Workbook 1 Time Value of Money 1 .

An art collector has the opportunity to invest in paintings; the investment requires an outlay of $2 million. He is certain that he will be able to sell the paintings for $2.18 million in one year. He also has the opportunity to invest in certificates of deposit (CDs) which pay 10% per year. What is the FV of the $2 million if the collector purchases the CDs? Is the investment in the paintings a good investment? 2 . In Problem 1, what is the rate of return for the investment in paintings? 3 . For the paintings described in Problem 1, what is the PV of the future cash flow the collector would receive if he sold the paintings one year from now? What is the value of the paintings to the collector? 4 . An individual has the opportunity to invest $1,000 today to acquire an asset which will generate $300 in income one year from today and which can be sold for $900 at that time. Determine the minimum level of the market interest rate for which this investment would be attractive. 5. Solve for the unknown time period in each of the following: Present value Future value Interest rate Time (years) 4,100 $ 8,523 5% ?

6. Solve for the unknown interest rate in each of the following: Present value 10,543 Future value $21,215 Interest rate ? Time (years) 12

7. A local bank is offering 9% interest, compounded monthly, on savings accounts. If you deposit $700 today, how much will you have in 2 years? How much will you have in 2.5 years? 8. You have just joined the investment banking firm of Knot, Wirthem, et al. They have offered you two different salary arrangements. You can have $50,000 per year for the next 3 years or $25,000 per year for the next 3 years, along with a $50,000 signing bonus today. If the market interest rate is 16%, which salary arrangement do you prefer? 9. Judi Jordan wishes to accumulate $8,000 by the end of 5 years by making equal annual deposits over the next 5 years beginning now. If Judi can earn 7% on her investments, how much should her annual deposit be to meet this goal? 10. Mr. Amatya, owner of Amatya enterprise, is negotiating with Nabil Bank for a Rs. 500,000, 1 year loan. Nabil bank has offered Amatya the following alternatives. Calculate the effective annual interest rate for each alternative. Which alternative has the lowest effective annual interest rate: A 13 percent annual interest rate payable at the end of the year or a 12 percent annual interest rate payable every quarter? 11. A local loan shark offers 'four for five on payday,' this means you borrow $4 today and you must repay $5 in 6 days, when you get your paycheck. What is the effective annual interest rate for this loan?

S.B.Khatri (Financial Management)

12. You expect to receive an annuity of $1000 per year for the next five years. The market rate of interest is 12%. Assuming that you do not spend any of the income at any other time, what is the most you can spend from these payments at the end of five years? What is the most you can spend today? 13. Consider a perpetuity which pays $100 per year; the market rate of interest is 10%. What is the PV of the perpetuity? What is the PV of the perpetuity three years from now? What is the present value of the perpetuity n years from now? Under what circumstances does the value of a perpetuity change? 14. Suppose you take an Auto loan of Rs. 50,000 for 5 years to buy a motorcycle from finance company. The company charge 10% interest rate. You have to repay the loan amount within five years in an annual instalment basis. How much you have to pay in each instalment? How much is the total interest paid to finance company? Develop an amortization schedule to pay the principal plus interest 15. Mr. Binod requires a stream of cash flow of Rs 2000 for coming three years and then Rs 3000 per year for next six years. a. How much he needs to deposit now in the bank if the interest rate offered is 10% monthly interest compounding? b. How much he needs to deposit for first 7 years equally every year if interest rate offered is 12% annual compounding ? 16. A finance company advertises that it will pay a lump sum of Rs 10,000 at the end of six years to investors who deposit annually Rs 1,000 for 6 years. What is the interest rate implicit in this offer? You are not allowed to use the table for FVIF. 17. Suppose someone offers you the following financial contract. If you deposit Rs 20,000 with him, he promises to pay Rs 4,000 annually for 10 years. What interest rate would you earn on this deposit? 18. If the interest rate is 12 % how much investment is required now to yield an income of Rs 12,000 per year from the beginning of the 10th year and which continues thereafter forever? 19. Mr B deposits Rs 10,000 in a bank now. The interest rate is 10% and compounding is done semiannually. What will the deposit grow to after 10 years? If the inflation rate is 8% per year, what will be the value of the deposit after 10 years in terms of current rupees? (Hint: 2nd part of question asks how much is the present worth of deposit after 10 years in terms of current rupees) 20. Company A has to retire Rs 10 million of debentures each at the end of 8,9, and 10 years from now. How much should the firm deposit in a sinking fund account annually for 5 years, in order to meet the debenture retirement need? The net interest rate earned is 8%. 21. An individual is planning to draw, after six years, a fixed sum semiannually for 5 years. If his bank pays 10% p.a. (compounded semiannually), how much will he be able to draw semiannually: (a) if he deposits Rs 34 million now? (b) if he deposits Rs 3 million semiannually for six years? 22. Mr. A deposits Rs 10,000 in a bank now. The interest rate is 10% and compounding is done semiannually. I. What will the deposit grow after 10 years? II. If the inflation rate is 8% per year, what will be the value of the deposit after 10 years in terms of the current rupees? http://www.youtube.com/watch?v=PG2kr0APt6k&feature=related
S.B.Khatri (Financial Management)