Usage of Compound Interest Tables.

Feb 8-12. 1

Review Inflation Feb 1-5. 2

Exercise 1:

A press at an automotive supplier is expected to have a life of 10 years and its cost is
expected to be $3’000,000. If the inflation is estimated to be 6% per year, how much would
we need to separate today in real dollars?

Exercise 2:
You have 2,500 USD today (current dollars). With an inflation rate of 5% every year,
what would your purchasing power be after 15 years?

Exercise 3:
At 4% annual inflation, how much will 15,000 USD be worth in 20 years?

Answer 1:

R​n​ = C​n​ / (1 + f)​ n

R​15​ = $3’000,000 / (1 + 0.06)​10
R​15​ = $1,675,184

Answer 2:
R​n​ = C​n​ / (1 + f)​ n
R​20​ = $2,500 / (1 + 0.05)​15
R​20​ = $1,202.54

Exercise 3:
R​n​ = C​n​ / (1 + f)​ n
R​20​ = $15,000 / (1 + 0.04)​20
R​20​ = $6,845.80
Compound Interest Factors and Patterns of Cash Flows
In order to “play the game” of Engineering Economics, let us study the three rules for
the game that we need to know.

1. Rule and Pattern number 1:

N= Number of time periods (typically years but it could be months)

i= Interest rate over the time period
P= Present Value (Worth) of Future amounts ($)
F= Future Value (Worth) of Present amounts ($)

Provided that we know i and N and either one of P or F, we can use the following two
formulas:
P = F ​(P / F, i, N)
F = P ​(F / P, i, N)

What is ​highlighted​ is called ​Compound Interest Factors.

2. Rule and Pattern Number 2:

N= Number of time periods (typically years but it could be months)

i= Interest rate over the time period
P= Present Value (Worth) of Annual amounts ($)
A= Annual Value (Worth) of Present amounts ($)

Provided that we know i and N and either one of P or A, we can use the following two
formulas:

P = A ​(P / A, i, N)
A = P ​(A / P, i, N)
 3. Rule and Pattern Number 3:

N= Number of time periods (typically years but it could be months)

i= Interest rate over the time period
A= Annual Value (Worth) of Future amounts ($)
F= Future Value (Worth) of Annual amounts ($)

Provided that we know i and N and either one of P or A, we can use the following two
formulas:

F = A ​(F / A, i, N)
A = F ​(A / F, i, N)

Again, the ​highlighted factors are called ​Compound Interest Factors. ​And, the six
formulas presented in the three rules (two formulas for each rule) are called the Time Value
of Money Equations. They will allow us to know what variables I know, what variables I do
not know.

Given I and N and any one of P, A, and F, the other two values can be calculated.

P/F Present Value of a Future Sum

P/A Present Value of an Annual Sum
A/F Annual Value of a Future Sum
A/P Annual Value of a Present Sum
F/P Future Value of a Present Sum
F/A Future Value of an Annual Sum
 Given the interest rate (I) and the number of years (N) use the following formulas:

You may find the compound interest tables in the following link:
https://global.oup.com/us/companion.websites/9780199778126/pdf/Appendix_C_CITables.p
df

Example 1: Future (F) Value of a Present (P) Sum.

$2,000 is deposited into a savings account that earns 6 % interest. What is the future value
of this deposit after 10 years?
F = P * (F/P) = $2,000 * 1.791 = $3,582.00

What is the Present (P) value? P = P = $2,000

Example 2: Future (F) Value of an Annual (A) Sum.

$2,000 will be deposited annually into a savings account that earns 6 % interest. What is the
future value of these deposits after 10 years?
F = A * (F/A) = $2,000 * 13.181 = $26,362.0

Example 3: Present (P) Value of an Annual (A) Sum.

$2,000 will be deposited annually into a savings account that earns 6 % interest. What is the
present value of these deposits for 10 years?
P = A * (P/A) = $2,000 * 7.3601 = $14,720.20

Example 4: Present (P) Value of a Future (F) Sum.

A car dealer agrees to let you pay $20,000 at the end of 10 years at the future value of dollar
in 10 years for a car that you can start using now. What is the cost of this car today at 6%
interest rate?
 P = F * (P/F) = $20,000 * 0.5584 = $11,168.00

Example 5: Annual (A) Value of a Future (F) Sum.

The parents of an 8 year old child estimate that they will need $80,000 (future dollars) in 10
years for the child's college education. How much must they deposit (in present dollar value)
each year for the next 10 years at 6% interest to have $80,000 in the bank 10 years from
now?
A = F * (A/F) = $80,000 * 0.07587 = $6,069.60

Note that $6,069.60 times 10 year is $60,696 and not $80,000. The first years deposit earns
interest for 10 years, the second years deposit earns interest for 9 years, etc.

Example 6: Annual (A) Value of a Present (P) Sum.

The loan on a car is $20,000 and the payment period is 10 years. What is the annual
payment with an interest rate of 6%?
A = P * (A/P) = $20,000 * 0.13587 = $2,717.40 ($226.45/month)

Note if the payments are paid monthly then the principal is reduced every month and the
monthly payment is $222.05 which is less than $2,717.40 / 12 = $226.45.

