TUTORIAL UNIT 2: TIME VALUE OF MONEY

QUESTION 1 (20 MARKS)

(a) Differentiate between simple interest and compound interest. (2)

(b) On completion of his bachelor’s degree, Roland gets a job as a trainee accountant at
a local bank. The bank offers him a 4-years loan requiring monthly repayments of
R1 053.35 at 12% per annum compounded monthly. Calculate the principal amount
that Roland would have borrowed from the bank. (3)

(c) You have been hired as a financial advisor to Oupa Manyisa, a South African
professional footballer. He has received two offers for playing professional football and
wants to select the best offer, based on considerations of money only as he wishes to
prepare for his life after the soccer playing career. Offer A (a move to Sundowns
Football Club) is a R10m offer paying R2m a year for the next 5 years. Offer B (to
remain at Orlando Pirates) is a R11m offer of R1m a year for four years and R7m in
year 5. Advise Oupa Manyisa on the better option assuming an annual interest
rate of 12%. (6)

(d) Suppose you borrow R100 000 from FNB Bank at an annual interest rate of 11% per
year, interest compounded annually and repayment over the next 5 years in equal
yearly instalments.

REQUIRED

(i) Calculate the annual instalment assuming that payments are required at the beginning
of each year. (2)
(ii) Calculate the annual instalment assuming that payments are required at the end of
each year. (1)
(iii) Construct the loan amortisation schedule if payments are required at the end of each
year. (6)

QUESTION 2 (20 MARKS)

(a) What is the future value of R10 000 invested for two years at a nominal interest rate of
12%, compounded annually? (2)
(b) What is the future value of R10 000 invested for 10 years at a nominal rate of 10% per
year compounded continuously? How much higher is this value than the value
obtained with annual compounding for 10 years at 10% per year? (3)

(c) Which would you rather receive: the proceeds from a 2-year investment paying 5%
simple interest per year or from one paying 5% per year compound interest? Motivate
your choice briefly. (3)

(d) An investor will receive R110 000 in one year’s time. What is the value of the R110
000 today if the interest rate is 10% per year? (2)

(e) Mr Bond purchased a house for R750 000 and paid a deposit of R50 000. He obtained
a 20-year mortgage loan from ABSA Bank to finance the balance of the purchase price
at an interest rate of 15% per annum, compounded monthly.

REQUIRED:

Calculate the following:

(i) Calculate his monthly loan repayment. (2)

(ii) Construct an amortisation schedule for the first five (5) months if equal
payments are required at the end of each month. (6)

(iii) The revised shortened duration of the loan if the monthly instalment is
increased by R500 from commencement of the loan. (2)

QUESTION 3 (20 MARKS)

(a) What is the nominal interest rate if R80 000 yields R120 000 in three years’ time and
interest is compounded annually? (2)

(b) What is the future value of R100 000 invested for one year at a nominal interest rate
of 12% per year, compounded quarterly? (2)

(c) You expect to receive R500 000 in 5 years’ time. Calculate the present value of this
future receipt at the continuously discounted rate of 12% per annum. (2)
(d) The nominal rate of interest on a Bank Certificate of Deposit is 8% per year. If
compounding occurs continuously, what is the effective annual rate? (2)

(e) What is the future value of R50 000 invested for 10 years at a nominal rate of 10% per
annum compounded continuously? How much higher is this value than the value
obtained with annual compounding for 10 years at 10% per year? (3)

(f) Which would you rather receive: the proceeds from a 2-year investment paying 5%
simple interest per year or from one paying 5% per year compound interest? Motivate
your choice briefly. (3)

(g) Suppose you borrow R220 000 from FNB Bank at an annual interest rate of 12%
effective to be repaid over the next 5 years, calculate the annual instalment assuming that
payments are required at the beginning of each year. Also construct the amortisation
schedule. (6)