Engineering Economic

Analysis

Chapter 3  Interest and Equivalence

http://academic.udayton.edu/ronalddeep/enm530.htm

10/15/20 rd 1
 Irrelevant Characteristics

Monetary Units
Dollars
Pounds
Yen
Marks
Effective Period
Day Month Year Century

10/15/20 rd 2
 Interest and Equivalence

Computing Cash Flows

Time Value of Money
Equivalence
Single Payment Compound Interest Formulas

10/15/20 rd 3
 Why Engineering Economy?

Should I pay off my credit card balance with borrowed money?

What are the worth of graduate studies over my career?
Are tax deductions for my home mortgage a good deal or
should I accelerate my mortgage payments?
Exactly what rate of return did we make on our stock
investments?
Should I buy or lease my next car, or keep the one I have now
and pay off the loan?
When should I replace my present car?
Which cash flow is preferable?

10/15/20 rd 4
 Time Value of Money

The change in the amount of money over a given time

period is call the the time value of money; and is the
most important concept in engineering economy.

You borrow $10,000 and repay $10,700 a year later. Find

the rate of interest.
i = (10.7K – 10K)/10K = 700/10000 = 7%

10/15/20 rd 5
 Cash Flow Diagram
P ~ Present at time 0; F ~ Future A ~ Uniform or Equal
G ~ Gradient i ~ effective interest n ~ Number of pay periods
F
ie nt
r ad
g
A uniform

0 1 2 3 4 5 n

I = 7%

10/15/20 rd 6
 Compounding Process
Given: i = 10%
n = 7 years
P = $3000 F = P(1 + i)n
Find: F = 3000(1 + 0.10)7 compounding factor

= $5846.15
P = F(1 + i)-n
Discounting factor

F = P(F/P, i%, n)
Genie command is (FGP 3000 10 7)  5846.15

10/15/20 rd 7
 F/P

n Start Interest End

1 P iP P(1 + i)1
2 P(1 + i)1 iP(1 + i)1 P(1 + i)2
3 P(1 + i)2 iP(1 + i)2 P(1 + i)3
.. …. …. …..
n P(1 + i)n-1 iP(1 + i)n-1 P(1 + i)n

10/15/20 rd 8
 (F/P, i%, n)
formula
F given P; F = P(1 + i)n = 1000(1 + 0.04)5  1000(1.2167)
= 1216.652  1216.70
calculator table
F = 1216.65

i = 4% compounded annually
n= 5

P = $1000 (F/P 1000 4 5)  1216.65

10/15/20 rd 9
 (F/A, i%, n)
F = A(F/A, i%, n)
(F/A, i%, n) = A[(1 + i)n-1 + (1 + i)n-2 + … + (1 + i)1 + 1]
(Summing from right to left) = A[1 – (1 + i)(1 + i)n-1]/[1 – (1 + i)]
= A[(1 + i)n - 1]/i
F

1 2 3 4 5 6 … n-2 n-1 n

10/15/20 rd 10
 (F/A, i%, n)
F given A; F = A(F/A, i%, n); F = 500(5.4163, 4%, 5)
= $2708.16
(1  i ) n  1 (1  0.04)5  1
(F/A, i%, n) =   5.4163
i 0.04
F = $2708.16 = (F/A 500 4 5)

i = 4%
0 1 2 3 4 5

A = $500
10/15/20 rd 11
 P/A
F/A P/F
n n
P/A = F * P = (1+i) -1 * 1

(1+i) -1
n
A F i (1+i) i(1+i) n

Find the present worth of 5 yearly deposits of $1000 at 7%

compounded annually.
P = A(P/A, 7%, 5) = 1000(4.100197) = $4100.20
= 1000(F/A, 7%, 5)(P/F, 7%, 5)
= 1000 * 5.750749 * 0.712986
= $4100.20

