Petroleum Department Third Stage Petroleum Economics $934.58 .. $873.44 - $816.30- $2,624.32 = PVA, > Amount of an Annuity Due An annuity due is paid at the beginning of each period instead of at the end. It is essentially the same as an ordinary annuity that starts a period early but without the last payment. To solve such a problem: 1. Add 1 to the number of periods for the computation 2. After calculating the value for S, subtract the last payment. > Cash flows (FV) occur at the beginning of the period. pets eet] -R=Rseaiy -- (12) : Find the future value of an annuity due if payments of $500 are made at the beginning of each quarter for 7 years, in an account paying 6% compounded annually. Solution: Lecture3 8/12/2016Petroleum Department Third Stage Petroleum Economics 3 $1,070 ~ $1,145 +$1,225 $3,440 = FVAD,| coma ba Lecture3 8/12/2016Petroleum Department Third Stage Petroleum Economics $1,000.00 $1,900 $ 934.58- $ 873.44- - $2,808.02 = PVAD, Ordinary Annuity Annuity Due Future value Present value Future value a)" = Dre “|= — parm = ES es TRER Say Raa Lecture3 8/12/2016Petroleum Department Third Stage Petroleum Economics Amortizing Loan An important use of present value concepts is in determining the payments required for an installment-type loan. The distinguishing feature of this loan is that it is repaid in equal periodic payments that include both interest and principal. These payments can be made monthly, quarterly, semiannually, or annually. Installment payments are prevalent in mortgage loans, auto loans, consumer loans, and certain business loans. > Amortization Payments A loan of P dollars at interest rate i per period may be amortized in n equal periodic payments of R dollars made at the end of each period, where Pi To illustrate with the simplest case of annual payments, suppose you borrow $22000 at 12% compound annual interest to be repaid over the next 6 years. Equal installment payments are required at the end of each year. In addition, these payments must be sufficient in amount to repay the $22000 together with providing the lender with a 12% return. To determine the annual payment, R, we set up the problem as follows: > Amortization schedule A table showing the repayment schedule of interest and principal necessary to pay off a loan by maturity. End Of Principal Amount Installment Annual Principal Year Owing at Year End Payment Interest Payment 0 $22000 - - - 4 19289 $5351 $2640 $2714 2 16253 $5351 2315 3036 3 12853 $5351 1951 3400 4 9044 $5351 1542 3809 5 4778 $5351 1085 4266 6 0 $5351 573 4778 Total $3106 $10106 $22000 Lecture3 8/12/2016Petroleum Department Third Stage Petroleum Economics Inflation In an inflationary economy, the money received today, has more purchasing power than the money to be received in future. In other words, a dollar today represents a greater real purchasing power than a dollar a year hence. Inflation erodes the purchasing power of money. For example, suppose there is an annual rate of inflation of 3%, Then $1000 worth of purchasing power now will be worth only $970 in one year. In general, for an annual inflation rate of r%, the amount A that $P will purchase after n years is A=P (1-41)9 — — (13) A) Suppose the inflation rate is 4%, After 4 years, how much will $1000 purchase? B) Suppose the inflation rate is 3%. How long will it take until purchasing power is halved? Solution: Lecture3 8/12/2016