ASSIGNMENT - 1

Financial Theory
(Fall-2017)
Financial Theory Fall-2017 Dr. Muhammad Jamil

Q 1: Answer the following questions and calculate Net Present Value.

i) Uni-Liver Industries has a project with the following projected cash flows:
Initial Cost, Year 0: Rs 240,000
Cash flow year one: Rs 25,000
Cash flow year two: Rs 75,000
Cash flow year three: Rs 150,000
Cash flow year four: Rs 150,000
a. Using a 10% discount rate for this project and the NPV model should this project be
accepted or rejected?
b. Using a 15% discount rate?
c. Using a 20% discount rate?

ii) Campbell Industries has a project with the following projected cash flows:
Initial Cost, Year 0: Rs 468,000
Cash flow year one: Rs 135,000
Cash flow year two: Rs 240,000
Cash flow year three: Rs 185,000
Cash flow year four: Rs 135,000
a. Using an 8% discount rate for this project and the NPV model should this project be
accepted or rejected?
b. Using a 14% discount rate?
c. Using a 20% discount rate?
iii) Sarah wants to give her daughter Rs 25,000 in 8 years to start her own business. How
much should she invest today at an annual interest rate of 8% compounded annually to
have Rs25,000 in 8 years?
a. Rs 12,802.95
b. Rs 13,506.72
c. Rs 13,347.70
d. Rs 13,210.34
e. None of the above

iv) Sadia expects to receive $75,000 from a trust fund in 6 years. What is the current value
of this fund if it is discounted at 9% compounded semiannually?
a. Rs 57,592.18
b. Rs 44,720.05
c. Rs 44,224.79
d. Rs 42,794.31
e. None of the above

v) Mudasar expects to receive Rs 75,000 in 5 years. His opportunity cost is 10%

compounded monthly. What is this sum worth to Bill today?
a. Rs 45,584.14
b. Rs 46,043.49
c. Rs 46,569.10
d. Rs 48,542.09
e. None of the above
vi) Sidra wants to accumulate Rs 57,000 in 8.5 years to purchase a boat. She expects an
annual rate of return of 10.5% compounded quarterly. How much does Mary Sue need
to invest today to meet her goal?

Department of Economics and Finance, Pakistan Institute of Development Economics, Islamabad

Financial Theory Fall-2017 Dr. Muhammad Jamil

a. Rs 23,529.87
b. Rs 23,619.30
c. Rs 23,883.56
d. Rs 24,364.33
e. None of the above
vii) Ali wants to buy a new watch. He estimates that it will take him one year to save the
money and that the watch will cost Rs-2000. At an interest rate of 10%, how much does
Ali need to set aside today to purchase the watch in one year?
viii) Calculate the Net Present Value (NPV) for each of the following projects separately. If
we use an 8% discount rate on these projects are they accepted or rejected? If they use
12% discount rate?
Projects A B C D
Cost Rs 40,000 Rs 250,000 Rs 75,000 Rs 100,000
Cash Flow Year One Rs 10,000 Rs 40,000 Rs 20,000 Rs 30,000
Cash Flow Year Two Rs 10,000 Rs 120,000 Rs 35,000 Rs 30,000
Cash Flow Year Three Rs 10,000 Rs 200,000 Rs 40,000 Rs 30,000
Cash Flow Year Four Rs 10,000 Rs 200,000 Rs 40,000 Rs 20,000
Cash Flow year Five Rs 10,000 Rs 200,000 Rs 35,000 Rs 10,000
Cash Flow Year Six Rs 10,000 Rs 200,000 Rs 20,000 Rs 0
ix) Tayota Industries has four potential projects all with an initial cost of Rs 2,000,000. The
capital budget for the year will only allow Tayota industries to accept one of the four
projects. Given the discount rates and the future cash flows of each project, which
project should they accept?
Cash Flows Project A Project B Project C Project D
Year one Rs 500,000 Rs 600,000 Rs 1,000,000 Rs 300,000
Year two Rs 500,000 Rs 600,000 Rs 800,000 Rs 500,000
Year three Rs 500,000 Rs 600,000 Rs 600,000 Rs 700,000
Year four Rs 500,000 Rs 600,000 Rs 400,000 Rs 900,000
Year five Rs 500,000 Rs 600,000 Rs 200,000 Rs 1,100,000
Discount Rate 6% 9% 15% 22%
x) Pak-Telecom has four potential projects all with an initial cost of Rs 1,500,000. The
capital budget for the year will only allow Pak-Telecom to accept one of the four projects.
Given the discount rates and the future cash flows of each project, which project should
they accept?
Cash Flows Project A Project B Project C Project D
Year one Rs 350,000 Rs 400,000 Rs 700,000 Rs 200,000
Year two Rs 350,000 Rs 400,000 Rs 600,000 Rs 400,000
Year three Rs 350,000 Rs 400,000 Rs 500,000 Rs 600,000
Year four Rs 350,000 Rs 400,000 Rs 400,000 Rs 800,000
Year five Rs 350,000 Rs 400,000 Rs 300,000 Rs 1,000,000
Discount Rate 4% 8% 13% 18%

