Practice Problems

Time Value of Money

Problem 1
Your friend offers to sell his house to you for P4.5 million. You make a down payment of 20% and agree to pay the balance through equal monthly payments over the next 30 years at an annual interest of 7.5 % compounded monthly. Your first payment is made one month after paying the down payment. After several years, your friend asks you to pay off the remaining balance at the end of 8 years as he needs the money to migrate to the U.S. How much do you need to pay at the end of 8 years?

Solution 1
Total amount of loan = 4.5M x 0.80 = 3.6M (a) Monthly payments = pmt n = 30 yrs x 12 mo / yr = 360 mos i = 0.075 / 12 By Formula: pmt = PV i / [ 1 (1+i)] = (3.6M) ( 0.075/12) 1 (1 + 0.075/12) = 25,171.72 By Excel: = pmt(rate, nper, pv, fv, type) = pmt ( 0.075/12, 30 x 12, -3600000, 0, 0 ) = 25,171.72

Solution 1
(b) Balance at the end of 8 years: n = 8 yrs x 12 mos/yr = 96 mos By Formula = PV (1 + i) - {pmt [(1+i) - 1]} / I = 3.6M[1+(0.075/12)] - 25,171.72(1+0.075/12) /( 0.075/12 ) = 6,547,390.82 3,297,373. 47 = 3,250,017.34 By Excel: FV(rate, nper, pmt, pv, type) = FV( 0.075/12, 96, 0, -3600000,0) - FV (0.075/12, 96, -25171.72, 0,0) Or Excel : = FV(0.075/12, 96, 25171.72, -3600000,0)

Alternative solution for Balance

Get the present value of regular payments for remaining 22 years: By Formula: PV = {Pmt [1 (1 + i )]} / i = {25,171.72 [1 ( 1 +(0.075/12)}/(0.075/12) = 3,250,017.04 By Excel: =PV(rate, nper, pmt, fv, type) = PV (0.075/12, 22x12, -25171.72,0,0) = 3,250,017.34

Problem 1A
In order to pay your friend the total amount by the eight year, you plan to borrow from a local bank. You will borrow P3,250,000 at an interest rate of 6.2% per annum compounded quarterly, payable in 20 years. So as not to upset your budget, you intend to pay the bank semi-annually. How much will your payment be each time?

Solution to Problem 1A
Interest per quarter = 0.062/4 = 0.0155 Interest per 6 months: = (1.0155) -1 = 0.03124 No. of periods = 20 yrs x 2 = 40 PV = 3,250,000 Pmt = pmt (rate, nper, pv, fv, type) = pmt ( 0.03124, 40, -3250000, 0, 0) = 143,435.48

Problem 2
Your existing credit card has an unpaid balance of P60,000. The interest rate is 24 % per year, compounded monthly. To reduce interest payments you transfer the balance to a second bank which offers an introductory interest rate of 2.4% per year compounded monthly for the first 6 months, and increasing thereafter to 18% per year compounded monthly for the succeeding months. Assuming you make no subsequent payments, how much interest charges will you save at the end of one year by transferring the balance to the second bank?

Solution to Problem 2
Formula: FV = PV (1 + i ) i = .24/12=.02 n=12 Current bank: FV = 60,000 (1.02) = 76,094.51 Excel: FV = FV (rate, nper, pmt, pv, type) = FV (.24/12, 12, 0, -60000, 0) Second bank: FV1 = 60,000 [1 + (0.024/12)] = 60,723.61 Excel: FV1 = FV (.024/12, 6, 0, -60000, 0) FV2 = 60,723.61 [ 1 + (0.18/12)] = 66,397.82 Excel: FV2 = FV (.18/12, 6, 0, -60723.61, 0) Interest charges saved = 76,094.51 - 66,397.82 = 9,696.69