CHAPTER 6

FINANCIAL MATHEMATICS
6.0 Introduction
This Chapter is a continuation of the previous chapter, it introduces the types of
interest and applies geometric and arithmetic progressions to solve problems in
Financial Mathematics. It concludes with annuities.
6.1 Simple Interest
Persons who rent buildings or equipment expect to pay for the use of
someone elses property. Similarly, those who borrow money must pay
for the privilege of borrowing anothers money. This privilege is called
interest. The amount of money that was borrowed is the principal of a
loan.
This interest which increases in value by the same amount each year is
called Simple interest. This simple interest is given by the formula
) 1 . 6 ( t r P I
where I = interest
P = Principal
r% = Interest rate
,
_

100
r
T = time in years
Therefore, the total value (Amount or future value) after t years, is the
principal plus interest and is given by
) 2 . 6 ( ) 1 ( +
+
rt P
t r P P A
t
When the total value (Amount or future value), the interest rate and time
are known, the principal (present value) may be calculated by rewriting
formula (6.2) as:
) 3 . 6 (
1
) 1 (

+
rt
A
P
rt P A
t
t
Formula (6.3) is often referred to as the present value formula.
Example 1
K25 000 000 is invested for three years at an interest rate of 15%.
a) Calculate the simple interest paid in any one year.
b) Calculate the total value of savings at the end of one, two, and three years. Show
that the total value of savings at the end of successive years is an arithmetic
progression.
c) Calculate the present value (principal) when the future value (total value) is K3
750 000 after three years.
a) Start by writing down any information given in the question.
P = 25 000 000;
100
15
r
and t = 3 years.
Therefore:
000 250 11
3
100
15
000 000 25
K
t r P I

b) Using formula (6.2), the total value of the savings after t years is
calculated as:
After 1 year, t = 1
000 500 32
) 3 . 1 ( 000 000 25
)) 2 ( 15 . 1 ( 000 000 25
2 , 2
000 28750
)) 1 ( 15 . 1 ( 000 000 25
) 1 (
2
1
K
A
t years After
K
A
rt P A
t

+
+
After 3 years, t = 3
000 250 36
) 45 . 1 ( 000 000 25
)) 3 ( 15 . 1 ( 000 000 25
3
K
A

+
When the total value of the investment is calculated for each year, notice
that the increments are constant, indicating that this is an arithmetic
progression where the difference between any two consecutive years is K3
750 000.
c) The present value K36 250 000 earned in three years time may be
calculated by using (6.3), given r = .15 and t = 3.
. 000 000 25
45 . 1
000 250 36
) 3 ( 15 . 0 1
000 250 36
1
K
rt
A
P
t

6.2 Compound Interest

In the modern business environment, the interest on money borrowed (lent or
invested) is usually compounded. For example, if K10 000 is placed in savings
Account at 20% per year interest, then I = 10 000 .20 1 = K2 000 interest
will be added to the account in the first year to bring the balance to K12 000.
During the second year I = 12 000 .20 1 = K24 000 will be paid. Interest
calculated in this way is called Compound Interest.
In other words, compound interest pays interest on the principal plus any interest
accumulated in previous years. When interest is compounded in this way, the
total value t
A
, of principal P, at 2% per annum is given by the formula
) 4 . 6 ( ) 1 ( +
t
t
r P A
Example 2
K1 million is invested at an interest rate of 12%. What is the value of the
investment at the end of year 9?
76 . 078 773 2
) 773078757 . 2 ( 000 000 1
) 12 . 1 ( 000 000 1 ) 1 (
9 ,
100
12
, 000 000 1
9
9
K
r P A
years t r P
t

+ +

Example 3
a) Calculate the amount owed on a loan of K5 000 000 over 4 years at an
interest rate of 12.5% compounded annually.
20 . 033 009 8
) 125 . 1 ( 000 000 5 ) 1 (
4 , 125 .
100
5 . 12
, 000 000 5
4
4
K
r P A
years t r P
t

+

b) Musenge places K25 000 on deposit in a bank earning 5% compound
interest per annum. Find the amount that would have accumulated:
i) After 1 year
ii) After 2 years
iii) After three years.
The final amount accumulated (terminal value),
n
r P S ) 1 ( +
Where P = Principal
r = Interest rate per annum
n
= time.
i)
000 500 287 ) 15 . 1 ( 000 000 25 K S
ii) 500 3062 3 ) 15 . 1 ( 000 000 25
2
K S
iii) . 875 021 38 ) 15 . 1 ( 000 000 25
3
K S
6.3 Terminal Values
Comparison of Projects.
If we were to be given the choice between two Projects A and B, the expected
profits of which over the next four years are:
A: K25,000,000 at 5% inter per annum
B: K30,000,000 per annum
Which would we prefer (assuming both require the same initial outlay)?
On Project A, we have to compound each flow by adding on interest at 5% pa for
the number of years remaining until the end of the projects, that is the year 1 cash
flow of K25,000,000 earns 3 years interest and is thus worth K107 753 125 at the
end of 4 years. We have compounded the flows to produce what is termed as the
Terminal value of each flow.
Project A Cashflows K
Year 1 625 , 940 , 28 ) 05 . 1 ( 000 000 25
3

