ES 312b - Engineering Economy 1st Sem, S.Y.

2020-2021

MODULE 4
Principles of Money-Time Relationship (Part 2)

After completing this module, you are expected to:

1. Perform Interest Formulas Relating Uniform Series Present and Future
Equivalent Values.
2. Solve for Annuity

Relating a Uniform Series (Annuity) to Its Present

and Future Equivalent Values
READ (IMPORTANT!)
Annuity - a series of uniform (equal) receipts (or
payments), each of amount A, occurring at the end of • Page 18 to 29
each period for N periods with interest at i% per Textbook: Engineering
period. The notations involved here are: Economy, 3rd
Ed. (Sta. Maria)
1. P (present equivalent value) occurs one interest
READ (IMPORTANT!)
period before the first A (uniform amount).
2. F (future equivalent value) occurs at the same • Page 123 to 133
time as the last A, and N periods after P.
Textbook: Engineering
3. A (annual equivalent value) occurs at the end of Economy, 16th
periods 1 through N, inclusive. Ed.

Ordinary Annuity
The first cash flow being made is at the end of the first period,

1. Finding F when given A

(𝟏 + 𝒊)𝑵 − 𝟏
𝐅 = 𝐀[ ]
𝒊
𝐅 = 𝐀(𝑭/𝑨, 𝒊%, 𝑵)
Where:
(𝟏+𝒊)𝑵 −𝟏
[ ] = (𝑭/𝑨, 𝒊%, 𝑵) - Uniform Series Compound Amount Factor
𝒊

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Engr. Ryan James S. Olivo
ES 312b - Engineering Economy 1st Sem, S.Y. 2020-2021

Example: If eight (8) annual deposits of $187.45 each are placed in an account.
How much money has accumulated immediately after the last deposit? Interest
rate is 10%.

(1 + 0.10)8 − 1
F = A(𝐹/𝐴, 10%, 8) = $187.45 [ ]
0.10
𝐅 = $𝟐, 𝟏𝟒𝟑. 𝟔𝟎

If the principle of money-time relationship is not considered (i.e. disregarding

interest rate), the accumulated amount at the end of eight (8) annual deposits is
just F = 8*$187.45 = $1,499.6. This is not how money should work with time.
Therefore, do not just store money in your piggy bank, invest it or put it in a bank.

Example: Who wants to be a millionaire by saving Php 1.00 a day? “If you are 20
years of age and save Php 1.00 each day for the rest of your life, you can become a
millionaire.” Let’s assume that you live to age 80 and that the annual interest rate
is 10% (i = 10%). Under these specific conditions, we compute the future
compound amount (F) to be:

(1 + 0.10)60 − 1
F = Php 365(𝐹/𝐴, 10%, (80 − 20 = 60)𝑦𝑒𝑎𝑟𝑠) = 𝑃ℎ𝑝 365 [ ]
0.10

𝐅 = 𝐏𝐡𝐩 𝟏, 𝟏𝟎𝟕, 𝟕𝟎𝟕. 𝟗𝟖 (𝐘𝐨𝐮′ 𝐫𝐞 𝐚 𝐦𝐢𝐥𝐥𝐢𝐨𝐧𝐚𝐢𝐫𝐞 𝐛𝐲 𝐚𝐠𝐞 𝟖𝟎)

2. Finding P when given A

(𝟏 + 𝒊)𝑵 − 𝟏
𝐏 = 𝐀[ ]
𝒊(𝟏 + 𝒊)𝑵
𝐏 = 𝐀(𝑷/𝑨, 𝒊%, 𝑵)
Where:
(𝟏+𝒊)𝑵 −𝟏
[ ] = (𝑷/𝑨, 𝒊%, 𝑵) - Uniform Series Present Worth Factor
𝒊(𝟏+𝒊)𝑵

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Engr. Ryan James S. Olivo
ES 312b - Engineering Economy 1st Sem, S.Y. 2020-2021

Example: Suppose you want to have an eight (8) annual withdrawal of $187.45 in
an account. How much money should you deposit at the beginning? Interest rate
is 10%.

