ENGINEERING ECONOMICS

ECOR 3800 - A

Time Value of Money

Instructor: Karim Ismail

Carleton University
Department of Civil & Environmental Engineering

ECOR 3800 – Engineering Economics

(Khan, A., Zalok, E., and Ismail, K.)
Learning Objectives
 Basic definitions of terms related to interest
calculations.
 Simple interest versus compound interest.
 Different compound factors for common cash
flow patterns.
 Effective versus nominal interest rates.
 Discrete versus continuous compounding.

Engineering Economics
2
 Time Value of Money
 Money has a time value because it can earn more money
over time (earning power).
 Time value of money is measured in terms of interest
rate.
 Interest is the cost of money—a cost to the borrower and
an earning to compensate a lender for:
 Administrative cost of making a loan
 Risk of non-repayment
 Loss of locking the loaned money (missed opportunity)
 Engineering Economics: interest is the productive gain
from the efficient use of money resources.
3
 Definitions
 Interest: is the cost of assigning (locking) money for a
specific investment and not using it in any other means.
 Interest rate: is a measure of cost of money per unit
time. It is also the interest periodically applied and added
to an amount (or varying amounts) of money over a
specified length of time and expressed as a percentage
per period of time.
 Interest rate has a big effect on the value of money for
example $1 million will/should earn $100,000 in one
year time at 10% annual interest rate.

4
 Elements of Transactions Involving Interest
 Principal: An initial amount of money that, in transactions
involving debt or investments.
 Interest period: Is the period of time that determines how
frequently interest is calculated and potentially added to
the principal. Typically, selected to be one year.
 Number of interest periods: A representation of the
analysis duration in terms of how many interest periods it
contains.
 Payment: is a sum of money disbursed (cost).
 Receipt: is a sum of money received (revenue).
 A future worth of money: is the amount of money that
results from accumulation of interest on a principal over a
number of interest periods, i.e., principal plus interest).
5
 Important Notations
An A generic notation for a discrete payment or receipt occurring at
the end of some interest period.
i The interest rate per interest period (a proportion of principal).
N The total number of interest periods.
P A present equivalent of money at a the beginning of an analysis
duration ( also referred to as present value or present worth).
F A future equivalent of money at the end of analysis duration (also
referred to as future value or future worth).
A An end-of-interest-period payment or receipt in a uniform series
that continues for N periods, where A1 = A2 = A3 = … = An.
Vn A generic equivalent amount of money at the end of specified
period n that considers the time value of money.
For example, Vo = P and VN = F.

6
 Example (interest on loan)
Suppose an electric manufacturing company buys a
new machine for $25,000. $5,200 is paid from
liquid cash and part is financed as follows:
 Borrowed from the bank $20,000
 Annual interest rate 9%
Administrative fees to create a
 Origination fee $200 bank account to process a loan.

 Cash received  $20,000 - $200 = $19,800

 Two repayment plans: [1] equal payment due at the
end of every year over 5 years and [2] single
payment at the end of 5 years
7
Example (interest transaction) cont.
Receipts Payments
Plan 1 Plan 2
Year 0 20,000.00 200.00 200.00
Year 1 5,091 0
Year2 5,091 0
Year 3 5,091 0
Year 4 5,091 0
Year 5 5,091 30,465

P = $19,800+$200, A = $5,091, F= $30,465

8
 Methods of Calculating Interest
Simple interest: the practice of charging an interest
rate only to an initial sum (principal amount).
Compound interest: the practice of charging an
interest rate to both [1] the initial sum and [2] any
previously accumulated interest that has not been
repaid/withdrawn.
 Interest rates for Bank operations in Canada:
 Nov 2007: 4.75%, Nov 2009: 0.5%, Nov 2011: 1.25%

9
 Simple Interest
Simple interest: the practice of charging an interest
rate only to an initial sum (principal amount),
even if interest is left in the account.
Interest earned (I) = PiN
I  Interest earned End of Beginning Interest Ending
Year Balance earned Balance
P  Principal loaned
0 $1,000
i  Interest rate per period
N  No. of interest periods 1 $1,000 $80 $1,080

