Chapter 2: Concepts of Value and Return

Problem 1
Time preference (discount) rate
(i) A. Investment
B. Period (years)
C. Compound value factor at 9% for 4 years
D.
Compound value at the end of 4 years: [A x C]
: 15,000 (1.09)4 = 15,000 x 1.4116

(ii)

A. Investment
B. Period (end of year)
C. Compounding periods
D. Compound value factor (lump sum)
E. Compound value [A x D]
5
: 6,000 (1.09) = 6,000 x 1.5386
4
: 6,000 (1.09) = 6,000 x 1.4116
(iii) A. Annual investment (end of year)
B. Period (years)
C. Compound value factor (annuity)
D. Compound value at the end of 8 years [A x C]
8
: 18,000 [(1.09) - 1]/0.09 = 18,000 x 11.0285
(iv) A. Annual investment (beginning of year)
B. Periods (years)
C. Compound value factor (annuity due)
D. Compound value at the end of 8 years [A x C]
8
: 18,000 [{(1.09) - 1}/0.09] (1.09) = 18,000 x 12.0210

9%
15,000
4
1.4116
21,173.72
Now
After 1 year
6,000
6,000
5
5
5
4
1.5386
1
9,231.74
8,469
18,000
8
11.0285
198,512.53
18,000
8
12.0210
216,378.66
Withdrawal

(v) A. Annual investment for 4 years

B. Compound value at the end of 4 years:
: 18,000 x [{(1.09)4-1}/0.09]
C. Compound value at the end of 5 years:
: (82,316.32 x 1.09) - 12,000
C. Compound value at the end of 6 years:
: (77,724.79 x 1.09) - 12,000
D. Compound value at the end of 7 years:
: (72,720.02 x 1.09) -12,000
E. Compound value at the end of 8 years:
: (67,264.82 x 1.09) - 0

82,316.32
89,724.79

12,000

77,724.79

84,720.02

12,000

72,720.02

79,264.82

12,000

67,264.82

73,318.66

73,318.66

Problem 2
Discount rate
(i) A. Cash flow
B. Period
C. Present value factor
D. Present value (Rs): 2,000/(1.13)0
(ii) A. Cash flow
B. Period
C. Present value factor: 1/(1.13)1
D. Present value (Rs): [A x C]: 2,000/(1.13)1

Balance

18,000.00

13%
2,000
0
1
2,000
2,000
1
0.8850
1,769.91

(iii) A. Cash flow

B. Period
C. Present value factor
D. Present value (Rs) [A x C]

2,000
2
0.7831
1,566.29

(iv) A. Cash flow

B. Period
3
C. Present value factor: 1/(1.13)
D. Present value (Rs): [A x C]: 4,000/(1.13)3

4,000
3
0.6931
2,772.20

(v) A. Cash flow

B. Period
C. Present value factor: 1/(1.13)3
D. Present value (Rs) [A x C]: 7,000/(1.13)3

7,000
3
0.6931
4,851.35

(vi) A. Cash flow

B. Period
C. Present value factor: 1/(1.13)4
4
D. Present value (Rs): [A x C]: 3,000/(1.13)

3,000
4
0.6133
1,839.96

(vii) A. Cash flow (annuity)

B. Period
C. Present value annuity factor:
[{(1.13)5-1}/{0.13(1.13)5}]
D. Present value (Rs):[A x C]:

4,000
5
3.5172

PV

41,.000
13

t
t

4,000 3.5172

t 1

(viii) A. Cash flow

B. Period
C. Present value factor (annuity due)
[{(1.13)5-1}/{0.13(1.13)5}](1.13)
D. Present value (Rs):

14068.93

4,000
5
3.9745
15,897.89

Problem 3
Discount rate
Year
A. Cash flows
B. PVF at 14%
C. Present value [A x B]
4

PV

1.14

3,000
t

t 1

14%
0

12832.30
7,000

1.14 5

1,000

1.14 6

3,000 2.9138 7,000 0.5194 1,000 0.4556

Rs12,832.30

Problem 4
A. Rate of interest
B. Sum received now (Rs)
C. Period (years)
D. Present value factor (annuity) at 15%

