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7/10/2013

Reviewer/Interest Factor…
Cash flow diagram:
A cash flow is the difference between total cash receipts (inflows)
and total cash disbursements (outflows) expenditures for a given
period of time.
A cash flow diagram is used to visualized a cash flow;
individual cash flows are presented as vertical arrows along a
horizontal time sale
Positive cash flows (net inflows) are represented by “upward-
pointing ” arrows and negative “cash flows” (net outflows) by
“downward-pointing” arrows. The length of an arrow is proportional
to the magnitude of the corresponding cash flow. Each cash flow is
assumed to occur at the respective time period. The cash flow
diagram is dependent on the point on view (e.g. lender vs. borrower
viewpoint).

Example of a cash flow diagram: Reviewer/Interest Factor…


End –of- Event or transaction P80,000 P100,000
period
0 (now) Outlay of P100,000
P60,000
1 Additional expenditure of
P25,000
2 Receipts of P60,000
0 1 2
3 4 5 6 7 periods
3 to 6 Uniform receipts of
P80,000
-P25,000
7 Receipts of P100,000

-P100,000

Reviewer/Interest Formulas
1. A uniform payment series is one that consists of Reviewer/Interest Formulas
equal payments
a) starting now up to year n
b) starting one year from now up to year n A
c) starting one year from now increasing by a
uniform amount up to year n
d) none of the above 1 2 3 4 5 6 7 n-1 n

Answer: b
P

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Table of interest factors for discrete compounding; interest rate of 5%


n (F/P,I%,n) (P/F,I%,n) (F/A,I%,n) (A/F,I%,n) (P/A,I%,n) (A/P,I%,n) (A/G,I%,n)
1 1.0500 0.9524 1.0000 1.0000 0.9524 1.0500 0.0000
2
3
4
1.1025
1.1576
1.2155
0.9070
0.8638
0.8227
2.0500
3.1525
4.3101
0.4878
0.3172
0.2320
1.8594
2.7232
3.5460
0.5378
0.3672
0.2820
0.4878
0.9675
1.4391
Reviewer/Interest Formulas
5 1.2763 0.7835 5.5256 0.1810 4.3295 0.2310 1.9025
6 1.3401 0.7462 6.8019 0.1470 5.0757 0.1970 2.3579

2. The equal payment series sinking fund factor is used


7 1.4071 0.7107 8.1420 0.1228 5.7664 0.1728 2.8052
8 1.4775 0.6768 9.5491 0.1047 6.4632 0.1547 3.2445
9 1.5513 0.6446 11.0266 0.0907 7.1078 0.1407 3.6758
10 1.6289 0.6139 12.5779 0.0795 7.7217 0.1295 4.0991
11 1.7103 0.5847 14.2068 0.0704 8.3064 0.1204 4.5144
12
13
1.7959
1.8856
0.5568
0.5303
15.9171
17.7130
0.0628
0.0565
8.8633
9.3936
0.1128
0.1065
4.9219
5.3215
a) to find F given A c) to find A given F
14
15
1.9799
2.0789
0.5051
0.4810
19.5986
21.5786
0.0510
0.0463
9.8986
10.3797
0.1010
0.0963
5.7133
6.0973
b) to find A given P d) none of the above
16 2.1829 0.4581 23.6575 0.0423 10.9378 0.0923 6.4736
17 2.2920 0.4363 25.8404 0.0367 11.2741 0.0887 6.8423
18 2.4066 0.4155 28.1324 0.0355 11.6896 0.0855 7.2034
19 2.5270 0.3957 30.5390 0.0327 12.0853 0.0827 7.5569
20 2.6533 0.3769 33.0660 0.0302 12.4622 0.0802 7.9030
21 2.7860 0.3589 35.7193 0.0280 12.8212 0.0780 8.2416 Answer: c
22 2.9253 0.3418 38.5052 0.0260 13.1630 0.0760 8.5730
23 3.0715 0.3256 41.4305 0.0241 13.4886 0.0741 8.8971
24 3.2251 0.3101 44.5020 0.0225 13.7986 0.0725 9.2140
25 3.3864 0.2953 47.7271 0.0210 14.0939 0.0710 9.5238
30 4.3219 0.2314 66.4388 0.0151 15.3725 0.0651 10.9691
35 5.5160 0.1813 90.3203 0.0111 16.3742 0.0611 12.2498
40 7.0400 0.1420 120.7998 0.0083 17.1591 0.0583 13.3775
50 11.4674 0.0872 209.3480 0.0048 18.2559 0.0548 15.2233
60 18.6792 0.0535 353.5837 0.0028 18.9293 0.0528 16.6062
80 49.5614 0.0202 971.2290 0.0010 19.5965 0.0510 18.3526
100 131.5010 0.0076 2610.025 0.0004 19.8479 0.0504 19.2337

