TIME VALUE OF

MONEY : CHAPTER 2
PARVESH AGHI

COMPOUND INTEREST

Question 1
2000 is invested at annual rate of interest of
10%. What is the amount after 2 years if
compounding is done ?
(a) Annually ?

(b) Semi annually ?

(c) Monthly ?
(d) Daily ?

SOLUTION
(a) Annually ?
FVn

= P (1+i)n

FV2

= 2000 (1.10)2

FV2

= 2000 X 1.21

FV

= 2420

(b) Semi annually ?

Fn = P(1 + i/m)n*m m= no of compounding per year
Fn = 2,000(1 + .10/2)2*2

= 2,000(1.05)4

FV = 2000 x 1.2155 = 2,431

(c) Monthly ?

Fn = P(1 + i/m)n*m
Fn = 2000(1 + .10/12)2*12
Fn = 2000(1.00833)24
Fn = 2000 X 1.22029 = 2440.58

(c) Daily ?

Fn = P(1 + i/m)n*m
Fn = 2000(1 + .1/365)2*365
Fn = 2000(1.00027)730
Fn = 2000 X 1.22135 = 2442.70

Question 2
Determine the compound amount and compound
interest on 1000 at 6% compounded semi
anually for 6 years .
Given that (1+i) n = 1.42576 for i = 3% and n=12

Solution
Fn = P(1 + i/m)n*m m= no of compounding per
year

Compound amount (CA ) = 1000 ( 1.03)12 =

CA = 1000 X 1.42576 = 1425.76
Compound Interest = 1425.76-1000 = 425.76

Question 3
What annual rate of interest compounded
annually doubles an investment in 7 years ?
Given that 21/7 = 1.104090

FVn = 2P

FVn = P (1+i)n
2P= P (1+i)7
2= (1+i)7
21/7= 1+i
1.104090= 1+i
i= 1.104090-1 = .104090 = 10.41%

10

Question 4
A person opened an account on April 2012 with a deposit of 800 .
The account paid 6% interest compounded annually quarterly . On
October 1 2012 , he closed the account and added enough additional
money to invest in a 6 month time deposit for 1000 earning 6%
compounded monthly
(a) How much additional amount did the person invest on October 1?

(b) what was the maturity value of his Time deposit on April 1 , 2013 ?
(c) how much total interest was earned ?
Given that (1+i) is 1.03022500 for i= 11/2 % , n= 2 and is
1.03037751 for i= % and n= 6

11

Question 5
Ramanuj has taken a 20 month car loan of
6,00,000 . The rate of interest is 12 percent per
annum . What will be the amount of monthly loan
amortization

12

Solution
A=P / PVFA i N

A = 6,00,000 / PVFA 1% 20
A = 6,00,000 / 18.0456

A = 33,249.1

13

EFFECTIVE RATE OF INTEREST

14

Question 6
A Ltd offers interest of 13% on its Public Deposits
What is the effective rate of interest per annum if
compounding is done
(a) Half yearly

(b) Quarterly
(c) Monthly
(d) Weekly ?
Given that (1+i) is 1.1342 for i= 6.5% , n= 2 , 1.1365 for i= 3.25% and n= 4 ,
1.1380 for i = 1.083% , n= 12 , 1.1386 i = .25% n = 52

15

PRESENT VALUE

16

Question 7
What is the present value of 50,000 to be
received after 10 years at 10 per cent
compounded annually

17

P = F X PVFni

= 50,000 X .38554

= Rs 19, 277

18

Question 8
An investor can make an investment in a real
estate development and receive an expected
cash return of 45,000 after six years. Based on
a careful study of other investment alternatives,
she believes that an 18 percent annual return
compounded quarterly is a reasonable return to
earn on this investment. How much should she
pay for it today?

PVFi,n = .3477 for i= 4.5% n = 24

19

Solution
P/Y = 4, N = 6 4 = 24, I = 18, PMT = 0, FV =
45,000 PV = 15,646.66.

