Page 55 - DMGT409Basic Financial Management

Basic Financial Management

Notes m = No. of times per year discounting is done.
I = Discount rate (annual).
Illustration 26: Mr. A expected to receive `1,00,000 at the end of 4 years. His required rate of
return is 12 per cent and he wants to know PV of ` 1,00,000 with quarterly discounting.
Solution:
×
⎛ 1 ⎞ 44
PV = 1,00,000 ⎜ ⎟
1 0.12/4⎠
⎝ +
= 1,00,000 × PVIF
3per cent 4y
= 1,00,000 × 0.623 = ` 62,300

Task Calculate the following:
1. Mr. A deposits at the end of each year ` 2000, ` 3000, ` 4000, ` 5000 and ` 6000 for the
consequent 5 years respectively. He wants to know his series of deposits value at the
end of 5 years with 6 per cent rate of compound interest.
2. A borrower offers 16 per cent rate of interest with quarterly compounding. Determine
the effective rate of income.
3. What is the present value of ` 1,00,000, which is receivable after 60 years. If the
investor required rate of interest is 10 per cent.

Evolution of different Alternatives

he application of the time value of money principles can help you make decisions on
loan alternatives. This exercise requires you to compare three mortgage alternatives
Tusing various combinations and points. Points on a mortgage refer to a payment
that is made upfront to secure the loan. A single point is a payment of one per cent of the
amount of the total mortgage loan. If you were borrowing ` 200,000 a single point would
require an upfront payment of ` 2,000.
When you are evaluating alternative mortgages, you may be able to obtain a lower rate by
making an upfront payment. This comparison will not include an after-tax comparison.
When taxes are considered, the effective costs are affected by interest paid and the
amortization of points on the loan. This analysis will require you to compare only before-
tax costs.
Zeal.com allows you to compare the effective costs on alternative mortgages. You are
considering three alternatives for a ` 250,000 mortgage. Assume that the mortgage will
start in December, 2006. The mortgage company is offering you a 6% rate on a 30-year
mortgage with no points. If you pay 1.25 points, they are willing to offer you the mortgage
at 5.875%. If you pay 2 points, they are willing to offer you the mortgage at 5.75%.
Questions
1. What are the mortgage payments under the three alternatives?
2. Which alternative has the lowest effective cost?
3. Can you explain how the effective rate is being calculated?

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