LECTURE # 5 Equivalence

Dictionary meaning
‡ ‡ ‡ ‡ ‡ Sameness Likeness Similar Correspondence Equal

‡ But not identical ‡ Two things can be identical but they may not be equivalent

Why Equivalence
‡ Two or more alternatives are required to be judged on an equivalent criteria ‡ If two or more situations are to be compared, their characteristics must be placed on an equivalent basis ‡ Which is more? A pounds of product A or 2.5 Kilograms of product B ± It is necessary to place the two products on an equivalent basis by applying a conversion factor ‡ Only then you can decide which is more!!!

‡ Two things are said to be equivalent if they have the same effect ‡ Three elements are involved in the equivalence of sums of money
± The amounts of the sum ± The time of occurrence of the sum ± The interest rate

‡ Interest formulas consider all the above elements

‡ An engineer sells his product and he is offered a choice of $ 12500 now or $ 2000 per year for the next ten years. years. Engineer is paying 12% interest on his other loans. What 12% loans. should he do? ‡ He needs to create equivalence in the two situations. HOW situations. !!!!! ‡ He should find out the present worth of $ 2000. 2000. ‡ Can we use this formula

Sn = P0(1+i)n

No«.. What should we do

‡ How about factors «. But which factor to be used ‡ In this question u have to find P for an equal annual payment (A) of $ 2000 ««««

‡ F / P = Single payment future worth factor ‡ P / F = Single payment present worth factor ‡ F / A = Equal payment series future worth factor ‡ A / F = Equal payment series sinking fund factor ‡ P / A = Equal payment series present worth factor ‡ A / P = Equal payment series capital recovery factor ‡ A / G = Arithmetic gradient series factor ‡ F / G = Arithmetic gradient future worth factor ‡ P / G = Arithmetic gradient present worth factor ‡ Geometric Gradient factor

‡ We need to use P / A = Equal payment series present worth factor

‡ Here A = $2000, i = 12% and n = 10 ‡ Putting the values P = $ 11322.75 which is less then the $12500 therefore 12500, He should go for $ 12500 now

Principles of Equivalence
‡ Equivalent cash flows have the same values ‡ Equivalence can be established at any point of time since it is know that for one cash flow to be equivalent to another, their values must be equal

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