2 $1,080 $80 $1,160

Example:
3 $1,160 $80 $1,240
P = $1,000 i = 8% N = 3 years
10
Example:
Calculate Future Worth “F” (one-time repayment).
Given: P = $1000, N= 3 years, I = 8 %
Solution
I  PiN
 8 
I  $1000     3  $240
 100 
F  FutureSum  P  I OR  P(1  iN )
F  $1000  $240
F  $1240
11
 Compound Interest
Compound interest: the practice of charging an
interest rate to an initial sum and to any
previously accumulated interest that has been left
in the account.
End of Beginning Interest Ending
Year Balance earned Balance
Compound interest 0 $1,000
FN  P(1  i ) N
1 $1,000 $80 $1,080

FN  1000(1  0.08) 3
2 $1,080 $86.40 $1,166.40

FN  1,259.71 3 $1,166.40 $93.31 $1,259.71

12
 Compound Interest
P present future F  P(1  i) N

0 1 2 3 N 1 N
F  P  Pi F  P(1  i)  P(1  i)i
 P(1  i)  P(1  i) 2
 P(1  i)1
Future Worth ( F )  P(1  i ) N

Where :
(1  i ) N
is Compound Amount Factor
(1  i )  F / P
N

13
Depiction of Loan Repayment
$1,000 NOW
$1,080 ONE year later
OR
$1,166 TWO years later
OR
$1,259 THREE years later
 Power of Compounding Interest
John was born in 1988. As a birth day gift, his dad made a one-time
deposit of $1,000 for him in a Savings account that earns a fixed
annual interest rate of 8% for the next 25 years.
How much John would have in his account now (2013) if no
withdrawal has been made form this account?

Compound Interest Simple Interest

P = $1,000 F = P(1+iN)
i = 8.0% F = $1,000(1+.08*25)
N = 25 years F= $3,000
F = $1,000 (1+0.08)25
F = $6,848

15
 Exercise
3500
What is the interest rate
3000
that corresponds to the
2500
following graph of the

Interest Amount, $
2000
incremental future 1500
worth of a principal of 1000
$1,000 (what is added 500
to the principal)? 0

7
9
3
5
1

13
15
17
19
21
23
25
11
Number of Time Periods, N

Simple
Compound
16
How to read factors?
(1  i ) N
is Compound Amount Factor
(1  i )  FN / P
N

FN / P  (1  i ) N

…this Quantity
…this Factor multiplied by..
This Quantity Equals..

where :
( FN )  Future Sum
X Y i , N  Find X, given Y for specified i & N
17
 Common Patterns of Cash Flows
$100
Single cash flow
n=0 n=1 n=2 n=3 n=4
$100 $100 $100 $100
Equal (uniform) payment series
n=0 n=1 n=2 n=3 n=4
$100
Linear gradient series $75
$50
$25

n=0 n=1 n=2 n=3 n=4

$200
$100
Geometric gradient series $50
$25

n=0 n=1 n=2 n=3 n=4

18
 Useful Factors
To better understand the conversion process, we need to
study the development of the interest factor formulas.

1. Compound Amount Factor

2. Present Worth Factor
3. Compound Amount Factor for Uniform Series (Future
Worth Factor)
4. Uniform Series Present Worth Factor
5. Sinking Fund Factor (Uniform Series)
6. Capital Recovery Factor (Uniform Series)

19
 1. Compound Amount Factor (Single Payment)
 A factor that when multiplied by the single sum (P) of
payments will give the future worth (F) of that sum.
 Used to find the Future worth (F) of a single payment,
given the Present amount (P). Symbol: [F/P, i%, N]
From : F
F  P(1  i) N

Fi , N  P(1  i ) N F  P( F / P, i, N )
 Fi , N / P  (1  i ) N
0
 Fi , N  P * ( F / P, i, N ) P
N

( F / P, i, N )  Compound Amount Factor

Note: For given P , the higher the i , the higher F.
20
Application
Find F at i  6% and N  10 years Already in the
future
Case 1 $1000
F  $1000 10
0

$1000 F ?
Case 2
F  $1000 * ( F P,6%,1)
0 9 10
F  $1060 .00

21
 2. Present Worth Factor (Single Payment)
 A factor that when multiplied by the single sum (F) of
Future worth will give the Present worth (P) of that sum.
 Used to find the Present amount (P) of a single payment,
given the Future worth (F). Symbol: [P/F, i%, N]
P  F(1  i)  N F
From : P  F( P / F, i, N )
Fi , N  P(1  i ) N
 P  Fi , N (1  i )  N 0