10/15/20 rd 12
 A/F & A/P
A[(1+i) n -1]
F/A 
i
Fi
A/F =
(1+i) n -1

F P A[(1+i) n -1]
P/A  * =
A F i(1+i) n

A F Pi(1+i) n
A/P  * 
F P (1+i) n -1

10/15/20 rd 13
 Compound Interest Factors 7%

n F/P P/F A/F A/P F/A P/A A/G P/G

1 1.0700 0.9346 1.0000 1.0700 1.0000 0.9346 0.0000 0.0000
2 1.1449 0.8734 0.4831 0.5531 2.0700 1.8080 0.4831 0.8735
3 1.2250 0.8163 0.3111 0.3811 3.2149 2.6243 0.9549 2.5061
4 1.3108 0.7629 0.2252 0.2952 4.4399 3.3872 1.4155 4.7948
5 1.4026 0.7130 0.1739 0.2439 5.7507 4.1002 1.8650 7.6467
6 1.5007 0.6663 0.1398 0.2098 7.1533 4.7665 2.3032 10.9784
7 1.6058 0.6227 0.1156 0.1856 8.6540 5.3893 2.7304 14.7149
8 1.7182 0.5820 0.0975 0.1675 10.2598 5.9713 3.1466 18.7890
9 1.8385 0.5439 0.0835 0.1535 11.9780 6.5152 3.5517 23.1405
10 1.9672 0.5083 0.0724 0.1424 13.8165 7.0236 3.9461 27.7156
11 2.1049 0.4751 0.0634 0.1334 15.7836 7.4987 4.3296 32.4666
12 2.2522 0.4440 0.0559 0.1259 17.8885 7.9427 4.7025 37.3507

10/15/20 rd 14
 Relationships
a. (F/P, i%, n) = i(F/A, i%, n) + 1
b. (P/F, i%, n) = 1 – i(P/A,i%, n)
c. (A/F, i%, n) = (A/P, i%, n) – i
d. (A/P i%, n) = i / [1 – (P/F, i%, n)]
e. Find (F/P, 10%, 37)
(F/P, 10%, 37) = (F/P, 10%, 35)(F/P, 10%, 2)
= 28.1024 *1.21
= 34.0039
f. (P/A, i%, n) – (P/A, i%, n-1) = (P/F, i%, n)

10/15/20 rd CW3B-15
 Computing Cash Flows
You bought a machine for $30,000. You can either pay the full price now
with a 3% discount, or pay $5000 now; at the end of 1 year pay $8000,
then at the end of the next 4 years pay $6,000. i = 7% compound yearly.

Option 1  0.97 * 30K = $29,100

Option 2  $31, 470

0 1 2 3 4 5

-$5000 -$6000 -$6000 -$6000 -$6000

-$8000
Continued … 

10/15/20 rd 16
 Option 2

0 1 2 3 4 5

7%
compounded
-$5000 -$6000 -$6000 -$6000 -$6000 annually
-$8000

P = 6K(P/A, 7%, 4)(P/F, 7%, 1) + 8K(P/F, 7%, 1) + 5K

= 6K * 3.387 * 0.9346 + 8K(0.9346) + 5K
= 31,470

10/15/20 rd 17
 Simple Interest
Simple interest is: P * i * n = Pin

You borrow $10,000 for 5 years at a simple interest rate of

6%. At the end of 5 years, you would repay: Principal plus
simple interest

F = P + Pin = 10,000 + 10,000 * 0.06 * 10

= 10,000 + 600
= $10,600

10/15/20 rd 18
 Compound Interest

Compound Interest is: P(1 + i)n

You borrow $10,000 for 5 years at 6% compounded

annually. At the end of 5 years, you would repay:
Principal plus compound interest

F = P(1 + 0.06)5 = $13,382.26

versus the simple interest $10,600.00
Difference $ 2,782.26

10/15/20 rd 19
 Equivalence

10/15/20 rd 20
 Equivalence

When comparing alternatives that provide the same

service, equivalent basis depends on
Interest Rate
Amounts of money involved
Timing of the cash flow
Perspective (Point of View)

12 inches = 1 foot …continued 

10/15/20 rd 21
 Equivalence
Your borrow $5,000 at 8% compounded annually.
You may return the $5,000 immediately, or pay according to
Plan A or Plan B The 3 options are equivalent.
n 1 2 3 4 5
A -1400 -1320 -1240 -1160 -1080
B -400 -400 -400 -400 -5400

PWA = 1400(P/A, 8%, 5) – 80(P/G, 8%, 5)

= $5000

PWB = 400(P/A,8%,5) + 5000(P/F,8%,5)

= 1597.08 + 3402.92
= $5000.