20

Question 9
Mr X has made real estate investment for
12,000 which he expects will have a maturity
value equivalent to interest at 12% compounded
monthly for 5 years . If most saving institutions
currently pay 8% compounded quarterly on a 5
year term , what is the least amount for which Mr
X should sell his property ?
Given that (1+i)n = 1.81669670 for i = 1% and n=
60 and that (1+i) -n = 0.67297133= 2% and n = 20

21

 It is a two part problem . First being determination of maturity value of

the investment of 12000 and then finding the present value of the
obtained maturity value.
A . Maturity Value of the Investment

F = P ( 1+i)n
P = 12,000
i = 12%/12 = 1%
n = 12X 5 = 60
F = 12000 X ( 1.01)60

= 12000 X 1.8167

= 21,800.40

22

B . Present value of the obtained maturity

value
P = F X PVF i,n
P = 21,800
i= 8%/4 = 2% n = 5 x 4 = 20 PVF 2%,20 =
0.67297
P = 21,800.40 X .67297 = 14,671.02
X should not sell the property for less than
14,671.02
23

Question 10
Suppose you have the opportunity to make an investment in a real
estate venture that expects to pay investors 750 at the end of each
month for the next eight years. You believe that a reasonable return
on your investment should be 17 percent compounded monthly.
Required :
a) How much should you pay for the investment?
b) What will be the total sum of cash you will receive over the next
eight years?
c) Why is there such a large difference between (a) and (b)?

Given PVFA i,n = 52.2972 where i = 1.4167% n = 96

24

Solution
(a)P/Y = 12, N = 8 12 = 96, I = 17, PMT = 750,
FV = 0 39,222.96
(b) This can be solved by setting I = 0, PV = 0,
and computing FV = 72,000.

(c ) The difference between the answers in parts

(a) and (b) represents the foregone interest that
results from receiving the payments in the future,
rather than today.

25

Question 11
ABC is evaluating an investment that will provide
the following returns at the end of each of the
following years:
year 1, 12,500; year 2, 10,000; year 3, 7,500;
year 4, 5,000; year 5, 2,500; year 6, 0; and year
7, 12,500.
ABC believes that he should earn an annual rate
of 9 percent on this investment. How much
should he pay for this investment?
Given Present value factors at 9% for years 1-7: 0.917, 0.842, 0.772
,0.708 0.650, 0.596, 0.547
26

Solution
This can be solved using the irregular cash flow worksheet:
CF0 = 0
C01 = 12,500
C02 = 10,000
C03 = 7,500
C04 = 5,000
C05 = 2,500
C06 = 0

C07 = 12,500
Set I = 9 and solve for NPV = 37,681

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ANNUITY

28

Question 12
A person is required to pay four equal annual
payments of 4000 each in his Deposit
account that pays 10% interest per year .
Find out the future value of annuity at the end
of 4 years
Given : CVFA i,n = 4.641 where i = 10% n = 4

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Solution
F = A { (1+ i)n-1 }

i
F = A X CVFAn,i
F4 = 4000 ( 1.10)4 -1 )/ .10

= 4000 X ( .14641-1 /.10)

= 4000 X 4.641

= 18564

CVFA 4,10% = 4.641

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Question 13
200 is invested at the end of each
month in an account paying interest 6%
per year compounding monthly . What is
the amount of this annuity after 10th
payment ?
Given that CVFA .005% ,10= 10.22

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Question 14
A investor wants to accumulate
43,746 at the end of four years from now
How much should deposited each year
at an interest rate of 6% so that it grows
to 43,746 at the end of fourth year ?
Given : CVFAi.n where i = 6% n= 4

32

Question 15
Y bought a TV costing 13,000 by making a
down payment of 3000 and agreeing to make
equal annual payment for 4 years . How much
would be each payment if the interest on unpaid
amount be 14% compounded annually ?
Given PVFA i,n = 2.914 where i=14% n= 4

33

Solution
Y bought a TV costing 13,000 by making a down payment of 3000 and
agreeing to make equal annual payment for 4 years . How much would be
each payment if the interest on unpaid amount be 14% compounded annually
?

A = P/ PVFAi,n
A = 10,000 / PVFA i,n
= 10,000 /2.914

= 3431.71

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Perpetuity

35

Question 16
Ramesh wants to retire and receive 3000 a
month . He wants to pass this monthly payment
to future generations after his death . He can
earn an interest of 8% compounded annually .
How much will he need to set aside to achieve
his perpetuity goal ?

36

Solution
A = 3000

P = A

i = .08/12 = .006667
P = 3000
.00667
= Rs 4,49,775
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Question 17
When Sunil retires he wants to have a
pension of Rs 60,000 per annum to grow
at 5% per annum if the insurance
company can get a return of 11% after
meeting its expenses , what lump sum
amount should Sunil pay now to
Insurance company.

