IC212: Financial Modelling

Exercise 2: Time Value of Money and Some Financial Arithmetic

1. You have decided to pursue higher education and enroll in a MBA program. If you

borrowed $150,000 at a fixed interest rate of 7.5% and can only make payments of

$25,000 per year to pay off the loan, at the end of this and each additional year. How

many years will it take before you can once again live debt-free?

2. You would like to have enough money saved to receive £200,000 per year after retirement

so that you and your family can lead a good life for 30 years (from age 65 to 95). If you

will be 35 years old when you graduate and plan on making savings contributions at the

end of your first year out of school, how much would you need to save in your post-MBA

retirement fund to achieve this goal? Assume an interest rate is 8%. (See template

below)

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3. Your wedding tuxedo suit costs £2,500. The clothing store has two payment plans: If you

pay in cash, you get a 10% discount; alternatively, you can put £0 down now and pay the

£2,500 in 10 equal monthly payments, starting one month from now. What is the EAR of

these payment plans? If your credit card charges 12%, should you pay cash or take the

store’s payment plan?

4. You want to buy a new luxury car which costs £85,000. However, you are not sure

whether to purchase the car or to lease it. You plan to use the car for six years. The

bank’s annual interest rate is 10% and the lease includes seven annual payments of

£15,000 with the first payment due at the inception of the lease. Assume that the car’s

market value at the end of the six years is £20,000

• Should you buy or lease?

• Will your answer change assuming interest rate of 7.5%?

• What lease payment will make you indifferent between the lease and the purchase?

5. A firm is considering purchasing manufacturing equipment in the amount of $700,000.

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The life span of the equipment is 7 years, and the firm uses straight line depreciation,

with no terminal value. The estimated income from the equipment is $300,000 and the

estimated operating expense is $150,000, both for a 7-year period. The firm’s tax rate is

40% and its discount rate is 11%.

• Calculate the equipment NPV and IRR.

• What is the minimum annual income (before tax) in which the firm should invest in the

equipment? (Use Excel’s function ‘Goal Seek’)?

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