TVM-Exercises

MGFB Principles of Finance

Jincheng Tong
University of Toronto

January 22, 2024

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what we have learnt so far
1. $1 today is different from $1 tomorrow: interest rate is the price of money!
2. FV PV relation: FV = PV × (1 + r )T
- it holds for a single cash flow

- it holds for multiple cash flows

 m
APR
3. APR (quoted interest rate) to EAR, EMR, EQR: EAR = 1 + m ,
  k1
EkR = 1 + EAR − 1, k ∈ {M, Q, SA}
C
4. perpetuity: constant stream of cash flow forever PVperp = r
C
- growing perpetuity PV = r −g , r >g
 
C 1
5. annuity: constant cash flow until time T: PVann = r 1− (1+r )T
  T 
- growing perpetuity: C
r −g 1 − 11+
+r
g

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for today’s lecture

1. a mortgage problem

2. move cash flows backward/forward in time

3. indirect use of Annuity/Perpetuity formulas

4. ”saving for retirement problem”

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example

a mortgage problem

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example
Nancy has just bought a house in Scarborough. To finance the purchase, she took a
mortgage loan of $800,000 at 1 % interest rate compounded semiannually. The term
period for the mortgage loan is 10 years.

a. Determine how much she has to pay every week to pay off the loan in 10 years?
What if the quoted APR rises to 6%?

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example
Nancy has just bought a house in Scarborough. To finance the purchase, she took a
mortgage loan of $800,000 at 1 % interest rate compounded semiannually. The term
period for the mortgage loan is 10 years.

b. How much will she owe to the bank after making payments for 4 years?

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example
Nancy has just bought a house in Scarborough. To finance the purchase, she took a
mortgage loan of $800,000 at 1 % interest rate compounded semiannually. The term
period for the mortgage loan is 10 years.

c. In part a) if she increases the weekly payment by $300 a week, how long will it
take her to pay off the loan?

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example
How much would you pay for a perpetuity which pays $500 (the first payment
coming three years from today) every three years grows by 2% each payment? What
is the year-10 value (i.e., future value) of this stream of cash flow? The discount rate
is 5% per year.

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example

more on perpetuity and annuity

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example
Consider a perpetuity that pays you $200 when the year number is odd and $400
when the year number is even (including year 0), starting at year 0 and lasting
forever. Assuming annual interest rate of 10%, what is the year-0 value (i.e. present
value) of this perpetuity? What is the year-15 value (i.e. future value) of this
”perpetuity”?

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example cont.

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example
On December 2019, Amazon corp. is launching a new cloud server to meet the
increasing demand for cloud computing. Starting from next January, this new server
will generate $1M revenue per month forever, except on Februaries. Every February,
the server needs to be shut down (no revenue) and serviced. The maintenance cost
is $ 2M each time. The discount rate is 1% per month. How much value does this
new server add to Amazon corp.?

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example cont.

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example cont.

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example

a saving-for-retirement problem

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example
Scott wants to save money to meet two objectives

a) First, he would like to be able to retire 30 years from now with a retirement
income of $70,000 per year for 20 years, with the first payment coming 31 years from
today and the last one 50 years from today.

b) Second, he would like to pay for his childs college education. He assumes that the
first payment for the education will be 10 years from today and cost $20,000 per year
for four years (i.e. four payments in total)

He also just won the lottery which will pay him $10,000 per year for 20 years (the
first annual payment will come one year from today). He will use these proceeds to
help meet his goals outlined in above.

If he can earn 5 % per year on his investments, how much will he have to save each
year, with the first saving amount starting in one year, for each of the next 30 years?

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example cont.

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example cont.

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example cont.

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if you are looking for more exercises

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example Question 5.38
You need a 30-year, fied-rate mortgage to buy a new home for $ 250000. Your bank
will lend you the money at 5.3 percent APR, compounded monthly, for this 360
month loan. However, you can only afford monthly payment of $950, so you can
offer to pay off any remaining loan balance at the end of the loan in the form of a
single balloon payment. How large will this balloon payment have to be for you to
keep your monthly payments at $ 950?

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example cont.

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example cont.

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