CASH FLOW

Time value of the money (TVM)

• The time value of money seems like a sophisticated concept, yet it is one
that you grapple with every day. Should you buy something today or save
your money and buy it later? Here is a simple example of how your buying
behavior can have varying results: Pretend you have $100 and you want to
buy a $100 refrigerator for your dorm room. If you buy it now, you end up
broke. But if you invest your money at 6% annual interest, then in a year
you can still buy the refrigerator, and you will have $6 left over. However,
if the price of the refrigerator increases at an annual rate of 8% due to
inflation, then you will not have enough money (you will be $2 short) to
buy the refrigerator a year from now. In that case, you probably are better
off buying the refrigerator now (Case 1 in Figure 2.1). If the inflation rate is
running at only 4%, then you will have $2 left over if you buy the
refrigerator a year from now (Case 2 in Figure 2.1).
• Earning power Vs. Purchase power
• Earning power> purchase power= buy in future
• Earning power < purchase power = Buy now
 Elements of Transactions Involving Interest

Many types of transactions involve interest-e.g., borrowing money, investing money, or purchasing
machinery on credit-but certain elements are common to all of these types of transactions:
1. The initial amount of money invested or borrowed in transactions is called the principal (P).
2. The interest rate (i) measures the cost or price of money and is expressed as a percentage per
period of time.
3. A period of time called the interest period (n) determines how frequently interest is calculated.
(Note that, even though the length of time of an interest period can vary, interest rates are
frequently quoted in terms of an annual percentage rate.
4. A specified length of time marks the duration of the transaction and thereby establishes a certain
number of interest periods (N).
5. A plan for receipts or disbursements (A) that yields a particular cash flow pattern over a
specified length of time. (For example, we might have a series of equal monthly payments that
repay a loan.)
6. A future amount of money (F) results from the cumulative effects of the interest rate over a
number of interest periods.
 Example 1

• Suppose you deposit $1,000 in a bank savings

account that pays interest at a rate of 8% per year.
Assume that you don't withdraw the interest earned at
the end of each period (year), but instead let it
accumulate. How much would you have at the end of
year three with simple interest?
Solution:
 Compound interest
• It is Interest on interest
• in the previous example if compound interest has been considered the gain will be
considered
 Economic equivalent
• Economic equivalence refers to the fact that a cash flow whether a single
payment or a series of payments can be converted to an equivalent cash
flow at any point in time.
• 𝐹 = 𝑃 1+𝑖 𝑁
• Notation the factor (F/P, i, N)= 1 + 𝑖 𝑁
• F: future value
• P: present value
• i: interest rate %
• N: duration
 Present and future value
• To find future value from
present value we multiply by
discount factor
𝑁
• 1/ 1 + 𝑖
 Example 2
• Suppose you are offered the alternative of receiving either
$3,000 at the end of five years or P dollars today. There is
no question that the $3,000 will be paid in full (i.e., no
risk). Because you have no current need for the money,
you would deposit the P dollars in an account that pays
8% interest. What value of P would make you indifferent
to your choice between P dollars today and the promise of
$3,000 at the end of five years?
Solution
Example 3
Solution
 Using excel sheet

• the excel syntax to find present value for even cash

flow is Bracket means that
this input is optional
• =PV(rate, nper, pmt, [fv], [type])
• For uneven cash flow:
• =NPV(rate, cah flow 1, cash flow 2,….)
 Example 4
• Suppose that you are offered an investment that will pay the following cash
flows at the end of each of the next five years
period cash flow

0 0

1 100

2 200

3 300

4 400

5 500

How much would you be willing to pay for this investment if your required
rate of return is 12% per year?
 Solution

• Using the excel syntax

• =NPV(rate, cah flow 1, cash flow 2,….)
• =NPV(12%, 100, 200, 300, 400, 500)=1000.18$
• Regarding the future value please visit the link
• http://www.tvmcalcs.com/index.php/calculators/excel
_tvm_functions/excel_tvm_functions_page3
 Example 5: Solving for i
• Suppose you buy a share of stock for $10 and sell it for $20; your profit is thus $10.
If it takes five years, what would be the rate of return on your investment? (See
Figure 2.11.)
Solution
 Cont’
Pmt: payments the amount of money you pay
• Method 3: excel sheet or receive weekly, monthly, yearly, ….. Etc.