Year 2 25 000 000

2
) 05 . 1 ( = 27,562,500
Year 3 25 000 000(1.05) = 26,250,000
ear 4 25 00 000 25,000,000
K107,753,125
=========
Project B
Year 120,000,000 = 120,000,000
Net Terminal Value
With the calculations just carried out , we are in a position to choose between the two
projects since they have the same outlay. However, we have not as yet considered
whether either of them is worthwhile. This will depend on the initial outlay required to
generate K107 753 125 which we could receive by investing in Project A. If we end up
with a deficit, we could reject the project.
Suppose in this case the projects require an initial outlay of K15 000 000 at the beginning
of year 1 (refered to as year 0). We cannot compare this outlay directly to K107, 753,125
generated since this is the return at the end of four years. At that time we will have lost
four years potential interest on the outlay of K15 000 000. To allow for this we need to
calculate the terminal value of the initial outlay by adding four years interest at 5% The
complete solution is as follows:
Year Cash flow Compound factor Terminal Value
0 (15 000 000)
4
) 05 . 1 ( (18 232 593.75)
1 25 000 000
3
) 05 . 1 ( 28 940 625
2 25 000 000
2
) 05 . 1 ( 27 562 500
3 25 000 000
) 05 . 1 (
26 250 000
4 25 000 000 25 000 000
K89 520 531.25
==========
Note that the year column refers to the end of various years. Thus the initial outlays
occur at the start of the project, i.e., the end of year 0 (which means the beginning of year
1). The first cash flow is received at the end of year 1, and so on for the subsequent cash
flows. The net surplus in this case K89,520,531.25 is called the net terminal value
(NTV) and since it is positive, indicating a surplus, the project is worthwhile and should
be accepted. The positive net terminal value indicates that the cash and interest earned
from the project exceed the value of the initial outlay plus interest. If the net terminal
value is negative, indicating a deficit, the project would be rejected.
Example
Find the terminal values of the following investment
a) An initial outlay of K500 000 which will generate the following cash flows.
Year Cash flow
1 30 000
2 20 000
3 40 000
4 50 000
The annual interest rate available for deposit is 7.5%.
b) An initial outlay of K5 000 000 which will generate the following cash flows:
Year Cash flow
1 2 500 000
2 2 000 000
3 -
4 5 000 000
The annual interest rate available for deposits is 10%.
c) An initial outlay of K3 000 000 which will generate cash flows of k120 0000 for
four years. The annual interest rate available for deposits is 8.5%.
Solution
The net terminal values are calculated as follows:
a) Year Cash flow Compound factor Terminal value
00 . 000 50 000 50 4
00 . 000 43 ) 075 . 1 ( 000 40 3
50 . 112 23 ) 075 . 1 ( 000 20 2
91 . 268 37 ) 075 . 1 ( 000 30 1
) 57 . 734 667 ( ) 075 . 1 ( ) 000 500 ( 0
2
3
4

(514 353.16)
So the project would be rejected.
b) Year Cash flow Compound factor Terminal value
000 000 5 000 000 5 4
3
000 420 2 ) 10 . 1 ( 000 000 2 2
00 5 327 3 ) 10 . 1 ( 000 500 2 1
) 500 320 7 ( ) 10 . 1 ( ) 000 000 5 ( 0
2
3
4

3 427 000
So the project would be accepted.
c) Year Cash flow Compound factor Terminal value
00 . 000 200 1 000 1200 4
00 . 000 302 1 ) 085 . 1 ( 000 1200 3
00 . 670 412 1 ) 085 . 1 ( 000 200 1 2
95 . 746 32 5 1 ) 085 . 1 ( 000 1200 1
) 10 . 576 157 4 ( ) 085 . 1 ( ) 000 000 3 ( 0
2
3
4

(1 289 840.85)
=========
So the project would be rejected.
6.4 Other Applications of the Compound Interest Formula
In the Compound Interest Formula, there are four variables,
. , , t and r P A
t If
any three of these variables are given, the fourth may be determined. In some
cases, you will require the rules for indices and logs. For example, a general
expression for r may be derived as:
t
t
r P A ) 1 ( +
dividing throughout by P, we get
t t
r
P
A
) 1 ( +
then take the t th root on both sides
r
P
A
t
t
+
,
_

1
1
making r the subject of the formula gives the required formula for r .
) 5 . 6 ( 1
1

,
_

t
P
A
r
t
Example 4
a) Find the compound interest rate required for K15 000 000 to grow to
K25 000 000 in 5 years.
b) A bank pays 13.5% interest compounded annually. How long will it take
for K15 000 000 to grow to K20 000 000?
a) Calculate r when given
5 , 000 000 15 , 000 000 25
5
t and P A
Direct from the formula, (6.5)
%. 8 . 10
108 . 0 1 108 . 1
1
00 000 15
000 000 25
5
1

,
_

r or
r
An interest rate of 10.8% is required if this investment is to be doubled in
value over a period of 5 years.
b) When
%. 5 . 13 000 000 15 , 000 000 25 r and P A
t Direct from
compound interest formula (6.4),
t
t
) 135 . 1 ( 667 . 1
) 135 . 1 ( 000 000 15 000 000 25

+
taking natural logarithms or common logarithms on both sides gives us
0355 . 4
12663265 . 0
511025603 . 0
) 135 . 1 ln(
) 667 . 1 ln(
) 135 . 1 ln( ) 667 . 1 ln(

t
t
So, at 13.5% interest, it will take over 4 years for the investment to double
in value.
6.5 Present Value At Compound Interest
At present value of a future sum,
t
A
, is the amount which, when put on deposit
now (i.e.
P t , 0
), at (r%) rate of interest, will grow to the value of t
KA
after t
years. The present value, P, is calculated by arranging the compound interest
(6.4).
) 6 . 6 (
) 1 (
) 1 (

+
t
t
t
t
r
A
P
r P A
Example 5
If the future value of an investment is K25 000 000 invested at 12.5% compound
interest per annum for five years. Compute the present value.
years t r K A 5 , 125 . , 000 000 25
5

. Using formula (6.6)
93 . 223 873 13
) 125 . 1 (
000 000 25
5
K P
P

6.6 Nominal and Effective Rates

When interest is compounded several times per year, for example it may be
compounded daily, weekly, monthly, quarterly, semi-annually or continuously.
Each period is called a conversion period or interest period. Then the amount of
the future value is given by the formula
where t m n = total number of conversion periods
m
= conversion periods per year
t = number of years
Example 6
K25 000 000 is invested for five years at 12.5%. Calculate the total value of the
investment when compounded
i) Monthly
) 7 . 6 ( 1
,
_

+
mt
t
m
r
P A
ii) Daily
Assume a year has 365 days.
i) P = 25 000 000, r = 12.5% = .125, t = 5 and
m
= 12. Using
formula (6.7) the total value after three years with 60 5 12 t m n
conversion periods is calculated as:
11 . 402 555 46
) 01041666 . 1 ( 000 000 25
12
125 .
1 000 000 25
1
60
60
5
K
P
m
r
P P
mt
t

,
_

,
_

+
ii)
1825 5 365 , 365 , 5 %, 5 . 12 , 000 000 25 t m n m t r P
000 700 46
) 868 . 1 ( 000 000 25
365
125 .
1 000 000 25
1
1825
5
K
m
r
P P
t m

,
_

,
_

When working with problems involving interest we use the term payment
period as follows:
Annually Once per year
Semi-annually Twice per year
Quarterly 4 times per year
Monthly 12 times per year
Daily 365 timer per year (some basics use 360 times per
year)
6.7 Effective Rate Of Interest
Interest rates are usually cited as nominal rates of interest expressed as per annum
figures. However, as compounding may occur several times during the year with
the nominal rate, the amount owed or accumulated will be different from that
calculated by compounding once a year. So a standard measure used to compare
the amount earned (owed) at quoted nominal rates of interest when compounding
is done several time per year is called the annual percentage rate (APR) or
effective annual rate or effective rate of interest.
Let us consider formula (6.7)
mt
t
m
r
P A
,
_