Department of Economics and Finance, Pakistan Institute of Development Economics, Islamabad

Financial Theory Fall-2017 Dr. Muhammad Jamil

Q 2: Questions Related to Future Value:

i) How much do you need to invest today at 3% to be certain to accumulate a future value
of Rs 100,000 at the end of 10 years?

ii) Sidra has just received a cash gift of Rs-50,000 from his rich uncle. She wants to set it
aside to pay for her daughter Sumbal’s college education. Sumbal will begin college in
10 years and Sidra’s financial advisor says that she can earn 5% interest on an
investment in a special college fund. How much will Sidra have in the fund when Sumbal
begins college?

iii) Kashif has Rs-10,000 that he invests in a safe financial instrument expected to return
3% annually. Umar has Rs-5000 and invests in a more risky venture that is expected to
return 7% annually. Who has more after 20 years? And how much does he/she have in
FV terms?

iv) The Saeed family is worried about their ability to pay fee for their daughter Nimra. Tuition
rates are currently Rs-9,500 per semester at the QAU and have been increasing at a
rate of 5% per semester. Nimra will begin college in 5 years. The Saeed have Rs-9,500
set aside now in a college plan that will earn 6% per year. They recently heard about a
plan to pre-pay tuition at current rates, that is pay Rs-9,500 per year of QAU. Should
they pre-pay Nimra’s first semester now or keep the money invested and pay the tuition
5 years from now? How much are they saving in FV terms with this decision?

v) Mahnoor’s grandparents opened a savings account for her and placed Rs-5000 in the
account. The account pays 3.5% interest. Mahnoor wants to be a singer and she has her
heart set on a new Guitar. The Guitar costs Rs-1500. How much less will the account be
worth in 8 years if she buys the Guitar now versus leaving the account untouched?

vi) Today Kashif purchased an investment grade gold coin for Rs 50,000. He expects the
coin to increase in value at a rate of 12% compounded annually for the next 5 years.
How much will the coin be worth at the end of the fifth year if his expectations are
correct?
a. Rs 89,792.82
b. Rs 6691 1.28
c. Rs 88,117.08
d. Rs 89,542.38
e. None of the above

vii) A client invested Rs 10,000 in an interest-bearing promissory note earning an 11%

annual rate of interest compounded monthly. How much will the note be worth at the end
of 7 years assuming all interest is reinvested at the 11% rate?
a. Rs 13,788.43
b. Rs 20,762.60
c. Rs 21,048.52
d. Rs 21,522.04
e. None of the above

Department of Economics and Finance, Pakistan Institute of Development Economics, Islamabad

Financial Theory Fall-2017 Dr. Muhammad Jamil

viii) Muhammad Akbar purchased Rs 60,000 worth of silver coins 8 years ago. The coins
have appreciated 7.5% compounded annually over the last 8 years. How much are the
coins worth today?
a. Rs 107,008.67
b. Rs 102,829.46
c. Rs 99,719.03
d. Rs 99,542.95
e. None of the above

ix) Determine the future value of a periodic deposit of Rs 6,100 made at the beginning of
each year for 10 years to a mutual fund expected to earn 11.5% compounded annually
during the projection period. Calculate the future value rounded to the nearest dollar.
a. Rs 104,493
b. Rs 116,510
c. Rs 113,040
d. Rs 124,344
e. Rs 39,229

x) Determine the future value of a periodic deposit of Rs 6,100 made at the beginning of
each year for 10 years to a mutual fund expected to earn 11.5% compounded
quarterly during the projection period. Calculate the future value rounded to the
nearest dollar.
a. Rs 447,130
b. Rs 116,510
c. Rs 119,931
d. Rs 107,076
e. Rs 459,985

