MODULE 3

THE TIME VALUE

OF MONEY
(PART 3)
 RELATING
RELATING A
A UNIFORM
UNIFORM SERIES
SERIES (DEFERRED
(DEFERRED
ANNUITY)
ANNUITY) TO
TO PRESENT
PRESENT // FUTURE
FUTURE
EQUIVALENT
EQUIVALENT VALUES
VALUES
• If an annuity is deferred j periods, where j < N
• And finding P given A for an ordinary annuity is
expressed by: P = A ( P / A, i%,N )
• This is expressed for a deferred annuity by: A
( P / A, i%,N - j ) at end of period j
• This is expressed for a deferred annuity by: A
( P / A, i%,N - j ) ( P / F, i%, j ) as of time 0
(time present)
Deferred Annuities

P00 = A(P/A, i%,N-J)(P/F,i%,J)

Deferred Annuities

P00 = A(P/A, i%,N-J)(P/F,i%,J)

P0 = A(P/A, i%,N-J)(P/F,i%,J)
The present worth is always located one period prior to
the first uniform series amount when using the P/A factor.
Deferred Annuities

The future worth is always located in the same

period as the last uniform series amount when using
the F/A factor.
(Eng Eco by Leland and Tarquin)
Recalibration of sensitive measuring devices costs $8000
per year. If the machine will be recalibrated for each of 6
years starting 3 years after purchase,, calculate the 8-
year equivalent uniform series at 16% per year.
 Ex.3.4 An offshore design group
just purchased upgraded CAD
software for $5000 now and annual
payment of $500/yr for 6 yrs
starting 3 yrs from now for annual
upgrades. What is the present
worth in year 0 of the payments if
the interest rate is 8% per year?
 Ex.3.5
Ex.3.5 AA design-build-operate
design-build-operate engineering
engineering company
company in in Texas
Texas
that
that owns
owns aa sizable
sizable amount
amount of of land
land plans
plans toto lease
lease the
the drilling
drilling
rights
rights (oil
(oil and
and gasgas only)
only) to to aa mining
mining and
and exploration
exploration company.
company.
The
The contract
contract calls
calls for
for the
the mining
mining company
company to to pay
pay $20,000
$20,000 perper
year
year for
for 20
20 years
years beginning
beginning 33 years years from
from now
now (i.e.,
(i.e., beginning
beginning
at
at the
the end
end of of year
year 33 and and continuing
continuing though
though yearyear 22)
22) plus
plus
$10,000
$10,000 six six years
years from
from now now andand $15,000
$15,000 sixteen
sixteen years
years from
from
now.
now. Utilize
Utilize engineering
engineering economy
economy relations
relations to
to determine
determine thethe five
five
equivalent
equivalent listed
listed below
below at at 16%
16% perper year.
year.
1)
1) Total
Total present
present worth
worth P PTT in
in year
year 00
2)
2) Future
Future worth
worth FF inin year
year 2222
3)
3) Annual
Annual series
series over
over all
all 22
22 years
years
4)
4) Annual
Annual series
series over
over the
the first
first 10
10 years
years
5)
5) Annual
Annual series
series over
over the
the last
last 12
12 years
years
 EQUIVALENCE CALCULATIONS INVOLVING
MULTIPLE INTEREST FORMULAS
•• All
All compounding
compounding of of interest
interest takes
takes place
place once
once per
per time
time
period
period (e.g.,
(e.g., aa year),
year), andand to
to this
this point
point cash
cash flows
flows also
also occur
occur
once
once per
per time
time period.
period.
•• Consider
Consider an an example
example where where aa series
series of
of cash
cash outflows
outflows
occur
occur over
over aa number
number of of years.
years.
•• Consider
Consider that
that the
the value
value ofof the
the outflows
outflows isis unique
unique forfor each
each
of
of aa number
number (i.e.,
(i.e., first
first three)
three) years.
years.
•• Consider
Consider that
that the
the value
value ofof outflows
outflows isis the
the same
same forfor the
the last
last
four
four years.
years.
•• Find
Find a)a) the
the present
present equivalent
equivalent expenditure;
expenditure; b) b) the
the future
future
equivalent
equivalent expenditure;
expenditure; and and c)c) the
the annual
annual equivalent
equivalent
expenditure
expenditure
 PRESENT
PRESENT EQUIVALENT
EQUIVALENT EXPENDITURE EXPENDITURE
•• Use
Use P P00 == F(
F( P P // F,
F, i%,
i%, NN )) for
for each
each of of the
the unique
unique years:
years:
--
-- FF isis aa series
series of of unique
unique outflow
outflow forfor year
year 11 through
through year
year 3;
3;
--
-- ii is
is common
common for for each
each calculation;
calculation;
--
-- NN is is the
the year
year in in which
which thethe outflow
outflow occurred;
occurred;
--
-- Multiply
Multiply the the outflow
outflow times
times the the associated
associated tabletable value;
value;
--
-- Add
Add the the three
three products
products together;
together;
•• Use
Use A A (( P
P // A,i%,N
A,i%,N -- jj )) (( P
P // F,
F, i%,
i%, jj )) --
-- deferred
deferred annuity
annuity --
-- for
for
the
the remaining
remaining (common(common outflow)
outflow) years:
years:
--
-- AA is is common
common for for years
years 44 through
through 7; 7;
--
-- ii remains
remains the the same;
same;
--
-- NN is is the
the final
final year;
year;
--
-- jj is
is the
the last
last year
year aa unique
unique outflow
outflow occurred;
occurred;
--
-- multiply
multiply the the common
common outflow outflow value
value times
times table
table values;
values;
--
-- add
add this this to
to the
the previous
previous total
total for
for the
the present
present equivalent
equivalent
expenditure.
expenditure.
e.g. Calculating P, F and A Values
Uniform (Arithmetic) Gradient of
Cash Flows
• Involve receipts or expenses that are
projected to increase or decrease by a
uniform amount each period, thus
constituting an arithmetic sequence of
cash flow.
 Cash Flow Diagram for a Uniform Gradient
Increasing by G Dollars per period