+ 1 nominal rate compounded m times per year.

t
t
APR P A ) 1 ( + APR rate compounded annually. Note that
m
= 1 i.e, once
per year.
Equating the two amounts since they are the same, we have
t
mt
APR P
m
r
P ) 1 ( 1 +
,
_

+
making APR subject of the formula, we have
) 8 . 6 ( 1 1
,
_

+
m
m
r
APR
Example 7
Interest on a savings account is payable semi-annually at a (nominal) rate of
12.5% per annum. What is the effective rate of interest?
R = 0.125 and
m
= 2 because interest is payable twice yearly, so
1289 . 0
1
2
125 . 0
1
2

,
_

+ APR
The effective rate of interest is 12.89%
Example 8
a) A finance company advertises money at 25% nominal interest, but compounded
quarterly. Find the effective interest rate (APR)
b) Two banks in a local town quote the following nominal interest rates. Bank X
pays interest on a saving account at 12.5% compounded monthly and bank Y pays
12.5% on a savings account compounded quarterly, which pays its savers the
most interest?
a) r = .25, and
m
= 4 because interest is payable 4 times a year, so
274 . 0
1
4
25 . 0
1
4

,
_

+ APR
The effective rate of interest is 27.4%.
b) Bank X pays interest of 12.5% compounded monthly
% 2 . 13
132 . 0 1
12
125 .
1
12

,
_

+ APR
Bank Y offers the greater effective interest rate and thus pays its savers
more interest.
6.8 Investment Appraisal
If an initial investment will bring in payments at future times, the payments are
called cash flows. The net present value, denoted NPV, of cash flows is defined
to be the sum of the present values of the cash flows (revenue), minus the initial
investment (cost). If NPV > 0, then the investment is profitable, if NPV < 0 the
investment is not profitable.
Example 9
Suppose that you can invest K100 000 000 in a business that guarantees you cash
flows at the end of years 1, 2 and 3, as indicated in the table. Assume an interest
rate of 12.5% compounded annually and find the net present value of the cash
flows.
Year Cash Flow
1 5 000 000
2 400 000
3 200 000
NPV = cash inflows cash outflows
(Revenue) (cost)
79 . 039 099 95
000 000 100 39 . 466 140 38 . 049 316 44 . 444 444 4
000 000 100 ) 125 . 1 ( 000 200 ) 125 . 1 ( 000 400 ) 125 . 1 ( 000 000 5
3 2 1
K
+ +
+ +

Since NPV < 0, the business venture is not profitable. If one considers the time
value of money, it would be better to invest the K100 000 000 in a bank paying
12.5%.
6.9 Internal Rate Of Return
The discount rate at which a project has a net present value of zero is called the
Internal rate of return (IRR). There is no precise formula for calculating the
IRR of a given project. However, it can be estimated (using linear interpolation
technique) with:
a) graphically, or
b) by formula given by IRR =
) 9 . 6 (
1 2
1 2 2 1

NPV NPV
NPV r NPV r
Both techniques need that the NPV is calculated using two different discount
rates. We explain the two methods in the following examples.
Example 10
A project involves an initial outlay of K100 000 000. The expected cash flow at the end
of the next four years is given as given as follows (the amounts are in million of
kwachas).
Year 1 2 3 4
Cash flows 50 125 167 182
a) Determine IRR graphically by plotting the NPV against r. For r = 0.05, 0.08, .
10, .20.
b) By formula, show that the value of the IRR is slightly different when calculated
from pairs of points.
a) Graphically. Excel is ideal at this point. Since calculation of NPVs
requires the repeated use of the formula
t
t
r A NPV

+

) 1 (
where
is the symbol for the sum of several NPVs. Then we plot the curve of
NPV against r .
Table 6.1 Excel Sheet for Calculating NPVs at Different Interest Rates
t
Cash
flow
r = 0.05 r = 0.08 r = 0.10 r = 0.20 r =0.24
0
1
2
3
4
300
50
125
167
182
300
47.61905
113.3787
144.2609
149.7319
154.9905
300
46.2963
107.1674
132.5700
133.7754
119.8091
300
45.45455
103.3058
125.4696
124.3084
98.53835
300
41.66667
80.0000
85.5040
74.5472
-18.2821
-300
40.32258
81.2953
87.58937
76.98119
-13.8113
NPV
200
150


100
50

0
-50 0.1 0.2 0.3 r
IRR
Figure 6.1
The NPV for each discount rate is plotted in Figure 6.1. The IRR is the value of
r at which this graph crosses the horizontal axis. In Figure 6.1 this point is
between r = 10% and 20%, but considerably closer to 20%.
b) In Table 6.1 are several positive and negative NPVs. Therefore, the IRR given by
formula (6.9) is calculated from any such pair.
Summarising points already calculated.
Points A B C D E
r 0.05
24 . 0 20 . 0 10 . 0 08 . 0

NPV 154.9905 119.8091 98.53835 18.2821 13.8113
i) From points C and D
1843 . 0
82045 . 116
53586 . 21
53835 . 98 2821 . 18
) 53835 . 98 ( 20 . 0 ) 2821 . 18 ( 10 . 0
1 2
1 2 2 1

IRR
NPV NPV
NPV r NPV r
IRR
Therefore, IRR = 18.43%.
ii) From points B and E,
22346 . 0
6204 . 133
859088 . 29
8091 . 119 8113 . 13
) 8091 . 119 ( 24 . 0 ) 8113 . 13 ( 08 . 0
1 2
1 2 2 1

NPV NPV
NPV r NPV r
IRR
Therefore, IRR = 22.346%
The two results (i) and (ii) demonstrate that slightly different estimates are
calculated from different pairs of points.
6.10 Comparison of Appraisal Techniques: NPV and IRR
When comparing the profitability of two or more projects, the most profitable
project would be (a) the project with the largest NPV, (b) the project with the
largest IRR.
The advantages of NPV method is that :
i) It gives results in cash terms
ii) It is practical as it discounts net cash flows.
The disadvantage is that it relies on the choice of one discount rate which means
that a change in the discount rate could lead to a change in the choice of project.
The advantage of the IRR is that it does not depend on external rates of interest.
A major weakness is that the method does not differentiate between the scale of
projects; for example, one project might involve a cash flow in units of
K5 000 000 while another involve units of K5. Not that in most cases where two
or more similar project are being ranked in order of preference, the methods of
NPV and IRR will generally agree on the best project but this is not a hard and
fast rule.
Example 11
The net cash flow for two projects, A and B, is as follows:
K000, 000
Year 0 1 2 3 4
Project A -45.0 -13.5 18 27 36
Project B -22.5 -9 4.5 13.5 22.5
a) Use the net present value criterion to decide which project is the most
profitable if a discount rate of
i) 8%, and
ii) 12% is used.
b) Calculate the IRR of each project. Which project would now be
considered more profitable?
Project A
Year Net Flow Discount
Factor at
8%
Present
Value
Discount
factor at
12%
Present
Value
0
1
2
3
4
-45
-13.5
18
27
36
1.0000
0.9259
0.8573
0.7938
0.7350
-45.0
-12.50
15.43
21.43
26.46
5.82
1.0000
0.8929
0.7972
0.7118
0.6355
-45.00
-12.05
14.35
19.22
22.88
-0.68
116 . 0
42 . 6
7464 . 0
42 . 6
048 . 0 6984 . 0
82 . 5 6 . 0
) 6 . 0 )( 08 . , 10 ( ) 82 . 5 ( 12 .
1 2
2 1 1 2
+