Reviewer/Interest Formulas Reviewer/Interest Formulas


F 3. The amount of P65,000 was to be borrowed at an annual
interest rate of 12% to be repaid in 5 years. Two different
A
plans, both equally desirable, could be selected to repay the
loan. The first plan requires paying 1/5 of the principal each
year + interest due. The second plan requires paying an
0 1 2 3 4 5 6 7 n
equal amount every year. In Plan 1, the amount to be
repaid at the end of year 1 will be closest to
a) P17,680 b) P20,800 c) P18,240 d) P16,120

Reviewer/Interest Formulas Reviewer/Interest Formulas


4. A loan can be repaid in 4 years using any of the 3 following plans:
Given: P = P65,000
i=12%/yr Plan End-of Interest Total owed at Payment
end of Year
Year for Year
n = 5 yrs Plan 1 1 7,200 97,200 27,173
2 5,602 75,629 27,173
For Plan 1, 1st payment = I + 1/5P
3 3,876 52,332 27,173
Find: Amt of 1st payment 4 2,013 27,173 27,173
Plan 2 1 7,200 97,200 0
Solution: 2 7,776 104,976 0
1st Payment = I + 1/5P = (P×i) + 1/5P 3 8,398 113,374 0
4 9,070 122,444 122,444
= (65,000×0.12) + (1/5)(65,000) Plan 3 1 7,200 97,200 7,200
= 7,800 + 13,000 = P20,800 b 2 7,200 97,200 7,200
3 7,200 97,200 7,200
4 7,200 97,200 97,200

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Reviewer/Interest Formulas
The original amount of the loan is:
a) P72,000 c) P108,692
b) P90,000.00 d) P97,200
Reviewer/Interest Formulas
Given: 3 different plans to pay a loan as shown in the table. 5. The value of the interest factor needed to find the
Find: P equivalent at time 0 of P155,000 occurring 7 years from
now when interest rate is 9% per year compounded yearly
Solution: Since interest rate is not given, it is best to look at is
interest earned and total amount owed at the end of year 1. a) 1.8280 c) 0.0129
For all plans, total amount owed at year 1, F1 = P97,200. b) 0.5470 d) none of the above
Interest earned for year 1, I1 = P7,200.
Therefore, P = F1 – I1 = P97,200 – P7,200 = P90,000 b

Reviewer/Interest Formulas
Given: F7 = P155,000
n = 7 yrs Reviewer/Interest Formulas
i = 9%/yr
Find: Value of interest facto to find P given F 6. The value of the interest factor needed to find a
Solution: series of equal revenues that must be received every
Cash flow diagram is as follows:
year for 12 years to realize a return of 25% from an
initial investment of P25M is
F = P155,000
a) 0.2685 c) 0.0687
(P/F) b) 0.0185 d) none of the
above
i=9%/yr n=7yrs

P?
(P/F,i,n) = (1+i)-n = (1 + 0.09)-7 = 0.5470 b

Reviewer/Interest Formulas Reviewer/Interest Formulas


7. Five years ago, P12,000 was deposited into a savings
account that provides an interest of 6.5% compounded
A annually. If a uniform amount of P3,000 was withdrawn
yearly starting at the end of the first year after the initial
deposit was made, then
a) all the money will be gone by now
1 2 3 4 5 6 7 8 9 10 11 12 b) an amount greater than P3,000 can still be
P = P25M withdrawn now
(A/P,i,n) = [i×(1+i)n] = [0.25×(1+0.25)12]
c) an amount less than P3,000 can still be withdrawn
(1+i)n-1 (1+0.25)12-1
now
d) none of the above
(A/P,i,n) = 0.2684 a

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Reviewer/Interest Formulas
Solution 1: Step-wise approach

Reviewer/Interest Formulas End of


year
P I P+I Amt
withdrawn
Remaining
amount after
A= P3,000 year n
A5=P3,000?
1 12,000 780 12,780 3,000 9,780
2 9,780 635.7 10,416 3,000 7,416
1 2 3 4 5

i=6.5%/yr 3 7,416 482 7,898 3,000 4,898


4 4,898 318 5,216 3,000 2,216

P=P12,000 5 2,216 144 2,360 3,000? -640

Answer: c

Reviewer/Interest Formulas Reviewer/Interest Formulas


8. A loan of P10,000 is to be paid in 3 years at an
Solution 2: Analytical approach
A  P  ( A / P, i , n) interest of 6% per year. Which of the payment plans
below is not equivalent to the others?
[i  (1  i )n ] a) Pay interest payment of P600 each year during the
A  P
(1  i )n  1 first 2 years and P10,600 at the end of the third year.
b) Pay P4,600 at the end of the first year, P3,600 at
[0.065  (1  0.065)5 ] the end of the second year and P3,600 at the end of the
A  12,000 
(1  0.065)5  1 3rd year.
c) Pay with a single amount of P11,910 at the end of 3
A  P 2,888 Uniform amt to be withdrawn to last 5 years
years.
Since the amount withdrawn for the last 4 years exceeds d) Pay with 3 equal payments of P3,741 every year for
the amount of P2,888, then it follows that the amount that 3 years.
can be withdrawn on the 5th year can not be P3,000.

