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For burcolene, Kaplan has added an additional part (C).
In this part, Burcolene wants to set up a foreign subsidiary in South America. The subsidiary will remit 180 million pesos to Burcolene each year. However, the government in South America is blocking remittances for three years.I am not stating the entire question, but referring just to a mathematics related problem here.
Now Burcolene has decided that it will invest this money in South America, and earn interest on it. Kaplan kit has made the assumption, that money(180m pesos) will be reinvested each year, until the end of three year period when all the money will be remitted back to Burcolene in US.
My question is:
They have calculated the total amount to be remitted as follows.Year 1 180(1+r)^2
year 2 180(1+r)
year 3 180They then added these amounts up and converted at year three exchange rate, and multiplied by year three discount factor.
John why is this 180(1+r)^2? How does this open up. I am not getting the logic behind this formula?
Thankyou
If they invest 180 at time 1, then by time 3 it will have grown because of the interest on it for 2 years.
Multiplying by (1+r)^2 is the standard way of adding interest at r per annum for 2 years.
Similarly, 180 invested at time 2 will have earned one years interest by time 3, so multiply by 1+r.
Obviously the 180 at time 3 will not have earned any interest.So the sum of these is the total remittance in 3 years time, which we convert and discount in the normal way.
(If you are unsure about compounding interest, then do watch the relevant Paper MA (was F2) lectures. )
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