UNO - R: FINMGT1

MODULE 3 - TIME VALUE OF MONEY

“Time is more valuable than money. You can get more money, but you cannot get
more time”. – Jim Rohn

Many would agree that our peso or dollar today will not be worth the same
after, five or 10 years, or even just after a year. Money’s value is measured by the
quantity of goods and services is can afford. Perhaps, when we were kids, we were
so happy receiving P50 pesos because we can buy a lot of things then. Receiving
the same amount now, will we feel the same excitement? Probably not. Things have
gone expensive and we’ll have less now for the same amount that we had ten years
ago.
Indeed, time is one key element that determines money’s value. However, is
it all that there is? In this module, we will uncover the importance of time as an
element in determining one’s worth. We will also uncover other elements that
underlie money valuation.

Learning
At the end of thisObjectives
module, you will be able to:
1. Explain how the time value of money works and why it is such an important
concept in finance
2. Calculate the present values and future values of lump sum and annuities
3. Explain the difference between nominal, periodic, and effective interest rates
4. Develop a loan amortization schedule for long term borrowings

EXPLAIN

Chapter 5 – Time Value of Money

Essentials of Financial Management 4 th Edition by Brigham, F., Houston, F., Hsu, J.,
Kong, Y & Bany-Ariffin, AN. (2019). Pg. 155 - 188

Time value of money is a concept that adhere to the principle the money
today is not worth the same in the future. It expounds that money can earn some
sort of return (in terms of interest) and that, if not taken advantage of, will decrease
the value of any some in the future. In a way, this encourages investments. The
longer is the investment time, the greater interest is earned.

Time Lines - Show the timing of cash flows.

Tick marks occur at the end of periods, so Time 0 is today; Time 1 is the end of the
first period (year, month, etc.) or the beginning of the second period.
To further illustrate the time line, take note of the following:

Clarifying the terms above, lumpsum means a single payment while an

annuity is a series of equal amounts paid or received on fixed regular intervals.
There are instances however that the amounts received per period are not equal.
This is called an uneven cash flow stream or mixed streams and is illustrated as
follows:

FUTURE VALUE (Simple)

Interest is the return earned on money investment

Future Values - Amount to which an investment will grow after earning interest.

Compound Interest - Interest earned on interest.

Simple Interest - Interest earned only on the original investment.

Example - Simple Interest

Interest earned at a rate of 6% for five years on a principal balance of $100.

Year 0 1 2 3 4 5
Interest Earned 0 6 6 6 6 6
Value 100 106 112 118 124 130
Therefore, its value after 5 years is 130.

Example - Compound Interest

Interest earned at a rate of 6% for five years on the previous year’s balance.

Year 0 1 2 3 4 5
Interest Earned 0 6 6.36 6.74 7.15 7.57
Value 100 106 112.36 119.10
126.25 133.82
 Therefore, its value after 5 years is 133.82

Interest for Year 1: 100 x 0.06 = 6

Interest for Year 2: 106 x 0.06 = 6.36
Interest for Year 3: 112.36 x 0.06 = 6.74
Interest for Year 2: 119.10 x 0.06 = 7.15
Interest for Year 2: 126.25 x 0.06 = 7.57

Computing the future value using the step by step approach is tedious, thus
the formula approach is recommended. The general formula to computer for the
future value of a single sum is:

n
FV =PV ( 1+i )
Where:
FV – Future Value; PV – Present Value (a single sum); i – interest per period; n – no.
of compounding period
Applying the formula, the following is determined:
FV = 100 (1+.06)^5
FV = 133.82

PRESENT VALUE (Simple)

Present Value - Value today of a future cash flow.

Discount Factor - Present value of a $1 future payment.

Discount Rate - Interest rate used to compute present values of future cash flows.

The present value is just the reciprocal of future value, thus, its general
formula is:

−n
PV =FV ( 1+i )

Where: PV – Present Value; FV – Future Value; interest per period; n – no. of

compounding period

Example: What is the present value (PV) of $100 due in 3 years, if I/YR = 4%?

