CERTIFICATE IN BUSINESS FINANCE

Business Finance 1

G Muponda

University of Zimbabwe, Dept. of Business Studies.

 UNIT ONE

THE TIME VALUE OF MONEY

EXPECTED OUTCOMES :
At the end of this UNIT, you are expected to have mastered the following concepts :
The time value of money.
Simple interest and simple discount.
Equivalent simple interest rate.
You must also be able to count the exact number of days between payments and receipts and
apply the concept of simple interest to different payment dates.

1.1. Interest and the value of time.

The time value of money is an important concept in financial management. You will come across
it frequently in your study of the subject. The concept is used, for example, in the evaluation of
investment projects, the calculation of a company's cost of capital and the valuation of a
company's shares.

The concept of the time value of money is based on the observation that people prefer to receive
money now rather than in the future, or to make payments some time in the future rather than
now. In other words, a dollar received today is worth more than a dollar to be received
tomorrow. There is a very simple reason for this. The reason is that a dollar received today can
be invested to earn interest.

Interest is the cost of delaying the payment of money and the reward for delaying the receipt
of money.

Thus, when you borrow money, you must pay interest on the money borrowed and when you lend
money, you will earn interest on the money lent.

1.2. Simple interest and compound interest.

The concept of interest applies to both business decisions and decisions made by individuals.
Interest can, however, be calculated as simple interest or compound interest. Interest is calculated
as a fraction of the amount borrowed or lent, which is known as the principal. The difference
between simple interest and compound interest lies in the manner in which the fraction is applied
to the principal.

1.3. Simple interest.

Let us start with simple interest using the following example.

Example 1.1. Suppose that you borrow $10 000 for one year from the bank at an interest rate of
20% per year. How much interest will you be charged ?
At the end of the year you must pay back the principal of $10 000 plus interest. The interest to be
paid will be equal to :

20% of $10 000, or

20 / 100 x 10 000, or
0.20 x 10 000 = $2 000.

Thus, at the end of the year you must pay back $10 000 + $2 000 = $12 000.

Now, suppose you deposit $10 000 into an account that pays a simple interest rate of 20% per
year and leave it there for two years. The interest that you will receive for the full term of the
loan will be :

0.20 x 10 000 x 2 years = $4 000.

You can see that with simple interest, the interest per year is multiplied by the number of years
when more than one year is involved. Thus, we can generalize and say that simple interest is
given by the following relationship :

I = Pit

Where :
I = the simple interest calculated in dollars.
P = the principal amount borrowed or deposited. We shall refer to P as the present
value.
i. = the rate of interest to be applied to the principal.
t = the term or period for which the amount is borrowed or saved.

Example 1.2. Suppose you deposit $10 000 today into an account that pays simple interest of
20% pa. How much will you have at the end of 3 years?

The sum accumulated, S, or the future value is equal to the principal, P, plus the interest, I. Thus

S = P + I

The future value of your deposit will therefore be equal to 10 000 + ( 10 000 x 0.20 x 3 ) =
$16 000.

Since I = Pit,

then S = P + ( Pit ),

which is the same as :

 S = P ( 1 + it )
Since ab + ac = a(b+c)
Thus, the sum accumulated at the end of three years would be :

S = P ( 1 + it )
= 10 000 ( 1 + 0.20 x 3 ) = $16 000.

We can apply this relationship to any term , t, that we like. Let us look at the following example :

Example 1.3. You borrow $18 000 for 125 days at a simple interest rate of 22% per year. How
much do you have to pay to your lender?

The amount to be paid would be equal to :

S = P ( 1 + it )

Where t = 125 / 365, i = 0.22, and P = 18 000.

Thus , S, the amount to be paid, will be equal to

18 000 ( 1 + 0.22 x 125 / 365 ) = $19 356.16.

Let us try the following exercise:

EXERCISE 1.1. Calculate the sum accumulated at the end of 3 years, 4 months and 17 days on a
deposit of $20 000 and an interest rate of 18.27% per year.

1.4. Simple discount.

A concept which is slightly related to simple interest is simple discount. Simple discount arises
from the fact that the present value, P, of the sum accumulated at the end of the term, S, is found
by discounting the future value back to the present.

We have seen that the sum accumulated, S, is found by :

S = P ( 1 + it).

If we rearrange this we find that the present value, P, will be equal to : p= s/(1+it)

P = S / (1+

Thus, when you expect to receive some money some time in the future [ a future cash flow ] you
must discount it into its present value terms in order to take into account the risk and the interest
foregone. When you keep money for some time in a bank or some other investment, you must
compound it into its future value to take into account the interest to be earned on the money.

The concept of discounting is often applied to financial instruments found on the money market.
Firms as well as the government borrow money on a short-term basis using money-market
instruments such as Treasury Bills (T-Bills), certificates of deposit ( CD ), bankers' acceptances
(commercial paper) and trade bills (notes).

Treasury bills are issued by the Reserve bank when the government intends to borrow money
from the public. They are also used to control the money supply.
A certificate of deposit (CD ) is also known as a time deposit. The investor deposits an amount
for a period of time, usually up to 90 days, during which it may not be withdrawn on demand.
The bank pays the interest and principal to the investor only at the end of the agreed period. The
certificate is a negotiable instrument in that it can be sold to another investor if the owner needs
to cash it before its maturity date.

Commercial paper is created when large, reputable companies borrow money on a short-term
basis by issuing their own short-term notes to the investing public rather than borrowing directly
from the bank. Commercial paper is often supported by a bank line of credit, which gives the firm
access to cash that may be used to pay off the paper at maturity. Commercial paper can be issued
for up to 270 days, but it is often for less than one or two months.

Trade bills, also known as bills of exchange, or promissory notes, are created when firms sell
goods on credit and the customer makes a signed undertaking to pay the money on a specified
future date, usually 30, 60, or 90 days from the date of signing. This date is known as the
maturity date. A trade bill is a negotiable instrument. This means that it can be negotiated, or
passed on to a third party at a discount before the maturity date. The bill can be negotiated to a
discount house or a bank. The bank will then pay the face value of the bill, less the amount of the
discount, or interest to be charged for the period left to the maturity of the bill.

These instruments are known as discount instruments because they are traded on discount basis.
Discount instruments have the following features.;

Upon its maturity, the bill will then be presented to the person who has accepted (signed) it, who
is then obliged to honor it. The nominal value (face value) of the bill is the amount that will be
received by the holder when the bill matures. It is therefore also the future value. The discounted
value is the price that must be paid today for the bill. It is therefore also the present value. The
discount is the difference between the nominal value and the discounted value :

D = N - P, and P = N - D.

Where : D is the discount, N is the nominal value , and P is the discounted value of the bill, or
note.

Calculating the consideration ooon discount securities (P)

If we know the discount rate, d, which is also similar to the interest rate, the discount is then
found by the following :
 D = Ndt

Since P = N - D, then

P = N - Ndt

P = N ( 1 - dt )

Let us try the following example :

Example 1.4. A customer signed a promissory note agreeing to pay $100 000 in three months'
time. You them decide to discount the note with a bank at a discount rate of 22 %. How much
would you receive from the bank now ?

P = N (1 -dt), N = 100 000, d = 0.22, and t = 3/12

Therefore : P = 100 000 ( 1 - 0.22 x 3/12) = 96 333.33.

You therefore receive $96 333.33 now from the bank and the discount on the face value would be
equal to $100 000 - $96 333.33 = $3 666.67.

Exercise 1.5 a discount security with a tenre of 91 days and a nominal value of $1000000 is
issued at a discount of 18%p.a. what is the consideration(issue price) of the security
.
Calculating the discount rate, d, to full tenor.
An investor may want to know the discount rate,d ,given the full tenor ,the face value ,and the
issue price of the security. To get the discount rate we
Se the following formular.

D=(d/s)*(365/t)

Where D = is the discount amount in $

S=is the nominal or face value ,
T=is the tenor of the security
1.5. Equivalent simple interest rate.
The interest rate charged on a loan is not equivalent to the rate that is charged when a bill is
discounted before its maturity date. The difference arises from the fact that the discount rate is
calculated on the future value ( D = Ndt), whereas the interest rate is calculated on the present
value ( I = Pit). Infact, when a note is discounted, the interest rate which is equivalent to the
discount rate will be greater than the actual discount rate.

Let us look at the following example :

Example 1.5. Determine the discount, the discounted value, and the equivalent simple interest
rate on a note of $35 000 which is due in 9 months at a discount rate of 26%.

The simple discount, D, is found by :

D = Ndt, where N = 35 000, d = 0.26 , and t = 9/12 = 3/4

Therefore, D = 35 000 x 0.26 x 3/4 = $6 825

The discounted value, P, is found by :

P = N-D

= 35 000 - 6 825 = $28 175.

Since we know that S = P - I, then I = S - P. This means that the interest on the note
should be equivalent to the discount, that is :

I = 35 000 - 28 175= 6825

Since the principal, P, is equal to $28 175, the equivalent simple interest rate is the rate that will
yield an interest amount of $6 825 when applied to this principal over a term of 9 months.

We know that I = Pit, therefore,

6 825 = 28 175 x i x 3/4 , solving for i,

6 825 = 21 131.25i

i = 0.32298

Thus, the simple interest rate which is equivalent to the discount rate of 26% is 32.30%.

Now, try the following exercise:

EXERCISE 1.7. : Calculate the simple interest rate that is equivalent to a discount rate of 24%
for seven months.

The equivalent simple interest rate that is the yield on the money market security. The yield is not
the same as the discount rate , try the following exercise,

EXERCISE 1.8 determine the

discount, the discounted
value and the equivalent
simple interest rate (yield) on
a note of $100 000 which Is
due in 65 days and can be
discounted at a discount rate
of 26%
1.6. Using the exact number of days.
When we deposit money into a bank, or discount a note, we often do not necessarily deal with
complete months. Thus it is necessary to determine the exact number of days between the date of
depositing the money, or discounting the note, and the maturity date.

The convention is that to determine the exact number of days between the two dates, we include
the day the money is deposited or discounted and exclude the last day. The reasoning behind this
is the simple fact that if you deposit money on the 12th of June and withdraw it on the 13th of
June, there is only one day between the two dates, not two.

Example 1.6. Calculate the number of days between 24 May and 16 August.

You must remember that some months have 31 days while others have 30 days. You should be
able to get the number of days by a simple count of your fingers :

Month Days
May (including 24 May) 8
June 30
July 31
August (excluding 16 August) 15
Total 84 days

Now try the following:

EXERCISE 1.3. Calculate the number of days from 16 July 2002 and 19 September 2003

EXERCISE 1.4. On 26 March you deposit $45 000 into an account that pays simple interest of
22% . How much will you have when you withdraw the money on 8 August?

1.7.Valuation of payments and obligations on different dates.

The value of a sum of money is determined by the date on which it is paid or received.

For example, if you owe $20 000 that you are required to pay in ten months time, by the end of
that time you would have to pay more than the $20 000. Suppose that the interest rate was 27%,
then you would have to pay :

20 000 x ( 1 + 0.27 x 10 / 12 ) = $24 500.

Five months ago the $20 000 would have been worth less than that. If you wanted to have
$20 000 today five months ago, you would have needed to invest only $17 977.53 , which is
found as follows :

20 000
( 1 + 0.27 x 5 / 12 )

= $17 977.53

Up to this point we have been considering single receipts and payments. However, the situation
gets a little complicated when we look at more than one receipt or payment of money being
received or paid on different dates. Now, when this happens, we should not simply compare the
receipts or payments without considering the different dates. We call these dated values.

Suppose you owe the following amounts to a friend ;

$100 000 to be paid 4 months from now.

$120 000 to be paid 7 months from now.

Now, suppose you negotiate to pay back all the amounts owed 10 months from now and the
friend agrees, subject to interest being charged at 22% per year. How much do you have to pay to
settle the debt?

Your obligations have now been extended for a further period for which you have to pay interest.

$100 000 extended for 6 months ( 10 - 4 months) becomes :

100 000 x ( 1 + 0.22 x 6 / 12 ) = $111 000

$120 000 extended for 3 months ( 10 - 7 months ) becomes :

120 000 x ( 1 + 0.22 x 3 / 12 ) = $126 600.

Thus, your total obligations are now:

$111 000 + $126 600 = $237 600

Suppose you have offered to pay $20 000 immediately as an incentive for your friend to agree to
the new arrangement. This amount cannot simply be deducted from the $237 600 that you will
owe.

For comparison purposes, all dated values must be brought to the same date.

This means that the payments must equal the obligations in terms of the time value of money.
The $20 000 must also be extended for ten months from now for it to be set off against the
obligations :

$20 000 extended for 10 months (10 - 0 months) becomes :

20 000 x (1 + 0.22 x 10 / 12 ) = $23 667.

Your obligation at the end of ten months is therefore going to be :

$237 600 - $23 667 = $213 933.

You may now try the following exercise :

EXERCISE 1.5. Last year Martin borrowed some money which must be paid in nine months time
from now. After taking into account the interest of 26% per year, the amount to be paid will be
$150 000.
(a) If he decides to pay now, how much must he pay?
(b) If decides to pay five months from now, how much must he pay?
(c) What if he decides to pay in twelve month's time?
1.8.Calculating t, or i.
We have seen that the interest, I, is found by the following formula:

I = Pit

We can use this relationship to calculate the interest , i, required for a given amount to
accumulate to a certain target amount.

Given that I = Pit, then, rearranging we find that :

i = I
Pt

Alternatively, we can also use it to calculate the period, t, required to achieve the target.

t = I
Pi

Let us study the following example.

Example 1.7. You deposit $200 000 in an investment, hoping that this amount will accumulate to
$350 000 in eleven month's time. What simple interest rate would you be looking for in order to
achieve this objective?