(1 + 0.10)8 − 1
P = A(𝑃/𝐴, 10%, 8) = $187.45 [ ]
0.10(1 + 0.10)8
𝐏 = $𝟏, 𝟎𝟎𝟎. 𝟎𝟑

Example: “Make your best deal with us on a new automobile and we’ll change
your oil for free for as long as you own the car!” If you purchase a car from this
dealership, you expect to have four free oil changes per year during the five years
you keep the car. Each oil change would normally cost you $30. If you save your
money in a mutual fund earning 2% per quarter, how much are the oil changes
worth to you at the time you buy the car? (How much is the discount (discounted
through oil change) when you buy the car at the beginning)

𝑖 = 2% 𝑝𝑒𝑟 𝑞𝑢𝑎𝑟𝑡𝑒𝑟 – This means that the r = 2% (4) = 8% per year.

𝑁 = (5 𝑦𝑒𝑎𝑟𝑠)(4) = 20 𝑝𝑒𝑟𝑖𝑜𝑑𝑠; 𝑚 = 4 (𝑞𝑢𝑎𝑟𝑡𝑒𝑟𝑙𝑦)

(1 + 0.02)20 − 1
( )
P = $30 𝑃/𝐴, 2%, 20 = $30 [ ]
0.02 (1 + 0.02)20

𝐏 = $𝟒𝟗𝟎. 𝟓𝟒
This is what you save when you buy at that dealer (your savings is in a form of
four free oil changes per year at $30 per oil change, assuming that the interest
rate is 2% per quarter). This would help you decide in choosing what dealer has
better offer.

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Engr. Ryan James S. Olivo
ES 312b - Engineering Economy 1st Sem, S.Y. 2020-2021

3. Finding A when given F

𝒊
𝐀 = 𝐅[ ]
(𝟏 + 𝒊)𝑵 − 𝟏
𝐀 = 𝐅(𝑨/𝑭, 𝒊%, 𝑵)
Where:
𝒊
[(𝟏+𝒊)𝑵 ] = (𝑨/𝑭, 𝒊%, 𝑵) – Sinking Fund Factor
−𝟏

Example: A 45-year-old person wants to accumulate $500,000 by age 70. How

much will she need to save each month, starting one month from now, if the
interest rate is 0.5% per month?

𝑖 = 0.5% 𝑝𝑒𝑟 𝑚𝑜𝑛𝑡ℎ – This means that the r = 0.5% (12) = 6% per year.
t = 70-45 = 25 years; 𝑁 = (25 𝑦𝑒𝑎𝑟𝑠)(12) = 300 𝑝𝑒𝑟𝑖𝑜𝑑𝑠; 𝑚 = 12 (𝑚𝑜𝑛𝑡ℎ𝑙𝑦)
0.005
A = $500,000(𝐴/𝐹, 0.5%, 300) = $500,000 [ ]
(1 + 0.005)300 − 1
𝐀 = $𝟕𝟐𝟏. 𝟓𝟏 𝐩𝐞𝐫 𝐦𝐨𝐧𝐭𝐡

4. Finding A when given P

𝒊(𝟏 + 𝒊)𝑵
𝐀 = 𝐏[ ]
(𝟏 + 𝒊)𝑵 − 𝟏

𝐀 = 𝐏(𝑨/𝑷, 𝒊%, 𝑵)
Where:
𝒊(𝟏+𝒊)𝑵
[(𝟏+𝒊)𝑵 ] = (𝑨/𝑷, 𝒊%, 𝑵) – Capital Recovery Factor
−𝟏

Example: You borrow Php 350,000 from your credit union to purchase a used car.
The annual interest rate on your loan is 3% payable for 3 years. What is your
monthly payment?

