0

QUESTION ONE
If you invest Sh.20, 000 today, how much will you have in 25 years at 12 percent?
SOLUTION
PV= Shs 20000
Time= 25 years
Rate = 12%
FV

PV (1 k )

FV = 20000 ( 1.12

25

= Shs 340,001.2881

QUESTION FOUR
You are making the following deposits into an investment that earns annual rate of 10
percent. What will be the value of the investment at the end of the five year period?
Year
Cash flow
0

1
5,000

2
6,000

3
3,000

4
2,000

C1

C2

C3

C4

C5

Future value of uneven stream of cash flows

FV = C1 ( (1+k )

+ C2 (1+ k)

1+k

C3

+ C 4 (1+k ) + C5

FV = 5,000(1.1)4 +6,000(1.1)3 +3,000(1.1)2 +2,000(1.1) + 1,500

= Ksh 22,636.5

QUESTION 5
3

5
1,500

Assume you are making Sh. 5,000 deposit each year into an investment for 15 years earning
an annual rate of 10 percent. What will be the value of the investment at the end of the fifteen
year period?
Annutiy = Ksh 5,000
Time = 15 years
Rate = 10%
n1

FV annuity = PMT { (1+k )

k

15
FV annuity = 5,000{ (1+0.1) 1 }
0.1

FV annuity = Shs 158,862.4085

QUESTION 11
CAT ltd is contemplating acquiring RAT Ltd. On successful acquisition, incremental cash
flows will as follows
Year
Cash flows in
millions

1-10
3

11-20
2

21-40
1.5

41-60
0.5

If the appropriate discounting rate is 10 percent, how much should CAT Ltd pay in order to
acquire RAT Limited?
Rate = 10%
n
PV annuity = { 1(1+ K )
} for period between 1-10
k
n 1
PV annuity = A[{ 1(1+ k)
}-{
k

Substituting the values;

1(1+ k)n
}] For periods 11-20, 21-40, 41-60
k

10

PV 110 = 3{ 1(1+0.1)
0.1

} = Shs 18.433million

20
PV 1110 = 2[{ 1(1+0.1)
}-{
0.1

1(1+0.1)10
}] = 4.737993228 million
0.1

40
PV 2140 = 1.5[{ 1(1+0.1)
}-{
0.1

1(1+0.1)20
}] = 1.898230498 million
0.1

60
PV 4160 = 0.5[{ 1(1+0.1)
}-{
0.1

1(1+0.1)40
}] = 0.094053289 million
0.1

Total PV = 18.433+4.737993228+1.898230498+0.094053289
PV = 25.16327702 million

QUESTION 12
CAT ltd is contemplating acquiring RAT Ltd. On successful acquisition, incremental cash
flows will as follows
YEAR
CASH FLOW
(ShMillions)

1-5
2.5

After the fifth year cash flows are expected to grow at an annual rate of 3 percent forever. If
the appropriate discounting rate is 10 percent, how much should CAT Ltd pay in order to
acquire RAT LTD.?
0

Annuity 15 = 2.5 million

Annuity period n = 5 years
k= 10%

Perpetuity 5 growth rate g = 3%

1(1+ K )n
PV = C{
} +(
k

1(1+0.1)
2.5{
0.1

} + {(

C
-n
kg )*(1+k)

2.5
1+k
5
)*
(
0.10.03

= 9.476966923+ 22.17576154

= Ksh 31.6527846 million

QUESTION 13
The estimated free cash flow for Savvy solutions ltd at the end of the current period is Sh.
1.5 million. After the end of current period, cash flows are expected to grow an annual rate
of 8 percent for 25 years. After the 8 percent growth period, annual growth rate in cash flows
is expected to be 3 percent forever. The weighted average cost of capital during the high
growth period is 10 percent and 5 percent in the stable growth period. Compute the enterprise
value of Savvy solutions ltd.
Solution
C1 = 1.5 million

K1 = 10%

g1 = 8%

K2 = 5%

n1 =26 years
g2 = 3%

26

g1 = 8% K1 =10%

g2= 3%

K2 = 5%

At the end of year one T1, Cash flow C1 =1.5 million

At the end of year 2 T2, cash flow C2 = 1.5(1.08)
After 25 years i.e. at T26 cash flow C26 =1.5(1.08)25 = Ksh 10.27271279 million
25
g1 = 8%

