Accounts Assignment

1.
You won the lottery and have a choice of receiving a lump sum amount of $9,159,724
now or $700,000 annually, at the start of each year, for 20 years. Current interest rates
are 5% annually.
Which option (lump sum or instalments) is more money, assuming interest rates hold?
Ans : if its lump sum it is going to be : $9,159,724 as given in the question
Now lets calculate the amount we get by instalments :

To determine which option would yield more money, we need to calculate the present value of the
annuity payments and compare it to the lump sum amount.
Annuity Option:
We can calculate the present value of the annuity payments using the formula for the present value
of an ordinary annuity:
PV = PMT * [(1 (1 + r)^ n) / r]
where:
PMT = Annual payment
r = Interest rate per period
n = Number of periods
from the given question

PMT = $700,000
r = 5% = 0.05
n = 20
PV = $700,000 * [(1 (1 + 0.05)^ 20) / 0.05]

= $700,000 * [17.9086]
= $12,535,020.19
Comparing the lump sum to the present value of the annuity payments, we see that the annuity
option yields more money over the 20 year period.
Which option would you choose and why?

Before deciding upon weather to take lump sum or to take as instalments I ask myself few questions
1. Do I have any plans of investment?
2. is it safe investment
3. Do I want to take risk or to have stable monthly income
4. how confident am I ?
If I found some investment that’s going to give me more than stable money and have my fair share of
options, I would consider having lump sum if not I will consider of taking the lump sum investing
some amount and some I will deposit In my bank account that also gives me interest monthly.
2. You invest $1,000 in a savings account earning 8% simple interest annually.

How much interest will you have earned in 5 years?
First, let's calculate the interest earned in 5 years with simple interest:
I = PXRXT
Where
P = principal amount
R = interest rate
T = time
I = 1000*0.05*5
= $400
Assuming you did not make any withdrawal from the savings account, what is the account
balance in year 5?
Account balance formula A= P+I
A = 1000+ 400 = $1400
How would the interest amount earned differ if interest was compounded at 8%?
Interest earned with compound interest.
A= PX (1+r) ^t
A= future value of interest
P= principal amount
R= interest rate per period
T = Time
A = $1000(1+0.08) ^5
A= $1469.33
Difference in interest earned
Difference = compound interest earned – simple interest earned
= 1469.33 – 1400
= 69.33
3. Your bank offers two savings accounts, one earns compounded interest at 6% annually
and the other 8% simple interest annually. You plan on investing $1,000.
If you plan to invest fo five years, which savings account would you choose?
To compare the two savings accounts, let's calculate the returns for each scenario:
1. Investment for 5 years:

Compound Interest Account (6% annually):
Using the compound interest formula ( A = P(1 + r/n)^{nt} ), where:
( P = $1,000 ) (principal)
( r = 6 % = 0.06 ) (annual interest rate)
( n = 1 ) (compounded annually)
( t = 5 ) (number of years)
[ A = 1000(1 + 0.06/1)^{1*5} = 1000(1.06)^5 ]
[ A = 1000(1.338225) = $1,338.23 ]
Simple Interest Account (8% annually):

Using the simple interest formula ( A = P(1 + rt) ),
where:
( P = $1,000 ) (principal)
( r = 8% = 0.08 ) (annual interest rate)
( t = 5 ) (number of years)
[ A = 1000(1 + 0.08*5) ]
[ A = 1000(1 + 0.4) = 1000(1.4) = $1,400 ]
Comparing the two accounts, the Simple Interest Account yields a higher return after 5 years. So,
we would choose the Simple Interest Account for a 5 year investment.
If you plan to invest for 15 years which savings account, would you choose? And why?
Investment for 15 years:
Compound Interest Account (6% annually):
[ A = 1000(1.06) ^{15} ]
[ A = 1000(2.012196) = $2,012.20]
Simple Interest Account (8% annually):
[ A = 1000(1 + 0.08*15) ]
[ A = 1000(1.2) = $1,200 ]
Comparing the two accounts, the Compound Interest Account yields a higher return after 15 years.
So, we would choose the Compound Interest Account for a 15 year investment.
4. The university received a $60 million gift for a new building to be paid in equal
installments over 10 years (i.e., $6 million annually). Payments are due on December
31st of every year. The university is borrowing money at a 5% rate. Executive
leadership reached out to you, the project manager, to develop a project budget so that
the entire project is covered by the gift amount. What should your project budget be?
Given:
Annual gift instalment: $6 million
Number of years: 10
Borrowing rate: 5%
We aim to calculate the project budget, considering the present value of the gift instalments using the
borrowing rate.
The formula for Present Value of an Annuity:

