a) In order to create an endowment, which pays Rs 500,000 per year, forever, how much money must be set aside today in the rate of interest is 10%? If the first payment of Rs 500,000 will be received after 3 years, what will be present value of such cash payment?b) Which deal is better, 8.4% compounded annually or 8.6% compounded quarterly or 8.7% compounded monthly?c) What is real interest rate if Rs. 500,000 is invest at 10% per annum for 5 years and inflation rate is 7%?

Answered: a) In order to create an endowment,…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter5: The Time Value Of Money

Section: Chapter Questions

Problem 16P

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a) In order to create an endowment, which pays Rs 500,000 per year, forever, how much money must be set aside today in the rate of interest is 10%? If the first payment of Rs 500,000 will be received after 3 years, what will be present value of such cash payment?
b) Which deal is better, 8.4% compounded annually or 8.6% compounded quarterly or 8.7% compounded monthly?
c) What is real interest rate if Rs. 500,000 is invest at 10% per annum for 5 years and inflation rate is 7%?

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Step 2

1 (a) Calculate PV of endowment as below:

$\begin{array}{rcl} Present Value of Perpetuity & = & \frac{Periodic Payment}{Periodic Interest Rate} \\ = & \frac{Rs 500, 000}{0.10} \\ = & Rs 5, 000, 000 \end{array}$

Hence, Amount of RS 5,000,000 must be set aside today.

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