38

Solution

P= 60,000/11%-5%
P= 60,000/6% = 10,00,000

A
P=
ig

39

Question 18
You own an oil pipe line which will generate a
2 million cash return over the coming year . The
pipelines operating costs are negligible , and it is
expected to last for a very long time .
Unfortunately, the volume of oil shipped is
declining , and cash flows are expected to decline
by 4% per year. The discount rate is 10%
what is the present value of the pipelines cash
flow if its cash flows are assumed to last forever ?

40

Solution

41

Question 19
You plan to retire 33 years from now. You expect that you will live 27
years after retiring.

You want to have enough money upon reaching retirement age to

withdraw 12,00,000 from the account at the beginning of each year
you expect to live, and yet still have 50,00,000 left in the account at
the time of your expected death (60 years from now).
You plan to accumulate the retirement fund by making equal annual
deposits at the end of each year for the next 33 years. You expect that
you will be able to earn 12% per year on your deposits. However, you
only expect to earn 6% per year on your investment after you retire
since you will choose to place the money in less risky investments.
What equal annual deposits must you make each year to reach your
retirement goal?
Given : CVFA i,n where i= 12% n =33 , PVFA i,n where i = 6% n = 27

PVF i,n where i=6% n = 27

Solution
You must solve this problem in two steps.

First, calculate the PV at the time of

retirement of the amount needed to give
you the annuity and remaining sum wanted.
Second, calculate the payment necessary
each year over the period from now until
retirement to generate the goal.

43

 Annuity = 12,00,000

FV =

= 6%

I=

27

N=

N=

50,00,000
6%
27

PV = A X PVFA 6%,27 X (1.06)

PV = FX PVF 6%,27

PV = 12,00,000 X 13.21053
X1.06

PV = 50,00,000 X . 0.20737
PV = 10,36,850

PV = 1,68,04,392
TOTAL = 1,68,03,794
+10,36,850= 1,78,40,644
A = F / CFVA 12%,33
A = 1,78,40,644/ 342.4294 =
52,100
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Sinking Fund

45

Question 20
How much amount is required to be invested
every year so as to accumulate 3,00,000 at the
end of 10 years if the interest is compounded
annually at 10%
Given CVFA i n = 15.9374 where i is 10% and n=
10

46

Solution
How much amount is required to be invested
every year so as to accumulate 3,00,000 at the
end of 10 years if the interest is compounded
annually at 10%
FV = 3,00,000
A = P / CVFA 10 , 10%
= 3,00,000 /15.9374
18,823.62

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Question 21
XYZ company is creating a sinking fund to
redeem its preference capital of 10 lakhs
issued on April 6 ,2012 and maturing on April 5,
2023 . The first annual payment will be made on
April 6 2012 . The company will make equal
annual payments and expects that the fund will
earn 12 percent per year . How much will be the
amount of sinking fund payment ?

CVFA i % n = 24.1331 where i = 12% n= 12

48

Solution
A = P / CVFA 12,12% X 1.12

= 10,00,000/ 24.1331 x 1.12

= 10,00,000 / 27,029072

= 36 , 997.35

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Question 22
A doctor is planning to buy an X-ray machine for
his hospital . He has two options . He can either
purchase it by making a cash payment of 5
lakhs or 6,15,000 are to be paid in six equal
annual instalments . Which option do you suggest
to the doctor assuming the rate of return is 12% ?
Present value of annuity of Re 1 at 12 percent
rate of discount for six years is 4.111

50

 A doctor is planning to buy an X-ray machine for his hospital . He has two
options . He can either purchase it by making a cash payment of 5 lakhs or
6,15,000 are to be paid in six equal annual instalments . Which option do
you suggest to the doctor assuming the rate of return is 12% ? Present value
of annuity of Re 1 at 12 percent rate of discount for six years is 4.111

Annual Instalment = 6,15,000 / 6 = 1,02,500

I = 12% n= 6
P= A X PVFAi,n
P = 1,02,500 X 4.111 = 4,21,377.50
The doctor should buy x ray machine on instalment basis as PV is less than
the Cash price

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Question 23
Consider that an investor has an opportunity of
receiving following amounts at the end every year for
five years
Year 1= 1000
year 2= 1500
Year 3 = 800
Year4 = 1100
Year 5 = 400
Find the present value of this stream of cash flows if
the investors required rate of return is 8%
52

Year

Cash Flow (Rs)

Factor
Present Value (Rs)
Discounted
Cash Discount
Flow

System
A
(8%)
(CF x DF)

1000

.926

926

1500

0.857

1285.5

800

0.794

635.2

1100

0.735

808.5

400

0.681

272.4

Total

3927.6

Question 24
A company offers a fixed deposit scheme
whereby 10,000 matures to 12625 after 2
years , on a half yearly compounding basis .
If the company wishes to amend the scheme by
compounding interest every quarter , what will be
the revised maturity value ?

