GENTECH 3EE3

MIDTERM REVIEW QUESTIONS

In-class Review Problem Questions
 Capitalized Formula Problem

What is the PW of a cost to install= $2,500,000, infinite life,

maintenance of $300,000 every 10 years, annual i=5%?

SOLUTION

PW = 2,500,000 + 300,000(A/F,i,n)/i
PW = 2,500,000 + 300,000(A/F,5%,10)/0.05
PW = 2,500,000 + 300,000(0.07950)/0.05
PW = $2,977,000

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 Non Uniform Annuity Problem
Write the general mathematical expression that calculates A when
PW = 0 for the cash flow diagram shown below.

Calculate A if P = $50,000, X = $5,000, i = 5% and g = 2%.

P

A A A A A A

0 1 2 3 8 9 10 11 12 13 38 39 40

X
X(1+g)
X(1+g)2

X(1+g)27
X(1+g)28

X(1+g)29

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 Non Uniform Annuity Problem, Contd
SOLUTION

P +A(P/A,i,10) x(P/A,i,g,30)(P/F,i,10) = 0
A = [x(P/A,i,g,30)(P/F,i,10) P][1/(P/A,i,10)]

(A/P,i,10) = 1/(P/A,i,10), substitute into above expression

A = [x(P/A,i,g,30)(P/F,i,10) P](A/P,i,10) or

(A/P,i,10) = (F/P,i,10)(A/F,i,10), substitute into above expression

A = [x(P/A,i,g,30)(P/F,i,10) P](F/P,i,10)(A/F,i,10)
A = [x(P/A,i,g,30)(P/F,i,10)(F/P,i,10) P(F/P,i,10)](A/F,i,10)
A = [x(P/A,i,g,30) P(F/P,i,10)](A/F,i,10)

io = (1+i)/(1+g) 1 = (1+0.05)/(1+0.02) 1 = 0.029412

A = [5,000(P/A,2.94%,30)/(1+0.02) 50,000(F/P,5%,10)(A/F,5%,10)
A = $1,222 4
 PW Comparison Method Problem
A company is upgrading one of their oldest operating lines at their
packaging facility. Two options are available for upgrading; option A
and B.

Option A upgrading costs $65,000 now and yields annual savings of

$25,000 in the first year, $24,000 the second year, $23,000 in the
third year, and so on.

Option B costs $15,000 and saves $6,500 in the first year, with the
savings decreasing by 15% each year thereafter.

If the upgraded packaging line will last for eight years, which
upgrading option is better using the present worth method and
8% MARR? Draw a cash flow diagram for both options.

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PW Comparison Method Problem, Contd

SOLUTION

OPTION A:
PWA = -65,000 + [(25,000 1,000(A/G,8%,8)](P/A,8%,8)
PWA = -65,000 + (25,000 1,000(3.0985)(5.7466)
PWA = $60,859.16

OPTION B:
io = (1+i)/(1+g) 1 = (1+0.08)/(1-0.15) 1 = 0.270588
PWB = -15,000 + 6,500(P/A,g,i,n)/(1+g) = -15,000 + 6,500(P/A,io,8)/0.85
PWB = -15,000 + 24,100.36 = $9,100.36

Since PWA > PWB, select OPTION A!

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 Uniform Annuity Cash Flow Problem
You would like to save $10,000 for an upgrade to your business
computer system in 2 years time. If you deposit $350 every month
(starting today), what nominal interest rate is required in order for
you to reach your financial goal if the investment is compounded
monthly?
SOLUTION

Given F = 10,000, A = 350

n = 25 months

A = F(A/F,i,n) or F=A(F/A,i,n)
A = F(A/F,i,n) = F{i/[(1+i)^n-1]}
350 = 10,000{i/[(1+i)^n-1]}

i = 1%; A = 354.07
i = 2%; A = 312.20

Linear Interpolation:
i = 1+(2 1)[(350 354.07)/(312.20 354.07)]=1.097206

Therefore, r = mi = 12(1.097206) = 13.166% compounded monthly

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 Mortgage Problem
You have just bought a house for $300,000 and put $50,000 down.
The rest of the cost has been obtained from a mortgage. The
mortgage has a nominal interest rate of 3%, compounded monthly
with a 10-year amortization period. The term of the mortgage is 5
years. What is the monthly mortgage payment? How much will you
owe in 5 years?
SOLUTION

P = 300,000 50,000 = 250,000

i = 0.25%
n = 120 months

A = P(A/P,i,n) = 250,000(A/P,0.25%,120) = 250,000(0.009656)

A = $2,414.02

F5 = P(F/P,i,n) A(F/A,i,n)
F5 = 250,000(F/P,0.25%,60) 2,414.02(F/A,0.25%,60)
F5 = 250,000(1.161617) 2,414.02(64.647)
F5 = $134,345.83
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 Bond Problem 1
A man buys a corporate bond from a bond brokerage house for
$925. The bond has a face value $1,000 and pays 4% of the face
value each year. If the bond is paid off at the end of 10 years, what
rate of return will the man receive?
SOLUTION

PW of Cost = PW of Benefits
$925 = $40 (P/A, i%, 10) + $1,000 (P/F, i%, 10)

Try i = 5%
$925 = $40 (7.722) + $1,000 (0.6139) = $922.78 (i is too high)

Try i = 4.5%
$925 = $40 (7.913) + $1,000 (0.6439) = $960.42 (i is too low)

i* = 4.97%

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 Bond Problem 2
At what coupon interest rate will a $20,000 bond yield a nominal 12%
interest compounded quarterly if the purchaser pays $18,000 and the
bond becomes due in 20 years? Assume the bond interest is
payable quarterly.

SOLUTION

x = coupon rate per quarter

NPW = 0 = ($20,000* x) (P/A, 3%, 80) + $20,000 (P/F, 3%, 80) - $18,000

($20,000* x) (30.201) = $18,000 $20,000 (0.0940)

x = ($18,000 $20,000 (0.0940))/($20,000 30.201) = 0.0267 = 2.67%

Coupon rate = 2.67%/qtr 4 qtr/yr = 10.68%

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