 Finding the PV of a cash flow or series of cash flows is called

discounting (the reverse of compounding).
 The PV shows the value of cash flows in terms of today’s purchasing
power.

PV = 100 (1+.04)^-3
PV = = $88.90

Solving for Interest (I)

In certain cases, the problem may ask about the interest. Depending on the
given, the general formula provided can be referred to and algebra is applied to
compute for the unknown.

Example:
 What annual interest rate would cause $100 to grow to $119.10 in 3 years?

With the illustration, the following solution can be made:

FV = PV (1+i)3
119.10 = 100 (1+i)3
119.10 / 100 = (1+i)3
1.191 = (1+i)3
√3 1.191=(1+ i)
1.059995253 = 1 + i
I = 0.059995253 >> I = 0.06 or 6%

Solving for n (compounding period)

Similar to finding the interest rate, when the compounding period is asked,
the general formula will still be utilized and algebra will be used. However, to do
away with the derivation, when the compounding period is unknown, the following
formula is suggested:

n = ln (FV/PV) / ln (1 + i)

ln (in scientific calculator) – Natural Logarithm

Example: If sales grow at 10% per year, how long before sales double?

n = ln (2 / 1) / ln (1+.10)
n = 0.69314718 / 0.0953101
n = 7.27 years

ANNUITIES
In the previous examples, a single sum of money was the focus. In practice
however, annuities are more used. Annuity refers to a series of payments made at
equal intervals. Examples of annuities are regular deposits to a savings account,
monthly home mortgage payments, etc. An annuity has two requisites: first, there is
a regular payment of fixed amount; second, the payment is done on a regular
interval.

There are two types of annuity: Ordinary Annuity and Annuity Due. In an
ordinary annuity, the payment is made at the end of the period while in annuity
due, the payment is made at the beginning of the period. Graphically, the difference
between the two can be illustrated as follows:

Present Value of Ordinary Annuity

In computing for the present value of an annuity, we are solving for the value
TODAY of the series of cash flow that we will receive in the future. That is, the
present value at year 0.
The formula to compute for the present value of an ordinary annuity is given
as follows:
 ( )
−n
1 − ( 1+i )
PVOA=PMT
i

Where: PVOA – Present Value of all payments

PMT – regular annuity payments
i – interest
n – compounding period

Example: What is the present value of $100 payments at the end of each period
using 4% interest, made for three years?

PVOA=100 ( 1− (1+ 0.04 )− 3

0.04 )
PVOA = 277.51

Present Value of Annuity Due

The only difference between annuity due and ordinary annuity is the timing of
the payment. For the former, payment is made at the beginning of each period,
while in the latter, at the end of each period. With this, annuity due will normally
have an additional compounding period, rending the total value (present or future)
higher than that of the ordinary annuity.
Formula to compute for Present Value of Annuity Due (PVAD) is given below:

( )(
−n
1− ( 1+i )
PVAD=PMT 1+i )
i

Example: What is the present value of $100 payments at the beginning of each
period using 4% interest, made for three years?

PVAD=100 (
1 − (1+ 0.04 )− 3
0.04 )
(1+0.04)

PVAD = 277.51 (1.04)

PVAD = 288.61
Future Value of An Ordinary Annuity
Computing the future value of an annuity involves the determination of the
total value of a series of cash flow at a certain time in the future. That is, its total
value at end of X number of years.
Once again, ordinary annuity means, the cash flow is received/paid at the
end of the period. The formula to compute for the future value of an ordinary
annuity is given as follows:

FVOA=PMT ( ( 1+i )n − 1
i )
Where: FVOA – Future Value of all payments
PMT – regular annuity payments
i – interest
n – compounding period

Example: Find the future value of a 3-Year Ordinary Annuity of $100 at 4%.