10/15/20 rd 22
 Re-Payment Plans
APR = 8%
n owed interest total principal total
for year owed owed payment paid ( P+I)

1 $5000 $400 $5400 $1000 $1400

2 4000 320 4320 1000 1320
3 3000 240 3240 1000 1240
4 2000 160 2160 1000 1160
5 1000 80 1080 1000 1080
$1200 $6200
(IRR '(-5000 1400 1320 1240 1160 1080))  8%

10/15/20 rd 23
 Re-Payment Plans

APR = 8%
n owed interest total principal total
for year owed owed payment paid
1 $5000 $400 $5400 $0 $400
2 5000 400 5400 0 400
3 5000 400 5400 0 400
4 5000 400 5400 0 400
5 5000 400 5400 5000 5400
$2000 $7000
(IRR '(-5000 400 400 400 400 5400))  8%

10/15/20 rd 24
 Re-Payment Plans

APR = 8%
n owed interest total principal total
for year owed owed payment paid
1 $5000 $400 $5400 $ 852 $1252.28
2 4148 331 4479 921 1252.28
3 3227 258 3484 994 1252.28
4 2233 178 2411 1074 1252.28
5 1159 93 1252 1159 1252.28
$1260 $ 6261.40
(IRR '(-5000 1252.28 1252.28 1252.28 1252.28 1252.28))  8%

10/15/20 rd 25
 Re-Payment Plans
APR = 8%
n owed interest total principal total
for year owed owed payment paid
1 $5000 $400 $5400 $ 0 $ 0
2 5400 432 5832 0 0
3 5832 467 6299 0 0
4 6299 504 6803 0 0
5 6803 544 7347 5000 7347
$2347 $5000 7347
(IRR '(-5000 0 0 0 0 7347))  8%

10/15/20 rd 26
 Equivalence
-5 0 0 0 -5 0 0 0 -5 0 0 0 -5 0 0 0
1400 400 1252.28 0
1320 400 1252.28 0
1240 400 1252.28 0
1160 400 1252.28 0
1080 5400 1252.28 7347
8.000% 8.000% 8.000% 8.001%

(IRR '(-5000 1400 1320 1240 1160 1080))  8%

(IRR '(-5000 400 400 400 400 5400))  8%
(IRR '(-5000 1252.28 1252.28 1252.28 1252.28 1252.28))  8%
(IRR '(-5000 0 0 0 0 7347))  8%

10/15/20 rd 27
 Simple vs. Compound Interest
Fs = P(1 + ni) Simple interest
Fc = P(1 + i)n Compound interest
Given P = $24, i = 5%, n = 20 years vs. compounded annually.
Fs = 24(1 + 20 * 0.05) = $48
Fc = 24(1.05)20 = $63.68.

In 1626 Peter Minuit paid $24 for Manhattan Island.

In Year 2008: Fs = 24(1 + 382 * 0.05) = $482.40
Fc = 24(1.05)381 = $2,982,108,814.51

10/15/20 rd 28
 Effective Interest Rate
Annual Percentage Rate (APR)  r; for example, 12% per year
Effective interest rate  ieff APY ~ annual percent yield
r m
(1+ ) -1
ieff = m , where m is the number of pay periods

Example: APR is 12% compounded monthly.