Reviewer/Interest Formulas Reviewer/Interest Formulas


Given: P = P10,000
n = 3 yrs
i = 6%/yr Looking at plan: (b)
Find: Repayment plan that is not equivalent to the others.
Looking over at each plan: (a)

End of P I P+I Amt Paid Remaining End of P I P+I Amt Paid Remaining
year amount after year amount after
year n year n
1 10,000 600 10,600 600 10,000 1 10,000 600 10,600 4,600 6,000
2 10,000 600 10,600 600 10,000 2 6,000 360 6,360 3,600 2,760
3 10,000 600 10,600 10,600 0 3 2,760 165.6 2925.6 3,600 Overpaid

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Reviewer/Interest Formulas Reviewer/Interest Formulas

Looking at plan: (c) Looking at plan: (d)

End of P I P+I Amt Paid Remaining End of P I P+I Amt Paid Remaining
year amount after year amount after
year n year n
1 10,000 600 10,600 0 10,600 1 10,000 600 10,600 3,741 6859
2 10,600 636 11,236 0 11,236 2 6,859 411.54 7270.54 3,741 3529.54
3 11,236 674 11,910 11,910 0 3 3,529.54 211.77 3741 3,741 0

Answer: Plan b is different from the others

Reviewer/Interest Formulas Reviewer/Interest Formulas


9. At 10% interest, the cash flow below Solution:
i=10%/yr
0 1 2 3 4 0 1 2 3 4 0 1 2 3 4

P2,000 P2,000
P2,500 P2,500 A=?
P3,000 P3,000
P3,500 P3,500

is equivalent to a uniform yearly cash flow of


a) P3,500 b) P2,780 c) P2,691 d) P3,025

Reviewer/Interest Formulas
Reviewer/Interest Formulas 2nd Approach; Solve for P, then find A using the capital
recovery factor interest formula.
1st approach: First find P, then solve for A algebraically.
P  2,000  (1.1)  2,500  (1.1)  3,000  (1.1)  3500  (1.1)
1 2 3 4 A  P  ( A / P, i , n)
 i 1  i  
n
P  8,528.6
A  8528.6   
P  A  (1.1)  A  (1.1)  A  (1.1)  A  (1.1)
 (1  i )  1
1 2 3 4
n

P  A(0.9091  0.8264  0.7513  0.683)  A  3.1698


 0.11  0.1 
4

Solving forA : A  8528.6   


 (1  0.1)  1
4

AP  P8,528.6  P 2691


3.1698 3.1698
A  P 2,691

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Reviewer/Interest Formulas Reviewer/Interest Formulas


3rd Approach: Use the uniform gradient interest factor formula.
10. Which of the following interest relationships
is not true?
a) (P/A,i,n) = [1 + (P/F,i,n)](1/i)
A  A  G ( A / G , i , n)
1 b) (A/P,i,n) = (A/F,i,n) + i
c) (P/F,i,n) = (P/F,i,n1)×(P/F,i,n2) provided n1 + n2 = n
1 n
A  A  G [  ] d) (F/A,i,n ) = 1 + ( F/P,i,1) + (F/P,i,2) + ….. + (F/P,i,n-1)
i (1  i )  1 e) none of the above
1 n

1 4
A  2,000  500  [  ]
0.1 (1  0.1)  1 4

A  P 2,691

Reviewer/Interest Formulas Reviewer/Interest Formulas


Solution: Prove each identity given, starting with (a) Proving identity (b).
?

(P/A, i, n)  [1  (P/F,i, n)](1/i)


 1  i   1
n
?
1 A / P, i, n) ( A / F , i, n i
?

 i  1  i    [1  (1  i ) ]  i
n

 i  (1  i )   
n
 
n
?
i
 1  i   1 1  (1  i )
 (1  i )    (1  i )  1  i
   
n n n n
?

 i  1  i    [
n
]
  i  i  (1  i ) n
  i  i  ((1  i )  1)   i  i  (1  i )  i 
?
n n

 1   (1  i )   
(1  i )  1   (1  i )  1 
  
n n n
1
 1  i   1  (1  i )   1  i   1
n n n
?

 i  1  i        i  (1  i )   i  (1  i ) 
n n

  i  (1  i )   (1  i )    (1  i ) 
n
  
n
i
   
n n

 
 1  i   1  1  i   1
n n

 i  1  i     i  (1  i ) 
n
   
n

Reviewer/Interest Formulas Reviewer/Interest Formulas


Proving identity c).
F=F2
F1 A
F=?

n=n1+n2
P n1 n2
0 1 2 3 4 5 6 7 n-1 n

From the cash flow diagram, we can see that ?