 ( P / F , i, N )  Present Worth Factor N

P
22
Application
Find P at i  6%
$1000
Case 1
P  $1000 0 10

Case 2 P? $1000

P  $1000 * ( P F ,6%,1)
0 1 10
P  $943.40

23
 Example 1: Present Worth Factor
Calculate P ?
Given : F  $1254 , i  12% , N  2 Years

Solution : Remember :

 1  Fi , N  P(1  i ) N
P  $1254 *  2 1
 (1  0.12)   P / Fi , N 
(1  i ) N
P  $1000 (Present Worth Factor)

24
 Example 2: Present Worth Factor
Calculate Present Worth of $1,254 income (or expense) that
will occur in year 2? Remember :
Solution: Fi,N  P (1  i ) N

1
 P / Fi , N 
(1  i ) N
 1  (Present Worth Factor)
at i  0%, P  $1254 *  2
 $1254
 (1  0.0) 
 1 
at i  12%, P  $1254 *  2
 $1000
 (1  0.12) 
 1 
at i  15%, P  $1254 *  2
 $950
 (1  0.15)  25
Solution (cont.)
Present Worth of a sum of money of $1,254 that will be
received in year 2.
Conclusion: For given F, the higher the i, the lower the P.

$1254 i  0%
$1000 i  12%
$950 i  15%

0 1 2
26
 3. Compound Amount Factor or Series
Future Worth Factor (Uniform Series)
( F / A, i%, N ) F
0 1 2 3 .......................... N 1
N
A A A A A
 To find Future worth “F”, given “A”
 A = Equal annual amount of payment (annuity) starting
at the “end of period” 1, ending at “end of period” N.
 Example: retirement deposits
 For a 5 year period: First payment draws interest for 4 years,
and the fifth payment (last) receives no interest.
27
 Compound Amount Factor (Uniform
Series) F
0 1 2 3 .......................... N 1
( F / A, i%, N ) N

Future Worth : A A A A A

F  P(1  i ) N
P  A (annity amount) & Number of periods  N-1
F  A(1  i )  A(1  i )  ..  A(1  i )
0 1 N 2
 A(1  i ) N 1
 (1)
Multiply each side by (1  i )
F (1  i )  A(1  i )  A(1  i )  ..  A(1  i )
2 N 1
 A(1  i )  (2)
N

Subtract 1 from 2 and simplify;

28
 Result:
 (1  i ) N  1
F  A 
 i 
Where :
(1  i )  1
N
F / Ai , N 
i
is “Uniform Series Compound Amount Factor”

29
 4. Series Present Worth Compound
Factor (Uniform Series)
Used to calculate the present value “P” of a series of
future annuity payment “A”.
Knowing: Interest rate (i) and number of payment (N)

From previous slide :

 i (1  i ) N 
 A / Pi , N   
 (1  i )  1
N

 (1  i )  1
N
 P / Ai , N   N 
Series Present Worth Factor
 i (1  i )  30
 5. Sinking Fund Factor
(Uniform Series)
It allows the calculation of “A” that results in a given Future
amount “F”.
 (1  i ) N  1
From previous slide F  A 
 i 
 i 
A  F 
 (1  i )  1
N

Where :
i
A / Fi , N 
(1  i ) N  1
is called " Sinking Fund Factor ". 31
 6. Capital Recovery Factor
(Uniform Series)
Used to calculate the amount of each future annuity
payment “A” required to dissipate (pay a debt) of
a given present value “P”.
 Knowing: Interest rate (i) and number of payment (N)

P
1 2 3 4 N 1 N
0
A A A A A A
[ A / Pi , N , i, N ]
32
Capital Recovery Factor
(Uniform Series)

From before :
 i 
A  F  &  F  P (1  i ) N

 (1  i )  1
N

 i (1  i ) 
N
 A  P 
 (1  i )  1
N

 i (1  i ) 
N
 A / Pi , N  
 (1  i )  1
N

33
 Summary

PF F P i , N Compound Amount Factor

FP P Fi , N Present Worth Factor
A F F Ai , N Compound Amount Factor (U. Series)
FA A F i , N Sinking Fund Factor (U. Series)
PA A P i , N Capital Recovery Factor (U. Series)
A P P Ai , N Series Present Worth Factor

