72 views

Uploaded by Mohammed Al-Ismail

Lecture Slides for chapter 3 in Fundamentals of Engineering Economics Book..

- Calculating Bank Interest Rates
- 2 Capitalization
- Compound Interest
- Test 2 Interest
- Basic Percentage Concept
- Park - Fundamentals of Engineering Economics_ 2nd Edition_solution Manual_ch2
- 33960_pasantia_981
- Econimics(Nominal&Effective)
- Mrunal [Aptitude] Compound Interest Rate, Population Growth Without Formulas - Mrunal
- Compound Interest
- Simple and Compund Interest practise
- Mathematics of Finance
- Chapter 5 Engineering Economics
- California Public Utilities Commission Letter 04-04-16
- QuantapptQuestionsforpractice.doc
- Case Digest on Civil Law Review
- cfpb trid
- The Abington Journal 06-06-2012
- FM UC2F1410_Time Value of Money_Lecture, Tutorial, Updates_6, 7 November 2014, Week 4_FM Students
- Sps. Biesterbos v. CA de LUNA

You are on page 1of 57

CHAPTER 3

1. If payments occur more frequently than annual, how do you calculate economic equivalence? 2. If interest period is other than annual, how do you calculate economic equivalence? 3. How are commercial loans structured? 4. How should you manage your debt?

Nominal Interest Rate: Interest rate quoted based on an annual period Effective Interest Rate: Actual interest earned or paid in a year or some other time period

18% Compounded Monthly

Nominal interest rate Interest period

Interest rate per month (i) = 18%/12 = 1.5% Number of interest periods per year (N) = 12

Bank will charge 1.5% interest each month on your unpaid balance, if you borrowed money. You will earn 1.5% interest each month on your remaining balance, if you deposited money.

In words,

Question: Suppose that you invest $1 for 1 year at 18% compounded monthly. How much interest would you earn? Solution:

18%

1.5%

18%

1.5%

or

ia (1 r / M ) 1

M

r = nominal interest rate per year ia = effective annual interest rate M = number of interest periods per year

First quarter

Second quarter Third quarter Fourth quarter

Base amount + Interest (2.25%)

= New base amount + Interest (2.25%) = New base amount + Interest (2.25%) = New base amount + Interest (2.25 %) = Value after one year

$10,000 + $225

= $10,225 +$230.06 = $10,455.06 +$235.24 = $10,690.30 + $240.53 = $10,930.83

Effective Rates

Nominal Rate

Compounding Annually Compounding Semi-annually Compounding Quarterly Compounding Monthly Compounding Daily

4% 5 6 7 8 9

10

11 12

10.00

11.00 12.00

10.25

11.30 12.36

10.38

11.46 12.55

10.47

11.57 12.68

10.52

11.62 12.74

Payment period

Interest period

Effective interest rate per payment period

Month

i [1 r / CK ] 1

C

C = number of interest periods per payment period K = number of payment periods per year CK = total number of interest periods per year, or M r/K = nominal interest rate per payment period

12% compounded monthly Payment Period = Quarter; Compounding Period = Month

1st Qtr

1% 1% 1% 3.030 %

2nd Qtr

3rd Qtr

4th Qtr

One-year Effective interest rate per quarter i (1 0.01) 3 1 3.030 % Effective annual interest rate

ia (1 0.01)12 1 12.68% ia (1 0.03030 )4 1 12.68%

i [1 r / CK ] 1

C

i lim[(1 r / CK ) 1]

C

(er )1/ K 1

Payment Period = Quarter Interest Period = Quarterly

1st Q

2nd Q

1 interest period

3rd Q

4th Q

Given r = 8%, K = 4 payments per year C = 1 interest period per quarter M = 4 interest periods per year

Payment Period = Quarter Interest Period = Monthly

1st Q

2nd Q

3 interest periods Given r = 8%,

3rd Q

4th Q

K = 4 payments per year C = 3 interest periods per quarter M = 12 interest periods per year

Payment Period = Quarter Interest Period = Weekly

1st Q

2nd Q

13 interest periods Given r = 8%,

3rd Q

4th Q

K = 4 payments per year C = 13 interest periods per quarter M = 52 interest periods per year

Payment Period = Quarter Interest Period = Continuously

1st Q

2nd Q

interest periods Given r = 8%,

3rd Q

4th Q

Case 0

8% compounded quarterly Payments occur quarterly 2.000% per quarter

Case 1

8% compounded monthly Payments occur quarterly 2.013% per quarter

Case 2

8% compounded weekly Payments occur quarterly 2.0186% per quarter

Case 3

8% compounded continuously Payments occur quarterly 2.0201% per quarter

Practice Problem

If your credit card calculates the interest based on 12.5% APR, what is your monthly interest rate and annual effective interest rate, respectively? Your current outstanding balance is $2,000 and skips payments for 2 months. What would be the total balance 2 months from now?