The interest, I, that you are looking for is $350 000 - $200 000 = $50 000 on a principal, P, of
$200 000, for a term, t, of 11/12.

Therefore, i = 50 000
200 000 x 11 / 12

= 0.2727 = 27.27%

Now try the following exercises.

EXERCISE 1.6. How long will it take for an amount of $300 000 to accumulate to $650 000 if the
simple interest rate is 22% pa.

EXERCISE 1.7. There is a promissory note which is valued at $92 580 on the market on the 2nd of
March 2002. The face value of the promissory note is $100 000 with a maturity date of 6 May
2002. Calculate the discount rate on the note.

Summary.
In this UNIT, we have studied the time value of money using simple interest and simple discount.
We have seen that these concepts can be applied to a wide range of situations such as depositing
money in a bank or obtaining a loan as well as money market instruments and dated values. You
must note that the counting of days is also an important issue which you will meet in UNIT
TWO.

In UNIT TWO we extend the concept of the time value of money to cover compound interest.

UNIT TWO

COMPOUND INTEREST

EXPECTED OUTCOMES.
This UNIT introduces you to the concept of compounding and discounting. At the end of the UNIT
you should be able to

1. distinguish between compound interest and simple interest.

2. use financial tables to calculate the future value or present value of an investment
3. use various formulae in the calculation of present values and future values.
4. calculate the number of years required to achieve a target accumulated sum of money.
5. calculate "effective annual rates" (EAR) and continuously compounded rates.
6. compare investments using continuous compounding.
7. apply continuous compounding to forward and futures contracts.
8. Use time lines to compare dated values.

2.1. Compounding.

The process of going from todays values [present value] to future values is called compounding.
Compound interest is different from simple interest in that the interest is compounded, that is,
interest is earned on interest that has been earned before.

Suppose you deposited $ 1000 in a bank account that pays 10% interest each year. How much
will you have at the end of the year ?

This question is requires us to calculate the future value of $1000.00 compounded annually for
one year.

The future value of $1 compounded annually for n years is given by the following formula.

Future Value FVn = PV ( 1 + i )n

Where : FV is the future value of $1,

PV is the present value of $1,
i is the rate of interest [or discount rate],
and n is the number of years.

Therefore, in our example, the future value is :

$ 1 000 ( 1 + 0.10 )
= $1 000 ( 1.10 )
= $ 1 100.00

If you were to deposit this money for a period of 5 years, the future value would be :

$ 1 000 ( 1.10 )5
= 1 000 ( 1.6105 )
= $1 610.50.

The reasoning behind this formula is simple. If you deposit the initial $1 000 for one year you
will earn interest equivalent to :
 1000 x 0.10 = $100

Thus, at the end of the year your total investment, including the interest would be :

1 000 + 100 = $1 100.

At the same time, the interest will also earn its own interest, thus, if the investment is left for five
years the amount will be compounded to $1 610.50. This can be demonstrated in the following
table :

End of period Beginning Amount x Interest = Ending Amount

1 1 000.00 x 1.10 = 1 100.00
2 1 100.00 x 1.10 = 1 210.00
3 1 210.00 x 1.10 = 1 331.00
4 1 331.00 x 1.10 = 1 464.10
5 1 464.10 x 1.10 = 1 610.51

The future value of $ 1000.00 compounded annually for 3 years, for example is $1 331.00 which
is found by :

$1 000 ( 1.10 )3 = $ 1 000 ( 1.0331)

= $ 1 331.00.

Study the following example.

Example 2.1. You deposit $15 000 into an account that pays compound interest at a rate of 22%
per year, payable once per year. How much will you have at the end of 7 years?

Future Value FVn = PV ( 1 + i )n

= 15 000 (1 + 0.22 )7 = 15 000 x ( 1.22 )7 = $60 340.66

Therefore at the end of seven years you will have an amount of $60 340.66 in the bank.

2.2. Future Value Interest Factors [Table B-1]

You do not have to calculate these values all the time as there are tables that have been created to
take care of this. These are found in APPENDIX B, as Tables B-1, B-2, B-3, and B-4.

In Table B-1, we find future value interest factors (FVIF). The FVIF is the future value of $1 at
the end of n years at and interest rate of i% payable ( compounded ) once per year .

For example, the future value of $1 at the end of 5 years at 10% compounded once per year is
$1.6105. This is found by looking for the interest rate of 10% across the top of the table and then
the period 5 years down the left side of the table. Where to two figures meet inside the table you
find the future value interest factor [FVIF 10%,5years ] = 1.6105.

Consider the following example :

The future value of $100,00 deposited for 5 years when the interest rate is 5% per year
compounded once per year is found by multiplying $100 by the future value interest factor for
5% and 5 years in the table as follows

FV = 100 (FVIF 5%,5years ]

= 100 ( 1.2763 )
= $ 127,63.

Now try the following exercise:

EXERCISE 2.1. Find the future value after 9 years, of $60 000 which is deposited into an
investment that pays interest at 28% per year, payable once per year.

2.3. Discounting.
The process of bringing future, expected, values to the present is called discounting.

Suppose you were offered an alternative between a guaranteed $ 1610.50 at the end of 5 years or
$1 000,00 today, when the interest rate is 10%. You would be indifferent between the two
because $1 000.00 is the present value of $ 1 610.50 payable in 5 years at 10%.

Discounting is the reverse of compounding. The equation for finding the future value of $1 at i%
per year compounded annually for n years is given by :

FV = PV ( 1 + i )n
Therefore

PV = FV / ( 1 + i )n or FV x 1 / (
n

Thus , 1 000 = 1 610. 50 / ( 1.10 )5

= $1 000.

Example 2.2. Find the present value of $170 000 which is to be received at the end of 8 years
when the interest rate is 22.67% per year compounded once per year.

PV = 170 000 / ( 1.2267 )8 = $33 154.46

EXERCISE 2.2. Find the present value of $290 000 which is expected to be received in 6 years
time when the interest rate is 6.79% per year compounded once per year.

2.4. Present Value Interest Factors ( PVIF ), Table B-2.

The present value of $1payable in n years at i% can be found in Table B-2. For example, the
present value of $1 payable in 5 years at 10% is 1.6105. This is found by looking for the interest
rate of 10% across the top of the table and then the period 5 years down the left side of the table.
Where the two figures meet inside the table you find the present value interest factor

[PVIF 10%,5years ] = 1.6105.

To find the present value of $106 890 which is expected to be received at the end of 6 years when
the interest rate is 18% per year using the tables we simply multiply the future value of $106 890
by the present value interest factor :

106 890 x PVIF18%, 6 years = 106 890 x 0.3704 = $39 592.06

2.5. Unequal Cash Flow Streams.

So far, we have looked only at equal cash flow streams. If the cash flows are unequal we apply
the PVIF to each of the cash flows to find the present value of the total or the FVIF to find the
future value.

Suppose we had the following cash flows. At a discount rate of 10%, the present value would be
found as :

Year Cash flow PVIF [10%] Present value.

1 300 x 0.9091 = 272.73
2 100 x 0.8264 = 82.64
3 200 x 0.7513 = 150.26
$505.63

The same approach can also be applied to future values. Try the following exercise:

EXERCISE 2.3. Find the future value of the following cash flows given a discount rate of 20% :
Year Cash flow ($000)
1. 4 500
2. 5 800
3. 4 690
4. 5 760
5. 6 260

2.6. Non integer values of interest rates.

You also need to be able to calculate the FVIF and PVIF for fractional interest rates or interest
rates outside the range of the years provided in the tables.

For example, for n = 10 and i = 8.25%. These are not found in the tables, therefore we use the
formula for present value or future value.

FVIF = 1 x (1 + i )n = 1.082510 = 2.2094

PVIF = 1 / (1 + i )n = 1 / 1.082510 = 0.4526.

Study the following example:

Example 2.3. Find the present value of the following cash flows. The discount rate is 22.67% per
year compounded annually.

YEAR : 1. 2. 3. 4.
CASH FLOW ($) 12 000 15 000 16 900 26 950
We know that PVIF = 1 / (1 + i )n , therefore the present value of the cash flows would be
found by dividing each cash flow by the factor (1 + i )n ,as shown in the following table :

Year Cash flow ($) / (1 + i )n = Present value

1. 12 000 / ( 1.2267 ) = 9 732.34
2. 15 000 / ( 1.2267 )2 = 9 968.15
3. 16 900 / ( 1.2267 )3 = 9 155.28
4. 26 950 / ( 1.2267 )4 = 11 901.60
TOTAL = $40 757.37

Try the following exercise :

EXERCISE 2.4. You expect to receive the following amount at the end of each year for the next
four years. How much will you have at the end of the fourth year? The interest rate is 18.65% pa

Year 1 2 3 4
Cash flow ($) 40 000 46 000 65 000 88 000

2.7. Semi annual and other compounding.

Interest does not have to be paid exactly once per year at the end of each year. Interest can in fact
be paid any number of times during the year.

For semiannual and other compounding we divide the nominal or stated interest rate by the
number of times compounding occurs and multiply the years by the number of compounding
periods.

Let us suppose that an investment of $100 earns interest at 10% per year compounded
semiannually , that is every six months. Since this means that interest is actually paid each six
months, the annual interest rate is divided by 2 but twice as many compounding periods are used
because interest is paid twice a year.

The reason for this is very simple. The interest paid for the first six months would be 5% of $100,
which is equal to :

0.05 x 100 = $5.

Thus, at the beginning of the second six months, the principal would now be $100, plus the
interest of $5, which is equal to $105. A further 5% interest would then be earned on this
amount, that is :

0.05 x 105 = $5.25.

At the end of the year, you would then have a total of $100 plus $10.25 interest, which is equal to
$110.25.

2.8. Using the tables.

We can use the tables to find the discount rate to apply in such cases. Suppose you invest
$1 000.00 in a security that pays a return of 10% semiannually. How much will you have at the
end of 5 years ?
The solution to this is found by dividing 10% by 2 and multiplying the years by 2. From Table
B-1 under 10 years at 5% we get :

FVIF5%,10yrs = 1.6289

Thus, the amount will grow to 1 000 x 1.6289 = $1 628.90. If we had annual compounding,
the amount would have been $ 1 610.50.

COMPOUNDING DISCOUNTING
ANNUAL FV = PV ( 1 + i ) n PV = [FV / (1 + i)n ]]
SEMIANNUAL FV = PV ( 1 + i /2 )2n PV = [ FV / ( 1 + i / 2 )2n
MONTHLY FV = PV ( 1 + i / 12)12n PV = [FV / (1 +i / 12 )12n

We can generalize and say that the future value of an amount of $1 earning interest at i% per year
which is compounded m times per year for n years would found by :

FV = 1( 1 + i / m )mn

This also means that the present value of $1 at i% per year which is compounded m times for n
years would be :

PV = [ 1 / ( 1 + i / m )mn
]

Example 2.4. You deposit $10 000 into an investment that promises a return of 22.24% per year.
How much will you have at the end of 5 years if the interest rate is compounded :
(a) Semi-annually,
(b) Quarterly ( four times per year ) ?

(a) Future value with semi-annual compounding :

FV = 10 000 ( 1 + 0.2224 )5 x 2 = 10 000 ( 1.1112 )10 = $28 702.67

2
(b) FV with quarterly compounding :

FV = 10 000 ( 1 + 0.2224 )5 x 4 = 10 000 ( 1.0556 )20 = $29 511.25

4

EXERCISE 2.5. Find the future value of $40 000 which is deposited into an account that earns
12.62% per year compounded :

1. Yearly.
2. Semi-annually.
 3. Quarterly.
4. Monthly.
5. Daily.

2.9. Effective Annual Rate [EAR].

When you increase the number of periods of compounding the effect is to increase the effective
annual rate of interest. The EAR is that interest rate which would produce the same future value
if annual compounding had been used.

If, for example, we compound $100 annually at 6% for three years, the result would be 100(1.06)3
= $119,10. But if we compound the same amount semi-annually the result would be 100 (1.03)6
= $119.41.

The EAR is found by the following formula :

EAR = ( 1 + i / m )m - 1.00

Where : i = the nominal (quoted) rate,

And m = the number of compounding periods per year.

Let us suppose that a bank gives you a quotation of 26% with semiannual compounding for a
loan that you are applying for. The EAR is

(1 + 0.26 / 2)2 - 1.00 = (1.13)2 - 1.00 = 0.2769

This means that , effectively, you will be paying 27.69% on the loan. Thus, you always pay a
higher interest rate than the quoted rate when the number of discounting periods is increased.

Let us go back to Example 2.4. You will notice that the amount of $10 000 compounded semi-
annually at 22.24% would accumulate to $28 702.67. Now, if the interest had been compounded
annually, the sum accumulated would be :

10 000 ( 1.2224)5 = $27 293.97.

The effective annual rate for semi-annual compounding in this example is :

EAR = ( 1 + 0.2224 )2 - 1.00 = ( 1.1112 )2 - 1.00 = 0.23476544

2
If you were to compound $10 000 for 5 years at 23.476544% per year, payable once per year, this
would also amount to $28 702.67 :

10 000 ( 1.23476544 )5 = $28 702.67.

EXERCISE 2.6. A bank offers you a loan at 24% per year compounded monthly. Effectively,
what interest rate are you paying?

2.10.Valuation of payments and obligations on different dates.

We met the concept of dated values in our discussion of simple interest in UNIT 1. We now
extend this concept using compound interest.

You may, for example, decide to settle a debt before its maturity date. If your creditor agrees,
how much will you have to pay? Let us look at the following example.

Example 2.5. Peter Gomo has to pay an amount of $200 000 which is due in 4 year's time to his
bank. He decides to settle his debts earlier than the due date. The loan attracts interest at 18% pa
compounded monthly.

