Tutorial I for FM-I

1. HDFC Bank pays 9.20% on fixed deposit schemes and compounds interest quarterly. If Rs. 10,000 is deposited initially, how much shall it grow at the end of 5 years? Rs. 15,528 (rounded off to nearest Rs.) 2. You are 25 years old. If you invest Rs. 25,000 today at a compound interest of 9%, what will be its future value when you reach 70 years of age? What will be your corpus if you save Rs. 5,000 every year? Rs. 1,208,182 (rounded off to nearest Rs.) Rs. 2,629,294 (rounded off to nearest Rs.) 3. How much should be invested now to have an income stream of Rs. 30,000 each year from years 1 to 5 and Rs. 70,000 each year from years 6 to 10, if the discount rate is 12%? 4. A 12-payment annuity of Rs. 10000 will begin 7 years hence. The first payment occurs at the beginning of 8 th year. What is the present value of this annuity if the discount rate is 14%? PV = Rs 25,788 (rounded off to nearest Rs.) 5. Axis bank offers 10.20% nominal interest for a three year fixed deposit to senior citizens. If the compounding is done quarterly, then what is the effective annual rate of interest? Effective Interest Rate (EIR) = EIR = 6. If a bank offers to double your money in 8 years, what is the effective rate of interest? Ans: 9.05% 7. An old machine is being replaced. The new machine is expected to save cost of operations and requires an investment of Rs. 1,000,000. If the life of the machine is 10 years, how much cost savings should be made each year to recover the cost? The cost of funds is 11%. Rs. 169,801 8. Abhijeet borrows Rs. 80,000 for a music system at a monthly interest rate of 1.25%. The loan is to be repaid in 2 years using equal monthly instalments, payable at the beginning of each month. Calculate the amount of each instalment? Rs. 80,000 loan is PV of Annuities (in this case monthly instalment). A = Rs. 3,879 (rounded off to the nearest Rs.) 9. A finance company advertises that it will pay Rs. 100,000 at the end of 5th year to any person, who deposits Rs. 16,000 at the end of every year for 5 years. What interest rate is implicit in this offer? Implicit interest rate = 11.18% 10. A company has issued debentures of Rs. 50 lakh to be repaid after 7 years. How much should the company invest in a sinking fund earning 12% in order to be able to repay debentures? Annual investment = Rs. 4.96 lakhs 11. At the time of his retirement, Mr. Jain is given a choice between two alternatives. (a) an annual pension of Rs. 5.5 lakhs as long as he lives, and (b) a lump sum amount of Rs. 42 lakhs now. If Mr. Jain expects to live for 25 years, and the interest rate is 12.5%, which option appears more attractive? a) PVA = Rs. 41.68 lakhs; b) Rs. 42.00 lakhs. Hence option (b) is better. 12. Mr. X is borrowing Rs. 100,000 to buy a low-income group house. If he pays equal instalments for 15 years and 4 per cent interest on outstanding balance, what is the amount of instalment? What shall be the amount of instalment if quarterly payments are required? Annual instalment: Rs.8,994.11; Quarterly instalment: Rs. 2,224.44

