cost N100,000 now and yield N18000 per annum for
every year in perpetuity, given the interest rate of 15%. Calculate if this project is viable, given
that NPV = N20,000.
Solution

Sinking Funds
A sinking fund[a] is an investment into which equal annual installments are paid, in order to
earn sufficient interest, so that by the end of a given number of years, the investment is
large enough to pay off a loan committed at that time.

Example
xyz is considering an investment which the terminal value of the sinking fund will be 160,000
for 6 years at 8%

a. What will be the annual payment into the fund?

b. What is the total payment for 6 years?
c. Is there any difference between the terminal value and total payment for the 6
years(Give reason for your answer).
Solution

a.
 b.
c.

Valentines(Feb 14th, 2024) – Under Review

Risk Analysis
By Oluseye Samuel Ajuwon

Risk & Uncertainty

Both concepts deal with the probability of loss or the chance of adverse outcomes.
Risk
Risk: The possible outcomes and their probabilities are known.
Uncertainty
Uncertainty: The possible outcomes are not known. It is therefore a state of limited
knowledge where

The higher The variance, the higher the risk,

Utility Theory and Rut Analyses"

Data is very important

Risk neutral: 1
Risk averse: decreasing
Risk loving: increasing
pg 24.

Project A is our desired value, we have ignored expected value.

pg 29.

Game theory, also known as Devil's alternative (Advisable to Take action and minimize the
people that will die)

You either maximize gain or minimize loss.

Minimize maximum possible outcome
pg 85

[a]very similar to annuity