Admas university

Academic Year 2019 -20

Department: accounting and finance

Name of Assignment: department cost allocation

Full Name: Medhane Nega

Roll No.: 1861/19
Subject: intermediate accounting
Section: “A2”
Date of Submission: January-12-2023
 1. What is the time value of money?
 The time value of money is a financial principle that states the value of a dollar today is
worth more than the value of a dollar in the future. The time value of money is the widely
accepted conjecture that there is greater benefit to receiving a sum of money now rather
than an identical sum later.
2. Why does money have time value?
 Because, as the basis of Western finance, you will use it in your daily consumer, business
and banking decision making. All of these systems are driven by the idea that lenders and
investors earn interest paid by borrowers in an effort to maximize the time value of their
money. Your job within this system is to limit the cost of money to you and to increase
returns on your investments.
3. What is compound interest? Compare compound interest to discounting?
 Compound interest is the interest you earn on interest. This can be illustrated by using basic
math: if you have $100 and it earns 5% interest each year, you'll have $105 at the end of the
first year. At the end of the second year, you'll have $110.25. Not only did you earn $5 on
the initial $100 deposit, you also earned $0.25 on the $5 in interest. While 25 cents may not
sound like much at first, it adds up over time. Even if you never add another dime to that
account, in 10 years you'll have more than $162.
 Compound interest VS discounting

BASIS FOR COMPOUNDING DISCOUNTING

COMPARISON

Meaning The method used to determine the future value The method used to determine
of present investment is known as the present value of future cash
Compounding. flows is known as Discounting.
Concept If we invest some money today, what will be the What should be the amount we
amount we get at a future date. need to invest today, to get a
specific amount in future.
Use of Compound interest rate. Discount rate
Factor Future Value Factor or Compounding Factor Present Value Factor or
Discounting Factor
Formula FV = PV (1 + r)^n PV = FV / (1 + r)^n

4. How is present value affected by a change in the discount rate?

 Setting a high discount rate tends to have the effect of raising other interest
rates in the economy since it represents the cost of borrowing money for most
major commercial banks and other depository institutions. This could be
 considered a contractionary monetary policy. Exactly how much a high discount
rate affects the economy as a whole depends on the relationship between the
discount rate and the normal market rate of interest for loans to banks.
5. What is annuity?

 The term "annuity" refers to an insurance contract issued and distributed by financial
institutions with the intention of paying out invested funds in a fixed income stream in
the future.
6. How does continuous compounding benefit an investor?
 Reinvest gains perpetually
One of the benefits of continuous compounding is that the interest is reinvested into the
account over an infinite number of periods. It means that investors enjoy the continuous
growth of their portfolios, as compared to when they earn interest monthly, quarterly, or
annually with regular compounding.
 Interest amount will keep on growing
In continuous compounding, both the interest and the principal keep on growing, which
makes it easier to multiply the returns in the long term. Other forms of compounding
only earn interest on the principal and that interest is paid out as it is earned.
Reinvesting the interest allows the investor to earn at an exponential rate for an infinite
number of periods.
7. What formula would you use to solve for the payment required for a car loan if you
know the interest rate, length of the loan, and the borrowed amount? Explain.
 Your monthly auto loan payment will depend on the car price, down payment, length of
the loan (term), and interest rate of the loan, which is highly dependent on your credit
score. Interest rates on used car loans also tend to be higher than those on new car loans.
Use the inputs below to get a sense of what your monthly auto loan payment could end
up being.You can use the car loan calculator to determine how much interest you owe, or
you can do it yourself if you're up for a little math. Here's the standard formula to
calculate your monthly car loan interest by hand:
Monthly interest=(interest rate )×loan balance
To calculate your monthly car loan payment by hand, divide the total loan and interest
amount by the loan term (the number of months you have to repay the loan).

M=p*i/1-(1+I) ^-L

Problems

1. Meron has just taken out a bank loan for $12,000 which will be paid back monthly over a
3 year period. If the annual interest rate is 8% compounded monthly, what are her
monthly loan payments?

Solution
n
FV =P ( 1+ i )
3
FV =12,000(1+0.08)
FV =15,116.544
2. Samrawit is saving for a car that she wishes to purchase from her Uncle in 5 years. Her
Uncle has promised to sell her the car for $7,000 at that time. How much does Samrawit
have to put in her savings account at the beginning of each year if her account receives
interest of 5% annually? Her deposits will start tomorrow and will continue annually until
the beginning of the 5th year.

Solution

3. Mr. and Mrs. Mikihazemed would like to buy an annuity that will pay for their son’s
university education. They believe an annuity that pays $5,000 every six months for four
years will be adequate. Their son is in junior high school, so they will not need any
money from the annuity until the start of the 6th. Year. The interest rate available for the
annuity is 7% annually. How much will they pay today for the annuity?
4. NEBIR BANK’s preferred shares have a par value of $2,500 and pay an annual dividend
of $200. The current required rate is 6.42%. What is the current price of the shares?
5. Find the future value of an annuity of $600 per year for 4 years if the interest rate is 19
per cent.

Solution
FV =P ( 1+ i )n
4
FV =600( 1+ 0.19)
FV =1,203.203526

6. Find the future value at the end of 9 years of $500 invested today at an interest rate of 8
percent.

Solution
n
FV =P ( 1+ i )
9
FV =500(1+ 0.08)
FV =999.5023136
7. Find the present value of the following cash flow stream if the interest rate is 16 per cent.
0 1 2 3 4 5 6

$200 $400 $200 $200 $500 $300

 Solution
FV
PV =
( 1+ i )n
200+400+ 200+200+500+300
PV =
( 1+ 0.16 )6
PV =738.7960584

8. Find the present value of the following cash flow stream if the interest rate is 19 per cent.
0 1 2 3 4 5

$500 $500 $200 $200 $200

Solution
FV
PV =
( 1+ i )n
500+500+200+200+200
PV =
( 1+0.19 )5
PV =670.4789935
9. You want to buy an ordinary annuity that will pay you $4,000 a year for the next 20
years. You expect annual interest rates will be 8 percent over that time period. The
maximum price you would be willing to pay for the annuity is closest to
10. In 3 years you are to receive $5,000. If the interest rate were to suddenly increase, the
present value of that future amount to you would

B Rise.
11. Assume that the interest rate is greater than zero. Which of the following cash-inflow
streams should you prefer?
Year Year Year3 Year4
1 2
B. $100 $200 $300 $400
12. You are considering borrowing $10,000 for 3 years at an annual interest rate of 6%. The
loan agreement calls for 3 equal payments, to be paid at the end of each of the next 3
years. (Payments include both principal and interest.) The annual payment that will fully
pay off (amortize) the loan is closest to

Solution
n
FV =P ( 1+ i )
 9
FV =500(1+ 0.08)
FV =999.5023136