NPV NPV
NPV r NPV r
IRR

Project B
Year Net Flow Discount
Factor at
8%
Present
Value
Discount
factor at
12%
Present
Value
0
1
2
3
4
-22.5
-9
4.5
13.5
22.5
1.0000
0.9259
0.8573
0.7938
0.7350
-22.5
-8.33
3.86
10.72
16.54
0.29

1.0000
0.8929
0.7972
0.7118
0.6355
22.50
8.04
3.59
9.61
14.30
3.04
083 . 0
33 . 3
278 . 0
42 . 6
0348 . 0 2432 . 0
29 . 0 04 . 3
) 29 . 0 ( 12 . ) 04 . 3 ( 08 . 0
1 2
1 2 2 1

NPV NPV
NPV r NPV r
IRR

From (a) at rate 8%, project A has the highest NPV (9.42) and thus would be chosen as
best. (Note also that project B has the highest NPV (0.29)). And from (b) project A has
the highest rate of return at 11.6% and thus would be chosen as best agreeing with the
choice in (a). Overall clearly project A is the best choice.
Exercise 1
1) K5 400 000 is invested at 9.5% simple interest. How much will have to be
accrued after 5 years?
2) Find the amount of:
a) K 2 160 000 compounded at 13.5% for 3 years.
b) K5 580 000 compounded at 8.5% for 10 years.
3) Calculate the present value of K56 million that is expected to be received in five
years time when simple interest is 6.5%.
4) Calculate the compound interest rate required for K250 000 to grow to K450 000
in 3 years time.
5) Calculate the number of years it will take a sum of K450 000 to grow to K1 800
000 when invested at 4.5% interest compounded annually.
6) Calculate the APR for a 6.5% nominal rate of interest which is compounded
a) four times per year
b) 12 times per year, and
c) 3 times per year.
7) Two banks in a Geal town quote the following nominal interest rates: Bank X
charges interest on a loan at 9.5% compounded semi-annually and bank Y charges
9.0% on a loan compounded quarterly. Which bank charges the most interest on a
loan?
8) You have a choice of two savings schemes. Scheme A offers 7.0% interest
payable semi-annually and scheme B offer 6.5% interest payable quarterly.
Which bank charges the most interest on a loan?
9) Find the present value of K25 million in 6 years time if the discount rate is 13.5%
compounded semi-annually.
10) A Financial group can make investment of K240 million now and receive K264
million in two years time. What is the internal rate of return?
11) An investment project has the following NPV calculated for a range of discount
rates. Give an approximate IRR for the project.
Discount rate (%) NPV (Kmillion)
5
5.5
6
6.5
11.25
7.02
3.42
1.2
7 -2.349
The company considering the project could invest an equivalent amount of money
for a similar length of time at an interest rate of 7.5%. Should they undertake the
project?
12) Calculate the NPV of a project, which requires an initial outlay of K90 million
now but should return K36 million at the end of year 2 and K20 million at the end
of four years. Assume a discount rate of 3.5% compounded annually. Estimate
the IRR of this project.
13) Find the terminal value of the following compounded deposits.
a) K15 000 000 deposited for 3 years at an annual interest of 8.5%.
b) K30 000 000 deposited for 5 years at an annual interest rate of 12%.
c) K4 800 000 deposited for 4 years at an annual interest rate of 25%.
14) Find the terminal value and compound interest payable if you deposit
K24 000 000 for one year with a bank offering 5% interest per month on deposit
accounts.
6.11 Series of Payments
6.11.1 Amount of an Annuity and their Present Values
An annuity is a sequence of payments made at fixed periods of time over a
given time interval. The fixed period is called the payment period, and the
given time interval is the term of the annuity. An example of an annuity is
depositing of K100,000 in a savings account every 6 months for a year.
In this Section, we consider the amount accrued from a series of such
payments and also the present values of a series of such payments which
are to be made.
The amount of an annuity is found using the following formula:
( )
) 10 . 6 (
1 1

1
]
1

r
r
R A
n
while the present value of an annuity is found using the following formula.
) 11 . 6 (
) 1 ( 1
) (Pr
1
]
1

r
r
R annuity of value esent P
n
where A is the amount of an ordinary annuity
r is the interest rate per period
n
number of period
P is the present value of an ordinary annuity.
Example 11
Find the amount of an annuity consisting of payments of K225 000 at the
end of every 3 months for 4 years at the rate of 6.5% compounded
quarterly.
To find the amount of the annuity we use equation (6.10) with R =22 000,
n
= 4(4) = 16, and r =
01625 . 0
4
065 . 0

67 . 849 073 4
) 10599851 . 18 ( 000 225
01625 . 0
1 ) 01625 . 1 (
000 225
16
K
A

1
]
1

Example 12
What is the terminal or future value of an annuity of K4 500 000 for five years at 10% of
interest rate per annum?
R = 4 500 000, r = 0.10,
n
= 5 and
n
6
00 . 950 472 27
) 1051 . 6 ( 000 500 4
10 . 0
1 ) 10 . 1 (
500 4
5
K
A

1
]
1

Alternatively, we reason as follows:

The first payment will be made at the end of year 1, and so at the end of 5 years, it will
have been invested for 4 years and will have a value of
4
) 10 . 1 ( 000 500 4 . The next
payment is made at the end of year 2, and so at the end of year 5 it will have been
invested for 3 years and will have a value of . ) 10 . 1 ( 000 500 4
3
It is easy to work using
a table as follows:
End of
Year
Amount (K) Value of the end of
Year 5
5
4
3
2
1
000 500 4
000 500 4
000 500 4
000 500 4
000 500 4
000 500 4
) 10 . 1 ( 000 500 4
) 10 . 1 ( 000 500 4
) 10 . 1 ( 000 500 4
) 10 . 00091 500 4
2
3
4
Notice the pattern
At the end of year 5 the total value of all the payments will be the total of the third
column. In reverse order, we can see that this is a geometric series with the first term
a

