Question 1: Application of Time Value of Money (30 marks) a) You have won a lottery worth $1,000,000. The amount will be paid to you in equal installments over 20 years. If the interest rate is 10% compounded annually, how much will you be paid at the end of every year? (5 marks) b) You have just been offered a job by Johnson & Co. The company has offered you two different salary arrangements. You can have $75,000 per year for the next two years, or you can have $55,000 per year for the next two years, along with a $30,000 signing bonus today. If the interest rate is 12% compounded monthly, which is a better offer? NB: first convert the Quoted rate (12%) to EAR and use the EAR as the discount rate (10 marks) c) Mackay Inc, a small manufacturing firm, has hired to run their pension fund. The firm currently has S5 million in the fund and expects to receive additional cash of $2 million a year for the first 5 years followed by cash payout of S 3 million a year for the next 5 years Assume that interest rates are at 8% per annum i. How much money will be left in the fund at the end of the tenth year? (10 marks) ii. If you were required to pay a perpetuity after the tenth year (starting in year 11 and going through infinity) out of the balance left in the pension fund, how much could you afford to pay? (5 marks) (10+5+15-30 marks) Question 1: Application of Time Value of Money (30 marks) a) You have won a lottery worth $1,000,000. The amount will be paid to you in equal installments over 20 years. If the interest rate is 10% compounded annually, how much will you be paid at the end of every year? (5 marks) b) You have just been offered a job by Johnson & Co. The company has offered you two different salary arrangements. You can have $75,000 per year for the next two years, or you can have $55,000 per year for the next two years, along with a $30,000 signing bonus today. If the interest rate is 12% compounded monthly, which is a better offer? NB: first convert the Quoted rate (12%) to EAR and use the EAR as the discount rate (10 marks) c) Mackay Inc, a small manufacturing firm, has hired to run their pension fund. The firm currently has S5 million in the fund and expects to receive additional cash of $2 million a year for the first 5 years followed by cash payout of S 3 million a year for the next 5 years Assume that interest rates are at 8% per annum i. How much money will be left in the fund at the end of the tenth year? (10 marks) ii. If you were required to pay a perpetuity after the tenth year (starting in year 11 and going through infinity) out of the balance left in the pension fund, how much could you afford to pay? (5 marks) (10+5+15-30 marks)