A  ( F / A, i, n)  A  (1  i) ( nn )
 A  (1  i) ( n ( n 1 ))
 A  (1  i) n ( n  2 )
....A  (1  i) ( n 1 )

P  F ( P / F , i , n)  F ( P / F , i , n )  ( P / F , i , n )
2 2 1
A  ( F / A, i, n)  A  (1  i)  (1  i)  (1  i)  ...  (1  i)
?
0 1 2 n 1

Since F  F , then, ?
2
A  ( F / A, i, n)  A  [1  ( F / P, i,1)  ( F / P, i,2)  ...(F / P, i, n  1)]
(P/F,i, n)  ( P / F , i, n )  ( P / F , i, n )
2 1
( F / A, i, n)  1  ( F / P, i,1)  ( F / P, i,2)  ...(F / P, i, n  1)

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Reviewer/Effective vs. Nominal rates/Frequent Compounding Reviewer/Effective vs. Nominal rates/Frequent Compounding
Interest rate statement Interpretation Comment
Table 3. Specific examples of interest statements and interpretations.
i = 12% per year i = effective 12% per year When no compounding period
compounded yearly is given, interest rate is an Interest statement Type of Compounding period
i = 1% per month i = effective 1% per month effective rate, with interest
compounded monthly compounding period assumed
i = 3½% per quarter i = effective 3½% per quarter to be equal to stated time
compounded quarterly period. 15% per year compounded monthly Nominal Monthly
15% per year Effective Yearly
i = 8% per year, i = nominal 8% per year When compounding period is Effective 15% per year compounded Effective Monthly
compounded monthly compounded monthly given without stating whether monthly
i = 4% per quarter the interest rate is nominal or 20% per year compounded Nominal Quarterly
compounded monthly i = nominal 4% per quarter effective, it is assumed to be quarterly Nominal Weekly
i = 14% per year compounded compounded monthly nominal. Compounding period Nominal 2% per month
semiannually is as stated. compounded weekly Effective Monthly
i = nominal 14% per year 2% per month Effective Monthly
compounded semiannually 2% per month compounded monthly Effective Quarterly
Effective 6% per quarter Effective Daily
i = effective 10% per year i = effective 10% per year If interest rate is stated as an Effective 2% per month Nominal Continuously
compounded monthly compounded monthly effective rate, then it is an compounded daily Nominal Continuously
i = effective 6% per quarter i = effective 6% per quarter effective rate. If compounding 1% per week compounded
compounded quarterly period is not given, continuously
i = effective 1% per month i = effective 1% per month compounding period is 0.1% per day compounded
compounded daily compounded daily assumed to coincide with stated continuously
time period.

Reviewer/Effective vs. Nominal Reviewer/Effective vs. Nominal


rates/Frequent Compounding rates/Frequent Compounding
11. In which statement is the interest rate not 12. Which will provide the largest annual
given as an effective rate? effective rate?
a) effective 12% per year compounded a) effective 18% per year compounded yearly
monthly b) 18% per year compounded daily
b) 10% per year compounded daily c) 17.5% per year compounded weekly
c) 2% per month compounded monthly d) nominal 18.5% per year compounded semi-
d) none of the above annually

Reviewer/Effective vs. Nominal rates/Frequent


Compounding
Reviewer/Effective vs. Nominal
Solution: a) 18%
b)
rates/Frequent Compounding
 0.18 
365

i  1    1  19.72% 13. If a borrower just made the first quarterly


 365  payment of P700 in interest for a loan that carries
a

c) an interest rate of 2% per quarter, the original


amount of loan is:
 0.175 
52

i  1    1  19.09% a) P8,750.00 c) P140,000


 52  b) P35,000.00 d) P165,000
a

d)
 0.185 
2

i  1    1  19.36%
 2 
a

Answer : b

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Reviewer/Effective vs. Nominal rates/Frequent Reviewer/Effective vs. Nominal


Compounding rates/Frequent Compounding
Given: Iq=P700
14. Which of the following is not equivalent to
iq=2%/quarter
24% per year compounded monthly?
Solution: a) 2% per month
b) effective 26.82% per year
For the first interest period,
c) 6.12% per quarter
I=P×i×n, where n=1 d) 12.24% per semi-annual period
P700=P ×0.02 × 1
Solving for P,
P=P700/0.02=P35,000 b

Reviewer/Effective vs. Nominal rates/Frequent


Compounding
Given: interest statement: 24%/yr compounded monthly Reviewer/Effective vs. Nominal
= 2% /month rates/Frequent Compounding
a) 2%/month: ia=(1+0.02)12-1=26.82%
15. An appliance worth P7,875 is made available for
b) 26.82%/year a 1 and ½ year loan, payable in monthly
c) 6.12% / quarter: ia=(1+0.0612)4-1=26.82% installments of P500. The effective annual interest
d) 12.24%/semiannual period: rate is closest to
ia=(1+0.1224)2-1=25.98% a) 12.6% b) 18.8% c) 13.5% d) 21.6%

Answer: d

Reviewer/Effective vs. Nominal rates/Frequent Reviewer/Effective vs. Nominal rates/Frequent


Compounding Compounding
Given: P=7,875 For this type of problem, solution is by trial and error
method, using the values in the multiple choice. It is best
n=1 and ½ yrs = 18 months
to start trials with values in the middle of the range of
A=P500 choices.
Find: ia
Try b) 18.8% i  0.188  (1  i )  1
a m
12

The equation of value is


Solving for i :
m

P7,875 = P500× (P/A,i,n) 0.188  1  (1  i ) 12


m

 1  i '  1  1  i  (1.188)
n ( 1 / 12 )

7,875  500    m

 i '(1  i ' )  i  1.0144595  1  1.44595%


n
m

 1  i '  1  7,875
n

   15.75 Use this in the equation of value, and if it gives an


 i '(1  i ' )  500
n
answer of 15.75, then it is the answer. Otherwise, try
the others.