𝑟 3%
𝑖= = = 0.25% 𝑝𝑒𝑟 𝑚𝑜𝑛𝑡ℎ.
𝑚 12 𝑚𝑜𝑛𝑡ℎ𝑠
t = 3 years; 𝑁 = (3 𝑦𝑒𝑎𝑟𝑠)(12) = 36 𝑝𝑒𝑟𝑖𝑜𝑑𝑠; 𝑚 = 12 (𝑚𝑜𝑛𝑡ℎ𝑙𝑦)
0.0025(1 + 0.0025)36
A = Php 350,000(𝐴/𝑃, 0.25%, 36) = Php 350,000 [ ]
(1 + 0.0025)36 − 1

𝐀 = 𝐏𝐡𝐩 𝟏𝟎, 𝟏𝟕𝟖. 𝟒𝟐 𝐩𝐞𝐫 𝐦𝐨𝐧𝐭𝐡

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Engr. Ryan James S. Olivo
ES 312b - Engineering Economy 1st Sem, S.Y. 2020-2021

Deferred Annuity

READ (IMPORTANT!)
The cash flow does not begin until some later
date. • Page 30 to 35
If the annuity is deferred for J periods (J < N),
Textbook: Engineering
the situation is as portrayed in the Figure, in Economy, 3rd Ed.
which the entire framed ordinary annuity has (Sta. Maria)
been moved away from “time present,” or “time
READ (IMPORTANT!)
zero,” by J periods. Remember that, in an annuity
deferred for J periods, the first payment is made • Page 135 to 137
at the end of period (J + 1) (upward arrow – start
Textbook: Engineering
of payment), assuming that all periods involved Economy, 16th Ed.
are equal in length.

1. Present Equivalent of a Deferred Annuity

𝐏𝟎 = 𝑷𝑱 (𝑷/𝑭, 𝒊%, 𝑱) = 𝑷𝑱 (𝟏 + 𝒊)−𝑱

(𝟏 + 𝒊)𝑵−𝑱 − 𝟏
𝐏𝐉 = 𝑭𝑱 = 𝑨(𝑷/𝑨, 𝒊%, 𝑵 − 𝑱) = 𝐀 [ ]
𝒊(𝟏 + 𝒊)𝑵−𝑱
(𝟏 + 𝒊)𝑵−𝑱 − 𝟏
𝐏𝟎 = 𝐀 [ ] (𝟏 + 𝒊)−𝑱
𝒊(𝟏 + 𝒊)𝑵−𝑱
Where:
𝑷𝟎 – The present amount at “time present” or “time zero”
𝑷𝑱 – The present amount when the receipts (or payment) is deferred for J periods
𝑭𝑱 – Equal to 𝑷𝑱 , this is the future amount for 𝑷𝟎 after J periods (time when the
annuity deferred by J periods starts)

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Engr. Ryan James S. Olivo
ES 312b - Engineering Economy 1st Sem, S.Y. 2020-2021

Example: To illustrate the preceding discussion, suppose that a father, on the day his
son is born, wishes to determine what lump amount would have to be paid into an
account bearing interest of 12% per year to provide withdrawals of $2,000 on each
of the son’s 18th, 19th, 20th, and 21st birthdays.

The father wants the withdrawal to start on his son’s 18th birthday (this is J+1) up
to his son’s 21st birthday. Therefore, J = 17 and N = 21. He wants to know P0.
P0 = 𝑃𝐽 (𝑃/𝐹, 12%, 17) = 𝑃𝐽 (1 + 0.12)−17
(1 + 0.12)21−17 − 1
PJ = 𝐹𝐽 = $2,000(𝑃/𝐴, 12%, 21 − 17) = $2,000 [ ]
0.12(1 + 0.12)21−17
PJ = 𝐹𝐽 = $6,074.70

P0 = $6,074.70(𝑃/𝐹, 12%, 17) = $6,074.70(1 + 0.12)−17

𝐏𝟎 = $𝟖𝟖𝟒. 𝟕𝟓
His father needs to set-up an account and deposit $𝟖𝟖𝟒. 𝟕𝟓 at the start of age of his
son in order for his son to withdraw $2,000 on his son’s 18th, 19th, 20th and 21st
birthday.