0.12 12
(1+ ) -1
i = 12 = 12.68% effective yearly rate.
eff

All interest rates is formulas are effective interest rates

commensurate with the pay periods.
10/15/20 rd 29
 Effective Interest Rate
Annual Percentage Rate (APR) is 12%
If compounded monthly,
effective monthly rate is 1% 12/12
effective quarterly rate is 3.03% (1 + 0.03/3)3 - 1
effective yearly rate is 12.68% (1 + 0.12/12)12 - 1
If compounded quarterly,
effective quarterly rate is 3% 12/4
effective yearly rate is 12.55% (1 + 0.12/4)4 - 1
r m
ieff = (1+ ) -1
m

10/15/20 rd 30
 Effective Interest Rate
$1000 is invested for 5 years at 12% APR compounded monthly.
Compute its future worth using effective

a) annual rate b) quarterly rate

c) monthly rate and d) 3-year rate.

F5 years = 1000(1 + 0.126825)5 = $1816.70

F20 qtrs = 1000(1 + 0.030301)20 = $1816.70
F60 mths = 1000(1 + 0.01)60 = $1816.70
F2.5yrs = 1000(1 + 0.2697)2.5 = $1816.70
Effective 3 year rate is (1 + 0.36/36)36 – 1 = 43.07688%
F3 yrs = 1000(1 + 0.4307688)5/3 = $1816.70

10/15/20 rd 31
 Interest Rates
You borrow $1000 and agree to repay with 12 equal
monthly payments of $90.30.
Find the a) effective monthly interest rate.
b) nominal annual interest rate
c) effective annual interest rate.
a) 1000 = 90.30(P/A, i%, 12) => P/A factor = 11.0742
=> imonth-eff = 1.25%
b) APR = 12 * 1.25% = 15%

c) Annual effective rate = (1 + 0.15/12)12 – 1 = 16.08%.

10/15/20 rd 32
 Continuous Compounding

F = Pern where r is the APR and n is the number of years

e  lim (1  x )1/ x (1 + 0.0001)10000 = 2.7181

x 0

The effective rate for continuous compounding is given by

er - 1.

Substitute er - 1 for i in the formulas.

For example, F = P(1 + i)n = P(1 + er – 1)n = Pern

10/15/20 rd 33
 Continuous Compounding

Traffic is currently 2000 cars per year growing at a rate of

5% per year for the next 4 years. How much traffic is
expected at the end of 2 years?

F = 2000 e2*0.05 = 2210.34 cars

Investment is currently $2000 per year growing at a rate of

5% per year for the next 4 years. How much investment is
expected at the end of 2 years?

F = 2000 e2*0.05 = $2210.34

10/15/20 rd 34
 Problem
$100 at time 0 is $110 at time pay period 1 and
was $90 at time pay period –1.
Find the APR for year –1 to 0 and for 0 to 1.
100 = 90(1 + i) => i = 11.11% 90 100 110

110 = 100(1 + i) => i = 10%; -1 0 1

If $90 is invested at time –1 returns $110 at time

+1, find i. 110 = 90(1 + i)2 => i = 10.55%.

10/15/20 rd 35
 Problem
You plan to make 2 deposits, $25K now and $30K at the end
of year 6. You draw out $C each year for the first 6 years and
C + 1000 each year for the next 6 years. Find C at 10%
interest compounded annually.

C(P/A, 10%, 12) + 1000(P/A, 10%, 6)(P/F, 10%, 6) = [25K + 30K(1.1)-6]

C = $5,793.60. C + 1K
$C

1 6 12
25K 30K

10/15/20 rd 36
 Time to Double

How many years until an investment doubles at 5%

compounded annually?

F = 2P = P(1 + 0.05)n => 2 = 1.05n => Ln 2 = n Ln 1.05

n = Ln 2 / Ln 1.05 = 14.20669 years
Check
F = 1000 (1.05)14.21 = $2000
(NGPFI 1 2 5)  14.2067 years

10/15/20 rd 37
 Computing i given P, F and n
F = P(1 + i)n
i = (F/P)1/n – 1
Example: What interest rate generates $3456 in
5 years by investing $1000 now?

i = 3.4561/5 – 1 = 28.14886%.
(IGPFN 1000 3456 5)  28.14886

10/15/20 rd 38
 Computing n given P, F and i
F = P(1 + i)n
n = Ln (F/P) / Ln (1 + i)