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13. When you purchased your house, you took a 30-year annual payment mortgage with an interest rate of 10% per year. The annual payment of the mortgage is 97,525. You have just made a payment and have now decided to pay the mortgage off by repaying the outstanding. What is the payoff amount if you have lived in the house for 11 years? Rs. 815, 789 14. Mr. Tiwari is planning for his retirement. He has 15 years to retire. His current cost of leaving is Rs. 400,000 per annum. He is expecting that by the time he retires, his annual cost of leaving would have doubled. He wishes to maintain the living cost after his retirement. How much he should invest every year in a Pension Fund so that he can have his retirement life as planned? It is assumed that he will live for 15 years after his retirement and the rate of return from the pension fund is 12%. Rs. 146,157 15. Ram is 35 years old and working for a reputed MNC. Ram is seeking your advice in planning for his retirement. You expect to retire at the age of 70. You ask about his current average monthly household expenditure and find that it is Rs. 50,683. The household expenses are expected to grow by 4% every year. Ram wants to maintain his current lifestyle and is expected to live till the age of 90. He is currently saving Rs. 1500 per month. How much additional savings he need to do to have the required monthly income from his pension funds? The pension fund investment will give him a return of 13.5% per annum. On retirement, Ram will put the accumulated funds in a fixed deposit with a bank at 9% per annum. Monthly investment = Rs. 2,298.59; additional investment required = 2298.59-1500 = 798.59 16. Your buddy a mechanical engineer has invented a money machine. The main drawback of the machine is that it is slow. It takes one year to manufacture 600. However, once built, the machine will last forever and will require no maintenance. The machine will take one year to build, and it will cost 6,000. Your buddy wants to know if he should invest the money to construct it. If the interest rate is 13.0%, what should your buddy do? PV of all notes printed at the end of 1 year from now = 4615.38 PV now = 4084 NPV = 4084 - 6000 = - 1916; Should not invest. 17. Ashlyn owns her business and is considering an investment. If she undertakes the investment, it will pay 32,000 at the end of each year for next three years. This opportunity requires an initial investment of 8,000 plus an additional investment of 40,000 at the end of second year. What is the NPV of this opportunity if the interest rate is 9% per year? Should Ashlyn Take it? NPV = Rs. 39,334. Ashlyn should take the investment 18. You are thinking of building a new machine that will save you 5000 in the first year. The machine will then begin to wear out so that the savings decline at a rate of 4 % per annum forever. What is the present value of the savings if interest rate is 5% per year? PV of savings = 55,555.55 19. You work for a pharma company that has developed a new drug. The patent on the drug will last for 17 years. You expect that the drugs profits will be 3 mn in its first year and this amount will grow at a rate of 5% per year for next 17 years. Once the patent expires, other pharma companies will be able to produce the same drug and competition will likely drive profits to zero. What is the present value of the new drug if the interest rate is 11% per year? Growing annuity: 30.56 mn 20. You are designing an income scheme. The investment period in this scheme is 40 years. The investments generate a return of 12% per annum. Income to be received from this will be for 25 years. The expected income in the first year is Rs. 250,000. This is expected to grow at 5% per annum. How much should be invested every year to receive the growing income? Corpus needed to receive income of Rs. 250,000 in Year1 which grows at 5% = Rs. 2.86 million

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Annual investment required for 40 years = Rs. 3728.39 21. You would like to buy a house that costs 350,000. You have 50,000 in cash that you can use a down payment and borrow the rest from a bank. The bank is offering you a 30 year mortgage that requires annual payments and has an interest rate of 9% per year. You can afford to pay only 28,620 per year. The bank agrees to allow you to pay this amount each year, yet still borrow 300,000. At the end of 30 years, you must pay a balloon payment: that is, you must repay the remaining balance on the mortgage. How much will this balloon payment be? Balloon payment: 79,182 22. Suppose you have the rights to a coal mine for next 30 years. You plan to extract 1MTPA of coal every year. Current price is Rs. 1500/ ton and is expected to increase by 3% every year. What is the present value (PV) of this coal mine? Assume the discount rate to be 10%. Rs. 1900 crore 23. A project requires an investment of Rs. 10.30 lakhs now and is expected to generate cash flows of Rs. 1.50 lakhs, Rs. 2.00 lakhs, Rs. 3.50 lakhs, Rs. 4.50 lakhs, Rs. 6.00 lakhs in year 1 to 5. If the discount rate is 12%, is it good to invest in this project? NPV = Rs. 1.39 lakhs. It is good to invest in this project. 24. The bond of LIC Housing Finance Ltd. is trading at Rs. 100.90. It carries a coupon rate of 9.6% and will mature in 2015. If an investors expected return is 10%, should he buy this bond? Buying this bond will give interest income of Rs. 9.6 every year for 2013, 2014 and 2015. On maturity bond will give a CF of Rs. 100. PV of all CFs = Rs. 99.01. Since the bond is trading higher at Rs. 100.90, should not buy. 25. Steve & Co Ltd.s stock is trading at Rs. 44.35. It is expected to give dividends per share of Rs. 2.40, Rs. 3.00, Rs. 3.60 and Rs. 4.00 in the next four years. The price at the end of four years is expected to go to Rs. 68.40. Should you buy this stock if you are looking for a return of 20%? PV of all CFs = 41.08. the stock is trading higher. Should not buy the stock.

FM-I, GIM, 2012

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