i = effective interest rate (N-1)G

per period
(N-2)G
G = uniform gradient
amount; constant (N-3)G
arithmetic change in CF
from one time period to 3G
the next; 2G
G may be + or - G

1 2 3 4 N-2 N-1 N
End of Period
RELATING A UNIFORM GRADIENT OF CASH
FLOWS TO FUTURE EQUIVALENTS

•• Find
Find F
F when
when given
given G:
G:
 RELATING A UNIFORM GRADIENT OF CASH
FLOWS TO FUTURE EQUIVALENTS

•• Find
Find F
F when
when given
given G:
G:
•• Find
Find the
the future
future equivalent
equivalent value
value when
when given
given the
the
uniform
uniform gradient
gradient amount
amount
 RELATING A UNIFORM GRADIENT OF CASH
FLOWS TO FUTURE EQUIVALENTS

•• Find
Find FF when
when given
given G: G:
•• Find
Find the
the future
future equivalent
equivalent value
value when
when given
given thethe
uniform
uniform gradient
gradient amount
amount
(1+i) N-1 -1
(1+i)N-1 -1 (1+i) N-2 -1
(1+i)N-2 -1 (1+i)
(1+i) 11 -1
-1
•• F
F == G
G ++ ++ ...
... ++
i i i
 RELATING A UNIFORM GRADIENT OF CASH
FLOWS TO FUTURE EQUIVALENTS

•• Find
Find FF when
when given
given G: G:
•• Find
Find the
the future
future equivalent
equivalent value
value when
when given
given thethe
uniform
uniform gradient
gradient amount
amount
(1+i) N-1 -1
(1+i)N-1 -1 (1+i) N-2 -1
(1+i)N-2 -1 (1+i)
(1+i) 11 -1
-1
•• F
F == G
G ++ ++ ...
... ++
i i i
•• Functionally
Functionally represented
represented as
as (G/
(G/ i)i) (F/A,i%,N)
(F/A,i%,N) -- (NG/
(NG/ i)i)
 RELATING A UNIFORM GRADIENT OF CASH
FLOWS TO FUTURE EQUIVALENTS

