Cash Flow Diagrams

-a graphical representation of cash flows drawn on a time scale

Meaning of the arrows in the cash flow diagram:

An arrow pointing upwards represents a receipt (cash inflow)

An arrow pointing downwards represents a disbursement (cash outflow)

Illustration:
A loan of P 100 at simple interest of 10% will become P 150 after 5 years.

A. Lender’s Viewpoint
P 150

Ist yr 2 nd yr 3rd yr 4th yr 5th yr

_____I_____I_____I_____I_____I_

P 100

B. Borrower’s Viewpoint
P 100

Ist yr 2 nd yr 3rd yr 4th yr 5th yr

_____I_____I_____I_____I____I_

P 150

Example:
Annual deposits were made in a fund earning 10% per annum. The first deposit was P2,000 and
each deposit thereafter was P 200 less than the preceding one. Determine the amount in the
fund after the sixth deposit.
Solution:

Ist yr 2 nd yr 3rd yr 4th yr 5th yr

__________I__________I__________I__________I_________I

P2,000 P1,800 P1,600 P1,400 P1,200 P1,000

i = r/m = 0.10/1 = 0.10

F = 2,000 (1+0.10)5 + 1,800 (1+0.10)4 + 1,600 (1+0.10)3 + 1,400 (1+0.10)2 + 1,200 (1+0.10)1 + 1,000

F = P 12,000 (Answer)

Equation of Value
-is obtained by equating the sum of the values on a certain comparison or focal date of one set
of obligations (payments) to the sum of the values on the same date of another set of
obligations (payments)

Example:
A debt of P15,000 was paid for as follows:
P4,000 at the end of 3 months
P5,000 at the end of 12 months
P3,000 at the end of 15 months
A final payment F at the end of 21 months.
If the rate of interest was 18% compounded quarterly, find the final payment F.

Solution:

P15,000

3 mos. 6 mos. 9 mos. 12 mos. 15 mos 18 mos. 21 mos.

_________I__________I__________I__________I_________I_________I_________I

P4,000 P5,000 P3,000 F=?

n=7

i = r/m = 0.18/4 = 0.045

Equate the sum of the present values of all payments to the amount of the loan of P 15,000
15,000 = 4,000 (1+0.045)-1 + 5,000 (1+0.045)-4 + 3,000 (1+0.045)-5 + F (1+0.045)-7

Solving for F:

F = 4,572.09 / 0.73483

F = P6,221.97 (Answer)

Exercise

An engineer is considering the purchase of a machine that is expected to be obsolete in 5 years. The
machine is worth P100,000. The prevailing rate of interest is 15%. The estimate of the annual gross
incomes from the use of the machine is as follows:

Year: 1 2 3 4 5
Income: P20,000 P25,000 P35,000 P30,000 P28,000

Should the machine be purchased by the engineer? Draw a cash flow diagram (in the perspective of the
engineer) as a part of your analysis. (Hint: the engineer should buy the machine if the present worth of
all the incomes is greater than its price)