1. How much does he have to pay if he pays the money 8 months from now? We will use the
following time line to illustrate the problem :

Now Due date

3 4/12 years

0 8/12years 4 years

We know that the present value of $1 is given by :

PV = [ 1 / ( 1 + i / m )mn ]

In this case the present value of $200 000 will be equal to :

PV = [ 200 000 / ( 1 + i / m )mn ], where :

i = 0.18, m = 12, and n = 3 years and 4 months between 8 months from

now and the due date of 4 years. This is the same as 3 4/12 years = 3.3333 years

The amount to be paid in eight months from now is therefore equal to :

PV = 200 000
________________________
(1 + 0.18 )(12 x 3.3333)
12

= 200 000
______________
( 1.015 )40

= $110 252.46
2. Now, suppose Peter decides to pay the money some 2 years after the due date. How much
does he have to pay ?
The amount to be paid will be equal to :

200 000 ( 1 + 0.18 )(2 x 12) = $285 900.56

12
In certain cases you may be able to renegotiate the terms of the loan, that is the dates of payments
and the amounts to be paid as well as the interest rate. Let us study the following example.

Example 2.6. Suppose James Banda owes the following amounts to his bank:
1. Two years ago he borrowed $20 000 at 21% pa compounded semi-annually. This
money is now due in 8 month's time.
2. Nine months ago he also borrowed $9 000 at 25% pa compounded quarterly. This
money is due in 14 months time from now.
James negotiates with his bank to pay back the money under the following terms :
1. Pay back $8 000 now and the remainder to be rescheduled for 20 months from today.
2. A new interest rate of 27% pa compounded monthly be applied to all obligations for
the extended period.
How much will James have to pay in 20 month's time?

To solve this problem we use the following procedure :

1. Calculate the maturity values of your original obligations at the original interest rate.
2. Calculate the maturity values of your new obligations at the new interest rate.
3. Calculate the values of your payments, assuming that the amount to be paid at the end of 20
months is $X.
4. Your payments must equal your obligations.

This problem can be illustrated using the following time line.

OBLIGATIONS
32 months
$20 000 $9 000 12 months
23 months 6 months

24 months 9 0 8 14 20
months
1. Maturity value of original obligations :
 (a) 20 000 with i = 0.21, m = 2 and n = 32 months = 32/12 years

Future value of $1 = ( 1 + i / m )mn

FV of 20 000 = 20 000 ( 1 + 0.21)(2 x 32 / 12 )
2
= $34 063.99

(b) 9 000 with I = 0.25, m = 4 , and n = 23 months = 23/12 years.

FV of 9 000 = 9 000 ( 1 + 0.25 )(4 x 23 / 12)
4
= $14 325.10

2. Maturity values of new obligations:

(a) 34 063.99 x ( 1 + 0.27 )(12 x 12 /12)
12
= $ 44 489.27
(b) 14 325.10 x ( 1 + 0.27 )(12 x 6 / 12)
12
= $16 371.09.

3. Maturity values of payments :

(a) FV of 8 000 = 8 000 x ( 1 + 0.27 )(12 x 20 / 12 )
12
= $12 484.07

(b) $X, which is not compounded because it is made on the final date.

4. Payments must equal obligations :

Obligations = payments
44 489.27 + 16 371.09 = 12 484.07 + X
Solving for X : X = 48 376.22

Thus, the final payment will be equal to $48 376.22.

EXERCISE 2.7. Ana owes $12 000 due in 2 months, $14 000 due in 5 months, $15 500 due in 8
months, and $500 due in 18 months. She decides to pay back in three equal installments. The first
will be in 3 months from now, the second in 6 months and the final payment will be in 10 months
from now. Calculate the size of each payment if interest is compounded monthly at 24% pa and
the end of 10 months is taken as the comparison date for interest purposes.

2.11. Solving for i and n using tables.

Compounding is simply the reverse of discounting. Thus, the equations for calculating the PVIF
and the FVIF are reciprocals of each other, that is since

FV = PV ( 1 + i )n
 and

PV = FV / ( 1 + i )n

and there are four variables in each of the equations, that is PV, FV, n, and i, if you know the
values of any three you can find the value of the fourth..

Example 2.7. Suppose a bank offers to lend you $1 000.00 today and you agree to pay $1 762.30
at the end of 5 years in full settlement of the loan. How much interest will you be paying on the
loan ?

FVn = PV ( FVIFi,n, )

Therefore 1 762.30 = 1 000.00 ( FVIFi,n )

and FVIFr,5 = 1 762.30 / 1 000.00 = 1.7623.

Looking up across the row for the 5th year (Table B-1), we find the value 1.7623 in the 12%
column. Therefore the interest on the loan is 12%.

EXERCISE 2.8. You borrow $25 000 from the bank on which you are required to pay $186 040 at
the end of five years from now. How much interest are you paying on the loan ?

Example 2.8. You buy a security (an investment, such as a share) which earns a return of 5% per
year for $78,35 today. You anticipate that you will be able to sell the security for $100.00 when it
matures but you do not know the maturity date.

FVn = PV (FVIFr,n )

therefore

100 = 78.35 (FVIF5%,n )

and

(FVIF5%,n ) = 100 / 78.35 = 1.2763.

Looking down the 5% column in table B-1 we find 1.2763 coinciding with 5 years, that is the
number of years required.

EXERCISE 2.9. How long will it take for you to invest $200 000 at 28% per year so that it
accumulates to $419 440?

2.12. Solving for i and n when tables cannot be used.

You will notice that is all the examples that we have covered on this issue we were able to use the
tables to solve for either i or n. Now what would you do if the tables cannot be applied? In order
to handle such problems we will have to appeal to the law of logarithms, which states that :

ln mn = n ln m
( Note that the term ln is pronounced as "lin" )

The law of logarithms also states that if a and b are equal, then their natural logarithm will also
be equal, that is to say :

ln a = ln b

We know that the future value of any sum with interest compounded once per year for n years is
found by the following formula :

FV = PV( 1 + i )n

We can rearrange this to be :

( 1 + i )n = ( FV / PV )

Now, using the law of logarithms, this then becomes :

n = ln (FV / PV )
ln (1 + i )

n ln (1 + i ) = ln (FV / PV ),

Dividing both sides by ln ( 1 + i ) , we then get :

This will give us the number of years required for a sum of money (PV) to accumulate to a given
amount (FV) when we know the interest rate (i ), which is compounded once per year.

Let us try the following exercise :

EXERCISE 2.10. You intend to deposit $100 000 into an investment so that it will accumulate to
$350 000. The interest earned will be 22.45% pa compounded once per year. How long will it
take you to accumulate this amount ?

Suppose interest is compounded more than once per year ? We know that the future value of an
amount that is compounded m times per year at an interest rate of i% is found by the following
formula :

FV = PV( 1 + i / m )mn

Since we have already seen that :

n = ln (FV / PV )
ln (1 + i )

This therefore means that :

 nm = ln ( FV / PV )
ln (1 + i/m )nm

Thus :

n = ln (FV / PV )
m ln (1 + i/m )

Study the following example.

Example 2.9. You would like your money to double from $400 000 to $800 000. You invest it in
an account that earns 23.67% pa compounded semi-annually. How long do you have to wait
before you achieve your goal?

n = ln (FV / PV )
m ln (1 + i/m )

n = ln (800 000 / 400 000)

2 ln ( 1 + 0.2367
2

Your money will double in 3.0984 years time.

How do we find the interest rate when we have been given the number of years? We know that
the future value is found by:

FV = PV( 1 + i / m )mn

Rearranging this equation, you will see that :

( i / m ) = ( FV / PV )(1 / nm ) - 1

Thus :

i = m[( FV / PV )(1 / nm ) - 1
]

This will give you the interest ( i ) compounded m times, that will make an amount (PV)
accumulate to a given future value (FV) after a given period of time ( n ).

Try the following exercise.

EXERCISE 2.11. You have $40 000 to invest in a security that pays annual interest quarterly. You
want this amount to accumulate to $200 000 in five years' time. What interest rate should you
consider?

2.13. Continuous Compounding.

You will notice that as we increase the number of times that interest is compounded, the
accumulated value also increases due to the increase in the EAR. However, the increase in the
accumulated value decreases as we increase m. For example, in the case of 12.62 % per year, we
find that the EAR would be as follows :

m EAR (%)
Annually 12.62
Semi-annually 13.02
Quarterly 13.23
Monthly 13.37
Daily 13.44

If we were to plot the EAR against the number of times that interest is compounded we would
produce a graph which is similar to the one that appears below:

EAR (%)

As can be seen from this illustration, there is a limit regarding the effect of increasing m on the
accumulated value. The limit, when m is so large that it approaches infinity, is e, which is the
base of the natural logarithm. Thus, for continuos compounding ( when m is equal to infinity ),
the EAR becomes :

ic = ei - 1

The factor e in the equation is an irrational number with an approximate value of 2.71828. Let us
study the following example.
Example 2.10. An investor buys a security that pays an interest rate of 20% per year. If the rate
were compounded continuously, what would it be equal to?.

ic = 2.7182(0.20) - 1 = 0.2213 = 22.13%

With continuous compounding you should note that an amount of $X invested for n years at an
interest rate of i% would grow to :

Xein

For example, if you invested $20 000 for one year at a continuous rate of 25%, the amount at the
end of the year would be :
20 000e0.25 = $25 680.50

Compounding a sum (X) continuously for n years at a rate of i% requires us to multiply it by ein.
Similarly, discounting at a continuous rate of i% requires us to multiply the sum (X) by e(-in)

EXERCISE 2.12. An investor deposited $15 000 at 20% per year compounded continuously for 6
years. Calculate the sum to be accumulated during the five-year period.

If we know that ic is a rate of interest with continuous compounding and im is the equivalent rate
with compounding m times per year, we find that the accumulated sum (X) would be :

X [ e(ic) n ] = X [ ( 1 + im / m )mn ]

This is the same as :

e(ic) = ( 1 + im / m ) m

Now, if we solve for im, we find that the equivalent rate can be found by :

im = m ( eic / m - 1

We can use this equation to convert an interest rate which is compounded m times per year to a
continuously compounded rate. Look at the following example:

Example. 2.11. An investor quotes the interest rate on loans at 18% per year with continuous
compounding. The interest rate is, however, paid quarterly, what is the equivalent rate ?

m = 4, ic = 0.18

Therefore the equivalent rate with quarterly compounding is :

i = 4 ( e(0.18 / 4) - 1 = 0.1841 = 18.41%

Now, let us try the following exercise:

EXERCISE 2.13. A lender quotes the interest rate on loans at 22% per year with continuous
compounding but interest is actually paid quarterly. Find the amount of interest to be paid on a
loan of $250 000.

Alternatively, if e(ic) = ( 1 + im / m )m , we can solve for ic by taking the natural logarithm of

both sides of the equation, that is :

ln e(ic) = ln [ ( 1 + im / m )m ],
Therefore
ic ln e = m ln ( 1 + im / m )m

This gives us the equivalent rate for continuous compounding, given the rate im compounded m
times:

ic = m ln ( 1 + im / m )

2.14. Applications of continuous compounding.

You may now be wandering how this "abstract" concept ca actually be used in practice. Well, we
can use the concept of continuous compounding to compare two or more investment
opportunities. For example, you may have the following investment opportunities and you would
like to select the better option:

1. 22.86% per year compounded semi-annually, or

2. 22.10% per year compounded monthly.

We use continuous rates to decide which is the better option :

Since ic = m ln ( 1 + im / m )

For option 1 : ic = 2 ln ( 1 + 0.2286 ) = 0.21645 = 21.65%

2

For option 2 : ic = 12 ln ( 1 + 0.2210 ) = 0.218989 = 21.90%

12
On the basis of this calculation, the second option is therefore better than the first option.

2.15. Futures and Forward contracts.

The concept of continuos compounding is also used in the valuation of futures and forward
contracts. These are agreements whereby one party agrees to buy or sell an asset with another
party in the future at an agreed price.

A forward contract is a commitment that is made today to carry out a transaction in the future. It
is not an investment. Forward contracts are made as a means of hedging other investments
against risk. They are used for example, where a company expects to receive a payment in foreign
currency from a customer in another country. The firm can then hedge against the risk that the
exchange rate between the two currencies may change before it receives its payment by going
into a forward contract.
A futures contract is a contract that requires the delivery of an asset at a specified delivery or
maturity date, for an agreed price. Futures can therefore be used as investments.

The concept of continuous compounding is central to the valuation of futures and forward
contracts. In these contracts, interest is compounded continuously. It is for this reason therefore
that we now take some time to discuss these agreements in detail.

The investor can take either a short position or a long position in a forward contract. The long
position is taken by the investor who agrees to purchase the underlying asset on the maturity date.
The short position is taken by the investor who undertakes to sell or deliver the asset on the
agreed date. The investor in the long position therefore buys the contract or the asset whereas the
investor who takes the short position sells the contract or the asset.

We will use the following notations :

T = The date of maturity for the contract, measured in years.
t = This is now, that is the current time.
F = The forward price. This is the anticipated price of the asset at time t.
S = The spot price. This is the price of the underlying asset now, at time t.
i = The interest rate applicable to the contract. Usually, the risk-free rate,
which is the Treasury Bill rate.

If the price of the underlying asset is expected to increase in the future, in such a way that the
investor believes that the future price will be greater than the future value of the spot price, there
would be an opportunity for making a profit. That is, profit opportunities will exist where :

F > S [ei(T- t) ]

If this is the case, the investor will take the following steps :
1. Take a long position on the asset. The investor will borrow money for the period ( T - t ) at
the interest rate, i, and buy the asset.
2. Take a short position in the forward contract. The investor will undertake to sell the asset at
maturity, time T, at the agreed price, F.
3. At time T, the investor will sell the asset and make a profit of F - S [ei(T- t) ]

If, on the other hand, F < S [ei(T- t) ], the investor would make a profit by taking the following
steps :
1. Take a long position in the forward contract. The investor will undertake to buy the asset at
time T.
2. Take a short position on the asset. The investor will sell the asset now at the spot price, S.
This cash inflow will then be invested at i for the period (T - t ).
3. At time T, the investor buys the asset under the terms of the contract, at F and makes a profit
equal to
S [ei(T- t) ] - F.

