2

CORPORATE FINANCE TVM EXERCISES

Instructions:
Map out the cash flows for the problems on the next page. To
standardize our efforts, please use the following symbols/ instructions:
1. A horizontal line to reflect time, divided into the periods relevant
to the problem (usually in years). Example 2: What is the future value of Php100,000 today at the end of
year 5 assuming a required rate of 8% p.a.
2. Arrows to indicate the following: r = 8%
Up arrow – cash in/ benefits/ opportunity gains
Down arrow – cash out/ investments/ opportunity losses
?
Left Arrow – find present value (the value at time 0)
Right Arrow – find the value at a future period
0 1 2 3 4 5
3. The letter “r” to reflect the discount rate. 100
4. The punctuation mark “?” to indicate the value you wish to solve
to answer the question.
Example 3: What is the maximum you should pay for an investment with
5. An ellipsis “…” to indicate the passage of time or consistent an annual cash inflow of Php100 from the end of Year 10 to end of Year
flows. 25 assuming that the discount rate for the first 5 years is 5% and 7%
The following examples of mapping the cash flows might help: thereafter?
? r = 5% r = 7%
Example 1: Bank ABC is offering an investment product where an
investment of Php100,000 today will generate cash inflows of Php20,000 100 100 100
in year 1, Php30,000 in year 2, Php40,000 in year 3, and Php50,000 in ... ...
year 5. If the required rate is 10%, should you invest? 0 5 10 25

? r = 10%
20 30 40 50

0 1 2 3 4
100

© Michael Barron

CORPORATE FINANCE
Extension Exercises
27. Your younger brother has come to you for advice. He is about to
21. You have the opportunity to make an investment that costs $900. If
you make this investment now, you will receive $180 one year from
today. You will also receive $215 and $785 two and three years
from today, respectively. The appropriate discount rate for this
investment is 10%.
Should you make the investment? If the investment is $950, should
you invest?
22. Your aunt has promised to give you $3,170 in trade-in value for your
car when you graduate one year from now. Your roommate offered
you $2,800 for the car now. The prevailing interest rate is 12%.
Should you accept your roommate’s offer?
23. What is the future value three years hence of $1,000 invested in an
account with a stated annual interest rate of 8%? a) Compounded
annually? b) Compounded semi-annually? c) Compounded monthly?
d) Compounded continuously?
24. If the interest rate is 8% per year, what is the value in Year 7 of a
perpetual stream of $100 payments starting in year 12?
28. The MBA Publishing Company is trying to decide whether or not to
25. What is the value of a 10-year annuity that pays $300 a year? The
annuity’s first cash flow is at the end of year 6 and the stated annual
interest rate is 15% for years 1 through 5 and 10% thereafter.
26. You are saving for the college education of your two children. They
are two years apart in age; one will begin college in 15 years, the
other in 17 years. College expenses will be $21,000 per year per
child for a 4 year course. The annual interest rate is 15%, and it will
remain 15% through the next 25 years. How much money must you
place in an account each year to fund your children’s education?
© Michael Barron
2
TVM EXERCISES
You will begin payments one year from today. You will discontinue
payments when your oldest child enters college.
enter college and has two options open to him. His first option is to
study engineering. If he does this, his undergraduate degree would
cost him $12,000 a year for 4 years. Having obtained this, he would
need to gain 2 years of practical experience; in the first year he
would earn $20,000, in the second year he would earn $25,000. He
then would need to obtain his master’s degree, which will cost
$25,000 a year for 2 years. After that he will be fully qualified and
can earn $40,000 per year for 25 years.
His other alternative is to study accounting. If he does this, he would
pay $13,000 a year for 4 years and then he would earn $31,000 per
year for 30 years.
The effort involved in the two careers is the same, so he is interested
only in earnings the jobs provide. All earnings and costs are paid at
the end of the year. What advice would you give him if the
applicable interest rate is 5%? A day later he comes back and says
he took your advice, but in fact, the applicable interest rate was 6%.
Has your brother made the right choice?
revise a popular textbook. They have estimated that the revision will
cost $40,000. Cash flows from increased sales will be $10,000 in the
first year. These cash flows will increase by 8% per year for the next
2 years, then remain stable for 2 more years. The book will go out of
print 5 years from now. Assume the initial cost is paid now and all
revenues are received at the end of each year. If the company
requires a 11% return for such an investment, should it undertake the
revision? Should the company still undertake the revision if the
required return is 12%?