ACC741: CORPORATE FINANCIAL MANAGEMENT I

TOPIC FOUR: TIME VALUE OF MONEY

TUTORIAL QUESTIONS

1. Would you rather have a savings account that pays 5% interest compounded
semi-annually or one that pays 5% interest compounded daily? Explain.

2. Give a verbal definition of the term present value, and illustrate it using a
cash flow time line with data from an example you construct. As part of your
answer, explain why present values are dependent on interest rates.

3. Suppose you are evaluating two investments, both of which require you to
pay $5,500 today. Investment A will pay you $7,020 in five years, whereas
investment B will pay you $8,126 in eight years.
a) Based only on the return you would earn from each investment,
which is better?
b) Can you think of any factors other than the expected return that
might be important to consider when choosing between the two
investments alternatives?

4. A company borrowed $25,000. The loan is to be repaid in equal instalments

at the end of each of the next five years, and the interest rate is 10%.
a) Set up an amortization schedule for the loan.
b) How large must each annual payment be if the loan is for $50,000?
Assume that the interest rate remains at 10% and that the loan is paid
off over five years.
c) How large must each payment be if the loan is for $50,000, the
interest rate is 10% and the loan is paid off in equal instalments at the
end of each of the next 10 years? This loan is for the same amount as
the loan in part (b) but the payments are spread out over twice as
many periods. Why are these payments not half as large as the
payments on the loan in part (b)?

5. John did various part-time jobs and intends to save for college. Now he is 20
years and he is about to begin college studies. A few months ago, John
received a scholarship that will cover all of his college tuition for a period not
exceeding five years. The money he saved will be used for his living expense
which is an equivalent of $10,000. Suppose he invested this money for his
graduation in four years’ time (on his 24th birthday) in an account that pays
interest of 12% compounded monthly;
a) How much can John withdraw every month while he is in college if
the first withdrawal occurs today?
b) How much can John withdraw every month while he is in college if
he waits until the end of this month to make the first withdrawal?

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6. In 2012, a research foundation was established by a fund of $2,000,000 invested
at a rate that would provide $240,000 payments at the end of each year, forever.

1. What interest rate was being earned in the fund?

2. After the payment in 2017, the foundation learned that the rate of interest
earned on the fund was being changed to 𝑖1 = 10% p.a. If the foundation
wants to continue annual payments forever, what size will the new payments
be?