FSDM 1

Financial Strategy and Decision Making 1 (FSDM1)

Week 1: Revision on Time Value of Money

1. Definition:
“Time Value of Money”
It is a fundamental concept that a dollar today is worth more now than a dollar in the future due to its
earning power. (interest)

2. Explanation:
Future Value, FV = PV (1+r)n
Where PV is the present value and r is the annual compound interest and n is the number of year.

A dollar today, PV =$1.

A dollar in the future one year, n=1, FV=$1, if the interest is compounded 10% annually, hence
PV = FV/ (1+r)-n = $1 / (1.1)1 =$0.909
Hence, $1 today is worth more now than S1 a year later, as $1 a year later is worth only $0.90 today.

3. Annuity and Perpetuity

Annuity: It a series of equal cash flows that is made at a regular interval.
Perpetuity: It is a series of equal cash flows that are made indefinitely.

Present value of Annuity, PV = PMT x [ 1-(1+r)-n]/ r

Present value of Perpetuity, PV = PP/r

We also have Future value of Annuity, FV = PMT x [(1+r)n -1]/r

PMT means the amount of equal cash flow, r is the annual interest rate, n the number of years.

4. Future value compounded non-annually

M=2, compounded semi-annually
M=4, compound quarterly
M-12, compounded monthly

FV = PV [1+r/m]mn

5. Future value compounded continuously.

FV = PVert

6. Effective Annual Rate, EAR = (1 + quoted rate/m) m -1 [The annual rate that produce the same
return of the compounded rate.

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Time Value of Money Extra Problem Set 1

1. You are planning to retire in twenty years. You'll live ten years after retirement. You want to be
able to draw out of your savings at the rate of $10,000 per year. How much would you have to
pay in equal annual deposits until retirement to meet your objectives? Assume interest remains at
9%. [$1254]

2. You can deposit $4000 per year into an account that pays 12% interest. If you deposit such
amounts for 15 years and start drawing money out of the account in equal annual installments,
how much could you draw out each year for 20 years? [$19964.12]

3. What is the value of a $100 perpetuity if interest is 7%? [$1428.57]

4. You deposit $13,000 at the beginning of every year for 10 years. If interest is being paid at 8%,
how much will you have in 10 years? [$203391.33]

5. You are getting payments of $8000 at the beginning of every year and they are to last another
five years. At 6%, what is the value of this annuity? [35720.84]

6. How much would you have to deposit today to have $10,000 in five years at 6% interest
compounded semiannually? [$7440.94]

7. Construct an amortization schedule for a 5-year loan of $20,000 if interest is 6%. How much is
the outstanding amount of the loan after 3 years. [$4,748 AND $8,705]

8. If you get payments of $15,000 per year for the next ten years and interest is 4%, how much
would that stream of income be worth in present value terms? [$121663.50]

9. Your company must deposit equal annual beginning of year payments into a sinking fund for an
obligation of $800,000 which matures in 15 years. Assuming you can earn 4% interest on the
sinking fund, how much must the payments be? [$38415]

10. If you deposit $45,000 into an account earning 4% interest compounded quarterly, how much
would you have in 5 years? [$54908.55]

11. How much would you pay for an investment which will be worth $16,000 in three years? Assume
interest is 5%. [$13821]

12. You have $100,000 to invest at 4% interest. If you wish to withdraw equal annual payments for 4
years, how much could you withdraw each year and leave $0 in the investment account?
[$27548]

13. You are considering the purchase of two different insurance annuities. Annuity A will pay you
$16,000 at the beginning of each year for 8 years. Annuity B will pay you $12,000 at the end of
each year for 12 years. Assuming your money is worth 7%, and each costs you $75,000 today,
which would you prefer? [$102228 and $95312]

14. If your company borrows $300,000 at 8% interest and agrees to repay the loan in 10 equal
semiannual payments to include principal plus interest, how much would those payments be?
[$36897]

15. You deposit $17,000 each year for 10 years at 7%. Then you earn 9% after that. If you leave the
money invested for another 5 years how much will you have in the 15th year? [$361374]

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