•• Find
Find FF when
when given
given G: G:
•• Find
Find the
the future
future equivalent
equivalent value
value when
when given
given the
the
uniform
uniform gradient
gradient amount
amount
(1+i) N-1 -1
(1+i)N-1 -1 (1+i) N-2 -1
(1+i)N-2 -1 (1+i)
(1+i) 11 -1
-1
•• F
F == G
G ++ ++ ...
... ++
i i i
•• Functionally
Functionally represented
represented asas (G/
(G/ i)i) (F/A,i%,N)
(F/A,i%,N) -- (NG/
(NG/ i)i)
•• Usually
Usually more
more practical
practical to
to deal
deal with
with annual
annual and
and present
present
equivalents,
equivalents, rather
rather than
than future
future equivalent
equivalent values
values
RELATING A UNIFORM GRADIENT OF CASH
FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
•• Find
Find A
A when
when given
given G:
G:
 RELATING A UNIFORM GRADIENT OF CASH
FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
•• Find
Find A
A when
when given
given G:
G:
•• Find
Find the
the annual
annual equivalent
equivalent value
value when
when given
given the
the
uniform
uniform gradient
gradient amount
amount
 RELATING A UNIFORM GRADIENT OF CASH
FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
•• Find
Find AA when
when given
given G:
G:
•• Find
Find the
the annual
annual equivalent
equivalent value value when
when given
given the
the
uniform
uniform gradient
gradient amount
amount
11 N
N
•• A
A == G
G --
ii (1
(1 ++ ii )) NN -- 11
 RELATING A UNIFORM GRADIENT OF CASH
FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
•• Find
Find AA when
when given
given G:
G:
•• Find
Find the
the annual
annual equivalent
equivalent value value when
when given
given the
the
uniform
uniform gradient
gradient amount
amount
11 N
N
•• A
A == G
G --
ii (1
(1 ++ ii )) NN -- 11
•• Functionally
Functionally represented
represented as as AA == G
G (( A
A // G,
G, i%,N
i%,N ))
 RELATING A UNIFORM GRADIENT OF CASH
FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
•• Find
Find AA when
when givengiven G:
G:
•• Find
Find the
the annual
annual equivalent
equivalent value value when
when given
given the
the
uniform
uniform gradient
gradient amount
amount
11 N
N
•• A
A == G
G --
ii (1
(1 ++ ii )) NN -- 11
•• Functionally
Functionally represented
represented as as AA == G
G (( A
A // G,
G, i%,N
i%,N ))
•• The
The value
value shown
shown in in [[ ]] isis the
the gradient
gradient toto uniform
uniform series
series
conversion
conversion factor
factor and
and is is presented
presented in in column
column 99 of
of
Appendix
Appendix C C (represented
(represented in in the
the above
above parenthetical
parenthetical
expression).
expression).
CASH FLOW DIAGRAMS RELATING G
AND A WHEN USING THE FORMULA
TO FIND A GIVEN G

Note that the first uniform gradient cash

flow,G, occurs at the end of period two.
RELATING A UNIFORM GRADIENT OF CASH
FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
•• Find
Find P
P when
when given
given G:
G:
 RELATING A UNIFORM GRADIENT OF CASH
FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
•• Find
Find P
P when
when given
given G:
G:
•• Find
Find the
the present
present equivalent
equivalent value
value when
when given
given the
the
uniform
uniform gradient
gradient amount
amount
 RELATING A UNIFORM GRADIENT OF CASH
FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
•• Find
Find PP when
when given
given G: G:
•• Find
Find the
the present
present equivalent
equivalent value value when
when givengiven the
the
uniform
uniform gradient
gradient amount
amount
11 (1
(1 ++ ii )) NN-1
-1 N
N
•• P
P == G
G --
ii ii (1
(1 ++ ii )) NN (1
(1 ++ ii )) NN
 RELATING A UNIFORM GRADIENT OF CASH
FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
•• Find
Find PP when
when given
given G: G:
•• Find
Find the
the present
present equivalent
equivalent value value when
when given given the
the
uniform
uniform gradient
gradient amount
amount
11 (1
(1 ++ ii )) NN-1
-1 N
N
•• P
P == G
G --
ii ii (1
(1 ++ ii )) NN (1
(1 ++ ii )) NN
•• Functionally
Functionally represented
represented as as P P == G
G (( P P // G,
G, i%,N
i%,N ))
 RELATING A UNIFORM GRADIENT OF CASH
FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
•• Find
Find PP when
when given
given G: G:
•• Find
Find the
the present
present equivalent
equivalent value value when
when given given the
the
uniform
uniform gradient
gradient amount
amount
11 (1
(1 ++ ii )) NN-1
-1 N
N
•• P
P == G
G --
ii ii (1
(1 ++ ii )) NN (1
(1 ++ ii )) NN
•• Functionally
Functionally represented
represented as as P P == G
G (( P P // G,
G, i%,N
i%,N ))
•• The
The value
value shown
shown in{ in{ }} is
is the
the gradient
gradient to to present
present
equivalent
equivalent conversion
conversion factor factor andand isis presented
presented in in
column
column 88 of of Appendix
Appendix C C (represented
(represented in in the
the above
above
parenthetical
parenthetical expression).
expression).
CASH
CASH FLOW
FLOW DIAGRAMS
DIAGRAMS RELATING
RELATING G
G AND
AND P
P
WHEN
WHEN USING
USING THE
THE FORMULA
FORMULA TO
TO FIND
FIND P
P
GIVEN
GIVEN G
G

