UNIT 2

HOW TO CALCULATE PRESENT VALUES

PROBLEM SET

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

1 SOLVED PROBLEMS
1. You have just taken out a five-year loan from a bank to buy an engagement
ring. The ring costs 5.000€. You plan to put down 1.000€ and borrow 4.000€. You
will need to make annual payments of 1.000€ at the end of each year.
a) Show the timeline of the loan from your perspective.
b) How would the timeline differ if you created it from the bank’s perspective?

Solution:

a) From my perspective:

b) From bank’s perspective:

2. Calculate the future value of 2.000€ in:

a) Five years at an interest rate of 5% per year.

b) Ten years at an interest rate of 5% per year.

c) Five years at an interest rate of 10% per year.

d) Why is the amount of interest earned in part (a) less than half the amount of interest
earned in part (b)?

Solution:

2
To solve this problem we need the future value formula:

FV n=C 0 x (1+r )n
a) r= 5%, n=5 years

FV n=C 0 x (1+r )n=2.000∗1,05⁵=2.552,56 €

b) r= 5%, n=10 years
n 10
FV n=C 0 x (1+r ) =2.000∗1,05 =3.257,79 €
c) r= 10%, n=5 years

FV n=C 0 x (1+r )n=2.000∗1,15=3.221,02 €

d) Learning Objective 2: Compound interest.

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

USING LIBREOFFICE CALC: CALCULATING FUTURE VALUE

We can calculate the future value of a single Cash Flow with two methods:

a) Using Calc as a calculator. Formula at B7= B3*(1+B5)^B4

b) Using FV function. This function has five arguments.

Argument Help
RATE The rate of interest for period
NPER Total number of periods
PMT We must use it for a stream of constant cash-flows.
C1=C2...=Cn=C
PV It is the C0 cash-flow. The single cash-flow that we want to
calculate the future value.
Type 0 for Ordinary Annuity-1 for Annuity Due

FV function returns a negative value always. So, it depends of what side we are analysing the
problem, it could be needed to change the sign of the calculation.

3. What is the present value of 10.000€ received

a) Twelve years from today when the interest rate is 4% per year?

b) Twenty years from today when the interest rate is 8% per year?

c) Six years from today when the interest rate is 2% per year?

Solution:

We use the Present Value Formula to solve this problem:

Cn
PV =
(1+r )n
3
a) r = 4%, n= 12

Cn 10.000
PV = n
= =6.245,97 €
(1+r ) 1,04 12

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

b) r = 8%, n= 20

Cn 10.000
PV = n
= =2.145,48 €
(1+r ) 1,08 20
c) r = 2%, n= 6

Cn 10.000
PV = n
= 6
=8.899,96 €
(1+r ) 1,02

USING LIBREOFFICE CALC: CALCULATING PRESENT VALUE

We can calculate the present value of a single Cash Flow with two methods:

a) Using Calc as a calculator. Formula at B7=B3/(1+B5)^B4

b) Using PV function. This function has five arguments.

Argument Help
RATE The rate of interest for period
NPER Total number of periods
PMT We must use it for a stream of constant cash-flows.
C1=C2...=Cn=C
FV It is the Cn cash-flow. The single cash-flow that we want to
calculate the present value.
Type 0 for Ordinary Annuity-1 for Annuity Due

4. Your brother has offered to give you either 5.000€ today or 10.000€ in 10 years.
If the interest rate is 7% per year, which option is preferable?

Solution:

2
a) Calculate the future value of 5.000€ with n= 10 and r= 7%.

FV =5.000∗1,0710=9.835,76 €
Since the future value is smaller than 10.000€. It is better if you wait.

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

3
b) Calculate the present value of 10.000 with n= 10 and r=7%.

10.000
PV = =5.083,49 €
1,0710
The conclusion is the same, the present value of 10.000€ at r=7% is higher than
5.000€ today.

5. Consider the following alternatives:

i. 100€ received in one year

ii. 200€ received in five years

iii. 300€ received in ten years

a) Rank the alternatives from most valuable to least valuable if the interest rate is 10%
per year.

b) What is your ranking if the interest rate is only 5% per year?

c) What is your ranking if the interest rate is 20% per year?

