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To find future value CVF

To find present value PVF

To find future value if given

annuity CVAF

To find present value if

given annuity PVAF

To find annuity if given present

value (Capital Recovery)
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Engineering Economy MGTS 301

Chapter-4
Sixteenth Edition
Time value of money
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Today’s class

Deferred Annuities

Uniform (Arithmetic) Gradient C/F

Nominal & Effective Interest Rates

Interest Formula for Continuous compounding

&Discrete C/F

3
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9. Pause and solve

10 years from now Mr. X will start receiving a

pension of $ 3000 a year for 16 years. How much
the pension worth now if interest rate is 10%.
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Sometimes cash flows change by a constant amount each period.

We can model these situations as a uniform gradient of
cash flows. The table below shows such a gradient.

End of Period Cash Flows

1 0
2 G
3 2G
: :
N (N-1)G
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It is easy to find the present value of a uniform gradient

series.
Similar to the other types of cash flows, there is a formula
(albeit quite complicated) we can use to find the present value,
and a set of factors developed for interest tables.
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We can also find A or F equivalent to a uniform gradient

series.
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The annual equivalent of End of Year Cash Flows ($)

this series of cash flows can 1 2,000
be found by considering an
2 3,000
annuity portion of the cash
flows and a gradient 3 4,000
portion. 4 5,000

End of Year Annuity ($) Gradient ($)

1 2,000 0
2 2,000 1,000
3 2,000 2,000
4 2,000 3,000
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Sometimes cash flows change by a

constant rate, ,each period--this is a
geometric gradient series.

This table presents a

geometric gradient series. It End of Year Cash Flows ($)
begins at the end of year 1 1 1,000
and has a rate of growth, , 2 1,200
of 20%. 3 1,440
4 1,728
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We can find the present value of a

geometric series by using the appropriate
formula below.

Where is the initial cash flow in the series.

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Present Equivalent of an Increasing Arithmetic Gradient Series

As further example of the use of arithmetic gradient formulas, suppose that
we have cash flows as follows:

End of Year Cash Flows ($)

1 5,000
2 6,000
3 7,000
4 8,000
Also, assume that we wish to calculate their present equivalent at i = 15%
per year, using gradient conversion factors.
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Present Equivalent of a Decreasing Arithmetic Gradient Series

As further example of the use of arithmetic gradient formulas, suppose that
we have cash flows as follows:

End of Year Cash Flows ($)

1 8,000
2 7,000
3 6,000
4 5,000
Also, assume that we wish to calculate their present equivalent at i = 15%
per year, using gradient conversion factors.

Nominal and Effective Interest Rates
In finance and economics,
the nominal interest rate or
nominal rate of interest is
either of two distinct
things: the rate of interest
before adjustment for
inflation; or, for interest
rates "as stated" without
adjustment for the full
effect of compounding.
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The effective annual interest rate is
the interest rate that is actually
earned or paid on an investment, loan
or other financial product due to the
result of compounding over a given
time period. It is also called
the effective interest rate,
the effective rate or the annual
equivalent rate.
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• Nominal annual interest rate per year, r , is the annual interest rate
without considering the effect of any compounding
• Effective annual interest rate per year, ia, is the annual interest rate
taking into account the effect of any compounding during the year.
= (1 + i)m-1

Where,
i = effective interest rate per compounding sub-period = r/m
m = number of compounding sub-periods per year
r = nominal interest rate per year
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Pause and solve

Suppose $600 were deposited in a bank savings account,

and the bank’s interest policyis 6% compounded
quarterly. How much money would be in the account at
the end of first year?
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Pause and solve

If a credit card charges 1.5% interest every month, what

are the nominal and effective interest rates per year?
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Nominal and effective interest rates.

• More often than not, the time between successive compounding, or
the interest period, is less than one year (e.g., daily, monthly,
quarterly).
• The annual rate is known as a nominal rate.
• A nominal rate of 12%, compounded monthly, means an interest of
1% (12%/12) would accrue each month, and the annual rate would be
effectively somewhat greater than 12%.
• The more frequent the compounding the greater the effective interest.
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Rs. 10000 (1+0.1)1 = Rs. 11000

Rs. 10,000 (1+0.1/2)2= Rs, 11,025

Rs. 10,000 (1+0.1/4)4= Rs. 11,038.13
Rs. 10000 (1+0.1/12)12= 11,047.13

= (1+ 0.1/2)2 – 1
= 10.25%
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Interest can be compounded continuously.

• Interest is typically compounded at the end of discrete
periods.
• In most companies cash is always flowing, and should be
immediately put to use.
• We can allow compounding to occur continuously
throughout the period.
• The effect of this compared to discrete compounding is
small in most cases.
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We can use the effective interest

formula to derive the interest
factors.

As the number of compounding periods gets larger (M gets

larger), we find that
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Continuous Compounding and Single Amounts

You have $10,000 to invest for two years. Your bank offers 5% interest,
compounded continuously for funds in a money market account.
Assuming no additional deposits or withdrawals, how much money will
be in that account at the end of two years?

F = $10,000 (F/P, r=5%, 2 yrs) = $10,000 e (0.05)(2) = $10,000 (1.1052) = $11,052

Comment
If the interest rate was 5% compounded annually, the account would have been
worth

F = $10,000 (F/P, 5%, 2 yrs) = $10,000 (1.1025) = $11,025

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Calculation of Interest and Annuity for Discrete Compounding by using Calculator

PVF 1 . 0 7 ➗ = = = = =
Y1 Y2 Y3 Y4 Yn
PVAF 1 . 0 7 ➗ = = = = = GT
Y1 Y2 Y3 Y4 Yn
CVF 1 . 0 7 ✖ = = = = =
Yn
Y2 Y3 Y4
CVAF 1 . 0 7 ✖ = = = = =
Y3 Y4 Y5 Y6 GT + 2 . 0 7 Y7