54

F = P (1+i) n

12625 = 10,000 (1+i)4

10,000 (1+i) 4 = 12625
10,000 = 12625 / (1+i) 4
10,000 = 12625 X PVF i,4
PVF i,4 = 10,000/12625
PVF i,4 = .79207 = I = 6% for half year
i= 12% for full year
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If the company wishes to amend the scheme by

com pounding interest every quarter the revised
maturity

F = 10,000 (1+ 12%/4)4x2

= 10,000 (1.03)8
= 10,000 X 1.267
= 12,670

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Question 25
You are considering the purchase of an
investment that is expected to generate cash
flows of 15,000 per year for the next five years.
After that, cash flows are expected in increase at
the rate of 5 percent per year for the indefinite
future.
Thus, in year 6 the cash flow will be 15,750,
etc. How much is this investment worth to you
today if your required return is 15 percent?

57

58

Question 26
You are valuing an investment that will pay you 26,000
per year for the first 9 years, 34,000 per year for the
next 11 years, and 47,000 per year the following 14
years (all payments are at the end of each year).
Another similar risk investment alternative is an account
with a quoted annual interest rate of 9.00% with monthly
compounding of interest. What is the value in today's
rupee terms of the set of cash flows you have been
offered?

Given : ( 1.0075)12 = 1.0938 , PVFAin = 5.904 where i=

9.38% and n= 9 , PVFAi,n = 8.887 where i=9.38% and
n= 20, PVFAi,n = 10.155 where i= 9.38% and n= 34
59

Solution
Since the payments occur annually, but the interest is
compounded monthly, we first must calculate the effective
annual interest rate.
EIR = (1+i/m)nm -1
EIR = ( 1+ 9%/12)12 = ( 1.0075)12-1 = 1.0938 -1 = .0938 =
9.38%
PVAi,n = 5.904
PVAi,n = 8.887
PVAi,n = 10.155

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Present value of the cash in flows

Particulars

Cash Flow
per year

PVFA

Amount

26,000 per year for

the first 9 years

26000

5.904

1,53,504

34,000 per year for

the next 11 years

34,000

8.887 5.904
=2.983

1,01,422

47,000 per year the

following 14 years

47,000

10.1558.887 =
1.268

59596

Value in today's rupee terms of the set of cash flows 3,14,522

you have been offered?

61

Question 27
ABC Ltd is considering the purchase of an
apartment project for 100,000. They estimate
that they will receive 15,000 at the end of each
year for the next 10 years.
At the end of the 10th year, the apartment project
will be worth nothing. If the company insists on a
9 percent return compounded annually on its
investment, is this a good investment?
PVA n.i = 6.41766 where i= 9% and n= 10

62

P/Y = 1, N = 10, I = 9, PMT = 15,000, FV = 0

PV = $96,264.87. Based on
the NPV rule, this is a poor investment because
the present value of future cash

flows is less than the required investment of

$100,000.
Alternatively, you could enter PV = $100,000
and solve for I = 8.14%. Because the IRR of this
investment is less than the 9% hurdle rate, Dallas
should not invest in this project
63

Question 28
Amit is considering the purchase of a Plot. He
can buy the Plot today and expects the price to
rise to 15,00,000 at the end of 10 years. He
believes that he should earn an investment yield
of 10 percent annually on this investment. The
asking price for the plot is 7,00,000. Should he
buy it?

64

P/Y = 1, N = 10, I = 10, PMT = 0, FV = 15,00,000

PV = 5,78,314.93 . Because
the present value of this investment is less than
the 7,00,000 asking price for the lot,

Amit should not buy it.

65

Question 29
The quarterly returns on investment account of an
investor over the past year have been as follows:
First Quarter 5%
Second Quarter 2%
Third Quarter 7%
Fourth Quarter 1.5%
If Investor had 12,000 in the account at the beginning of
the year, what is the value in the account at the end of the
fourth quarter?

