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 P 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 Cash Flow Formula
Single payment compound amount factor (growth factor) Given: i = 1 0 % N = 8 years P = $ 2 ,0 0 0 Find: F
F = $2,000(1 + 010 )8 . = $2,000( F / P,10%,8 ) = $4,28718 .

F = P(1 + i) N F = P( F / P, i, N)
0

F

N P 2.1436

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 GIVEN: years? P = $1,600
DIAGRAM: 0 1 2 3 N=17 $1,600 F17? i = 12% N = 17 FIND F17: F17 = P(F|P,i,N) = 1,600(F|P,12%,17) = 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: 0 1 2 3 N=17 $1,600 $10,986

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
F 0 P? 1 2 3 N

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

S.V. Atre

3

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

Single Cash Flow Formula
Single payment present worth factor (discount factor) Given: i = 1 2 % N = 5 y e a rs F = $ 1,0 0 0 Find: P
P = $1, 000 (1 + 0 .12 ) − 5 = $1, 000 ( P / F ,12% ,5 ) = $567.40

P = F(1 + i)− N P = F(P / F, i, N)
0

F

N P 0.5674

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

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: 0 1 2 3 F50 = P50 51 1 P? P50 52 2 $6,200 N=53 3 = 6,200(P|F,12%,3) = 6,200(0.7118) = F50 P = F50(P|F,i,N) = P50(P|F,12%,50) = 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

P

S.V. Atre

5

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 A

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

0

1

2

3 N

A

(1 + i ) N − 1 F=A i = 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
DIAGRAM: 0 1 2 3 9 N=10 $1,400 F10 ? i = 18% N = 10 FIND F10: F10 = A(F|A,i,N) = 1,400(F|A,18%,10) = 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

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
F 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
0 1 2 3 N

A= F
A

i (1 + i) N − 1 = 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: 0 1 2 3 N=72 A? $90 000 FIND A: A = F72(A|F,i,N) = F72(A|F,6.3%,72)

⎡ ⎤ i = F72 ⎢ ⎥ N ⎣ (1 + i) − 1⎦ ⎡ ⎤ 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.

S.V. Atre

9

ENGR 390 Winter 2006 Section 1 Lecture 2 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 A

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 0 2 3 N

A

(1 + i ) N − 1 P= A i (1 + i ) N = 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: DIAGRAM:

P? 1 0 2 3

A = $1,000 i = 8% N=9
FIND P:

N=9 $1,000

P = A(P|A,i,N) = 1,000(P|A,8%,9) = 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

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
P 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
1 0 2 3 N

A

i(1 + i) N A= P (1 + i) N − 1 = 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: DIAGRAM:

P = $50,000 i = 8.5% N = 10
FIND A:

$50,000 1 0 2 3

A = P(A|P,i,N) N=10 A? = 50,000(A|P,8.5%,10)
⎡ i(1 + i)N ⎤ = P⎢ ⎥ N ⎣ (1 + i) − 1⎦ ⎡ 0.085(1 + 0.085 )10 ⎤ = 50000 ⎢ ⎥ = $7620 10 ⎣ (1 + 0.085 ) − 1 ⎦

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

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 G 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

F

i(1+i) N −iN −1 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

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? 1 0

GIVEN:

2

3

N=30 $250 $100 $1,450
FIND P:

Payments i = 9% N = 30

$50

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:

P? 1 0

PA ? 1 3 N=30 $250 $100 $1,450 0 PG ? 1 0

2

3

N=30 $250

2

$50

2 $50

3 $100

N=30

$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 0

2

3

N=30 P = PA + PG = A(P|A,i,N) + G(P|G,i,N) $250 $100 $1,450 = 250(P|A,9%,30) + 50(P|G,9%,30) = 250(10.2737) + 50(89.0280) = 2,568.43 + 4,451.40 = $7,020

$50

S.V. Atre

16

ENGR 390 Winter 2006 Section 1 Lecture 2 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 G 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 :

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 ? 1 0 $10 000 2 3 N=42 0 $100 $200 $4 100 1 2 3 N=42 FG ?

F42 = FA – FG = A(F|A,i,N) – G(F|G,i,N) = 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 ⎡ (1 + i)N − 1 ⎤ ⎞ ⎡ (1 + i)N − 1⎤ − N⎥ ⎟ F42 = A(F|A,i,N) – G(F|G,i,N) = A ⎢ ⎥ − G⎜ ⎢ ⎜i ⎟ i i ⎣ ⎦ ⎦⎠ ⎝ ⎣ ⎛ 1 ⎡ (1 + 0.08)42 − 1 ⎡ (1 + 0.08)42 − 1⎤ ⎤⎞ = 10000 ⎢ − 42⎥ ⎟ ⎥ − 100⎜ ⎜ 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 The geometric gradient will help us deal with inflation.

Geometric Gradient Series

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

S.V. Atre

19

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

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

P

Find: P
. . 1− (1+ 007)5 (1+ 012)−5 . . 012 − 007 = $151,109

P = $54,440

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% i = 5% N = 4 years A1 = $10,000

P = A1(P|A1,g,i,N)

Find: P
DIAGRAM: $10,000

1 − [(1 + g ) /(1 + i )]N P = A1{ } (i – g) 1 − [(1 + 0.08) /(1 + 0.05)]4 P = 10,000{ } (0.05 – 0.08)

0 P?

1

2

3

N=4

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

Standard Factors Used to Solve ECON Problems
( F | P, i, N) ( P | F, i, N) ( F | A, i, N) ( A | F, i, N) ( P | A, i, N) ( A | P, i, N) ( P | G, i, N) ( A | G, i, N) ( F | G, i, N) Find F Given P Find P Given F Find F Given A Find A Given F Find P Given A Find A Given P Find P Given G Find A Given G Find F Given G

S.V. Atre

22