26
g1 =10%

27

g2 = 3%

Cash flow at T27 = C26( 1.03)

= 10.27271279 * 1.03
C27 = Ksh 10.58089418 million

PVSavvy ltd = PV growing Annuity + PVgrowing perpetuity

PVSavvy ltd =

PV =

C1
k 1g 1

1.5
0.10.08

C27
1+ g 1
* [1- ( 1+ k 1 ) n1] + [ k 2g 2 * (1+k1)-n1]

* [1-(

1+0.08
) 26] + [
1.1

10.58
-26
0.050.03 * (1+0.1) ]

PVSAVVY = Kshs (28.45542255+44.38598458) million

= Kshs 72.84140713 million

QUESTION 14
Madam Grace is celebrating her 35th birthday today and wants to start saving for her anticipated
retirement at age of 65. She wants to be able to withdraw khs. 120,000 from her savings account
on each birthday for 15 years following her retirement; the first withdrawal will be on her 66th
birthday. She is interested in investing in her local commercial bank, which offers 8% interest per
year. She wants to make equal annual payments on each birthday into account established at the
local commercial bank for her retirement fund.

a) If she starts making these deposits on her 36th birthday and continues to make deposits until
she is 65, (the last deposit will be on her 65th birthday), what amount she must deposit annually
to be able to make the desired withdrawals at retirement.
b) Suppose Madam Grace has just inherited a large sum of money. Rather than making equal
annual payments, she has decided to make one lump sum payment on her 35 birthday to cover
her retirement needs. What amount does she have to deposit?
c) Suppose Madam Graces employer will contribute Ksh. 1,500 to the account every year as part
of the companys profit sharing plan. In addition she expects a ksh. 25,000 distributions from
family trust fund on her 55th birthday, which she will also put into the retirement account. What
amount must she deposit annually now to be able to make the desired withdrawals at retirement?
Solution
Rate of interest = 8%
C1 =amount saved to retirement
C2 = Amount withdrawn after retirement = Ksh 120000
Time to retirement n1 = 30 years
Time after retirement n2 = 15 years

35

36

37

65

66

80

30

31

45

C1

C1

C1

a)
1( 1+ k )n 2
PV65 Annuity = C2 {
}
k
PV65 = 120000 {

1( 1+0.08 )15
}
0.08

PV65 = Ksh 1027137.443

FVA65 = C{

(1+k )n1
}
k

C2
C2

C2

C2

30

(1+0.08) 1
}
0.08

1027137.443 = C{

1027137.443 = C (113.2832111)
C1 = Ksh 9,066.987353 (Amount to be deposited annually)

b) To be able to receive Ksh 120,000.00 per month for 15 years, the accumulated amount at
T65 = Ksh 1,027,137.44

35

65

30

80
45

1+k
Discounting amount at T65 to T35 = C65 ( n
N =31
= 1,027,137.443(

1+0.08
31

= Ksh 94,513.12893
c)
Let Yearly contribution to be C1
Employers contribution yearly C2 = Ksh 1,500
Distribution at 55th birthday i.e. at T20 = Kshs 25,000
Accumulated Amount at 65th Birthday i.e. T30 to be to be able to withdraw Ksh 120,000 yearly =
Ksh 1,027,137.443
1+k
FV of Ksh 25,000 at T30 = C ( n

Where C = Ksh 25000

= 2,500(

n = 10 years

k = 8%

1+0.08
10

= Ksh 53,973.12493

35

55

65

80

20

30

45

The balance to be accumulated = Ksh (1027137.443 - 53973.12493)

= KSh 973,164.3181

(1+k )n1
FVannuity = C{
}
k
Where C = C1 + C2
K = 8%
n =30 years
30

(1+0.08) 1
C1 + 1500{
} = Ksh 973,164.3181
0.08

(C1 + 1500)*113.2832111 =973,164.3181

C1 + 1500 = Ksh 8,590.643193 million
C1 = (8,590.543193-1,500) million
C1 = 7,090.543193 million

QUESTION 15
Assume that your guardian plans to borrow Sh. 1.5 Million from a local commercial bank to
meet cost of education of your sibling who is travelling abroad for post-graduate studies. The
annual interest rate on the loan is 15.9 percent and the loan term is ten years with equal annual
installments. Prepare a loan amortization schedule for your guardian.
10