66

Solution:
This is simply a series of percent changes, where the
percent change is different in each period. To solve for
the future value, you must multiply by (1 + r) for each
period, and the r changes each time. So first convert
each percent (Big R) to the (1 + r) format: Divide by 100
and add 1.
First Quarter (1 + r) = 1.05
Second Quarter (1 + r) = 1.02
Third Quarter (1 + r) = 0.93
Fourth Quarter (1 + r) = 0.985
FV = 12,000 x 1.05 x 1.02 x 0.93 x 0.985 11,773.07
67

Question 30
What are the monthly payments on each of the
following Housing loans? Which loan is the best
option for a homeowner who can afford payments
of 875 per month? What is the total amount that
will be paid for each loan? Assume each Loan is
100,000.
Loan A: 30-year loan with a fixed interest rate of 8.5 percent
Loan B: 15-year loan with a fixed interest rate of 7.75 percent

Loan C: 20-year loan with a fixed interest rate of 8.125 percent

68

 Loan A. To determine the monthly payment for a 30-year loan with an 8.5-percent fixed
interest rate, clear your calculators memory, then set your calculator to 12 monthly
payments and end mode. Input the following to solve this equation:
PV = $100,000
N = 360 (Calculate the number of monthly periods by multiplying the length of the loan
by the number of months in a year: 30 * 12 = 360.)
I = 8.5/12
PMT = ?
Your monthly payment for this loan would be $768.91, and the total amount of all
payments would be $768.91 * 360, or $276,807.60.
The formula is: PV/((1-(1/(1+(I/P))^(N*P)))/(I/P))

69

Loan B. For a 15-year loan at 7.75 percent

interest, follow the same steps explained above.
This time, input the information listed below:
PV = $100,000

N = 15 * 12 = 180
I = 7.75
PMT = ? The monthly payment for this loan would
be $941.28, and the total amount of all payments
would be $941.28 * 180, or $169,430.40.
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Loan C. For a 20-year loan at 8.125 percent

interest, the calculations are still the same. Input
the
following in your financial calculator:

PV = $100,000 N = 20 * 12 = 240
I = 8.125
PMT = ?

71

The monthly payment for this loan would be

$844.24, and the total amount of all payments
would be $844.24 * 240, or $202,617.60.
Considering the mortgage payment the
homeowner can afford, the best financial option is
Loan Cthe 20-year fixed-rate mortgage at
8.125 percent interest. This loan would allow the
homeowner to pay off the home in 10 fewer years
than if he or she had the 30-year loan and to pay
$74,190 less

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THANK YOU

73

Question
You plan to retire 33 years from now. You expect that you will
live 27 years after retiring.

You want to have enough money upon reaching retirement age

to withdraw 180,000 from the account at the beginning of each
year you expect to live, and yet still have 2,500,000 left in the
account at the time of your expected death (60 years from now).
You plan to accumulate the retirement fund by making equal
annual deposits at the end of each year for the next 33 years.
You expect that you will be able to earn 12% per year on your
deposits. However, you only expect to earn 6% per year on your
investment after you retire since you will choose to place the
money in less risky investments.
What equal annual deposits must you make each year to reach
your retirement goal?

 27. You must solve this problem in two steps. First, calculate the PV at the time of
retirement of the amount needed to give you the annuity and remaining sum wanted.
Second, calculate the payment necessary each year over the period from now until
retirement to generate the goal.
n = 27
i=6
FV = 2500000

PMT = 180000
solve for PV (answer: = 3,038,989.79)
(make sure you are in begin mode)
n = 33

i = 12
FV = 3038989.79
solve for PMT (answer: = 8,874.79)
(make sure you are in end mode)
75

 XYZ Ltd is thinking of acquiring a new computer system

that will enhance productivity for five years to come. This
computer system project essentially - requires an initial
investment of 1 million today, - but yields in return the
following sequence of cash inflows in the future, as a
result from the enhanced productivity:
Year 1: 100,000
Years 2, 3, 4 300,000
Year 5: 100,000
Assess the computer system project at cost of capital of
5%
NPV = =951,662,
76

question
You are considering the purchase of two different
insurance annuities. Annuity A will pay you
16,000 at the beginning of each year for 8
years. Annuity B will pay you 12,000 at the end
of each year for 12 years. Assuming your money
is worth 7%, and each costs you 75,000 today,
which would you prefer? [102228 and 95312]

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