ACCTG 151G Tutorial 4

Contents:
Test Revision
 FVIF
𝐹𝑉 = 𝑃𝑉 ∗ (1 + 𝑟)𝑛 (Table 1)
1 PVIF
𝑃𝑉 = 𝐹𝑉 ∗
Interest is re-invested (1 + 𝑟)𝑛 (Table 2)

default [ 1 + 𝑟 𝑛 − 1] FVIFA
𝐹𝑉𝐴_𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 = 𝑪𝑭 ∗ (Table 3)
𝑟
1
1− PVIFA
(1 + 𝑟)𝑛
𝑃𝑉𝐴_𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 = 𝑪𝑭 ∗ [ ] (Table 4)
𝑟

[ 1 + 𝑟 𝑛 − 1]
𝐹𝑉𝐴_𝑑𝑢𝑒 = 𝑪𝑭 ∗ ∗ (1 + 𝑟)
𝑟
Ensure Consistency! 1
1−
e.g., CF: monthly payment (1 + 𝑟)𝑛 ∗ (1 + 𝑟)
r: monthly interest 𝑃𝑉𝐴_𝑑𝑢𝑒 = 𝑪𝑭 ∗ [ ]
n: the number of month 𝑟
 Fixed time intervals
1. Present Value of the Monthly Payments

Calculate the monthly payments on a $10,000 loan which is to be repaid

in 24 monthly instalments (starting at the end of the first month) and is
being charged interest at an annual rate of 24%

Pmts = Loan Amount ÷ PVIFA

Loan = $10,000 r = 24% / 12 months n = 24 months

= 2% or 0.02
= $10,000 ÷ 18.914
= $528.71

PVIFA24mths,2%
 2. Interest on Loan
What is the total amount of interest you would end up paying on this loan?

Total Payments = Monthly payments * Number of Periods

= $528.71 x 24
= $12,689.00 (approximately)

Interest Amount = Total Payments – Principal

= $12,689.00 - $10,000
= $2,698.00

How about interest amount in a specific year?

Before we move to Q2……
Loan Interest Deductions

Liz Rogers just closed a $10,000 business loan that is to be repaid in three
equal, annual, end-of-year payments. The interest rate on the loan is
13%. As part of her firm’s detailed financial planning, Liz wishes to
determine the annual interest deduction attributable to the loan. (Because
it is a business loan, the interest portion of each loan payment is tax-
deductible to the business.)
a) Determine the firm’s annual loan payment.
1 1
PV = CF −
r r(1+r)n

PV 10,000
CF = 1 1 = 1 1
= $4,235.22
− −
r r(1+r)n .13 .13(1+.13)3

PVAF = 2.3612
b) Prepare an amortization schedule for the loan

Amortization is the paying off of debt with a fixed repayment schedule in

regular installments.

Loan Payment=Interest Payment +Principal payment

Interest Payment= Beginning of year principal*interest rate

End of Loan Beginning of year Payments End of year

year Payment $ Principal $ principal $
Interest $ Principal $
1 4235.22 10,000 1,300 2935.22 7,064.78

2 4235.22 7,064.78 918.42 3,316.80 3,747.98

3 4235.22 3,747.98 487.24 3,747.98 0

This schedule helps you determine the interest amount for a specific year
 3. Savings Amount

You are trying to save for the deposit on a house. The deposit is 10% of the total
price of the house. You expect the house to cost about $500,000 in three years-
time, your proposed purchase date. If you have access to a savings plan that
allows you to deposit money every month and agrees to compound interest on a
monthly basis, how much will you need to save each month if the account offers a
nominal rate of 12% p.a.
Required deposit = Cost * Deposit rate
= $500,000 x 10% = $50,000
FV36mths = r = 12% / 12 months
Savings Amount x FVIFA36mths,1% = 1% or 0.01
$50,000 = Savings amount x 43.077 n = 3 years * 12 months
Savings Amount = $50,000 ÷ 43.077 = 36 months
= $1,160.71
 4. Investment
You’ve been offered an investment opportunity that appears good but you’ve
decided you need to analyse it properly, the investment is this: for a payment of
$5,000 today you are promised a payment of $2,200 at the end of each the
following 3 years. Your friend says to you that this represents a total return of
$6,600 over the 3 years i.e. a profit of $1,600 on your $5,000 investment which is
a 32% return overall, or just over 10% p.a. compared to your bank account that
pays 12% p.a. this isn’t good.