PV=PMT×((1−(1+r)^−n)/r)
Where:
PV is the present value of the annuity.
PMT is the annual payment (the gift installment).
r is the borrowing rate per period.
n is the number of periods.
Using the given values:
[ PV = 6,000,000 ( {1 (1 + 0.05)^{ 10}}{0.05} ]
After calculation, the present value of the $60 million gift, considering a borrowing rate of 5%, equals
approximately $46,330,440.
Therefore, to cover the entire project within the gift amount while considering the borrowing rate, the
project budget should be approximately $46,330,440.
5. Your company is building a new office building and you need to borrow $10 million
from the bank in order to fund the project.
Assuming the bank is charging you a 3.5% compounded interest for a 20 year loan,
what are your annual installments/payments which are due at the beginning of the year
Annual Installments/Payments Calculation:
To calculate the annual installments/payments for a $10 million loan with a 3.5% compounded
interest rate for 20 years and due at the beginning of each year:
PMT = {PV * r}{1 (1 + r)^{ n}} ]
Where:
PMT is the periodic payment (annual installment)
PV is the present value of the loan (loan amount), which is $10 million
r is the interest rate per period, which is {3.5%}{100%} = 0.035 )
n is the total number of periods, which is ( 20 times 1 = 20) (since the payments are annual)
PMT = $643,019.76
What is the total you will have paid at the end of the loan (i.e., after 20 years)
To find out the total amount paid at the end of the loan (i.e., after 20 years):
Total amount paid = PMT times n

Therefore, the total amount paid at the end of the loan, after 20 years, would be approximately
$12,860,395.20.
6. You invested $500 and received $650 after three years.

What had been the interest rate assuming it is compounded annually?
Compounded Annually:
For compounded interest, we can use the formula:
[ A = P(1 + r)^n ]
Where:
( A ) is the amount of money accumulated after ( n ) years, including interest.
( P ) is the principal amount (the initial amount of money).
( r ) is the annual interest rate (in decimal).
( n ) is the number of years the money is invested for.
Given:
( P = $500 )
( A = $650 )
(n=3 )
We need to solve for ( r ) (the interest rate).
[ 650 = 500(1 + r)^3 ]
Divide both sides by 500:
[ frac{650}{500} = (1 + r)^3 ]
[ 1.3 = (1 + r)^3 ]
Now, take the cube root of both sides:
[ sqrt[3]{1.3} = 1 + r ]
[ r = sqrt[3]{1.3} 1 ]
[ r = 0.1 ]
[ r = 10 % ]
So, the interest rate for compounded annually is approximately ( 10 % ).
What had been the interest rate assuming it is a simple interest rate?
Simple Interest:
For simple interest, we can use the formula:

[ A = P(1 + rt) ]
Where:
( A ) is the amount of money accumulated after ( t ) years, including interest.
( P ) is the principal amount (the initial amount of money).
( r ) is the annual interest rate (in decimal).
( t ) is the time the money is invested for.
Given:
( P = $500 )
( A = $650 )
(t=3 )
We need to solve for ( r ) (the interest rate)
[ 650 = 500(1 + r times 3) ]
[ frac{650}{500} = 1 + r times 3 ]
[ 1.3 = 1 + r times 3 ]
Now, subtract 1 from both sides:
[ 0.3 = r times 3 ]
[ r = frac{0.3}{3} ]
[ r = 0.1 ]
[ r = 10 % ]
So, the interest rate for simple interest is also ( 10 % ).
Therefore, the interest rate for both compounded annually and simple interest is ( 10 % ).
7. You have a project that is forecasted to bring in $7 million of revenue annually and have
operating expenses of $2 million (before debt service). Your investors require a 6%
margin (remember margin is (revenue expenses)/revenue).
How much annual debt service can your project afford in order to maintain a 6% margin?
To maintain a 6% margin, we need to ensure that the operating expenses plus the annual debt
service do not exceed 94% of the revenue.
Given:
Revenue: $7 million
Operating expenses: $2 million
Margin required: 6% = 0.06
We need to find the maximum allowable debt service.
Let ( D ) be the annual debt service.
The margin formula is:
[ text{Margin} = frac{ text{Revenue} text{Expenses}}{ text{Revenue}} times 100 ]
Substitute the given values:
[ 0.06 = frac{7,000,000 (2,000,000 + D)}{7,000,000} times 100 ]
Simplify:
[ 0.06 = frac{5,000,000 D}{7,000,000} times 100 ]
[ 0.06 = frac{5,000,000 D}{70} ]