15%
100
10
5.0188

1
3,000.00
1
2,632

2
3,000.00
0.7695
2308.40

3
4
3,000.00 3,000.00
0.6750
0.5921
2024.91 1776.24

E. Capital recovery factor (annuity) at 15%

: [1/D]: 1/5.0188
F. Annual instalment (end of period) [B x E]
10

100

1
A 1 .15

t 1

0.1993
19.93

100 5 . 0188 A
A 100 / 5 . 0188 Rs 19 . 93
G. Present value factor (annuity due) at 15%:
: 5.0188 x 1.15
H. Capital recovery factor (annuity due) at 15% [1/G]
I. Annual instalment (beginning of period) [B x H]

5.7716
0.1733
17.33

Problem 5
A. Interest rate
B. Debt payable now (Rs)
C. Period of instalments (years)
D. Present value factor (annuity) at 10%
E. Capital recovery factor (annuity) at 10%
F. Annual instalment (end of period): [B x E]
5

1, 000

A 1 .101
t 1

10%
1,000
5
3.7908
0.2638
263.80

1, 000 A / 3 . 7908
A 1, 000 (1 / 3 . 7908 ) Rs 263 . 80

Problem 6
A. Time value of money
12%
B. Payment now (Rs)
13,000
C. Period of instalments (years)
5
D. Present value factor (annuity) at 12%
3.6048
E. Capital recovery factor (annuity) at 12%: [1/D]
0.2774
F. Annual instalment (end of period): [B x E], 13,000 x 0.2774
3606.33
G. Present value factor (annuity due) at 12%: [D x 1.12]
4.0373
H. Capital recovery factor (annuity due) at 12% [1/G]
0.2477
I. Annual instalment (beginning of period) (Rs): [B x H], 13,000 x 0.2477
3219.93
Problem 7
A. Discount rate
B. Outlay now
C. Period of instalments (years)
D. Present value factor (annuity) at 11%
E. Capital recovery factor (annuity) at 11% [1/D]
F. Annual instalment (end of period) [B x E or B/D]
G. Present value factor (annuity due) at 11%
H. Capital recovery factor (annuity due) at 11% [1/G]
I. Annual instalment (beginning of period) [B x H]

11%
10,000
5
3.6959
0.27057
2705.70
4.1024
0.24376
2437.57

Problem 8
A. Discount rate
B. Annual interest payment
C. Period (years)
D. Present value factor (annuity), 30 periods, 8%

8%
150
30
11.25778

E. Present value of annual interest [B x D]

F. Maturity value at the end of 30 years
G. Present value factor, end of 30 years
H. Present value of maturity value [F x G]
I. Present value of bond [E + H]:
30

PV

1150
.08

t 1

1688.67
1,000
0.09938
99.38
1788.04

1,000

1.0830

150 11.2578 1,000 0.0994 Rs1,788.04

Problem 9
A. Discount rate
B. Annual pension
C. Periods of pension
D. Present value factor, 20 years, 15%
E. Present value of pension at the end of 20 years
F. Present value factor, end of 20 years
G. Present value of pension now [E x F]

15%
10,000
20
6.25933
62593.31
0.06110
3824.47

Problem 10
A. Interest rate
B. Year
C. Cash flow
D. Present value factor
E. Present value (Rs) [C x D]
F. Net present value (Rs)

10%
0
-10,000.00
1.0000
-10,000.00
2,384.11

1-6
2,000
4
8,711

7
-1,500.00
0.5132
-769.74

8
9-12
1,600.00 2,500.00
0.4665
1.4788
746.41 3,696.91

0
-100
100
1,000

1
114
-112
0

0
-100

1
0

2
0

3
0

6,000
6%

6,000
10%

6,000
20%

6,000
30%

12,000

12,000

12,000

12,000

2
0.0583

2
0

2
0.1823

2
0.2624

Problem 11
IRR
( i ) Deposit and receive
( ii ) Borrow and pay
( iii ) Borrow and pay

14.0%
12.0%
13.0%

The following formula is used to compute IRR:

NPV

1 IRR
NCFt

C0 0

t 1

Problem 12
Year
Bank deposit

13%

Problem 13
We can use the following formula in calculating the time period, n, in this problem:

n ln 1 + r ln 2
1 + r
n = ln 2/ln

A. Investment
B. Interest rate (annual)
C. Expected amount after n years:
6000(1+r)n = 12,000
D. Compound value factor:(1.06)n
= 12,000/6,000
E. ln (1+r)