= 4 500 000, common ratio r = 1.10 and
n
= 5.
That is
4 3 2
) 10 . 1 ( 000 450 ) 10 . 1 ( 00 450 ) 10 . 1 ( 000 4500 ) 10 . 1 ( 000 4500 000 4500 + + + +
1
]
1

1
1
r
r
a S
n
n using formula (5.6)
1
]
1

1 10 . 1
1 ) 10 . 1 (
5
5
a S

. 950 472 27 ) 1051 . 6 ( 000 4500 K
The present value of an annuity is the sum of the present values of all the payments. It
represents the amount that must be invested now to purchase the payments due in the
future. Unless otherwise specified, we assume that each payment is made at the end of a
payment period, that is called an ordinary annuity.
Example 13
Find the present value of an annuity of K450 000 per month for 3 years at an interest rate
of 6.5% compounded monthly.
Using equation (6.11), R = 450 000,
. 36 ) 3 ( 12
12
065 . 0
n and r
Thus

77 . 731 686 14
6371817 . 32 ( 450
0054 . 0
) 0054 . 1 ( 1
000 450
36
K
P

1
]
1

Alternatively, there will be altogether 12(3) = 36 monthly payments. The interest

rate is
. 0054 . 0
12
065 . 0

The present value of the payment is therefore:

36 2
) 0054 . 1 (
000 450
. . .
) 0054 . 1 (
000 450
0054 . 1
000 450
+ + +
This is a geometric series with
. 36
0054 . 1
1
,
0054 . 1
000 450
n and r a
So the sum is 1
]
1

1
1
r
r
a S
n
n using formula (5.6)
77 . 731 686 14
1
0054 . 1
1
1
0054 . 1
1
0054 . 1
000 450
36
K
1
1
1
1
]
1

,
_

6.12 Equation of Value

Example 14
Suppose that Mr Chilufya owes Mr Banda two sums of money: K500 000 due in
2 years and K300 000 due in 5 years. If Mr Chilufya wishes to pay off the total
debt now by a single payment, how much should the payment be? Assume an
interest of 5% compounded semiannually.
The single payment
x
due now must be such that it would grow and eventually
pay off the debts when they are due. That is, it must equal the sum of the present
values of the future payments. As shown in the figure below, we have
10 4
) 025 . 1 ( 000 300 ) 025 . 1 ( 000 500

+ x
This equation is called an equation of value. We find that
84 . 334 687 52 . 234359 32 . 452975 K x +
Year
0 1 2 3 4 5
Single
Payment x 500 000 300 000
Present 500 000 (1.025)
-4
4 periods
Value of
Dents
300 000(1.025)
-10
10 periods
Replacing two future payments by a single payment now for Example 13
In general, an equation of value illustrates that when one is considering two methods of
paying a debt (or other transaction), at any time the value of all payments under one
method must equal the value of all payments under the other method.
Example 15
A debt of K15 000 000, which is due 7 years from now is instead to be paid off by three
payments: K2 500 000 now, K7500 000 in 4 years, and a final payment in the 6
th
year.
What would this payment be if an interest rate of 5% compounded annually is assumed?
Let
x
be the final payment due in 6 years. Setting up the equation of value, we have
1
2 6
) 05 . 1 ( 000 000 15
) 05 . 1 ( 000 7500 ) 05 . 1 ( 000 2500

+ + x
Year
0 1 2 3 4 5 6 7
2500 000 7500 000
x
15 000 000
7500 000 (1.05)
2

2500 000(1.06)
6
15 000 000 (1.06)
-1
Time values of payment for Example 15
3546297.78 + 8268 750 +
x
= 14285714.29

x
= K2470666.51
6.13 Perpetuities
When the present value of an annuity continue for an indefinitely long period of
time, we have what we call Perpetuities . The present value of annuity say
receivable in arrears in perpetuity at a given discount rate r is given by the
following formula:
PV of perpetuity =
) 12 . 6 (

,
_

rate discount
cashflows Annual
r
A
Example 15
Find the present value of K25 000 000 receivable annually in arrears at a discount
rate of 7.5% . A = 25 000 000, r = 0.075
30 . 333 333 333
075 .
000 000 25
K
r
A
PV
Example 16
The T Company is expected to pay K11 250 every 6 months indefinitely on a
share of its preferred stock. If money is worth 6.5% compounded semi annually
to X, what should he be willing to pay for a share of the stock?
A = 11 250, r = 0.0325; then
85 . 153 346
0325 . 0
11250
K
r
A
PV
6.14 Amortization of Loans
When borrowing a sum of money from a bank or building Society for house
purchase (a mortgage), it is usual to repay it by a series of regular equal
installments. The present value of the series will be the same as the amount
borrowed.
Example 17
Chisha wishes to borrow a sum of money to buy a house. She wishes to repay
exactly K2 500 000 a month for 15 years at the rate of 13.5% compounded
monthly,. Find how much she can borrow.
Using formula (6.11),
180 12 15 , 01125 . 0
12
135 .
, 000 500 2 n r R
.
80 . 750 556 192
) 02270031 . 77 ( 000 500 2
01125 . 0
) 01125 . 1 ( 1
000 500 2
180
K

1
]
1

Alternatively, there will be 180 12 15 . Monthly repayments of K2 500 000.

The interest rate is 1.125%. The present value of repayments is therefore
( )
80 . 750 556 192
1
01125 . 1
1
1
01125 . 1
1
01125 . 1
000 500 2
180 ,
01125 . 1
1
,
01125 . 1
000 500 2
01125 . 1
000 500 2
. . .
) 01125 . 1 (
000 500 2
) 01125 . 1 (
000 500 2
01125 . 1
000 500 2
180
180 3 2
K
n r a

1
1
1
1
]
1

,
_

+ + + +
Example 18
Lungowe borrows K11250 000 to be paid in 4 years to buy a car. How much
must she repay per month assuming an interest rate of 7.5% a year compounded
monthly.
Using formula (6.11)
00625 . 0
12
075 . 0
, 48 ) 12 ( 4 , 000 250 11
) 1 ( 1

