Future values of cash flows are discounted becau

investment does not meet or exceed the investor

opportunity elsewhere.
The connection between future value of investme
rate. The discount rate determine the discount fa
discounts the future value to the present value. T
current period.
If the discount rate were 10% on a cash flow of
However, if the rate of return required is 11%, th
one would not pay more than
The other factors effecting the discount rate is th

f cash flows are discounted because the investor demand a certain rate of return. If the
s not meet or exceed the investors expectations, he/she will look for a better

between future value of investment and present value of investment is the discount
unt rate determine the discount factor, which when multiplied with the future value,
uture value to the present value. This depends on the price one is willing to pay in the

rate were 10% on a cash flow of 110 after 1 year, then the price would be 100.
rate of return required is 11%, then the price one is willing to pay changes. In this case,
pay more than 99.1 for a cash flow of 110 after one year.
rs effecting the discount rate is the inflation and risk.

PROB 2
A
CD

18000

Future value for 8.4%

19,512.00

B
Future value for 3.2%
Future value for 16.8%

18,576.00
21,024.00

Analysis:

If the level of interest increases, the future

If the level of interest decreases, the futur

C
The First National Bank of San Francisco offers CDs with an 8.4 percent nominal (stated)
interest rate but compounded semiannually.
Future value
Effective rate of interest
Future value using the effective
rate of interest

19,543.75
8.58%

As we can see that the future value compounded sem

and the future value at 8.58%, which is the effective r
no difference

19,543.75

D
Pacific Trust offers 8.4 percent annual interest CDs with quarterly compounding
Future value

19,560.30

Bay State Savings and Loan offers the same rate with daily compounding
Future value

19,577.13

E
Bay State Savings and Loan offers the same rate with daily compounding
Future value

19,577.13

nominal rate the First National Bank have to offer to make its semiannual
compounding CD competitive with Bay State Savings and Loans daily compounding
CD
Future value
19,577.13
Present value
18,000
Required rate when compounded
semi annually
0.08577888
8.578%

18576.00
If the level of interest increases, the future value increases
If the level of interest decreases, the future value decreases

ent nominal (stated)

we can see that the future value compounded semi annually at 8.4%
d the future value at 8.58%, which is the effective rate of interest have

There is a direct relation that exist between frequency of compounding

and future value

PROB 4
Future value
Period

35,000
6 years

A
Present value

-21,572.10

B
If 18000 is invested
To get 35000 as future value,
Rate of interest

11.72%

C
If only $18,000 is invested,stated rate the First National Bank must offer on its
semiannual compounding CD to accumulate the required funds
Rate of interest
Effective annual rate of interest
Pacific Trust

5.70%
11.72%

Rate of interest
Effective annual rate of interest
Bay State Savings and Loan.

2.81%
11.72%

Rate of interest
Effective annual rate of interest

0.03037%
11.72%

PROB 5
A
Annuity regular
B

8.40%

0
1
2
3
4
5
6
Future value of the annuity
C

FV
3000
3000
3000
3000
3000
3000

semi annually
8.40%

4,490.22
4,142.27
3,821.28
3,525.17
3,252.00
3,000.00
22,230.94

Effective rate of interest

1
3000
2
3000
3
3000
4
3000
5
3000
6
3000
Future vlue of annuity invested
with first national bank, compounded
semi annually

8.58%
4,526.87
4,169.30
3,839.97
3,536.65
3,257.29
3,000.00
22,330.08
22,330.08

QUARTERLY
Effective rate of interest

8.67%

Future value of annuity compounded quarterly

22,381.93

Daily
Effective rate of interest
Future value of annuity compounded Daily

22,434.79

D
Future value
Interest rate
Period
Equal installments

8.76%

35000
8.40%
6 years
-4,723.15

The client is now paying 3000. Therefore the clients have to pay 1723 more to acquire 35000 at the end of sixth yea

E
Future value

22230.940

Present value

Period compuonding
0
1
1500
2
1500
3
1500
4
1500
5
1500
6
1500
7
1500
8
1500
9
1500
10
1500
11
1500
12
1500

