Solutions Manual

to accompany

Introducing
Corporate Finance 2e
Diana Beal, Michelle Goyen
Abul Shamsuddin

Prepared by

Diana Beal

© John Wiley & Sons Australia, Ltd 2008

Chapter Four: Financial Mathematics

Questions

4.1 Explain in your own words why an expected $100 Christmas present is
worth less to you in January of the same calendar year than an expected
$100 April birthday present.

The April birthday present is received earlier and thus can be invested to earn a return
eight months before the Christmas present is received. Therefore, it is worth more
than the Christmas present.

4.2 Georgi buys a new utility with which to make deliveries in his business.
The ute costs $22 000. Georgi’s bookkeeper charges $4500 depreciation
for the use of the ute for the year, so that its written down value at the end
of the year is $17 500. Which of these figures is/are cash flow(s)?

The payment of $22 000 only.

4.3 Rigo sells some land which is no longer integral to his business’s
expansion plans. The sale price is $220  000; the transaction costs are
$6000; the land cost $100 000 and Rigo’s capital gain is $114 000. Which
of these values are cash flows?

Sales price and transaction costs now and the cost price previously.

4.4. A2Z Banking Co. advertises that it pays 0.5% higher than cash rate on all
savings accounts with the interest paid 3-monthly on lowest balance. Does
this specification describe simple interest? How could a bank pay more
than cash rate and still make a profit?

Yes, it is paid on a single amount for a set period. Paying on lowest balance over a
lengthy period means a large amount of funds are retained by the bank interest-free
when account balances fluctuate, so it can pay a higher interest rate on the low
balances and still be profitable.

4.5 Sunni borrows $2000 from his mate Greg for one year at 5% p.a.
compounding annually. Is the interest payable more or less (or the same)
as 5% simple interest?

The compound interest here is the same as simple interest because there is only one
compounding period.

© John Wiley and Sons Australia, Ltd 2008 4.1

Introducing Corporate Finance 2e Solutions Manual

4.6 Yield in relation to a commercial bill is a percentage of what dollar

amount?

The amount actually paid by the lender initially.

4.7 A discount in relation to a commercial bill is a percentage of what dollar

amount?

The face value of the bill.

4.8 How many days are assumed to be in a year for the calculation values of
commercial bills?

365 days

4.9 How many days are assumed to be in leap years for the calculation of
values of commercial bills?

365 days unless the loan period includes 29 February.

4.10 Jill has $1000 saved and can invest it at 5% p.a. simple interest or
compounding monthly? Which deal will give her more funds at the end of
12 months?

Compounding monthly, because she is earning interest on interest.

4.11 The present value (PV) of $20 000 received in two years’ time is always
more than the PV of the same sum received in four years’ time, assuming
each will be received with 100% certainty. Is this true? Why?

True, because the longer period involves a higher discount rate. Put another way, a
smaller sum is necessary now to grow to a given future sum in four years than is
necessary now to grow to the same future sum in two years.

4.12 Explain the difference between nominal and effective rates of interest.

A nominal periodic rate of interest does not reflect compounding during the period,
whereas an effective annual rate does.

4.13 An annuity is a series of … payments received at the … of several …-

length periods. Fill in the blanks.

equal; end; equal

© John Wiley and Sons Australia, Ltd 2008 4.2

 Chapter Four: Financial Mathematics

4.14 The payments in an annuity-due occurs when in each of the equal-length

periods?

At the start.

4.15 Fung is thinking of buying either an annuity or an annuity due for a

retirement income stream. How could she structure her finances so that
an annuity becomes effectively an annuity due?

Keep the first payment in hand and start the annuity payments at the end of the first
period.

4.16 Assume you have been given a monthly annuity due that is deferred for
six months. How many months must elapse before you receive the first
payment?

Seven.

4.17 Give an example of perpetuity.

A 10% $1 preference share yields 10 cents / share / annum in perpetuity.

4.18 Are coupons and bond yields the same thing?

No. Coupons are the interest rate payable on the bond, i.e. 8% p.a. paid semi-annually.
Yield also includes any capital gain or loss.

4.19 As the stockmarket falls, bonds normally become more attractive and
investors rush to buy bonds. What happens to bond prices and to bond
yields?

Investors rushing to buy bonds will bid the prices up and, as coupons are normally
fixed, yields will fall.

4.20 Explain to your friend the value of using time lines to help solve cash flow
problems.

The use of time lines allows a clear pictorial statement of when cash flows are
receivable or payable. They help analyse, decide on methodology and solve each
problem.

© John Wiley and Sons Australia, Ltd 2008 4.3

Introducing Corporate Finance 2e Solutions Manual

Financial Problems

4.1 Sue Chee’s Fruit and Veges arranges for finance using a 6.5% p.a.
$50 000 commercial bill for 90 days. How much does she receive?

Using equation 3.3

FS
P
(1  in)
50,000
P 50,000
 90  = = $49211.27
 1  0 .065   1.0016027
 365 

4.2 If Sue Chee’s bill were for 180 days, how much would she receive?

$50 000 / 1.03205 = $48 447.04

4.3 Frank’s Fishing Co. contracts with a bank to sell a $100  000 180-day
commercial bill with a 10% yield. How much will Frank receive?