Solution:

3
a) r=10%

200 300 100

PV = =124,18 € ; PV = =115,66 € ; PV = =90,91 €
1,1
5
1,1
10
1,1
b) r=5%

300 200 100

PV = =184,17 € ; PV = =156,71 € ; PV = =95,24 €
1,05 10 1,05 5
1,05
c) r=20%

200 100 300

PV = =80,38 € ; PV = =83,33 € ; PV = 10 =48,45 €
1,2 5
1,2 1,2
6. Your daughter is currently eight years old. You anticipate that she will be going
to college in 10 years. You would like to have 100.000€ in a savings account to
fund her education at that time. If the account promises to pay a fixed interest
rate of 3% per year, how much money do you need to put into the account today
to ensure that you will have 100.000€ in 10 years?
Solution:

3
100.000
PV = 10
=74.409,39 € , You need to put into the account 74.409,39 € today.
1,03

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

7. You are thinking of retiring. Your retirement plan will pay you either 250.000€
immediately on retirement or 350.000€ five years after the date of your
retirement. Which alternative should you choose if the interest rate is

a) 0% per year?

b) 8% per year?

c) 20% per year?

Solution:

2
a) r=0%, n=5
5
FV =250.000∗1,00 =250.000 € <350.000 ,You would decide wait 5 years.
b) r=8%, n=5
5
FV =250.000∗1,08 =367.332,02 € >350.000 , you would be better with
250.000 today.

c) r=20%, n=5
5
FV =250.000∗1,2 =622.080,00 € € > 350.000 , you would be better with
250.000 today.

8. Your grandfather put some money in an account for you on the day you were
born. You are now 18 years old and are allowed to withdraw the money for the
first time. The account currently has 3.996€ in it and pays an 8% annual interest
rate.
a) How much money did your grandfather originally put in the account?

b) How much money would be in the account if you left the money there until your 25th
birthday?

Solution:

a) r=8%, n=18

3
3.996
PV = =1.000,00 €
1,08 18
b) r=8%, n=7

2
7
FV =3.996∗1,08 =6.848,44 €

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

9. Suppose you receive 100€ at the end of each year for the next three years.
a) If the interest rate is 8% annual, what is the present value of these cash flows?

b) If the interest rate is 8% annual, what is the future value of these cash flows?

Solution:

a) r=8%, n= 3

5
PV annuity =C∗
[ 1
−
1
r r ( 1+ r)n
]=100∗
[1
−
1
0,08 0,08(1+ 0,08)3 ]
=257,71 €

Using LibreOffice Calc to solve the problem. Now, the argument PMT is B3, that is, the
stream of cash-flows we have to discount. Type: Select 0 for ordinary annuity.

b) r=8%, n= 3

Future Value Annuity=C x [ (1+r )n−1

r ]=100 x [
(1+0,08)3−1
0,08 ]
=324,64 €

Using LibreOffice Calc to solve the problem. Now, the argument PMT is B3, that is, the
stream of cash-flows we have to compound. Type: Select 0 for ordinary annuity.

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

10. Suppose you receive 500€ at the beginning of each year for the next four
years.
a) If the interest rate is 5% annual, what is the present value of these cash flows?

b) If the interest rate is 5% annual, what is the future value of these cash flows?

Solution:

a) r=5%, n= 4

PV annuity DUE=C∗
[ 1
−
1
r r (1+ r)n ]
∗(1+r )=

=500∗
[ 1
−
1
0,05 0,05(1+0,05)4 ]
∗(1+,05)=1.861,62 €

Using Calc to solve. Type: Select 1 for annuity due.

b) r=5%, n= 4

Future Value Annuity DUE=C x

(1+r )n−1
r [
x (1+ r)=]
=500 x [ (1+ 0,05)4−1
0,05 ]x(1+ 0,05)=2.262,82 €

Using Calc to solve. Type: Select 1 for annuity due.

