Southern Adventist University

School of Business and Management

Assignment for Course: BUAD 520 – Financial Management

Submitted to: Prof. Braam Oberholster
Submitted by: Oksana Ursulenko
471221
oksanau@southern.edu

Olivia DeWitt
452632
oliviadewitt@southern.edu

Date of Submission: 13 September 2017

Title of Assignment: Group project: Case #92. Macmillan & Grunski Consulting

CERTIFICATION OF AUTHORSHIP: I certify that I am the author of this paper and that
any assistance I received in its preparation is fully acknowledged and disclosed in the
paper. I have also cited any sources from which I used data, ideas or words, either quoted
directly or paraphrased. I also certify that this paper was prepared by me specifically for
this course.

Student's Signature: Olivia DeWitt

*****************************************************************

Instructor's Grade on Assignment:

Instructor's Comments:

Olivia DeWitt
Oksana Ursulenko

Case #92 Olivia DeWitt & Oksana Ursulenko Page 1

September 13, 2017

Case #92
Macmillan and Grunski Consulting – Discounted Cash Flow Analysis

Summary of Case
Sandra Macmillan started a financial consulting firm with the help of her partner Betsy Grunski.
They are looking for more help, and the firm’s secretary Mary Somkin, wants to be promoted. To
make sure Mary can do the job, Sandra has asked her to take on a sample case. This case involves
two parents who want to begin investing money into fixed interest securities in order to raise the
money for their daughter’s college. Sandra has instructed Mary to look into several options, and
to calculate the time value of money for these options so that these parents can afford their
daughter’s college.

Question 2
Consider a one-year, $18,000 CD.
a. What is its value at maturity if it pays 8.4 percent (annual) interest?

Response:
Future value of a single amount of $18,000 after 1 year with an interest 8.4% will be: amount
invested x (1+i) = $18,000x1.084 = $19,512.

b. Compute the future value if the CD pays 3.2 percent; if it pays 16.8 percent. Overall,
what do these results indicate about the relation between level of interest and future value?

Response:
If the CD pays 3.2%, the future value of $18,000 invested will be $18,000x1.032 = $18,576.
If the CD pays 16.8%, the future value of $18,000 invested will be $18,000x1.168 = $21,024.
The bigger the interest, the bigger is return on the investment (future value). However, if interest
level is lower than inflation rate, the reality would be different and actual future value will
decrease.

c. The First National Bank of San Francisco offers CDs with an 8.4 percent nominal
(stated) interest rate but compounded semiannually. What is the effective annual rate on such a
CD? What is the value of the CD at the end of the year? Explain the difference between this CD
and the annual interest CD.

Response:
The effective annual rate in this case would be calculated using the following formula: EAR = (1
+ Inom/M)m - 1 = ( 1 + 0.084/2)2 - 1 = 0.085764 or 8.58 %. Therefore, the value of the CD at the
end of the year with the interest rate compounded semiannually will be $18,000x1.085764 =
$19,543.75.
If we use the EAR for explanation, the real interest (EAR) when using compounded interest will
be higher (EAR is 8.568%) than the nominal rate (8.4%), which is the same as EAR for an annual
rate. The EAR of the compounded interest is higher is the result of reinvesting the interest, rather 
than paying it out, so that interest in the next period is then earned on the principal sum plus 
previously­accumulated interest.

Case #92 Olivia DeWitt & Oksana Ursulenko Page 2

d. Pacific Trust offers 8.4 percent annual interest CDs with quarterly compounding while
Bay State Savings and Loan offers the same rate with daily compounding. What are the effective
annual rates and values at maturity of these CDs? (Use a 365-day year.) Overall, what do these
results indicate about the relation between the frequency of compounding and future value?

Response:
The formula used in following calculation is the same as in question 2c. Therefore, effective
annual rate for CD at the Pacific Trust will be: (1 + 0.084/4)4 – 1 = 0.086683 or 8.67%.
The value is going to be 18,000 x 1.086683 = 19,560.6
For the Bay State and Loan the effective annual rate for CD is going to be: (1 + 0.084/365)365
– 1 = 0.087618 or 8.76%. The value at maturity then will be 18,000 x 1.0876 = 19,576.8. Since
compounded interest involves earning on the interest earned in prior periods, the future value of
the deposit using this compound interest will be bigger than that using annual interest. In other
words, when interest is calculated for the second period (for compound interest), the base for it
includes not only a principal, but also all the previously earned interest. Therefore, since the base
is bigger, the value will be bigger too. Thus the more frequent the compounding, the more quickly
the principle will build and the more interest can be collected, resulting in a higher future value.

