Fundamentals of Financial Management 2013

TUTORIAL Lecture 2
1. Textbook, Chapter 4: 4, 5, 6, 10, 15, 20, 22, 25, 28, 30, 31, 35, 44, 47, 50, 58, 60, 64, 74, 78.
2. A wealthy relative give Barney $5,000 to help provide for his new born childs university fee.
He decides to invest this money at 10% p.a. until his child is ready to go to university. How
much will be in the account 18 years from now?
3. Barney wants to provide $20,000 for his new born childs education, which will begin 18
years from today. How much should Barney invest now, if the interest rate is 10% p.a.?
4. How long will it take for a $1,000 investment to double in size when invested at the rate of
8% per year?
5. Suppose you have $500 to invest and you want to know how long will it take for this amount
to double in size if the interest rate is 10% p.a.
6. You borrow money on your credit card at 17.5% p.a., compounding quarterly. What is the
effective annual interest rate?
7. The following interest rates are being offered by three competing banks: 4% compounded
monthly; 4.1% compounded quarterly; 4.15% compounded annually. Which one is the most
attractive?
8. Barney lends $100,000 to John, his cousin in 10 years at 5% p.a.
a. How much John has to pay after 10 years ( if use simple interest rate)
b. How much John has to pay after 10 years ( if use compounded interest rate)
c. Assume that Barney lends $100,000 to John, using simple interest rate, but wants to
receive the payment which is equal to that if using compounded interest. What should
the interest rate be?
9. You have just received a letter from your aunt, which advises that she has written to you
into her will. On her passing, you will receive an inheritance of $50,000. Assuming r= 8% p.a.,
what is the inheritance worth in todays dollars if your aunt lives another 5 years? 15 years?
10. On a contract, you have a choice of receiving $25,000 six years from now or $50,000 twelve
years from now. At what implied compound annual interest rate should you be indifferent
between the two contracts?
11. You have just won the prize in the State lottery. A recent innovation is to offer prize winners
a choice of payoffs. You must choose one of the following prizes:
a. $1,000,000 paid immediately
b. $600,000 paid exactly one year from today, and another $600,000 paid exactly 3 years
from today
c. $70,000 payment at the end of each year forever (first payment occurs exactly 1 year
from today)
d. An immediate payment of $600,000, then beginning exactly 5 years from today, an
annual payment of $50,000 forever
e. An annual payment of $200,000 for the next 7 years (first payment occurs exactly 1 year
from today)
f. Require: you believe that 8% p.a. compounded annually is an appropriate discount rate.
Assuming you wish to maximize your current wealth, which is the best prize?
12. Ann buys a new computer. The stated price is $2,000, but the retailer has a special offer
whereby she has to pay $400 immediately and then another $400 each year of the next 7
years. If the interest rate is 8% p.a., what is the effective cash price?

Fundamentals of Financial Management 2013

13. Mr. and Mrs. Haiku have two offers for their apartment in Tokyo. The first calls for payment
of 50 million now and 50 million in one year. The second would pay 90 million
immediately. The appropriate interest rate is 4%. Which offer has the higher PV?
14. Muffin Megabucks is considering two different savings plans in 10 years. The first plan would
have her deposit $500 every six months, and she would receive an interest rate at 7% p.a.
(compounding semi-annually). Under the second plan she could deposit $1,000 every year
with the rate of interest of 7.5% p.a. (compounding annually)

15.

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Which plan should Muffin use? (Assuming that the initial deposit of Plan 1 would be made 6
months from now, and with Plan 2, one year hence)
Kates financial advisor tells her that she will need $2 million to fund her retirement. She
plans to work for another 30 years before retiring. She will make 30 contributions to a
pension plan. How much will each contribution be, if the interest rate is 9% p.a.?
Mary has just retired and has $1 million in her retirement account. Her bank offers an
arrangement whereby the bank takes her $1 million now and pays her $110,000 at the end
of each year for the next 20 years. Is it a fair deal, if the offered rate is 10% p.a.?
Joe Hernandez has inherited $25,000 and wishes to purchase an annuity that will provide
him with a steady income over the next 12 years. He has heard that the local bank is
currently paying 6% p.a. (compounding annually). If he were to deposit his fund, what is the
equal amount would he be able to withdraw at the end of each year for 12 years?
Your company anticipates the introduction of environmental protection laws 3 years from
now. Under these laws, you will have to pay an environment tax of $5,000 at the end of each
year. If the rate is 6% p.a., what is the present value of your companys obligation under this
law?
Vernal Equinox wishes to borrow $10,000 for three years. A group of individuals agrees to
lend him this amount if he contracts to pay them $16,000 at the end of the 3 years. What is
the implicit compound annual interest rate implied by this contract?
The Happy Hang Glide Company is purchasing a building and has obtained a $190,000
mortgage loan for 20 years. The loan bears a compound interest rate of 17% p.a. and calls
for equal annual installment payments at the end of each of 20 years. What is the amount of
annual payment?
Mary enters into a loan agreement to borrow $90,000 to help finance the purchase of her
new home.
a. The agreement specifies the term of 20 years with monthly repayment at the fixed rate
of 9% p.a. (compounded monthly). What is her monthly payment?
b. Five years has passed. A rival lender offers to refinance Marys loan at the fixed rate of
8% p.a. (compounded monthly). The cost associated with this refinancing is $1,500.
Should she refinance?
c. Suppose 9 years have passed since Mary enters the original loan. Shes considering
making an extra payment of $10,000 off her loan. If she plans to keep the term of the
loan the same, how much will her monthly repayment reduce?