Chapter 2: Concepts of Value and Return

Problem 1

Time preference (discount) rate 9%

(i) A. Investment 15,000
B. Period (years) 4
C. Compound value factor at 9% for 4 years 1.4116
D. Compound value at the end of 4 years: [A x C]
: 15,000 (1.09)4 = 15,000 x 1.4116 21,173.72

Now After 1 year

(ii) A. Investment 6,000 6,000
B. Period (end of year) 5 5
C. Compounding periods 5 4
D. Compound value factor (lump sum) 1.5386 1
E. Compound value [A x D]
: 6,000 (1.09)5 = 6,000 x 1.5386 9,231.74
: 6,000 (1.09)4 = 6,000 x 1.4116 8,469

(iii) A. Annual investment (end of year) 18,000

B. Period (years) 8
C. Compound value factor (annuity) 11.0285
D. Compound value at the end of 8 years [A x C]
: 18,000 [(1.09)8 - 1]/0.09 = 18,000 x 11.0285 198,512.53

(iv) A. Annual investment (beginning of year) 18,000

B. Periods (years) 8
C. Compound value factor (annuity due) 12.0210
D. Compound value at the end of 8 years [A x C]
: 18,000 [{(1.09)8 - 1}/0.09] (1.09) = 18,000 x 12.0210216,378.66

Withdrawal Balance
(v) A. Annual investment for 4 years 18,000.00
B. Compound value at the end of 4 years:
: 18,000 x [{(1.09)4-1}/0.09] 82,316.32
C. Compound value at the end of 5 years:
: (82,316.32 x 1.09) - 12,000 89,724.79 12,000 77,724.79
C. Compound value at the end of 6 years:
: (77,724.79 x 1.09) - 12,000 84,720.02 12,000 72,720.02
D. Compound value at the end of 7 years:
: (72,720.02 x 1.09) -12,000 79,264.82 12,000 67,264.82
E. Compound value at the end of 8 years:
: (67,264.82 x 1.09) - 0 73,318.66 0 73,318.66

Problem 2

Discount rate 13%

(i) A. Cash flow 2,000
B. Period 0
C. Present value factor 1
D. Present value (Rs): 2,000/(1.13)0 2,000

(ii) A. Cash flow 2,000

B. Period 1
C. Present value factor: 1/(1.13)1 0.8850
D. Present value (Rs): [A x C]: 2,000/(1.13)1 1,769.91

(iii) A. Cash flow 2,000

 B. Period 2
C. Present value factor 0.7831
D. Present value (Rs) [A x C] 1,566.29

(iv) A. Cash flow 4,000

B. Period 3
C. Present value factor: 1/(1.13)3 0.6931
D. Present value (Rs): [A x C]: 4,000/(1.13)3 2,772.20

(v) A. Cash flow 7,000

B. Period 3
C. Present value factor: 1/(1.13)3 0.6931
D. Present value (Rs) [A x C]: 7,000/(1.13)3 4,851.35

(vi) A. Cash flow 3,000

B. Period 4
C. Present value factor: 1/(1.13)4 0.6133
D. Present value (Rs): [A x C]: 3,000/(1.13)4 1,839.96

(vii) A. Cash flow (annuity) 4,000

B. Period 5
C. Present value annuity factor:
[{(1.13)5-1}/{0.13(1.13)5}] 3.5172
D. Present value (Rs):[A x C]:

14068.93

(viii) A. Cash flow 4,000

B. Period 5
C. Present value factor (annuity due)
[{(1.13)5-1}/{0.13(1.13)5}](1.13) 3.9745
D. Present value (Rs): 15,897.89

Problem 3

Discount rate 14%

Year 0 1 2 3 4 5
A. Cash flows 3,000.00 3,000.00 3,000.00 3,000.00 7,000.00
B. PVF at 14% 1 0.7695 0.6750 0.5921 0.5194
C. Present value [A x B] 12832.30 2,632 2308.40 2024.91 1776.24 3635.58

