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Training Exercises With Solutions

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7 views

Training Exercises With Solutions

Uploaded by

mamaz.mieze
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Most results were obtained by making calculations on Excel.

As a consequence the values


are as close as possible to the right results. If you find different results it might be due to
the rounding of your intermediary results while you perform your own calculations.

1. What is the Present Value of €500 received in 5 years if you use 5%, 7% and 10% discount rates?
We know that FV = €500, n = 5 and discount rates "r" are 5%, 7% and 10%, and that PV = FV / (1+ r)n:
PV = €500/(1 + 5%)5 = €391.76
PV = €500/(1 + 7%)5 = €356.49
PV = €500/(1 + 10%)5 = €310.46

2. What is the Present Value at 8% of €1,500 received in 3 years, 5 years and 10 years? What are
the discount factors (a discount factor is what multiplies the cash flow to discount it)?
We know that FV = €1,500, n = 3, 5 and 10 years and discount rate "r" is 8% and that PV = FV / (1+ r)n.
Furthermore, discount factor ("DF") formula is 1/(1+r)n or (1+r)-n:
PV3 = €1,500 x (1 + 8%)-3 = € 1,190.75 where DF = (1 + 8%)-3 = 0.793832
PV5 = €1,500 x (1 + 8%)-5 = € 1,020.87 where DF = (1 + 8%)-5 = 0.680583
PV10 = €1,500 x (1 + 8%)-10 = € 694.79 where DF = (1 + 8%)-10 = 0.463193

3. How much would €5,000 be worth in five years, invested at 5%, 10% and 20%? And why is what
you obtain in the end with 20% not exactly the double of what you obtain in the end with 10%?
PV = €5000, and FV = PV x (1+r)5
€5000 x (1+5%)5 = € 6,381.41
€5000 x (1+10%)5 = € 8,052.55
€5000 x (1+20%)5 = € 12,441.60
FV@20% ≠ 2 x FV@10% because of the compounding of interests

4. How much would €1,000 be worth in 5 years, 10 years and 20 years if it was invested at 8%?
Why is what you obtain at the end of the 20 years not the double of what you obtain at the end of
10 years?
We know €1,000 is the PV, and the FV = PV x (1+r)n.
Hence, FV10 = € 1,000 x (1.08)5 = € 1,469.33
and FV10 = €1,000 x (1.08)10 = € 2,158.02
and FV20 = €1000 x (1.08)20 = € 4,660.96.
FV20 does not double FV10 because of the compounding of interests

5. You want to obtain your helicopter pilot’s licence. A club offers you lessons over two years, and
the price of all lessons is supposed to amount to €15,000. The club leaves you the choice between
the following payment terms:

a. you can either pay all lessons immediately with a 5% discount on the total price
(“discount” means “reduction” here, not the discount rate) ;

THE TIME VALUE OF MONEY and NET PRESENT VALUE 1/6


Exercises
b. or you can make two annual payments: the first one, €7,000, due immediately, and
the remaining amount in 1 year from now.
Question: what discount rate "r" would make you indifferent between both proposals?
PV of first proposal is €15,000 x .95 = €14,250. PV of second proposal is equal to €7,000 paid upfront
plus PV of the second instalment i.e. €8,000/(1+r). We are looking for the "r" which will make €7,000
+ PV1 of €8,000 = €14,250:
€14,250 = €7,000 + €8,000 / (1+r)
⇔ €7,250 x (1+r) = €8,000
⇔ €7,250 x r = €750 ⇔ r = 10,34%

6. What is the present value at 5.75% (with yearly compounding) of €200 to be received in five
years, three months and 12 days?
Discounting period is 5 years + 3/12 th year + 12/365th year, which makes 5.283 years exactly. PV =
€200/(1+.0575)5,283 = €148.85

7. How much would you have to invest today to have €100 in 7 years if the interest rate was
3.5 %? What is the capitalisation factor?
As €100 is the FV, PV = FV/(1+3.5%)7 = €78.60

8. At 7.5%, would you rather have €250 today or €359 in 5 years’ time? Why?
PV = €250, and FV = €250 x (1+7.5%)5 = €358.91, hence it makes no difference.

9. You are only prepared to forego immediate spending if you get a 7% return on your investment.
What would be the top price you would be prepared to pay for a security today that would pay
you €132 in 3 years? If other investors were asking for 5.5%, what would happen?
I would be prepared to pay €132/(1.07)3 = € 107.75, but if other investors are ready to ask 5.5%, they
would be prepare to pay more, as €132/(1.055)3 = €112.41 which would cancel my investment
opportunity.

10. If instead of buying a sheep for 30 pieces of silver in year 28 BC, a man had invested them
at 3.5% per annum, how much would his descendants get in 2022? And at 1.5%?
n = 2022 – (-28) = 2050 years, PV = 30, FV=30 x (1+3.5%)2050 = 1.27 x 1032. Although mathematically
possible, the descendants would be unlikely to get anything at all, given the wars, revolutions, periods
of inflation, state bankruptcies, etc. that have occurred since 28 BC ! It would be “only” at 5.40 x 1014
at a 1.5% interest rate. Over a very long period a small change in return creates huge differences.

11.You have the choice between buying a painting for €125,000 which will be worth €215,000 in 7
years and investing in government bonds at 8.05%. What would your choice be? Why?
€125,000 x (1.0805)7= 214,923.26 €, so it makes (almost) no difference, except risk is taken into
account ... Those two assets belong to two different categories, which makes them not directly
comparable.

THE TIME VALUE OF MONEY and NET PRESENT VALUE 2/6


Exercises

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