Effective rate of interest

-13,701.94

FV
2,457.56
2,358.50
2,263.44
2,172.20
2,084.65
2,000.62
1,919.98
1,842.59
1,768.33
1,697.05
1,628.65
1,563.00
23,756.57
23,756.57
8.40%

Directly calculated using effective rate of interest

723 more to acquire 35000 at the end of sixth year

Semi annual Compounding

0
1
1500
2
1500
3
1500
4
1500
5
1500
6
1500
7
1500
8
1500
9
1500
10
1500
11
1500
12
1500

Effective rate of interest

FV
4,026.40
3,708.35
3,415.43
3,145.65
2,897.18
2,668.33
2,457.56
2,263.44
2,084.65
1,919.98
1,768.33
1,628.65
31,983.93
31,983.93
8.58%

Quarterly compounding
0
1
1500
2
1500
3
1500
4
1500
5
1500
6
1500
7
1500
8
1500
9
1500
10
1500
11
1500
12
1500

Effective rate of interest

FV
4,067.49
3,743.04
3,444.46
3,169.70
2,916.86
2,684.18
2,470.07
2,273.03
2,091.72
1,924.86
1,771.32
1,630.02
32,186.76
32,186.76
8.67%

12
11
10
9
8
7
6
5
4
3
2
1

PROB 6
A
Annuity Due
B

8.40%

0
1
2
3
4
5
6
Future value of the annuity
C

semi annually
8.40%

FV
3000
3000
3000
3000
3000
3000

4,867.40
4,490.22
4,142.27
3,821.28
3,525.17
3,252.00
24,098.34

Effective rate of interest

1
3000
2
3000
3
3000
4
3000
5
3000
6
3000
Future vlue of annuity invested
with first national bank, compounded
semi annually

8.58%
4,915.12
4,526.87
4,169.30
3,839.97
3,536.65
3,257.29
24,245.20
24,245.20

QUARTERLY
Effective rate of interest

8.67%

Future value of annuity compounded quarterly

24,322.06

Daily
Effective rate of interest
Future value of annuity compounded Daily

8.76%
24,400.49

D
Future value
Interest rate
Period

35000
8.40%
6 years

Directly calculated using effectiv

Equal installments

-4,357.15

The client is now paying 3000. Therefore the clients have to pay 1357 more to acquire 35000 at the end of six

Yearly compuonding
0
1
1500
2
1500
3
1500
4
1500
5
1500
6
1500
7
1500
8
1500
9
1500
10
1500
11
1500
12
1500

Effective rate of interest

FV
2,457.56
2,358.50
2,263.44
2,172.20
2,084.65
2,000.62
1,919.98
1,842.59
1,768.33
1,697.05
1,628.65
1,563.00
23,756.57
23,756.57
8.40%

Semi annual Compounding

0
1
1500
2
1500
3
1500
4
1500
5
1500
6
1500
7
1500
8
1500
9
1500
10
1500
11
1500
12
1500

Effective rate of interest

Directly calculated using effective rate of interest

acquire 35000 at the end of sixth year

al Compounding

ate of interest

FV
4,026.40
3,708.35
3,415.43
3,145.65
2,897.18
2,668.33
2,457.56
2,263.44
2,084.65
1,919.98
1,768.33
1,628.65
31,983.93
31,983.93
8.58%

Quarterly compounding
0
1
1500
2
1500
3
1500
4
1500
5
1500
6
1500
7
1500
8
1500
9
1500
10
1500
11
1500
12
1500

Effective rate of interest

FV
4,067.49
3,743.04
3,444.46
3,169.70
2,916.86
2,684.18
2,470.07
2,273.03
2,091.72
1,924.86
1,771.32
1,630.02
32,186.76
32,186.76
8.67%