Department of Economics and Finance, Pakistan Institute of Development Economics, Islamabad

Financial Theory Fall-2017 Dr. Muhammad Jamil

Q 3: Questions Related to Internal Rate of Return (IRR):

i) Project A has an internal rate of return (IRR) of 21 percent. Project B has an IRR of 7
percent. Project C has an IRR of 31 percent. Project D has an IRR of 8% percent. Which
of these would be the BEST project?
a. Project A
b. Project D
c. Project C
d. Project B

ii) What is the IRR (or Yield to Maturity) earned on an investment in a Zero-coupon bond
with a Rs 1,000 face value, a price of Rs 746 and 3 years to maturity?

iii) What is the IRR that has been earned from investing in a coin collection that was
 purchased for Rs 1,200 6 years ago,
 was expanded at the end of the 3rd year at a cost of Rs 400, and
 has just sold for Rs 2,500?
Rs 2500

0 1 2 3 4 5 6
Rs1200 Rs 400

iv) What are the IRRs of the four projects of Tayota Industries which has four potential
projects all with an initial cost of Rs 2,000,000?
Cash Flows Project A Project B Project C Project D
Year one Rs 500,000 Rs 600,000 Rs 1,000,000 Rs 300,000
Year two Rs 500,000 Rs 600,000 Rs 800,000 Rs 500,000
Year three Rs 500,000 Rs 600,000 Rs 600,000 Rs 700,000
Year four Rs 500,000 Rs 600,000 Rs 400,000 Rs 900,000
Year five Rs 500,000 Rs 600,000 Rs 200,000 Rs 1,100,000
Discount Rate 6% 9% 15% 22%

v) Calculate IRRs for four projects of Pak-Telecom which has four potential projects all with
an initial cost of Rs 1,500,000?
Cash Flows Project A Project B Project C Project D
Year one Rs 350,000 Rs 400,000 Rs 700,000 Rs 200,000
Year two Rs 350,000 Rs 400,000 Rs 600,000 Rs 400,000
Year three Rs 350,000 Rs 400,000 Rs 500,000 Rs 600,000
Year four Rs 350,000 Rs 400,000 Rs 400,000 Rs 800,000
Year five Rs 350,000 Rs 400,000 Rs 300,000 Rs 1,000,000
Discount Rate 4% 8% 13% 18%

Department of Economics and Finance, Pakistan Institute of Development Economics, Islamabad

Financial Theory Fall-2017 Dr. Muhammad Jamil

Q 4: Questions related to compounding:

i) How much do you need to invest today at 3% (compounding monthly) to be certain to

accumulate a future value of Rs 100,000 at the end of 10 years?

ii) Sohail bought 10 shares of an aggressive growth mutual fund at Rs 90 per share 7 years
ago. Today he sold all 10 shares for Rs 4,500. What was his average annual compound
rate of return on this investment before tax?
a. 17.46%
b. 19.58%
c. 21.73%
d. 25.85%
e. None of the above

iii) Ali borrowed Rs 800 from his father to purchase a mountain bike. Ali paid back $1200 to
his father at the end of 5 years. What was the average annual compound rate of interest
on John’s loan from his father?
a. 11.5646%
b. 8.4472%
c. 7.7892%
d. 5.1990%
e. None of the above

iv) Kashifa Luni purchased a zero-coupon bond 6.5 years ago for Rs 525. If the bond
matures today and the face value is Rs 1,000, what is the average annual compound
rate of return (calculated semiannually) that Susan realized on her investment?
a. 11.3372%
b. 10.5713%
c. 10.400%
d. 10.163%
e. None of the above

v) A client is to receive Rs 650 per month for 5 years beginning one year from today at the
beginning of the month. What is the present value of all payments (rounded to the
nearest dollar) assuming an annual discount rate of 9%?
a. Rs 33,070
b. Rs 28,943
c. Rs 30,339
d. Rs 31,548
e. Rs 28,728