2. Deferred Future Value of Annuity

Example: When you take your first job, you decide to start saving right away for
your retirement. You put Php 500 per month into an insurance policy which
averages 6% interest per year. The payment will stop after you completed the
payment for 10 years and the policy will mature. You can then only get the
accumulated future amount of your savings at the end of year (EOY) 40. How much
is the accumulated future amount?

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Engr. Ryan James S. Olivo
ES 312b - Engineering Economy 1st Sem, S.Y. 2020-2021

Soln.
Periods of payment = (12 months) (10 years) = 120 periods
Total periods = (12 months) (40 years) = 480 periods
i = 6%/12 = 0.5%

(1 + 0.5%)120 − 1
F10 ( )
= Php 500 𝐹/𝐴, 0.5%, 120 = 𝑃ℎ𝑝 500 [ ]
0.5%
F10 = 𝑃ℎ𝑝 81,939.67
F40 = 𝑃ℎ𝑝 81,939.67(𝐹/𝑃, 0.5%, (480 − 120)) = 𝑃ℎ𝑝 81,939.67(1 + 0.5%)360
𝐅𝟒𝟎 = 𝑷𝒉𝒑 𝟒𝟗𝟑, 𝟒𝟖𝟕. 𝟖𝟑
Saving Php 500 per month for 10 years without considering the principle of money-
time relationship will only give you a saving of (12)(10)(Php 500) = Php 60,000.

Annuity Due and Perpetuity

READ (IMPORTANT!)
• Page 36 to 39
Textbook: Engineering
Economy, 3rd Ed.
(Sta. Maria)

Annuity due is one where the payments are made at the beginning of each period
1. Finding P when A is given
(𝟏 + 𝒊)𝑵−𝟏 − 𝟏
𝐏 = 𝐀+ 𝐀[ ]
𝒊(𝟏 + 𝒊)𝑵−𝟏
(𝟏 + 𝒊)𝑵−𝟏 − 𝟏
𝐏 = 𝐀 {𝟏 + [ ]}
𝒊(𝟏 + 𝒊)𝑵−𝟏
𝐏 = 𝐀 + 𝐀(𝑷/𝑨, 𝒊%, 𝑵 − 𝟏)
𝐏 = 𝐀[𝟏 + (𝑷/𝑨, 𝒊%, 𝑵 − 𝟏)]
Example: A man bought an equipment costing Php 60,000 payable in 12 quarterly
payments, each installment is payable at the beginning of each period. The rate of
interest is 24% compounded quarterly. What is the amount of each payment?

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Engr. Ryan James S. Olivo
ES 312b - Engineering Economy 1st Sem, S.Y. 2020-2021

Soln.
P = Php 60,000; N = 12; i = 24%/4 = 6%
(1 + 6%)12−1 − 1
Php 60,000 = A(1 + 𝑃/𝐴, 6%, 12 − 1) = A {1 + [ ]}
6%(1 + 6%)12−1
𝐀 = 𝐏𝐡𝐩 𝟔, 𝟕𝟓𝟏. 𝟓𝟑
2. Finding F when A is given
(𝟏 + 𝒊)𝑵+𝟏 − 𝟏
𝐅 = 𝐀[ ]−𝑨
𝒊
(𝟏 + 𝒊)𝑵+𝟏 − 𝟏
𝐅 = 𝐀 {[ ] − 𝟏}
𝒊
𝐅 = 𝐀(𝑭/𝑨, 𝒊%, 𝑵 + 𝟏) − 𝑨
𝐅 = 𝐀[(𝐅/𝑨, 𝒊%, 𝑵 + 𝟏) − 𝟏]
3. Perpetuity
A perpetuity is an annuity in which the payments continue indefinitely
𝐀
𝐏=
𝐢

Continuous Compounding for Uniform Series (Annuity)