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

11. Find the future value of an investment of 100.000€ made today for five years,
paying 8,75% for the following compounding periods:

a) Quarterly

b) Monthly

c) Daily

Solution:

2
a) r=8,75%/4=2,19%, m=4, n= 5x4=20

FV =100.000∗1,021920=154.154,24 €
Using Open Cal to solve the problem:

b) r=8,75%/12=0,73%, m=12, n= 5x12=60

FV =100.000∗1,0072916760≅154.637,37 €
Using Open Cal to solve the problem:

c) r=8,75%/365=0,023972603%, m=365, n= 5x365=1825

FV =100.000∗1,000239726031825 ≅154.874,91 €
Using Open Cal to solve the problem:

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

12. Suppose you receive 10.000€ at the end of quarter for the next 10 years.
a) If the interest rate is 8% annual, what is the present value of these cash flows?

b) If the interest rate is 8% annual, what is the future value of these cash flows?

c) Same than (a) but at the beginning of each quarter.

d) Same than (b) but at the beginning of each quarter.

Solution:

a) r=8% annual, n= 10, m= 4  r quarterly= 8%4=2%. Total Periods = 10*4= 40

7
PV =10.000∗
[ 1
−
1
0,02 0,02(1+0,02)40 ]
=273.554,79 €

Using Calc to solve the problem. Compounded: Select 4 in the list. Type: Select 0.

b) r=8% annual, n= 10, m= 4  r quarterly= 8%4=2%. Total Periods = 10*4= 40

FV =10.000 x [
(1+ 0,02)40 −1
0,02 ]
=604.019,83 €

Using Calc to solve the problem. Compounded: Select 4 in the list. Type: Select 0.

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

c) r=8% annual, n= 10, m= 4  r quarterly= 8%4=2%. Total Periods = 10*4= 40

7
PV =10.000∗
[ 1
−
1
0,02 0,02(1+0,02)40 ]
∗1,02=279.025,89 €

Using Calc to solve the problem. Compounded: Select 4 in the list. Type: Select 1.

d) r=8% annual, n= 10, m= 4  r quarterly= 8%4=2%. Total Periods = 10*4= 40

FV =10.000 x [
(1+ 0,02)40 −1
0,02 ]
∗1,02=616.100,23 €

Using Calc to solve the problem. Compounded: Select 4 in the list. Type: Select 1

13. The British government has a consol bond outstanding paying £100 per year
forever. Assume the current interest rate is 4% per year.
a) What is the value of the bond immediately after a payment is made?

b) What is the value of the bond immediately before a payment is made?

Solution:

a) r=4%, n=∞

8
C 100
PV ordinary = = =£ 2.500
r 0,04

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

b) r=4%, n=∞

C 100
PV due=C + =100+ =£ 2.600
r 0,04

14. Today’s value of a consol bond is 3.500€ if the payment is 150€ per year. What
is the interest rate?

Solution:

C C 150
PV = →r= = =0,04285=4,285 %
r PV 3.500
15. You are evaluating a growing perpetuity product from a large financial
services firm. The product promises an initial payment of 20.000€ at the end of
this year and subsequent payments will thereafter grow at a rate of 3,4 per cent
annually. If you use a 9 per cent discount rate for investment products, what is the
present value of this growing perpetuity?

Solution:

C 20.000
PV = = =357.142,85 €
r−g 0,09−0,034
9

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

16. You have been offered a unique investment opportunity. If you invest 10.000€
today, you will receive 500€ one year from now, 1.500€ two years from now, and
10.000€ three years from now.
a) What is the NPV of the opportunity if the interest rate is 8% per year? Should you
take the opportunity?

b) What is the NPV of the opportunity if the interest rate is 2% per year? Should you
take it now?

Solution:
n
Ct
NPV =−C 0 + ∑
t=1 (1+r )t
10
a)

500 1.500 10.000

=−10.000+ + + =−312,71 €
1,08 1,08² 1,083
The NPV is negative, so you will not accept this investment opportunity.

