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Unconventional Equivalence

Calculations

Lecture No. 7
Professor C. S. Park
Fundamentals of Engineering Economics
Copyright © 2005
$200

Composite $150 $150 $150 $150

Cash Flows $100 $100 $100


$50

0
1 2 3 4 5 6 7 8 9

PGroup 1  $50( P / F ,15%,1)


 $43.48

PGroup 2  $100( P / A,15%,3)( P / F ,15%,1)


 $198.54
PGroup 3  $150( P / A,15%, 4)( P / F ,15%, 4)
 $244.85
PGroup 4  $200( P / F ,15%,9)
 $56.85
P  $43.48  $198.54  $244.85  $56.85
 $543.72
Unconventional Equivalence Calculations

Situation 1: If you make


4 annual deposits of
$100 in your savings
account which earns
10% annual interest,
what equal annual
amount can be
withdrawn over 4
subsequent years?
Unconventional Equivalence Calculations

 Situation 2:
What value of A
would make the two
cash flow
transactions
equivalent if i =
10%?
Multiple Interest Rates
Find the balance at the end of year 5. F=?

6% 6% 4% 4%
5%

0
2 4 5
1 3

$400
$300
$500
Solution
n  1:
$300( F / P, 5%,1)  $315
n  2:
$315( F / P, 6%,1)  $500  $833.90
n  3:
$833.90( F / P, 6%,1)  $883.93
n  4:
$883.93( F / P, 4%,1)  $400  $1, 319.29
n  5:
$1, 319.29( F / P, 4%,1)  $1, 372.06
Cash Flows with Missing Payments

P=?

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
0

$100

i = 10% Missing payment


Solution

P=? Add this cash flow to


$100 offset the change

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
0

$100
Pretend that we have the 10th
i = 10% payment
Approach

P=?
$100

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
0

$100

i = 10%

Equivalent Cash Inflow = Equivalent Cash Outflow


Equivalence Relationship

P  $100( P / F ,10%,10)  $100( P / A,10%,15)


P  $38.55  $760.61
P  $722.05
Unconventional Regularity in Cash Flow
Pattern
$10,000

i = 10%

1 2 3 4 5 6 7 8 9 10 11 12 13 14
0

C C C C C C C

Payment is made every other year


Approach 1: Modify the Original Cash
Flows
$10,000

i = 10%

1 2 3 4 5 6 7 8 9 10 11 12 13 14
0

A A A A A A A A A A A A A A

A  $10, 000( A / P,10%,14)


 $1,357.46
Relationship Between A and C
$10,000

i = 10%
1 2 3 4 5 6 7 8 9 10 11 12 13 14
0
C C C C C C C
$10,000

i = 10%
1 2 3 4 5 6 7 8 9 10 11 12 13 14
0

A A A A A A A A A A A A A A
Solution
A  $10,000( A / P,10%,14)
 $1,357.46

 
i = 10%

C C  A( F / P,10%,1)  A
 1.1A  A
 2.1A
A A
 2.1($1,357.46)
A =$1,357.46  $2,850.67
Approach 2: Modify the Interest Rate

 Idea: Since cash flows occur every other


year, let's find out the equivalent compound
interest rate that covers the two-year period.
 How: If interest is compounded 10% annually,
the equivalent interest rate for two-year
period is 21%.
(1+0.10)(1+0.10) = 1.21
Solution
$10,000
i = 21%
1 2 3 4 5 6 7
1 2 3 4 5 6 7 8 9 10 11 12 13 14
0
C C C C C C C

C  $10,000( A / P, 21%,7)
 $2,850.67