1
]
1

r n P where
r
r
R P
n
Substituting these values in the above formula
1
]
1

00625 . 0
) 00625 . 1 ( 1
000 250 11
48
R
and making R the subject of the formula
70312.5 = R(0.258489819)
R = K272 012.65
6.15 Amortization Schedule
An analysis of how each payment in the loan is handed can be given in a table
called an Amortization Schedule. The amortization schedule contains
i) Principal outstanding at the beginning of the period
ii) Interest for period
ii) Payment at the end of the period
iv) Principal repaid at end of period
A loan is amortized when part of each payment is used to pay interest and the
remaining part is used to reduce the outstanding principal. Since each payment
reduces the outstanding principal, the interest portion of a payment decreases as
time goes on. For examination purposes, a schedule would only be asked for
where the period was relatively short; for example, up to 5 or 6 time periods.
Example 19
A debt of K22 500 000 with interest at 6% compounded semi-annually is
amortized by equal payments for the next 2 years.
a) Find monthly payment
b) Construct an amortization schedule.

a) Using formula (6. 11)
52 . 108 053 6
) 717098403 . 3 ( 000 500 22
03 . 0
) 03 . 1 ( 1
000 500 22
4 2 2 ,
2
06 . 0
, 000 500 22
4
K R
R
R
n r P

1
]
1

The monthly repayments must be K6 053 108.52

b) The Amortization Schedule is shown in Table 1.0
Period Principal
Outstanding at
Beginning of
period
Interest for
period
Payment at
End of Period
Principal Repaid
at End of Period
1
2
3
4
Total
22 500 000
17 121 891.48
11 582 439.70
5 876 804.37
675 000
513 656.74
347 473.19
176 304.13
1712 434.06
6 053 180.52
6.053 108.52
6 053 108.52
6 053 108.50
24 212 434.06
5 378 108.52
5 539 457.78
57 05 635.33
5 876 804.37
22 500 000.00
The final payment is adjusted to offset rounding errors. Note that:
1) Principal repaid = payment made + interest paid
2) Outstanding principal at beginning of period = principal outstanding
(current)
At beginning of period (previous) principal repaid at end of period (previous)
6.16 Sinking Fund
A sinking fund is a fund into which periodic payments are made in order to satisfy
a future obligation. This is the amount of an annuity as opposed to the present
value of an annuity in the case of a loan. Here we use formula (6.10).
1
]
1

r
r
R
annuity an of Amount A
n
1 ) 1 (
) (
Sinking funds are commonly used for the following purposes:
a) repayments of debts
b) to provide funds to purchase a new asset when the existing asset is fully
depreciated.
c) To pay for future school fees or a pension.
Example 20
The Board of Education received permission to issue K200 000 000 I bonds to
build a new block of classrooms. The board is required to make payments, every
6 months into a sinking fund paying 12.5% compounded semi-annually. At the
end of 15 years the bond obligation will be retired. What should each payment
be?
The payment R required twice a year to accumulate to K200 000 in 15 years
30 2 15 (
payments at a rate of interest
0625 . 0
2
125 .

per payment period).

Using formula (6.10),
38 . 567 420 2
) 62525618 . 82 (
0625 . 0
1 ) 0625 . 1 (
000 000 200
1 ) 1 (
30
K R
R
R
r
r
R A
n

1
]
1

1
]
1

Example 21
A woman borrows K13 500 000, which will be paid back to the lender in one
payment at the end of 4 years. She agrees to pay interest semi annually at 15%.
At the same time she sets up a sinking fund in order to repay the loan at the end of
4 years. She decides to make equal deposits into her sinking fund, which earns
6.5% interest compounded semi-annually.
a) What is the monthly sinking fund deposit?
b) Construct a table that shows how the sinking fund grows over time.
c) How much does she need each month to be able to pay the interest on the
loan and make the sinking fund deposit?
a) The sinking fund deposit is the value of R in the formula.
1
]
1

r
r
R A
n
1 ) 1 (
where A equal the amount to be accumulated namely,
.
2
065 . 0
, 8 2 4 , 00 500 13 r and n K A
The sinking fund
deposit is therefore:
55 . 745 504 1
) 97161647 . 8 ( 000 500 13
2
065 .
1
2
065 . 0
1
000 500 13
8
K R
R
R

1
1
1
1
]
1

,
_

b) The table below shows the growth of the sinking fund over time. The
entries for payment number 8 are obtained by using the amount of an
annuity formula for a monthly payment of K1 504 745.55 made for 8
months at 6.5% compounded monthly.
79 . 816 318 6
) 199259328 . 4 ( 55 . 1504745
2
065 . 0
1
2
065 . 0
1
55 . 1504745
8
K
Total

1
1
1
1
]
1

,
_

The deposit for payment number 8, the final payment, is only K1 504
745.58 because a deposit of K1 504 745.58 results in a total payment of
K134 99999 97.
Period Interest
Added
Deposit Increase in
Fund
Amount in
Fund at End of
Period
1
2
3
4
5
6
7
8
0
48 904.23
99.397.85
151 532.51
205 361.55
260 940.03
318 324.81
377 574.59
1 504 745.55
1 504 745.55
1 504 745.55
1 504 745.55
1 504 745.55
1 504 745.55
1 504 745.55
1 504 745.55
1504 745.55
1 553 649.78
1 604 143.40
1 656 278.06
1 710 107.10
1 765 685.58
1 823 070.36
1 882 320.17
1 504 745.55
3 058 395.33
4 662 538.73
6 318 816.79
8 028 923.89
9 794 609.47
11 617 679.83
13 500 000.00

c) The monthly interest payment due on the loan of K13 500 000 at 15% interest is
found using the simple interest formula.
500 , 012 , 1
2
1
) 15 . 0 ( 000 500 13 K I
,
_

Thus the woman needs to be able to pay K1 504 745.55 + K1 012 500
= K2 517 245 55 each month.
Example 22
A copper mine is expected to yield an annual net return of 900 million for the next 15
years, after which it will be worthless. An investor wants an annual return on the
investment of 18%. If she can establish a sinking fund earning 12% annually, how much
should he be willing to pay for the mine?
Let
x
be the purchase price. Then 0.185
x
represents an 18.5% annual return on
investment. The annual sinking fund contribution needed to obtain the amount
x
in 15
years is found by solving
1
1 ) 1 (

1
]
1

+
r
r
x
n
where n = 15 and r = 0.12. The investor
should be willing to pay an amount
x
so that
Annual return + Annual sinking = Annual return
on investment fund requirement
00 . 526 805 248 4
000 000 900 211824239 . 0
000 000 900 026824239 . 0 185 . 0
000 000 900
12 .
1 ) 12 . 1 (
185 . 0
1
15
K x
x
x x
x x