Solution

12.5% 1.0417% 12

ia (1 0.010417)12 1 13.24%

Practice Problem

Suppose your savings account pays 9% interest compounded quarterly. If you deposit $10,000 for one year, how much would you have?

Solution

(a) Interest rate per quarter: 9% i 2.25% 4 (b) Annual effective interest rate: ia (1 0.0225) 4 1 9.31% (c) Balance at the end of one year (after 4 quarters) F $10, 000( F / P, 2.25%, 4) $10, 000( F / P, 9.31%,1) $10, 931

Step 1: Identify the payment period (e.g., annual, quarter, month, week, etc)

Step 2: Identify the interest period (e.g., annually, quarterly, monthly, etc) Step 3: Find the effective interest rate that covers the payment period.

Step 1: Identify the number of compounding periods (M) per year Step 2: Compute the effective interest rate per payment period (i) i = r/ M Step 3: Determine the total number of payment periods (N) N = M (number of years) Step 4: Use the appropriate interest formula using i and N above

Financial Data:

Given:

Invoice Price = $21,599 Sales tax at 4% = $21,599 (0.04) = $863.96 Dealers freight = $21,599 (0.01) = $215.99 Total purchase price = $22,678.95 Down payment = $2,678.95 Dealers interest rate = 8.5% APR Length of financing = 48 months

$20,000

1 2 3 4 0 48

A

Given: P = $20,000, r = 8.5% per year

K = 12 payments per year N = 48 payment periods

Find A:

Step 1: M = 12 Step 2: i = r/M = 8.5%/12 = 0.7083% per month Step 3: N = (12)(4) = 48 months Step 4: A = $20,000(A/P, 0.7083%,48) = $492.97

What three levels of coffee drinkers who bought drinks every day for 50 years at $2.00 a cup would have if they had instead banked that money each week: Level of drinker

1 cup a day 2 cups a day 3 cups a day

$193,517 $387,034 $580,552

Note: Assumes constant price per cup, the money banked weekly and an annual interest rate of 5.5% compounded weekly

Step 1: Determine the effective interest rate per payment period: Payment period = weekly 5.5% interest compounded weekly i = 5.5%/52 = 0.10577% per week Step 2: Compute the equivalence value Weekly deposit amount A = $2.00 x 7 = $14.00 per week Total number of deposit periods N = (52 weeks/yr.)(50 years) = 2600 weeks F = $14.00 (F/A, 0.10577%, 2600) = $193,517

Step 1: Identify the following parameters M = No. of compounding periods K = No. of payment periods C = No. of interest periods per payment period Step 2: Compute the effective interest rate per payment period For discrete compounding C

i [1 r / CK ] 1

i er / K 1

Step 3: Find the total no. of payment periods N = K (no. of years) Step 4: Use i and N in the appropriate equivalence formula

Step 1: M = 12 compounding periods/year K = 4 payment periods/year C = 3 interest periods per quarter Step 2: i [1 0.12 / (3)(4)]3 1 Step 3: Step 4:

ie

Step 3: Step 4:

Practice Problem

A series of equal quarterly payments of $5,000 for 10 years is equivalent to what present amount at an interest rate of 9% compounded

A = $5,000

0 12 40 Quarters

(a) Quarterly

A = $5,000

0 12 40

9% i 2.25% per quarter 4 N 40 quarters P $5, 000( P / A, 2.25%, 40) $130,968

(b) Monthly

A = $5,000

0 1 2 40

9% i 0.75% per month 12 i p (1 0.0075)3 2.267% per quarter N 40 quarters P $5, 000( P / A, 2.267%, 40) $130,586

(c) Continuously

A = $5,000

0 1 2 40

Debt Management

$20,000 1 2 24 25 48

Suppose you want to pay off the remaining loan in lump sum right after making the 25th payment. How much would this lump be?

$20,000 1 0 $492.97 25 payments that were already made $492.97 23 payments that are still outstanding 2 24 25 48

Consider the 7th payment ($235.37) (a) How much is the interest payment? (b) What is the amount of principal payment?

$5,000

A $5, 000( A / P,1%, 24) $235.37

i = 1% per month

0 1 2 3 4 5 6 7 22 23 24

A = $235.37

Interest payment = ?

Principal payment = ?