Nper: number of payments (duration)

[type]: is a logical value at the beginning of

payment =1
At the end of payment =0

[pv]: present value of the money

[fv]: future value of the money

Some details
may be
found in
function
icon
 Example 6: Finding N
You have just purchased 100 shares of General Electric stock at $30 per share.
You will sell the stock when its market price doubles. If you expect the stock
price to increase 12% per year, how long do you expect to wait before selling
the stock (Figure 2.12)
Cont’
Cont’
 Net present worth
evaluation of single project
• Pw criterion
• If PW(i) > 0, accept the investment.
• If PW(i) = 0, remain indifferent.
• If PW(i) < 0, reject the investment.
 Example 7
• Tiger Machine Tool Company is considering the acquisition of a new metal cutting
machine. The required initial investment of $75,000 and the projected cash benefits
over a three-year project life are as follows:

You have been asked by the president of the company to evaluate the economic merit of
the acquisition. The firm's MARR( minimum attractive rate of return) is known to be
15%.
sol
Selection criteria
Example 8
Two projects are available to develop a chemical plan. Which
one should be selected? Take i= 10%
Solution check
it
Example 9
In general, we can use factors to find the cash flow
Conclusion
F: Future, P: Present, A: Annual, G: gradation
Convert Symbol Formula
𝑛
P to F (F/P, i%, n ) 1+𝑖
F to P (P/F, i%, n ) 1 + 𝑖 −𝑛
1+𝑖 𝑛−1
A to P (P/A, i%, n) 𝑖 1+𝑖 𝑛
P to A (A/P, i%, n) 𝑖 1+𝑖 𝑛
1+𝑖 𝑛−1
𝑖
F to A (A/F, i%, n) 1+𝑖 𝑛−1
A to F (F/A, i%, n) 1+𝑖 𝑛−1
𝑖
𝑛
G to P (P/G, i%, n) 1+𝑖 −1 𝑛
−
𝑖2 1 + 𝑖 𝑛 𝑖 1+𝑖 𝑛
 Present Worth Comparison of Different-Lived Alternatives

• In the previous examples, the useful life of each

alternative was equal to the analysis period. But, there
will be many situations where the alternatives have
useful lives different from the analysis period. one
method is to select an analysis period which is the
least common multiplier of the lives of both
equipment.
 Example
• A purchasing agent is considering the purchase of some
new equipment for the mailroom. Two different
manufacturers have provided quotations. An analysis of the
quotations indicates the following:

• Which manufacturer’s equipment should be selected?

Assume 7% interest rate and equal maintenance cost.
 Solution

• As equipment a has a useful life of 5 years and B has useful life of 10

years, one method is to select an analysis period which is the least common
multiplier of the lives of both equipment. Thus, we would compare the ten-
year life of B against an initial purchase of A plus its replacement with a
new one with the same values. The basis is to compare both alternatives on
10-years period.
 Example :

• Make a present-worth comparison of the

different-life machines for which costs are
shown below, if i = 15%. Which machine would
you select?
equal-payment-series compound amount
factor
• uniform- series compound-amount factor
 Example 1

• Suppose you make an annual contribution of $5,000

to your savings account at the end of each year for
five years. If your savings account earns 6% interest
annually, how much can be withdrawn at the end of
five years
solution
 Using excel sheet

Using attachments
 Deposing at the beginning of time
• In Example 2.9, the first deposit of the five-deposit
series was made at the end of period one, and the
remaining four deposits were made at the end of each
following period. Suppose that all deposits were made
at the beginning of each period instead. How would
you compute the balance at the end of period five?
Solution
 Equivalent Uniform Annual Worth Analysis
• Instead of computing equivalent present sum, in this
section alternatives could be compared based on
their equivalent annual costs (cash flows). Based on
particular situation, the equivalent uniform annual
cost (EUAC), the equivalent uniform annual
benefits (EUAB), or their difference could be
calculated. The major advantage of this method is
that it is not necessary to make the comparison over
the same number of years when the alternatives
have different lives. The reason for that, it is an
equivalent annual cost over the life of the project .
 Example :
• If the minimum required rate of return is 15% which
project should be selected?
Gradient series cash flow (linear series)
 Example :
A firm is considering which of two mechanical devices
to install to reduce costs in a particular situation. Both
devices cost LE1000 and have useful lives of five years
and no salvage value. Device A is expected to result in
LE300 savings annually. Device B will provide savings
for LE400 the first year but will decline LE50 annually.
With interest rate 7%, which device should the firm
purchase?
 Solution