Example 2.12. Suppose there is a forward contract on Delta Ltd shares. The contract matures in
three months and the three-month T-bill rate is 18% p.a. The current ( spot ) price of Delta shares
is 120 cents.

T-t = 0.25 years, that is 3/12 months.

I = 0.18,
 S = 120

For there to be no profit opportunities, the forward price should be equal to the future value of the
spot price. The future value of the spot price would be equal to :

S [ei(T- t) ] = 120e(0.18 x 0.25)

= 125.52 cents.
If, however, the forward price on the market is greater than 125.52, investors would buy the
shares and short the forward contract to make a profit. If, on the other hand, the forward price is
less than 125.52, investors would short the shares, invest the proceeds, and take a long forward
position to make a profit.

2.16. Integer values of n.

In practice you may deposit money on a date which does not necessarily coincide with the date on
which interest is credited. Let us say, for example, that you deposit some money into a bank
account on the 6th of July, but interest is payable monthly on the first day of each month. It is
clear from this that on the day that you have deposited the money you have already missed the
interest date for that month. This does not, however, mean that the bank will not credit your
account with the interest from the 6th of July to the next interest date, which is the first of August.

Further, what would happen if you decide to withdraw you money on the 9th of September.
Again, there is another fraction of the month at the end of the period which occurs after the
interest date of September. Thus, you are going to have two fractions of the month both at the
beginning and at the end of the period.

How are these fractions to be treated? If interest is paid using compound interest, it is usual for
banks to use simple interest in respect of the fractions at the beginning and end of the period.

Let us try the following example.

Example 2.13. You deposit $20 000 on 18 June and withdraw it on 24 October of the same year.
The interest rate is 21.6% pa compounded monthly on the first day of each month. How much
will you have at the end of the period?

The calculation is done in three steps as follows :

1. Calculate the interest from 18 June to 1 July, the first interest date, using simple interest.
2. Calculate the interest from 1 July to 1 October, covering the full three months, using
compound interest.
3. Calculate the interest from 1 October to 24 October, after the final interest date, using simple
interest.

In this example we must use the exact number of days using the rule which states that we include
the first day but exclude the last day:

1. 18 June to 1 July = 13 days.

Simple interest = S = P ( 1 + it )
= 20 000 ( 1 + 0.216 x 13 ) = $20 153.86301
365
2. 1 July to 1 October = 3 months.
The amount of $20 153.86 is then invested for a period of three months. The interest is
21.6% compounded monthly as follows :

FV = 1( 1 + i / m )mn , where, n = 3/12, m = 12, mn = 3/ 12 x 12 = 3

= 20 153.86301 ( 1 + 0.216 )3
12
= 21 261.8787.

3. 1 October to 24 October = 23 days.

This amount is now invested for 23 days at a simple interest rate of 21.6% :

S = P ( 1 + it )
= 21 261.8787 ( 1 + 0.216 x 23 )
365
= $22 601.67

A more accurate method would be to calculate the accumulated sum month by month instead of
using simple interest for the fractions of the month. This is shown below:

S = 20 000 x ( 1 + 0.216 x 13 / 365 ) : June

x ( 1 + 0.216 x 31 / 365 ) : July
x ( 1 + 0.216 x 31 / 365 ) : August
x ( 1 + 0.216 x 30 / 365 ) : September
x ( 1 + 0.216 x 23 / 365 ) : October

= $21 560.67

Summary.

We have seen that the compound interest is quite different from simple interest. In fact, most
lenders and borrowers use compound interest rather than simple interest. The tables that are
provided in Appendix B are a useful tool for problems that involve compound interest. However,
as we have seen, most problems would require you to use the actual equations for the derivation
of the FVIF and the PVIF.

We have also seen that time lines are very helpful in the comparison of payments and obligations
in which dated values with compound interest are involved. The use of EAR and continuous
compounding are also very important concepts that you have to master.

In this UNIT we have applied compound interest to single receipts and payments. In the next
UNIT we will apply compound interest to annuities, that is receipts and payments which occur
over a period of time. You will meet the concept of continuous compounding again in this UNIT.
 UNIT THREE

ANNUITIES

EXPECTED OUTCOMES. This UNIT introduces you to annuities. By the end of the UNIT you
will be expected to have understood the following:

1. Defining annuities, including ordinary annuities, annuity-due, perpetuities and deferred

annuities.
2. Use the tables and the formulae to calculate annuity factors ( FVIFA and PVIFA ).
3. What to do when the annuity amount has changed.
4. What to do when the annuity date differs from the interest date.
5. The amortization of loans and the construction of an amortization schedule.
6. What to do when the interest rate changes during the life of the annuity.
7. Sinking funds and the construction of a sinking fund schedule.

3.1. Annuities.
An annuity is a series of equal payments made at fixed intervals for a specified number of
periods. For example, a promise to pay $ 1 000 a year for 3 years is a 3-year annuity. There are
two types of annuities : annuity due and ordinary (deferred) annuity.

If the payments are made at the end of each period, that is, they are made at the same time that
interest is credited, it is an ordinary annuity. If the payments are made at the beginning of each
period, the annuity is known as an annuity due.

3.2. Future Value of an Ordinary Annuity

Suppose you deposit $ 100 at the end of each year for 3 years in a savings account that pays 5%
interest per year, how much will you have at the end of 3 years ?

In this example, each payment is compounded out to the end of period n, and the sum of the
compounded payments is the future value of the annuity.

This problem can be set out in a time line as shown below :

0 1 2 3

100 100 100.00

105.00
110.25
= 315.25

Thus, the future value of the annuity = [ 100 (1.05)2 + 100 (1.05) + 100 ] = $315.25.

3.3. Future Value Interest Factor (Annuity) , FVIFA

The future value of an annuity of $1 for a period of n years at an interest rate of i is given by the
following formula:

( 1 + i )n - 1
FVIFA = __________________
i

Thus, for example, the future value interest factor for 3 years at 5% is equal to :

[ (1.05 )3 - 1 ] / 0.05
= ( 1.157625 - 1 ) / 0.05
= 3.1525

Therefore the future value of our three-year annuity is 100 (3.1525 ) = $ 315.25.

The FVIFA can be found in table B-3. For example, the FVIFA3years,5% is found to be 3.1525.

EXERCISE 3.1.. Find the future value of an annuity after 10 payments of $5 000 each, paid
annually at the end of each year. The annuity earns interest at 19.76% per year, payable once per
year.

3.4. Future Value of an Annuity Due.

If the $100 payments had been made at the beginning of each year, this would be an annuity due
and the time line would look as shown below :

0 1 2 3

100 100 100

105.00
110.25
115.76
331.01

Thus, the future value of the annuity due is [ 100 (1.05) + 100 (1.05)2 + 100 (1.05)3 ] = $331.01.
Since the payments occur earlier, more interest is also earned, thus the future value of an annuity
due is larger ($331,01) than that of an ordinary annuity ($315.25).

To get the future value of an annuity due we compound the future value of an ordinary annuity by
an extra period.

Future value of annuity due = Annual payment (FVIFA)(1+i)

In our example the future value of the annuity due is 100 ( 3.1525)(1.05) = $331.01.
Example 3.1. Find the future value of an annuity of $12 000 per year. The amounts are deposited
at the beginning of the year for 6 years at an interest rate of 14% per year payable at the end of
each year.

The future value will be found by :

FVIFA14%, 6 x 12 000 x ( 1 + 0.14 )

= 8.5355 x 12 000 x ( 1 + 0.14 ) = $116 765.64

Since the future value tables are calculated for end-of-year payments, we can, alternatively, arrive
at the same solution by the following method :

12 000 ( FVIF14%, 6 years + FVIFA14%,, 6 years - 1 )

= 12 000 x ( 2.1950 + 8.5355 - 1 ) = $116 766.00

Try the following exercise:

EXERCISE 3.2. You deposit $25 000 at the beginning of each year into a pension fund that earns
interest at 22.56% per year compounded annually. How much will you have at the end of 25
years?

3.5. FVIFA, compounding more than once per year.

We have seen that when interest is compounded more than once per year, the FV of $1 will be
found by :

FV = PV( 1 + i / m )mn

Similarly, the future value of an annuity of $1 when the interest is compounded more than once
per year will be found by the following formula :

( 1 + i/m )nm - 1
FVIFA = __________________
i/m

Let us try the following example.

Example 3.2. Find the future value of an annuity of $3 000 which is made at the end of every
year for the next four years. The interest rate is 22% pa compounded four times per year.

( 1 + i/m )nm - 1
FVIFA = __________________
i/m

Where, m = 4, n = 4, and i = 0.22.

 ( 1 + 0.22 )( 4 x 4 ) - 1
FVIFA = 4
0.22
4
= 24.64113999

Thus, the future value of the annuity will be 24.6411399 x 3 000 = $73 923.42

3.5. Present Value of an Ordinary Annuity.

Suppose you were offered the following alternatives : a three year annuity of $1 000.00 or a lump
sum payment today. What must the lump sum payment be to make it equivalent to the annuity if
the interest rate is 10% ?

If the payments come at the end of each year, the annuity is an ordinary annuity and the time line
will look as shown below :
0 1 2 3

1000 1000 1000

909.10
826.40
751.30
2 486.80

Thus, the present value of the annuity is given by :

[ (1 000 ) / (1.10) + (1 000 ) / (1.10)2 + (1 000 )(1.10)3] = $2 486.80

This is the present value of three payments of $1 000 each deposited at the end of each year.

3.6. Present Value Interest Factor (Annuity) , PVIFA

The present value of an annuity of $1 for a period of n years at an interest rate of i is given by the
following formula:

( 1 + i )n - 1
PVIFA = _______________
i ( 1 + i )n
If, for example, we had a three year annuity whose interest rate is 7.5% the PVIFA would be
equal to :

1 - [ 1 / (1.075)3]
______________________________
0.0075
= 2.6005

The PVIFA can be found in table B-4. For example, the PVIFA3years,5% is found to be 2.7232.
3.7. Interest compounded more than once per year.
Just like we have seen in the case of future values, the present value, when interest is
compounded more that once per year will be found using the following formula :

[ ( 1 + i/m )nm ] - 1
PVIFA = _______________
i/m ( 1 + i/m )nm

Try the following example :

Example 3.2. Calculate the present value of an annuity of $1 which is paid over a period of six
years at an interest rate of 24.56% pa compounded four times per year.

[ ( 1 + i/m )nm ] - 1
PVIFA = _______________
i/m ( 1 + i/m )nm

[ ( 1 + 0.2456 /4 )( 6 x 4 ) ] - 1
PVIFA = ( 0.2456 / 4 )( 1 + 0.2456 / 4)( 6 x 4 )

= 12.3896

3.8. Annuity of different amounts.

Annuities come in different forms. Let us look at the following example :

Example 3.3. You expect to receive $100 000 at the end of each year for the next 5 years,
$150 000 per year for anther five years after that. Calculate the present value of these receipts at
18% pa.

Since 18% can be found in the tables, we can apply the PVIFA at 18% using the following
procedure :

Year Amount x PVIFA = Present value

1-5 $100 000 x 3.1272 = $312 720
6 - 10 150 000 x 1.3669 = 205 035
TOTAL = $517 755

The PVIFA for years 6 - 10 is not available directly from the tables. You can obtain it in two
ways.

1. Subtract the PVIFA for years 1 - 5 from the PVIFA for years 1 - 10 :

PVIFA10 years, 18% - PVIFA5 years, 18%

4.4941 - 3.1272 = 1.3669
 2. Alternatively, you can discount the PVIFA for years 1 - 5 back by five years :

( PVIFA5 years, 18% ) x ( PVIF5 years, 18% )

3.1272 x 0.4371 = 1.3669.

Try the following exercise using any of these methods:

EXERCISE 3.3. The following amounts are deposited into an investment at the end of each year.
The interest is 24% pa compounded once per year. Determine their present value.
YEAR AMOUNT
1-4 $120 000
5 - 10 300 000
11 - 15 450 000

3.9. Deferred annuity.

In certain cases, you may decide to set up an annuity in which the first payment is to be done
some time in the future. For example, a college student may get a loan from the bank for which
installments for repayment will only commence after the end of his or her studies. This is called a
deferred annuity. Let us look at the following example.

Example 3.4. John Gonzo, a college student, obtains a loan from the bank for his degree studies.
The loan is repayable in installments of $50 000 pa for five years after the end of his fourth year
at college. The bank charges an interest rate of 20% pa, compounded once per year. How much
will John be advanced by the bank?

To solve this problem, we first find the present value of an annuity of $50 000pa for 5 years at
20% pa:

50 000 x PVIFA20%, 5 years = 50 000 x 2.9906 = 149 530.

Since the annuity only starts four years from now, we then discount this back to the present, that
is for four years :

149 530 x PVIF20%, 4 years = 149 530 x 0.4823 = $72 118.32.

This is the amount that will be advanced by the bank.

Now, try the following exercise :

EXERCISE 3.4. Sheila obtains a loan of $500 000 for her poultry project on the following terms :
Interest will be charged at a rate of 22.45% pa compounded monthly but no payments will be
required until two years from now. Thereafter, equal payments will be made every month for five
years. Determine the size of the monthly payments that Sheila must make.

