SM Nahidul Islam

Dept. of Finance & Banking (2nd batch)

Problems & Solutions

Problem -1: What is the- present value (today) of the following cash flows at an interest rate of 12
percent per year?
a. $100 received five years from now.
b. $100 received each year beginning one year from now and
ending ten years from now.
c. $100 received each year beginning one year from now and continuing forever.
Solution:
a. Given that,
Future value (FV) = $100
Number of years (n) = 5 years
Annual interest rate (i) = 12% = .12
Present value (PV) =?
We know that,
n
PV = FV (1+i)

5
= $100 (1+.12)

=$ 56.74
b. Given that
Amount received at the end of each year (A) = $100
Number of years (n) = 10 years
Annual interest rate (i) = 12% = .12
Present value (PVA) =?
We know that,

PVA = A

1(1+i)
i

]
Islamic University, Kushtia
[1]

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)

= $100

10

1(1+.12)
.12

=$ 100 5.6502
= $ 565.02
c. Given that,
Amount received at the end of each year (A) = $100
Annual interest rate (i) = 12% = .12
Present value of a perpetual annuity (PV) =?
We know that,
Present value of a perpetual annuity (PV) =

A
i
$ 100
.12

= $833.33
Problem-2: What is the value of the following investments five years from now at an interest rate of
8 percent per year, 2 percent per quarter, or

2
3 percent per month depending on the compounding

period?
a. $100 invested today with interest compounded annually.
b. $ l00 invested today with interest compounded quarterly.
c. $100 invested today with interest compounded monthly.
Solution:
a. Given that,
Present value (PV) = $100
Number of years (n) = 5 years
Annual interest rate (i) = 8% = .08
Future value (FV) =?
Islamic University, Kushtia
[2]

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)
We know that,
n
FV = PV (1+i)
5
= $100 (1+.08)

= $100 1.4693
= $146.93
b. Given that,
Present value (PV) = $100
Number of years (n) = 5 years
Annual interest rate (i) = 8% =.08
Number of times per year interest is compounded (m) = 4
Future value (FV) =?
We know that,
n m
FV = PV (1+i/m)
54
= $100 (1+.08/4 )
20

= $100 (1+.02)
= $100 1.4859
= $ 148.59

c. Given that,
Present value (PV) = $100
Number of years (n) = 5 years
Annual interest rate (i) = 8% =.08
Number of times per year interest is compounded (m) = 12
Future value (FV) =?
We know that,
n m
FV = PV (1+i/m)
5 12
= $100 (1+.08/12)
60
= $100 (1+.0066)

= $100 1.4898
= $ 148.98

Problem-3: Find the future value of the following investments; the interest rate is 8 percent per year,
compounded annually:
a. $100 is invested each year beginning one year from now and continuing through year 10,
when the proceeds are withdrawn.
Islamic University, Kushtia
[3]

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)

b. $100 is invested each year starting today and continuing through year 10, when the proceeds
are withdrawn.
c. $100 is invested each year beginning one year from now and continuing through year 9. The
proceeds are to be withdrawn in year 10.

Solution:
a. Given that,
Amount invested at the end of each year (A) = $100
Number of years (n) = 10 years
Annual interest rate (i) = 8% =.08
Future value of ordinary annuity (FVA) =?

We know that,

FVA = A

(1+i ) 1
i

= $100

]
10

( 1+ 0.08) 1
0.08

= $100 14.4866
= $1448.66
b. Given that,
Amount invested at the starting of each year (A) = $100
Number of years (n) = 10 years
Annual interest rate (i) = 8% =.08
Future value of annuity due (FVA) =?

We know that,

FVA = A

(1+i) 1
i

(1+i)

Islamic University, Kushtia

[4]

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)

= $100

10

( 1+ 0.08) 1
0.08

(1+0.08)

= $100 15.6455
= $1564.55

c. Given that,
Amount invested at the starting of each year (A) = $100
Number of years (n) = 9 years
Annual interest rate (i) = 8% =.08
Future value (FV) =?