1
]
1

A purchase price of K4 248 805 526.00 will achieve the investors goals.
Example 23
A machine costing K18 million new is estimated to have after 6 years of use a scrap
value of K1.8million. if the depreciation fund earns 3%, use the sinking fund method to:
a) Find the annual deposit into the fund,
b) Find the amount in the fund at the end of 4 years,
c) Prepare a depreciation schedule.
a) Original cost Scrap value = 18 1.8 = 17.2
Therefore:
51 . 479 504 2
194052296 . 0
486 . 0
1 ) 03 . 1 (
) 03 . 0 ( 2 . 17
03 . 0
1 ) 03 . 0 1 (
2 . 17
6
6

1
]
1

R
R
Age Depreciation
Charge
Interest
fund
Increase fund Amount in
fund
Book value
0
1
2
3
4
5
6
0
2 504 479.51
2 504 479.51
2 504 479.51
2 504 479.51
2 504 479.51
2 504 479.51
0
0
152
522.80
232.232.8
7
314
334.24
398
898.66
486 00.00
0
2 504 479.51
2 657 002.31
2 889 235.18
3 203 569.42
3 602 468.08
4 088 468.08
0
2 504 479.51
5 084 093.41
7 741 095.72
10 477 808.1
13 296 621.85
16 200 000.02
18 000 000
15 495 520.49
12 915 906.59
10 258 904.28
7 522 191.90
4 703 378.15
1 799 999.98
The error of K0.02 in the final book value is due to rounding off all entries to 2
decimal places.
Exercise 2
1) Find the present value of the given future payment at the specified interest rate.
a) K24 million due in 15 years at 5% compounded annually.
b) K15.75 million due in 7 years at 6% effective
c) K18 million due in 12 years at 7.5% compounded semi-annually
d) K11.25 million due in 15 months at 6.5% compounded quarterly.
e) K9 million due in 2 years at 18% compounded monthly.
2) Mulenga wishes to borrow a sum of money to buy a house. She wishes to repay
exactly K2 000 000 a month for 15 years, starting at the end of the present. How
much can she borrow assuming an interest rate of 13.5% payable monthly?
3) Construct amortization schedules for the indicated debts. Adjust the final
payment, if necessary.
a) K25 million repaid by four equal yearly payment interest at 15%
compounded annually.
b) K36 million repaid by six equal semi annual payments with interest rate of
8% compounded semi annually.
c) K4050 000 repaid by five equal quarterly payments with interest at 10%
compounded quarterly.
4) A person borrows K9million and will pay off the loan by equal payments at the
end of each month for 6 years. If interest is a the rate of 18.5% compounded
monthly, how much is each payment?
5) Find the monthly payment of a 6-year loan for K31.5million if interest is at
12.24% compounded monthly.
6) What sum must a parent invest now in order to obtain school fees of K9 million
payable 3 times a year for 10 years starting in 4 months time, when the nominal
interest rate is 6.5% compounded 3 times a year?
7) Chibuye is saving for his daughters wedding in 3 years time. He decides to save
either
i) K67 500 a month starting at the end of the current month at a nominal rate
of 7.5% a year compounded monthly or
ii) K 2 070 000 a quarter starting at the end of the first 3 months at a nominal
rate of 6.5% a year compounded quarterly. How much does he save?
8) A debt of K500 000 000 compounded at 18.5% is to be discharged over 4 years
using a sinking fund method. Find the annual payment (based on an ordinary
annuity) if the fund earns 12.5%. Draw up a schedule showing both the position
of the debt and the fund each year.
9) A debt of K2 000 000 due in 4 years and K2 000 000 due in 5 years is to be repaid
by a single payment now. Find how much the payment is if an interest rate of
10% compounded quarterly is assumed.
10) A debt of K5 000 000 due in 5 years is to be repaid by a payment of K3 000 000
now and a second payment at the ends of 6 years. How much should the second
payment be if the interest rate is 5% compounded quarterly?
EXAMINATION QUESTIONS WITH ANSWERS
MULTIPLE CHOICE QUESTIONS
(SECTION A)
1.1) Today Chisenga purchase an annuity of K6 750 000 per year for 15 years from an
insurance company which was 3% compounded annually. If the first payment is
due in one year, what did the annuity cost Chisenga?
a) K80 581 061.25 b) K3 037 500 c) K125 542 668.70
d) K9 787 500
(Natech, 1.2 Mathematics & Statistics, November/December 2000)
1.2) A certain machine costs K5 400 000. The depreciation for a month at the end of
any month is estimated to be 5% of the value of the beginning of the month. At
what value is the machine cared after 24 months of use?
a) K1 659 727.08 b) K1 576 740.73 c) K11 610 000
d) K90 990 000
(Natech, 1.2 Mathematics & Statistics, November/December 2000)
1.3) Find the Net present value of a project which requires an initial outlay of K50 000
and guarantees you a cash flow of K30 000 per annum for the next three years
with an interest sale of 10%.
a) K25 608 b) K24 606 c) K50 000
d) K25 000
(Natech, 1.2 Mathematics & Statistics, June 2002)
1.4) In how many years will K1 000 000 amount to K3 207 000 at 6% per annum
compound interest? (Give your answer to the nearest whole number).
a) 17 b) 18 c) 19
d) 20
(Natech, 1.2 Mathematics & Statistics, June 2002)
1.5) Calculate the annual effective rate of interest of 5% compounded monthly to two
decimal places.
a) 6% b) 5.12% c) 5% d) 4.91%