34
 Typical Assumptions
 All payments and receipts (transactions) during an
interest period are summed up and placed at the end of
the interest period. After transactions are assumed to take
place at the end of an interest period, time value of
money is considered.
 Interest rate is always provided per interest period. That
is, interest accumulated at the end of the interest period
as percentage of the principal.
 Interest period is typically taken as one year. This is
commonly assumed to be the length of the interest period
unless otherwise mentioned.
35
 Example: Future Worth & Present Worth

For cash flow shown below, find the future worth (F) at
the end of year 7 and the present worth (P).
Interest rate is 7%.

$500 $500 / yr

0 1 2 3 4 5 6 7 year

36
 Solution
$500

year

0 1 2 3 4 5 6 7

$500

0 1 2 3 4 5 6 7 year
 $500 / yr

0 1 2 3 4 5 6 7 year
37
 Solution (contd.)
Find F and P ? Given: A=$500, i=7, N=7.
Compound Amount Factor (single payment) (F/P,i%,N)
Fi , N / P  (1  i) N  1.60578

Compound Amount Factor (Uniform Series) (F/A,i%,N)

(1  i) N  1
F / Ai , N   8.65402
i

See Appendix D, in your textbook, for Factors. You either

calculate the factors or get them from the Appendix.
38
Solution (contd.)
F  P  ( F P,7%,7)  A  ( F A,7%,7)
F  $500  ( F P,7%,7)  $500  ( F A,7%,7)
 $500  (1.60578)  $500  (8.65402)
 $802.89  $4,327.01
 $5,129.9
1
Then, we can find P : P / Fi , N   0.62275
(1  i ) N

P  F  ( P F ,7%,7)  $5,129.9  (0.62275)

 $3,194.65
39
 Solution (another approach)
Using Series Present Worth Factor. (P/Ai,N ,i%,N)

 (1  i ) N  1
P / Ai , N   N 
 5.38929
 i (1  i ) 
P  $500  $500 * ( P A,7%,7)
P  $500  $500 * (5.38929)
P  $500  $2,694.65
P  $3,194.65
40
 Application of Interest Formulas
For the given payments, find: $1000 / yr
1. Present Worth
2. Future Worth
3. Annual Worth
0 1 2 6 10
at i = 6%

Present Worth (PW or P)

0 1 2 6 10

P  $1000  ( P A,6%,5)  ( P F ,6%,1)

P  $1000  4.21236  0.94340 (calculate or from tables)
P  $3973.94

41
 Application of Interest Formulas
Future Worth (FW) or (F) $1000 / yr
Same as:
0 1 2 6 10
Future Value (FV) or (F)

0 2 6 10
F  $1000 ( F A ,6%,5) * ( F P,6%,4)
F  $1000 * 5.63709 *1.26248
F  $7116.71

42
 Application of Interest Formulas
For the previous example, find the Equivalent Uniform
Annual Worth (EUAW, AW, or A)

0 1 10
A  P * ( A P,6%,10)
A  3973.94 * 0.13587
A  $539.94

43
 Example: Present Worth

Consider a loan of $8000 received 1 year ago. This loan

must be repaid at an interest rate i = 7%,
and the following revenues are predicted:
 End of period 0 (now) $5000
 End of period 1(1 yr. from now) $3000

Can this loan be paid out with only these two revenues?

44
 Solution
Income  $8000( F P ,7%,1Yr.)
at the end of period 0 :
Income  $8000(1  0.07)  $8560
1

Note: We are moving $8000 from Yr. –1 to Yr. 0

Therefore (F/Pi,N) is used.
1
0

$8000
45
 Solution (contd.)
Present Worth (PW) of Expenses at the end of Yr. 0

P  $5000  $3000( P F ,7%,1)

$5000
 1 
P  $5000  $3000 1
$3000
 (1  0.07) 
P  $5000  $2803.70 0 1 2
 PW of Expenses
P  $7803.70
Ans. NO revenues are less than the loan plus its interest
46
Example: Changing Interest Rates
Ontario Savings Bonds worth $10,000 were bought by
an engineer on January 12, 2010. The following interest
rates are payable by the Govt. of Ontario.