PENSION FUNDs
When a person plans for their retirement through a contribution to a pension fund , we can apply
the concept of annuities to calculate the amount of money that they will raceive afte r they retire.
They are two types of pension plans defined plans and a defined contribution plan. Let u s look at
the following defined benefit plan. \
Example 3.6 sten gumbo plans t=
3.10. Perpetuity.
You may come across annuities that do not have a fixed maturity date. These are called
perpetuities. Perpetuities are found in various forms.

When a firm needs to borrow money from the investing public, for example, it may issue bonds.
An irredeemable bond is a bond on which interest will be paid in perpetuity. Another example of
a perpetuity are the dividends received on a share, because shares are also issued in perpetuity.

There are two types of shares that can be issued by a firm: an ordinary share and a preference
share.

Ordinary shareholders receive their dividend ( share of the profits ) only after the preferred share
holders have been paid theirs. The ordinary share holders receive a dividend which is variable in
amount, whereas the preferred share holders receive a fixed divided which is fixed as a
percentage of the nominal value ( the book value of the share when it was first issued ).

Ordinary shares are always issued in perpetuity, which means that the ordinary dividend will be
paid for ever to the holder of the share. Preferred shares may, however, be redeemable or
irredeemable. If they are redeemable, the firm will "redeem" them buy paying back the nominal
value to the holders of the shares at the expiry of a specified period of time. If they are
irredeemable, the fixed dividend will be paid in perpetuity.

Let us look at the following example :

Example 3.5. A certain financial institution decides to set up a scholarship fund for students at
the University of Zimbabwe. The scholarship will be for $$80 000 pa. The money can be invested
to earn 20%pa. How much should the institution donate?

The present value of a perpetuity is simply found by dividing the annual payment by the interest
rate :

= 80 0000
0.20

= $400 000

Thus, if the institution donates $400 000, this amount can be invested at 20%pa. At the same
time, a payment of $80 000 can be made to the deserving student every year for ever.

Try the following exercise.

EXERCISE 3.5. An investor is considering a preference share with a fixed dividend of 15% and
a nominal value of $100. The required rate of return on the share is currently 11%. How much is
the investor prepared to pay?

3.11. Annuity payment date different from interest payment date.

The payment of interest does not have to coincide exactly with the payment of the annuity. If this
happens, we will have to convert the interest rate using continuous compounding. Consider the
following example.
Example 3.6. You make payments of $10 000 into an account at the end of every four month
period for the next six years. Calculate the accumulated value of these payments if interest is
compounded semi-annually at 19.5% pa.

This problem can be represented in the following time line :

Interest Interest

$10 000 $10 000 $10 000

3 x 6 = 18 payments

0 2 4 6 8

The first thing to do is to convert the semi-annual ( twice per year ) compounding of interest to
compounding three times per year to coincide with the number of payments per year. We do this
in two steps :

1. Calculate the equivalent continuous rate for i = 0.195 and m = 2

We have seen that ic = m ln ( 1 + im / m ), therefore in this case :

ic = 2 ln ( 1 + 0.195 )
2
= 0.18606973

2. Calculate the equivalent nominal rate for m = 3:

We know that , im = m ( eic / m - 1, thus in this case :

im = 3 [( e(o.81606973 / 3 ) ) - 1 ]
= 0.191961225

We now have an ordinary annuity with 18 payments of $10 000 at an interest rate of 19.196%
compounded three times per year. Thus, the future value of the annuity if found by :

( 1 + i/m )nm - 1
FVIFA = __________________, where , i = 0.19196, and n = 6, and m = 3
i/m

= ( 1 + 0.19196 )(6 x 3 ) - 1
3
0.19196
3
= 32.0984

The accumulated sum would be :

= 32.0984 x 10 000 = $320 984.93.
Now try the following exercise:

EXERCISE 3.6. You enter into a contract that requires you to pay $100 000 at the end of every
four months ( three times per year ) for four years. At the and of the fourth year you will also be
required to pay a lump sum of $500 000. The interest rate is 24% pa compounded monthly. How
much have you borrowed? How much do you still owe after two years ?

3.12. Amortization of Loans.

When a firm borrows money, the repayments may be in the form of fixed installments which
include both the interest payment and the repayment of the principal amount borrowed. The term
"amortization" , therefore refers to the repayment of loan obligations, including both interest and
principal. You should therefore be able to calculate the amount that is required to completely
"amortize" a loan.

Consider the following example.

Example 3.7. A firm borrows $ 100 000 which will be paid off by 3 equal installments made at
the end of each of the subsequent three years. The applicable interest rate is 12% per year. The
equal annual payments will combine both interest and repayment of principal so that the loan is
completely repaid by the end of the third year.

To calculate the annual payment we find the PVIFA12%,3yrs and then divide it into the amount
borrowed. The annual payment is the annuity that will pay off the amount borrowed.
Thus, the annual payment is :

100 000 / 2.4018 = $ 41 634.90

Try the following exercise :

EXERCISE 3.6. Peter borrows $240 000 at an interest rate of 25% compounded semi-annually.
The loan is to be amortized over a period of four years in equal installments made every six
months. Calculate the amount of the payment.

Again, the date on which interest is paid does not have to coincide with the date on which the
payments towards the amortization of the loan is made. Let us look at this example :

Example 3.8. A firm borrows $200 million at 22% pa compounded semi-annually. This amount
is to be paid off in equal monthly installments over a period of five years.

The first step is to convert the semi-annual compounding of interest to monthly compounding
using continuous interest rates :

First, we find the equivalent continuous rate for 22%:

ic = m ln ( 1 + im / m ), where m = 2 and i = 0.22

 ic = 2 ln ( 1 + 0.22 / 2 ) = 0.20872003

Then we calculate the equivalent nominal rate for this rate with monthly compounding :

im = m ( eic / m - 1, where m = 12, and i = 0.20872

im = 12 (e( 0.20872 / 12 ) - 1 ) = 0.210545768

We can now calculate the monthly payment as follows :

Monthly payment = 200 000 000

PVIFA

The PVIFA is found by

[ ( 1 + i/m )nm ] - 1
PVIFA = _______________
i/m ( 1 + i/m )nm

[ ( 1 + 0.210545768 / 12 )( 12 x 5 ) ] - 1
PVIFA = ( 0.210545768 / 12 )( 1 + 0.210545768 / 12)(12 x 5 )

= 36.92192634

Monthly payment = 200 000 000

36.92192634

= $ 5 416 835.46

3.13. Amortization schedule.

Firms are often interest in splitting the payment made towards the amortization of loans into the
payment of interest and the payment of the principal amount borrowed. The reason for this is that
interest payment is an expense which is allowed for tax purposes. The interest on a loan is
deducted before the deduction of tax, whereas the principal amount is deducted from after-tax
dollars. Therefore it is important to split the installments into their two components.

For us to do this we need to construct an amortization schedule . The following is the

amortization schedule for the loan in example 3.7 :

Year Beginning Annual Payment Interest Repayment of Remaining

Amount (12% x Col Principal balance
(1) (2) (1) (4) = (2) (3) (5) = (1) (4)
(3)
1 100 000.00 41 634.90 12 000.00 29 634.90 70 365.10
2 70 365.10 41 634.90 8 443.81 33 191.09 37 174.01
3 37 174.01 41 634.90 4 460.88 37 174.01 0.00
Thus, the total amount paid is $124 904.70 of which $24 904.69 is interest and $ 100 000.00 is
the principal amount.

The exercise that follows involves the use of continuous compounding. Try it.

EXERCISE 3.7. Show the first three lines of an amortization schedule for a loan of $25 000 that
is repayable at quarterly intervals for 12 years. The interest rate is 15.25% compounded semi-
annually.

3.14.Change in interest rate.

It is often the case that when you borrow money, the bank may subsequently adjust the rate
upwards or downwards during the life of the loan. Let us look at this example :

Example 3.9. You purchase a house by making a deposit of $100 000 of your own money. You
then obtain a ten-year loan of $300 000 at a rate of 20% pa compounded monthly in order to pay
off the balance. This loan is to be paid off in monthly installments. After four years and three
months the bank adjusts the interest to 28% pa compounded monthly. What are your new
monthly payments?

Initially your monthly payments were:

$300 000
PVIFA

Where: m = 12, n = 10, i = 0.20.

The PVIFA in this case is equal to 51.744923 (You must calculate this and check for yourself )

Therefore the monthly payment under the current conditions will be equal to :

300 000 / 51.744923 = $5 797.67

After four years and three months you have made 51 payments :

Payments to date = ( 4 years x 12 payments ) + ( 3 payments ) = 48 + 3 = 51 payments.

The remaining payments are therefore :

Outstanding payments = 120 - 51 = 69 payments.

The present value of the outstanding payments under the current conditions will be equal to

5 797.67 x PVIFA, where nm = 69 ( = 5 years 9 months x 12 ) , and i = 0.20.

= 5 797.67 x 40.820869 = $236 665.93.

This outstanding payment must now be amortized at the new interest rate of 28% pa. The FVIFA
at 28% with m = 12 and mn = 69 is 34.1306069

The monthly payments are now going to be :

 $236 665.93 / 34.1306069 = $6 934.13

Try the following exercise :

EXERCISE 3.8. Mr Dombo buys a house for $7 million. He deposits $1.2 million and borrows the
balance at 23% pa, compounded monthly. The loan is for a period of 25 years. Calculate the
monthly payments. Mr Dombo makes these payments for six years and the bank adjusts the
interest rate to 29% pa. Calculate the new monthly payments to be made. What is Mr Dombo's
equity in the house at this stage.

Note: The buyer's equity is the fraction of the loan that he has paid off so far at this stage. The
balance is known as the seller's equity.

3.15. Sinking Funds.

Companies usually borrow money from investors using bonds, or debentures. For example, if the
firm wanted to borrow $100 million dollars it could issue 100 000 bonds with a par value of
$1 000 and a coupon rate of , say, 20 % per year. The par value is also known as the nominal rate
or the principal amount that has been borrowed and the coupon rate is the interest that will be
payable annually on the loan. In most cases, however, interest is paid semi-annually. Thus, in this
case, the interest payable on every $1 000 borrowed would be ( 0.20 x 1 000 ) = $200 per year.
On a semi-annual basis it would be $100 every six months.

In most cases the firm does not have to pay the interest, or coupon, together with the principal
amount borrowed ( par value ). In such cases the bond will only be redeemed when it matures.
This means that the firm pays only the interest during the life of the bond and the par value is paid
at the end. To prepare for the eventual repayment of the principal, the firm must set up a sinking
fund into which it deposits a certain amount on a regular basis for the eventual redemption of the
bond. Meanwhile these deposits will also be earning interest.

Let us study the following example.

Example 3.10. A firm issues 100 000 bonds with a par value of $1 000 and a coupon rate of
20%. The bonds are redeemable at par in five years' time and the interest is payable semi-
annually. The firm then sets up a sinking fund into which a certain amount is deposited each
month to earn 18% per year compounded monthly. How much will it cost to service the debt each
year?

The payments into the sinking fund, together with the interest, must accumulate to the principal
amount of $100 million ( 100 000 x $1 000 ) by the end of the fifth year. Now, the monthly
deposit is an ordinary annuity with a future value of $100 million.

The future value of an annuity of $1 is given by :

( 1 + i/m )nm - 1
FVIFA = __________________, where , i = 0.18, and n = 5, and m = 12
i/m
 FVIFA = ( 1 + 0.18 )(5 x 12 ) - 1
12
0.18
12
= 96.21465171
Now, we want to know the monthly deposit (X) that will provide a future value of $100m after a
period of five years. To find the monthly payment, we simply divide the future value of $100
million by the FVIFA. The monthly payment is therefore equal to :

100 000 000 / 96.21465171 = 1 039 342.74

The interest on the bond is payable semi-annually. This interest is equal to :

I = Pit
= 100 000 000 x 0.20 x 0.5 = 10 000 000, payable every six months.

The total yearly cost of servicing the debt will be equal to the interest payments plus the sinking
fund deposits :

Total cost = ( 2 x 10 000 000 ) + (12 x 1 039 342.74 ) = $32 472 112.88.

3.16. Sinking fund schedule.

A sinking fund schedule is a table showing the way in which the fund will grow as a result of our
regular deposits into the fund. Let us look at the following example.

Example 3.11. A company borrowed $500 000 for a period of four years and wants to set up a
sinking fund for the repayment of the loan when it falls due at the end of four years. The fund will
earn interest at 22% per year compounded semi-annually. The company will deposit equal
amounts at the end of every six months into the fund. Determine the size of each deposit and
construct a sinking fund.

FVIFA = ( 1 + 0.22 )(4 x 2 ) - 1

2
0.22
2

= 11.85943427

Semi-annual deposits = 500 000 / 11.85943427 = $42 160.53.

The sinking fund schedule will as follows :

PERIOD Interest - half Deposit Change in fund Total in fund

yearly
(A) (B) (C) (D)
1 0 42 160.53 42 160.53 42 160.53
2 4 637.66 42 160.53 46 798.19 88 958.72
3 9 785.46 42 160.53 51 945.99 140 904.71
4 15 499.52 42 160.53 57 660.05 198 564.76
5 21 842.12 42 160.53 64 002.65 262 567.41
6 28 882.42 42 160.53 71 042.95 333 610.36
7 36 697.14 42 160.53 78 857.67 412 468.03
8 45 371.48 42 160.53 87 532.01 500 000.00
TOTAL 162 715.80 337 284.24 500 000.00

As you can see from this schedule, by the end of the fourth year we would have made eight
payments of $42 160.53 amounting to $337 284,24, which together with the interest of $162
715,80 would amount to the principal amount of $500 000.

Try the following exercise.