= B4 + NPV(B3;B5:B7)

Open Calc also has a built-in NPV function. This function has the format NPV(rate, value1,
value2, . . . ), where “rate” is the interest rate per period used to discount the cash flows,
and “value1”, “value2”, and so on are the cash flows (or ranges of cash flows).
Unfortunately, however, the NPV function computes the present value of the cash
flows assuming the first cash flow occurs at date 1. Therefore, if a project’s first cash
flow occurs at date 0, we must add it separately. For example, in the spreadsheet above, we
would need the formula = B4 + NPV(B3;B5:B7)

You must insert the value at B4 as a negative number.

b)

500 1.500 10.000

=−10.000+ + + =1.355,17 €
1,02 1,02² 1,023
With a interest rate of 2%, the investment is worth for you. You’ll take the opportunity.

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

17. You have just received a windfall from an investment you made in a friend’s
business. He will be paying you 10.000 at the end of this year, 20.000 at the end of
the following year, and 30.000 at the end of the year after that (three years from
today). The interest rate is 3,5% per year. What is the present value of your
windfall?
Solution:
n
Ct 10.000 20.000 30.000
PV =∑ t
= + + =55.390,33 €
t=1 (1+r ) 1,035 1,035² 1,0353

Using Open Calc to solve the problem. We only need to indicate that C0 is 0

10

18. Marian Plunket owns her own business and is considering an investment. If
she undertakes the investment, it will pay 4.000€ at the end of each of the next
three years. The opportunity requires an initial investment of 1.000€ plus an
additional investment at the end of the second year of 5.000€. What is the NPV of
this opportunity if the interest rate is 2% per year? Should Marian take it?
Solution:

10
4.000 4.000−5.000 4.000
=−1000+ + + =5.729,69 €
1,02 1,02² 1,023
Using Open Calc:

You must indicate C0 and C2 as negative Cash-flows.

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

19. You have an investment opportunity that requires an initial investment of

5.000€ today and will pay 6.000€ in one year. What is the IRR of this opportunity?
Solution:

FV FV 1
6.000 1
PV =
(1+r )n
→r =
PV ( ) n
−1 , r= ( 5.000) −1=0,2=20,00 %

11

20. Claude and Pauline Desmarais are getting ready to buy their first house. To
help make the down payment, Claude's aunt offers to loan them 15.000€, which
can be repaid in 10 years. If Claude and Pauline borrow the money, they will have
to repay Claude's aunt the amount of 23.750€. What rate of interest would Claude
and Pauline be paying on the 10-year loan?
Solution:
1
23.750
r= ( 15.000 ) 10
−1=0,047=4,70 %

11

21. Suppose you want to have in four years from now 2.300€ in your account. If
you deposit 500€ at the end of each year for the next four years. What interest
rate should offer your bank to obtain this amount?
Solution:

Future Value Annuity=C x

(1+r )n−1
r [ ] , 2.300=500 x[ r ]
(1+r )4 −1
→r =9,40 %

You DO NOT have to solve this equation in the final test (exam).

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

12

22. You are shopping for a car and read the following advertisement in the
newspaper: “Own a new Spitfire! No money down. Four annual payments of just
10.000€.” You have shopped around and know that you can buy a Spitfire for cash
for 32.500€. What is the interest rate the dealer is advertising (what is the IRR of
the loan in the advertisement)? Assume that you must make the annual payments
at the end of each year.
Solution:

PV annuity =C∗
[1
−
1
r r (1+ r)n ]
32.500=10.000∗
[ 1
−
1
r r (1+r )4 ]
→r=8,86 %

You DO NOT have to solve this equation in the final test (exam).

12

23. You have just received a bonus of €10.000€ and are looking to deposit the
money in a bank account for five years. You investigate the annual deposit rates of
several banks and collect the following information:

Bank Compounding Frequency Annual Rate

A Annually 5,00%
B Quarterly 5,00%
C Monthly 4,80%
D Daily 4,85%

Which bank should you choose?