Yr. 1 : 5% F ?
Yr. 2 : 6%
Yr. 3 : 6.5%
P  $10000

Find Future Worth F ?

(on Jan 12, 2013) 5% 6% 6.5%
0 1 2 3
47
 Solution

F  $10000 * ( F P,5%,1Yr .) * ( F P,6%,1Yr .) * ( F P,6.5,1Yr .)

F  $10,000 * (1.05) * (1.06) * (1.065)
F  $11,853.45

Note: Calculate (F/P) or Use Appendix D for Discrete Compounding

Interest Factors. Interpolation is needed.

48
 Example: Future Worth
How much money will be in an account on April
19, 2013, if the following deposits are made?
Interest Rate = 7%
F ?

$1000 $1000 $1000 $1000

Apr.19, Apr.19, Apr.19, Apr.19,

2007 2009 2011 2013
49
Solution: Future Worth

F  $1000 * ( F P,7%,6Yrs.)
 $1000 * ( F P,7%,4Yrs.)
 $1000 * ( F P,7%,2Yrs.)
 $1000
 F  $4,956.30

50
 Example
A loan is repaid in the following series of payments. Find
the equivalent worth of these payments in 2015 and in
2005.
Given i = 6%.

A  $1000 / yr.

2005 2010 2011 2015

51
 Solution

F  A( F A , i, N )  $1000 * ( F A,6%,5Yrs.)
F  $1000 * (5.6370) "from tables OR calculatio ns" 1

F  $5,637
P  ( FW @ 2015) * ( P F ,6%,10Yrs.)
2
P  ($5,637) * (0.55840)  $3,147.70 1
2
A  $1000 / yr.

2005 2010 2011 2015

52
Another Approach
P(2010)  $1000 * ( P A ,6%,5 yrs.)
 $1000 * 4.2123  $4212.3

P(2005)  P(2010) * ( P F ,6%,5 yrs.)

 $4212.3 * 0.74726
 $3,147.68
A  $1000 / yr.

2005 2010 2011 2015

53
Effective Nominal Interest Rate

What is the equivalent

annual interest rate if
interest is calculated
every one month and
interest per one month
is 0.5%?

Answer is in the following section!

54
 Nominal vs. Effective Interest Rates:
 Annual interest rate computed as the product of
interest rate per period and the number of periods
per year
 Normally interest rates are normally quoted on an
annual basis
 Or Compounding several times within a year:
 Semiannually
 Quarterly
 Monthly
 Weekly
 Daily

55
 Nominal vs. Effective Interest Rates:
Note Statements:
“8% Compounded Quarterly”
When nothing is added about what 8% is then: [1] it is a
nominal rate ( r ) and [2] it is per year}.

If we want to know the interest rate per quarter (3 months),

then: iquarter = 8% / 4 (quarters per year) = 2%
 Effective Interest Rate ieff :
The true value of interest rate computed by equations for
compound interest for a 1-year period, regardless of the
length of the compounding period.
56
 Effective Interest Rate
The ratio of the interest charge (F-P) for 1 year to
the principle (P).
F P
i
P
m
 r
i  1    1
i = effective interest rate / year
 m
r = nominal interest rate / year
m = no. of compounding periods / year
57
Nominal and Effective Interest Rates with
Different Compounding Periods
Effective Rates
Nominal Rate Compounding Compounding Compounding Compounding Compounding
Annually Semi-annually Quarterly Monthly Daily

4% 4.00% 4.04% 4.06% 4.07% 4.08%

5 5.00 5.06 5.09 5.12 5.13

6 6.00 6.09 6.14 6.17 6.18

7 7.00 7.12 7.19 7.23 7.25

8 8.00 8.16 8.24 8.30 8.33

9 9.00 9.20 9.31 9.38 9.42

10 10.00 10.25 10.38 10.47 10.52

11 11.00 11.30 11.46 11.57 11.62

12 12.00 12.36 12.55 12.68 12.74

58
 Example
F = ? (after 1 year). Given P = $1 and
r = 12% Compounded semi – annually
12
isix _ months   6%
2
m = 2 periods of six months

59
 Solution
m
 r
F  P * 1  
 m
2
 0.12 
F  $1* 1    $1* (1  0.06)  $1.1236
2

 2 
F  $1* ( F P ,6%,2)  $1.1236
The Interest part  $1.1236 - $1  $0.1236
 Effective i yr  0.1236  12.36%
It is the same as obtained from :
m 2
 r  0.12 
ieff yr  1    1  1    1  0.1236  12.36%
 m  2 
60
 Example
Calculate F = ? (after 1 yr.). Given P = $10,000 and
r = 9% Compounded semi – annually.