FVOA=100 (
( 1+ 0.04 )3 −1
0.04 )
 FVOA = 312.16

Future Value of An Annuity Due

Just like the present value of an annuity due, future value of an annuity due
begins the first payment at the start of each period, giving it an additional period of
compounding. Therefore, the formula is just an extension of the future value of
ordinary annuity, multiplied by the additional compounding period, summarized
below:

FVAD=100 ( 0.04 )
( 1+ 0.04 )3 −1
(1+ 0.04)

FVOA = 312.16 (1.04)

FVOA = 324.65

DISCOUNTING vs. COMPOUNDING

Compounding method is used to know the future value of present money.
Conversely, discounting is a way to compute the present value of future money. In
other words, they are the reverse of each other. To be technically correct, when
asked to compute for the present value, we refer to the process as discounting.
Compounding on the other hand is appropriate term for solving future values.

Perpetuity
 A stream of level cash payments that never ends, in other words, FOREVER.
 Present value of a Perpetuity is determined using the following formula:

PMT
PV =
i
Where: PV is the present value
PMT is the regular cash flow
i is the interest rate

Example: In order to create an endowment, which pays $100,000 per year, forever,
how much money must be set aside today in the rate of interest is 10%?

Solution:
PV = 100,000 / 0.10
PV = 1,000,000

Example: Continuing the preceding example, if the first perpetuity payment will not
be received until three years from today, how much money needs to be set aside
today?

Solution:
PV = 1,000,000 (1+.10)-3
PV = 751,315

Uneven Cash Flow Streams

In certain instance, cash flows are not even per period. If this is the case,
computation of either the present value or future value will use the simple formula,
and not the annuity. Consider the following example:

Year Cash Flow

0 0
 1 100
2 300
3 300
4 -50

The present value of the series of cash flow above at 4% interest is

determined as follows: PV = FV (1+i)-n

100 (1+.04)-1 = 96.15

300 (1+.04)-2 = 277.37
300 (1+.04)-3 = 266.70
-50 (1+.04)-4 = -42.74
Total 597.48 (Present Value)

Using the same example, the future value of the series of cash flow above at
4% interest is determined as: FV = PV (1+i) n

100 (1+.04)3 = 112.49

300 (1+.04)2 = 324.48
300 (1+.04)1 = 312.00
-50 (1+.04)0 = (50.00)
Total 698.97 (Future Value)

Note: The “n” in the equation is determined by the distance of each cash flow to the
end point. In the case of present value, the end point is Year 0. Hence, 100 will
travel one period back, 300 will travel two years back, and so on. Notice also that
the exponent is negative since it goes back to year zero. For the future value, the
end point is Year 4. So 100 in the first year will move three periods to reach year 4,
the 300 in year two by two periods, the 300 in year three by one period and the -50
by 0 since, it is on the same period.

Compounding/Discounting Period
The “n” in the formula does not necessarily indicate the time. It is the
number of compounding periods. Time is normally measured in years and the
timing of cash flow may not always be annually. It is therefore necessary to identify
the compounding period or the number of times in a year cash flow is received or
paid. For ease of understanding, the following are provided:

Timing No. of Compounding

Annual 1
Semi-Annual 2
Quarterly 4
Monthly 12
Bi-monthly 24
Weekly 52
Daily 365

Note: The more frequent is the compounding, the greater is its effect on the
value of a sum of money.

Classification of Interest Rates

 Nominal rate (INOM): also called the quoted or stated rate. An annual rate that
ignores compounding effects.
o INOM is stated in contracts. Periods must also be given, e.g. 4%
quarterly or 4% daily interest.
 Periodic rate (IPER): amount of interest charged each period, e.g. monthly or
quarterly.
 o IPER = INOM/M, where M is the number of compounding periods per year.
M = 4 for quarterly and M = 12 for monthly compounding.
 Effective (or equivalent) annual rate (EAR = EFF%): the annual rate of
interest actually being earned, considering compounding.
 EFF% for 4% semiannual interest
EFF% = (1 + INOM/M)M – 1
= (1 + 0.04/2)2 – 1 = 4.04%
 Should be indifferent between receiving 4.04% annual interest and
receiving 4% interest, compounded semiannually.

Why is it important to consider effective rates of return?

 Investments with different compounding intervals provide different effective
returns.
 To compare investments with different compounding intervals, you must look
at their effective returns (EFF% or EAR).
 See how the effective return varies between investments with the same
nominal rate, but different compounding intervals.
EARANNUAL 4.00%
EARSEMIANNUALLY 4.04%
EARQUARTERLY 4.06%
EARMONTHLY 4.07%
EARDAILY (365) 4.08%

When is each rate used?