EXERCISE 3.9. A church organization is planning to construct a church building. Construction

will commence at the beginning of the year 2005 when sufficient funds have been raised from the
member's collections. On average, the amount collected every month is $22 000. Since 1 January
2000 the church has deposited these collections into a sinking fund that pays interest monthly at
a rate of 18% pa. Calculate the amount that will be in the church fund when construction
commences.

Summary.
In this UNIT we have covered the calculation of the PVIFA and FVIFA using both the tables and
the formulae provided. We have seen that these concepts can be applied to various types of
annuities, that is deferred annuities and perpetuities.

We have also used the concept of continuous compounding to convert interest rates in cases were
the interest date differs from the annuity date. We have constructed amortization schedules and
sinking fund schedules. In constructing an amortization schedule, you should be careful to note
that the interest date coincides with the annuity date as well.

We now know what to do when the interest rate changes during the life of the annuity or the size
of the annuity changes during the life of the annuity.
 APPENDIX A.
Solutions to exercises
UNIT ONE

EXERCISE 1.1.
S = P ( 1 + it ), where:

P = 20 000,
I = 0.1827,
and t = ( 3 x 365days ) + ( 4 x 30 days ) + 17 days = 1232 days.

S = 20 000 ( 1 + 0.1827 x 1232 / 365) = $32 333.50

EXERCISE 1.2.
Assume that S = 100. Given that : d = 0.24, t = 7 / 12
We know that D = Ndt,
D = 100 x 0.24 x 7 / 12 = 14
And
P = N-D
= 100 - 14 = 86
Since
I = Pit
14 = 86 x i x 7 / 12
14 = 50.1667i
i = 0.27907

Therefore the simple equivalent interest rate is 27.907%

EXERCISE 1.3.
Month Days
July (including 16 July) 16
August 31
September (excluding 19 September) 18
Total 65 days

EXERCISE 1.4.
Number of days from 26 March to 8 August = 135 days:
 S = P ( 1 + it ), where, P = 45 000, i = 0.22, and t = 135 / 365
= 45 000 x ( 1 + 0.22 x 135 / 365 ) = 48 661.64

The sum accumulated will be $48 661.64

EXERCISE 1.5.

(a) 150 000

__________________ = $125 523.01
( 1 + 0.26 x 9 / 12 )

(b) $150 000 brought back four months ( 9 - 5 months ):

150 000
_____________________ = $138 036.81
( 1 + 0.26 x 4 / 12 )

(c) $150 000 extended three months ( 12 - 9 months )

150 000 x ( 1 + 0.26 x 3 / 12 ) = $159 750.

EXERCISE 1.6.

t = I
Pi

= ( 650 000 - 300 000 )

650 000 x 0.22

= 2.4475 years = 2 years and 163 days.

EXERCISE 1.7.
We have seen that :

P = N ( 1 - dt )

Rearranging this equation, we find that the discount rate, d, will be found by :

d = (1- P/N) ,
t

where, P = the present value = $92 580,

N = the nominal or face value = $100 000
t = the term = March = 29 days, April = 30 days, May = 5 days =
64 days.

Therefore, d = [ 1 - ( 92 850 / 100 000 )]

64 / 365

= 0.40777 = 40.78%
 UNIT TWO

EXERCISE 2.1.
$60 000 X (FVIF28%, 9 years ) = 60 000 x 9.2234 = $553 404

EXERCISE 2.2.
290 000 / ( 1.0679 )6 = $195 530.49

EXERCISE 2.3.
Year Cash flow ($000) x FVIF20%
1. 4 500 x 1.2000 = 5 400.00
2. 5 800 x 1.4400 = 8 352.00
3. 4 690 x 1.7280 = 8 104.32
4. 5 760 x 2.0736 = 11 943.94
5. 6 260 x 2.4883 = 15 576.76
TOTAL = 49 377.02

EXERCISE 2.4

Year Future cash flow = [ cash flow x ( 1 + i )n ]

1 40 000 x (1.1865 )3 = 66 813.35
2 46 000 x (1.1865 )2 = 64 757.98
3 65 000 x (1.1865 ) = 77 122.50
4 88 000 x (1.0000 ) = 88 000.00
TOTAL $296 693.83

You will notice that the final amount is not compounded as it is received at the end of the fourth
year.

EXERCISE 2.5.
1. Yearly compounding :

40 000 ( 1 + 0.1262 )6 = $81 611.83.

2. Semi-annual compounding :

40 000 ( 1 + 0.1262 )6 x 2
2
= 40 000 ( 1.0631 )12 = $83 358.41.

3. Quarterly compounding :
 40 000 ( 1 + 0.1262 )6 x 4
4
= 40 000 ( 1.03155 )24 = $84 299.85.

4. Monthly compounding :

40 000 ( 1 + 0.1262 )6 x 12 = $84 955.33

12
5. Daily compounding :

40 000 ( 1 + 0.1262 )6 x 365 = $85 280.73

365

EXERCISE 2.6.

EAR = ( 1 + i / m )m - 1.00

Where : m = 12, i = 0.24

EAR = ( 1 + 0.24 / 12 )12 - 1.00 = 0.2682 = 26.82%.

EXERCISE 2.6
All moneys must be taken to the comparison date of 10 months.

OBLIGATIONS

12 000 14 000 15 500

500

2 3 4 5 6 8 10
18

The values of the obligations at the end of 10 months will be :

For 12 000 : 12 000 x ( 1 + 0.24 )(12 x 8 / 12) : n = 8 / 12, m = 12

12
= $ 14 059.91

For 14 000 : 14 000 x ( 1 + 0.24 )(12 x 5 / 12 : n = 5 / 12, m = 12

12

= $ 15 457.13

For 15 500 : 15 500 x ( 1 + 0.24 )(12 x 2 / 12 ) : n = 2 / 12, m = 12

 12
= $ 16 126.20

For 500 : 500 x ( 1 + 0.24 )(12 x -8/12) : n = - 8 / 12, m = 12

12

= $426.75

Total obligations : = $32 010.08

The values of the payments at the end of month 10 are :

The first payment : X ( 1 + 0.24 )(12 x 7 / 12) : n 7 / 12, m = 12

12

The second payment : X ( 1 + 0.24 )(12 x 4/12) : n 4 / 12, m = 12

12

The third payment is also equal to X but is not compounded since it is made at the end of the 10th
month.

Payments = Obligations

X ( 1 + 0.24 )(12 x 7 / 12) + X ( 1 + 0.24 )(12 x 4/12) + X = 32 010.08

12 12
Therefore
X [ ( 1 + 0.24 )7 + ( 1 + 0.24 )4 + 1 ] = 32 010.08
12 12

X = 32 010.08
____________________________________
[ ( 1 + 0.24 )7 + ( 1 + 0.24 )4 + 1 ]
12 12

X = 32 010.08
__________________________________
1.148685 + 1.082432 + 1
X = $ 9 906.82

Conclusion : Ana must make three equal payments of $9 906.82 each.

EXERCISE 2.8.
186 040 / 25 000 = 7.4416
This is the FVIF for five years, which is equivalent to an interest rate of 20%. Therefore you are
paying 20% per year on the loan.
EXERCISE 2.9

FVn = PV (FVIFr,n )
therefore

419 440 = 200 000 (FVIF28%, n years )

and 419 440 = (FVIF28%, n years )

200 000

Therefore 2.0972 = (FVIF28%, n years )

From the table, this coincides with 3 years.

EXERCISE 2.10.

n = ln (FV / PV )
ln (1 + i )

n = ln ( 350 000 / 100 000 )

ln ( 1 + 0.2245 )

n = 6.1854 years

EXERCISE 2.11.

i = m[( FV / PV )(1 / nm ) - 1 ]

i = 4 [ ( 200 000 / 40 000 )(1 / 4 x 5 )

= 0.33519 = 33.519%

Check : 40 000 ( 1 + 0.33519 )(4 x 5 ) = $200 000.

EXERCISE 2.12.
FV5 = 15 000e(0.20 x 6)
= 15 000 x 3.319997 = $49 799.95

If interest had been compounded annually, the accumulated sum would be :

FV5 = 15 000 (1.20 )5 = $37 324.80. Thus, continuous

compounding results in additional interest.

EXERCISE 2.13.

Since im = m ( eic / m - 1
The equivalent rate with quarterly compounding will be :

4 ( e(0.22 / 4) - 1 = 0.22616 = 22.616%

This means that on a loan of $250 000, interest payments of :

250 000 (0.22616 / 4 ) = $14 135.00 would have to be made each quarter.

UNIT THREE

EXERCISE 3.1..

( 1 + i )n - 1
FVIFA = __________________, where , i = 0.1976, n = 10
i

= ( 1 + 0.1976 )10 - 1
_____________________ = 25.652886
( 0.1976 )

The future value of the annuity is therefore equal to 5 000 x 25.652886 = $128 264.43.

EXERCISE 3.2.
We know that the future value interest factor, annuity is given by :

( 1 + i/m )nm - 1
FVIFA = __________________, where , i = 0.2256, and n = 25, m = 1
i/m

= [ ( 1 + 0.2256 )25 - 1 ] / 0.2256 = 712.3372.

and the FVIF = ( 1 + i )n = ( 1.2256 )25 = 161.703272

Therefore the future value of your yearly deposits will be :

= 25 000 x ( 161.703272 + 712.3372 - 1 ) = $21 826 011.79

EXERCISE 3.3..
YEAR AMOUNT
1-4 $120 000
5 - 10 300 000
11 - 15 450 000

The PVIFA for each of the three periods is found as follows :

Years 1 - 4 (directly from the tables ) = 2.4043

Years 5 - 10 ( subtracting the factor for 1- 4 years from the factor for 1 - 10 years )
= 3.6819 - 2.4043 = 1.2776
 Years 11 - 15 ( subtracting the factor for 1 -10 years from the factor for 1 - 15 years )
= 4.0013 - 3.6819 = 0.3194

Amount x PVIFA = Present value

120 000 x 2.4043 = 288 516
300 000 x 1.2776 = 383 280
450 000 x 0.3194 = 143 730
TOTAL = $815 526

EXERCISE 3.4.

1. Value of obligation before the commencement of payments:

FV = 1 ( 1 + i / m)mn

FV = 500 000 ( 1 + 0.2245 )(12 x 2 )

12
= 780 129.35

By the time that Sheila starts paying, the loan value would have accumulated to $780 129.35.

The future value of an annuity of $1 is found by :

[ ( 1 + i/m )nm ] - 1
PVIFA = _______________
i/m

[ ( 1 + 0.2245 )(12 x 5 ) ] - 1
12
= ________________________________
0.2245
12

= 109.0864525

The future value of an annuity if $X at a PVIFA of 109.0864525 is $780 129.35

Therefore :

780 129.35 = X ( 109.0864525 )

X = 7 151.48.

Sheila will have to make monthly payments of $7 151.48 to pay off the loan.
EXERCISE 3.5.
The value of the share is the present value of the fixed dividends, discounted at the required
rate of return. The required rate of return is the dividend that investors would be prepared to
accept if the firm were to issue similar shares today.

Fixed dividend = 100 x 0.15 = $15.

Value of share = 15
0.11

= $136.36
EXERCISE 3.6.
Convert monthly compound interest to three time per year to coincide with the payment pattern.

ic = m ln ( 1 + im / m ), where : m = 12, i = 0.24,

= 12ln ( 1 + 0.24 )
12
= 0.237631527

im = m ( eic / m - 1 ), where : m = 3

= 3 ( e(0.237631527 / 3 ) - 1 )

= 0.247296479

We will now use this as the nominal rate, compounded three times per year. There are 12
payments ( 3 x 4 years ) to be made. The present value of these payments will be equal to PVIFA
x $100 000

[ ( 1 + i/m )nm ] - 1
PVIFA = _______________
i/m

[ ( 1 +0.247296479)(3 x 4 ) ] - 1
3
= ________________________________
0.247296479
3

= 7.442027389

The present value of the payments will be 7.442027389 x 100 000 = $744 202.74
In addition to these payments, there will be a final payment of $500 000 with a present value of :

500 000 ( 1 + 0.247296479 ) - ( 4 x 3 )

3
 = $193 268.81

Therefore the loan has a present value of 193 268.81 + 744 202.74 = $937 471.55. This is the
amount that you have borrowed.

If you have paid for two years, you now owe the following :

937 471.55 ( 1 + 0.247296479 )( 2 x 3 )

3

= $1 507 864.16.

EXERCISE 3.7.
[ ( 1 + i/m )nm ] - 1
PVIFA = _______________
i/m

Where : m 2, I = 0.25, n = 4

Therefore PVIFA = 4.88204

Therefore the semi-annual payment will be :

240 000
4.88204

= $49 159.78

EXERCISE 3.8.
Firstly, the interest rate must be converted to an equivalent quarterly rate:
ic = m ln ( 1 + im / m ), where m = 2 and i = 0.1525

= 2 ln ( 1 + 0.1525 / 2 ) = 0.146965

im = m ( eic / m - 1, where m = 12, and i = 0.146956

im = 12 (e( 0.146956/ 12 ) - 1 ) = 0.1497

FVIFA at 14.97% with quarterly compounding for 48 payments ( 12 x 4 ) will be equal to

22.13957261

The quarterly payments will be :

25 000 / 22.139573 = $1 129.19

The amortization schedule for the first three payments will be :

PRINCIPAL INTEREST PAYMENT PRINCIPAL REPAID

OUTSTANDING
25 000.000 935.625* 1 129.19 193.565
24 806.435 928.381 1 129.19 200.809
24 605.625 920.866 1 129.19 208.324

* = 25 000 x ( 0.1497 / 4 )

EXERCISE 3.9.
Mr Dombo borrowed 7 000 000 - 1 200 000 = $5 800 000
Under current conditions : i = 0.23, m = 12, n = 25. Thus, the FVIFA = 51.99856936

Therefore, the monthly payment will be :

5 800 000 / 51.99856936 = $111 541.53

The total payments required are 12 payments per year for 25 years = 300 payments.
The payments made to date are 12 payments per year for 6 years = 72 payments.
Therefore the outstanding payments are 300 - 72 = 228 payments.

