CORPFIN 7005 - Principles of Finance (M)
Topic 2: The time value of money
1. Why is a dollar today worth more than a dollar 1 year from now?
2. What is the difference between the interest rate (i) and the growth rate (g) in the future
value equation?
3. Your birthday is coming up, and instead of any presents, your parents promised to give
you $3000 in cash. Since you have a part time job and, thus, don’t need the cash
immediately, you decide to invest the money in a bank term deposit that pays 8 per cent
compounding quarterly for the next 2 years. How much money can you expect to gain in
this period of time?
4. You want to buy some zero coupon bonds that have a value of $1000 at the end of 3 years.
The bonds are said to pay 4 per cent interest per annum. How much should you pay for
them today?
5. You invest $150 in an investment fund today that pays 9 per cent interest per annum. How
long will it take to double your money?
6. Infosys Technologies Ltd, an Indian technology company, reported a profit of $419
million this year. Analysts expect the company’s earnings to be $1.468 billion in 5 years.
What is the expected growth rate in the company’s earnings?
7. You have $2500 you want to invest in your classmate’s start-up business. You believe
the business idea to be great and hope to get $3700 back at the end of 3 years. If all goes
according to the plan, what will be your return on investment?
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CORPFIN 7005 - Principles of Finance (M)
8. When you were born your parents set up a bank account in your name with an initial
investment of $5000. You are turning 21 in a few days and will have access to all your
funds. The account was earning 7.3 per cent for the first 7 years, and then the rates went
down to 5.5 per cent for 6 years. The economy then did well and your account was earning
8.2 per cent for 3 years in a row. Unfortunately, the next 2 years you only earned 4.6 per
cent. Finally, as the economy recovered, your return jumped to 7.6 per cent for the last 3
years.
a. How much money was in your account before the rates went down drastically (end
of year 16)?
b. How much money is in your account now, end of year 21?
c. What would be the balance now if your parents made another deposit of $1200 at
the end of year 7?
9. Luke Wilkshire and his agent are evaluating three contract options to return to play in the
A-League after a successful career with Dutch Ereduvusue team, Feyenoord. Each option
offers a signing bonus and a series of payments over the life of the contract. Wilkshire
uses a 10 per cent rate of return to evaluate the contracts. Given the cash flows for each
option, which one should he choose?
Year Cash Flow Type Option A Option B Option C
0 Signing Bonus $1,000,000 $1,200,000 $500,000
1 Annual Salary $700,000 $700,000 $700,000
2 Annual Salary $750,000 $700,000 $700,000
3 Annual Salary $800,000 $700,000 $700,000
4 Annual Salary $850,000 $700,000 $1,600,000
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CORPFIN 7005 - Principles of Finance (M)
10. Jimmal Bolts Ltd reported sales of $2.1 million last year. The company’s primary
business line is manufacturing nuts and bolts. Since this is a mature industry, the analysts
are certain that the sales will grow at a steady rate of 7 per cent a year for as far as they
can tell. The company reports profit that represents 23 percent of sales. The management
would like to buy a new fleet of trucks but can only do so once the profit reaches $620,000
a year. At the end of what year will Jimmal Bolts Ltd be able to buy the new fleet of
trucks? What will the sales and profit be that year?
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