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ENGR 390 Winter 2006 Section 1 Lecture 2

Time is Money: Problems

Types of Cash Flows

(a) Single cash flow


(b) Equal (uniform)
payment series
(c) Linear gradient
series
(d) Geometric
gradient series
(e) Irregular payment
series

Future Given Present


† P is the present value at Time 0
† F is the future value at Time N
„ (N periods in the future)
† i is the effective interest rate

F?

0 1 2 3 N

F = P(F/P,i,N)

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ENGR 390 Winter 2006 Section 1 Lecture 2
Time is Money: Problems

Single Cash Flow Formula

† Single payment
F
compound amount F = P(1 + i) N
factor (growth factor)
F = P( F / P, i, N)
† Given: i = 10%
N = 8 years 0
P = $ 2 ,0 0 0 N
† Find: F

F = $2,000(1 + 010
. )8 P
= $2,000( F / P,10%,8 ) 2.1436
= $4,28718
.

Example 1

If $1,600 is deposited (today) into an


account earning 12% compounded
annually, what amount of money will
be in the account at the end of 17
years? GIVEN:
P = $1,600
DIAGRAM: F17? i = 12%
N = 17
0 1 2 3 FIND F17:
F17 = P(F|P,i,N)

N=17 = 1,600(F|P,12%,17)
$1,600 = 1,600(6.8660) = $10,986

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Time is Money: Problems

Example 1 - Concept
Assuming a 12% per year return on
my investment, I am indifferent
between having $1,600 today and
$10,986 in 17 years.
DIAGRAM: $10,986

0 1 2 3

N=17
$1,600

Present Given Future


† P is the present value at Time 0
† F is the future value at Time N
„ (N periods in the future)
† i is the effective interest rate for each period

0 1 2 3 N

P?

P = F(P/F,i,N)

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Time is Money: Problems

Single Cash Flow Formula

† Single payment present P = F(1 + i)− N F


worth factor (discount
factor) P = F(P / F, i, N)
† Given: i = 1 2 %
N = 5 y e a rs 0
F = $ 1,0 0 0 N
† Find: P

P = $1, 000 (1 + 0 .12 ) − 5 P


= $1, 000 ( P / F ,12% ,5 ) 0.5674
= $567.40

Example 2
What is the present value of having
$6,200 fifty-three years from now at
12% compounded annually?
GIVEN:
F53 = $6,200
DIAGRAM: $6,200 i = 12%
N = 53
0 1 2 3 FIND P:
P = F53(P|F,i,N) = F53(1+ i)–N
N=53
= 6,200(1+ .12)–53
P?
= 6,200(0.00246) = $15.27

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Time is Money: Problems

Example 2 - Concept
Having $15.27 today is equivalent to
having $6,200 in 53 years assuming
that I will invest that $15.27 and earn
12% per year on my money.
P50 = F53(P|F,i,N)
ALTERNATIVE: $6,200
F50 = P50 = 6,200(P|F,12%,3)
= 6,200(0.7118) = F50
0 1 2 3 51 52 N=53
P = F50(P|F,i,N)
1 2 3 = P50(P|F,12%,50)
P? P50
= 6,200(0.7118)(P|F,12%,50)
= 6,200(0.7118)(0.0035) = $15.45

Equal Payment Series


A

0 1 2 3 4 5 N-1 N
F

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ENGR 390 Winter 2006 Section 1 Lecture 2
Time is Money: Problems

Future Given Annual


† A is the equal annual value over the time period
„ (time period: Time 0 to Time N, 1st flow at Time 1)
† F is the future value at Time N
„ (N periods in the future)
† i is the effective interest rate for each period

F?

0 1 2 3 N

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

†Note: cash flow A does not have to be annual, just periodic

Equal Payment Series Compound Amount Factor


F

(1 + i ) N − 1
0 1 2 3 F=A
N i
A
= A( F / A, i , N )
Example 4.13:
† Given: A = $3,000, N = 10 years, and i = 7%
† Find: F
† Solution: F = $3,000(F/A,7%,10) = $41,449.20

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Time is Money: Problems

Example 3
If $1,400 is deposited at the end of
each year (every year) for 10 years,
what is the accumulated value at the
end of 10 years at 18% compounded
GIVEN:
annually? A = $1,400
i = 18%
DIAGRAM: F10 ? N = 10
FIND F10:
0 1 2 3 9 F10 = A(F|A,i,N)
N=10
= 1,400(F|A,18%,10)
$1,400
= 1,400(23.5213) = $32,930

Example 3 - Concept
Assuming I can earn 18% on my
funds, I am indifferent between 10
yearly payments of $1,400 and having
$32,930 at the end of 10 years.

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Time is Money: Problems

Annual Given Future


† A is the equal annual value over the time period
„ (time period: Time 0 to Time N, 1st flow at Time 1)
† F is the future value at Time N
„ (N periods in the future)
† i is the effective interest rate for each period

0 1 2 3 N

A?

