Question

QUESTION 4 (UNIT 2)
a) Why does money have a time value? Does inflation have anything to do with making a ringgit today worth more than a ringgit tomorrow?

b) Discuss the present value of an annuity due with an example.

c) If your parents deposited RM15,000 into an account for you when you were born as part of a college savings fund and that count is earning 10% annually, how much will you have in your college savings fund on your 18th birthday?

BBF302/05 FINANCIAL MANAGEMENT AND ANALYSIS
JULY 2020
ASSIGNMENT 1
Page 5 of 5
d) You have a long-term goal of paying off your school loans in five years. You will graduate with a loan debt of RM20,000 and an interest rate of 6%. How much will you need to pay each month to have the debt paid off in five years?

e) Christina plans to contribute RM1,200 a year to her niece’s college education. Her niece will graduate from high school in 10 years. If the interest rate is 6%, how much money does Christina need to save for her by the time she graduates from high school?

-

Answer 1

a. Money has a value which will change over time. This is because of the existence of interest factor. And because of this, money received today is worth more than money received in the future. The factors influence the time value of money are interest and inflation. If the inflation increases in the future, the value of money in the future will be low when compared to the value of money now.

b. Annuity is a constant cash flow for a no: of years. Where there is a constant cash flow from year to year, we can calculate the present value by adding together the discount factors for the individual years (Annuity Factor)

- PV of annuity = constant annual cash flow × Annuity Factor

For example if you are receiving $5000 for the next 10 years at a rate of 10%, its PV will be 5000 x 6.145 = $30725.

- PV of 5 year annuity starting from 3^rd year = Constant annual cashflow x (7^th year Annuity Factor x 2^nd year Annuity Factor)

- Annuity can be normal, delayed or in advance

· If the annuity were expected to continue forever, it is known as a perpetuity. . Perpetuity is a constant annual cash flow that will last forever (infinity)

- P =      1r      or      1r-g

- P starting from 3^rd year = 1 / r x 2^nd year DF

c. FV = PV (1+r)^n

= 15000 (1+0.1)^18 = 83398

d. An equated monthly installment (EMI) is a fixed payment amount made by a borrower to a lender at a specified date each calendar month. Equated monthly installments are used to pay off both interest and principal each month so that over a specified number of years, the loan is paid off in full.

The EMI is calculated by adding together the principal loan amount and the interest on the principal and dividing the result by the number of periods multiplied by the number of months.

The Loan amount is $20,000, which is the principal loan amount, at an interest rate of 36% for 5 years. The investor’s EMI using the flat-rate method is calculated to be $361 or ($20,000 + ($20,000 x 5 x 0.06) / (6 x 12).

Assume that the EMI reducing-balance method was used instead of the EMI fixed-rate method in the previous calculation. The EMI would be calculated as follows: (($20,000 x (0.06)) x (1 + (0.06 / 12))60;) / (12 x (1 + (0.06/12))60; - 1). The EMI reducing-balance method is more cost-friendly to borrowers.