Concepts from the

example problems
( F / P, i, N)  Problem 1
( P / F, i, N)  Problem 2
( F / A, i, N)  Problem 3
( A / F, i, N)  Problem 4
( P / A, i, N)  Problem 5
( A / P, i, N)  Problem 6
( P / G, i, N)  Problem 7
( A / G, i, N)  Problem 8
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 Example 1
How much would you have to
deposit today to have $2000 in 4
years if you can get a 12% interest
rate compounded annually?
GIVEN:
F4 = $2 000
DIAGRAM: i = 12%
$2 000 FIND P:
0 1 2 3
P = F4(P/F,i,n)
n=4
= 2 000(P|F,12%,4)
P?
= 2 000(0.6355) = $1 271

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 Different Ways
of Looking at P/F
• From previous example, if you can earn
12% compounded annually, you need to
deposit $1271 to have $2000 in 4
years.
• You are indifferent between $1271
today and $2000 in 4 years, assuming
you can earn a return on your money of
12%.
• The present worth of $2000 in 4 years
is $1271 (i = 12% cpd ‡ annually).
‡
my abbreviation for compounded

If you could get 13% on your money,

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would you rather have the $1271
 Example 2
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? 4
 Present Given Gradient (Geometric)
• g is the geometric gradient over the time period
 (time period: Time 0 to Time n, 1st flow at Time 1)
• 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

Note: cash flow starts with A1 at Time 1, increases by constant g% per period

   (1  g )  n 
P?  1  
(1  i )  
   
  when i  g
0 1 2 3 n ig
  
( P / A, g , i, n)    

A1 
g=%  n
 when i  g
P = A1(P/A,g,i,n)  (1  i )

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 Example 2
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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 Example 2 - Concept
If your rich Aunt Edna wanted to
put a sum of money in the bank
today to pay for your next four
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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 Complex Cash Flows
Complex Cash Flows – Break
apart (or separate) complex
cash flows into component
cash flows in order to use the
standard formulas.
Remember: You can only
combine cash flows if they
occur at the same point in
time.
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(This is like building with

 Problem 3
A construction firm is considering the
purchase of an air compressor.

The compressor has the following expected

end of year maintenance costs:
Year 1 $800
Year 2 $800
Year 3 $900
Year 4 $1000
Year 5 $1100
Year 6 $1200
Year 7 $1300
Year 8 $1400

What is the present equivalent maintenance

cost if the interest rate is 12% per year
compounded annually?
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 Problem 3 – Alt Soln 1
GIVEN:
MAINT COST1-8 PER DIAGRAM
i = 12%/YR, CPD ANNUALLY
FIND P: P = PA + PG + PF = A(P/A,i,n) + G(P/G,i,n) + F(P/F,i,n)
= $700(P/A,12%,8) + $100(P/G,12%,8) + $100(P/F,12%,1)
DIAGRAM:
= $700(4.9676) + $100(14.4715) + $100(0.8929) = $5014
P? PA ?
1 2 3 4 1 2 3 4
n=8 n=8
0 $700 0 PF ?
$700 n=1
PG ?
$100 $100 $200 0
$300 $700 1 2 3 4 $100
n=8
0
$100 $200
NOTE: CAN BREAK INTO 3 CASH FLOWS: $300 $700
ANNUAL, LINEAR GRADIENT, AND FUTURE

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 GIVEN:
Problem 3 – Alt Soln 2
MAINT COST1-8 PER DIAGRAM
i = 12%/YR, CPD ANNUALLY
FIND P: P = PA + PG(PPG) = A(P/A,i,n) + G(P/G,i,n-1)(P/F,i,1)
= $800(P/A,12%,8) + $100(P/G,12%,7)(P/F,12%,1)
DIAGRAM: = $800(4.9676) + $100(11.6443)(0.8929) = $5014
P? PA ?
1 2 3 4 1 2 3 4
n=8 n=8
0 0
$800 $800

$100 $200 PPG ? PG ?

0 1 2 3
$600 n=7
0 1
NOTE: PG MUST BE OFFSET ONE YEAR – SO PG ? $100 $200
BRING THE OFFSET YEAR BACK TO TIME ZERO $600
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 Problem 4
A young couple has decided to make advance
plans for financing their 3 year old daughter’s
college education. Money can be deposited at 8%
per year, compounded annually.
What annual deposit on each birthday, from the
4th to the 17th (inclusive), must be made to provide
$7,000 on each birthday from the 18th to the 21st
DIAGRAM: (inclusive)? GIVEN:
$7 000
WITHDRAWALS18-21 = $7 000
4 17 i = 8%/YR, CPD YEARLY
FIND A4-17:
0 18 21 yrs
P17 = A(F/A,i,n) = A(P/A,i,n)
A?
= A(F/A,8%,14) = 7 000(P/A,8%,4)
STRATEGY: CAN BREAK INTO 2 CASH FLOWS,
SO PICK A CONVENIENT POINT IN TIME AND SET = A(24.2149) = 7 000(3.3121)
DEPOSITS EQUAL TO WITHDRAWALS…
 A = $957
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