Solution
Loan amount = Ksh 1.5 million

Interest Rate = 15.9%

PVIFA = Present value interest factor of annuity;

n

Annual instalment =

Annual instalment =

Loan Amount
PVIFA

10

1(1+ k)
k

PVIFA =

Period = 10 years

PVIFA =
1.5 million
4.85127629

1(1+0.159)
0.159

= 4.85127629

= Ksh 309,196.9846

Amortization table
Loan Data
Original Principal

Ksh
1,500,000

Loan Term (Years)

Annual Interest Rate

10

Payments per Year

15.90%
Ksh
309,196.98

Payment
Year

Payment

Interest

Principal

11

Balance
1,500,000.00

309,196.98

238,500.00

70,696.98

1,429,303.02

309,196.98

227,259.18

81,937.81

1,347,365.21

309,196.98

214,231.07

94,965.92

1,252,399.29

309,196.98

199,131.49

110,065.50

1,142,333.80

309,196.98

181,631.07

127,565.91

1,014,767.89

309,196.98

161,348.09

147,848.89

866,919.00

309,196.98

137,840.12

171,356.86

695,562.13

309,196.98

110,594.38

198,602.61

496,959.53

309,196.98

79,016.56

230,180.42

266,779.11

10

309,196.98

42,417.88

266,779.11

0.00

QUESTION 16
Your brother, James, will Join University in seven years, for his higher education. His ambition is
to pursue medicine at the University of Nairobi. The Cost of education will be Sh. 1.5 Million
per year for five years. Anticipating Jamess ambitions, your parents started investing Sh.
100,000 per year five years ago and will continue to do so each year for the next seven years.
How much more will your parents have to invest each year for the next seven years to have the
necessary funds for the education of your brother? Use 12 percent as the appropriate interest rate
throughout this problem
(a) The cost assumed to come at the end of each year
(b) The cost assumed to come at the beginning of each year
today
0 13

start
6

10

If John is going to pay 1.5 million for years starting at T12

Annuity C2 = Ksh 1.5 million
Rate = 12%
Time n2 = 5 years
a) Ordinary Annuity
1(1+ k)n 2
}
PVA12 = C2 {
k
5

1(1+0.12)
}
PVA13 = 1.5{
0.12

million

Ksh 5.407164303 million {Amount to be accumulated at the start of School.}

Amount accumulated from 5 years ago to now at C1 = Ksh 100,000 annually
n

(1+ K ) 1
FVannuity = C1{
}
k

12

11

12

(1+0.12) 1
FVA5 = 100,000{
} = Ksh 635,284.7364
0.12
FVA12 of 635,284.7364 = (1.12)7*635,284.7364
Ksh 1,404,412.155

Balance = Ksh 4,002,752.148

Let the additional money to deposited from T5 to T12 be C
n

FVA12 = C+C1 {

(1+ K ) 1
}
k

Where n = 7 years

C1= 100,000 C = Amount required n = 7years

4,002,752.148 = (C + 100,000) {

(1+0.12) 1
}
0.12

4,002,752.148 = (C + 100,000)10.08901173
(C + 100,000) =

4002752.148
10.08901173

(C + 100,000) = 396,743.7303
C = Ksh 296,743.7303

b) Annuity Due

PVA12 = PVA12 (ordinary annuity) * (1+k)

PVA12 = Ksh 5.407164303 *(1.12) million
PVA12 = 6.056024019 million {amount to be accumulated at the start of School)
FVA5 of Shs 100,000 deposited until T5
(1+0.12)5 1
FVA5 = 100,000{
} = Ksh 635,284.736
0.12
FVA12 of 635,284.7364 = (1.12)7*635,284.7364
13

= Ksh 1,404,412.155
Balance at T12 = 6,056,024.019 - 1,404,412.155
= Ksh 4,651,611.865
n

FVA12 = C+C1 {

(1+ K ) 1
}
k
7

(1+0.12) 1
4,651,611.865= C+ 100,000 {
}
0.12

4,651,611.865 = C+ 100,000 (10.08901173)

461,057.2362 = C+ 100,000
C = Ksh 361,057.2362
QUESTION 17
Solution

Parents investment to year 5 (current year)

A = Ksh 100,00 per month
n = 5 years = 60 months
k = 12% pa =1% per month
n

FVn5 =A{

(1+k ) 1
}
k
60

FVn5 = 10,000{

(1+0.01) 1
}
0.01

FVn5 = Ksh 816,696.6986

14

10

15

PV of the entire fee at n10 = ?