F. ln 2
G. n = ln 2/ln (1+r)
H. Interest rate (semi-annual)
I. ln (1+r/2)
J. n (half-years)= ln 2/ln (1+r/2)

0.6931
11.90
3%
0.0296
23.45

Problem 14
A. Annual earnings in 19X1
B. Period (years)
C. Annual earnings in 19X8
D. 45,000 (1 + g)7 = 67,550 = (1 + g)7 = 67,550/45,000
E. 7 ln (1+g)
F. ln (1+g)
G. (1+g)
H. g (growth): 1.06 - 1

1/ 7

67,550

g
45,000

1 1.50111/ 7 1 1.061 0.6 6%

45000
7
67,550
1.5011
0.4062
0.0580
1.060
6%

6%

Problem 15
A. Land price
B. Instalments
C. Annual instalment
D. Present value annuity factor required:40000/8213
E. From present value of annuity table, r equals 20%. We can
write the formula for IRR ( r ) as follows. The Excel in-built
formula can be used to calculate r. 20
8 , 213 t
40 , 000
1 r t
t 1

40,000
20
8,213
4.8703
20%

Problem 16
A. Needed future sum after 15 years
B. Period (years)
C. Interest rate
D. Future value factor of an annuity, 15 years, 12%
E. Annuity value [A/D]:

300,000
15
12%
37.2797
8047.27

1 . 12 15 1
A
30 , 000
0 . 12

37 . 28 A = 30,000
A = 30,000/37. 28 = Rs 8,047.27

Problem 17
A. Needed future sum at the age of 50
B. Period (years)
C. Interest rate
D. Future value factor of an annuity, 30 years, 10%
E. ( a ) Annuity value [A/D]
F. Future value factor of a lump sum, 30 years, 10%
G. ( b ) Lump sum deposited now [A/F]

1,000,000
30
10%
16.4494
60,792.48
17.4494
57,308.55

1
7
0
0
14

0.6931
3.80
10%
0.0953
7.27

0.6931
2.64
15%
0.1398
4.96

Problem 18
A. Savings today
B. Period (years)
C. Interest rate
D. Future value factor, 10 years, 10%
E. Future value [A x D]
F. Future value of an annuity factor, 10 years, 10%
G. Annual withdrawal [E/F]
H. Present value of annuity factor, 10 years, 10%
I. Annual withdrawal [A / H]

80,000
10
10%
2.5937
207499.40
15.9374
13,019.63
6.1446
13,019.63

Problem 19
A. Price of house
B. Cash payment
C. Balance
D. Instalment period
E. Interest rate
F. Present value of an annuity factor, 20 years, 12%
G. Annual instalment: 400,000/7.4694

500,000
100,000
400,000
20
12%
7.4694
53,551.51

The interest paid and principal repaid each year are as follows:
12%
Years
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

Balance
Instalment
400,000.00
394,448.49
53,551.51
388,230.80
53,551.51
381,266.98
53,551.51
373,467.51
53,551.51
364,732.10
53,551.51
354,948.45
53,551.51
343,990.75
53,551.51
331,718.13
53,551.51
317,972.80
53,551.51
302,578.02
53,551.51
285,335.87
53,551.51
266,024.67
53,551.51
244,396.12
53,551.51
220,172.14
53,551.51
193,041.29
53,551.51
162,654.74
53,551.51
128,621.79
53,551.51
90,504.90
53,551.51
47,813.98
53,551.51
0.15
53,551.51

Problem 20
A. Price of flat
B. Down payment
C. Loan processing fee
D. Net amount of loan
E. Period of mortgage loan (years)
F. Loan instalment
G. Required factor [D/F]
H. Present value of an annuity factor at trial rate 14%, 12 years

200,000
40,000
5,000
155,000
12
28,593
5.4209
5.6603

Interest
48,000.00
47,333.82
46,587.70
45,752.04
44,816.10
43,767.85
42,593.81
41,278.89
39,806.18
38,156.74
36,309.36
34,240.30
31,922.96
29,327.53
26,420.66
23,164.95
19,518.57
15,434.62
10,860.59
5,737.68

Principal
repaid
5,551.51
6,217.69
6,963.81
7,799.47
8,735.41
9,783.66
10,957.70
12,272.62
13,745.33
15,394.77
17,242.15
19,311.21
21,628.55
24,223.98
27,130.85
30,386.56
34,032.94
38,116.89
42,690.92
47,813.83

I. Present value of an annuity factor at trial rate 16%, 12 years

J. Rate of return:

5.660 5.421
14% 1%
14.52%
5.660 5.197

5.1971
15%
14.52%

Problem 21
Required rate
Year
0
1
2
3
4
5
6
7

13%
End
Cash flow
0
2000
2000
2000
1000
1000
1000
1000

Problem 22
A. Payment now
B. Annuity
C. Expected period for annuity (years)
D. Interest rate
E. Annuity factor
F. Present value of annuity
Sundaram should prefer Rs 200,000 now.

