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With reference to Kaplan Financial Management study text page 358,
CP Co wishes to issue $10 million of commercial paper for 90 days at an implicit interest rate of 5% pa
(Note: This could be expressed as stating that the paper will be issued at a discount of 5 %)
Determine the issue price.
Issue price = present value of future redemption.
=$10m × 1/(1+0.05 × 90/365) = $9,878,213.
I did that calculation on my basic calculator where I got wrong answer.
Whereas in scientific calculator, I’m getting it right.
My confusion is how to actually calculate the present value if it’s given in days?
I do not have the Kaplan Study Text – only the BPP Revision Kit – and I don’t believe that you have ever been asked to do this in the exam (or likely will in the future!).
However you discount using the formula given at the top of the PV tables.
The discount factor is 1/(1+r)^nHere r if 0.05 and n is 90/365
So it is not as you have typed it but should be $10m x 1/(1.05^(90/365))
I used the formula from the PV table and my answer was $ 9,880,416.
That answer was given in the study text (i.e. $9,878,213)
The difference between the two answers is $ 2203
If by chance, I face the same question in the exam, will I get mark for doing calculation based on the formula or do I need to follow the study text?I have no idea what the study text has done because I do not have the Study Text – only the Revision Kit.
However the correct answer is 9,880,416. Maybe they used 360 days in a year instead of 365, or maybe it is just rounding (a difference so small is irrelevant in real life 🙂 ).
Neither would be a problem in the exam because (as you will find when you come to practice questions in your Revision Kit), exam questions will tell you how many days to assume in a year, and questions like this will ask for the answer to the nearest $100,000.
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