READ (IMPORTANT!)
a. Finding F given A
• Page 160 to 163
𝐅 = 𝐀(𝑭/𝑨, 𝒓%, 𝑵)
Textbook: Engineering
𝒆𝒓𝑵 − 𝟏 Economy, 16th Ed.
𝐅 = 𝐀( 𝒓 )
𝒆 −𝟏
Factor Name:
Continuous Compounding Amount Factor (Uniform Series)

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Engr. Ryan James S. Olivo
ES 312b - Engineering Economy 1st Sem, S.Y. 2020-2021

b. Finding P given A
𝐏 = 𝐀(𝑷/𝑨, 𝒓%, 𝑵)
𝒆𝒓𝑵 − 𝟏
𝐏 = 𝐀[ ]
𝒆𝒓𝑵 (𝒆𝒓 − 𝟏)
Factor Name: Continuous Compounding Present Equivalent Factor (Uniform
Series)
c. Finding A given F
𝐀 = 𝐅(𝑨/𝑭, 𝒓%, 𝑵)
𝒆𝒓 − 𝟏
𝐀 = 𝐅[ ]
𝒆𝒓𝑵 − 𝟏
Factor Name: Continuous Compounding Sinking Fund Factor
d. Finding A given P
𝐀 = 𝐏(𝑨/𝑷, 𝒓%, 𝑵)
𝒆𝒓𝑵 (𝒆𝒓 − 𝟏)
𝐀 = 𝐏 [ 𝒓𝑵 ]
𝒆 −𝟏
Factor Name: Continuous Compounding Capital Recovery Factor

The Concept of Equivalence

Alternatives should be compared when they produce similar results, serve the
same purpose, or accomplish the same function. As one of the principles of
engineering economy, it should answer the question: How can alternatives for
providing the same service or accomplishing the same function be compared
when interest is involved over extended periods of time? Thus, we should
consider the comparison of alternative options, or proposals, by reducing them
to an equivalent basis that is dependent on:
(1) the interest rate,
(2) the amounts of money involved, and
(3) the timing of the monetary receipts or expenses.

Example: Read the case study on page 163 to 166 on Engineering Economy
16th Edition PDF.

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Engr. Ryan James S. Olivo
ES 312b - Engineering Economy 1st Sem, S.Y. 2020-2021
SUMMARY:
The second part of Principle of Money-Time relationship introduced the concept
of uniform series which involved a series of uniform receipts (or payments) occurring
at every period (end or beginning). This series is what we call Annuity.
When a payment is made at the end of a period it is called Ordinary Annuity.
When a payment is made several periods after the “time zero” or which the payment
started at future periods less than the end period it is called Deferred Annuity.
When a payment is made at the beginning of a period it is called Annuity Due.
When a payment is made to continue indefinitely it is called Perpetuity.

EXERCISES:
NOTE: For VLE Students – No need to answer the problems here. What you need to do
is to solve the exercises in the VLE.
The exercises here are to be DONE ONLY by students who chose the “Printed
Module” mode of delivery. The solutions to this problem are to be handwritten and
to be passed to your instructor a week after you received this printed module.
SHOW YOUR SOLUTIONS.
Problem 1: Your parents make 20 equal annual deposits of $2,000 each into a bank
account earning 3% interest per year. The first deposit will be made one year from
today. How much money can be withdrawn from this account immediately after the
20th deposit?
Problem 2: How much money should be deposited each year for 12 years if you wish
to withdraw $309 each year for five years, beginning at the end of the 14th year? Let
i = 8% per year. Draw a cash-flow diagram.
Problem 3: A certain property is being sold and the owner received two bids. The
first bidder offered to pay Php 400,000 each year for 5 years, each payment is to be
made at the beginning of each year. The second bidder offered to pay Php 240,000
first year, Php 360,000 the second year and Php 540,000 each year for the next 3
years, all payments will be made at the beginning of each year. If money is worth 20%
compounded annually, which bid should the owner of the property accept?
Problem 4: What amount of money invested today at 15% interest can provide the
following scholarships; Php 30,000 at the end of each year for 6 years; Php 40,000 for
the next 6 years and Php 50,000 thereafter?
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Engr. Ryan James S. Olivo