Common Assessment Revision.pptx

Stathis Polyzos
FIN308 Introduction to Finance

 The Common Assessment will be on Blackboard, through Lockdown Browser
 Make sure you have access to BlackBoard and are comfortable using it
 You can only have your formula sheet
 The assessment duration is 60 minutes
 Date/Time: 5 October 2023, 12:30 (Common Break)
 Location: M1-0-026
 You need to have a scientific calculator
FIN308 Common Assessment Revision 2

 Material will cover Chapter 5 (Time Value of Money)
 The assessment will consist of exercises relating to time value of money and some
theoretical questions
 The assessment accounts for 15% of your course grade
S. Polyzos - FIN308 Common Assessment Revision 3

 Study all the slides, not only those in the revision
 Study all the material (read the book), not only that in the presentation slides
 Go through the examples we did in class and the examples in the book
 Remember to also read the theory, not only the exercises

You need to access the test using LockDown
Browser
Click here
http://www.respondus.com/lockdown/download.php?id=399140242

 All assessments are going to be on campus
 On-Campus Exam Rules
 Mobile phones are not allowed in class during the exam
 Having a mobile phone on you will mean that you will be graded with 0 on this exam, as per
College of Business instructions
 You will not be allowed to leave the classroom for any reason (bathroom, water, etc.)
unless there is a medical certificate
 You will be allowed to use only your formula sheet.
 You will not be allowed to exchange calculators, pens, etc.
 Screen brightness for monitors should be set to 100% (make sure you have a charger or
an extra battery)

 All exams to be on-campus
 It is your responsibility to follow the announcements by the University regarding
exam rules and campus access.
 Any deviations from the above will result in no points for the exam.

 Please follow the steps below in order to open the exam and submit your responses:
Step 1. Open Respondus LockDown Browser
Step 2. Log in to Blackboard (https://learn.zu.ac.ae), using your Zayed credentials
Step 3. Select your FIN308 course from the course list
Step 4. From the menu on the left, select “Course Common Assessments”
Step 5. Select “FIN 308_ Common Assessment_ Test" from the assessment list
Step 6. Read the instructions and press Start the Test
Step 7. Enter the password given

Time value of money
S. Polyzos - FIN308 Common Assessment Revision
10

 Theoretical Motivation
 We prefer present consumption to future consumption, since we can enjoy (derive utility
from) the goods for a greater period of time
 In the presence of inflation, the value of money decreases over time
 Uncertainty/risk reduces the value of a future cash flow

 Present Value – earlier money on
a timeline
 Future Value – later money on a
timeline
 Interest rate – “exchange rate”
between earlier money and later
money
 Discount rate
 Cost of capital
 Opportunity cost of capital
 Required return
 Inflation

 The three basic patterns of cash flows include:
 A single amount: A lump sum amount either held currently or expected at some future
date.
 An annuity: A level periodic stream of cash flow.
 A mixed stream: A stream of unequal periodic cash flows.

 Future value is the value at a given future date of an amount placed on deposit
today and earning interest at a specified rate. Found by applying compound
interest over a specified period of time.
 Compound interest is interest that is earned on a given deposit and has become
part of the principal at the end of a specified period.
 Principal is the amount of money on which interest is paid.

 We use the following notation for the various inputs:
 FVn = future value at the end of period n
 PV = initial principal, or present value
 r = annual rate of interest paid. (Note: On financial calculators, I is typically used to
represent this rate.)
 n = number of periods (typically years) that the money is left on deposit
 The general equation for the future value at the end of period n is

 Present value is the current dollar value of a future amount—the amount of
money that would have to be invested today at a given interest rate over a
specified period to equal the future amount.
 It is based on the idea that a dollar today is worth more than a dollar tomorrow.
 Discounting cash flows is the process of finding present values; the inverse of
compounding interest.
 The discount rate is often also referred to as the opportunity cost, the discount
rate, the required return, or the cost of capital.

 The present value, PV, of some future amount, FVn, to be received n periods from
now, assuming an interest rate (or opportunity cost) of r, is calculated as follows:

 An annuity is a stream of equal periodic cash flows, over a specified time period.
These cash flows can be inflows of returns earned on investments or outflows of
funds invested to earn future returns.
 An ordinary (deferred) annuity is an annuity for which the cash flow occurs at the end of
each period
 An annuity due is an annuity for which the cash flow occurs at the beginning of each
period.
 An annuity due will always be greater than an otherwise equivalent ordinary annuity
because interest will compound for an additional period.

 You can calculate the future value of an ordinary annuity that pays an annual
cash flow equal to CF by using the following equation:
 As before, in this equation r represents the interest rate and n represents the
number of payments in the annuity (or equivalently, the number of years over
which the annuity is spread).

 You can calculate the present value of an ordinary annuity that pays an annual

 You can calculate the present value of an annuity due that pays an annual cash
flow equal to CF by using the following equation:
 The future value of an annuity due is always higher than the future value of an
ordinary annuity.

 You can calculate the present value of an ordinary annuity that pays an annual

 A perpetuity is an annuity with an infinite life, providing continual annual cash
flow.
 If a perpetuity pays an annual cash flow of CF, starting one year from now, the
present value of the cash flow stream is
PV = CF ÷ r

 Shrell Industries, a cabinet
manufacturer, expects to receive the
following mixed stream of cash flows
over the next 5 years from one of its
small customers.

