Learning Resources

ACCTG 101
ACCOUNTING AND FINANCE
Student Guide

Time Value of Money II

Guidance Notes

1 Saving for an Overseas Holiday

6% per annum 8% per annum

= $12,000 * PV factor (6%, 3 years) = $12,000 * PV factor (8%, 3 years)
(a) Present value of
= $12,000 * 0.840 = $12,000 * 0.794
$12,000 in 3 years
= $10,080 = $9,528
= $12,000 * PV factor (6%, 5 years) = $12,000 * PV factor (8%, 5 years)
(b) Present value of
= $12,000 * 0.747 = $12,000 * 0.681
$12,000 in 5 years
= $8,964 = $8,172
The amount of deposit required becomes less as the period of investment increases and the percentage
return from investment increases.

2 Borrowing Opportunity
The amount your relation would lend you now would be the present value of the repayment.

(a) Father (10% per annum) (b) Grandmother (8% per annum)
= $10,000 * PV factor (10%, 4 years) = $10,000 * PV factor (8%, 4 years)
Present value of
= $10,000 * 0.683 = $10,000 * 0.735
$10,000 in 4 years
= $6,830 = $7,350
= $10,000 * PV factor (10%, 6 years) = $10,000 * PV factor (8%, 6 years)
Present value of
= $10,000 * 0.564 = $10,000 * 0.630
$10,000 in 6 years
= $5, 640 = $6,300

It would appear that it would be to your advantage to borrow from your grandmother and complete
your studies as soon as possible. An earlier repayment is preferred (less risk) and a lower rate of return
implies less need for the cash by the lender.

Prepared by Kathryn Caird

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 Problem: Time Value of Money 11

3 Hire Purchase or Pay Now

(a) You would choose the option that has the lower equivalent purchase price (smaller present
value of payment) using 4%, your required rate of return.
Present value for paying now = $5,500
Present value of hire purchase
= deposit ($1,100) + annuity ($525) * annuity factor (4%, 12 quarters)
= $1,100 + $525 * 9.385 = $6,027
As the PV of paying now is less than PV of hire purchase, it would be economical to forego
your current earnings and pay now.
(b) The finance made available under hire purchase is $4,400, so
Annuity factor (r%, 12 quarters) = present value ($4,400) / annuity ($525) = 8.381
Using the Table for Present Value of an Annuity of $1, select the row for 12 periods and you
will find the nearest figure to 8.381 in the column for 6%. The quarterly interest rate is
close to 6%.

4 Winning a Choice
You would choose the option that has the higher present value using 15%, your required rate of
return.
Present value of $100,000 now = ($100,000)
Present value of annuity of $15,000 = Annuity ($15,000) * annuity factor (15%, 12 years)
= $15,000 * 5.421 = $81,315
The receipt of $100,000 now is better than $15,000 per year for 12 years. If you take the
$100,000 now, you could spend $18,685, invest $81,315 at 15% per annum, and withdraw
$15,000 a year for 12 years.

5 A Challenge
Fifteen years is 180 months. The calculation of the annuity factor is
n 180
1 (1 r ) 1 (1 0.0068)
Annuity factor (r%, n periods) = = = 103.64
r 0.0068
Annuity amount = Present value ($225,000) / annuity factor (103.64) = $2,171 per month
Thus if you borrowed $225,000 for a fifteen year period at 8.5% per annum, the approximate
monthly repayments would be $2,171. This means you would pay a total of $390,780 of which
$165,780 would be interest.

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