We know that,

Future value of ordinary annuity (FVA) = A

= $100

(1+i ) 1
i

( 1+ 0.08) 91
0.08

= $100 12.4875
= $1248.75
1

Total future value = $1248.75 (1+.08)

= $1348.65
Problem-4:

Islamic University, Kushtia

[5]

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)

a. If you put $1000 into a savings certificate today paying interest of 10 percent per year, how
much money will you have in the account after six years if no withdrawals are made from it
until then? How much of this is interest?
b. Suppose you withdraw the interest every year. What will be your total earnings? Why does this
differ from the interest earned in a?
Solution:
a. Given that,
Present value (PV) = $1000
Number of years (n) = 6 years
Annual interest rate (i) = 10% = .10
Future value (FV) =?
We know that,
n

FV = PV (1+i)

6
= $1000 (1+.10)

= $100 1.7716
= $1771.6
Total interest = $1771.6 - $1000
= $ 771.6
b. Total earnings = $1000 10% 6
= $600
This differs from the interest calculated in part a by 171.6 ($771.6 $600) because the interest in part a is
calculated on the compounded interest rate but in part b the interest is calculated on the simple interest
rate.
Problem -5:

How much money should you put in a savings account at the end of each month in order to have
$10,000 in the account at the end of ten years? Assume that the same amount will be saved each
month and that the account pays

1
2

percent interest per month.

Solution:
Islamic University, Kushtia
[6]

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)
Given that,
Future value of ordinary annuity (FVA) = $10,000
Number of years (n) = 10 years
Number of times per year interest is compounded (m) = 12
Annual interest rate (i) = 6%
1
Monthly interest rate (i/m) = 2 % = 0.005
Amount invested at the end of each month (A) =?
We know that,

A = FVA

i/m
n m
( 1+i / m) 1

= $10,000

.005
10 12
(1+.005)
1

= $ 61.02

Problem 6:

Solution:

Islamic University, Kushtia

[7]

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)

Problem -7:

Islamic University, Kushtia

[8]

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)

Solution:

Islamic University, Kushtia

[9]

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)

Alternative B:
Cash flow stream:

Problem- 8:
Islamic University, Kushtia
[10]

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)

Loan amortization schedule: Joan Messineo borrowed $15,000 at a 14% annual rate of interest to
be repaid over 3 years. The loan is amortized into three equal, annual, end-of-year payments.
a. Calculate the annual, end-of-year loan payment.
b. Prepare a loan amortization schedule showing the interest and principal breakdown of each of
the three loan payments.
c. Explain why the interest portion of each payment declines with the passage of time.
Solution:
a.
A

= $15,000 (PVIFA14%,3)
= $15,000 2.322
= $6,459.95

A
A

Calculator solution: $6,460.97

b.

End of

Loan

Beginning of

Year

Payment

Year Principal

Payments

End of Year

Interest

Principal

Principal

$ 6,459.95

$15,000.00

$2,100.00

$4,359.95

$10,640.05

$ 6,459.95

10,640.05

1,489.61

4,970.34

5,669.71

$ 6,459.95

5,669.71

793.76

5,666.19

(The difference in the last year's beginning and ending principal is due to rounding.)
c.

Through annual end-of-the-year payments, the principal balance of the loan is declining, causing
less interest to be accrued on the balance.

Islamic University, Kushtia

[11]

SM Nahidul Islam
Dept. of Finance & Banking (2nd batch)

Exercise
1. If you wish to have $10,000 ten years from now, how much money must you invest today in a
savings certificate that pays 8 percent per year?
2. Assume that it is now January 1, 2015. On January 1, 2016, you will deposit $1,000 into a savings
account that pays 8 percent.
a. If the bank compounds interest annually, how much will you have in your account on January
1, 2019?
b. What would your January 1, 2019, balance be if the bank used quarterly compounding rather
than annual compounding?
c. Suppose you deposited the $1,000 in 4 payments of $250 each on January 1 of 2016, 2017,
2018, and 2019. How much would you have in your account on January 1, 2019, based on 8
percent annual compounding?
d. Suppose you deposited 4 equal payments in your account on January 1 of 2016, 2017, 2018,
and 2019. Assuming an 8 percent interest rate, how large would each of your payments have to
be for you to obtain the same ending balance as you calculated in part a?
3. Suppose Mr. X takes out a tk. 5,000 five year loan at 9%. The loan is payable at 5 annual
installments. Prepare the loan amortization schedule.
4. Find the PV of the stream of cash flows shown in the following table. Among the firms
opportunity cost is 12%.
Year
1
2
3
4
5

Cash
Flow
2,000
3,000
4,000
6,000
8,000

5. Rishi Singh has $1,500 to invest. His investment counselor suggests an investment that pays no
stated interest but will return $2,000 at the end of 3 years.
a. What annual rate of return will Rishi earn with this investment?
b. Rishi is considering another investment, of equal risk, that earns an annual return of 8%.
Which investment should he make, and why?
****** End *****

Islamic University, Kushtia

[12]