What is the total cash payment and how much was paid in interest?

Cash paid = $2,717.40 * 10 years = $27,174.00. Interest = $27,174 - $20,000 = $7,174.

Single Payment Compound Amount Factor

Exercise:
Use the compound interest table to find the final amount of each of the following
investments.
a. $2400 at 8% p.a. for 12 years
b. $6500 at 3% p.a. for 5 years
c. $8750 at 15% p.a. for 4 years
d. $11 000 at 6% p.a. for 10 years
e. $7024 at 20% p.a. for 2 years
f. $16 250 at 4% per month for 12 months
g. $13 700 at 5% per month for 8 months
h. $21 600 at 12% p.a. compounded monthly for 7 months
i. $8020 at 12% p.a. compounded quarterly for 2 years
j. $9785 at 10% p.a. compounded half-yearly for 3 years

Answers:
a. $6,043.20
b. $7,533.50
c. $15,303.75
d. $19,701
e. $10,114.56
 f. $26,016.25
g. $20,234.90
h. $23,155.20
i. $10,161.34
j. $13,111.90

Single Payment Present Worth Factor

Exercise:
1
(P / F, i, N) = ---------
(1 + i)​ n
Equivalent present value of 100 USD today in 5 years from now assuming an interest rate of
10%?
(P / F, i, N) = ( P / F, 10%, 5 yrs)
(P / F, i, N) = 0.6209
P = F (P / F, i, N)
P = 100 (0.6209)
P = 62.09

Uniform Payment Series Capital Recovery Factor

Exercise.
A company is considering the purchase of a piece of equipment that costs $5,000 and has a
life of 5 years. If the interest rate is 8%, how much will the equipment have to save every
year in order to recover the initial investment (purchase) amount?

A = P ( A / P, i, N)
A = $5,000 ( A / P, 8%, 5 years)
A = $5,000 (0.2505)
A = $1,252.50

Value of the savings that have to occur each year, in order for this investment to pay for itself
completely. The five yearly payments that are equivalent to the initial investment.
i ( 1 + i )​n
(A / P, i, N) = --------------
(1 + i)​ n​ - 1

Exercise:
 Brian receives $400,000 for winning a contest. He wishes to put these winnings into
an account and make a series of yearly withdrawals exhausting the account over the next 20
years. How much can Brian withdraw if his account earns 5%?

A = P ( A / P, i, N)
A = $400,000 ( A / P, 5%, 20 years)
A = $400,000 (0.0802)
A = $32,097.00

The factor for the twenty yearly withdrawals that will exhaust the initial investment.
i ( 1 + i )​n
(A / P, i, N) = --------------
(1 + i)​ n​ - 1

Exercise:
Suppose that $30,000 is borrowed today at 12% interest. The loan is to be repaid by
uniform annual payments for 5 years, beginning 1 year from now. Calculate the annual
payment.

A = P (A / P, 12%, 5) = $30,000 (0.2774) = $8,322 per year

A = P ( A / P, i, N)
A = $30,000 ( A / P, 12%, 5 years)
A = $30,000 (0.2774)
A = $8,322.00

The factor for the five yearly payments that will cover the initial loan.

i ( 1 + i )​n
(A / P, i, N) = --------------
(1 + i)​ n​ - 1

Exercise:
A person is considering the purchase of a used automobile. The total price is $6,200
with a down payment of $1,240 and the balance paid in 48 months equal monthly payments
with interest at 1% per month. The payments are due every month. Compute the monthly
payments.

A = P ( A / P, i, N)
A = $4,960 ( A / P, 1%, 48 months)
A = $4,960 (0.0263)
A = $130.45

The factor for the forty eight months that this person would have to pay may be obtained
with:
i ( 1 + i )​n
(A / P, i, N) = --------------
(1 + i)​ n​ - 1

Uniform Payment Series Sinking Fund Factor

Exercise:
 Betty’s goal is to have $200,000 in twenty years. How much money must she invest
at the end of each year in an account with an interest rate of 6% compounded annually?

A = F ( A / F, i, N)
A = $200,000 ( A / F, 6%, 20 years)
A = $200,000 (0.0272)
A = $5,440.00

The twenty year investment could also be calculated using the following formula for the
factor:
i
(A / F, i, N) = -----------------
(1 + i)​ n​ - 1

Exercise:
A company has to replace a present facility after 15 years that is estimated to cost
5’000,000. It plans to deposit an equal amount at the end of every year for the next 15 years
at an interest rate of 18% compounded annually. Find the equivalent amount that must be
deposited at the end of every year for the next 15 years.

A = F ( A / F, i, N)
A = $5’000,000 ( A / F, 18%, 15 years)
A = $5’000,000 (0.0164)
A = $82,000.00

The investment that this company has to do every year to be able to have 5’000,000 at the
end of 15 years could also be calculated using the following formula for the factor:

i
(A / F, i, N) = -----------------
(1 + i)​ n​ - 1

Exercise:
A woman wishes to make a uniform deposit every three months to her savings
account so that at the end of 10 years she will have $10,000 in the account. If the account
earns 6% annual interest, compounded quarterly, how much should she deposit each three
months?