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

† Note: cash flow A does not have to be annual, just periodic

Sinking Fund Factor


F
i
A= F
0 1 2 3 (1 + i) N − 1
N

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

Example 4.15:
† Given: F = $5,000, N = 5 years, and i = 7%
† Find: A
† Solution: A = $5,000(A/F,7%,5) = $869.50

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Time is Money: Problems

Example 4
What series of equal yearly payments
must be made into an account to
accumulate $90,000 in 72 years at
6.3% compounded annually?
GIVEN:
F72 = $90,000
i = 6.3%
N = 72
DIAGRAM: $90 000 FIND A:
A = F72(A|F,i,N) = F72(A|F,6.3%,72)
0 1 2 3
N=72 ⎡ i ⎤
= F72 ⎢ ⎥
⎣ (1 + i) − 1⎦
N
A?
⎡ 0.063 ⎤
= 90000 ⎢ ⎥ = $70.56
⎣ (1 + 0 . 063 )72
− 1⎦

Example 4 - Concept

If $70.56 was deposited in an


account earning 6.3% yearly,
$90,000 would be in the account
at the end of 72 years.

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Time is Money: Problems

Present Given Annual


† A is an equal annual flow over the time period
„ (time period: Time 0 to Time N, 1st flow at Time 1)
† P is the present value at Time 0
„ (N periods in the past)
† i is the effective interest rate for each period

P?

0 1 2 3 N

P = A(P/A,i,N)

† Note: cash flow A does not have to be annual, just periodic

Equal Payment Series Present Worth Factor

P
(1 + i ) N − 1
P= A
1 2 3 i (1 + i ) N
0 N

A = A( P / A, i , N )

Example 4.18:
† Given: A = $32,639, N = 9 years, and i = 8%
† Find: P
† Solution: P = $32,639(P/A,8%,9) = $203,893

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Time is Money: Problems

Example 5
What is the present worth of
deposits of $1,000 at the end of
each of the next 9 years at 8%
compounded annually?
GIVEN:
A = $1,000
DIAGRAM: i = 8%
P? N=9
FIND P:

1 2 3 P = A(P|A,i,N)
N=9
= 1,000(P|A,8%,9)
0 $1,000
= 1,000(6.2469) = $6,247

Example 5 - Concept
Assuming an 8% annual return
on investment, nine yearly
payments of $1,000 are
equivalent to $6,247 today.

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Time is Money: Problems

Annual Given Present


† A is the equivalent annual flow over the time period
„ (time period: Time 0 to Time N, 1st flow at Time 1)
† P is the present value at Time 0
„ (N periods in the past)
† i is the effective interest rate for each period

0 1 2 3 N

A?

A = P(A/P,i,N)

† Note: cash flow A does not have to be annual, just periodic

Capital Recovery Factor


P
i(1 + i) N
A= P
1 2 3 (1 + i) N − 1
0 N

A
= P( A / P, i, N )

Example 4.16:
† Given: P = $250,000, N = 6 years, and i = 8%
† Find: A
† Solution: A = $250,000(A/P,8%,6) = $54,075

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Time is Money: Problems

Example 6
What series of equal, annual
payments is necessary to repay
$50,000 in 10 years at 8.5%
compounded annually?
GIVEN:
P = $50,000
i = 8.5%
DIAGRAM: N = 10
$50,000 FIND A:
A = P(A|P,i,N)
1 2 3 = 50,000(A|P,8.5%,10)
N=10
⎡ i(1 + i)N ⎤
0 = P⎢ ⎥
A?
⎣ (1 + i) − 1⎦
N

⎡ 0.085(1 + 0.085 )10 ⎤


= 50000 ⎢ ⎥ = $7620
⎣ (1 + 0.085 ) − 1 ⎦
10

Example 6 - Concept
I am indifferent between having
$50,000 today and 10 annual
payments of $7,620, given a
return rate of 8.5% per year.

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Time is Money: Problems

Present Given Gradient


(Linear)
† G is the linear gradient over the time period
„ (time period: Time 0 to Time N, 1st flow at Time 2)
† P is the present value of the flow at Time 0
„ (N periods in the past)
† i is the effective interest rate for each period
P?

0 1 2 3 N

P = G(P/G,i,N)

† Note: cash flow is periodic, no flow at Time 1, flow of G at Time 2

Linear Gradient Series

i(1+i) N −iN −1
F P=G 2
i (1+i) N
= G( P / G,i, N)

F = P(1+i)N
P = G(F|G,i,N)

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Time is Money: Problems

Gradient Series as a Composite Series

Example 7
What is the present worth of a series
of 30 end of the year payments that
begin at $250 and increase at the
rate of $50 a year if the interest rate
is 9% compounded annually?
DIAGRAM: P? GIVEN:
1 2 3 Payments
N=30
i = 9%
0 N = 30
$250 FIND P:
$50
$100

$1,450

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Time is Money: Problems

Example 7
This can be broken into an Annual
flow and a Linear Gradient flow
DIAGRAM: PA ?
P? 1 2 3
N=30
1 2 3
N=30 0
0 $250
$250
$50
$100 PG ?
1 2 3
N=30
$1,450
0 $50
$100