Question 4
It is estimated that in six years the total cost for one year of college will be $35,000.

a. How much must be invested today in a CD paying 8.4 percent annual interest in order to
accumulate the needed funds.

Response:
PV (-21,572.10)
FV 35,000
N 6
I 8.4
PMT 0
In order to accumulate $35,000 in 6 years with 8.4% annual rate, $21,572.10 must be invested
today.

b. If only $18,000 is invested, what annual interest rate is needed to produce the needed
$35,000 after six years.

Response:
PV (18,000)
FV 35,000
N 6
I 11.72
PMT 0
If only $18,000 will be invested today, in order to accumulate $35,000 in 6 years, deposit should
be made with the 11.72% annual rate.

c. If only $18,000 is invested, what stated rate must the First National Bank offer on its
semiannual compounding CD to accumulate the required funds? Explain how the analysis
changes if the funds were invested with Pacific Trust or Bay State Savings and Loan.

Case #92 Olivia DeWitt & Oksana Ursulenko Page 3

Response:
PV (18,000)
FV 35,000
N 12
I 5.70
PMT 0
In this situation, the total number of periods will be n = 6 years x 2 periods in a year = 12. As a
result, we will get the periodic rate for 6 months period (5.70%). Or a nominal rate of 11.4
compounded semiannually.
To check ourselves we can find EAR for this periodic rate. To do so we will need to raise it to the
second power (or multiply the number by itself), which is going to be 1.05697 x 1.05697 - 1 =
0.1172 or 11.72%. This is the same number that was calculated in question 4b.

For Pacific Trust:

PV (18,000)
FV 35,000
N 24
I 2.81
PMT 0
Number of periods in this case will be 6 years x 4 quarters in a year = 24 periods. Therefore, the
interest rate is 2.81%.

Bay State Savings and Loan:

PV (18,000)
FV 35,000
N 2,190
I 0.03
PMT 0
Number of periods in this case will be 6 years x 365 days per year = 2,190 periods. Therefore, the
interest rate is 0.03%.

Question 5
Now consider the second alternative—six annual payments of $3,000 each made at the end of
each year.
a. What type of annuity is this?

Response:
This is going to be ordinary annuity since the payments are made at the end of the year. This
annuity includes payments of $3,000 over the next 6 years.
b. What is the future value of this annuity if the payments are invested in an account paying
8.4 percent interest annually?
Response:
PV 0
FV 22,230.94
N 6
I 8.4
PMT 3,000
The future value of the ordinary annuity over 6-year period with a payment of $3,000 is going to
be $22,230.94.

Case #92 Olivia DeWitt & Oksana Ursulenko Page 4

c. What is the future value if the payments are invested with the First National Bank, which
offers semiannual compounding? How does the analysis change with quarterly or daily
compounding?

Response:
First we should align compounding period with payment period. In this case we already
calculated the effective annual rates for semiannually, quarterly and daily compounded interests
in the question 2d in the amount of 8.58%, 8.67%, and 8.76% respectively:
EARannually = (1+ Inom/M)M = (1+ 0.084/2)2 - 1 = 0.085764 or 8.58%.
EARquarterly = (1+ 0.084/4)4 - 1 = 0.0866832 or 8.67%.
EARdaily = (1+ 0.084/365)365 - 1 = 0.0876183 or 8.76%.
Therefore, future values are going to be:
PV 0
FV 22,330.08
N 6
I 8.58
PMT 3,000
The future value of the annuity over 6-year period, with a payment of $3,000 and interest
compounded semiannually will be $22,330.08.

PV 0
FV 22,381.92
N 6
I 8.67
PMT 3,000
The future value of the annuity over 6-year period, with a payment of $3,000 and interest that is
compounded quarterly will be $22,381.92.

PV 0
FV 22,434.79
N 6
I 8.76
PMT 3,000
The future value of the annuity over 6-year period, with a payment of $3,000 and interest that is
compounded daily will be $22,434.79.

d. What size payment would be needed to accumulate $35,000 under annual compounding
at an 8.4 percent interest rate?