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Reviewer/Effective vs. Nominal rates/Frequent


Compounding
Reviewer/Effective vs. Nominal
rates/Frequent Compounding
 1  i '  1  16. How much money will be accumulated in 3 years
n

7,875  500   
 i '(1  i ' ) 
n
if a person made a monthly deposit of P2000 every
month up to the 3rd year when the account pays
 1  i '  1  7,875
n

   15.75 interest of 1% per month?


 i '(1  i ' )  500
n

a) P81,406 b) P90,028 c) P115,112 d) P86,154


 1  0.144594  1   7,875  15.75
18

 
 0.144594  (1  0.144594)  500
18

Answer: b

Reviewer/Effective vs. Nominal rates/Frequent


Compounding Reviewer/Effective vs. Nominal
Given: n = 3 yrs = 36 months rates/Frequent Compounding
Am=P2,000
17. How many years will be required for a given
i=1%/mo sum of money to triple, if it is deposited in a bank
account that pays 8% per year compounded
Find: F
F  A( F / A, i, n) quarterly?
 (1  i )  1 
n a) 14 c) 13
F  A  b) 15 d) 16
 i 
 (1  i )  1 
n

FA m
 where n  no. of months
 
m
i
 (1  .01)  1 
36

F  P2,000    P86,154
 0.01 
Answer : d

Reviewer/Effective vs. Nominal rates/Frequent


Reviewer/Effective vs. Nominal Compounding
rates/Frequent Compounding
F  3P  P  ( F / P, i , n )q q

Given: P 3  (1  1 )
nq
q

3  (1  .02)
nq
F = 3P
To solve for n , take the natural log of both sides
i=8%/yr compounded quarterly = 2%/q q

n ln(1.02)  ln 3
q

1.0986123
n 
q
 55.48q
Find: n such that F=3P at 2%/q 0.0198026
55.48 q  13.87 yrs  14 yrs

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Reviewer/Effective vs. Nominal rates/Frequent


Compounding
Reviewer/Effective vs. Nominal
Alternatively, we can solve for nyears directly by 1st rates/Frequent Compounding
obtaining ia: i  (1  i )  1 4
a q

i  (1  .02)  1  8.2432% / yr
4 18. If you invest P1,500,000 now in a house and lot,
how much must you rent your property per month
a

F  3P  P  ( F / P, i , n ) a
for 20 years if you want an annual return of 20% on
3  (1  1 )
n your investment?
a) P18,400 b) P21,450 c) P25,670 d) P30,000
a

3  (1  0.082432)
n

To solve for n , take the natural log of both sides


n ln(1.082432)  ln 3
1.09886123
n  yrs
 13.86 yrs  14 yrs
0.0792105

Reviewer/Effective vs. Nominal


rates/Frequent Compounding Reviewer/Effective vs. Nominal
Given: P=P1.5M rates/Frequent Compounding
n = 20 yrs
19. A series of equal payments of P500 is received
i=20%/yrs Find: Am semi-annually for 4 years. After the first 4 years, the
First, find A
semi-annual payments are doubled in size, and these
larger payments are received for 10 more years. If the
year

A  P ( A / P, i , n)
year
interest rate is 12% compounded quarterly, the single
 i (1  i )  n
present amount equivalent to the series of payments
A  P1.5M   
 (1  i )  1 
n
received over the 14-year period is
 0.20(1  0.20)  20 a) P10,075 b) P10,114 c) P10,190 d) P11,400
A  P1.5M     P308,034.8
 (1  0.20)  1 
20

A P308,034.8
A 
m
 year
 P 25,670 / mo
12 12

Reviewer/Effective vs. Nominal


rates/Frequent Compounding Reviewer/Effective vs. Nominal
Cash flow diagram: rates/Frequent Compounding
Given: A1s=P500 semi-annual payments during the first 4 yrs;
A2s
n1s=8
A2s = P1,000 semi-annual payments during the next 10 yrs;
A1s n2s=20
Find P:
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14

i=12% compounded quarterly Since cash flows are semi - annual, we have to first solve for i :
s

i  (1  i )  1
s q
2

0.12
i  (1 
s
)  1  0.0609  6.09%
2

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Reviewer/Methods of Evaluating Investment


Alternatives
Reviewer/Effective vs. Nominal
rates/Frequent Compounding Interest earned by an investment:
P=P1,000
P  A  ( P / A, i , n )  A  ( P / A, i , n )( P / F , i , n )
1s s 1s 2s s 2s s 1s

