Practical Application Questions

A common application of sequences and progression is the calculation of simple

and compound interest

Simple Interest – The interest which is paid direct to the investor instead of being
added to original amount.

Compound Interest
Compound interest calculates interest taking into account both the original principal
and accumulated interest

Link between GP and compound interest…

A sum $ 1000 which earns 10 percent interest each year .
Here common ratio is 1.1
The value of savings after n years using compound interest can be calculated by

Qn1
A worker invests a lump sum of $ 50,000 in bank account and expects to draw upon it when
she is 60 years i.e after 10 years have elapsed . The bank have guaranteed she will earn 4
percent each year on her savings. What will the value of her savings be when she comes to draw
upon it
T0=$ 50000
T1 = 50000 X (1.04) =$ 52000

T10 = 52000X (1.04 )10-1

=$ 74012.21
Qn 2
An economy has a GDP of $40billion and is expected to grow at 9 percent per year every year .
What will be the total and accumulated value of all economic activity over the first seven years
D=1.09
Sn = 40(1.097 -1)/ (1.09-1) =$ 368 billion

Compound Interest
Compound interest calculates interest taking into account both the original principal
and accumulated interest
The value of savings after n years using compound interest can be calculated by

Vn = Principal(interest) n

Question

A stockbroker invests $ 50000 in a bank account and is guaranteed a 3% return each year .

(a) What is the value of savings after seven years

(b) How many years will he need to invest his money to ensure he has $ 100,000 in his
savings

(a) Value= Principal(interest) n

= 50000 X(1.03) 7

=$61493.69
(b) Value= Principal(interest) n

100000 = 50000 X (1.03) n

100000/50000= (1.03)n

2= (1.03) n

log 2 = n log (1.03)

n= log 2 / log 1.03

= 23.45 years

Question

If the value of a car is depreciated 20% annually , what will be its estimated value at the end of
10th year if its present value is Rs 5000

Depreciated value = 5000( 1- 20/100) 10

= 5000 (.80)10

Question

If the population of a country rises by 2 % every year and it was 30 crore in 1960 , what was the
population in 1970

Population at the end of 1970 = P r n

= 30 X (1+ 2/100) 10
=
30 X (1.02) 10

= 36.6 crore
Practical Application-------Investment Appraisal ( PAGE NO.132---139)

Present Values
F= P(1+ i/100) n

where F = Future value

P= Principal

i= interest
n = No. of years of investing

Present value= F(1+i/100) –n

Qn:

Calculate the present value of $ 4500 in six years time if the compound interest rate is 4%

P = F(1+i/100) –n
=
4500X (1.04) -6

= $3556.42

Qn What must the principal investment be if $ 90000 is received in 10 years time and
compound rate of interest is 3.2 %

P= F(1+i/100) –n

= 90000( 1.032) -10

=$65681.87

---------------------------------------------------------------------------------------------------------------/.
The two principal methods for projecting the profitability of an investment
are

(1)Net present value(NPV)

(2) Internal rate of return (IRR)

Net present value(NPV)

Net present value of a project can be calculated by calculating the present value of an

Investment and subtracting the cost of investment project

N PV= F(1+i/100) –n - C
NPV Less than 0 -------- Project is not expected to be profitable

NPV=0 -------------The project will just break even

NPV greater than 0 -------The project is expected to earn a profit

Question

The Dorf Motor company is exploring ways to improve revenue and is considering
purchasing a new robotic welding system to improve the quality of its vehicle . The robotic
welding system would cost $ 3million and is expected to produce an additional $ 4 million
of revenue after 3 years . The discount rate is 6 %, find net present value

Ans : Net present value = N PV= F(1+i/100) –n - C

= 4million( 1+ 6/100) -3 - 3million

= .358477132million

= $ 358477 .132

The investment is expected to produce a positive present value of $ 358477 and the Dorf car
company should proceed.
Question

Consider the following investment opportunities for a large manufacturing company . The
discount rate is 5%

Investment A : Costs $ 150,000 and pledges to pay $ 175,000 after six years

Investment B: Costs $ 180,000 and pledges to pay $ 201,000 after seven years

Investment C : Costs $ 140,000 and pledges to pay $ 170,000 after two years

Which investment would be recommend and Why

Ans. Net present value = N PV 0f A = F(1+i/100) –n - C

= 175000(1+ 5/100) -6 -150000

=$130,587.69 - 150000

= - 19412.31

NPV of B = 201,000(1+ 5/100) -7 -180000

= - 37,153.05

NPV of C = 170000(1+ 5/100)-2 - 140,000

= 14195.01

Only investment C offers a positive NPV . Investment A and B would not be economic

Question 2

A fourth investment D is considered . The costs $150,000 and pays a return of $ 190,000
after 10 years .