Response:
PV 0

Case #92 Olivia DeWitt & Oksana Ursulenko Page 5

FV 35,000
N 6
I 8.4
PMT (4,723.15)
To accumulate $35,000 at an 8.4% annual rate in 6 years, the payment of $4,723.15 is required by
the end of each period.

e. What lump sum, if deposited today, would produce the same ending value as in Part b?

Response:
In Part b we’ve got future value of $22,230.94.
PV (13,701.94)
FV 22,230.94
N 6
I 8.4
PMT 0
In order to get ending value from Part b ($22,230.94), with an 8.4% annual rate, $13,701.94
should be deposed today.

f. Suppose the payments are only $1,500 each, but are made every six months, starting six
months from today. What would be the future value if the twelve payments were invested at 8.4
percent annual interest? What if they were invested at semiannual or quarterly compounding?
Response:

It is an ordinary annuity.
To find the future value of payments with annual interest, first, we should align interest period
(yearly) with payment period (semiannual). To find period interest we should first find the
effective annual rate: (1 + 0.084/1)1 -1 = 0.084. Then Iperiod = (0.084 +1)0.5 – 1 = 0.041153 or
4.12%
PV 0
FV 22,688.35
N 12
I 4.12
PMT 1,500
The future value of the annuity over 6-year period, with a payment of $1,500 made semiannually
and interest compounded yearly, is going to be $22,688.35.

To find the effective annual rate for semiannually compounded period with a semiannual payment
period, we should simply divide annual rate by 2 periods (4.2%). We can simply divide because
the compound period and the payment period are aligned.
PV 0
FV 22,799.01
N 12

Case #92 Olivia DeWitt & Oksana Ursulenko Page 6

I 4.2
PMT 1,500
The future value of the annuity over 6-year period, with a payment of $1,500 made semiannually
and interest compounded semiannually, is going to be $22,799.01.

To align quarterly compounding rate to semiannual payments, we should use this formula:
Isemian. = (1+Inom/m)n - 1 = (1 + 0.084/4)2 - 1 = 0.042441 or 4.24%.
PV 0
FV 22,856.88
N 12
I 4.24
PMT 1,500

The future value of the annuity over 6-year period, with a payment of $1,500 made semiannually
and interest compounded quarterly, is going to be $22,856.88.

Question 6
Assume now that the payments are made at the beginning of each period. Repeat the analysis in
Question 5 excluding section e. Explain the impact this has on present or future values.
Now consider the second alternative—six annual payments of $3,000 each made at the beginning
of each year.
a.What type of annuity is this?

Response:
It is annuity due because payments are made at the beginning of each period. This is beneficial
because the annuity essentially has another period during which it can grow. Therefore, annuity
dues generally earn more than ordinary annuities.

b. What is the future value of this annuity if the payments are invested in an account paying
8.4 percent interest annually?

Response:
First of all, for the question 6, we should switch to begin mode on the financial calculator.
PV 0
FV 24,098.34
N 6
I 8.4
PMT 3,000
The future value of the ordinary annuity over 6-year period with a payment of $3,000 is going to
be $24,098.34. But we can calculate it in more simple way. We can use the same number as in
answer 5b and simply multiply that FV of ordinary annuity by 1+ the interest rate: 23,230.94 x
1.084 = $24,098.34, since this numbers only one compounding apart. The value of the annuity
will always be greater than the ordinary annuity by a factor of (1+r)

c. What is the future value if the payments are invested with the First National Bank, which
offers semiannual compounding? How does the analysis change with quarterly or daily
compounding?

Case #92 Olivia DeWitt & Oksana Ursulenko Page 7

Response:
To find future values of annuity due, we can use the same effective annual rates that were
calculated in the question 5c:
EARannually = (1+ Inom/M)M = (1+ 0.084/2)2 - 1 = 0.085764 or 8.58%.
EARquarterly = (1+ 0.084/4)4 - 1 = 0.0866832 or 8.67%.
EARdaily = (1+ 0.084/365)365 - 1 = 0.0876183 or 8.76%.

Therefore, after switching to begin mode on the calculator, future values are going to be:
PV 0
FV 24,245.20
N 6
I 8.58
PMT 3,000
The future value of the annuity over 6-year period, with a payment of $3,000 made at the
beginning of each period and interest compounded semiannually, is going to be $24,245.20.

PV 0
FV 24,322.06
N 6
I 8.67
PMT 3,000
The future value of the annuity over 6-year period, with a payment of $3,000 made at the
beginning of each period and interest compounded quarterly, is going to be $24,322.06.