 If the firm expects to earn at least 8% on its investments, how much will it
accumulate by the end of year 5 if it immediately invests these cash flows when
they are received?
 This situation is depicted on the following timeline.

 Frey Company, a shoe manufacturer,
has been offered an opportunity to
receive the following mixed stream of
cash flows over the next 5 years.

 If the firm must earn at least 9% on its investments, what is the most it should
pay for this opportunity?
 This situation is depicted on the following timeline.

 Compounding more frequently than once a year results in a higher effective
interest rate because you are earning on interest on interest more frequently.
 As a result, the effective interest rate is greater than the nominal (annual)
interest rate.
 Furthermore, the effective rate of interest will increase the more frequently
interest is compounded.
 A general equation for compounding more frequently than annually

 Continuous compounding involves the compounding of interest an infinite number
of times per year at intervals of microseconds.
 A general equation for continuous compounding
where e is the exponential function.

 The nominal (stated) annual rate is the contractual annual rate of interest
charged by a lender or promised by a borrower.
 The effective (true) annual rate (EAR) is the annual rate of interest actually paid
or earned.
 In general, the effective rate > nominal rate whenever compounding occurs more
than once per year

 The following equation calculates the annual cash payment (CF) that we’d have to
save to achieve a future value (FVn):
 Suppose you want to buy a house 5 years from now, and you estimate that an
initial down payment of $30,000 will be required at that time. To accumulate the
$30,000, you will wish to make equal annual end-of-year deposits into an account
paying annual interest of 6 percent.

 Loan amortization is the determination of the equal periodic loan payments
necessary to provide a lender with a specified interest return and to repay the
loan principal over a specified period.
 The loan amortization process involves finding the future payments, over the term
of the loan, whose present value at the loan interest rate equals the amount of
initial principal borrowed.
 A loan amortization schedule is a schedule of equal payments to repay a loan. It
shows the allocation of each loan payment to interest and principal.

 The following equation calculates the equal periodic loan payments (CF) necessary
to provide a lender with a specified interest return and to repay the loan principal
(PV) over a specified period:
 Say you borrow $6,000 at 10 percent and agree to make equal annual end-of-year
payments over 4 years. To find the size of the payments, the lender determines the
amount of a 4-year annuity discounted at 10 percent that has a present value of
$6,000.
𝐶𝐹 = 𝑃𝑉 × 𝑟 ÷ 1 −
1
1 + 𝑟 𝑛

 It is often necessary to calculate the compound annual interest or growth rate
(that is, the annual rate of change in values) of a series of cash flows.
 The following equation is used to find the interest rate (or growth rate)
representing the increase in value of some investment between two time periods.

𝑛 =
log
𝐹𝑉
𝑛
𝑃𝑉0
log 1 + 𝑟

These exercises will be solved in class
S. Polyzos - FIN308 Common Assessment Revision
38

 Assume that Amaya Chidori makes a ¥2,500 deposit into an investment account
in a bank in Sendai, Japan. If this account is currently paying 0.7% per annum,
what will the account balance be after 1 year?

 Paul Jackson has saved £2,235 and decides to invest in an individual savings
account (ISA), which is a type of savings account that offers tax exemptions to
residents of the United Kingdom. If the ISA pays 2% annual interest with
monthly compounding, what will the account balance be after 4 years?

 Marina Tra just won $1.3 million in the Hong Kong mega lottery. She is given the
option of receiving a lump sum immediately or she can elect to receive an annual
payment of $100,000 at the end of each year for the next 25 years. If Marina can
earn 5% annually on her investments, which option should she take?

 Yassir Ismail is discussing investing in a
new machine for his metal fabrication
business in Dubai. The machine will cost
AED130,000. He estimates that the new
machine will generate the cash inflows
shown in the table to the right, over its 5-
year life.
 If Yassir requires 9% return on his
investments, should he invest in the new
machine?
Year Inflow Estimate
1 AED 35,000
2 50,000
3 45,000
4 25,000
5 15,000

Year Inflow Estimate Discount Factor Present Value
1 AED 35,000
2 50,000
3 45,000
4 25,000
5 15,000

 Jack and Jill have just had their first child. If they expect that college will cost
$150,000 per year in 18 years, how much should the couple begin depositing
annually at the end of each of the next 18 years to accumulate enough funds to
pay for the first year of tuition 18 years from now? Assume they can earn a 6%
annual rate of return on their investment.

 Peter just got his driver’s license and he wants to buy a new sports car for
$70,000. He has $20,000 to invest as a lump sum today. Peter is a conservative
investor and he only invests in safe products. After approaching different banks,
he is offered the following investment opportunities:
a) River Bank’s savings account with an interest rate of 10.8% compounded monthly.
b) First State Bank’s savings account with an interest rate of 11.5% compounded
annually
c) Union Bank’s saving account with an interest rate of 11.2% compounded quarterly.
 How long will it take for Peter to accumulate enough money to buy the car in each
of the three cases and which one should he choose?
45

Common Assessment Revision.pptx

Recommended

Recommended

More Related Content

Similar to Common Assessment Revision.pptx

Similar to Common Assessment Revision.pptx (20)

Recently uploaded

Recently uploaded (20)

Common Assessment Revision.pptx