 (1  i )  1
n1 s
 (1  i )  1 n2 s

P  A    A   i  (1  i )   (1  i )
 n1 s
i earned = ?
 i  (1  i )   
1s n1 s 2s n2 s

 (1  0.0609)  1  8
 (1  0.0609)  1  20

P  P500     P1,000   0.0609  (1  0.0609)   (1.0609)


8
P=P1,000
 0.0609  (1  0.0609)   
8 20

P  P10,190 P1=P500 P2=P500

i earned = ?
Answer: c
P=P1,000

Reviewer/Methods of Evaluating Investment


Alternatives Reviewer/Methods of Evaluating Investment
Alternatives
Interest earned by an investment:
20. The actual interest earned on an investment is
F1=P500 F2=P500 F3=P500 the interest rate that makes
a) the equivalent amount of receipts equal to the
equivalent amount of disbursements at time 0.
i earned = ?
b) the equivalent amount of receipts equal to the
F=P1,500 equivalent amount of disbursements at t = n.
P=P1,000
c) the equivalent yearly amount of receipts equal to
the equivalent yearly amount of disbursements
d) all of the above
i earned = ?

P=P1,000

Reviewer/Methods of Evaluating Investment Reviewer/Methods of Evaluating Investment


Alternatives Alternatives
Calculations involving bonds: 21. A P10,000 bond that will mature in 20 years is currently
A bond is a financial instrument setting forth the conditions sold for P7,500. It provides 10% interest payments paid
under which money borrowed. quarterly. The face value of the bond is
Par value or face value is the value stated on the bond (as in a) P7,500 c) P2,500
a check, note, bill or other paper security), usually in multiples of b) P10,000 d) none of the above
P1,000.
A bond’s yield to maturity is the effective annual interest rate
earned by a bond, taking into consideration periodic interest
payments and disposal or redemption price of the bond at
maturity.
Maturity refers to the time that a bond or note is payable.

11
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Reviewer/Methods of Evaluating Investment


Reviewer/Methods of Evaluating Investment
Alternatives
Alternatives Given: P=P2.5M WC = 25% of P = 0.25 × P2.5M
n = 7 yrs WC = P625,000
22. After passing the board exam, you plan to set up a
A = P600,000
business that requires a P2.5 M initial investment of which i= MARR = 16%/yr
25% is working capital. The P2.5 M also includes an amount SV = 80% of working capital = 0.8×P625,000=P500,000
of P575,000 for equipment, with no salvage value. The Find: Present Worth (PW) = Net present value (NPV)
business is good for 7 years and is projected to provide
yearly net cash flows of P600,000. In addition, you will PW   P  A  ( P / A, i, n)  SV  ( P / F , i, n)
recover 80% of your working capital at the end of 7 years.  (1  i ) n  1
PW   P  A   n 
 SV  (1  i )  n
At 16% interest per year, the present worth of this  i  (1  i ) 
investment is closest to  (1  0.16) 7  1 
a) P80,000 b) P100,060 c) P150,040 d) P224,360 P   P 2.5M  P600T   7
 P500T  (1  0.16) 7
 0.16  (1  0.16) 
P  P100,040

Reviewer/Methods of Evaluating Investment Reviewer/Methods of Evaluating Investment


Alternatives Alternatives
Simple payback period: The smallest value for which the relationship
23. Given the following cash flow for an investment and a below is satisfied: n

MARR of 12%: F  0
t 0
t

End of
Year 0 1 2 3 4 5 6 Sequentially solving for the value of ΣFt
Cash At t  1,
Flow -30,000 -19,000 10,000 10,000 10,000 20,000 20,000 1 ?

 F   P30,00  ( P19,000)  0
0
t

The simple payback period is At t  2,


a) 3 years b) 4 years c) 5 years d) 6 years 2 ?

 F   P30,000  ( P19,000)  ( P10,000)  0


0
t

At t  3,
3 ?

 F   P30,000  ( P19,000)  ( P10,000)  (10,000)  0


0
t

At t  4,
4 ?

 F   P30,000  ( P19,000)  ( P10,000)  (10,000)  (10,000)  0


0
t

Reviewer/Methods of Evaluating Investment


Reviewer/Methods of Evaluating Investment Alternatives
Alternatives 24. Given the following cash flow for an investment
and a MARR of 12%:
End of
Year 0 1 2 3 4 5 6
Cash
Flow -30,000 -19,000 10,000 10,000 10,000 20,000 20,000
At t  5,
5 ?

