ACCOUNTING AND FINANCE

University of Auckland
Executive Programmes
___________________________________________
Accounting and Finance for Graduate Diploma in Business

MODULE 1 – Practice examples

The Arithmetic of Finance

Optional reference: Chapter 14 of the Text “Financial Management

and Decision Making”
Practice problems

1. You have just inherited a trust. You and your heirs will receive $25,000 per year
forever, beginning one year from now. What is the present value of the trust
given an 8% discount rate?

a. $182,500
b. $200,000
c. $287,500
d. $312,500
e. $337,500

2. How much must be invested today in order to generate a five-year annuity of

$1,000 per year, with the first payment 1 year from today, at an interest rate of
10%?
a. $1,610.51
b. $3,446.17
c. $3.790.79
d. $4,545.45

A. Which of the following will increase the present value of an annuity, other things
equal?

a. Increasing the interest rate.

b. Decreasing the interest rate.
c. Decreasing the number of payments.
d. Decreasing the amount of the payment.

4. What is the present value of a five period annuity of $1,000 if the interest rate is
10% and the first payment is made today?

a. $3,169.87
b. $3,790.79
c. $4,169.87
d. $4,790.79

5. An amount of $3,000 is deposited into an account paying 10% annually, to

provide three annual withdrawals of $1,206.34 beginning in one year. How much
remains in the account right after the second payment has been withdrawn? (Hint:
simply consider the present value of the last remaining withdrawal.)

a. $1326.97
b. $1206.34
c. $1096.67
d. $ 587.32
6. If $50,000 is borrowed for a home mortgage, to be repaid at 10% interest over 30
years with monthly payments of $438.79, how much interest is paid over the life
of the loan?

a. $157,964.40
b. $150,000.00
c. $107,964.40
d. $ 75,000.00

7. What will be the monthly payment on a home mortgage of $75,000 at 12%

interest, to be amortized over 30 years?

a. $775.90
b. $771.46
c. $1028.61
d. $1034.53

8. Approximately how much must be saved in order to withdraw $100,000 per year
for the next 25 years for retirement if the balance earns 8% annually, and the first
payment occurs one year from now?

a. $1,067,000
b. $1,250,000
c. $2,315,000
d. $2,500,000

9. In 1899, Vincent Van Gogh's painting, "Sunflowers", sold for $125. One hundred
years later it sold for $36 million. Had the painting been purchased by your great-
grandfather and passed on to you, how much would your average annually
compounded rate of return have been?

a. 9.11%
b. 10.09%
c. 11.88%
d. 11.99%
e. 13.40%

10. A given rate is stated as 12% p.a., but has an affective annual rate of 12.55%.
What is the compounding interval during the year?

a. annually
b. semiannually
c. quarterly
d. monthly
e. daily

11. You want to buy a car for $20,000. You need to pay a 20% deposit today, and the
car dealer offers to finance the balance over 18 months at an interest rate of 12%
 per annum. Assume that payment is made at the end of each month. What is the
monthly payment required?

12. Would you prefer a savings account that paid 7% interest, compounded quarterly,
over an account that paid 7.5% with annual compounding if you had $1,000 to
deposit? Would the answer change if you had $100,000 to deposit?

13. After reading the fine print in your credit card agreement, you find that the “low”
interest rate is actually an 18% stated annual rate, or 1.5% per month. Now, to
make you feel even worse, calculate the effective annual interest rate.

14. A loan officer says that “thousands of dollars can be saved by switching to a 15-
year mortgage from a 30-year mortgage.” Calculate the difference in payments on
a 30-year mortgage at 9% interest versus a 15-year mortgage with 8.5% interest.
Both mortgages are for $100,000 and have monthly payments. What is the
difference in total dollars that will be paid to the lender under each loan?

15. This is a challenging one. Do not feel bad if you are confused. A gin tonic may
help. Suppose an average New Zealander starts work at age 25, retires at age 60,
and lives for another 20 years. Also assume that the average income is $40,000
p.a., and that a retirement income of $20,000 p.a. is desired. Assume a 6% interest
rate.

a. Calculate the present value of the average lifetime income (i.e. present value of a
35-year $40,000 annuity).

b. Calculate the present value of the retirement income at the beginning of retirement
(i.e. present value of a 20-year $20,000 annuity at that time).

c. Now calculate the present value today of the amount in part b (i.e. discount the
answer to part (b) back 35 years). What percentage of the average lifetime income
must be set aside (or taxed) to fund the retirement for an individual?

16. Most banks have a mortgage calculator in their website. For instance, visit:
http://www.nbnz.co.nz/personal/calculators/homeloan.asp. Verify the repayment
amount for a $100,000 20-year 8% p.a. standard (table) mortgage under monthly
and fortnightly payment using your own calculations.
Suggested answers for Module 1 (Finance) practice problems

1. d $25,000/0.08 = $312,500

2. c. $3,790.79. PV = $1,000 *(1/0.1)*(1 – 1/1.15) = $3,790.79

3. b Decreasing the interest rate.

4. c $4169.87.

PV = 1000 * (1/0.1)*(1 – 1/1.14) + 1000

= (1000 * 3.1699) + 1000 = 4169.87

5. c $1,096.67 1,206.34 / 1.1 = 1,096.67

6. c $107,964.40 (438.79 * 360) – 50,000 = $107,964.40

7. b $771.46

75,000 = C * (1/0.01)*(1 – 1/1.01360)

= C * 97.2183
C = 771.46

8. a $1,067,000

PV = 100,000 * (1/0.08)*(1 – 1/1.0825 )

= 1,067,477.62 ≅ 1,067,000

9. e. $125 = $36,000,000/(1+r)100 => r = (36,000,000/125)(1/100)-1 = 13.4%

10. c. 1.1255 = (1+0.12/m)m . By trial and error, m = 4.

11. Amount borrowed = $20,000*80% = $16,000

$16,000 = C *PVAF(1%,18) = C * 16.398
Therefore, C = $975.73

12. FV = (1 + i )n for simple interest

FV = (1 + i/m)n* m for compound interest

Then, FV = (1 + 0.07/4)1*4 = 1.0719

versus FV = (1 + 0.075)1 = 1.075

Thus, the 7.5% account will earn $3.10 more in the first year than the 7%
account with quarterly compounding. The amount to be deposited should not
change your preference.
13. 1 + effective rate = (1 + r/m)m
effective rate = (1+0.18/12)12 – 1
= 1.01512 –1
= 1.1956 –1
= 0.1956 or 19.56%

14. 100,000 = C * (1/0.0075)*(1 – 1/1.0075360)

C = 804.62

100,000 = C * (1/0.007083)*(1 – 1/1.007083180)

C = 984.69

Difference in total dollars = (804.62*360) – (984.69*180)

= 289,663.20 – 177,244.20
= $112,419

15.

a. PV = $40,000*(1/0.06)*(1- 1/1.0635) = $579,929.85

b. PV at age 60 = [$20,000*(1/0.06)*(1- 1/1.0620)] = $229,398.42

c. PV now = $229,398.42/1.0635 =$29,845.93

Percentage of income =$29,845.93/$579,929.85 = 5.15%

16. Don’t cheat. Go back and verify the answers.