(Natech, 1.2 Mathematics & Statistics, June 2002)
1.6) What is the present value of an annuity that pays K400 000 a month for the next
five years if money is worth 12% compounded monthly.
a) K24 000 000 b) K17 982 015 c) K28 800 000
d) K2 808 000
(Natech, 1.2 Mathematics & Statistics, June 2001)
1.7) What is the amount for an ordinary annuity of K10 000 a year for 4 years at 8%
compounded annually?
a) K45 061.12 b) K48 500.50 c) K13 300
d) K13 604.89
(Natech, 1.2 Mathematics & Statistics, December 1998)
1.8) If a boy undertakes to deposit K100 on September 1, K200 on September 2, K400
on September 3, K800 on September 4, and so, how much will be deposit from
September 1 to September 15, inclusive?
a) K32 767.00 b) K327 670.00 c) K3 276 700.00
d) K3 276.70
(Natech, 1.2 Mathematics & Statistics, December 1998)
1.9) Find the compound interest on K800 000 for 2 years at 6% per annum, interest to
be added half yearly.
a) K96 200.00 b) K192 400.50 c) K100 407.05
d) None of these
(Natech, 1.2 Mathematics & Statistics, December 1998)
1.10) If K40 000 000 invested for 5 years yields a simple interest of K3 800 000, what
will be the interest on K24 000 000 invested at the same rate for 7years?
a) K380 000 b) K240 000 c) K342 000
d) K760 000
(Natech, 1.2 Mathematics & Statistics, June 1998)
MULTIPLE CHOICE QUESTIONS
(SECTION B)
1.1) What sum will earn K15 750.00 simple interest in 146 days at 4.5% per annum?
a) K15 778.35 b) K284 112.30 c) K157 500.00
d) K875 000.00
(Natech, 1.2 Mathematics & Statistics, December 2002)
1.2) If 1 500 000 is deposited at simple interest of 3% per year, what amount of money
would be in the account at the end of 12 years?
a) K180 000 b) K518 000 c) K699 000
d) K18 000
(Natech, 1.2 Mathematics & Statistics, December 2002)
1.3) What is the discountable value of a bill for K475 000 drawn on 4
th
march at 3
months and discounted on 10
th
may at 6%?
a) K472 813.70 b) K28 500.00 c) K427 500.00
d) 2 186.30
(Natech, 1.2 Mathematics & Statistics, December 2002)
1.4) The terms for a five year lease agreement are that, K10 million must be paid at the
beginning of the first year, to be followed by four-equal payments at the
beginning of years two, three, four and five at a discount rate of 8%. If the
present value of the four equal payment is K26 496 000, the total amount to be
paid during the lease period is close to?
a) K32 million b) K40 million c) K42 million
d) K44 million
1.5) A machine assumed to depreciate at a fixed rate of 12% per annum, will have a
book value of K9 288 080 in six years time. Its purchase value to the nearest ten
is:
a) K15 million b) 21.5 million c) K25 million
d) K20 million.
1.6) A government bond of K1 million is advertised to become K1.57 million after 5
years. The effective annual rate of interest to the decimal place is:
a) 7.5% b) 9.0% c) 10.8%
d) 11.4%
1.7) The net present value of an investment at 20% is K12 400 000 at 12% is a loss of
K8 000 000. What is the internal rate of return of this investment?
a) 18% b) 17% c) 16% d) 15%
(Natech, 1.2 Mathematics & Statistics, December 2003)
1.8) How long will it take for K4 275 000 to amount to K4 446 000 at 8% simple
interest rate giving your anser in months?
a) 5 months b) 6 months c) 5.8 months
d) 3.0 months
(Natech, 1.2 Mathematics & Statistics, December 2001)
1.9) A bank accounts pays 12% annual interest compounded monthly. How much
must be deposited now so that the account contains exactly K45 000 000 at the
end of the year?
a) K39 935 215.14 b) K50 707 126.36 c) K450 000.00
d) K40 000 000.00
(Natech, 1.2 Mathematics & Statistics, December 2001)
1.10) Rearranging the compound interest formula
n
r P S ) 1 ( + , where P is the original
principal and S is the compound amount at the end of n interest periods at the
periodic rate of r. To make n the subject of the formula result in
a)
S
r P
n
) 1 ( +
b)
1
]
1

) 1 (
ln
r P
S
n
c)
) 1 ln(
ln
r
P
S
n
+

,
_

d)
) 1 ( ln
) ln(
r P
S
n
+

(Natech, 1.2 Mathematics & Statistics, December 2001)

SECTION B
QUESTION ONE
a) A borrower receives K4 000 000 today agreeing to repay the lender a total of
K4 800 000 at the end of 12 months. What annual simple interest rate is being
charged?
b) Find the present value of K15 000 in 9 months time at a simple interest rate of
6%.
c) What lump sum would ha e to be invested at 14% , compounded quarterly, to
provide an annuity of K1 250 000 a quarter for four years?

(Natech, 1.2 Mathematics & Statistics, December 1999 (rescheduled))
QUESTION TWO
a) An initial investment of K90 000 000 in a business guarantees the following cash
flow:
Year Cash Flow
3
4
6
K28 800 000
K36 000 000
K50 400 000
Assume an interest rate of 5% compounded Semi-annually.
i) Find the net present value of the cash flows.
ii) Is the investment profitable?
b) Chipasha Mulenga recently purchased a computer for K5 400 000 and agreed to
pay it off by monthly payments of K270 000. if the store charges interest at the
rate of 12% compounded monthly, how many months will it take to pay off the
debt?
c) i) Find the amount of an annuity consisting of payments of K180,000 at the
end of every 3 months for 3 years at the rate of 6% compounded quarterly.
iii) Also find the compounded interest.
iv)
(Natech, 1.2 Mathematics & Statistics, December 2001)
d) Miss Mwalilino has an obligation of K1 350 000 due five years from now. If
interest is assumed to be 7 percent and is compounded yearly, what is the present
value of the obligation?

(Natech, 1.2 Mathematics & Statistics, Nov/Dec 2000)
QUESTION THREE
a) Moonga borrows K500 000 now at an interest rate of 5% per annum. The loan
has the be repaid through five equal installments at the end of each year for the
next five years. Calculate the annual repayment.
b) Mr Sokonjo has just received his gratuity amount to K60 million. He wishes to
invest K50 million of the gratuity. He is now faced with a choice between two
investment opportunities, A and B. capital outlay for each is K50 million.
A is estimated to yield an annuity of K20 million at the end of each year
receivable every 5 years.
B yields K11 million receivable at the end in perpetuity. If the discounting rate is
estimated at 20% for Mr Sokonjo,
i) Evaluate the two (2) investment opportunities using Net Present
value (NPV) method.
ii) Recommend with a reason which one of the two (2) investment
opportunities Mr Sokonjo should choose.
(Natech, 1.2 Mathematics & Statistics, December 2004)
QUESTION FOUR
a) Supremo Stores advertises goods at K700 00 deposit and three further equal
annual payments of K500 000 for the next three years. If the discount rate is
7.5%, calculate the present value of the goods.
b) i) For how many years must I invest K20 000 if I want it to have a value of
at least K500 000 and the interest rate is 6%, payable annually?
ii) How does your answer change if interest is payable every 6 months?
(Natech, 1.2 Mathematics & Statistics, June 2003)
c) Mr Musole, a sole proprietor, is paying K500 000 each quarter into a fund which
pay 12% per year interest, compounded quarterly. How much will have
accumulated in the fund by the end of the fifth year?

(Natech, 1.2 Mathematics & Statistics, June 2001)
d) M-net offers a decorder for K540 000 and K67 500 per month for the next 12
months. If interest is charged at 9% compounded monthly, find the equivalent
cash value to be paid now.
(Natech, 1.2 Mathematics & Statistics, Nov/Dec 2000)