How many years for $1000 deposited now to accumulate

to $3465 at an APR of 28.14886%?
n = Ln 3.465 / Ln 1.2814886
= 5 years
(NGPFI 1000 3465 28.1488)  5

10/15/20 rd 39
 Arithmetic Gradient
(n – 2)G (n -1)G
2G
G
A

0 1 2 3 . . . n -1 n
Gradient begins in Year 2
P = A(P/A, i%, n) + G(P/G, i%, n)

10/15/20 rd 40
11. Given the cash flow in the diagram below, find the present
worth value at time 0 with interest rate 5% per year.

1300
1200

1100

1000

0 1 2 3 4 5 6

PW(5%) = [1000(P/A, 5%, 4) + 100(P/G, 5%, 4)](P/F, 5%, 2)

= $3679.12
(P/F (PGG 1000 100 5 4) 5 2)  3679.12

10/15/20 rd 41
 Arithmetic Gradient
Find the present worth of the following cash flow at 7%
compounded annually: A = 50, G = 20

n 1 2 3 4 5 6
cf 50 70 90 110 130 150

P = A(P/A, i%, n) + G(P/G, i%, n)

= 50(P/A, 7%, 6) + 20(P/G, 7%, 6)
= 238.326 + 219.567 = $457.89

(PGG A G i n)  (PGG 50 20 7 6)  $457.89

10/15/20 rd 42
 Geometric Gradient
A1; A2 = A1 + gA1 = A1(1 + g);
A3 = A2 +gA2 = A1(1 + g) + gA1(1 + g) = A1(1 + g)2
An = A1(1 + g)n-1
Pn = An(P/F, i%, n) = An(1 + i)-n
= A1(1 + g)n-1(1 + i)-n

P = A1(1 + i)-n

1  (1  g ) n (1  i )  n
A1
(P/A1, i, g, n) = ig

10/15/20 rd 43
 Geometric Gradient

Find the present worth of a cash flow beginning at $10K

and increasing at 8% for 4 years at 6% per year interest.
(PGGG-table 10000 8 6 4)
n Cash-flow 8% PW-factor 6% PWorth
1 10000.00 0.9434 9433.96
2 10800.00 0.8900 9611.96
3 11664.00 0.8396 9793.32
4 12597.12 0.7921 9978.10
$38,817.54

PW = 10K[1 – (1.08)4/(1.06)4(0.06 – 0.08)] = $38,817.54

10/15/20 rd 44
 Geometric Gradient
Example: Calculate the present worth of a contract awarded at
$1000 per year and increasing at a uniform rate of 10% per
year for 5 years at 7% APR compounded annually.

P = A1[1 – (1 + g)n(1 + i)-n]/(i – g)

= 1000[1 – 1(1 + 0.1)5(1 + 0.07)-5 ]/(0.07 - 0.10)
= $4942.38.
(PGGG A g i n) ~ (PGGG 1000 10 7 5)  $4942.38

10/15/20 rd 45
 Geometric Gradient
A modification costs $8K, expected to last 6 years with a $1300
salvage value. Maintenance is $1700 the first year and
increasing 11% per year thereafter. The interest rate is 8%.
Find the present worth.

PW = -8K – 1700[1- (1.11/1.08)6/(0.08 – 0.11)] =1300(1.06)-6

= -$17,305.88
(+ 8000 (PGGG 1700 11 8 6) (PGF -1300 8 6))  17305.88

10/15/20 rd 46
 Problem 3-11

n 0 1 2 3 4
cf -100 25 45 45 30

Find the compound annual interest rate.

Guess and test or

(IRR '(-100 25 45 45 30))  16.189%

10/15/20 rd 47
 Problem 3-12

Compute the difference in borrowing $1E9 at 4.5% for 30

years versus at 5.25%.

Diff = 1E9[(F/P, 5.25%, 30) – (F/P, 4.5%, 30)]

= $896,232,956.47

10/15/20 rd 48
 Problem 3-15

1903 painting valued at $600

1995 painting valued at $29,152,000
Find i.

