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FINS1613 Business Finance

Tutorial Week 3 Solutions
(RTBWJ Chapter 5)


Question 1
To find the PVA, we use the equation:


PVA = C({1 [1/(1 + r) ]} / r )
PVA@15 yrs: PVA = $7,000{[1 (1/1.09)
15
] / .09} = $56,424.82
PVA@40 yrs: PVA = $7,000{[1 (1/1.09)
40
] / .09} = $75,301.52
PVA@75 yrs: PVA = $7,000{[1 (1/1.09)
75
] / .09} = $77,656.48
To find the PV of a perpetuity, we use the equation:
PV = C / r
PV = $7,000 / .09
PV = $77,777.78


Notice that as the length of the annuity payments increases, the present value of the annuity
approaches the present value of the perpetuity. The present value of the 75-year annuity and
the present value of the perpetuity imply that the value today of all perpetuity payments
beyond 75 years is only $121.30.



Question 2
APR (%) Number of times Periodic rate Effective rate
compounded (EAR)
9 Quarterly 2.25 9.31
13 Monthly 1.08 13.80
16 Daily 0.044 17.35
19 Half-yearly 9.5 19.90



Question 3
Quarterly rate (periodic) = 38% 4 = 9.5%
Number of payments = 4 payments 5 years = 20

1

PV
O
=
r
1
(1 + r)
n


$670

=

0.095
1

1

(1 + 0.095)
2O

= $5,904.30

Question 4
t

1

PV
O
=
r
1
(1 + r)
n

$2,000 1
$20,000 =

n = 20.9
0.08

1
(1 + 0.08)
n



It will take 21 years for you to pay off the loan.


Question 5

1

PV
4
=

1
r (1 + r)
n

$5,000

=

0.06
1

1
(1 + 0.06)
2

= $63,916.78


PV
O
=

PV
4

(1 + r)
4
=

63,916.78

1.06
4
= $50,628.08


You shouldn't lend the money under these terms. The value of the repayments is only
$50,628.08.


Question 6
Here we need to find the present value of a perpetuity at a date before the perpetuity begins.
We will begin by find the present value of the perpetuity. Doing so, we find:


PVP = C / r
PVP = $2,500 / .0545
PVP = $45,871.56


This is the present value of the perpetuity at year 19, one period before the payments begin.
So, using the present value of a lump sum equation to find the value at year 7, we find:


PV = FV / (1 + r)
PV = $45,871.56 / (1 + .0545)
12

PV = $24,265.23


Question 7
PV =

PV =

r g

$1,000

(0.05 (0.02))
=

$1,000

0.07
= $14,286

The value of the savings produced by the machine is worth $14,826 today.
Question 8
Here we need to find the interest rate that equates the perpetuity cash flows with the PV of
the cash flows. Using the PV of a perpetuity equation:


PV = C / r
$160,000 = $2,500 / r


We can now solve for the interest rate as follows:


r = $2,500 / $160,000
r = .0156 or 1.56% per month


The interest rate is 1.56% per month. To find the APR, we multiply this rate by the number of
months in a year, so:


APR = (12)1.56%
APR = 18.75%
And using the equation to find the EAR, we find:
EAR = [1 + (APR / m)]
m
1
EAR = [1 + .0156]
12
1
EAR = .2045 or 20.45%


Question 9
1

PV
O
=
r
1
(1 + r)
n

PV
O
= PVIFA
i,n

50,000 = 2,353,67 PVIFA
i,24

PVIFA
i,24
= 21.2434

From annuity tables, the monthly interest rate (periodic rate) is 1%.
APR = Per od c rate m = 0.01 12 = 12%


EAR = 1 +

APR

m

rn

1 = (1 + 0.01)
2
1 = 12.68%

Question 10
PV
O
=
r
1

$960
1

(1 + r)
+

1
6

r g

(1 + r)

$960(1.03)

0.12 0.03
=
0.12
1
(1 + 0.12)
+
(1 + 0.12)
= $3,460.59 + $6,234.13
= $9,694.71