The present value of the remaining payments is therefore :

111 541.53 x PVIFA, where : m = 12 , n = 25 - 6 = 19, i = 23%

= 111 541.53 x 51.48598137
= $5 742 825.14

This means that Mr Dombo has paid off $5 800 000 - 5 724 825.14 = $57 174.86 of his loan. If
we add the deposit that he paid at the beginning, his total equity in the house is now :

Owners' equity = 57 174.86 + 1 200 000 = $1 257 174.86

Under the new conditions, i = 0.29, m = 12, n = 19. Thus, the FVIFA is 41.20054717

Therefore, the new monthly payment will be:

5 742 825.14 / 41.20054717 = $139 387.11

EXERCISE 3.10
The accumulated fund will be equal to $22 000 x FVIFA, where :

i = 0.18, m = 12, n = 5

= 22 000 x 96.21465171 = $2 116 722.34.

 APPENDIX B

FINANCIAL TABLES
TABLE B-1 : FUTURE VALUE OF $1 AT THE END OF n PERIODS

FVIF = ( 1 + i )n

PERIOD 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 1.0100 1.0200 1.0300 1.0400 1.0500 1.0600 1.0700 1.0800 1.0900 1.1000
2 1.0201 1.0404 1.0609 1.0816 1.1025 1.1236 1.1449 1.1664 1.1881 1.2100
3 1.0303 1.0612 1.0927 1.1249 1.1576 1.1910 1.2250 1.2597 1.2950 1.3310
4 1.0406 1.0824 1.1255 1.1699 1.2155 1.2625 1.3108 1.3605 1.4116 1.4641
5 1.0510 1.1041 1.1593 1.2167 1.2763 1.3382 1.4026 1.4693 1.5386 1.6105

6 1.0615 1.1262 1.1941 1.2653 1.3401 1.4185 1.5007 1.5869 1.6771 1.7716
7 1.0721 1.1487 1.2299 1.3159 1.4071 1.5036 1.6058 1.7138 1.8280 1.9487
8 1.0829 1.1717 1.2668 1.3686 1.4775 1.5938 1.7182 1.8509 1.9926 2.1436
9 1.0937 1.1951 1.3048 1.4233 1.5513 1.6895 1.8385 1.9990 2.1719 2.3579
10 1.1046 1.2190 1.3439 1.4802 1.6289 1.7908 1.9672 2.1589 2.3674 2.5937

11 1.1157 1.2434 1.3842 1.5395 1.7103 1.8983 2.1049 2.3316 2.5804 2.8531
12 1.1268 1.2682 1.4258 1.6010 1.7959 2.0122 2.2522 2.5182 2.8127 3.1384
13 1.1381 1.2936 1.4685 1.6651 1.8856 2.1329 2.4098 2.7196 3.0658 3.4523
14 1.1495 1.3195 1.5126 1.7317 1.9799 2.2609 2.5785 2.9372 3.3417 3.7975
15 1.1610 1.3459 1.5580 1.8009 2.0789 2.3966 2.7590 3.1722 3.6425 4.1772

16 1.1726 1.3728 1.6047 1.8730 2.1829 2.5404 2.9522 3.4259 3.9703 4.5950
17 1.1843 1.4002 1.6528 1.9479 2.2920 2.6928 3.1588 3.7000 4.3276 5.0545
18 1.1961 1.4282 1.7024 2.0258 2.4066 2.8543 3.3799 3.9960 4.7171 5.5599
19 1.2081 1.4568 1.7535 2.1068 2.5270 3.0256 3.6165 4.3157 5.1417 6.1159
20 1.2202 1.4859 1.8061 2.1911 2.6533 3.2071 2.8697 4.6610 5.6044 6.7275

21 1.2324 1.5157 1.8603 2.2788 2.7860 3.3996 4.1406 5.0338 6.1088 7.4002
22 1.2447 1.5460 1.9161 2.3699 2.9253 3.6035 4.4304 5.4365 6.6586 8.1403
23 1.2572 1.5769 1.9736 2.4647 3.0715 3.8197 4.7405 5.8715 7.2579 8.9543
24 1.2697 1.6084 2.0328 2.5633 3.2251 4.0489 5.0724 6.3412 7.9111 7.8497
25 1.2824 1.6406 2.0938 2.6658 3.3864 4.2919 5.4274 6.8485 8.6231 10.835
 TABLE B-1 Continued

PERIOD 12% 14% 15% 16% 18% 20% 24% 28% 32% 36%
1 1.1200 1.1400 1.1500 1.1600 1.1800 1.2000 1.2400 1.2800 1.3200 1.3600
2 1.2544 1.2996 1.3225 1.3456 1.3924 1.4400 1.5376 1.6384 1.7424 1.8496
3 1.4049 1.4815 1.5209 1.5609 1.6430 1.7280 1.9066 2.0972 2.3000 2.5155
4 1.5735 1.6890 1.7490 1.8106 1.9388 2.0736 2.3642 2.6844 3.0360 3.4210
5 1.7623 1.9254 2.0114 2.1003 2.2878 2.4883 2.9316 3.4360 4.0075 4.6526

6 1.9738 2.1950 2.3131 2.4364 2.6996 2.9860 3.6352 4.3980 5.2899 6.3275
7 2.2107 2.5023 2.6600 2.8262 3.1855 3.5832 4.5077 5.6295 6.9826 8.6054
8 2.4760 2.8526 3.0590 3.2784 3.7589 4.2998 5.5895 7.2058 9.2170 11.703
9 2.7731 3.2519 3.5179 3.8030 4.4355 5.1598 6.9310 9.2234 12.166 15.917
10 3.1058 3.7072 4.0456 4.4114 5.2338 6.1917 8.5944 11.806 16.060 21.647

11 3.4785 4.2262 4.6524 5.1173 6.1759 7.4301 10.657 15.112 21.199 29.439
12 3.8960 4.8179 5.3503 5.9360 7.2876 8.9161 13.215 19.343 27.983 40.037
13 4.3635 5.4924 6.1528 6.8858 8.5994 10.699 16.386 24.759 36.937 54.451
14 4.8871 6.2613 7.0757 7.9875 10.147 12.839 20.319 31.691 48.757 74.053
15 5.4736 7.1379 8.1371 9.2655 11.974 15.407 25.196 40.565 64.359 100.71

16 6.1304 8.1372 9.3576 10.748 14.129 18.488 31.243 51.923 84.954 136.97
17 6.8660 9.2765 10.761 12.468 16.672 22.186 38.741 66.461 112.14 186.28
18 7.6900 10.575 12.375 14.463 19.673 26.623 48.039 85.071 148.02 253.34
19 8.6128 12.056 14.232 16.777 23.214 31.948 59.568 108.89 195.39 344.54
20 9.6463 13.743 16.367 19.461 27.393 38.338 73.864 139.38 257.92 468.57

21 10.804 15.668 18.822 22.574 32.324 46.005 91.592 178.41 340.45 637.26
22 12.100 17.861 21.645 26.186 38.142 55.206 113.57 228.36 449.39 866.67
23 13.552 20.362 24.891 30.376 45.008 66.247 140.83 292.30 593.20 1178.7
24 15.179 23.212 28.625 35.236 53.109 79.497 174.63 374.14 786.02 1603.0
25 17.000 26.462 32.919 40.874 62.669 95.396 216.54 478.90 1033.6 2180.1
 TABLE B-2 : PRESENT VALUE OF $1 DUE AT THE END OF PERIOD n.

PVIFi,n = 1 / (1 + i )n
PERIOD 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 .9901 .9804 .09709 .9615 .9524 .9434 .9346 .9259 .9174 .9091
2 .9803 .9612 .9426 .9246 .9070 .8900 .8734 .8573 .8417 .8264
3 .9706 .9423 .9151 .8890 .8638 .8396 .8163 .7938 .7722 .7513
4 .9610 .9238 .8885 .8548 .8227 .7921 .7629 .7350 .7084 .6830
5 .9515 .9057 .8626 .8219 .7835 .7473 .7130 .6806 .6499 .6209

6 .9420 .8880 .8375 .7903 .7462 .7050 .6663 .6302 .5963 .5645
7 .9327 .8706 .8131 .7599 .7107 .6651 .6227 .5835 .5470 .5132
8 .9235 .8535 .7894 .7307 .6768 .6274 .5820 .5403 .5019 .4665
9 .9143 .8368 .7664 .7026 .6446 .5919 .5439 .5002 .4604 .4241
10 .9053 .8203 .7441 .6756 .6139 .5584 .5083 .4632 .4224 .3855

11 .8963 .8043 .7224 .6496 .5847 .5268 .4751 .4289 .3875 .3505
12 .8874 .7885 .7014 .6246 .5568 .4979 .4440 .3971 .3555 .3186
13 .8787 .7730 .6810 .6006 .5303 .4688 .4150 .3677 .3262 .2897
14 .8700 .7579 .6611 .5775 .5051 .4423 .3878 .3405 .2992 .2633
15 .8613 .7430 .6419 .5553 .4810 .4173 .3624 .3152 .2745 .2394

16 .8528 .7284 .6232 .5339 .4581 .3936 .3387 .2919 .2519 .2176
17 .8444 .7142 .6050 .5134 .4363 .3714 .3166 .2703 .2311 .1978
18 .8360 .7002 .5874 .4936 .4155 .3503 .2959 .2502 .2120 .1799
19 .8277 .6864 .5703 .4746 .3957 .3305 .2765 .2317 .1945 .1635
20 .8195 .6730 .5537 .4564 .3769 .3118 .2584 .2145 .1784 .1486

21 .8114 .6598 .5375 .4388 .3589 .2942 .2415 .1987 .1637 .1351
22 .8034 .6468 .5219 .4220 .3418 .2775 .2257 .1839 .1502 .1228
23 .7954 .6342 .5067 .4057 .3256 .2618 .2109 .1703 .1378 .1117
24 .7876 .6217 .4919 .3901 .3101 .2470 .1971 .1577 .1264 .1015
25 .7798 .6095 .4776 .3751 .2953 .2330 .1842 .1460 .1160 .0923

26 .7720 .5976 .4637 .3607 .2812 .2198 .1722 .1352 .1064 .0839
27 .7644 .5859 .4502 .3468 .2678 .2974 .1609 .1252 .0976 .0763
28 .7568 .5744 .4371 .3335 .2551 .1956 .1504 .1159 .0895 .0693
29 .7493 .5631 .4243 .3207 .2429 .1846 .1406 .1073 .0822 .0630
30 .7419 .5521 .4120 .3083 .2314 .1741 .1314 .0994 .0754 .0573

35 .7059 .5000 .3554 .2534 .1813 .1301 .0937 .0676 .0490 .0356
40 .6717 .4529 .3066 .2083 .1420 .0972 .0668 .0460 .0318 .0221
45 .6391 .4102 .2644 .1712 .1113 .0727 .0476 .0313 .0207 .0137
50 .6080 .3715 .2281 .1407 .0872 .0543 .0339 .0213 .0134 .0085
55 .5785 .3365 .1968 .1157 .0683 .0406 .0242 .0145 .0087 .0053
 TABLE B-2 : Continued

PERIOD 12% 14% 15% 16% 18% 20% 24% 28% 32% 36%
1 .8929 .8772 .8696 .8621 .8475 .8333 .8065 .7813 .7576 .7353
2 .7972 .7695 .7561 .7432 .7182 .6944 .6504 .6104 .5739 .5407
3 .7118 .6750 .6575 .6407 .6086 .5787 .5245 .4768 .4348 .3975
4 .6355 .5921 .5718 .5523 .5158 .4823 .4230 .3725 .3294 .3975
5 .5674 .5194 .4972 .4761 .4371 .4019 .3411 .2910 .2495 .2149

6 .5066 .4556 .4323 .4104 .3704 .3349 .2751 .2274 .1890 .1580
7 .4523 .3996 .3759 .3538 .3139 .2791 .2218 .1776 .1432 .1162
8 .4039 .3506 .3269 .3050 .2660 .2326 .1789 .1388 .1085 .0854
9 .3606 .3075 .2843 .2630 .2255 .1938 .1443 .1084 .0822 .0628
10 .3220 .2697 .2472 .2267 .1911 .1615 .1164 .0847 .0623 .0462

11 .2875 .2366 .2149 .1954 .1619 .1346 .0938 .0662 .0472 .0340
12 .2567 .2076 .1869 .1685 .1372 .1122 .0757 .0517 .0357 .0250
13 .2292 .1821 .1625 .1452 .1163 .0935 .0610 .0404 .0271 .0184
14 .2046 .1597 .1413 .1252 .0985 .0779 .0492 .0316 .0205 .0135
15 .1827 .1401 .1229 .1079 .0835 .0649 .0397 .0247 .0155 .0099

16 .1631 .1229 .1069 .0930 .0708 .0541 .0320 .0193 .0118 .0073
17 .1456 .1078 .0929 .0802 .0600 .0451 .0258 .0150 .0089 .0054
18 .1300 .0946 .0808 .0691 .0508 .0376 .0208 .0118 .0068 .0039
19 .1161 .0829 .0703 .0596 .0431 .0313 .0168 .0092 .0051 .0029
20 .1037 .0728 .0611 .0514 .0365 .0261 .0135 .0072 .0039 .0021