9
isix_months   4.5%
2

m = 2 periods of six months duration.

61
 Solution
m
 r
Remember!! ieff  1    1
 m
  0.09  2

 F  $10,000 * 1  1    1  $10,920.25
  2  
 F  $10,000 * (1  0.045) 2  $10,920.25

The Interest part  $10,920.25 - $10,000

 $920.25 for $10,000
62
 Solution (contd.)
 $920.25 
Therefore Effective i yr    *100  9.203%
 $10,000 
Use of the equation
Nominal Rate  9%  r ; m  2
m 2
 r  0.09 
ieff   1    1  1   1
 m  2 
ieff  0.092025  9.203%
Effective Rate ieff / yr  9.203 %

63
Continuous Compounding, Discrete Cash Flow
Continuous Compounding is the ultimate limit for the
number of compounding periods in 1 year.(m →
infinity). Starting from:
m
 r
i  1    1 m
 m
r

 r
m
 r
m
r 
i  lim  1    1  lim   1    1
m 
 m m 
 m  
r
 r
m
r 
lim   1     e r
 i  e r
 1 ( where e  2.718)
 m 
m 
 64
Continuous Compounding Discrete Cash Flow
Tables available
Appendix D No Tables available
Discrete Continuous
Compounding Compounding
F
P (1  i) N (1  er  1) N  erN
(1  i )  1
N e rN  1
F
A e r . 1
. .i
. . .
NOTE:
. . .
We are not covering “Continuous Compounding, Continuous Cash
Flow” case. Please DO NOT use Appendix E.
65
 Effect of Discrete Compounding vs.
Continuous Compounding
Example:
Find the effective interest rate per year that corresponds
to a nominal rate of 10% / yr:

1. Compounded Semi – annually m = 2

2. Compounded Continuously m  

66
 Solution
(1) Compounded Semi – annually
r = nominal rate = 10% or 0.1 m=2
m
 r
i  1    1
 m
2
 0.1 
i  1    1
 2 
i  0.1025
i  10.25%

67
 Solution (contd.)
(2) Compounded Continuously
m
i  e r  1  e 0.1  1  0.1052
i  10.52%

Note:
 The higher the m, the higher the ieff/year
 We are using Continuous Compounding &
Discrete Cash Flow Case.

68
 Arithmetic - Gradient
Gradient series: A pattern of receipts or disbursements
(expenditure) for a series that has a uniform linear
(arithmetic or constant) or geometric increase in each
time period
2G 3G ( N  1)G A
G

Periods
0 1 2 3 4 N 0 1 2 3 N
1 N 
A  G  
 i 1  i   1
N

Used to find A, Given G

A  G A / G , i, N  69
 Arithmetic – Gradient Conversion
to Uniform Series
General Case
( N  2)G
G 2G ( N  1)G

A A A A A
0 1 2 3 N 1 N
How to recognize the pattern?
The pattern :
A, A  G, A  2G, A  3G,......, A  ( N  1)G
N , is the duration of the series

70
 Arithmetic – Gradient Conversion
to Uniform Series
Another Form

A  G A  2G

A

0 1 2 3 N 1 N

The pattern :
A, A  G, A  2G, A  3G,......, A  ( N  1)G
N , is the duration of the series

71
 Example
Find the Present Worth “P” of cash flow.Given: i = 12%
End of Year 1 2 3 4 5
Revenue $1000 $1250 $1500 $1750 $2000
Solution
G  $250 G  $250
$1000 / yr
$1000
yrs.  
0 1 2 3 4 5 0 1 5 0 1 2 5