 F   P30,000  ( P19,000)  ( P10,000)  (10,000)  (10,000)  ( P 20,000)  0


The internal rate of return is closest to
t
0

a) 8.6% b) 9.4% c) 10.8% d) 11.3%


5
At t  5,  F  0; n  5 yrs.
t
0

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Reviewer/Methods of Evaluating Investment


Alternatives
Given: MARR = 12%
Reviewer/Methods of Evaluating Investment
n = 6 yrs Alternatives
n n
Cash flow – as given in the Table
Find: IRR
 R  ( P / F , i'%, k )  E
k 0
k
k 0
k  ( P / F , i'%, k )

IRR is the value of the interest rate, i’, that will make the 10,000  ( P / A, i' ,3)  ( P / F , i' ,2)  20,000  ( P / A, i' ,2)  ( P / F , i' ,4) 
equivalent amount of receipts equal to the equivalent amount P30,000  P19,000  ( P / F , i' ,1)
of disbursements:
n n Sequentially try the interest rate given as choices,
 R  ( P / F , i'%,k )  E  ( P / F , i'%,k )
k 0
k
k 0
k starting with values in the middle of the range.

Reviewer/Methods of Evaluating Investment


Alternatives Reviewer/Methods of Evaluating Investment
n n

 R  ( P / F , i'%, k )  E
k 0
k
k 0
k  ( P / F , i'%, k ) Alternatives
Capital Recovery (C.R.) cost defined:
10,000  ( P / A, i' ,3)  ( P / F , i' ,2)  20,000  ( P / A, i' ,2)  ( P / F , i' ,4) 
P30,000  P19,000  ( P / F , i' ,1)
 (1  i' )3  1  (1  i' ) 2  1
CR  P( A / P, i, n)  S ( A / F , i, n)
10,000   3 
 (1  i' ) 2  20,000   2 
 (1  i' ) 4 
 i' (1  i' )   i' (1  i' ) 
P30,000  P19,000  (1  i' ) 1 
Using i’=9.4%, equivalent receipts equal P47,368 and
equal disbursement equal P47,402. The other choices
do not come close, and the difference could be due to
rounding discrepancies. Therefore, IRR = 9.4%

Reviewer/Methods of Evaluating Investment Reviewer/Methods of Evaluating Investment


Alternatives Alternatives
25. A machine which costs P100,000 when new has a Given: P=P100,000
lifetime of 15 years and a salvage value equal to 20% of its SV = 20% of P=0.2× P100,000=P20,000
original cost. If interest rate is 10% compounded annually, i = 10% compounded annually
the capital recovery of the machine is closest to n = 15 years
a) P12,518 c) P15,324
b) P14,645 d) P16,846 CR  P( A / P, i, n)  S ( A / F , i, n)
 i (1  i ) n   i 
CR  P100,000     P 20,000   
 (1  i )  1  (1  i )  1
n n

 0.1(1  0.1)15   0.1 


CR  P100,000     P 20,000   
 (1  0.1)  1  (1  0.1)  1
15 15

CR  P12,518

Answer: b

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Reviewer/Comparison Between Reviewer/Comparison Between


Investment Alternatives Investment Alternatives
26. You are to make a choice between 2 investment alternatives as follows:
(MARR is 15% per year). The salvage value is 20% of the net cash flow at Given: MARR = 15%/yr
the end of each alternative’s useful life.
End-of-Year Alternative Prime Alternative Mover SV = 20% of net cash flow
0 -P 160,000 -P240,000
1 50,000 45,000 Find: PW of alternative Prime using repeatability assumption.
2 50,000 45,000 P130,000 P130,000
3 50,000 45,000 A=P50T
4 130,000 45,000
5 45,000
6 45,000 0 1 2 3 4 5 6 7 8
7 45,000
8 100,000

Using repeatability assumption, what would be the closest -P160,000 -P160,000


value to the PW of alternative Prime?
a) P30,286 b) P40,648 c) P44,780 d) P52,280

Reviewer/Comparison Between
Reviewer/Comparison Between Investment
Alternatives
Investment Alternatives
Two electric motors are being evaluated for an automated
paint booth application. Each motor must have an output of
PW   P160T  P50T ( P / A,15%,8)  P80T ( P / F ,15%,4)  P80T ( P / F ,15%,8) 10 horsepower (hp). It is estimated that the booth will be
PW  P44,778 operated an average of 8 hours per day for 250 days per
year. MARR is 12% per year before taxes and the machine
must return the capital in 5 years. Motor A costs P68,000
Answer: c and has a guaranteed efficiency of 85% at the indicated
operating load. Motor B costs P56,000 and has a
guaranteed efficiency of 80% at the same operating load.
Electric energy costs P6.80 per kilowatt-hour and 1hp =
0.746 kw. (Recall that efficiency equals output/input).
The annual cost of electric energy in operating motor A is
closest to
a) P119,360 b) P126,820 c) P142,320 d) P163,270

Reviewer/Comparison Between Reviewer/Comparison Between


Investment Alternatives Investment Alternatives
Given: For Motor A, Calculation:

P=P68,000 output
eff 
eff = 85% input
output 10hP
output, O = 10 hP Input    11.764706hP
eff 0.85
1 hP = 0.746 kw 0.746kw hrs P6.80
Annual cost of electricit y  11.764706hP   2000  
hP yr kw  hr
electric energy cost = P6.80/kw-hr Annual cost of electricit y  P119,360
Avg no. of hours of operation/year =
= 8 hrs/day × 250 days/yr = 2,000 hrs/year Answer: a
Find: Annual cost of operating Motor A