21 .0926 .0638 .0531 .0443 .0309 .0217 .0109 .0056 .0029 .0016
22 .0826 .0560 .0462 .0382 .0262 .0181 .0088 .0044 .0022 .0012
23 .0738 .0491 .0402 .0329 .0222 .0151 .0071 .0034 .0017 .0008
24 .0659 .0431 .0349 .0284 .0188 .0126 .0057 .0027 .0013 .0006
25 .0588 .0378 .0304 .0245 .0160 .0105 .0046 .0021 .0010 .0005

26 .0525 .0331 .0264 .0211 .0135 .0087 .0037 .0016 .0007 .0003
27 .0469 .0291 .0230 .0182 .0115 .0073 .0030 .0013 .0006 .0002
28 .0419 .0255 .0200 .0157 .0097 .0067 .0024 .0010 .0004 .0002
29 .0374 .0224 .0174 .0135 .0082 .0051 .0020 .0008 .0003 .0001
 TABLE B-3 : FUTURE VALUE OF AN ANNUITY OF $1 PER PERIOD FOR n PERIODS

FVIFA = [ ( 1 + i )n - 1 ] / i

PERIOD 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000
2 2.0100 2.0200 2.0300 2.0400 2.0500 2.0600 2.0700 2.0800 2.0900 2.1000
3 3.0301 3.0604 3.0909 3.1216 3.1525 3.1836 3.2149 3.2464 3.2781 3.3100
4 4.0604 4.1216 4.1836 4.2465 4.3101 4.3746 4.4399 4.5061 4.5731 4.6410
5 5.1010 5.2040 5.3091 5.4163 5.5256 5.6371 5.7507 5.8666 5.9847 6.1051

6 6.1520 6.3081 6.4684 6.6330 6.8019 6.9753 7.1533 7.3359 7.5233 7.7156
7 7.2135 7.4343 7.6625 7.8983 8.1420 8.3938 8.6540 8.9228 9.2004 9.4872
8 8.2857 8.5830 8.8923 9.2142 9.5491 9.8975 10.260 10.637 11.028 11.436
9 9.3685 9.7546 10.159 10.583 11.027 11.491 11.978 12.488 13.021 13.579
10 10.462 10.950 11.464 12.006 12.578 13.181 13.816 14.487 15.193 15.937

11 11.567 12.169 12.808 13.486 14.207 14.972 15.784 16.645 17.560 18.531
12 12.683 13.412 14.192 15.026 15.917 16.870 17.888 18.977 20.141 21.384
13 13.809 14.680 15.618 16.627 17.713 18.882 20.141 21.495 22.953 24.523
14 14.947 15.974 17.086 18.292 19.599 21.015 22.550 24.215 26.019 27.975
15 16.097 17.293 18.599 20.024 21.579 23.276 25.129 27.152 29.361 31.772

16 17.258 18.639 20.157 21.825 23.657 25.673 27.888 30.324 33.003 35.950
17 18.430 20.012 21.762 23.698 25.840 28.213 30.840 33.750 36.974 40.545
18 19.615 21.412 23.414 25.645 28.132 30.906 33.999 37.450 41.301 45.599
19 20.811 22.841 25.117 27.671 30.539 33.760 37.379 41.446 46.018 51.159
20 22.019 24.297 26.870 29.778 33.066 36.786 40.995 45.762 51.160 57.275

21 23.239 25.783 28.676 31.969 35.719 39.993 44.865 50.423 56.765 64.002
22 24.472 27.299 30.537 34.248 38.505 43.392 49.006 55.457 62.873 71.403
23 25.716 28.845 32.453 36.618 41.430 46.996 53.436 60.893 69.523 79.543
24 26.973 30.422 34.426 39.083 44.502 50.816 58.177 66.765 76.790 88.497
25 28.243 32.030 36.459 41.646 47.727 54.865 63.249 73.106 84.701 98.347

26 29.526 33.671 38.553 44.312 51.113 59.156 68.767 79.954 93.324 109.18
27 30.821 35.344 40.710 47.084 54.669 63.706 74.484 87.351 102.72 121.10
28 32.129 37.051 42.931 49.968 58.403 68.528 80.698 95.339 112.97 134.21
29 33.450 38.792 45.219 52.966 62.323 73.640 87.347 103.97 124.14 148.63
30 34.785 40.568 47.575 56.085 66.439 79.058 94.461 113.28 136.31 164.49
 TABLE B-3 Continued
PERIOD 12% 14% 15% 16% 18% 20% 24% 28% 32% 36%
1 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000
2 2.1200 2.1400 2.1500 2.1600 2.1800 2.2000 2.2400 2.2800 2.3200 2.3600
3 3.3744 3.4396 3.4725 3.5056 3.5724 3.6400 3.7776 3.9184 4.0624 4.2096
4 4.7793 4.9211 4.9934 5.0665 5.2154 5.3680 5.6842 6.0156 6.3624 6.7251
5 6.3528 6.6101 6.7424 6.8771 7.1542 7.4416 8.0484 8.6999 9.3983 10.146

6 8.1152 8.5355 8.7537 8.9775 9.4420 9.9299 10.980 12.136 13.406 14.799
7 10.089 10.730 11.067 11.414 12.142 12.916 14.615 16.534 18.696 21.126
8 12.300 13.233 13.727 14.240 15.327 16.499 19.123 22.163 25.678 29.732
9 14.776 16.085 16.786 17.519 19.086 20.799 24.712 29.369 34.895 41.435
10 17.459 19.337 20.304 21.321 23.521 25.959 31.643 38.593 47.062 57.352

11 20.655 23.045 24.349 25.733 28.755 32.150 40.238 50.398 63.122 78.998
12 24.133 27.271 29.002 30.850 34.931 39.581 50.895 65.510 84.320 108.44
13 28.029 32.089 34.352 36.786 42.219 48.497 64.110 84.853 112.30 148.47
14 32.393 37.581 40.505 43.672 50.818 59.196 80.496 109.61 149.24 202.93
15 37.280 43.842 47.580 51.660 60.965 72.035 100.82 141.30 198.00 276.98

16 42.753 50.980 55.717 60.925 72.939 87.442 126.01 181.87 262.36 377.69
17 48.884 59.118 65.075 71.673 87.068 105.93 157.25 233.79 347.31 514.66
18 55.750 68.394 75.836 84.141 103.74 128.12 195.99 300.25 459.45 700.94
19 63.440 78.969 88.212 98.603 123.41 154.74 244.03 385.32 607.47 954.28
20 72.052 91.025 102.44 115.38 146.63 186.69 303.60 494.21 802.86 1298.8

21 81.699 104.77 118.81 134.84 174.02 225.03 377.46 633.59 1060.8 1767.4
22 92.503 120.44 137.63 157.41 206.34 271.03 469.06 812.00 1401.2 2404.7
23 104.60 138.30 159.28 183.60 244.49 326.24 582.63 1040.4 1850.6 3271.3
24 118.16 158.66 184.17 213.98 289.49 392.48 723.46 1332.7 2443.8 4450.0
25 133.33 181.87 212.79 249.21 342.60 471.98 898.09 1706.8 3226.8 6053.0

26 150.33 208.33 245.71 290.09 405.27 567.38 1114.6 2185.7 4260.4 8233.1
27 169.37 238.50 283.57 337.50 479.22 681.85 1383.1 2798.7 5624.8 11198.0
28 190.70 272.89 327.10 392.50 566.48 819.22 1716.1 3583.3 7425.7 15230.3
29 214.58 312.09 377.17 456.30 669.45 984.07 2129.0 4587.7 9802.9 20714.2
30 241.33 356.79 434.75 530.31 790.95 1181.9 2640.9 5873.2 12941 28172.3
 TABLE B-4 : PRESENT VALUE OF AN ANNUITY OF $1 FOR n PERIODS

PVIFAi,n. = [ (1 + i )n - 1 ] / [ i ( 1 + i ) n]

PERIOD 1% 2% 3% 4% 5% 6% 7% 8% 9%
1 0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174
2 0.9704 1.9416 1.9135 1.8861 1.8594 1.8334 1.8080 1.7833 1.7591
3 2.9410 2.8839 2.8286 2.7751 2.7232 2.6730 2.6243 2.5771 2.5313
4 3.9020 3.8077 3.7171 3.6299 3.5460 3.4651 3.3872 3.3121 3.2397
5 4.8534 4.7135 4.5797 4.4518 4.3295 4.2124 4.1002 3.9927 3.8897

6 5.7955 5.6014 5.4172 5.2421 5.0757 4.9173 4.7665 4.6229 4.4859

7 6.7282 6.4720 6.2303 6.0021 5.7864 5.5824 5.3893 5.2064 5.0330
8 7.6517 7.3255 7.0197 6.7327 6.4632 6.2098 5.9713 5.7466 5.5348
9 8.5660 8.1622 7.7861 7.4353 7.1078 6.8017 6.5152 6.2469 5.9952
10 9.4713 8.9826 8.5302 8.1109 7.7217 7.3601 7.0236 6.7101 6.4177

11 10.3676 9.7868 9.2526 8.7605 8.3064 7.8869 7.4987 7.1390 6.8052

12 11.2551 10.5753 9.9540 9.3851 8.8633 8.3838 7.9424 7.5361 7.1607
13 12.1337 11.3484 10.6350 9.9856 9.3936 8.8527 8.3577 7.9038 7.4869
14 13.0037 12.1062 11.2961 10.5631 9.8986 9.2950 8.7455 8.2442 7.7862
15 13.8651 12.8493 11.9379 11.1184 10.3797 9.7122 9.1079 8.5595 8.0607

16 14.7179 13.5777 12.5611 11.6523 10.8378 10.1059 9.4466 8.8514 8.3126

17 15.5623 14.2929 13.1661 12.1657 11.2741 10.4773 9.7632 9.1216 8.5436
18 16.3983 14.9920 13.7535 12.6593 11.6896 10.8276 10.0591 9.3717 8.7556
19 17.2260 15.6785 14.3238 13.1339 12.0853 11.1581 10.3356 9.6036 8.9501
20 18.0456 16.3514 14.8775 13.5903 12.4622 11.4699 10.5940 9.8181 9.1285

21 18.8570 17.0112 15.4150 14.0292 12.8212 11.7641 10.8355 10.0168 9.2922

22 19.6604 17.6580 15.9369 14.4511 13.1630 12.0416 11.0612 10.2007 9.4424
23 20.4558 18.2922 16.4436 14.8568 13.4886 12.3034 11.2722 10.3711 9.5802
24 21.2434 18.9139 16.9355 14.2470 13.7986 12.5504 11.4693 10.5288 9.7066
25 22.0322 19.5235 17.4131 15.6221 14.0939 12.7834 11.6536 10.6748 9.8226
 TABLE B-4 Continued

PERIO 10% 12% 14% 15% 16% 18% 20% 24% 28% 32%
D
1 0.9091 0.8929 0.8772 0.8696 0.8621 0.8475 0.8333 0.8065 0.7813 0.7576
2 1.7355 1.6901 1.6467 1.6257 1.6052 1.5656 1.5278 1.4568 1.3916 1.3315
3 2.4869 2.4018 2.3216 2.2832 2.2459 2.1747 2.1065 1.9813 1.8684 1.7663
4 3.1699 3.0373 2.9137 2.8550 2.7982 2.6901 2.5887 2.4043 2.2410 2.0957
5 3.7908 3.6048 3.4331 3.3522 3.2743 3.1272 2.9906 2.7454 2.5320 2.3452

6 4.3553 4.1114 3.8887 3.7845 3.6847 3.4976 3.3255 3.0205 2.7594 2.5342
7 4.8684 4.5638 4.2883 4.1604 4.0386 3.8115 3.6046 3.2423 2.9370 2.6775
8 5.3349 4.9676 4.6389 4.4873 4.3436 4.0776 3.8372 3.4212 3.0758 2.7860
9 5.7590 5.3282 4.9464 4.7716 4.6065 4.3030 4.0310 3.5655 3.1842 2.8681
10 6.1446 5.6502 5.2161 5.0188 4.8332 4.4941 4.1925 3.6819 3.2689 2.9304

11 6.4951 5.9377 5.4527 5.2337 5.0286 4.6560 4.3271 3.7757 3.3351 2.9776
12 6.8137 6.1944 5.6603 5.4206 5.1971 4.7932 4.4392 3.8514 3.3868 3.0133
13 7.1034 6.4235 5.8424 5.5831 5.3423 4.9095 4.5327 3.9124 3.4272 3.0404
14 7.3667 6.6282 6.0021 5.7245 5.4675 5.0081 4.6106 3.9616 3.4587 3.0609
15 7.6061 6.8109 6.1422 5.8474 5.5777 5.0916 4.6755 4.0013 3.4834 3.0764

16 7.8237 6.9740 6.2651 5.9542 5.6685 5.1624 4.7296 4.0333 3.5026 3.0882
17 8.0216 7.1196 6.3729 6.0472 5.7487 5.2223 4.7746 4.0591 3.5177 3.0971
18 8.2014 7.2497 6.4674 6.1280 5.8178 5.2732 4.8122 4.0799 3.5294 3.1039
19 8.3649 7.3658 6.5504 6.1982 5.8775 5.3162 4.8435 4.0967 3.5386 3.1090
20 8.5136 7.4694 6.6231 6.2593 5.9288 5.2527 4.8696 4.1103 3.5458 3.1129

21 8.6487 7.5620 6.6870 6.3125 5.9731 5.3837 4.9813 4.1212 3.5514 3.1158
22 8.7715 7.6446 6.7429 6.3587 6.0113 5.4099 4.9094 4.1300 3.5558 3.1180
23 8.8832 7.7184 6.7921 6.3988 6.0442 5.4321 4.9245 4.1371 3.5592 3.1197
24 8.9847 7.7843 6.8351 6.4338 6.0726 5.4509 4.9371 4.1428 3.5619 3.1210
25 9.0770 7.8431 6.8729 6.4641 6.0971 5.4669 4.9476 4.1474 3.5640 3.1220