Chapter 03 Math Solution

Math : Solve Problems
Problem 1: A firm wants to open a new coal mine. The price of coal is very volatile and the
projected profits over the next five years are : Rs. 100,000 , Rs. 250,000 , Rs. 10,000 , Rs.
200,000 and Rs. 50,000 respectively. After that profits will be a constant Rs. 150,000 per year for
next 20 years at which time the mine closes. If 7% is the appropriate discount rate for the first five
years and is 8% after that, what is the present value of the mine?
Solution:
Total Present Value = 508,208.96 + 1,050,025.44

Answer: Rs. 1,558,234.4
Problem 2: You are borrowing Rs. 80,000 for 25 years at 10% nominal annual interest. How much
must your annually payments be if you will completely retire the loan over the 25-year period by
factor formula?
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Solution:
Answer: Rs. 8,813.48
Problem 3: Perpetuity makes payments of Rs. 500 every year, with the first payment coming one
year from today. If the discount rate is 5%, what is the present value of the perpetuity?
Solution:
Answer: Rs. 10,000
Problem 4: Waleed just purchased a new house for Rs. 120,000. He was able to make a down
payment equal to 25% of the value of the house; the balance was mortgaged. The rate by the bank
is 10% compounded annually. The mortgage has a 20 year amortization period (this means that
payments are calculated assuming it will take 20 years to pay off the loan).
(a) What will be the size of the payments by factor formula?

(b) What will be the balance remaining on the mortgage after 5 years?
Solution:
Down Payment = 120,000* 25% = Rs. 30,000
Loan Amount = 120,000 – 30,000 = Rs. 90,000
CCF = Rs. 10,571.32
Answer: (a) Rs. 10,571.32 (b) Rs. 80,409
Problem 5: If you borrow Rs. 150,000 for a house at 8% compound annual interest rate for 30
years, what is your monthly payment by general formula?
Solution:
Answer: Rs. 10,935.73

Problem 6:
An annual interest rate of 12% compounded monthly has an
effective yield of?
Solution:
Answer: 12.68%
Problem 7: An annual interest rate of 12% compounded quarterly has an effective yield of?
Solution:
Answer: 12.55%
Problem 8: A simple annual interest rate of 12% compounded semi-annually is an effective yield
of?
Solution:
Answer: 12.36%
Problem 9: A real estate investor feels that the cash flow from a property will enable his to pay a
lender Rs. 15,000 per year, at the end of every year, for 10 years. How much should the lender be
willing to loan her if he requires a 9% annual interest rate by general formula (annually
discounting, assuming the first of the 10 equal payments arrives one year from the date the loan is
disbursed)?
Solution:
Answer: Rs. 96,265.5

Problem 10: Now that you are finished school, you also have to start paying back your student
loans. You borrowed a total of Rs. 12,500. You plan to pay back the loan over 10 years at an interest
rate of 9.4% interest, compounded monthly. How much will your monthly payments be?
Solution:
Answer: Rs.161.06
E. Class Work
PROBLEM:
1. The value of a house is estimated to be $80,000 today.
A. If it has increased in value by 7 percent per year for the last 10 years, what was the
value 10 years ago?
B. If the house had increased in value by 48 percent over the total 10-year period, what
would have been the annual percentage increase?
PROBLEM:
2. You are thinking about purchasing 65 acres of land that you believe can be developed as a
shopping center. You estimate that you could sell the land 3 years from now at $15,000 per
acre.
A. How much should you pay now for the land if the required rate of return is 25%?
B. Suppose the seller is asking $10,000 per acre; what is the expected rate of return at
this price?
PROBLEM:
3 You are interested in buying a duplex as an investment. Your required before-tax rate of
return is 12 percent. You are shown a property which has an asking price of $30,000. You
expect the following cash flows for a holding period of 6 years:
Year (n) Cash Flow
1 $ 4,500
2 5,000
3 6,000
4 3,000
5 8,000
6 20,000
A. Should you buy the investment?