14
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Reviewer/Comparison Between Investment


Alternatives Reviewer/Depreciation Methods and
SV
Taxation
27. Among the following depreciation methods, that
which will produce the lowest present worth of taxes
paid is
a) straight-line method
b) sinking fund method
Unrecovered capital recovery c) declining balance method
cost d) service-output method

Imputed salvage value = SV×(P/F,i,n-n’)+CR×(P/A,i, n-n’)

Reviewer/Depreciation Methods and Reviewer/Depreciation Methods and


Taxation Taxation
28. A contractor imports an equipment for P1.2M.
Customs, installation and other costs initially incurred to Given: B = purchase cost + installation cost
make the equipment serviceable amounted to P200,000. B = P1.2M + P200,000 = P1.4M
At the end of 5 years, the equipment will have a market
value of P200,000. If depreciated by the straight-line n = 5 years
method, cumulative depreciation through the end of the S = P200,000
second year will be
a) P240,000 c) P200,000 dep method = SLM
b) P480,000 d) P400,000 Find: cumulative depreciation through year 2

In the straight line method, the cumulative depreciation equals


depreciation/year times no. of years

Reviewer/Depreciation Methods and


Reviewer/Depreciation Methods and Taxation
Taxation 29. An optical scanning machine that will be used for
[B  S ] reproducing blueprints of engineering drawings can be
dep / year  purchased for P12M and has an estimated market value
n
where : B  cost basis; S  salvage value; and n  depreciable life of P2.4M at the end of 10 years. If the machine were to
[ P1.4M  P0.2M ] be depreciated using declining balance method that will
dep/year   P 240T result in book value equal to market value at the end of
5
depreciation through year 2  dep/year  no. of years 10 years, by what rate must the machine be depreciated?
depreciation through year 2  P240T  2  P480,000 a) 18.62% c) 11.42%
b) 25.31% d) 14.87%

Answer: b

15
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Reviewer/Depreciation Methods and


Reviewer/Depreciation Methods and
Taxation
Taxation 30. The newly established All-Natural Drug Company is deciding
Given: B=P12M between two pill-forming machines described below:
SV = P2.4M
Round Oval
n = 10 years First Cost P7,200,000 P4,500,000
Depreciation method = declining balance Salvage Value 1,080,000 900,000
Find: R such that MV = BV at the end of 10 years Annual Revenue 1,200,000 1,000,000
Less Expenses
Solution:
Life, years 6 6
  SV 1/ n    P 2.4M 1/10 
R  1      1      14.87% Using the straight line method of depreciation, an effective tax rate of
  B     P12M   30%, and an after tax return of 20%, the amount of taxes to be paid for
the first year for the round machine is closest to
a) P80,000 b) P106,000 c) P212,000 d) P54,000

Reviewer/Depreciation Methods and Reviewer/Depreciation Methods and


Taxation Taxation
Given: B=P7.2M To solve this problem, it is convenient to set up a table as
follows:
S = P1,080,000
End-of- Before-tax Dep Taxable Taxes
R-E=P1,200,000 year cash flow Income Paid
n = 6 years (BTCF)
depreciation method = SLM 1 P1,200,000 P1,020,000 P180,000 P54,000

eff tax rate = 30% where: Dep = (P7,200,000-P1,080,000)/6=P1,020,000

after-tax MARR = 20% Taxable Income = BTCF-Dep= P1.2M-P1,020,000=P180,000


and Taxes Paid = Tax Rate × Taxable Income = P180,000 × 0.30 =
Find: Taxes paid for year 1 for the round machine
= P54,000

Answer: d

Reviewer/Depreciation Methods and


Taxation Reviewer/Depreciation Methods and
31. Ferdinand Shipping Company bought a tugboat for
P750,000. This boat is expected to last for 5 years, after which
Taxation
it could be sold for P120,000. The following revenues and Given: Revenues – P2,000,000
expenses are expected for the first operating year. Expenses – P840,000
Revenues – P2,000,000 Depreciation – P40,000
Expenses – P840,000 n = 5 years
Depreciation – P40,000. S = P120,000
If the company is taxed at a rate of 30%, what is the net tax rate = 30%
income at the end of the first year?
a) P287,000 d) P268,000 Find: net income at end of year 1
b) P784,000 e) none of the above
c) P824,000

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Reviewer/Depreciation Methods and


Taxation
As in the previous problem, setting up a table is a convenient
way to solve this type of problem:
End-of- BTCF Dep Taxable Taxes ATCF or
year Income Paid Net
Income
after tax
1 P1,160,000 P40,000 P1,120,000 P336,000 P824,000

where: BTCF = Revenue – Expenses = P2M-P840,000 = P1,160,000


Taxable Income = BTCF – Dep = P1,160,000 – P40,000 = P1,120,000
Taxes paid = Taxable Income × tax rate = P1,120,000 × 0.30 = P336,000
And ATCF = BTCF – Taxes Paid = P1,160,000 – P336,000 = P824,000

17