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

Solution:

Bank A, r= 5% n= 5

FV =10.000∗(1+0,05)⁵=12.762,82 €
Bank B, r=5% annual, n= 5, m= 4  r quarterly= 5%4=1,25%. Total Periods = 5*4=20
20
FV =10.000∗(1+0,0125) =12.820,37 €
Bank C, r=4,8% annual, n= 5, m= 12  r monthly= 4,8%  12 = 0,4%. Total Periods =
5*12=60
60
FV =10.000∗(1+0,004 ) =12.706,41 €
Bank C, r=4,85% annual, n= 5, m= 365  r Daily= 4,85%  365 = 0,013287671%. Total
Periods = 5*365=1825
1825
FV =10.000∗(1+0,000132877) =12.744,11 €
That Bank B provides the highest value at the end of five years.

13

You can use Sheet 13 to solve this problem.

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

2 SELF-STUDY PROBLEMS
1. A rich relative has bequeathed you a growing perpetuity. The first payment will occur in a
year and will be 1.000€. Each year after that, on the anniversary of the last payment you will
receive a payment that is 8% larger than the last payment. This pattern of payments will go
on forever. If the interest rate is 12% per year,

a) What is today’s value of the bequest?

b) What is the value of the bequest immediately after the first payment is made?

Solution → a= 25.000,00€; b= 26.000,00€

2. Your firm spends 5.000€ every month on printing and mailing costs, sending statements to
customers. If the interest rate is 0,5% per month, what is the present value of eliminating
this cost by sending the statements electronically?

Solution → 1.000.000,00 €

3. You are thinking of purchasing a house. The house costs 350.000€. You have 50.000€ in
cash that you can use as a down payment on the house, but you need to borrow the rest of
the purchase price. The bank is offering a 30-year mortgage that requires annual payments
and has an interest rate of 7% per year. What will your annual payment be if you sign up for
this mortgage?

Solution → 24.175,92 €

4. You have just made an offer on a new home and are seeking a mortgage. You need to
borrow 600.000€.

a) The bank offers a 30-year mortgage with fixed monthly payments and an interest
rate of 0,5% per month. What is the amount of your monthly payment if you take
this loan?

b) Alternatively, you can get a 15-year mortgage with fixed monthly payments and an
interest rate of 0,4% per month. How much would your monthly payments be if you
take this loan instead?

Solution → a= 3.597,30 €; b= 4.682,49 €

5. You are saving for retirement. To live comfortably, you decide you will need to save $2
million by the time you are 65. Today is your 30th birthday, and you decide, starting today
and continuing on every birthday up to and including your 65th birthday, that you will put the
same amount into a savings account. If the interest rate is 5%, how much must you set
aside each year to make sure that you will have 2€ million in the account on your 65th
birthday?

Solution → 28.669,40 €

6. Suppose you invest 2.000€ today and receive 10.000€ in five years. What is the IRR of this
opportunity?

Solution → 37,97%

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UNIT 2: FINANCIAL MANAGEMENT I 2017/18

7. A local bank is running the following advertisement in the newspaper: “For just 1.000€ we
will pay you 100€ forever!” The fine print in the ad says that for a 1.000€ deposit, the bank
will pay 100€ every year in perpetuity, starting one year after the deposit is made. What
interest rate is the bank advertising (what is the IRR of this investment)?

Solution →10%

8. You are considering purchasing a warehouse. The cost to purchase the warehouse is
500.000€. Renting the equivalent space costs 20.000€ per year. If the annual interest rate is
6%, at what rate must rental cost increase each year to make the cost of renting comparable
to purchasing?

Solution →2%

9. Suppose you plan to take a 'graduation vacation' to Asia when you finish university in two
years. If your savings account at the bank pays 6 per cent, how much money do you need to
set aside today to have 8.000€ when you leave for Asia?ç

Solution →7.119,97 €

3 BIBLIOGRAPHY
Principles of Corporate Finance 12th edition. Richard A. Brealey, Stewart C. Myers, Franklin
Allen. Mcgraw-hill.

Fundamentals of Corporate Finance. 2014. Jonathan Berk, Peter Demarzo Jarrad Harford.
Pearson.

Fundamentals of Corporate Finance. 2017. Robert Parrino, David S. Kidwell, Thomas Bates.
Wiley & Sons Inc.

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