Solution:

Outstanding balance at the end of Period 6: (Note: 18 outstanding payments) B6 $235.37( P / A,1%,18) $3, 859.66 Interest payment for Period 7: IP7 $3,859.66(0.01) $38.60 Principal payment for Period 7: PP7 $235.37 $38.60 $196.77 Note: IP7 PP7 $235.37

Option 1 Debt Financing

Price Down APR

Monthly

Length Fees Cash

payment

$372.55

36 months

$236.45

36 months $495 $300 $8.673.10

Purchase Cash

due at signing

$731.45

Debt Financing:

Pdebt = $2,000 + $372.55(P/A, 0.5%, 36) - $8,673.10(P/F, 0.5%, 36) = $6,998.47

Lease Financing:

Please = $495 + $236.45 + $236.45(P/A, 0.5%, 35) + $300(P/F, 0.5%, 36)

= $8,556.90

Key Points

Financial institutions often quote interest rate based on an APR. In all financial analysis, we need to convert the APR into an appropriate effective interest rate based on a payment period. When the payment period and the interest period differ, calculate an effective interest rate that covers the payment period. Then use the appropriate interest formulas to determine the equivalent values

15, 16, 21, 24, 41, 47,

29,

31,

42,

44,

48,

- Calculating Bank Interest RatesUploaded byotilius
- 2 CapitalizationUploaded byRenato Mam
- Compound InterestUploaded byMATHEMATICS GURU
- Test 2 InterestUploaded byJoshua Johnson
- Basic Percentage ConceptUploaded byMaham Ahsan
- Park - Fundamentals of Engineering Economics_ 2nd Edition_solution Manual_ch2Uploaded byMobin Akhand
- 33960_pasantia_981Uploaded byIng Mirla Muñoz Cruzati
- Econimics(Nominal&Effective)Uploaded byapi-26367767
- Mrunal [Aptitude] Compound Interest Rate, Population Growth Without Formulas - MrunalUploaded byRahul Gaurav
- Compound InterestUploaded bySalay Girla
- Simple and Compund Interest practiseUploaded byKibria Rizvy
- Mathematics of FinanceUploaded byAnis Fadzilah Zulkifle
- Chapter 5 Engineering EconomicsUploaded byAdhela aditama
- California Public Utilities Commission Letter 04-04-16Uploaded byL. A. Paterson
- QuantapptQuestionsforpractice.docUploaded byJignesh Patel
- Case Digest on Civil Law ReviewUploaded byF Anton Nicolas
- cfpb tridUploaded byapi-296282969
- The Abington Journal 06-06-2012Uploaded byThe Times Leader
- FM UC2F1410_Time Value of Money_Lecture, Tutorial, Updates_6, 7 November 2014, Week 4_FM StudentsUploaded bySalmaAlnofali
- Sps. Biesterbos v. CA de LUNAUploaded byJohn Henry Valencia
- 4CM0_01_que_20130508.pdfUploaded byAbdullah Nabi Yusufi
- KEI Conf Call Qr 4-17-18Uploaded bygauravinflames
- Central Bank v. CloribelUploaded byKrisleen Abrenica
- ECO Paper - TylerUploaded byTyler Toro
- 12-17Uploaded byWoods

- ACC501 Mod1 CaseUploaded byChristina Taylor
- Ingles Jordy NuevoUploaded byopdeokdekfmejifenie
- Libby Financial Accounting Chapter2Uploaded byJie Bo Ti
- General Knowledge BankUploaded byshankarinadar
- Final Bank Branch Audit 2012Uploaded bynil she
- Session 03_Returns to Alternative Savings VehiclesUploaded byTasmin
- av inUploaded byQuyen Nguyen
- Internship PSTU MainUploaded bySohel Joy
- Case StudyUploaded bychandu1113
- What's behind Microsoft & Skype Acquisition?Uploaded byPiotr Bartenbach
- MSFin296 Ayala Policy Paper 4_v0.1Uploaded byLiboy Toledo
- Microsoft - Analysis of the Equity StatementUploaded byyiushum281
- The PrivateerUploaded bysloonie
- El informe de Moody´s sobre el gasto en Latinoamérica.Uploaded byLa Politica Online
- Management of Inflation in IndiaUploaded byMohit Singh Panwar
- Collateral ImportanceUploaded byAli Faiz
- Hasan Hoca ÖdevUploaded byHasan Alpagu
- Lecture Note for Elements of Economic Analysis IV1Uploaded byFederico Perez Cusse
- What Capital Cycles Mean for Investment PerformanceUploaded byIosias
- NBFCUploaded byjagdish91
- PPT Chapter 16Uploaded byYui Lee
- Capital StructureUploaded byDeepTi SinGh
- Minerals Commission Act,1993 Ghana.Uploaded byJuan Luis Berrio
- 22-htmlUploaded byOrafuJames
- Armenian Banking Sector OverviewUploaded byMisak Davtian
- Monetary PolicyUploaded byMisha Saeed
- Banking PptUploaded byAdithya Kannan
- Axis Bank ProjectUploaded bymaulik_kadao16622
- lic dUploaded byNia Sharma
- 79682337-MONEY-PADUploaded byThirumalesh Jodu