Page 36 - DMGT207_MANAGEMENT_OF_FINANCES

Unit 2: Time Value of Money

2. Define the following terms and phrases: Notes
(a) Compound sum of an annuity
(b) Present value of a future sum
(c) Present value of an annuity

(d) Annuity
(e) Discount rate
3. What happens to the effective rate of interest as the frequency of compounding is increased?

4. As a financial consultant, will you advise your client to have term deposit in a commercial
bank, which pays 8% interest compounded semi-annually or 8% interest compounded
annually? Why?
5. What effects do (1) increasing rate of interest and (2) increasing time periods have on the
(a) present value of a future sum and (b) future value of the present sum? Why?

6. Can annuity tables be used for all types of cash flows?
7. For a given interest rate and a given number of years, is the factor for the sum of an
annuity larger or smaller than the interest factor for the present value of the annuity?
8. Explain the mechanics of calculating the present value of a mixed stream that includes an
annuity.

9. A limited company borrows from a commercial bank 10,00,000 at 12% rate of interest to
be paid in equal end-of-year installments. What would the size of the instalment be?
Assume the repayment period is 5 years.
10. If ABC company expects cash inflows from its investment proposal it has undertaken in
time zero period, 2,00,000 and 1,50,000 for the first two years respectively and then
expects annuity payment of 1,00,000 for next eight years, what would be the present
value of cash inflows, assuming 10% rate of interest?
11. The XYZ company is establishing a sinking fund to retire 5,00,000 8% debentures
10 years from today. The company plans to put a fixed amount into the fund each year for
10 years. The first payment will be made at the end of current year. The company anticipates
that the fund will earn 6% a year. What equal annual contributions must be made to
accumulate 5,00,000, 10 years from now?

12. Calculate the price of 10% debentures having face value of 100, to be redeemed after
10 years at par and paying interest after every six months, assuming the market rate of
interest of debentures of similar risk and maturity period is (a) 10%, (b) 12%, (c) 8%

Answers: Self Assessment

1. interest 2. accumulated interest
3. compounding 4. compounding
5. discounting 6. smaller

7. Annuity 8. present value
9. future value 10. perpetuity
11. rate of interest 12. present value

LOVELY PROFESSIONAL UNIVERSITY 31