CGE660 Norrulhuda M Taib

Time Value of Money

PART I: Present Value & Future Value
Time Value of Money: Know this terminology and notation
(1)
n
Future Value Interest Factor |Compound|
1/(1)
n
Present Value Interest Factor |Discount|
Rate per period
n Time period
A. Compound Interest
1. You have $10,000 cash and wish to earn money by savings in a compound account.
Currently, bank pays up to 5 interest per year. Calculate the amount that you will have aIter five
years oI savings.
Final Amount Initial Amount] x (1)
n
$10,000 ] x (1.05)
5
$12,762.82
2. Your Iinancial institution oIIers to provide tiered proIit rates Ior ten years oI investment. The
investment earns 4 Ior Iour years and then earns 6 Ior the remaining six years.
Determine the Iinal amount which you can earn Irom an initial investment oI $10,000.
Final Amount Initial Amount] x (1)
n
x (1)
n
$10,000 x (1.04)
4
x (1.06)
6
$16,594.67
3. Compare the earnings you received Irom the tiered rate with another institutions oIIer oI Ilat
rate oI 5 per annum. Determine the Iinal amount which you can earn Irom the same initial
investment oI $10,000.
Final Amount Initial Amount] x (1)
n
$10,000 x (1.05)
10
$16,288.95
4. You deposited $10,000 into an oIIshore account. Ten years later, your investment is
worth $17,910. What rate oI return did your earn Irom the investment?
Solution:
$17,910 $10,000 x (1i)
10
(1i)
10
$17,910/10,000 1.7910
(1i) (1.7910)
1/10
1.060
i .060 6.0
SemSept2013
Class Notes 2
B. Nominal Rate
SAP savings bank advertises their loan terms on nominal basis. To compare between
the actual loan values, you need to convert the SAP advertised Nominal Rates into EIIective
Rates.
12 nominal rates compounded quarterly
Step 1: Determine the nominal periodic rate; 12 / 4 3 per quarter
Step 2: Determine the annual EIIective Rate;
i
a
(1.03)
4
1 12.55
14 nominal interest rates compounded monthly
Step 1: Determine the nominal periodic rate ; 14 /12 1.167 per month
Step 2: Determine the annual EIIective Rate ;
i
a
(1.0167)
12
1 14.94
2 per month compounded monthly
Step 1: Determine nominal rate 2 x 12 24 per year compounded monthly
Step 2: Determine the annual EIIective Rate ;
i
a
(1.02)
12
-1 26.82
4 per quarterly compound
Step 1: Determine nominal rate .04 * 4 16 compounded monthly
Step 2: Determine the annual EIIective Rate ;
i
a
(1.04)
4
-1 16.98
B. Comparison between Rates;
You intend to select the best loan provider to Iinance your E&P project. EnRON
bank, government Iunds and private Iinanciers advertise their loan terms on varying
compounding periods.
Which is better?
a. Bank: 12 compounded quarterly
b. Government Funds: 10 compounded semi annually
c. Private Financiers: 1.5 per month