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491 views22 pagesEngineering Economics 390. Courtesy of Atre, Sundar V Associate Professor, Oregon State University.

May 29, 2007

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Engineering Economics 390. Courtesy of Atre, Sundar V Associate Professor, Oregon State University.

Attribution Non-Commercial (BY-NC)

491 views

00 upvotes00 downvotes

Engineering Economics 390. Courtesy of Atre, Sundar V Associate Professor, Oregon State University.

Attribution Non-Commercial (BY-NC)

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(b) Equal (uniform)

payment series

(c) Linear gradient

series

(d) Geometric

gradient series

(e) Irregular payment

series

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)

S.V. Atre 1

ENGR 390 Winter 2006 Section 1 Lecture 2

Time is Money: Problems

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

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

S.V. Atre 2

ENGR 390 Winter 2006 Section 1 Lecture 2

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

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)

S.V. Atre 3

ENGR 390 Winter 2006 Section 1 Lecture 2

Time is Money: Problems

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

= $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

S.V. Atre 4

ENGR 390 Winter 2006 Section 1 Lecture 2

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

A

0 1 2 3 4 5 N-1 N

F

S.V. Atre 5

ENGR 390 Winter 2006 Section 1 Lecture 2

Time is Money: Problems

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)

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

S.V. Atre 6

ENGR 390 Winter 2006 Section 1 Lecture 2

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.

S.V. Atre 7

ENGR 390 Winter 2006 Section 1 Lecture 2

Time is Money: Problems

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)

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

S.V. Atre 8

ENGR 390 Winter 2006 Section 1 Lecture 2

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

account earning 6.3% yearly,

$90,000 would be in the account

at the end of 72 years.

S.V. Atre 9

ENGR 390 Winter 2006 Section 1 Lecture 2

Time is Money: Problems

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)

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

S.V. Atre 10

ENGR 390 Winter 2006 Section 1 Lecture 2

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.

S.V. Atre 11

ENGR 390 Winter 2006 Section 1 Lecture 2

Time is Money: Problems

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)

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

S.V. Atre 12

ENGR 390 Winter 2006 Section 1 Lecture 2

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

= 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.

S.V. Atre 13

ENGR 390 Winter 2006 Section 1 Lecture 2

Time is Money: Problems

(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)

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)

S.V. Atre 14

ENGR 390 Winter 2006 Section 1 Lecture 2

Time is Money: Problems

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

S.V. Atre 15

ENGR 390 Winter 2006 Section 1 Lecture 2

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)

S.V. Atre 16

ENGR 390 Winter 2006 Section 1 Lecture 2

Time is Money: Problems

(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)

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 :

S.V. Atre 17

ENGR 390 Winter 2006 Section 1 Lecture 2

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

= 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

S.V. Atre 18

ENGR 390 Winter 2006 Section 1 Lecture 2

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

us deal with inflation.

A , if i ≠ g

P= 1 i−g

NA1 / (1+ i), if i = g

S.V. Atre 19

ENGR 390 Winter 2006 Section 1 Lecture 2

Time is Money: Problems

Find P, Given A1,g,i,N

Given:

P

g = 7%

i = 12%

N = 5 years

A1 = $54,440

Find: P

. )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?

S.V. Atre 20

ENGR 390 Winter 2006 Section 1 Lecture 2

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.

S.V. Atre 21

ENGR 390 Winter 2006 Section 1 Lecture 2

Time is Money: Problems

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

S.V. Atre 22

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