Now, let's solve for ( D ):
[ 0.06 times 70 = 5,000,000 D ]
[ 4.2 = 5,000,000 D ]
[ D = 5,000,000 4.2 ]
[ D = 999,999.8 ]
So, the project can afford an annual debt service of approximately $999,999.80 in order to
maintain a 6% margin.
8. Based on the debt service in Question 1, how much money can you borrow assuming a
5% annual interest rate and a 20 year loan, with payments at the end of the period
you have a $22 million project. How much more will you have paid if you borrow money rather
than pay cash for this project at a 3.5% interest rate for a 30 year loan with MONTHLY payments
of $98,500?
1. Borrowing with 5% Annual Interest Rate for 20 Years:
Given the annual debt service from Question 1 is approximately $999,999.80, we can use this to
calculate the loan amount using the formula for the present value of an annuity.
Given:
Annual debt service ( (D )) = $999,999.80
Interest rate ( (r )) = 5% or 0.05
Number of periods ( (n )) = 20 years
We need to find the present value ( (PV )) of the annuity (the loan amount).
Using the formula:
[ PV = frac{D}{r} left(1 frac{1}{(1 + r)^n} right) ]
Substitute the given values:
[ PV = frac{999,999.80}{0.05} left(1 frac{1}{(1 + 0.05)^{20}} right) ]
After calculation, the present value of the annuity (loan amount) comes out to be approximately
$12,979,745.29.
2. Paying Cash vs. Borrowing at 3.5% Interest Rate for 30 Years:
First, let's calculate the total amount paid if we borrow $22 million at a 3.5% interest rate for 30
years with monthly payments of $98,500.
Given:
Loan amount ( (L )) = $22,000,000
Annual interest rate ( (r )) = 3.5% or 0.035 (monthly interest rate would be (0.035/12 ))
Loan term ( (n )) = 30 years
Monthly payment ( (M )) = $98,500
We can use the formula for the present value of an ordinary annuity to find the total amount paid over
30 years.
[ M = frac{L . r}{1 (1 + r)^{ n}} ]
Substituting the given values:
[ 98500 = frac{22000000 . 0.0029167}{1 (1 + 0.0029167)^{ 360}} ]
[ 98500 = frac{6425.7}{1 0.5255} ]
[ 98500 = frac{6425.7}{0.4745} ]
[ 98500 = 13547.3 ]
Now, let's calculate the total amount paid over 30 years:
[ Total amount paid = M . 12 . 30 ]

[ Total amount paid = 13547.3 . 12 . 30 ]
[ Total amount paid ≈ 4,894,428 ]
Therefore, the total amount paid over 30 years with the loan would be approximately $4,894,428.
Now, let's compare this to the cost of paying cash for the project. If we pay cash for the $22
million project, the total amount paid would simply be $22 million.
Difference:
[ Difference = Total amount paid with loan Total amount paid with cash ]
[ Difference = 4,894,428 22,000,000 ]
[ Difference ≈ 17,105,572 ]
So, if we borrow money rather than pay cash for the project at a 3.5% interest rate for a 30 year
loan with monthly payments of $98,500, we would end up paying approximately $17,105,572 less
over the 30 years.
What are some other factors that might influence your decision to borrow or pay cash?
Other Factors Influencing the Decision:
Cash Flow: Borrowing might provide better cash flow management, as it spreads out the cost
over time.
Opportunity Cost: Borrowing allows you to keep cash on hand for other investments or
emergencies.
Tax Benefits: Interest payments on loans may be tax deductible, reducing the overall cost of
borrowing.
Risk Tolerance: Borrowing introduces debt and associated risks, while paying cash eliminates
these risks.
Interest Rates: The current interest rate environment and future rate expectations may influence
the decision.
Project Return: Consider the potential return on investment from the project compared to the
cost of borrowing.

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1.

Ans : if its lump sum it is going to be : $9,159,724 as given in the question

Now lets calculate the amount we get by instalments :

from the given question

PV = $700,000 * [(1 (1 + 0.05)^ 20) / 0.05]

Which option would you choose and why?

2. You invest $1,000 in a savings account earning 8% simple interest annually.

1. Investment for 5 years:

Simple Interest Account (8% annually):

The formula for Present Value of an Annuity:

Annual Installments/Payments Calculation:

PMT = {PV * r}{1 (1 + r)^{ n}} ]

Total amount paid = PMT times n

6. You invested $500 and received $650 after three years.

For simple interest, we can use the formula:

So, the interest rate for simple interest is also ( 10 % ).

[ 0.06 = frac{5,000,000 D}{70} ]

Now, let's calculate the total amount paid over 30 years:

[ Total amount paid = M . 12 . 30 ]

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