What discount rate is needed for this investment to :

 (a) Have a NPVof $ 10,000
(b) Break even ?

(a) N PV 0f D = F(1+r/100) –n - C
10,000= 190,000(1+ r/100)-10 - 150,000

160,000 =190,000(1+ r/100)-10

160000/190000 = (1+ r/100)-10

16/19=(1+ r/100)-10

1+ r/100 =(16/19) -1/10

r/ 100 =(19/16) 1/10 -1

r= (1.0173 -1)100= 1.73 %

b ) NPV=0

0= 190,000(1+r/100)-10 - 150,000 /. .

r= 2.39%

Internal Rate of retun (IRR)

IRR offers another method of evaluating the profitability of an investment project.

This method compares the rate of return offered by an investment project against the rate
of return offered by simply investing in a saving account.

i = (n√F/P -1)
Note : If IRR is higher than market rate the investment is profitable

Example

A stockbroker wants to increase his business and decides to offer ‘ guaranteed returns’ .

She offer potential investors $ 30,000 in six years time in return for a $ 20,000 investment .
She aware that market interest rate is 8%.

Given F=30,000 P =20,000

I = (n√F/P -1)= .0699

=6.99 %

Interpretation

The stockbroker may find it difficult to boost demand with her proposal . Her offer implies
a return of 6.99% while investors could earn 8 % per year simply by putting their money
elsewhere.

Home work

A project requiring an initial outlay of $ 15000 is guaranteed to produce a return of $

20000 in 3 years time . Use the

(a) Net present value (b) Internal rate of return

Method to decide whether this investment is worthwhile if the prevailing market rate is
5% annually . Would your decision be affected if the interest rate were 12%

Ans : NPV= $ 2276.75

The project is to be recommended because this value is positive

(b) IRR

i = 10% The project is therefore to be recommened because this value exceeds the
market value.
 If the interest rate is 12%, NPV= - ve . So the project leads to an effective loss and is
not to be recommedned .

IRR= 10%

You would be better of investing at market rate of 12 % . Since this gives the higher
yield .

Annuities

They are a popular financial product and are designed to provide a stream of income
over a period of time.Typically an investor pays a single lump sum of cash and in return
receives a interest payment and a regular payment

Annuities

Total present value of annuity (TPVA)= a( rn -1)/( r-1)

a— Present value of an annuity in the first year

r=rate of interest or discount rate (The interest rate that is used when going backwards

in time to calculate the present value from a future value)

, n – No. of years of investing

Qn. An annuity offers an annual income of $ 10000 at the end of each year for 10 years .
The interest rate is 7% compounded annually . What is the present value of annuity

The first payment of $10000 is made at the end of the first year. Its present value is
calculated using the formula

a= F(1+r/100) -1

= 10000(1+7/100) -1
= $9345.79

r=
1.07 -1
 TPVA
= a( rn -1)/( r-1) = 9345.79 [(1.07) -10 -1]/ [1.07 -1 -1]

= $ 70235.82

This represents the amount of money that needs to be invested now so that a regular
annual income of $ 10000 can be withdrawn from the fund for the next 10 years

Binomial
A binomial is a polynomial with two parts in the form , such as . When a
binomial is raised to a power, you could simplify it by multiplying out the brackets several times.
The expanded polynomial is called a binomial expansion, and all binomial expansions follow a
pattern that can be used to expand binomials quicker than multiplying out several brackets. For
now, we will only look at binomial expressions which are raised to positive integers.

Expansions of [

If you look at the coefficient of each term, you may notice a pattern. These numbers are called
binomial coefficients and are found by adding the two numbers above it.

Pascal's triangle

Binomial coefficients are more commonly known as Pascal's triangle, named after Blaise
Pascal.

The first 10 lines of Pascal's triangle are:

(1)
1 1
1 2 1
1 3 3 1
1 4 6 4 1
1 5 10 10 5 1
1 6 15 20 15 6 1
 1 7 21 35 35 21 7 1
1 8 28 56 70 56 28 8 1
1 9 36 84 126 126 84 36 9 1
1 10 45 120 210 252 210 120 45 10 1
1 11 55 165 330 462 462 330 165 55 11 1

Since each number is found by adding the two numbers above it, it is possible to find a few lines
of the triangle to help you expand binomials. For binomials raised to powers greater than 10, you
should use the binomial coefficient formula.

Binomial coefficient formula

When a binomial is raised to a large power, it may be too time consuming to find the binomial
coefficients by writing out Pascal's triangle. Fortunately, there is a formula that can find any line
of Pascal's triangle.

If is the power of the expansion, and is the number of the term in a single row, the binomial
coefficient formula is:

For example, for the expansion of :

in descending powers: