Petroleum Project
Economics
Econ210D
Presentation 3
Interest and Time Value of Money
Week 3
1
Simple Interest
Interest remains constant each year.
Interest is not reinvested
Interest is calculated by the formula.
I Prn
where: I = Interest, P = Principal, r =
interest, n = number of years.
Interest and Time Value of Money
Week 3
Compound Interest
Interest is based on principal plus reinvested interest
from previous years
Interest increase each successive year
A P 1 r
where: P = Principal, r = interest, n =
number of years, A = Principal + Interest,
Interest and Time Value of Money
Week 3
Future and Present Value
Future Value the value at some point in
the future of a single cash flow or a
series of cash flows in the future.
Present Value the value today of a
single cash flow or a series of cash flows
in the future
Values change over time due to interest
Interest is based on compound interest
Interest and Time Value of Money
Week 3
Future Value
F I 1 r
where:
F = Future value
I = Investment/Principal
r = rate of interest (for each time
period)
n = numberInterest
ofandtime
periods.
Time Value of Money
Week 3
Present Value
P
n
1 r
where:
P = Present value
I = Investment/Principal
r = rate of interest (for each time
period)
n = numberInterest
ofandtime
periods.
Time Value of Money
Week 3
Future Value of a Single Cash
Flow
An investor deposits $100 into an account
which offers 12% p.a. compound interest.
What is the value of the investment at the
end of 3 years?
Interest and Time Value of Money
Week 3
Present Value of a Single Cash
Flow
An investor is supposed to receive $100 in
3 years time. If the rate of compound
interest is 12% p.a. what is the present
value of the amount?
Interest and Time Value of Money
Week 3
Annuities Series of Cash flows
An annuity is a series of equal payments
at evenly spaced intervals
The payments occur at the beginning of
each period for an annuity due while they
occur at the end of each period for an
ordinary annuity
Interest is earned on amounts paid
Interest and Time Value of Money
Week 3
Annuity Due and an Ordinary Annuity over
3 years
Annuity Due
$100
Jan 1 2009
st
$100
Jan 1st 2010
$100
Jan 1st 2011
Dec 31st 2011
Ordinary Annuity
$100
Jan 1st 2009
Dec 31st 2009
$100
Dec 31st 2010
Interest and Time Value of Money
Week 3
$100
Dec 31st 2011
10
Future Value of an Annuity Due
At the beginning of each year an
investor deposits $100 into an account
which offers 12% p.a. compund
interest. What is the value of the
investment at the end of 3 years?
Interest and Time Value of Money
Week 3
11
Future Value of an Annuity Due
Time
Year
Amount
Workings
Jan 1st 2009
$100
$140
Jan 1st 2010
$100
$125
Jan 1st 2011
$100
$112
Dec 31st 2011
$0
$0
Total
$300
$378
Interest and Time Value of Money
Week 3
Future Value
12
Future Value of an Annuity Due
Interest and Time Value of Money
Week 3
13
Future Value of an Annuity Due
using Formula
FVADUE
1 r n1 1
1
I
where
I = periodic investment
r = interest rate per period
n = number of periods
Interest and Time Value of Money
Week 3
14
Future Value of an Ordinary
Annuity
At the end of each year an investor
deposits $100 into an account which
offers 12% p.a. compound interest.
What is the value of the investment at
the end of 3 years?
Interest and Time Value of Money
Week 3
15
Future Value of an Ordinary
Annuity
Time
Year
Amount
Workings
Jan 1st 2009
$0
$0
Dec 31st
2009
$100
$125
Dec 31st
2010
$100
$112
Dec 31st 2011
$100
$100
Total
$300
$337
Interest and Time Value of Money
Week 3
Future Value
16
Future Value of an Ordinary
Annuity
Interest and Time Value of Money
Week 3
17
Future Value of an Ordinary
Annuity using Formula
FVAORDINARY
1 r
I
where
I = periodic investment
r = interest rate per period
n = number of periods
Interest and Time Value of Money
Week 3
18
Question 1
At the beginning of each year an
investor deposits $10,000 into an
account which offers 10% p.a.
compound interest. What is the value of
the investment at the end of 4 years?
Interest and Time Value of Money
Week 3
19
Question 2
At the end of each year an investor
deposits $2,000 into an account
which offers 2% p.a. compound
interest. What is the value of the
investment at the end of 5 years?
Interest and Time Value of Money
Week 3
20
Question 3
At the end of each quarter an investor
deposits $400 into an account which
offers 12% p.a. compound interest.
What is the value of the investment at
the end of 1 year?
Interest and Time Value of Money
Week 3
21
Question 4
At the beginning of each month an
investor deposits $100 into an account
which offers 12% p.a. compound
interest. What is the value of the
investment at the end of 6 months?
Interest and Time Value of Money
Week 3
22
Present Value of an Annuity Due
At the beginning of each year an
investor deposits $100 into an account
which offers 12% p.a. compund
interest. What is the present value of
the investment?
Interest and Time Value of Money
Week 3
23
Present Value of an Annuity Due
Time
Year
Amount
Workings
Jan 1st 2009
$100
$100
Jan 1st 2010
$100
$89
Jan 1st 2011
$100
$80
Dec 31st 2011
$0
$0
Total
$300
$269
Interest and Time Value of Money
Week 3
Present Value
24
Present Value of an Annuity Due
Interest and Time Value of Money
Week 3
25
Present Value of an Annuity Due
Using the formula
PVADUE I
1
n 1
1 r 1
where
I = periodic investment
r = interest rate per period
n = number of periods
Interest and Time Value of Money
Week 3
26
Present Value of an Ordinary
Annuity
At the end of each year for 3 years an
investor deposits $100 into an account
which offers 12% p.a. compound
interest. What is the present value of the
investment?
Interest and Time Value of Money
Week 3
27
Present Value of an Ordinary
Annuity
Time
Year
Amount
Workings
Jan 1st 2009
$0
$0
Dec 31st
2009
$100
$89
Dec 31st
2010
$100
$80
Dec 31st 2011
$100
$71
Total
$300
$240
Interest and Time Value of Money
Week 3
Present Value
28
Present Value of an Ordinary
Annuity
Interest and Time Value of Money
Week 3
29
Present Value of an Ordinary
Annuity Using the Formula
1
1
n
1 r
r
PVAORDINARY I
where
I = periodic investment
r = interest rate per period
n = number of
periods
Interest and Time Value of Money
Week 3
30
Question 5
At the beginning of each year an
investor deposits $10,000 into an
account which offers 10% p.a.
compound interest. What is the present
value of the investment if this is done
over 4 years?
Interest and Time Value of Money
Week 3
31
Question 6
At the end of each year for 5 years an
investor deposits $2,000 into an
account which offers 2% p.a.
compound interest. What is the
present value of the investment?
Interest and Time Value of Money
Week 3
32
Question 7
At the end of each quarter an investor
deposits $400 into an account which
offers 12% p.a. compound interest.
What is the present value of the
investment if this is done over 1
year?
Interest and Time Value of Money
Week 3
33
Question 8
At the beginning of each month for 6
months an investor deposits $100 into
an account which offers 12% p.a.
compound interest. What is the
present value of the investment?
Interest and Time Value of Money
Week 3
34
