BFIN001 TUTORIAL ACTIVITIES – TUTORIAL 3

TIME VALUE OF MONEY 1

Learning Objectives

 Understand the Time Value of Money (TVM) concept

 Apply the TVM concept to a single cash flow to calculate present value or future value
 Compare different interest rates using an Effective Annual Rate
 Become familiar with using the formula and the financial calculator to solve cash flow problems

Activity 1
Ask your tutor any questions that you have from the previous lecture or from your tutorial preparation.

Activity 2
You have the choice of investing $10,000 in either:
- 8.4%pa compounding monthly, or
- 8.5%pa compounding semi annually

Which option would you choose? Why?

0.084 12
- 8.4%pa compounding (1+ ) − 1 = 8.73%
monthly, or 12
- 8.5%pa compounding 0.085 2
(1+ ) − 1 = 8.68%
semi annually 2

- I would invest in 8.4%pa compounding monthly as there is higher EAR rate meaning that higher return will be
received.

Would your answer be different if you were borrowing $10,000? Why?

- I would borrow at a 8.5%pa compounding semi annually as lower EAR rate means lower interest rate making it
less costly to borrow.

Activity 3
You placed $3,000 in the bank today and want to save a total of $5,000 in 3 years. Assuming monthly compounding,
what annual interest rate do you need to earn?

FV = PV ( 1 + i)n

5000 = 3000 ( 1 + i)36

I = 1.42 x 12
=17. 15 per annum
Activity 4
You have $4,500 in a bank account. How many years will it take you to save $5,000 if you can earn an interest rate
of 11%pa compounding monthly? Explain how “n” may change if the compounding frequency was half yearly. Use
an example to prove your answer.

5000= 4500 ( 1 + 0.11/2)n

n = 1.97/ 2
= 0.98

FV = PV ( 1 + i)n

5000= 4500 ( 1 + 0.11/12)n

n = 0.96

The higher the compounding frequency , the faster the amount of FV will be received

Activity 5 (advanced question to assist with TVM 2) - Attempt

In 2006 you invested $17,000 in a fund earning a constant return of 7.6%pa. In 2009 you withdraw $18,000 from the
fund. How much money will have invested in 2013?
Draw a timeline.

2006 2009 2013

17 000 = ( 1 + 7.6%)3

FV 2009 = 21178.04

PV = 21178.04 – 18 000

= 3178.04

FV = 3178.04 ( 1 + 7.6%)4

= 4259.99
Activity 6 (advanced question to assist with TVM 2) - Attempt

Use the information on the following timeline to calculate how much money you need to invest today.

I = constant 6%p.a

0 8 10
0

-$4,000

+$10,000

PV = FV ( 1 + i)-n

PV = 10 000 ( 1 + 6%)-2

PV = 8899.96
 8900

8900 - 4 000 = 4899.96

PV = FV ( 1 + i)-n

PV =4899.96 ( 1 + 0.06)-8
= 3074.31