• INOM: Written into contracts, quoted by banks and brokers. Not used in
calculations or shown on time lines.
• IPER: Used in calculations and shown on time lines. If M = 1, I NOM = IPER = EAR.
• EAR: Used to compare returns on investments with different payments per
year. Used in calculations when annuity payments don’t match compounding
periods.

Example:
What is the FV of $100 after 3 years under 4% semiannual compounding?
Quarterly compounding?

Can the effective rate ever be equal to the nominal rate?

• Yes, but only if annual compounding is used, i.e., if M = 1.
• If M > 1, EFF% will always be greater than the nominal rate.

Timing of Cash Flow Does Not Coincide with Compounding Period

There may be cases where the timing of the cash flow does not coincide with
the compounding period. In such instance, the normal annuity valuation cannot be
used. Let’s take for example the following illustration:
Example: What’s the FV of a 3-year $100 annuity, if the quoted interest rate is 4%,
compounded semiannually?

Observation: Payments occur annually, but compounding occurs every 6 months.

Graphically, it can be shown as:

One alternative to solve the problem is manually compound each cash flow:

FV3 = $100(1.02)4 + $100(1.02)2 + $100

FV3 = $312.28

Another way to deal with this is to compute the effective interest rate and
use the same to compound the series of cash flow using the computed effective
interest rate. This is illustrated as follows:

2
EAR=( 1+0.02 ) −1

EAR = 4.04%

FVOA=PMT ( ( 1+i )n − 1
i )
Continuation…

FVOA=100 ( ( 1+ 0.0404 )3 −1
0.0404 )
FVOA = 312.28

Loan Amortization
• Amortization tables are widely used for home mortgages, auto loans,
business loans, retirement plans, etc.
• Financial calculators and spreadsheets are great for setting up amortization
tables.

EXAMPLE: Construct an amortization schedule for a $1,000, 4% annual rate loan

with 3 equal payments.

The first issue in constructing an amortization table is the determination of

the key elements. Amortization table, such as any loan, or mortgage is always a
problem of present value. The principal amount is the present value and more
often, we will be asked to compute for the regular payments. In the problem above,
the following are dissected:

Present Value – 1,000

Interest - 4%
Term - 3 years
Compounding - Annual
 PMT - Unknown

To compute for the PMT, the present value of an ordinary annuity formula will
be used:

( )
−n
1 − ( 1+i )
PVOA=PMT
i

1,000=PMT (
1 − ( 1+0.04 )−3
0.04 )
PMT = 360.35

The amortization table will then look like this:

Period PMT Interest Principal Balance

1,000.0
0 0
360.3 40.0 320.3 679.6
1 5 0 5 5
360.3 27.1 333.1 346.4
2 5 9 6 9
360.3 13.8 346.4 (0.00
3 5 6 9 )

Comments:
PMT: is the amount computed; the regular payment per period
Interest: Previous period balance multiplied by the interest rate; interest
during the period
Principal: PMT less Interest; the portion of the total payment applied to
principal loan payment
Balance: Previous period balance less principal of the current period; The
remaining principal loan balance.

As the loan near maturity, the portion going to the interest declines but the
portion applied to principal loan increases.

Assignment:
Instructions:
1. Answer the following problems in your textbook.
2. This is a graded output.
3. Submission due Date: October 8 11:59PM.
4. Submit using an electronic format (MS Word, Excel or PDF) or write on a
yellow paper and take a photo

Problems to answer:

1. Problem 5 – 22, page 192

2. Problem 5 – 23, page 193
3. Problem 5 – 30, page 194
4. Problem 5 – 33, page 194
 5. Problem 5 – 37, page 195
6. Problem 5 – 42, page 196

SAMPLE PROBLEMS I

TIME VALUE OF MONEY - SAMPLE PROBLEMS (using Factors)