29152000 = 600(F/P, i%, 92) = 600(1 + i)92

48586.7 = (1 + i)92
1.12445066 = 1 + i
12.45% = i

10/15/20 rd 49
 Manhattan Island

Manhattan Island was bought for $24 in 1626 from

the native Americans. Compute the present day
worth if they had invested the money in an 8% APR
compounded yearly.
F = 24 (1 + 0.08)2008-1626 = $140,632,545,502,000
Today each of the 300 millions Americans could be
given $468,775.15. F is considerably more than
what Manhattan Island is now worth.

10/15/20 rd 50
 Learning Curve

The time to make the first unit is $1000 and the learning curve is 90%.
What is the cost to make the 2nd, 4th and 8th units?
T2 = 1000 * 2(log 0.90 2) = 1000 *2 -0.1520 = $900
T4 = 0.90 * $900 = $810
T8 = 0.90 * $810 = $729.
(sim-lc 1000 8 90)  Unit Hours Cumulative
1 1000.00 1000.00
2 900.00 1900.00
3 846.21 2746.21
4 810.00 3556.21
5 782.99 4339.19
6 761.59 5100.78
7 743.95 5844.73
8 729.00 6573.73

10/15/20 rd 51
 Cost of a Mortgage

Interest Rate
Loan Amount
Payment Frequency
Points (Prepaid interest of 1% of loan)
Fees (application, loan origination)

10/15/20 rd 52
 Principal Reduction and Interest Paid for
each payment

A = P(A/P, i%, N)

PRn = A(P/F, i%, N – n + 1); Interestn = A - PRn

PR5 = 1627.45(P/F, 10%, 10 – 5 + 1)

= $918.65

(P/F, i%, n) = (P/A, i%, n) – (P/A, i%, n - 1)

10/15/20 rd 53
 Mortgage Payments
Loan = $10,000 Interest 10%/year N = 10 years

Pay Num Payment Principal Interest Balance Total Interest

1 1627.45 627.45 1000.00 9372.55 1000.00
2 1627.45 690.19 937.26 8682.36 1937.26
3 1627.45 759.21 868.24 7923.15 2805.50
4 1627.45 835.13 792.32 7088.02 3597.82
5 1627.45 918.65 708.80 6169.37 4306.62
6 1627.45 1010.51 616.94 5158.86 4923.56
7 1627.45 1111.56 515.89 4047.30 5439.45
8 1627.45 1222.72 404.73 2824.58 5844.18
9 1627.45 1344.99 282.46 1479.59 6126.64
10 1627.45 1479.49 147.96 0.10 6274.60

A = 10K(A/P, 10%, 10) = $1627.45

10/15/20 rd 54
 Computing the Balance
On a loan of $10,000 for 10 years at 10% per year,
determine the annual payment and the balance after 6
years.

1 2 3 4 5 6 7 8 9 10

A = P(A/P, i%, N) = 10K(A/P, 10%, 10) = $1627.45

B6 = 1627.45(P/A, 10%, 4) = $5158.81

10/15/20 rd 55
 Points or No Points

You finance a home for $100K at 15 year interest rate. You can
either pay one point with 6.375% interest or no points with 6.75%
interest compounded monthly.
The 1 point implies that you get $99K but get charged as if you
borrowed $100K

A = 100K(A/P, 6.375/12 %, 180) = $864.25

99K = 864.25(P/A, i%, 180) looking for 114.55 P/A factor for 180
pay periods. i = 0.545 % => APR = 6.54%
Thus go with paying the point as 6.54% < 6.75%.

10/15/20 rd 56
 Monthly Payments

What is the monthly payment for a 5-year car loan of

$35,000 at 6% compounded monthly?
Find the amount of the principal reduction of the 25th
payment.

A = $35,000(A/P, 6% /12, 60) = $676.65.

PR25 = 676.65(P/F, 6%/12, 60 – 25 + 1)
= $565.44.