a) Is this an appropriate way to consider the return on your

investment? Explain
No it’s not appropriate. A simple average rate of return over
a number of periods fails to take account of compound
interest i.e. the interest on interest you could earn if you put
the investment money into an account that allowed
compounding.
 Investment
b) Demonstrate a more appropriate approach (Use the
tables to approximate an answer).
Possibly the most straight-forward approach is to use the
PV of an annuity formula. Doing this is like asking
yourself “how much would I have to deposit into an
account paying 10% p.a. compounding annually, so that I
could withdraw $2,200 each year for the next 3 years?”
The $2,200 are the payments on the annuity, n = 3 now look up
the table for k = 10%
The PVIFA3yrs,10% is 2.4869
$2,200 x 2.4869 = $5,471.18
So, you would have to have a deposit of $5,471.18 to be able to
do the same thing as this $5,000 investment and the
investment’s real rate of return must therefore be a lot higher
than 10%

Again, $2,200 * PVIFA3yrs,r% = $5,000

Rearranging, $5,000 ÷ $2,200 = 2.2727

The closest 3 year interest rate to this on your

table is 2.28232 for a 15% return
 5. Use the simple interest method to calculate the finance charges and
the Annual Percentage Rate (APR) on a single-payment loan of
$5,000 for three years at an annual stated interest rate of 10%.

Interest= Principal x Rate x Time

Principal = $5,000 Rate = 10% Time = 3 yrs
= $5,000 x 10% x 3 Finance charge
Finance Charges = $1,500 = $1,500
Average Annual Finance Charge Time = 3
APR =
Average Loan Balance Outstanding
APR = $1,500 ÷3 = 10% p.a. (same as the
$5,000
stated rate)
6. If the loan in Question 5. used the discount method to
calculate interest, what would be the APR for the loan?

Finance Charges are the same = $1,500

Average Annual Finance Charge
APR =
Average Loan Balance Outstanding

$1,500 ÷3
= ($5,000−$1,500)

= 14.3% p.a.
 7. Let’s say you want to retire in 35 years-time. When you
reach retirement age you believe that you’ll need at least
$1 million (in today’s money) invested so that you can live
through your retirement comfortably.
a) How much will you have to save every year from now until you
retire so that you can achieve this if you have a bank account that
pays 6% p.a. compounding annually?
FV = Savings Amount * FVIFA
FV = $1,000,000 r= 6% n = 35 yrs
FV35yrs = $1,000,000 = Savings Amount x FVIFA35yrs,6%
So Savings Amount = $1,000,000 ÷ FVIFA35yrs,6%
= $1,000,000 ÷ 111.435
= $8,974 (approximately)
 7. Time value of money
b) If inflation was running at 2% p.a. how would you
accommodate this in your calculations?
You would need to have more money in your account to cope with
higher prices.
You can calculate this as the compound growth on a single
amount.
PV = $1M r = 2% n = 35 yrs
$1,000,000 x (1 + 0.02)35 = $1,999,890 (approximately) or
$1,000,000 x FVIF35yrs2% = $1,000,000 x 1.9999
= $1,999,900
So, basically, twice as much cash just to cope with rising prices
c) If there was 2% inflation, how much would you have to
save every year so that you would have the same quality
of life you imagined from Question 7a

FV = Savings Amount * FVIFA

FV = $2,000,000 r= 6% n = 35 yrs
So Savings Amount = $2,000,000 ÷ FVIFA35yrs,6%
= $2,000,000 ÷ 111.435
= $17,947 (approximately)
Key Points

• Be alert when you use financial tables, choose the correct table

• Be aware whether you have to calculate the Present Value or the

Future Value

• Remember adjust the number of periods and the payment amount

• Series of equal amounts made at fixed time intervals (eg: monthly,

quarterly, annually)for a specified number of periods (eg: years); we
call these an annuity