1. Future Value (Single Payment)

a. Ralph deposited P50,000, 6% interest, compounded annually. What is the total value
of his deposit 5 years from now?
N = 5 I = 6%
FV = P50,000 (1.3382) = P 66,910.00
==========
b. Ralph deposited P50,000, 6% interest annually compounded semi-anunually. What
is the total vale of his deposit 5 years from now?
N = 10 I = 3%
FV = P50,000 (1,3439) = P 67,195.00
==========

2. Future Value Annuity (equal amount of periodic cash flows)

a. Ordinary Annuity (Cash flows made at the end of the period)

Maureen deposited P 50,000 every year for 5 years with 8% annual interest. The
deposit is made every end of the period. How much is her total deposit after 5 years?

N=5 I = 8%
FVOA = P50,000 (5.8666) = P293, 330.00
===========

b. Annuity Due (cash flows made at the beginning of the period)

Maureen deposited P50,000 every year for 5 years with 8%p.a. interest. The
deposit is made every beginning of the period. How much is her total deposit after 5
years?
N= 5 I = 8%
FVAD = P50,000 (5.8666 x 1.08) = P 316,796.00
===========

3. Future value of uneven cash flows (mixed stream)

a. Future Value - Mixed stream (deposit is made at the beginning of the year)

Girard and Kyla plan to have their wedding 5 years from now. They decided to
deposit every beginning of the period an amount as follows: 1 st year, P100,000; 2nd
year, P50,000; 3rd year, P150,000; 4th year, P75,000 and 5th year, P50.000. Interest rate
is 5% p.a. How much is their total deposit after 5 years?

1st year = P100,000 x 1.2763 = P 127,630

2nd year = 50,000 x 1.2155 = 60,775
3rd year = 150,000 x 1.1576 = 173,640
4th year = 75,000 x 1.1025 = 82,688
th
5 year = 50,000 x 1.0500 = 52,500
Total value after 5 years = P 497,233
=========
b. Same with a above except that deposit were made every end of the period:
 1st year P100,000 x 1.2155 = P 121,550
2nd year 50,000 x 1.1576 = 57,880
3rd year 150,000 x 1.1025 = 165,375
4th year 75,000 x 1.0500 = 78,750
5th year 50,000 x 1.0000 = 50,000
Total value after 5 years P 473,555
=========

1. PRESENT VALUE (Single payment)

a. Erica has been promised by her Tito to received P500,000 five years from now. The
interest rate is 6% discounted annually. How much is the value today of the money she
will receive 5 years from now?

N = 5 years I = 6%
PV = P500,000 (0.7473) = P 373,650
=========
b. same with a above, except that the 6% interest is discounted semi-annually.

N = 10 I = 3%
PV = P500,000 (0.7441) = P 372, 050
=========

2. Present Value - Annuity (equal amount of periodic cash flow)

a. Present Value - Ordinary annuity (cash flow received at the end of the period)

Alexa is promised by her Maninoy to receive P75,000 every end of the year for 6
years. The interest rate is discounted at 5% per annum. How much is the present value
of the money Alexa wil receive?

N= 6 I + 5%
PVOA = P 75,000 (5.0757) = P380,677.50
==========

b. Present Value - Annuity Due (cash flow received at the beginning of the period)

Same with (a) above, except that the amount is received at the beginning of the
year.

PVAD = P75,000 (5.0757 x 1.05) = P399,711.00

===========

3. Present Value - Mixed Streams

a. Present Value of uneven cash flows received at the end of the period

Princess won the “Keep your Smile” contest. Her prize to to received sum of
money at the end of every year. 1 st year, P100,000, 2nd and 3rd year, P50,000 each year,
and 4th and 5th year P150,000 per year. What is the present value of her winnings at a
discount rate of 10% p.a.?