Department of Economics and Finance, Pakistan Institute of Development Economics, Islamabad

Financial Theory Fall-2017 Dr. Muhammad Jamil

Q 5: Questions related to Mortgage Payments:

i) Sofia recently purchased a house for Rs 350,000. She made a down payment of 20%
and financed the balance over 30 years at 7%. How much is Sofia’s monthly payment?
ii) Akbar made an offered of Rs 370,000 to purchase a house. He made a down payment
of 5% and financed the balance over 15 years at 5.5%. How much is Akbar’s monthly
payment?
iii) Akram expects to receive Rs 5,000 at the end of each of the next 4 years. His
opportunity cost is 14% compounded annually. What is this sum worth to Akram today?
a. Rs 14,568.56
b. Rs 16,608.16
c. Rs 19,568.56
d. Rs 17,165.41
e. None of the above
iv) Sajida wants to withdraw Rs 4,000 at the beginning of each year for the next 7 years.
She expects to earn 10.5% compounded annually on her investment. What lump sum
should Sajida deposit today?
a. Rs 19,157.21
b. Rs 18,667.20
c. Rs 20,627.25
d. Rs 21,168.72
e. None of the above
v) Bushra wants to withdraw Rs 1,200 at the beginning of each month for the next 5 years.
She expects to earn 10% compounded monthly on her investments. What lump sum
should Bushra deposit today?
a. Rs 56,478.44
b. Rs 56,949.10
c. Rs 58,630.51
d. Rs 59,119.10
e. None of the above
vi) Saleem received an inheritance of Rs 200,000. He wants to withdraw equal periodic
payments at the beginning of each month for the next 5 years. He expects to earn 12%
annual interest, compounded monthly on his investments. How much can he receive
each month?
a. Rs 4,404.84
b. Rs 4,448.89
c. Rs 49,537.45
d. Rs 55,481.95
e. None of the above
vii) Imran wants to purchase a fishing camp in 5 years for Rs 60,000. What periodic
payment should he invest at the beginning of each quarter to attain the goal if he can
earn 10.5% annual interest, compounded quarterly on investments?
a. Rs 2,319.42
b. Rs 2,260.09
c. Rs 8,805.91
d. Rs 9,730.53
e. None of the above

Department of Economics and Finance, Pakistan Institute of Development Economics, Islamabad

Financial Theory Fall-2017 Dr. Muhammad Jamil

viii) Tina wants to purchase a home 6 years from now. She anticipates spending Rs
150,00000. To attain this goal, how much should Tine invest at the end of each 6-
month period if she expects to earn a 12% annual compound rate of return,
compounded semiannually, on her investments?

ix) Sidra purchased a car for $ 19,500. She is financing the auto at 11% annual interest
rate, compounded monthly for 3 years. What payment is required at the end of each
month to finance Sidra’s car?
a. $ 606.71
b. $ 638.40
c. $ 632.61
d. $ 684.97
e. None of the above.

x) What is the monthly payment made at the end of each month required to accumulate a
balance of Rs 150,000 in 10 years at an assumed interest rate of 11% compounded
monthly and a beginning savings balance of Rs 2,500?
a. Rs 684.97
b. Rs 691.25
c. Rs 656.81
d. Rs 650.85
e. Rs 712.14

Department of Economics and Finance, Pakistan Institute of Development Economics, Islamabad

Financial Theory Fall-2017 Dr. Muhammad Jamil

Q 6: Miscellineous questions:

i) How much would you need to invest at age 22 to accumulate Rs 1,200,000 at age 65,
assuming you earn a 3% investment return?

ii) Akbar knows that he is going to have to replace his roof soon. If he has the roof replaced
now, it will cost Rs-10,000. He could wait 5 years, but it will then cost him Rs-20,000. At
what rate will these options cost the same. (Hint: This is also known as the break-even
point. Exact calculation up to two decimals is not difficult. If stuck, trial and error will help.

