1
WEEK 3 - SOLUTIONS
TUTORIAL QUESTIONS
1. KZB 8.1 Problem 6, p.224
(Attempt this problem using your calculator first, then check the result using
Excel.)
Which of the following projects should a company choose if each proposal
costs $5000 and the cost of capital is 10% p.a.?
End-of-year cash flow
Year 1 Year 2 Year 3 Year 4 Year5
Project A $20 000 $10 000 $5 000 $10 000 $20 000
Project B $5 000 $20 000 $20 000 $20 000 $5 000
Answer: Set up a spreadsheet for your calculations. Check your answers using the
inbuilt NPV function.
Excel output. Formula in B11 is =NPV(B9,B3:B7)+B2
A B C
1 Project A Project B
2 0 -50000 -50000
3 1 20000 5000
4 2 10000 20000
5 3 5000 20000
6 4 10000 20000
7 5 20000 5000
8
9 rate 0.1 0.1
10
11 NPV -$548.58 $2,865.55
Project B has the greater NPV of $2866 to the nearest dollar.
2. (Adapted from QMA final exam, June 2000)
Sam, a 20 year old graduate, has just found his first full-time job. An
investment analyst suggests that he should try to have a substantial amount
saved by the time of his planned retirement on his 65th birthday. The analyst
presents a comparison between two savings plans.
Plan A: Sam should invest $5,000 on his 21st birthday then $2,000 on each
birthday up to and including his 31st. No further deposits are made but
the money invested continues to earn interest until his 65th birthday.
Plan B: Sam should make the first deposit of $5,000 on his 31st birthday then
continue to deposit $2,000 per birthday with the last deposit being made
on his 65th birthday.
If the effective annual rate of interest is 7.5% p.a., how much should Sam have in
savings at age 65 under each plan?
2
Answer: Plan A: $451, 302.34 ( Hint: Compound $5000 for 10 periods and add
to FV of an ordinary annuity with ten payments of $2000 to find amount at age 31
then compound this sum for 34 periods.)
Plan B : $343,579.13 (Hint: Find amount at age 65 by compounding $5000 for 34
periods and adding to FV of an annuity with 34 periods.)
3. KZB 2.6 Problem 12, p.50
A piece of land can be purchased by paying $50 000 cash or $20 000 deposit and
two equal payments of $20 000 at the end of 2 years and 4 years respectively. To
pay cash, the buyer would have to withdraw the money from an investment
earning interest at j2 = 8% (i.e. 8% p.a. compounded twice per year). Which
option is better and by how much, in present value terms?
Answer: Cash option better by $1709.88
4. HPW 5.4 Problem 14, p.216
Answer:
1 (1 0.05) 8
1000 * 1000 * 6.463213 6463.21
0.05
5. HPW 5.4 Problem 18, p.216
Answer:
( 60 1)
0.07
1 1
150 150 * 12
150 150 * 49.796588 7619.49
0.07
12
6. HPW 5.4 Problem 20, p.216
Answer:
16
0.08
1 1
600 * 4
600 * 18.639285 11183.57
0.08
4
7. HPW 5.4 Problem 24, p.216
Answer:
31
0.10
1 1
600 * 4
600 600 * 46.0002711 27000.16
0.10
4
8. HPW 5.4 Problem 30, p.217
Answer:
1 (1 r ) n
A R(1 r )
r
r
RA
(1 r )(1 (1 r ) n )
R 31,948.19