A = F ( A / F, i, N)
A = $10,000 ( A / F, 6% / 4, 10 years = 40 quarters)
A = $10,000 (0.0184)
A = $184.00

The woman must deposit $184 every quarter to be able to have 10,000 at the end of
10 years. The formula to calculate the factor would be:

i
(A / F, i, N) = -----------------
(1 + i)​ n​ - 1

Uniform Payment Series Compound Amount Factor

Exercise:
Sally makes regular payments of $1,250 every month into an account that gives her
12% interest annually compounded monthly. What will the balance be after 36 months?
F = A (F / A, i, N)
F = $1,250 (F / A, 12% / 12, 36 months)
F = 1,250 (43.077)
F = $53,846.25

( 1 + i )​n ​- 1
F= A x ------------------
i

( 1 + 0.01 )​36 ​- 1
F = $1,250 x ----------------------
0.01

Exercise:
Assume you save $4,000 per year and deposit it at the end of the year in a savings
account that gives you 6% interest rate per year compounded annually, for 20 years. How
much money will you have at the end of the 20th year?
F = A (F / A, i, N)
F = $4,000 (F / A, 6%, 20 months)
F = $4,000 (36.786)
F = $147,144

( 1 + i )​n ​- 1
F=A x ----------------------
i

( 1 + 0.06 )​20 ​- 1
F = $4,000 x ----------------------
0.06

Exercise:
If $100 is deposited at the end of each year in a savings account that pays 6%
interest per year, how much will be in the account at the end of the 5 years?

F = A (F / A, i, N)
F = $100 (F / A, 6%, 5 years)
F = $100 (5.637)
F = $563.70

( 1 + i )​n ​- 1
F=A x ----------------------
i

( 1 + 0.06 )​5 ​- 1
F = $100 x ----------------------
0.06
Exercise:
A couple wants to get monthly payments of $232.50 for 10 years with an interest rate
of 1% per month. How much must the couple deposit in order to be able to obtain this
monthly quantity?

P = A (P / A, i, N)
P = $232.50 (P / A, 1%, 120 months)
P = $232.50 (69.701)
P = $16,205.48

( 1 + i )​n ​- 1
P=A x ----------------------
i

( 1 + 0.01 )​120 ​- 1
P= $232.50 x ----------------------
0.01

Uniform Payment Series Present Worth Factor

Exercise:
What is the Present Value of a series of $3,250 payments made every month for 3
years in an account with an interest rate of 6% compounded monthly?
P = A (P / A, i, N)
P = $3,250 (P / A, 6% / 12 months = 0.005, 36 months)
P = $3,250 (32.871)
P = $106,830.75

( 1 + i )​n ​- 1
(A / P, i, N) = (-----------------)
i (1 + i)​ n

( 1 + 0.005 )​36 ​- 1
P =A x (-----------------------------)
0.005 (1 + 0.005)​ 36

Exercise:
Suppose that ​a recent college graduate has $3,000 available as a down payment on
a new car. The graduate can afford a uniform car loan payment of no more than $500 per
month for 48 months, beginning 1 month from now. Interest is 6%, compounded monthly.
What is the most that the graduate can spend today on a new car?

Let X = most can spend (budget).

X = PV + $3,000
A = $500 per month
i = 0.5% per month (6% / 12 months)
n = 48 months
( 1 + i )​n ​- 1
(A / P, i, N) = (-----------------)
i (1 + i)​ n

PV = A [ (1 + i) n​ ​- 1 ] / [ i (1 + i) n​ ​]
= $500 [ (1.005) 48​ ​ - 1 ] / [ (0.005) (1.005) 48​
​ ] = $21,290
Or, using the 0.5% interest table, which is quicker:
PV = A (P/A,0.5%,48) = $500 ( 42.580 ) = $21,290
X = $21,290 + $3,000 = $24,290

Exercise:
Consider a lottery that is held in a country. In this particular lottery, the winner is
given three different payment options. The first is a lump sum payment immediately of
$1’000,000. The second is a series of 21 annual payments of $50,000. The third is a
whopping $2’000,000 to be paid ten years from now. How does the winner choose which
option to take? Of course, that will depend on the winners personal needs, but beyond that,
taking into consideration the financial aspect only, which option is the best? Let’s assume
that the person who won the lottery knows that he can make 5% interest on the money in
some safe investment.

Present Value = $1’000,000.

Annuities = $50,000
Final Value = $2’000,000
i = 5%
n = 5

1. FV = PV (1 + i)​n
FV = $1’000,000 (1 + 0.05)​10
FV = $1’628,894

3. PV = FV / (1 + i)​n
PV = $2’000,000 / (1 + 0.05)​10
PV = $1’227,826
(1+i)​n​ - 1
2. FV = A x ------------
i
(1 + 0.05)​21​ - 1
FV = 50,000 x -----------------------
0.05
FV = $1,785,962

FV = PV (1 + i)​n
FV = $1’000,000 (1 + 0.05)​21
FV = $2’,785,962