PV 0
FV 24,400.48
N 6
I 8.76
PMT 3,000
The future value of the annuity over 6-year period, with a payment of $3,000 made at the
beginning of each period and interest compounded daily, is going to be $22,434.79.
Frequency of compounding has an influence on future value, as well as time when the money was
invested. Future value will be bigger if interest is compounding more often, or/and if money was
deposited earlier (annuity due, for example, has bigger future value than ordinary annuity with all
other variable been equal).

d. What size payment would be needed to accumulate $35,000 under annual compounding
at an 8.4 percent interest rate?
Response:
All the calculations are made in the begin mode.

PV 0
FV 35,000

Case #92 Olivia DeWitt & Oksana Ursulenko Page 8

N 6
I 8.4
PMT (4,357.15)
To accumulate $35,000 at an 8.4% annual rate in 6 years, the payment of $4,357.15 is required by
the beginning of each period.

f. Suppose the payments are only $1,500 each, but are made every six months, starting
today. What would be the future value if the twelve payments were invested at 8.4 percent annual
interest? What if they were invested at semiannual or quarterly compounding?
Response:
To find future values in each situation, we should know the effective annual rate for each
situation, where compounding period and payment period are aligned (to semiannual payment).
We already calculated them in the question 5f. The only change is that the future value was
calculated using the begin mode on the calculator.

Isemiannual = (0.084 +1)0.5 – 1 = 0.041153 or 4.12%

PV 0
FV 23,622.04
N 12
I 4.12
PMT 1,500
The future value of the annuity over 6-year period, with a payment of $1,500 made semiannually
at the beginning of period and interest compounded yearly, is going to be $23,622.04.

To find a rate for semiannually compounded period we should simply divide annual rate
by 2 periods (4.2%).
PV 0
FV 23,765.57
N 12
I 4.2
PMT 1,500
The future value of the annuity over 6-year period, with a payment of $1,500 made semiannually
at the beginning of period and interest compounded semiannually, is going to be $23,765.57.

To align quarterly compounding rate to semiannual payment we should use this formula:
Isemian. = (1+Inom/m)n - 1 = (1 + 0.084/4)2 - 1 = 0.042441 or 4.24%.
PV 0
FV 23,826.95
N 12
I 4.24

Case #92 Olivia DeWitt & Oksana Ursulenko Page 9

PMT 1,500

The future value of the annuity over 6-year period, with a payment of $1,500 made semiannually
at the beginning of period and interest compounded quarterly, is going to be $23,826.95.

Question 7
Now consider the schedule of payment from Payment C in Table 1.
a. What is the value of this payment stream at the end of Year 6 if the payments are invested
at 8.4 percent annually?
Response:
Cf0 (1,000)
Cf1 (1,500)
Cf2 (2,000)
Cf3 0
Cf4 (3,500)
Cf5 (4,500)
Cf6 (5,500)
I 8.4
NPV (13,017.09)
The net present value of mixed stream shown in the table is $13,017.09.

PV 13,017.09
FV 21,119.79
N 6
I 8.4
PMT 0
The future value of mixed stream is $21,119.79.

b. What payment today (Year 0) would be needed to accumulate the needed $35,000?
(Assume that the payments for Year 1 through 6 remain the same as part a.)
Response:
Let’s first find a present value of the $35,000.
PV (21,572.10)
FV 35,000
N 6
I 8.4
PMT 0

Since the required present value of future $35,000 is $21,572.10. We need to find a required
payment for the stream, which will be the difference between the new PV and PV calculated in
question 7a plus the payment of $1,000 which was included in the PV from the question 7a:
21,572.10 – 13,017.09 + 1,000 = $9,555.01. Therefore, the new schedule of payments should be
as shown in the following table.
Cf0 (9,555.01)
Cf1 (1,500)
Cf2 (2,000)
Cf3 0
Cf4 (3,500)
Cf5 (4,500)

Case #92 Olivia DeWitt & Oksana Ursulenko Page 10

Cf6 (5,500)
I 8.4
NPV (21,572.10)
The new payment today is $9,555.01. The present value in this case will be $21,572.10, required
to make $35,000 in the future.

Question 8
Consider San Francisco Savings Bank, which pays 8.4 percent interest compounded
continuously.
a. What is the effective annual rate under these terms?