iii) Rizwan is in the market for a new car. He has narrowed his search down to 2 models.
Model A costs Rs-320,000 and Model B costs Rs-280,000. With both cars he plans to
pay cash and own them for 4 years before trading in for a new car. His research
indicates that the trade in value for Model A after 4 years is 60% of the initial purchase
price, while the trade in value for Model B is 45%. The interest rate is 5%. For simplicity
assume that operating and maintenance costs for the models are identical. Which model
is the better decision and how much "cheaper" is it than the alternative?

iv) Dr Tahir is a new homebuyer. Dr Tahir wants to make sure that he incorporates the cost
of maintenance into his decision. He estimates that routine repairs and maintenance on
the home he is considering will be Rs-1,590 in the first year (one year from now). Due to
the increasing age of the home, he expects that maintenance costs will increase 6%
annually. The interest rate is 5%. If he plans to be in the home for 10 years, what is the
present value of all future maintenance? (Note that maintenance costs will change
annually, and starts one year from now and he plans to do the last one before selling his
house.)

v) Ayesha owns a rental property on Main street, but she is considering selling the property
to another real estate investor. In preparation for negotiating a price, Ayesha wants to
know the value of the property. The Net Operating Income (NOI) is the cash flow from
real estate and the Cap Rate is the rate, where NOI is rental revenue less all expenses
except loan servicing. The property has an NOI of Rs-12,000 per year. The local real
estate market has a cap rate of 6%. What is a fair price for the property assuming that
the building's life is 35 years?

vi) Asma has just turned 65 and she has deposited her annual payment of Rs-20,000 into
her retirement account. She made her first such saving deposit into this fund on her 35th
birthday. Asma has also retired and wants to figure out how much money she has in her
retirement account for her retired life. You are Asma's friend who knows finance. How
much is Asma's savings worth today given that the fund has earned an annual return of
5.5%?

vii) You are interested in a new Ford Taurus. After visiting your Ford dealer, doing your
research on the best leases available, you have three options.
a. Purchase the car for cash and receive a Rs-15000 cash rebate from Dealer A. The
price of the car is Rs-150,000.
b. Lease the car from Dealer B. Under this option, you pay the dealer Rs-5,000 now
and Rs-2000 a month for each of the next 36 months (the first Rs-2,000 payment
occurs 1 month from today). After 36 months you may buy the car for Rs-80,000.

Department of Economics and Finance, Pakistan Institute of Development Economics, Islamabad

Financial Theory Fall-2017 Dr. Muhammad Jamil

c. Purchase the car from Dealer C who will lend you the entire purchase price of the car
for a zero interest 36-month loan with monthly payments. The car price is Rs-
150,000. Suppose the market interest rate is 6%.
What is the net cost today of the cheapest option?

viii) If Rs 1000 is paid in the form of ordinary annuity for 5 years then what will be future
value of all these cash payments?

ix) What will be future value of Rs100 after 2 years when compounding is semiannual given
the market rate of interest is 8%.

x) Kashif began setting aside Rs-6,000 per year in a mutual fund at the age of 25. He has
turned 34, and has just made a deposit. The mutual fund has returned 6.5% annually.
How much does Kashif have in his account today?
a. Rs 90955
b. Rs 80967
c. Rs 60000
d. Rs 70967
e. Rs 85350

xi) Shafqat purchased an Oriental rug for Rs 8,000. Today, he sold the rug for Rs 15,000.
Mike determined the average annual compound rate of return on the rug was 12%.
Approximately how many years did Shafqat own the rug? (rounded to the nearest .0000)
a. 6.8452
b. 5.5468
c. 4.5337
d. 5.8451
e. 6.0000

xii) Today, Rizwan put all of his cash into an account earning an annual interest rate of 9%
compounded monthly. Assuming he makes no withdrawals or additions into this account,
approximately how many years must Rizwan wait to double his money? (rounded to the
nearest .00)
a. 7.75
b. 8.25
c. 8.75
d. 7.25
e. 8.00

xiii) Nadia has been investing Rs 1,000 at the end of each year for the past 15 years. How
much has accumulated assuming she has earned 10.5% compounded annually on his
investment?
a. Rs 20,303.72
b. Rs 23,349.28
c. Rs 33,060.04
d. Rs 36,531.34
e. None of the above