Problem 4

A. Rate of interest 15%

B. Sum received now (Rs) 100
C. Period (years) 10
D. Present value factor (annuity) at 15% 5.0188
E. Capital recovery factor (annuity) at 15%
: [1/D]: 1/5.0188 0.1993
F. Annual instalment (end of period) [B x E] 19.93
 6
1,000.00
0.4556
455.59
G. Present value factor (annuity due) at 15%:
: 5.0188 x 1.15 5.7716
H. Capital recovery factor (annuity due) at 15% [1/G] 0.1733
I. Annual instalment (beginning of period) [B x H] 17.33

Problem 5

A. Interest rate 10%

B. Debt payable now (Rs) 1,000
C. Period of instalments (years) 5
D. Present value factor (annuity) at 10% 3.7908
E. Capital recovery factor (annuity) at 10% 0.2638
F. Annual instalment (end of period): [B x E] 263.80

Problem 6

A. Time value of money 12%

B. Payment now (Rs) 13,000
C. Period of instalments (years) 5
D. Present value factor (annuity) at 12% 3.6048
E. Capital recovery factor (annuity) at 12%: [1/D] 0.2774
F. Annual instalment (end of period): [B x E], 13,000 x 0.2774 3606.33
G. Present value factor (annuity due) at 12%: [D x 1.12] 4.0373
H. Capital recovery factor (annuity due) at 12% [1/G] 0.2477
I. Annual instalment (beginning of period) (Rs): [B x H], 13,000 x 3219.93
0.2477

Problem 7

A. Discount rate 11%

B. Outlay now 10,000
C. Period of instalments (years) 5
D. Present value factor (annuity) at 11% 3.6959
E. Capital recovery factor (annuity) at 11% [1/D] 0.27057
F. Annual instalment (end of period) [B x E or B/D] 2705.70
G. Present value factor (annuity due) at 11% 4.1024
H. Capital recovery factor (annuity due) at 11% [1/G] 0.24376
I. Annual instalment (beginning of period) [B x H] 2437.57

Problem 8

A. Discount rate 8%
B. Annual interest payment 150
C. Period (years) 30
D. Present value factor (annuity), 30 periods, 8% 11.25778
E. Present value of annual interest [B x D] 1688.67
F. Maturity value at the end of 30 years 1,000
G. Present value factor, end of 30 years 0.09938
H. Present value of maturity value [F x G] 99.38
I. Present value of bond [E + H]: 1788.04

Problem 9

A. Discount rate 15%

B. Annual pension 10,000
C. Periods of pension 20
D. Present value factor, 20 years, 15% 6.25933
E. Present value of pension at the end of 20 years 62593.31
F. Present value factor, end of 20 years 0.06110
G. Present value of pension now [E x F] 3824.47

Problem 10

A. Interest rate 10%

B. Year 0 1-6 7 8 9-12
C. Cash flow -10,000.00 2,000 -1,500.00 1,600.00 2,500.00
D. Present value factor 1.0000 4 0.5132 0.4665 1.4788
E. Present value (Rs) [C x D] -10,000.00 8,711 -769.74 746.41 3,696.91
F. Net present value (Rs) 2,384.11

Problem 11

IRR 0 1 2 3 4
( i ) Deposit and receive 14.0% -100 114
( ii ) Borrow and pay 12.0% 100 -112
( iii ) Borrow and pay 13.0% 1,000 0 0 0 0

The following formula is used to compute IRR:

Problem 12

Year 0 1 2 3 4
Bank deposit 13% -100 0 0 0 0

Problem 13
We can use the following formula in calculating the time period, n, in this problem:

A. Investment 6,000 6,000 6,000 6,000

B. Interest rate (annual) 6% 10% 20% 30%
C. Expected amount after n years:
6000(1+r)n = 12,000 12,000 12,000 12,000 12,000
D. Compound value factor:(1.06)n
= 12,000/6,000 2 2 2 2
E. ln (1+r) 0.0583 0 0.1823 0.2624
F. ln 2 0.6931 1 0.6931 0.6931
G. n = ln 2/ln (1+r) 11.90 7 3.80 2.64
H. Interest rate (semi-annual) 3% 0 10% 15%
I. ln (1+r/2) 0.0296 0 0.0953 0.1398
J. n (half-years)= ln 2/ln (1+r/2) 23.45 14 7.27 4.96
5 6 7 8 9 10