1st year P100,000 x 0.9091 = P 90,910

2nd year 50,000 x 0.8264 = 41,320
3rd year 50,000 x 0.7513 = 37,565
 4th year 150,000 x 0.6830 = 102,450
5th year 150,000 x 0.6209 = 93, 135

Total present value of cash flows P 365,480

=========

b. Same with (a) above, except that cash flows received at the beginning of the period:
1st year P 100,000 x 1.0000 = P 100,000
2nd year 50,000 x 0.9091 = 45,455
rd
3 year 50,000 x 0.8264 = 41,320
4th year 150,000 x 0.7513 = 112,695
5th year 150,000 x 0.6830 = 102,450

Total present value of cash flows = P 401,920

=========

SAMPLE PROBLEMS II

The following are additional illustrations to help further digest the topics on
time value of money.

Example 1: If you invest $100 today for one year at a 10% rate of return, how
much money will you have one year from now?

Solution: FV =PV ( 1+i )n

1
FV =100 ( 1+.10 )
FV = 110

Example 2. You will receive $12,000 a year for the next ten years from a trust fund
your grandmother is establishing. What is this gift worth today at a 9% discount
rate?

Solution:

PVOA=PMT (
1 − ( 1+i )−n
i )

( )
−10
1− (1+.09 )
PVOA=12,000
0.09
PVOA = 77,011.89

Example 3. Annuity due present value

You are buying some land from your parents today. You agree to pay them $5,000 a
year for six years. The first payment is due today. What is the actual selling price of
the land if your parents are only charging you 3% interest?

Solution:

PVAD=PMT ( 1− ( 1+i )−n

i )
(1+i)

( )
−6
1 − (1+ 0.03 )
PVAD=5,000 (1+ 0.03)
0.03
 PVAD = 27,898.54

Example 4. Ordinary annuity future value

You are planning on investing $3,500 in the stock market every year for your
retirement. You will make your first investment at the end of this year. The average
rate of return you expect to earn is 7%. How much money do you expect to have
when you retire forty years from now?

Solution:

FVOA=PMT (
( 1+i )n − 1
i )
FVOA=3,500 (
( 1+ 0.07 )40 −1
0.07 )
FVOA = 698,722.89

Example 5. Annuity due future value

Your parents are giving you $3,000 at the beginning of each year for four years. You
are saving this money and earning a 2.5% rate of return on your savings. How much
money will you have at the end of the four years?

Solution:

FVAD=PMT
i (
( 1+i )n − 1
(1+i) )
FVAD=3,000
0.025 (
( 1+ 0.025 )4 −1
(1+ 0.025) )
FVAD = 12,457.55

Example 6. Annuity – annual payments

You plan on retiring at age 60 and then living another 25 years. Your goal is to have
$500,000 in your retirement savings on the day you retire and spend it all by the
time you die. During your retirement, you expect to earn 5% on your savings.
a. How much money can you withdraw from your savings each year during your
retirement if you withdraw the funds on the last day of each year?
b. What if you withdraw the money on the first day of each year?

Solution:

( )
−n
1 − ( 1+i )
a. PVOA=PMT
i

500,000=PMT (
1 − ( 1+0.05 )− 25
0.05 )
PMT = 35,476.23
 The 500,000 is the present value of all withdrawals for the next 25 years after
the retirement at age 60. This is the reason why present value of ordinary annuity
was used.

( )
−n
1− ( 1+i )
b. PVAD=PMT (1+i)
i

500,000=PMT (
1 − ( 1+0.05 )− 25
0.05 )
(1+0.05)

PMT = 33,786.88

Example 7. Annuity – monthly payments

You currently owe $3,780 on your credit card. You are not charging any more on the
account. The interest rate is 1.5% per month. How much do you have to pay each
month if you want to have this bill paid off within two years?

Solution:

( )
−n
1 − ( 1+i )
PVOA=PMT
i

3,780=PMT (
1 − ( 1+0.015 )− 24
0.015 )
PMT = 188.71

In the example above, notice that the payment occurs on a monthly basis.
The general formula presented above is for the per period interest and “n”
corresponds to the number of periods. The interest therefore remains at 1.5%
(monthly rate). The annual rate is 1.5% x 12, which is 18%. There are 24 months in
2 years, thus, “n” is 24. The computed payment is the monthly amortization. Also,
since this is a loan problem, present value is to be used.

Example 8. Annuity – quarterly payments

Your company recently borrowed $12,000 to buy some office equipment. The
financing terms call for eight equal quarterly payments. The interest rate is 10%.
What is the amount of each quarterly payment?

