FNCE10002 Principles of Finance Semester 1, 2018

FNCE10002 Principles of Finance

Semester 1, 2018

Introduction to Financial Mathematics I

Tutorial Questions for Week 1

This tutorial is divided into two parts. The answers to the questions in Part I need to be submitted at the
beginning of your tutorial. All answers must be handwritten and in original (photocopies/emails will
not be accepted). Please follow the instructions on the Tutorial Hand-in Sheet available on the LMS via
the Tutorials link. The answers to the questions in Part II do not need to be submitted and will be
discussed in your tutorial. Please make sure that you have worked through these questions as well and
are prepared to discuss them if called upon by your tutor.

Note that questions flagged as “PEQ” are past exam questions that I’ve used in subjects that are similar
in scope to this subject, while those flagged as “TXT” are sourced from the textbook. Detailed answers
to the questions in Part II will only be provided in tutorials. Brief answers may be provided via the LMS
after a time lag. This policy is in place to ensure that you attend your tutorials regularly and receive
timely feedback from your tutor. If you are unsure of any answer you should check with your tutor, a pit
stop tutor, online tutor or me.

Part I: Answers to be Submitted to Your Tutor

A. Problems

A1. Assume that you have $4,000 invested in an account today (that is, year 0). Calculate the future
value of this amount at the end of each of the following time horizons and interest rates:

a) End of three years at an interest rate of 6% per annum.

b) End of six years at an interest rate of 6% per annum.

c) End of three years at an interest rate of 12% per annum.

Why is the total amount of interest earned in part (a) less than half the amount of interest earned
in part (b)? Explain.
PEQ
A2. Your friend’s grandfather put some money in an investment account for her on the day she was
born. She is now 18 years old and can withdraw the money for the first time. The account

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FNCE10002 Principles of Finance Semester 1, 2018

currently has $4,200 in it and pays an interest rate of 12% per annum. (Hint: Use a timeline to
visualize the cash flows.)

a) How much money would be in the account if she left the money there until your 25th
birthday?

b) How much money would be in the account if she left the money there until your 65th
birthday?

c) How much money did her grandfather originally put in the account when she was born?
TXT
A3. As part of your personal budgeting process, you have determined that at the end of each of the
next five years you will incur significant maintenance expenses on your apartment. You’d like
to cover these expenses by depositing a lump sum in an account today (or year 0) that earns 8%
per annum. You will draw down this account each year as maintenance bills come due.

End of Year Budget Shortfall

1 $5,000
2 $4,000
3 $6,000
4 $10,000
5 $3,000

a) How much money must you deposit today to cover these expenses? Round your
calculations to the nearest dollar.

b) Demonstrate that the amount you have deposited today is just enough to cover your
expenses over the five-year period. Show all calculations.

c) What effect does an increase in the interest rate have on the amount calculated in part (a)?
Explain.

Part II: Submission of Answers Not Required

B. Multiple Choice Questions

For each question pick the most reasonable response based only on the information provided.

B1. If you invest $50,000 in a savings account paying 6% per annum, the amount you will have
accumulated at the end of five years is closest to:

a) $50,250.
b) $63,124.
c) $66,911.
d) $67,443.
TXT
B2. Melissa Gould wants to invest today in order to assure adequate funds for her son’s university
education. She estimates that her son will need $20,000 in 18 years; $25,000 in 19 years;
$30,000 in 20 years; and $40,000 in 21 years. The total amount Melissa would need to invest
today if the fund earns an interest rate of 6% per annum is closest to:

a) $34,330.
b) $36,390.
c) $38,573.

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FNCE10002 Principles of Finance Semester 1, 2018

d) $40,000.

B3. Consider the following cash flow alternatives:

Alternative 1: $140 received at the end of one year.

Alternative 2: $230 received at the end of five years.
Alternative 3: $320 received at the end of ten years.

The rank of these alternatives from most valuable to least valuable if the interest rate is 8% per
annum is:

a) Alternative 1, then alternative 2, followed by alternative 3.

b) Alternative 2, then alternative 3, followed by alternative 1.
c) Alternative 1, then alternative 3, followed by alternative 2.
d) Alternative 3, then alternative 2, followed by alternative 1.
PEQ
B4. Suppose you invested $10,000 in an investment account paying an interest rate of 2% per
annum. The total amount of interest-on-interest that you would have earned on this investment
at the end of 20 years would be closest to:

a) $859.
b) $4,000.
c) $4,859.
d) $10,859.
PEQ
B5. Your friend owns her own business and is considering an investment opportunity. If she
undertakes the investment, it will pay $4,000 at the end of each of the next three years. The
opportunity requires an initial investment of $1,000 and an additional investment at the end of
the second year of $5,000. The net present value of this investment opportunity if the interest
rate is 2% per annum is closest to:

a) $5,730.
b) $6,000.
c) $6,730.
d) $7,652.

C. Problems
TXT
C1. Ruth Nail receives two offers for her seaside home. The first offer is for $1 million today while
the second offer involves the following annual payments:

End of Year Payment

0 $200,000
1 $200,000
2 $200,000
3 $200,000
4 $200,000
5 $300,000

Assuming that Ruth earns an interest rate of 8% per annum on her investments, which offer should
she take? Round your calculations to the nearest dollar.
TXT
C2. Robert Williams is considering an offer to sell his medical practice, allowing him to retire five
years early. He has been offered $500,000 for his practice and can invest this amount in an

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FNCE10002 Principles of Finance Semester 1, 2018

account earning 10% per year. If the practice is expected to generate the following cash flows,
should Robert accept this offer and retire now?

End of Year Cash Flow

1 $150,000
2 $150,000
3 $125,000
4 $125,000
5 $100,000
PEQ
C3. You have been offered an investment opportunity which involves investing $20,000 today to
receive $1,000 one year from now, $3,000 two years from now and $20,000 ten years from
now. All cash flows occur at the end of the year.

a) What is the NPV of the opportunity if the interest rate is 12% per annum? Should you take
the opportunity?

b) What is the NPV of the opportunity if the interest rate is 2% per annum? Should you take
the opportunity now?

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