0 0 0 0 0 -3,395

5 6 7 8 9
0 0 0 0 300
Problem 14

A. Annual earnings in 19X1 45000

B. Period (years) 7
C. Annual earnings in 19X8 67,550
D. 45,000 (1 + g)7 = 67,550 = (1 + g)7 = 67,550/45,000 1.5011
E. 7 ln (1+g) 0.4062
F. ln (1+g) 0.0580
G. (1+g) 1.060
H. g (growth): 1.06 - 1 6%

6%

Problem 15

A. Land price 40,000

B. Instalments 20
C. Annual instalment 8,213
D. Present value annuity factor required:40000/8213 4.8703
E. From present value of annuity table, r equals 20%. We 20%
can write the formula for IRR ( r ) as follows. The Excel in-
built formula can be used to calculate r.

Problem 16

A. Needed future sum after 15 years 300,000

B. Period (years) 15
C. Interest rate 12%
D. Future value factor of an annuity, 15 years, 12% 37.2797
E. Annuity value [A/D]: 8047.27

Problem 17

A. Needed future sum at the age of 50 1,000,000

B. Period (years) 30
C. Interest rate 10%
D. Future value factor of an annuity, 30 years, 10% 16.4494
E. ( a ) Annuity value [A/D] 60,792.48
F. Future value factor of a lump sum, 30 years, 10% 17.4494
G. ( b ) Lump sum deposited now [A/F] 57,308.55

Problem 18

A. Savings today 80,000

B. Period (years) 10
C. Interest rate 10%
D. Future value factor, 10 years, 10% 2.5937
E. Future value [A x D] 207499.40
F. Future value of an annuity factor, 10 years, 10% 15.9374
G. Annual withdrawal [E/F] 13,019.63
H. Present value of annuity factor, 10 years, 10% 6.1446
I. Annual withdrawal [A / H] 13,019.63

Problem 19

A. Price of house 500,000

B. Cash payment 100,000
C. Balance 400,000
D. Instalment period 20
E. Interest rate 12%
F. Present value of an annuity factor, 20 years, 12% 7.4694
G. Annual instalment: 400,000/7.4694 53,551.51

The interest paid and principal repaid each year are as follows:
12%
Principal
Years Balance Instalment Interest repaid
0 400,000.00
1 394,448.49 53,551.51 48,000.00 5,551.51
2 388,230.80 53,551.51 47,333.82 6,217.69
3 381,266.98 53,551.51 46,587.70 6,963.81
4 373,467.51 53,551.51 45,752.04 7,799.47
5 364,732.10 53,551.51 44,816.10 8,735.41
6 354,948.45 53,551.51 43,767.85 9,783.66
7 343,990.75 53,551.51 42,593.81 10,957.70
8 331,718.13 53,551.51 41,278.89 12,272.62
9 317,972.80 53,551.51 39,806.18 13,745.33
10 302,578.02 53,551.51 38,156.74 15,394.77
11 285,335.87 53,551.51 36,309.36 17,242.15
12 266,024.67 53,551.51 34,240.30 19,311.21
13 244,396.12 53,551.51 31,922.96 21,628.55
14 220,172.14 53,551.51 29,327.53 24,223.98
15 193,041.29 53,551.51 26,420.66 27,130.85
16 162,654.74 53,551.51 23,164.95 30,386.56
17 128,621.79 53,551.51 19,518.57 34,032.94
18 90,504.90 53,551.51 15,434.62 38,116.89
19 47,813.98 53,551.51 10,860.59 42,690.92
20 0.15 53,551.51 5,737.68 47,813.83

Problem 20

A. Price of flat 200,000

B. Down payment 40,000
C. Loan processing fee 5,000
D. Net amount of loan 155,000
E. Period of mortgage loan (years) 12
F. Loan instalment 28,593
G. Required factor [D/F] 5.4209
H. Present value of an annuity factor at trial rate 14%, 12 years 5.6603
I. Present value of an annuity factor at trial rate 16%, 12 years 5.1971
J. Rate of return: 15%
14.52%

Problem 21
Required rate 13%
End Beginning
Year Cash flow PVF PV Cash flow PV
0 0 1.000 0 2000 2000.0
1 2000 0.885 1769.9 2000 1,769.9
2 2000 0.783 1566.3 2000 1,566.3
3 2000 0.693 1386.1 1000 693.1
4 1000 0.613 613.3 1000 613.3
5 1000 0.543 542.8 1000 542.8
6 1000 0.480 480.3 1000 480.3
7 1000 0.425 425.1 0.0
6783.8 7665.7

Problem 22

A. Payment now 200,000

B. Annuity 25,000
C. Expected period for annuity (years) 20
D. Interest rate 12%
E. Annuity factor 7.4694
F. Present value of annuity 186,736
Sundaram should prefer Rs 200,000 now.

Problem 23

A. Time value of money 10%

B. 30-year annuity 5,000
C. PVAF, 10%, 30 year 9.4269
D. Present value of 30-year annuity 47,134.57
E. 20-year annuity 6,600
F. PVAF, 10%, 20 year 8.5136
G. Present value of 20-year annuity 56,189.52
H. Cash right now 50,000.00
You should choose 20-year annuity of Rs 6,600 as it has highest PV.

Problem 24

Interest rate 8%
( i ) Amount now or 80,000
10-year annuity 14,000
PVAF, 8%, 10 year 6.7101
Present value of 10-year annuity [14,000 x 6.7101] 93,941
Ms Punam should choose 10-year annuity

( ii ) Amount now or 150,000

20-year annuity 14,000
PVAF, 8%, 20 year 9.8181
Present value of 20-year annuity [14,000 x 9.8181] 137,454
Ms Punam should choose to have Rs 150,000

(iii) Amount now or 120,000

15-year annuity 14,000
PVAF, 8%, 15 year 8.5595
Present value of 15-year annuity [14,000 x 8.5595] 119,833
Both alternatives are almost the same.

Problem 25

Required rate of return 14%

 End Beginning
Cash flow PVF PV Cash flow PV
0 0 1.0000 0 2,000 2,000
1 2,000 0.8772 1754 2,000 1,754
2 2,000 0.7695 1539 2,000 1,539
3 2,000 0.6750 1350 2,000 1,350
4 2,000 0.5921 1184 2,000 1,184
5 2,000 0.5194 1039 3,000 1,558
6 3,000 0.4556 1367 3,000 1,367
7 3,000 0.3996 1199 3,000 1,199
8 3000 0.3506 1052 3,000 1,052
9 3,000 0.3075 923 6,000 1,845
10 6,000 0.2697 1618 6,000 1,618
11 6,000 0.2366 1420 6,000 1,420
12 6,000 0.2076 1245 6,000 1,245
13 6,000 0.1821 1092 6,000 1,092
14 6,000 0.1597 958 6000 958
15 6,000 0.1401 841 0 0
PV 18581 21,182

Problem 26

Borrowing 50,000
Interest rate 10%
Annuity factor, 10%, 5 year 3.7908
Annual payment: 50,000/3.7908 13,190

Year Outstanding Instalment Interest Repayment

0 50,000 0 0
1 41,810 13,190 5,000 8,190
2 32,801 13,190 4,181 9,009
3 22,891 13,190 3,280 9,910
4 11,990 13,190 2,289 10,901
5 0 13,190 1,199 11,991

Problem 27

Nominal rate of interest 12%

Period 1
Effective interest rate: annual compounding 12%
Half-yearly compounding:
Compounding period 2
Half-yearly rate [12%/2] 6%
Effective (annual) interest rate [(1.06)2-1] 12.36%
Quarterly compounding:
Compounding period 4
Quarterly rate [12%/4] 3%
Effective (annual) interest rate [(1.03)4-1] 12.55%
Monthly compounding:
Compounding period 12
Monthly rate [12%/12] 1%
Effective (annual) interest rate [(1.01)12-1] 12.68%

Problem 28

A. Face value of debenture 1,000

B. Current yield (annual) 18%
C. Half-yearly yield [18%/2] 9%
D. Period (years) 10
E. Compounding periods [10 x 2] 20
F. Half-yearly interest amount 75

G. PVAF, 9%, 20 periods 9.1285

H. Present value of 20-period annuity of Rs 75 [F x G] 684.64
I. PVF of a lump sum, 9%, 20 periods 0.17843
J. PV of maturity value of Rs 1000 [1,000 x 0.1784] 178.43
K. Present value of the debenture [H + J]

863.07

Problem 29

A. Initial deposit 1,000

B. Interest rate (annual) 12%
C. Compounding period in a year 4
D. Quarterly rate [12%/4] 3%
E. Period 7.5
F. Total compounding periods [C x E] 30
G. FVF, 3%, 30 periods 2.42726
H. Future value [A x G]: [(1.03)30 x 1,000] 2427.26

Problem 30

A. Half-yearly interest 50
B. Maturity (years) 7
C. Maturity value (at par) 1,000
D. Maturity value (at premium) 1,100
E. Required rate of return 12%
F. Present value annuity factor, 6%, 14 periods 9.2950
G. Present value factor, 6%, 14 periods 0.4423
H. Value of the bond (redeemed at par): 907.05
(a) Value of interest [A x F] 464.75
(b) Present value of maturity value [C x G] 442.30
I. Value of bond (redeemed at premium): 951.28
(a) Value of interest [A x F] 464.75
(b) Present value of maturity value [D x G] 486.53

Problem 31

Current deposit (Rs) 10000

Montly withdrawal 100
Annual interest rate 8%
Quarterly rate 2%
Monthly interest rate 0.006667
The present value of your deposit is Rs 10,000 and you want to withdraw Rs 100 every month. Thus
You will be able to completely withdraw your deposit in about 14 years.

Problem 32

A. Preference share capital 800,000

B. Maturity period (years) 8
C. Required return 12%
D. Compound value annuity factor, 12%, 8 years 12.2997
E. Sinking fund factor, 12%, 8 years [1/D] 0.0813
F. Annual contribution in SF (end of the year) [A x E] 65,042.27
G. Compound value annuity factor (annuity due), 12%, 8 years 13.7757
H. Sinking fund factor (annuity due), 12%, 8 years [1/G] 0.0726
I. Annual contribution in SF(beg. of the year) [A x H] 58073.46

Problem 33

A. Face (and maturity) value of bond 1,000

B. Interest rate (half yearly) 7%
C. Half yearly interest 70
D. Remaining life of bond (half years) 8
E. Required rate of return (half yearly) 6%
F. Present value annuity factor, 6%, 8 years 6.2098
G. Present value factor, 6%, 8 years 0.62741
H. Value of bond: 1062.10
(a) Present value of interest [C x F] 434.69
(b) Present value of maturity value [A x G] 627.41

Problem 34

A. Annual payments 3,800

B. Period (years) 4
C. Principal 10,000
D. Internal rate of return: 19.14%

19.14%

By trial & error IRR is approx. 19%

Problem 35

A. Loan amount 10,000

B. Period (years) 8
C. Interest rate 12%
D. Annual repayment 2,013
E. Internal rate of return: 12%
12%

Interest rate charged by the bank and the internal rate of return are the same. 12% is the true rate of interest.

Loan amortisation schedule

Beg. Repayment End
Year balance Instalment Interest Principal balance
0 10,000
1 9,187 2,013 1,200 813 9,187
2 8,276 2,013 1,102 911 8,276
3 7,256 2,013 993 1,020 7,256
4 6,114 2,013 871 1,142 6,114
5 4,835 2,013 734 1,279 4,835
6 3,402 2,013 580 1,433 3,402
7 1,797 2,013 408 1,605 1,797
8 0 2,013 216 1,797 0

Problem 36

A. Amount deposited 1,000

B. Interest rate for years 1-5 (5 years) 10%
C. Interest rate for years 6-13 (8 years) 13%
D. Compound value for 13-year period:
[1,000(1.10)5 x (1.13)8] 4,281.45
E. Compound rate of interest:
[(4,281.45/1,000)1/13 - 1] 11.84%