LE 1000 LE 1000
 Example

• So, what could be better than winning a Super Lotto

Plus jackpot? Choosing how to receive your
winnings! Before playing a Super Lotto Plus jackpot,
you have a choice between getting the entire jackpot
in 26 annual graduated payments or receiving one
lump sum that will be less than the announced
jackpot. Take i=4.5% starting from 2 year
Example
Solution
 mixed types of cash flows.
• To illustrate, consider the cash flow stream shown in the next Figure. We want to
compute the equivalent present worth for this mixed-payment series at an interest
rate of 15%. Two different methods are presented:
Method 1: A "brute force" approach is to multiply each payment by the appropriate
(P/F, 10%. n) factors and then to sum these products to obtain the present worth of the
cash flows. $543.72 in this case. Recall that this is exactly the same procedure we used
to solve the category of problems called the uneven- payment series, which were
described previously this computational method. Excel is the best tool for this type of
calculation.
Method 2: We may group the cash flow components according to the type of cash flow
pattern that they fit. such as the single payment, equal-payment series, and so forth, as
shown in next Figure. Then the solution procedure involves the following steps:
Method 1 brute force approach
method 2 grouping approach
 Compound interests
• Compound interest is the addition of interest to
the principal sum of a loan or deposit, or in other
words, interest on interest. It is the result of
reinvesting interest, rather than paying it out, so that
interest in the next period is then earned on the
principal sum plus previously-accumulated interest.
Compound interest is standard in finance and
economics.
 Compounding Frequency (n)
• The compounding frequency is the number of times per year (or
other unit of time) the accumulated interest is paid out,
or capitalized(credited to the account), on a regular basis. The
frequency could be yearly, half-yearly, quarterly, monthly, weekly,
daily.
• For example, monthly capitalization with annual rate of interest
means that the compounding frequency is 12, with time periods
measured in months.
• The effect of compounding depends on:
1. The nominal interest rate which is applied and
2. The frequency interest is compounded.
Compounding frequency
 Calculation of compound interests
• F=P (F/P, i, n)
• Compounding for more than one time during specific period of time
𝑖 𝑚𝑡
• 𝐹 =𝑃 1+
𝑚
• t: times in years
• m: compounding number a year.
• m= 365 for daily compounding
• m= 4 Quarterly compounding
• m= 12 monthly compounding discrete compound
• m= 1 for annual compound
 Example
• Suppose a principal amount of $1,500 is deposited in a bank paying an
annual interest rate of 4.3%, compounded quarterly after six years.
• Find the amount of the interest received
sol: the balance after 6 years is found by using the formula above, with P =
1,500, r = 4.3%,
n = 4, and t = 6:
𝑖 𝑚𝑡
• F= 𝑃 1 +
𝑚
0.043 4∗6
• F= 1500 1 + ≈ 1938.84
4
• The amount of the interests =1938.84-1500=438.84
Example 8
 Continuous compound
The preceding discussion of types of interest has considered only the common
form of interest in which the payments are charged at periodic and discrete
intervals, where the intervals represent a finite length of time with interest
accumulating in a discrete amount at the end of each interest period. Although in
practice the basic time interval for interest accumulation is usually taken as one
year, shorter time periods can be used as, for example, one month, one day, one
hour, or one second. The extreme case, of course, is when the time interval
becomes infinitesimally small so that the interest is compounded continuously.
Continuously 𝒎 → ∞

𝑭 = 𝑷𝒆𝒊𝒕
 example
• For the case of a nominal annual interest rate 20%
determine:
a) the total amount to which one dollar of initial
principal would accumulate after one 365day year
with dai1y compounding.
b) the total amount to which one dollar of initial
principal would accumulate after one year with
continuous compounding.
Solution
 Example :

• If you invest 1000000$ in an account paying 12%

compounded continuously, how much will you have
in the account in 20 years.
• solution