200,000
25,000
20
12%
7.4694
186,736

Problem 23
A. Time value of money
10%
B. 30-year annuity
5,000
9.4269
C. PVAF, 10%, 30 year
D. Present value of 30-year annuity
47,134.57
E. 20-year annuity
6,600
8.5136
F. PVAF, 10%, 20 year
56,189.52
G. Present value of 20-year annuity
H. Cash right now
50,000.00
You should choose 20-year annuity of Rs 6,600 as it has highest PV.
Problem 24
Interest rate
( i ) Amount now or
10-year annuity
PVAF, 8%, 10 year
Present value of 10-year annuity [14,000 x 6.7101]
Ms Punam should choose 10-year annuity

8%
80,000
14,000
6.7101
93,941

( ii ) Amount now or
20-year annuity
PVAF, 8%, 20 year
Present value of 20-year annuity [14,000 x 9.8181]
Ms Punam should choose to have Rs 150,000

150,000
14,000
9.8181
137,454

PVF
1.000
0.885
0.783
0.693
0.613
0.543
0.480
0.425

PV
0
1769.9
1566.3
1386.1
613.3
542.8
480.3
425.1
6783.8

Beginning
Cash flow
2000
2000
2000
1000
1000
1000
1000

PV
2000.0
1,769.9
1,566.3
693.1
613.3
542.8
480.3
0.0
7665.7

(iii) Amount now or

15-year annuity
PVAF, 8%, 15 year
Present value of 15-year annuity [14,000 x 8.5595]
Both alternatives are almost the same.

120,000
14,000
8.5595
119,833

Problem 25
Required rate of return

0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
PV

14%
End
Cash flow
PVF
PV
0
1.0000
2,000
0.8772
2,000
0.7695
2,000
0.6750
2,000
0.5921
2,000
0.5194
3,000
0.4556
3,000
0.3996
3000
0.3506
3,000
0.3075
6,000
0.2697
6,000
0.2366
6,000
0.2076
6,000
0.1821
6,000
0.1597
6,000
0.1401

0
1754
1539
1350
1184
1039
1367
1199
1052
923
1618
1420
1245
1092
958
841
18581

Beginning
Cash flow
2,000
2,000
2,000
2,000
2,000
3,000
3,000
3,000
3,000
6,000
6,000
6,000
6,000
6,000
6000
0

Problem 26
Borrowing
Interest rate
Annuity factor, 10%, 5 year
Annual payment: 50,000/3.7908

50,000
10%
3.7908
13,190
Year Outstanding Instalment Interest
Repayment
0
50,000
0
0
1
41,810
13,190
5,000
8,190
2
32,801
13,190
4,181
9,009
3
22,891
13,190
3,280
9,910
4
11,990
13,190
2,289
10,901
5
0
13,190
1,199
11,991

Problem 27
Nominal rate of interest
Period
Effective interest rate: annual compounding
Half-yearly compounding:
Compounding period
Half-yearly rate [12%/2]
Effective (annual) interest rate [(1.06)2-1]
Quarterly compounding:
Compounding period
Quarterly rate [12%/4]
Effective (annual) interest rate [(1.03)4-1]

12%
1
12%
2
6%
12.36%
4
3%
12.55%

PV
2,000
1,754
1,539
1,350
1,184
1,558
1,367
1,199
1,052
1,845
1,618
1,420
1,245
1,092
958
0
21,182

Monthly compounding:
Compounding period
Monthly rate [12%/12]
12
Effective (annual) interest rate [(1.01) -1]

12
1%
12.68%

Problem 28
A. Face value of debenture
B. Current yield (annual)
C. Half-yearly yield [18%/2]
D. Period (years)
E. Compounding periods [10 x 2]
F. Half-yearly interest amount

1,000
18%
9%
10
20
75

G. PVAF, 9%, 20 periods

H. Present value of 20-period annuity of Rs 75 [F x G]
I. PVF of a lump sum, 9%, 20 periods
J. PV of maturity value of Rs 1000 [1,000 x 0.1784]
K. Present value of the debenture [H + J]
20