Response:
Effective annual rate should be calculated using continuously compounding interest formula:
i = e r - 1 = e0.084 - 1 = 8.7629%. Therefore, the effective annual rate is 8.7629%.

b. What is the future value of an $18,000 lump sum after six years?

Response:
PV (18,000)
FV 29,795.95
N 6
I 8.7629
PMT 0
The future value of invested $18,000 in six years will be $29,795.95 with 8.7629% annual rate.

c. What is the future value of a six-year ordinary annuity with payments of $3,000 each?
Explain the difference in ending values.

Response:
PV 0
FV 22,435.39
N 6
I 8.7629
PMT 3,000
The difference between the two numbers is because interest in first calculation was compounded
for a whole sum of $18,000 started from year 1, where in the second example the same amount
was deposited in payments of $3,000 at the end of each period over the 6 years period. Therefore
the interest did not have as much principle to work with, and therefore did not earn as much.
Therefore, the overall interest earned fell beyond the interest earned on the lump sum.

Interest earned in each year Total

interest
PV 1 2 3 4 5 6 
(-18,000) 1,577.33 1,715.54 1,865.87 2,029.38 2,207.21 2,400.63 11,795.96
0 0 262.88 548.81 859.79 1,198.02 1,565.89 4,435.39

Case #92 Olivia DeWitt & Oksana Ursulenko Page 11

First scenario earned more interest over the 6 years, even though the same total amount-18,000 –
was invested in both situation. This is because in first scenario, all the money was deposited at the
beginning and the money had more time to accumulate interest then payments deposited each
year.

d. Explain how the value changes if the payments are made at the beginning rather than the
end of the year. (Be specific about the relationship between the two values).

Response:
PV 0
FV 24,401.38
N 6
I 8.7629
PMT 3,000
The difference in two values is because annuity due starts receiving interest on its payments
starting at period 0, compared to ordinary annuity when just first payment is made at the end of
year 1. Annuity due has one more period for accumulating the interest and, therefore, the future
value of it is bigger than of ordinary annuity.
Interest earned in each year
PV 1 2 3 4 5 6
Ordinary annuity 0 0 262.88 548.81 859.79 1,198.02 1,565.89
Annuity due (3,000) 262.88 548.81 859.79 1,198.02 1,565.89 1,965.99

Question 9
The clients are also considering borrowing the $35,000 for their daughter’s first year of college
and repaying the loan over a four-year period. Assuming that they can borrow the funds at a 10.2
percent interest rate, what amount of interest and principal will be repaid at the end of each
year?

Response:
We must calculate the payments that the clients are making to pay off their current loan of 35,000
to hopefully owe a future balance of zero. The number of periods is 4, and the interest and
payment plan are the same (annual).
PV 35,000
FV 0
N 4
I 10.2
PMT 11,089.3

Therefore, the amount of interest and principal the clients must pay per payment to pay off the
$35,000 loan in four years with 10.2% interest is 11,089.3.

Question 10
The clients may decide to send their daughter to a state university costing $13,500 each year for
four years of college starting in Year 6. They would borrow the funds at the beginning of each
year at 10.2 percent annual interest rate compounded monthly. They would pay the loan back
with quarterly payments over fifteen years with the first payment due the first quarter after

Case #92 Olivia DeWitt & Oksana Ursulenko Page 12

graduation. Compute the amount of the quarterly payments amount to be repaid at the end of
each quarter. Note this is a multiple cash flow problem. A time line is useful for appropriately
tracking the cash flows.

Response:
First we should find the future value of the loan they will receive in payments of $13,500 each.
To do so we need to know the effective annual rate for the interest compounded monthly using
the formula from the question 2a: (1+0.102/12)12 – 1 = 0.1069 or 10.69%. And this is an example
of annuity due, so calculator should be switched to begin mode.

PV 0
FV 70,058.45
N 4
I 10.69
PMT 13,500

The clients will need to repay $70,058.45 of the loan. To do this, they want to pay off the loan
quarterly. Then we should find the effective annual rate for the interest compounded quarterly:
(1+0.102/12)3 – 1 = 0.02572 or 2.572%. Over the 15 years, it is going to be 60 periods.
Now we can find the payment.

PV 70,058.45
FV 0
N 60
I 2.57
PMT 2,303.95

The payment on the loan per quarter is 2,303.95

Case #92 Olivia DeWitt & Oksana Ursulenko Page 13