Department of Economics and Finance, Pakistan Institute of Development Economics, Islamabad

Financial Theory Fall-2017 Dr. Muhammad Jamil

xiv) Faheem has been investing Rs 3,000 at the beginning of each year for the past 15
years. How much has accumulated assuming he has earned 8% compounded
annually on his investment?
a. Rs 91,896.04
b. Rs 87,972.85
c. Rs 84,696.81
d. Rs 81,456.34
e. None of the above

xv) Faiza estimates his opportunity cost on investments at 10.5% compounded annually.
Which one of the following is the best investment opportunity for Faiza?
a. To receive Rs 45,000 today
b. To receive Rs 120,000 at the end of 10 years
c. To receive Rs 5,500 at the beginning of each year for 15 years
d. To receive Rs 5,500 at the end of each year for 19 years
e. To receive Rs 5,750 at the end of each year for 17 years

xvi) Hira estimates her opportunity cost on investments at 9% compounded annually,

which one of the following is the best investment opportunity?
a. To receive Rs 100,000 today
b. To receive Rs 310,000 at the end of 15 years
c. To receive Rs 1,200 at the end of each month for 11 years compounded monthly
d. To receive Rs 65,000 in 5 years and $125,000 5 years later
e. To receive Rs 65,000 in 5 years and $200,000 10 years later

xvii) Amna estimates her opportunity cost on investments to be 12% compounded annually.
Which one of the following is the best investment opportunity?
a. To receive Rs 50,000 today
b. To receive Rs 250,000 at the end of 14 years
c. To receive Rs 40,000 at the end of 4 years and $120,000 8 years later at the end of
the year
d. To receive Rs 5,000 at the beginning of each 6-month period for 9 years
compounded semiannually
e. To receive Rs 60,000 at the end of 3 years

xviii) Qaiser is ready to retire. He wants to receive the equivalent of Rs 25,000 in today's
Rupees at the beginning of each year for the next 20 years. They assume inflation will
average 4% over the long run, and they can earn an 8% compound annual after-tax
return on investments.
What lump sum do Qaiser need to invest today to attain their goal?
a. Rs 265,089.98
b. Rs 339,758.16
c. Rs 353,348.49
d. Rs 357,681.56
e. None of the above

xix) Ashfaq wants to start his own business in 6 years. He needs to accumulate Rs
200,000 (today's Rs) in 6 years to sufficiently finance his business. He assumes
inflation will average 4%, and he can earn a 9% compound annual after-tax return on
investments. What serial payment should Ashfaq invest at the end of the first year to
attain his goal?

Department of Economics and Finance, Pakistan Institute of Development Economics, Islamabad

Financial Theory Fall-2017 Dr. Muhammad Jamil

a. Rs 29,546.11
b. Rs 30,727.95
c. Rs 28,190.78
d. Rs 29,318.41
e. None of the above

xx) Two years ago Saima purchased a Rs-10,000 car; she paid $2000 down and borrowed
the rest. She took a fixed rate 60-month installment loan at a stated rate of 8% per year.
Interest rates have fallen during the last two years and she can refinance her car by
borrowing the amount she still owes on the car at a new fixed rate of 6% per year for 3
years. Should Saima refinance her loan? How much will she save per month for the next
three years if she decides to refinance?
a. Yes, 7
b. Yes, 5
c. No, 2
d. No, 5
e. No, 7
f. Yes, 2

NOTE: You can take help from the following materials.

 Class Notes
 Ehrhardt, Michael C. and Eugenef F. Brigham (2011) Financial Management: Theory
and Practice, South-Western Cengage Learning
o Chapter 4 (Time Value of Money)
 Gitman, Lawrence J. () Principles of Managerial Finance, 10th edition
o Chapter 4 (Time Value of Money)
o Chapter 5 (Risk and Return)
 Bossaerts, Peter and Bernt Arne Odegaard (2006) Lectures on Corporate Finance,
Second Edition
o Chapter 5 (Present Value)
o Chapter 6 (Capital Budgeting)

Department of Economics and Finance, Pakistan Institute of Development Economics, Islamabad