Solution:

( )
−n
1 − ( 1+i )
PVOA=PMT
i

12,000=PMT (
1 − ( 1+0.025 )− 8
0.025 )
PMT = 1,673.61

Example 8 above is similar to example 7. However, the interest in example 8

is given on an annual basis. Thus, it will be divided by 4 since quarterly payments
will require four payments in a year. By default, any interest given is an annual or
nominal interest, unless specifically identified otherwise.
Example 9. Annuity time periods
You own a landscaping business. Your goal is to purchase a professional lawnmower
costing $7,500. To do this, you are saving $2,000 a year. Your savings account
pays 3% interest. How long will you have to wait to buy the lawnmower if you want
to pay cash for the purchase?

Solution:

FVOA=PMT ( ( 1+i )n − 1
i )
7,500=2,000 ( ( 1+ 0.03 )n −1
0.03 )
( 7,500
2,000 )
0.03=( 1.03 ) − 1 n

0.1125 = (1.03)n – 1

1.1125 = (1.03)n

ln 1.1125 = n (ln1.03)

ln 1.1125
n=
ln 1.03

0.10661
n=
0.02956

n = 3.61

Example 10. Effective annual rate

You have a credit card with a quoted annual percentage rate of 17.9%. Interest is
applied to your account monthly. What is the effective annual rate?

Solution
EAR = (1 + 0.179/12)12 – 1
EAR = 0.1944 = 19.44%

Example 11. Continuous compounding

What is the effective annual rate of 14.9% compounded continuously?

Solution:
Formula for EAR using continuous compounding: EAR= ei – 1

EAR = e 0.149 – 1
EAR = 2.71828 0.149 – 1
EAR = 0.16067 = 16.07%

Note: The “e” in continuous compounding is constant and is found in

scientific calculators.
CASE STUDY ANALYSIS:

1. Answer the case that follow. Answers to be submitted electronically (MS

Word, PDF, or an image of your write up on the paper. This is due on
October 10 10pm
2. This is a group graded activity.
3. The case will be discussed in our class October 10, 2024
4. The case should contain the following:
a. Brief Background
b. Point of View
c. Statement of the Problem
d. Areas of Consideration
e. Alternative Courses of Action
f. Conclusion and Recommendation
5. The Rubric for the case study is given on the last part of this module.

Credit Card Balance owed $10,000 @ 15.99% per annum

College Loans owed $12,000 @ 5.25% per annum
(24 months remaining)

Minimum monthly payment required

on credit card debt 3% of balance owed
Car Loans owed $5,000 @ 5.99% per annum
(24 payments remaining)

Monthly rent $1200

Income Tax Rate 28%

Questions:
1. Based on the information provided in Table 1 if the Halls continue making
minimum payments on their outstanding debts, how much money will they
have left over for all other expenses?
2. How much money will Laura and Marty have to deposit each month
(beginning one month after the child is born and ending on his or her 18 th
birthday) in order to have enough saved up for their child’s college education.
Assume that the yield on investments is 8% per year, college expenses
increase at the rate of 4% per year, college expenses increase at the rate of
4% per year, and that their child will enter college when he or she turns 18
and will complete the degree in 4 years.
3. How much money will the Halls have to set aside each month so as to have
enough saved up for a down payment on the $140,000 house within 12
months? Assume that the closing costs amount to 2% of the loan and that the
down payment is 10% of the price.
4. If the interest rate on a 30-year mortgage is at 5% per year when the Halls
purchase their $140,000 house, how much will their mortgage payment be?
Ignore insurance and taxes.
5. Construct an amortization schedule for the 5%, 30-year mortgage.
6. If the Halls want to have as much of an after-tax income when they retire as
they currently have, and assuming they live until they are 80 years old, how
much money should they set aside each month so as to have enough money
accumulated in their retirement nest egg? Assume that annual inflation rate
is 4% per year for the whole term, the investment return is 8% per year
before and after retirement, and that their tax rate is 28% throughout their
life.
<<<END OF MODULE 4>>>