6
5
4
3
2
1

PROB 7
A
8.40%
End of Year

Payment A
0
1
2
3
4
5
6

Value of the payments

Payment B

15000
0
0
0
0
0
0

3000
3000
3000
3000
3000
3000
3000

-24,336.99

24,098.34
3000
27,098.34

End of Year

Payment A
0
1
2
3
4
5
6

Value of the payments

Payment B

15000
0
0
0
0
0
0

3000
3000
3000
3000
3000
3000
3000

-24,336.99

24,098.34
3000
27,098.34

Future value

35000

present alue

-21,572.10

-7,870.15

Payment C
1000
1500
2000
0
3500
4500
5500

Future values of payment C

1,622.47
2,245.11
2,761.51
0.00
4,112.70
4,878.00
5,500.00

6
5
4
3
2
1

21,119.79

Payment C
1000
1500
2000
0
3500
4500
5500

Future values of payment C

1,622.47
2,245.11
2,761.51
0.00
4,112.70
4,878.00
5,500.00
21,119.79

-9,555.01

19,497.32
15,502.68

6
5
4
3
2
1

PROB 8
A

Effective annual rate

Present value
Future value

0
1
2
3
4
5
6

8.76%
18000
29,795.93

3000
3000
3000
3000
3000
3000

-4,565.88
-4,198.02
-3,859.79
-3,548.81
-3,262.89
-3,000.00
-22,435.39

The interest for each annuity decreases as the compounding periods decreases for subsequent annuiti
therefore the total future value for annuities is less than that of the future value of the bulk amount
D

0
1
2
3
4
5
6

3000
3000
3000
3000
3000
3000

-4,965.99
-4,565.88
-4,198.02
-3,859.79
-3,548.81
-3,262.89
-24,401.37

Here we could observe the difference to be 1965.99

For the first annuity, we calculate the FV at effective
This is mainly because the payments are made at the

ses for subsequent annuities

alue of the bulk amount

difference to be 1965.99 when the paayments are made at the beginning of the period.
lculate the FV at effective rate of 8.76% for 6 periods unlike the previous case where we took only five periods.
payments are made at the beginning of the year and an extra compounding period is added.

6
5
4
3
2
1

PROB 9

yr1

opening principal interest

instalment principal repaid
35000
3570 11,089.32
7,519.32

yr2

27,480.68 2,803.03 11,089.32

8,286.29

yr3

19,194.39 1,957.83 11,089.32

9,131.49

yr4

10,062.90 1,026.42 11,089.32

10,062.90

closing principal
27,480.68
19,194.39
10,062.90
0.00

PROB 10
13500
TIMELINE
0

10.2% monthly compunding

13500

13500

the value of all the loan at the end of

year 9

values for equate quarterly instal

8
13500

10
11
repayment starts
13500
2292.55 2292.55

12

13

14

15

16

2292.55

2292.55

2292.55

2292.55

2292.55

FV
-20,266.42
-18,309.07
-16,540.76
-14,943.23
-70,059.48

From amortization template

ENTER VALUES
Loan amount
Annual interest rate
Loan period in years
Number of payments per year
Start date of loan
values for equate quarterly installments for each loan's future value
-20,266.42
663.18
663.18
663.18
-18,309.07
599.13
599.13
599.13
-16,540.76
541.26
541.26
541.26
-14,943.23
488.99
488.99
488.99
2292.56 2292.56 2292.56

663.18
599.13
541.26
488.99
2292.56

663.18
599.13
541.26
488.99
2292.56

663.18
599.13
541.26
488.99
2292.56

663.18
599.13
541.26
488.99
2292.56

17

18

19

20

21

22

23

24

25

2292.55

2292.55

2292.55

2292.55

2292.55

2292.55

2292.55

2292.55

2292.55

663.18
599.13
541.26
488.99
2292.56

663.18
599.13
541.26
488.99
2292.56

663.18
599.13
541.26
488.99
2292.56

LOAN SUMMARY
Scheduled payment
$2,292.55
Scheduled number of payments 60
60
Actual number of payments
$17,300.00
Total early payments
$248,196.12
Total interest

$70,059.23
10.20%
15
4

663.18
599.13
541.26
488.99
2292.56

663.18
599.13
541.26
488.99
2292.56

663.18
599.13
541.26
488.99
2292.56

663.18
599.13
541.26
488.99
2292.56

663.18
599.13
541.26
488.99
2292.56

663.18
599.13
541.26
488.99
2292.56