Value of bond =

75
1.09

t 1

1,000

1.09 20

9.1285
684.64
0.17843
178.43

863.07

Problem 29
A. Initial deposit
B. Interest rate (annual)
C. Compounding period in a year
D. Quarterly rate [12%/4]
E. Period
F. Total compounding periods [C x E]
G. FVF, 3%, 30 periods
H. Future value [A x G]: [(1.03)30 x 1,000]

1,000
12%
4
3%
7.5
30
2.42726
2427.26

Problem 30
A. Half-yearly interest
B. Maturity (years)
C. Maturity value (at par)
D. Maturity value (at premium)
E. Required rate of return
F. Present value annuity factor, 6%, 14 periods
G. Present value factor, 6%, 14 periods
H. Value of the bond (redeemed at par):
(a) Value of interest [A x F]
(b) Present value of maturity value [C x G]
I. Value of bond (redeemed at premium):
(a) Value of interest [A x F]
(b) Present value of maturity value [D x G]

50
7
1,000
1,100
12%
9.2950
0.4423
907.05
464.75
442.30
951.28
464.75
486.53

Problem 31
Current deposit (Rs)
Montly withdrawal
Annual interest rate

10000
100
8%

Quarterly rate
2%
Monthly interest rate
0.006667
The present value of your deposit is Rs 10,000 and you want to withdraw Rs 100 every month. Thus

1
1
10,000 100

12n
0.00667 0.00667 1.00667

1
100 150
12n
0.00667 1.00667

1.00667 12n

150 100 0.00667 0.333

1.0066712n 3.0
12n ln 1.00667 ln 3 12n 0.00665 1.0986
1.0986
n
13.8
12 0.00665

You will be able to completely withdraw your deposit in about 14 years.

Problem 32
A. Preference share capital
B. Maturity period (years)
C. Required return
D. Compound value annuity factor, 12%, 8 years
E. Sinking fund factor, 12%, 8 years [1/D]
F. Annual contribution in SF (end of the year) [A x E]
G. Compound value annuity factor (annuity due), 12%, 8 years
H. Sinking fund factor (annuity due), 12%, 8 years [1/G]
I. Annual contribution in SF(beg. of the year) [A x H]

800,000
8
12%
12.2997
0.0813
65,042.27
13.7757
0.0726
58073.46

Problem 33
A. Face (and maturity) value of bond
B. Interest rate (half yearly)
C. Half yearly interest
D. Remaining life of bond (half years)
E. Required rate of return (half yearly)
F. Present value annuity factor, 6%, 8 years
G. Present value factor, 6%, 8 years
H. Value of bond:
(a) Present value of interest [C x F]
(b) Present value of maturity value [A x G]

1,000
7%
70
8
6%
6.2098
0.62741
1062.10
434.69
627.41

Problem 34
A. Annual payments
B. Period (years)
C. Principal
D. Internal rate of return:

3,800
4
10,000
19.14%
4

NPV

13,800r

t 1

By trial & error IRR is approx. 19%

Problem 35

10 ,000 0

19.14%

A. Loan amount
B. Period (years)
C. Interest rate
D. Annual repayment
E. Internal rate of return:

10,000
8
12%
2,013
12%
12%

NPV

12,013r

10 ,000 0

t 1

Interest rate charged by the bank and the internal rate of return are the same. 12% is the true rate of interest.
Loan amortisation schedule
Year
0
1
2
3
4
5
6
7
8

Beg.
Repayment
balance
Instalment
Interest
10,000
9,187
2,013
1,200
8,276
2,013
1,102
7,256
2,013
993
6,114
2,013
871
4,835
2,013
734
3,402
2,013
580
1,797
2,013
408
0
2,013
216

Problem 36
A. Amount deposited
B. Interest rate for years 1-5 (5 years)
C. Interest rate for years 6-13 (8 years)
D. Compound value for 13-year period:
5
8
[1,000(1.10) x (1.13) ]
E. Compound rate of interest:
[(4,281.45/1,000)1/13 - 1]

1,000
10%
13%
4,281.45
11.84%

Principal
813
911
1,020
1,142
1,279
1,433
1,605
1,797

End
balance
9,187
8,276
7,256
6,114
4,835
3,402
1,797
0

5
6
7,000.00 1,000.00
0.5194
0.4556
3635.58
455.59

5 6 7 8

10

0 0 0 0

0 -3,395

4
0

5 6 7 8
9
0 0 0 0 300