B. What would be your expected rate of return?
PROBLEM:
6. Mr. and Mrs. Smith are considering the purchase of a house. They can afford to make a
mortgage payment of $750 per month.
A. If the current mortgage interest rate is 9%, with monthly payments for 30 years, and
they make a down payment of 20 percent of the purchase price, can they buy a house
costing $110,000?
B. What is the maximum amount they can borow?
PROBLEM:
7. You borrow $60,000 for 30 years with monthly amortization, and your monthly payment is
$758.67.
What is the interest rate being charged?
s
8. Jim makes a deposit of $12,000 in a bank account. The deposit is to earn interest annually
at the rate of 9 percent for seven years.
a. How much will Jim have on deposit at the end of seven years?
b. Assuming the deposit earned a 9 percent rate of interest compounded quarterly, how
much would he have at the end of seven years?
c. In comparing (a) and (&), what are the respective effective annual yields? (Hint:
Consider the s value of each deposit after one year only.) Which alternative is better?
9. Would you prefer making a $25,000 investment that will earn interest at the rate of 7
percent compounded monthly or making the same $25,000 investment at 8 percent
compounded annually. (Hint: Consider one year only.)
10. John is considering the purchase of a lot. He can buy the lot today and expects the price to
rise to $15,000 at the end of 10 years. He believes that he should earn an investment yield
of 10 percent annually on his investment. The asking price for the lot is $7,000. Should he
buy it? What is the effective annual yield of the investment if John purchases the property
for $7,000 and is able to sell it 10 years later for $ 15,000?
11. 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?
12. Jones can deposit $5,000 at the end of each six- month period for the next 12 years and
earn interest at an annual rate of 8.5 percent, compounded semiannually. What will the
value of the investment be after 12 years? If the deposits were made at the beginning of
each period, what would the value of the investment be after 12 years?
13. Suppose you deposit $1,250 at the end of each quarter in an account that will earn
interest at an annual rate of 15 percent compounded quarterly. How much will you have
at the end of four years?
14. Suppose you deposit $2,500 at the end of year 1, nothing at the end of year 2, $750 at the
end of year 3, and $1,300 at the end of year 4. Assuming that these amounts will be
compounded at an annual rate of 9 percent, how much will you have on deposit at the
end of five years?
15. An investor is considering an investment that will pay $2,150 at the end of each year for
the next 10 years. He expects to earn an annual return of 18 percent on his investment.
How much should he pay today for the investment? How much should he pay if the
investment returns are paid at the beginning of each year?
16. 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.
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)?
17. Walt 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. Walt believes that he should earn an annual
rate of 9 percent on this investment, compounded monthly. How much should he pay for
this investment?
18. A loan of $50,000 is due 10 years from today. The borrower wants to make annual
payments at the end of each year into a sinking fund that will earn interest at an annual
rate of 10 percent. What will the annual payments have to be? Suppose that the monthly
payments earn 10 percent interest, compounded monthly. What would the annual
payments have to be?
19. The Dallas Development Corporation 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
Dallas purchases the project, what will be its internal rate of return? If the company
insists on a 9 percent return compounded annually on its investment, is this a good
investment?
20. A corporation is considering the purchase of an interest in a real estate syndication at a
price of $75,000. In return, the syndication promises to pay $1,020 at the end of each
month for the next 25 years (300 months). If purchased, what is the expected internal rate
of return, compounded monthly? How much total cash would be received on the
investment? How much is profit and how much is return of capital?
21. An investment in a real estate venture will provide returns at the end of the next four
years as follows: year 1, $5,500; year 2, $7,500; year 3, $9,500; and year 4, $12,500. An
investor wants to earn a 13 percent annual return on her investment. How much should
she pay for the investment? Assuming that the investor wanted to earn an annual rate of
13 percent compounded, monthly, how much would she pay for this investment? Why are
these two amounts different?
22. A pension fund is making an investment of $ 100,000 today and expects to receive $ 1,500
at the end of each month for the next five years. At the end of the fifth year, the capital
investment of $100,000 will be returned. What is the internal rate of return on this
investment?
23. An investor has the opportunity to make an investment that will provide an effective
annual yield of 10 percent. She is considering two other investments of equal risk that will
provide compound interest monthly and quarterly, respectively. What must the
equivalent nominal annual rate (ENAR) be for each of these two investments to ensure
that an equivalent annual yield of 10 percent is earned?
24. An investment producing cash flows in the amount of $1,000 per month is undertaken for
a period of 28 months. The investor pays $24,000 for the investment and the contract
stipulates that investment returns must be calculated as annual returns (annual
compounding). What would be the annual interest rate reported to the investor? What
would be the annual rate compounded monthly for this investment.
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Math : Solve Problems

Total Present Value = 508,208.96 + 1,050,025.44

Answer: Rs. 8,813.48

Answer: Rs. 10,000

(a) What will be the size of the payments by factor formula?

CCF = Rs. 10,571.32

Answer: Rs. 10,935.73

Answer: Rs. 96,265.5

1. The value of a house is estimated to be $80,000 today.

A. Should you buy the investment?

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