$1,450

Example 7 - Concept
Annual payments that begin at $250
and increase with a linear gradient
of $50 each year for 30 years are
equivalent to $7,020 today,
assuming 9% return on investment.
DIAGRAM: P?
1 2 3
N=30
0 P = PA + PG = A(P|A,i,N) + G(P|G,i,N)
$250 = 250(P|A,9%,30) + 50(P|G,9%,30)
$50
$100 = 250(10.2737) + 50(89.0280)

$1,450 = 2,568.43 + 4,451.40 = $7,020

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Time is Money: Problems

Future Given Gradient


(Linear)
† G is the linear gradient over the time period
„ (time period: Time 0 to Time N, 1st flow at Time 2)
† F is the future value of the flow at Time N
„ (N periods in the future)
† i is the effective interest rate for each period
F?

0 1 2 3 N

F = G(F/G,i,N)

† Note: cash flow is periodic, no flow at Time 1, flow of G at Time 2

Example 8
What is the future worth of a series
of 42 deposits that begin at $10,000
and decrease at the rate of $100 a
year with 8% interest compounded
annually?
GIVEN:
Payments
i = 8%
N = 42
FIND F42 :

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Time is Money: Problems

Example 8
What is the future worth of a series
of 42 deposits that begin at $10,000
and decrease at the rate of $100 a
year with 8% interest compounded
annually?
FA ? FG ?
1 2 3 1 2 3
N=42 N=42
0 0
$100 $200
$10 000

F42 = FA – FG = A(F|A,i,N) – G(F|G,i,N) $4 100

= 10 000(F|A,8%,42) – 100(F|G,8%,42)

Example 8 - Concept
$2,714,631 would be accumulated if
yearly payments are made that begin
at $10,000 and decrease yearly with
a linear gradient of $100, given an
interest rate of 8%.
⎡ (1 + i)N − 1⎤ ⎛ 1 ⎡ (1 + i)N − 1 ⎤ ⎞
F42 = A(F|A,i,N) – G(F|G,i,N) = A ⎢ ⎥ − G⎜⎜ ⎢ − N⎥ ⎟

⎣ i ⎦ ⎝i⎣ i ⎦⎠
⎡ (1 + 0.08)42 − 1⎤ ⎛ 1 ⎡ (1 + 0.08)42 − 1 ⎤⎞
= 10000 ⎢ ⎥ − 100⎜⎜ ⎢ − 42⎥ ⎟

⎣ 0.08 ⎦ ⎝ 0.08 ⎣ 0.08 ⎦⎠
= 10000(304.24352 ) − 100[12.5(304.24352 − 42)]
= 3042435 − 327804 = $2714631

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Time is Money: Problems

Reviewing …
You may add or subtract cash
flows or equivalents only at the
same point in time!

G = Linear Gradient
g = Geometric Gradient

The geometric gradient will help


us deal with inflation.

Geometric Gradient Series

1− (1+ g) N (1+ i)− N


A , if i ≠ g
P= 1 i−g
NA1 / (1+ i), if i = g

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Time is Money: Problems

Example: Geometric Gradient:


Find P, Given A1,g,i,N

† Given:
P
g = 7%
i = 12%
N = 5 years
A1 = $54,440
† Find: P

1− (1+ 007 . )−5


. )5 (1+ 012
P = $54,440
. − 007
012 .
= $151,109

Example 9
Tuition costs are expected to inflate at the
rate of 8% per year. The first year’s
tuition is due one year from now and will
be $10,000. To cover tuition cost for 4
years, a fund is to be set up today in an
account that will earn interest at the rate
of 5% per year, compounded annually.
How much must be deposited into the
fund today in order to pay the 4 years of
tuition expenses?

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Time is Money: Problems

Example 9
† Given:
g = 8% P = A1(P|A1,g,i,N)
i = 5%
N = 4 years
A1 = $10,000 1 − [(1 + g ) /(1 + i )]N
P = A1{ }
† Find: P (i – g)
DIAGRAM:
$10,000
1 − [(1 + 0.08) /(1 + 0.05)]4
P = 10,000{ }
0 1 2 3
(0.05 – 0.08)
N=4

P?
P = 10,000{3.9759}
= $39,759

Example 9 - Concept
If your rich Aunt Edna wanted to put a
sum of money in the bank today to pay
for your next for years of tuition, that sum
would be $39,759 assuming 5% return on
investment and tuition that begins at
$10,000 increasing by 8% per year. This
problem assumes tuition is due at the end
of the year.

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Time is Money: Problems

Standard Factors Used to


Solve ECON Problems
( F | P, i, N) Î Find F Given P
( P | F, i, N) Î Find P Given F
( F | A, i, N) Î Find F Given A
( A | F, i, N) Î Find A Given F
( P | A, i, N) Î Find P Given A
( A | P, i, N) Î Find A Given P
( P | G, i, N) Î Find P Given G
( A | G, i, N) Î Find A Given G
( F | G, i, N) Î Find F Given G

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