12/19/2015rd1 engineering economic analysis chapter 3 interest and equivalence
TRANSCRIPT
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Engineering Economic Engineering Economic AnalysisAnalysis
Chapter 3 Interest and Equivalence
http://academic.udayton.edu/ronalddeep/enm530.htm
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Irrelevant CharacteristicsIrrelevant Characteristics
Monetary Units Monetary Units DollarsDollarsPounds Pounds Yen Yen MarksMarks
Effective PeriodEffective PeriodDay Month Year Century
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Interest and EquivalenceInterest and Equivalence
Computing Cash Flows
Time Value of Money
Equivalence
Single Payment Compound Interest Formulas
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Why Engineering Economy?Why Engineering Economy?
Should I pay off my credit card balance with borrowed money?
What are the worth of graduate studies over my career?
Are tax deductions for my home mortgage a good deal or should I accelerate my mortgage payments?
Exactly what rate of return did we make on our stock investments?
Should I buy or lease my next car, or keep the one I have now and pay off the loan?
When should I replace my present car?
Which cash flow is preferable?
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Time Value of MoneyTime Value of Money
The change in the amount of money over a given time period is call the the time value of money; and is the most important concept in engineering economy.
You borrow $10,000 and repay $10,700 a year later. Find the rate of interest.
i = (10.7K – 10K)/10K = 700/10000 = 7%
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Cash Flow DiagramCash Flow Diagram
P ~ Present at time 0; F ~ Future A ~ Uniform or Equal
G ~ Gradient i ~ effective interest n ~ Number of pay periods
F
P
0 1 2 3 4 5 n
A
I = 7%
g
radient
uniform
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Compounding ProcessCompounding Process
Given: i = 10% n = 7 years
P = $3000 F = P(1 + i)n
Find: F = 3000(1 + 0.10)7 compounding factor
= $5846.15
P = F(1 + i)-n
Discounting factor
F = P(F/P, i%, n)
Genie command is (FGP 3000 10 7) 5846.15
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n Start Interest End1 P iP P(1 + i)1
2 P(1 + i)1 iP(1 + i)1 P(1 + i)2
3 P(1 + i)2 iP(1 + i)2 P(1 + i)3
.. …. …. …..n P(1 + i)n-1 iP(1 + i)n-1 P(1 + i)n
F/PF/P
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F given P; F = P(1 + i)n = 1000(1 + 0.04)5 1000(1.2167) = 1216.652 1216.70
calculator table
F = 1216.65
i = 4% compounded annually
n = 5
P = $1000 (F/P 1000 4 5) 1216.65
(F/P, i%, n)(F/P, i%, n)
formula
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F = A(F/A, i%, n)
(F/A, i%, n) = A[(1 + i)n-1 + (1 + i)n-2 + … + (1 + i)1 + 1](Summing from right to left) = A[1 – (1 + i)(1 + i)n-1]/[1 – (1 + i)]
= A[(1 + i)n - 1]/i F
1 2 3 4 5 6 … n-2 n-1 n
A
(F/A, i%, n)
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F given A; F = A(F/A, i%, n); F = 500(5.4163, 4%, 5) = $2708.16
(F/A, i%, n) =
F = $2708.16 = (F/A 500 4 5)
i = 4%
0 1 2 3 4 5
A = $500
5(1 ) 1 (1 0.04) 15.4163
0.04
ni
i
(F/A, i%, n)(F/A, i%, n)
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P/AP/A
P/A =
Find the present worth of 5 yearly deposits of $1000 at 7% compounded annually.
