Overview
Assessment 4
Respond to four questions and solve three computational problems about time value of money (TMV) as it applies to annuity cash flows.
You know how the TVM concept as applies to single cash flow. However, in real life you will come across financial applications that require multiple or annuity cash flows. That is why it is important to know how to apply the TVM concept to annuity cash flows; for example, how to amortize a mortgage or car loan.
By successfully completing this assessment, you will demonstrate your proficiency in the following course competencies and assessment criteria:
• Competency 1: Evaluate the global financial environment.
o Explain why a saver would prefer more or less frequent interest compounding periods.
o Explain the purpose of an amortization schedule.
• Competency 2: Define finance terminology and its application within the business environment.
o Describe uses of an amortization schedule.
o Explain why interest paid in the early years of a home mortgage is more helpful in reducing taxes than interest paid in later years.
o Explain the differences between an ordinary annuity and an annuity due.
Assessment Instructions:
Respond to the questions and complete the problems.
Questions
In a Word document, respond to the following. Number your responses 1–4.
1. Explain whether you would you rather have a savings account that paid interest compounded on a monthly basis or compounded on an annual basis? Why?
2. Describe what an amortization schedule is and its uses. Explain the purpose of an amortization schedule.
3. Interest on a home mortgage is tax deductible. Explain why interest paid in the early years of a home mortgage is more helpful in reducing taxes than interest paid in later years.
4. Explain the difference between an ordinary annuity and an annuity due.
Use references to support your responses as needed. Be sure to cite all references using correct APA style. Your responses should be free of grammar and spelling errors, demonstrating strong written communication skills.
Problems
In either a Word document or Excel spreadsheet, complete the following problems.
• You may solve the problems algebraically, or you may use a financial calculator or an Excel spreadsheet.
• If you choose to solve the problems algebraically, be sure to show your computations.
• If you use a financial calculator, show your input values.
• If you use an Excel spreadsheet, show your input values and formulas.
In addition to your solution to each computational problem, you must show the supporting work leading to your solution to receive credit for your answer.
1. If interest rates are 8 percent, what is the future value of a $400 annuity payment over six years? Unless otherwise directed, assume annual compounding periods.
o Recalculate the future value at 6 percent interest and 9 percent interest.
2. If interest rates are 5 percent, what is the present value of a $900 annuity payment over three years? Unless otherwise directed, assume annual compounding periods.
o Recalculate the present value at 10 percent interest and 13 percent interest.
3. What is the present value of a series of $1150 payments made every year for 14 years when the discount rate is 9 percent?
o Recalculate the present value using discount rate of 11 percent and 12 percent.
Suggested Resources-
The following optional resources are provided to support you in completing the assessment or to provide a helpful context.
Library Resources:
• Weaver, S. C., & Weston, J. F. (2001). Finance and accounting for nonfinancial managers. New York, NY: McGraw-Hill.
• Sherman, E. H. (2011). Finance and accounting for nonfinancial managers (3rd ed.). New York, NY: American Management Association.
Course Library Guide
You are encouraged to refer to the resources in the BUS-FP3062 – Fundamentals of Finance Library Guide to help direct your research.
Other Resources:
• Cornett, M., Adair, T., & Nofsinger, J. (2019). M: Finance (4th ed.). New York, NY: McGraw-Hill. Available in the courseroom via the VitalSource Bookshelf link.
Time Value Of Money: Annuity Cash Flow
1.
Pournara (2013) describes compound interest as the interest calculated on a principal amount’s latest balance. Simply put, compound interest is the sum of interest on a given principal amount plus the accrued interest for other periods. Typically, individuals calculate compound interest on a different basis such as annually, semiannually, monthly and quarterly.
In my view, I would rather have a savings account that paid interest compounded monthly than annually because it would provide more cash in hand when financial needs arise. Arguably, a savings account compounded monthly and annually would earn the same interest rate at the end of the period. However, with the uncertainty of financial obligations, I would prefer to have an account that pays interest compounded monthly, allowing me to withdraw more money every month.
Scholars describe an amortization schedule or table as an entry that allocates the interest and principal for each loan payment (“Principles of accounting,” n.d.). Treece (2020) also adds that the amortization table lists the scheduled loan payments as determined by a loan calculator. In essence, an amortization table is an entry that shows how much principal and interest is paid on a loan amount, based on the agreed-upon interest rate and loan repayment period. The primary use of an amortization schedule is to outline the process of paying a loan by showing the principal and interest paid over a given period. When used in accounting and finance, the amortization schedule helps individuals track their loan payments and identify the principal balances on their loan amounts. Notably, with an amortization schedule, a borrower can identify the amount of interest and principal paid over time and deduct this value from the loan amount to determine their principal balances.
A tax deduction on a home mortgage loan enables homeowners to pay lower interest during their loan repayment. Often, interest paid in the early years of a home mortgage is more helpful in reducing taxes than that paid later in the years because at the beginning of each mortgage, a large portion of the monthly payments is directed to the interest. At the same time, a small proportion is listed as a principal amount at the beginning of the mortgage payment. Conversely, the amount paid later in the year goes mostly in the repayment of principal while a small amount is used to repay the remaining interest. Therefore, the interest paid in the early years helps reduce taxes because it is higher than the interest paid later in the years.
4.
The primary difference between annuity due and ordinary annuity is the point at which a payment is made. On the one hand, annuity due payments is made at the beginning of a period before an individual enjoys an asset’s benefits. For example, rent is an annuity due because it is paid immediately at the beginning of each month. Conversely, ordinary annuity occurs when payments are paid at the end of a given period. Bond payments are examples of an ordinary annuity because it is paid at the end of the agreed-upon period.
References
Pournara, C. (2013). Teachers’ knowledge of teaching compound interest. Pythagoras, 34(2), 1-10. http://dx.doi.org/10.4102/pythagoras.v34i2.238
Principles of accounting, Volume 1: Financial accounting (n.d.) OpenStax. https://opentextbc.ca/principlesofaccountingv1openstax/front-matter/preface/
Treece, K. (2020, July 22). What is loan amortization? Forbes. https://www.forbes.com/advisor/loans/what-is-loan-amortization/
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