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Tutorial 4 TVM Application

This document provides 9 exercises on time value of money concepts. The exercises cover topics like present value calculations for perpetuities, growing perpetuities, annuities, loans, interest rates and investments. Students are required to complete at least 8 exercises before attending the tutorial class.

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54 views4 pages

Tutorial 4 TVM Application

This document provides 9 exercises on time value of money concepts. The exercises cover topics like present value calculations for perpetuities, growing perpetuities, annuities, loans, interest rates and investments. Students are required to complete at least 8 exercises before attending the tutorial class.

Uploaded by

Trần Thảo
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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61FIN2FIM - FINANCIAL MANAGEMENT

TUTORIAL 5 – TIME VALUE OF MONEY APPLICATIONS

All exercises below are required exercises. If you exhaust the exercises, do exercises in the
corresponding textbook. We require that you complete at least 08 exercises before attending the
tutorial classes and send your works to your tutor.

1. You are receiving ANNUAL payments in the form of a perpetuity of $1,000. Provided an interest
rate of 12%, calculate the perpetuity’s present value in the following situations:
a. The first payment is made by the end of the first year.
b. The first payment is made immediately.
c. The payments are made SEMIANUALLY.

2. What is the present value of a growing perpetuity, where the first payment of $1500 will be
received in 6 months and the payment will then grow at 3% every 6 months, and the interest rate is
9% p.a., compounded semi‐annually? How would the present value be if the first payment were
received immediately?

3. What is the present value of $250 to be received every month for 3 years? The first payment is

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made in 1 month and interest rate of 10% p.a., compounded monthly?

4. What is the present value of $250 to be received every month for 3 years? The first payment is
made immediately and interest rate of 10% p.a., compounded monthly?

5. Your client is 40 years old; and she wants to begin saving for retirement, with the first payment to
come one year from now. She can save $5,000 per year; and you advise her to invest it in the stock
market, which you expect to provide an average return of 9% in the future.

a. If she follows your advice, how much money will she have at 65?

b. How much will she have at 70?

c. She expects to live for 20 years if she retires at 65 and for 15 years if she retires at 70. If her
investments continue to earn the same rate, how much will she be able to withdraw at the
end of each year after retirement at each retirement age?

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6. Jan sold her house on December 31 and took a $10,000 mortgage as part of the payment. The 10-
year mortgage has a 10% nominal interest rate, but it calls for semiannual payments beginning next
June 30. Next year Jan must report on Schedule B of her IRS Form 1040 the amount of interest that
was included in the two payments she received during the year.

a. What is the dollar amount of each payment Jan receives?

b. How much interest was included in the first payment? How much repayment of principal was
included? How do these values change for the second payment?

c. How much interest must Jan report on Schedule B for the first year? Will her interest income be the
same next year?

d. If the payments are constant, why does the amount of interest income change over time?

7. You want to buy a car, and a local bank will lend you $20,000. The loan will be fully amortized over 5
years (60 months), and the nominal interest rate will be 12% with interest paid monthly. What will
be the monthly loan payment? What will be the loan’s EAR?
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8. Bank A pays 4% interest compounded annually on deposits, while Bank B pays 3.5% compounded
daily.

a. Based on the EAR, which bank should you use?


b. Could your choice of banks be influenced by the fact that you might want to withdraw your
funds during the year as opposed to at the end of the year? Assume that your funds must be left
on deposit during an entire compounding period in order to receive any interest.

9. CHALLENGE. Erika and Kitty, who are twins, just received $30,000 each for their 25th birthday. They
both have aspirations to become millionaires. Each plans to make a $5,000 annual contribution to
her “early retirement fund” on her birthday, beginning a year from today. Erika opened an account
with the Safety First Bond Fund, a mutual fund that invests in high-quality bonds whose investors
have earned 6% per year in the past. Kitty invested in the New Issue Bio-Tech Fund, which invests in
small, newly issued bio-tech stocks and whose investors have earned an average of 20% per year in
the fund’s relatively short history.

a. If the two women’s funds earn the same returns in the future as in the past, how old will each
be when she becomes a millionaire?
b. How large would Erika’s annual contributions have to be for her to become a millionaire at
the same age as Kitty, assuming their expected returns are realized?
c. Is it rational or irrational for Erika to invest in the bond fund rather than in stocks?

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