Additional Solved

Problems

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 Chapter 2
P.2.12 An investor wishes to choose the better of the two equally costly cashflow streams, namely, Annuity X
(AX) and Annuity Y (AY). While AX is an annuity due (i.e. cash flows occur at the beginning of the year) with
a cash inflow of Rs 90,000 for each of 6 years, AY is an ordinary annuity (i.e. cash flows occur at the end of the
year) with a cash inflow of Rs 1,00,000 for each of 6 years. Assuming 15 per cent return on investment (a) find
the future value at the end of year 6 (FVA6) for both AX and AY and (b) which annuity is more attractive?
Solution
(a) Annuity X, FAV6 = Rs 90,000 3 FVIA (15.6 3 0.15)
= Rs 90,000 3 8.754 3 1.15 = Rs 9,06,039
Annuity Y, FVA6 = Rs 1,00,000 3 FVIFA(15,6)
= Rs 1,00,000 3 8.754 = Rs 8,75,400
(b) AX is more attractive as its FVA6 is larger than that of AY. This is so because the benefit of receiving the
cash flows of AX at the beginning of the year more than offsets the fact that its flows are Rs 10,000 less
than those of AY, which has year-end cash flows. The cash flows of AX earn 15 per cent for an extra
year, thereby enhancing its future value.
P.2.13 You have a choice of accepting either of two 5-year cashflow streams or lump-sum amounts given
below.
End of year Cash flow stream
Alternative I Alternative II
1 Rs 7,000 Rs 11,000
2 7,000 9,000
3 7,000 7,000
4 7,000 5,000
5 7,000 3,000
Lump-sum amount
At time zero (t = 0) 28,250 28,000

Assuming 10 per cent required rate of return, which alternative (I or II) and in which form (Cash flow or
lump-sum) would you prefer and why?
Solution
Alternative I:
Cash flow stream (annuity):
PVA5 = Rs 7,000 3 PVIFA(10,5)
= Rs 7,000 3 3.791 = Rs 26,537
Lump sum = Rs 28,250
Alternative II:
Cash flow stream (mixed stream)
Year (n) Cash flow PVIF(10,n) Present value
(1) (2) [(1) 3 (2)] (3)
1 Rs 11,000 0.909 Rs 9,999
2 9,000 0.826 7,434
3 7,000 0.751 5,257
4 5,000 0.683 3,415
5 3,000 0.621 1,863
27,968
Lump sum = Rs 28,000

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 Additional Solved Problems 3

Conclusion: Alternative I in the form of lump-sum payment is preferable as it has the largest present value.
P.2.14 You wish to accumulate Rs 80,00,000 by the end of 5 years by making equal annual year-end deposits
over the next 5 years. Assuming 7 per cent rate of return, how much should you deposit at the end of each
year to accumulate Rs 8,00,000?
Solution FVAn = X[FVIFA(r,n)]
FVA5 = Rs 80,000; FVIFA(7,5) = 5.751
  Rs 8,00,000 = 5.751 X
X = Rs 8,00,000 4 5.751 = Rs 1,39,106.
P.2.15 Compute the future values of (1) an initial Rs 100 compounded annually for 10 years at 10 per cent
and (2) an annuity of Rs 100 for 10 years at 10 per cent.
Solution
(1) The future value of an investment compounded annually = Fn = P(1 + i)n = P 3 FIVFi,n = F10 = Rs 100
(1 + 0.10)10 = Rs 100 (2.5937) = Rs 259.4
(2) The future value of an annuity = Sn = A 3 FVIFAi,n = Rs 100 3 15.937 = Rs 1,593.7.
P.2.16 An investor has two options to choose from: (a) Rs 6,000 after 1 year; (b) Rs 9,000 after 4 years. Assuming
a discount rate of (i) 10 per cent and (ii) 20 per cent, which alternative should he opt for?
Solution
(i) (a) Rs 6,000 after 1 year at 10 per cent discount = P = Rs 6,000(0.9091) = Rs 5,454.6.
(i) (b) Rs 9,000 after 4 years at 10 per cent discount = P = Rs 9,000(0.6830) = Rs 6,147.
At 10 per cent required rate, the investor should choose Rs 9,000 after 4 years.
(ii) (a) Rs 6,000 after 1 year at 20 per cent discount = P = Rs 6,000(0.8333) = Rs 4,999.8.
(ii) (b) Rs 9,000 after 4 years at 20 per cent discount = P = Rs 9,000(0.4823) = Rs 4,340.7.
  At 20 per cent required rate, the investor should choose Rs 6,000 after 1 year.
P.2.17 An investor is 50 years of age today. He will retire at the age of 60. In order to receive Rs 2,00,000
annually for 10 years after retirement, how much amount should he have at the time of retirement? Assume
the required rate of return is 10 per cent.
Solution Pn(present value of annuity) = A 3 PVIFAi,n = P10 = Rs 2,00,000 (6.1446) =
Rs 12,28,920.
P.2.18 A person would need Rs 100, 5 years from now. How much amount should he deposit each year in
his bank account, if the yearly interest rate is 10 per cent?
Solution Sn = A 3 FVIFAi,n or A = Sn/FVIFAi,n = Rs 100/6.1051 = Rs 16.38
P.2.19 X has taken a 20-month car loan of Rs 6,00,000. The rate of interest is 12 per cent per annum. What
will be the amount of monthly loan amortisation?
Solution
A = Rs 6,00,000/PVIFA1,20 = Rs 6,00,000/18.0456 = Rs 33,249.1. Monthly interest
= 12 per cent/12
= 1 per cent.
P.2.20 ABC Ltd has borrowed Rs 1,000 to be repaid in equal instalments at the end of each of the next 3
years. The interest rate is 15 per cent. Prepare a amortisation schedule.
Solution Amount of equal instalment, A = Pn/PVIFAi, n = Rs 1,000/2.2832 = Rs 437.98

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 4 Financial Management

Amortisation schedule
Year Payment Interest* Repayment of principal Balance outstand-
ing
1 Rs 437.98 Rs 150.00 Rs 287.98 Rs 712.02
2 437.98 106.80 331.18 380.84
3 437.98 57.13 380.85
*= Loan balance at the beginning of the year 3 interest rate, e.g., year 1 = (Rs 1,000 3 0.15) = Rs 150.

P.2.21 ABC Ltd has borrowed Rs 1,000 to be repaid in 12 monthly instalments of Rs 94.56. Compute the
annual interest.
Solution
Pn = A 3 PVIFAi,n
PVIFAi,n = Pn /A = Rs 1,000/Rs 94.56 = 10.5753
According to Table A-4 (Appendix), a PVIFA of 10.5753 for 12 periods at interest (i) = 2 per
cent. The annual interest rate is therefore 0.02 3 12 = 24 per cent.

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