Note: The conventional arithmetic gradient starts

in year 2 and P is located in year 0.
Ex.3.6
Ex.3.6 (Engineering
(Engineering Economy
Economy by by Leland
Leland and and
Tarquin)
Tarquin)
Neighbouring
Neighbouring parishes
parishes in in Louisiana
Louisiana have have
agreed
agreed to to pool
pool road
road tax
tax resources
resources already
already
designated
designated forfor bridge
bridge refurbishment.
refurbishment. At At aa recent
recent
meeting,
meeting, thethe engineering
engineering estimated
estimated thatthat aa total
total
of
of $500,000
$500,000 will
will be
be deposited
deposited at
at the
the end
end of of next
next
year
year into
into an
an account
account for for the
the repair
repair of of old
old and
and
safety-questionable
safety-questionable bridgesbridges throughout
throughout the the
area.
area. Further,
Further, they
they estimated
estimated that
that the
the deposits
deposits
will
will increase
increase byby $100,000
$100,000 per per year
year for
for only
only 99
years
years thereafter,
thereafter, then
then cease.
cease. Determine
Determine the the
equivalent
equivalent (a)(a) present
present worth,
worth, andand (b)
(b) annual
annual
series
series amounts,
amounts, ifif public
public funds
funds earn
earn at at aa rate
rate of
of
5%
5% per
per year.
year.
Ex.3.6 Cash Flow Diagram
(a) In $1000 units,
PT = 500(P/A,5%,10) +
100(P/G, 55,10)
= 500(7.7217) +
100(31.6520)
= $7026.05 or
7,026,050
(b) It is necessary to
consider the gradient and
the base amount separately.
AT =500+100(A/G,5%,10)
= 500 +100(4.0991)
= $909.91 or 909,910/yr
or: AT = PT (A/P,5%,10)
= 7026.05(0.1295)
= $909.873
Ex.3.7 The announcement of the XY steel plant
states that the $200M investment is planned for
2020. Most large investment commitments are
actually spread out over several years as the
plant is constructed and production is initiated.
Further investigation may determine , for
example, that the $200M is a present worth in
the year 2020 of anticipated investments during
the next 4 years (2021through 2024). Assume
the amount planned for 2021 is $100M with
constant decrease of $25 M each year
thereafter. As before, assume the time value of
money for investment capital is 10% per year.
Ex.3.7

(a)
(a) In
In equivalent
equivalent present
present worth
worth values,
values, does
does the
the
planned
planned decreasing
decreasing investment
investment series
series equal
equal thethe
announced
announced $200M
$200M in in 2020?
2020?
(b)
(b) Given
Given the
the planned
planned investment
investment series,
series, what
what isis the
the
equivalent
equivalent annual
annual amount
amount thatthat will
will be
be invested
invested from
from
2021
2021 to
to 2024?
2024?
•• Solution:
Solution: The
The investment
investment series
series is
is aa decreasing
decreasing
arithmetic
arithmetic gradient
gradient with
with aa base
base amount
amount of of $100M
$100M in in
year
year 1(2021)
1(2021) and
and GG == -$25M
-$25M through
through year
year 4(2024).
4(2024).
Cash Flow diagram for decreasing
gradient in $1M units:
PT = PA – PG
= 100(P/A,10%,4) -
25(P/G,10%, 4)
= 100(3.1699) –
25(4.3781)
= $207.537M
Thus, in present worth terms,
the planned series will exceed
the equivalent of $200M in 2020
by $7.537M