N = 3 *5 = 15 periods
Rate = 12%/3 = 4% per semester
Annuity A = Ksh 600,000
PVn10 = {

1(1+ k)n
}A
k

PVn10 = {

1(1+0.04 )15
}600,000
0.04

PVn10 = 6,671,032.459

The FV of the amount accumulated the past 5 years = Ksh 816,696.6986

n
So the FV of sum already accumulated at n10 = (1+k )

= 816,696.6986(1.01)60
= Ksh 1,483,690.196
Balanace at n10 : Total fee due= 6,671,032.459
Amount accumulated at n10= Ksh 1,483,690.196
Balanace at n10 = (6,671,032.459- 1,483,690.196)
Ksh 5,187,342.263

Let the additional contribution be C

Annuity from n5-n10 = (10,000+C)
FVAn10 = A{

(1+k )n1
}
k
60

(1+0.01) 1
5,187,342.263 = (10,000 +C){
}
0.01
5,187,342.263 = (10,000 +C){81.66966986}
63,516.141 = Ksh (10,000 +C)
C = Ksh 53,516.141
15

QUESTION 18
Solution

45

60

75

15

30

Average rate of return = (0.5*7) + (0.5*13)

k

= 10%

a) Between 60th -75th years;

Terminal amount = 1 million
Annuity C = Ksh 500,000
K = 10%
n = 15 years
1(1+ k)n
PVAage 60 = C {
}
k
1(1+0.1)15
PVA = 500,000 {
}
0.1
PVAage 60 = Ksh 3,803,039.753

PVage 60 of terminal value 1 million

n
PVage 60 = C (1+k )
15
PV = 1 (1+0.1)

= Ksh 239,392.04

16

Total PVage 60 = Ksh 4,042,431.75

b)
Amount at T15 = Ksh 4,042,431.75

Balance in bank at T0 = Ksh 600,000.00

n
FV of 600,000 at T15 = A ( (1+k )
15
= 600,000 ( (1+0.1)

= Ksh 2,506,348.90
Amount due from annuities = Ksh (4,042,431.75 -2,506,348.90)
= Ksh 1,536,082.85
n

FVAT15= A{

(1+k ) 1
}
k
15

1,536,082.85 = A{

(1+0.1) 1
}
0.1

1,536,082.85 = A(31.77248169)
A = Ksh 48,346.3289

c)
Donation

200,000

200,000

200,000

age

72

73

74

FVA = A{

(1+k )n1
}*(1+k)
k

A = Ksh 200,000
K =10%
n = 3 years
17

75

FVAage 75 = 200,000{

(1+0.1) 1
}*(1+0.1)
0.1

FVA age 75 = Ksh 728,200.00

n
Discounting to T15 (age 60) = C (1+k )

728,200.00

(1+0.1)15

= Ksh 174,325.29

d)

Salary = Ksh 400,000

Salary growth = 12%
Discount rate = 8%
Age

18

Amount

Growth

Rate

46

400,000

1.12

1.08

47

448,000.00

1.12

1.08

48

501,760.00

1.12

1.08

49

561,971.20

1.12

1.08

50

5 629,407.74

1.12

1.08

51

6 704,936.67

1.12

1.08

52

7 789,529.07

1.12

1.08

53

8 884,272.56

1.12

1.08

54

9 990,385.27

1.12

1.08

55
56

1,109,231.5
10 0
11

1.12
1.12

1.08
1.08

PVIF
0.9259259
26
0.8573388
2
0.7938322
41
0.7350298
53
0.6805831
97
0.6301696
27
0.5834903
95
0.5402688
85
0.5002489
67

PV
370,370.37
384,087.79
398,313.27
413,065.61
428,364.33
444,229.68
460,682.63
477,744.95
495,439.21

0.4631934
88 513,788.81
0.4288828

1,242,339.2
8
57

1,391,420.0
12 0

1.12

1.08

0.3971137
59 552,552.02

58

1,558,390.4
13 0

1.12

1.08

0.3676979
25 573,016.91

59

1,745,397.2
14 4

1.12

1.08

0.3404610
41 594,239.76

60

1,954,844.9
15 1

1.12

1.08

0.3152417
05 616,248.64

14,911,88
6

PV = Ksh

19

59 532,818.02

7,254,962.02

7,254,962.
02