Financial Management 1 Tutorial 1 2023
Interest, Discounting, Compounding
Please ensure that you have attempted all the questions in this tutorial before you write final
examinations
1) Suppose you deposit $10000 today in an account that pays simple interest of 20% per
annum. How much will you have at the end of 3 years? [4]
2) Establish the simple interest rate that grows $700 to $964 in 11 months and 16 days [4]
3) How long does it take to double an investment of $500 deposited in a savings account that earns
an interest of 7.45% per year compounded continuously? [4]
4) LK owes AT $20 000 due in six months and $6 000 due in a year. LK offers to pay $10
000 immediately if he can pay the balance in two year. AT agrees, on condition that they
use a simple interest rate of 18% per annum. They also agree that for settlement purposes
the $10 000 paid now will also be subject to the same rate. How much will LK have to
pay at the end of the two years? [5]
5) A bank’s simple discount rate is 18%. If you sign a promissory note to pay $4 000 in six
months’ time, how much would you receive from the bank now? What is the equivalent
simple interest rate? [6]
6) Outline the measures investors and other corporate stakeholders can take to minimise the
agency problem? [10]
7) Find the compounded amount on $5 000 invested for 10 years at 7.5% per annum
compounded semi-annually? [5]
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8) Mrs Tough decides to save for her daughter’s higher education and, every year, from the
child’s first birthday onwards, puts away $1 200. If she receives 11% interest annually,
what will the amount be after her daughter’s 18th birthday? [6]
9) You will need $50 000 at the end of 10 years to finance your PhD studies at Women’s
University in Africa. To accumulate this sum, you have decided to save a certain amount
at the end of each of the next 10 years and deposit it in the bank. The bank pays 8%
interest compounded annually for long term deposits such as this. How much will you
have to save each year (to the nearest dollar)? [8]
10) How long does it take to triple your money if the interest rate is 5% per year,
compounded annually? [6]
11) At what rate of simple interest will $600 amount to $654 in nine months? [5]
12) The simple discount rate of a bank is 16% per annum. If a client signs a note to pay $6
000 in nine months’ time, how much will the client receive? What is the equivalent
simple interest rate? [8]
13) A certain Bank has agreed to give you a loan of $120 000 on condition that you pay an annual
interest rate of 11.25% compounded monthly and also that you will pay-off the loan through 12
equal instalments each at the end of each quarter.
i) Determine the value of each instalment [5]
ii) Compute the principal amount outstanding after making the 9th quarterly payment [4]
iii) Draw the first 4 lines of an amortization schedule splitting interest and capital
payments for the above loan contract and comment on the relevance of such a
schedule to a loan applicant [6]
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14) A small businessman borrowed some money from the bank under the following
conditions:
$500 000 to be paid after 3 months from the date of the loan.
$800 000 to be paid one 1 year from the date of the loan.
$900 000 to be paid 1 year 6 months from the date of the loan.
The businessman has found things to be tough this year and fails to make any payments.
6 months from now he makes a payment of $300 000.
9 months later he pays $250 000.
The bank accepts this arrangement provided that the balance is to be paid on the last date as
agreed. If simple interest is charged at 22% per year, how much is to be paid by the
businessman? Illustrate in a time line. [10]
15) Mrs. Dudley decides to save for her daughter’s higher education and, every year from the
child’s first birthday onwards, puts away $1 200. If she receives 11% interest annually, what
will the amount be after her daughter’s 18th birthday? [10]
16) Determine the amount and the present value of an ordinary annuity with payments of $200
per month for five years at 18% per annum compounded monthly. What is the total interest
paid? [5]
17) Walgreen Pharmacies, has the following capital structures:
400 000 ordinary shares at 5 dollars each
200 000 10% preference share at 4 dollars each
Capital Reserves $350 000
Revenue Reserves $200 000
Retained Earnings $290 000
350 000 8% debentures at $12 each
Additional Information
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a) Ordinary share dividend is expected to grow by 15% p.a constantly and the
current price of $110 and a dividend of $30 have just been issued.
b) Preference shares attract a cost of 10%.
c) Debenture attract a cost of 8%.
d) Taxation is at 35%.
Required
Calculate the weighted average cost of capital (WACC) of Walgreen Pharmacies.
[10]
Comment on the significance of this measure in financial theory. [2]
18) Mrs Marufu decides to save for her son’s 4 year university education and other future family
financial obligations by saving $1 500 every quarter in sinking fund that earns 11% interest
annually compounded monthly. She will commence such deposits at her son’s first birthday
which will be celebrated exactly one year from now until his 24 th birthday. She expects to
make withdrawals each of $6 000 at the son’s 10 th, 15th and 20th birthdays to meet other
family commitments. The son will commence his first year university education at his 20 th
birthday and will graduate at his 24 th birthday. A fixed university annual tuition fee will be
paid in arrears at the end of each academic year. Mrs Marufu has structured the sinking fund
so that the value of the fund will be equal to the value of the above financial obligations.
Required
i) Illustrate the above financial arrangement on a timeline [4 marks]
ii) Calculate the fixed annual university tuition fee such that the inflows into the fund will
be equal to the outflows from the fund [10 marks]
iii) Outline any 3 benefits to Mrs Marufu of using a sinking fund [3 marks]
19)
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GOOD LUCK
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