$95 300.26

4.4 Dim Sum Ltd buys a 90-day $100  000 bill at 6% yield? How much will
Dim Sum pay?

$98 542.12

4.5 Jane’s advisor offers her a chance to fund a commercial bill by her
adviser. The bill is for $50 000, 183 days at 8%. How much must Jane
invest?

$48 071.86

4.6 David’s Hardware is offered 180-day $100  000 bill finance yielding
$93 000. What is the yield?

15.25%

4.7 Judy’s Consulting Services looks for high-yield investments. She is offered
this deal $100 000 commercial bill, 90 days, $96 500 to pay. What is the
yield?

14.71%

© John Wiley and Sons Australia, Ltd 2008 4.4

 Chapter Four: Financial Mathematics

4.8 Aquila Investments offers a borrower a $50  000 180-day bill for $48 000.
What is the yield?

8.45%

4.9 Don Ltd bought a $100 000 commercial bill in the secondary market with
100 days to maturity. It was discounted at 8%. How much did the
company pay?

Using equation 3.4

SP  FS (1  in)
 100 
SP  100 000(1   0.08  )
 365 
SP = $100 000 (1 – 0.021918) = $97 808.22

4.10 A 180-day $100 000 bill was sold for $93 000. What was the discount rate?

14.19%

4.11 Joe bought a $100 000 90-day bill for $96 500. What was the discount
rate?

14.19%

4.12 A $50 000 180-day bill was discounted at 8% and sold to Ngai. How much
did she pay?

$48 027.39

4.13 Jean invested her lottery prize of $80  000 in a fund that pays 6% pa. How
much will she have at the end of 8 years?

Using equation 3.5

FVn  PV (1  k ) n
= $80 000 (1.06)8
= $127 507.84

4.14 Jean invested her lottery prize of $80  000 in a fund that pays 6% pa,
compounded monthly. How much will she have at the end of 8 years?

$80 000 (1.005)96 = $129 131.42

© John Wiley and Sons Australia, Ltd 2008 4.5

Introducing Corporate Finance 2e Solutions Manual

4.15 Agricola Ltd extends ‘interest-free’ terms to customers. It has made sales
which will bring in $100 000 at the end of 2 years. How much is the
$100 000 worth now if money can earn 6% p.a. compounded monthly?

100 000/ (1.005)24 = $88 718.57

4.16 Agrico has contracted an interest-only loan. It must repay the principal of
$500 000 in 6 years’ time. How much must it invest at the end of the year
to have exactly $500 000 put aside if funds earn 6%?

Using equation 3.9 FVA n  C 

 
 1  k  n  1 

 k 
FVA n
C
Then [(1  k ) n  1]
k
= 500 000 / 6.97532
= $71 681.31

4.17 If Sootico borrowed $500 000 now at 6% compounding monthly, how

much must it repay monthly to pay off the loan in 6 years?

Using equation 3.8

 
 1  1  k   n 
PVA n  C  
 k 
PVA n
C
[1  (1  k )  n ]
k
= 500 000 / 60.33951
= $8286.44

4.18 A 7% coupon $10 000 bond with semi-annual payments has seven

payments to maturity. (The latest payment was received yesterday.) What
is its price if it yields 5.2%?

Bond pays $700 p.a. or $350 twice/year

PV of coupons = 350 (6.32529) = $2 213.85
PV of face value = 10 000 / 1.0267 = $8355.42
Price = $10 569.27

4.19 Sam Lee is saving for his retirement. He invests a regular $1000 per
month for 20 years and earns 8% p.a. on his investment. How much does
he have on his retirement?

Using equation 3.9

© John Wiley and Sons Australia, Ltd 2008 4.6

 Chapter Four: Financial Mathematics

 
 1  k  n  1 
FVA n  C  
 k 

FVAn  100
 
 1.006667  240  1 

 0.006667 
= $589 578

4.20 Sam says he will live for 18 years after he retires. He intends to spend all
of his nest egg of $590 000 through monthly payments from his pension
fund. He budgets on the fund earning 5% p.a. How much can he draw
each month?

PVA n
C
[1  (1  k )  n ]
k
590,000
C
[1  (1.0041667)  216 ]
0.0041667
= 590 000 / 142.24022
= $4147.90

4.21 Here are some details of $100 000 high-risk bonds. Calculate the current
price in each case.

* an interest payment is due on this day

4.22 A $100 000 8% bond with 6 years to maturity is sold for $93  970. What is
its yield, if interest is paid 6-monthly?

9.5%

4.23 A $50 000 9% (6-monthly interest) bond is purchased by a dealer for

$51 880. If it has 3 years to maturity, what is its yield?

7.7%

© John Wiley and Sons Australia, Ltd 2008 4.7

Introducing Corporate Finance 2e Solutions Manual

4.24 Sam is negotiating to purchase an annuity of $50  000 p.a. for 10 years.
Funds currently earn 6% p.a. To sweeten the deal, the supplier offers
(a) to make it an annuity due (with 10 payments in total) or (b)  to add an
extra payment of $10 000 to be paid immediately. Which is the better deal
for Sam, if the price remains the same?

(a) 9 payment annuity + $50 000. Price = $390 084.61

(b) 10 payment annuity + $10 000 Price = $378 004.35
If the price is the same, (a) is the better deal.

4.25 Jo is offered a $3000 monthly pension for 15 years with the first payment
deferred 24 months. What is the correct price of the pension now if funds
earn 8% pa?

$269 072.30

© John Wiley and Sons Australia, Ltd 2008 4.8