10/15/20 rd 57
 Mortgage Payments

You take out a loan for $350,000 at 6% APR compounded monthly for 30
years.
a) Your monthly payment is _________.
b) The principal reduction PR225 is ________.
c) The interest paid Int225 at this payment is _______.
d) The total interest paid to date at this payment is _______.
e) The balance at this payment is __________.
f) The per cent of your loan paid by the 225th is ______.

Ans. a) $2098.43 b) $1064.90 c) $1033.53 d) $327,786.21

e) $205,640.17 f) 41.245%

10/15/20 rd 58
 Compound Continuously

How long does it take for an investment to triple if interest

rate is compounded continuously at i = 7%?
F = Pern
3 = 1e0.07n => n = 15.69 years

You deposit $1000 a year for 5 years at 7% compounded

continuously. At the end of 5 years you can withdraw
_______. Substitute er – 1 for i into the F/A factor.
ans. $5779.59

10/15/20 rd 59
 Interest Rate

A credit card company charges 1.5% interest on the

unpaid balance each month.
Nominal annual interest rate is ________. ans. 18%

Effective annual interest rate is ________.

ans. 19.56%

10/15/20 rd 60
 Equivalence

Place an amount F3 at year 3 which is equivalent to the

cash flow below at 7%.

F3 = 500(P/A, 7%,5)(F/P,7%,3) = $2511.46.

1 2 3 4 5

A = $500

10/15/20 rd 61
 Preference

Which alternative would you choose at i = 10%? i = 9%?

1) Receive $100 now.

2) $120 two years from now.

10/15/20 rd 62
 P/A

Find the exact P/A factor at 9.35% compounded

continuously for n = 10 pay periods.

 (1  i ) n  1  e0.935  1
P/A =  i (1  i ) n   (e0.0935  1)e0.935  6.1974%
 

10/15/20 rd 63
 Time Value of Money

a) Joe wants to figure his annual car cost given the

following cash flow at i = 7%:
n 1 2 3 4 5
cf $45 90 135 180 225
(list-pgf '(0 45 90 135 180 225) 7)  $528.61
(A/P 528.61 7 5)  128.92

b) He got the 3rd and 4th year mixed. Refigure.

(list-pgf '(0 45 90 180 135 225) 7)  $531.01
(AGP 531.01 7 5)  $129.51

10/15/20 rd 64
 Problem 3-19

What sum of money is equivalent to $8250 2 years later if

interest is 4% compounded semiannually?

8250(1.04)-4 = $7052.13

10/15/20 rd 65
 Problem 3-23

A local bank pays 5% annual interest while an out of town

bank pays 1.25% compounded quarterly. You have
$3000 to deposit for 2 years. In which bank do you
deposit your money?

3000(1.05)2 = $3307.50
3000(1.0125)8 = $3313.46
$5.96

10/15/20 rd 66
 Problem 3-24

P1 = P2 at interest rate i. Which cash flow is better at 2i?

F1 F2

0 1 2 0 1 2 3

P1 = F1 (1 + i)-2 = F2 (1 + i)-3 = P2 => F2 = F1(1 + i)

P'1 = F1(1 + 2i)-2 P'2 = F2 (1 + 2i)-3 = F1(1 + i)(1 + 2i)-3

P'2 /P'1 = (1 + i)/(1 + 2i) < 1 => P'1 > P'2

For example, try F1 = $100 and F2 = $107.

10/15/20 rd 67
 Problem 3-27

A sum of money Q will be received 6 years from now. At

5% annual interest the present worth of Q is $60. At the
same interest rate, what would be the value of Q in 10
years?

F = 60(1.05)10 = $97.73

10/15/20 rd 68
10/15/20 rd 69
 Find A to equate the series at 10% compounded annually.
120 120 120
100 100

1 2 3 4 5
P0 = 100(P/A,10%,2) + 120(P/A,10%,3)(P/F,10%,2)
A A A A

1 2 3 4 5
P0 = A(P/A,10%,4)(P/F,10%,1) = $420.18 => A = $145.81

10/15/20 rd CW3B-70