P1 P2
P  P1  P2
72
 1 
Used to find A  GA / G, i, N 
N
A  G  
 i 1  i   1
N

Solution
G  $250 G  $250
$1000 / yr
$1000
yrs.  
0 1 2 3 4 5 0 1 5 0 1 2 5

P1 P2
P  P1  P2
P  P1  P2
P  AP / A,12%,5  G  A / G,12%,5* P / A,12%,5
P  $1000(3.6047)  $250(1.7745)(3.6047)
P  $5204
Note: N is equal to 5, not 4, because by definition of the
series, the first gradient value begins at period 2.
73
 Example
Find Future Worth “F”. Given: i = 10%, N = 5 yrs.
$1200 G  $200

0 1 2 3 4 5
Solution

F  AF / A,10%,5  $G  A / G,10%,5* F / A,10%,5

F  1200(6.105)  $200(1.8100)(6.1050)
F  $7,326.00  $2,210.01
F  $5,115.99

74
 Example: Cash Flow Analysis
Find P & F of the given cash flow. Given i = 6%.
End of Year 1 2 3 4 5
Revenue $1M $1.25M $1.50M $1.75M $2.00M
Solution
G  $0.25M
Note: The first G begins at Period 2.
$1M
yrs.
0 1 2 3 4 5
P  AP / A,6%,5  G  A / G,6%,5* P / A,6%,5
P
P  $1M (4.2123)  $0.25M (1.8833) * (4.2123)
P  $4.2123M  $1.9833M
P  $6.1956M 75
Solution

F  AF / A,6%,5  G  A / G,6%,5* F / A,6%,5

F  $1M (5.6370)  $0.25M (1.8833) * (5.6370)
F  $5.6370 M  $2.6540
F  $8.291M
To check : Use Present worth from above :
F  PF / P,6%,5 yrs   $6.1956(1.3382)
F  $8.291M " OK"

76
 Example: Arithmetic Gradient
For the given cash flow, calculate P & F. Given i = 6%.

G  $100 / yr

$1000

0 2 3 4 5 6 10

77
 Present Worth. Note Steps !
Solution
( P / A,6%,5) P
( P / F ,6%,1)

 
0 2 6 10 0 1 2 6 10 0 10

P  $1000  $100( A / G,6%,5) P / A,6%,5P / F ,6%,1

P  $1000  $100(1.88363) 4.212360.94340
P  $4722.47

78
Future Worth. Note Steps !
F

 
0 2 6 10 0 1 2 6 10 0 10

F  PF / P,6%,10  $4722.47(1.79085)

F  $8457.23
OR
F  $1000  $100 A / G,6%,5F / A,6%,5* F / P,6%,4
F  $8457.23
79
Geometric Series
General Form:

g % / yr

A
0 1 2 3 N

80
Geometric Series

End of Yr. Amount Present Worth

A(1  g )0
1 A(1  g )  A
0

(1  i )1
A(1  g )1
2 A(1  g )1
(1  i ) 2
:
:
N A(1  g ) N 1 A(1  g ) N 1
(1  i ) N

81
Note:
1
P / F , i, N  
(1  i ) N
N 1 
P  A (1  g ) k 1
k 
 k 1 (1  i ) 
From the above, it can be shown that :
1  (1  g ) N (1  i )  N 
for i  g P  A 
 ig 
 N (1  i ) k 1  N 1 
for i  g P  A k 
 A 
 k 1 (1  i )   k 1 (1  i ) 
P  ( NA) /(1  i )  ( NA) /(1  g )
82
 Example
Calculate P. Given A’=$1000, i=10%, g=8%, N=5
for i  g
1  (1  g ) N (1  i )  N  g%
P  A  P
 ig  A
1  (1.08) 5 (1  0.1) 5  0 1 2 5
P  $1000  
 0 . 1  0 .08 
P  $4,383
If i  8%,g  10%. P  $4 ,804
NA
If i  g  10%   5($1000) / 1.1  $4,545
(1  i ) 83
 Example
The revenue of the first year of an investment is $1,000. Due
to market contraction, the revenue is expected to decline by
8% for the next five years. Calculate the present worth of
these revenues.
Solution
Given i=10%, g=- 8% P
g  8%
1  (1  0.08)5 (1  0.1) 5 
P  $1000  A
 0 .1  ( 0.08) 
P  $3282 0 1 2 5

84
Joke of the day

"I'm a walking economy," a man was

overheard to say.

"My hairline's in recession, my waist

is a victim of inflation, and together
they're putting me in a deep
depression."

85