P = A(P/A, 7%, 5) = 1000(4.100197) = $4100.20 = 1000(F/A, 7%, 5)(P/F, 7%, 5) = 1000 * 5.750749 * 0.712986 = $4100.20
n n
n n
F P (1+i) -1 1 (1+i) -1* = *
A F i (1+i) i(1+i)
F/A P/F
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A/F & A/PA/F & A/PnA[(1+i) -1]
F/Ai
n
FiA/F =
(1+i) -1
n
n
F P A[(1+i) -1]P/A * =
A F i(1+i)
n
n
A F Pi(1+i)A/P *
F P (1+i) -1
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Compound Interest Factors 7%Compound Interest Factors 7%
n F/P P/F A/F A/P F/A P/A A/G P/G 1 1.0700 0.9346 1.0000 1.0700 1.0000 0.9346 0.0000 0.0000
2 1.1449 0.8734 0.4831 0.5531 2.0700 1.8080 0.4831 0.8735 3 1.2250 0.8163 0.3111 0.3811 3.2149 2.6243 0.9549 2.5061 4 1.3108 0.7629 0.2252 0.2952 4.4399 3.3872 1.4155 4.7948 5 1.4026 0.7130 0.1739 0.2439 5.7507 4.1002 1.8650 7.6467 6 1.5007 0.6663 0.1398 0.2098 7.1533 4.7665 2.3032 10.9784 7 1.6058 0.6227 0.1156 0.1856 8.6540 5.3893 2.7304 14.7149 8 1.7182 0.5820 0.0975 0.1675 10.2598 5.9713 3.1466 18.7890 9 1.8385 0.5439 0.0835 0.1535 11.9780 6.5152 3.5517 23.1405 10 1.9672 0.5083 0.0724 0.1424 13.8165 7.0236 3.9461 27.7156 11 2.1049 0.4751 0.0634 0.1334 15.7836 7.4987 4.3296 32.4666 12 2.2522 0.4440 0.0559 0.1259 17.8885 7.9427 4.7025 37.3507
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RelationshipsRelationshipsa. (F/P, i%, n) = i(F/A, i%, n) + 1
b. (P/F, i%, n) = 1 – i(P/A,i%, n)
c. (A/F, i%, n) = (A/P, i%, n) – i
d. (A/P i%, n) = i / [1 – (P/F, i%, n)]
e. Find (F/P, 10%, 37)(F/P, 10%, 37) = (F/P, 10%, 35)(F/P, 10%, 2) = 28.1024 *1.21 = 34.0039
f. (P/A, i%, n) – (P/A, i%, n-1) = (P/F, i%, n)
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Computing Cash FlowsComputing Cash Flows
You bought a machine for $30,000. You can either pay the full price now with a 3% discount, or pay $5000 now; at the end of 1 year pay $8000, then at the end of the next 4 years pay $6,000. i = 7% compound yearly.
Option 1 0.97 * 30K = $29,100
Option 2 $31, 470
0 1 2 3 4 5
-$5000
-$8000
-$6000 -$6000 -$6000 -$6000
Continued …
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Option 2Option 2
0 1 2 3 4 5
-$5000 -$6000 -$6000 -$6000 -$6000
-$8000
P = 6K(P/A, 7%, 4)(P/F, 7%, 1) + 8K(P/F, 7%, 1) + 5K
= 6K * 3.387 * 0.9346 + 8K(0.9346) + 5K
= 31,470
7% compounded annually
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Simple InterestSimple Interest
Simple interest is: P * i * n = Pin
You borrow $10,000 for 5 years at a simple interest rate of 6%. At the end of 5 years, you would repay: Principal plus simple interest
F = P + Pin = 10,000 + 10,000 * 0.06 * 10 = 10,000 + 600
= $10,600
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Compound InterestCompound Interest
Compound Interest is: P(1 + i)n
You borrow $10,000 for 5 years at 6% compounded annually. At the end of 5 years, you would repay: Principal plus compound interest
F = P(1 + 0.06)5 = $13,382.26versus the simple interest $10,600.00Difference $ 2,782.26
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Equivalence
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EquivalenceEquivalence
When comparing alternatives that provide the same service, equivalent basis depends on
Interest Rate
Amounts of money involved
Timing of the cash flow
Perspective (Point of View)
12 inches = 1 foot …continued
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EquivalenceEquivalenceYour borrow $5,000 at 8% compounded annually.You may return the $5,000 immediately, or pay according to Plan A or Plan B The 3 options are equivalent.n 1 2 3 4 5A -1400 -1320 -1240 -1160 -1080B -400 -400 -400 -400 -5400
PWA = 1400(P/A, 8%, 5) – 80(P/G, 8%, 5)= $5000
PWB = 400(P/A,8%,5) + 5000(P/F,8%,5) = 1597.08 + 3402.92 = $5000.
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Re-Payment PlansRe-Payment Plans
APR = 8%
n owed interest total principal total for year owed owed payment paid ( P+I)
1 $5000 $400 $5400 $1000 $14002 4000 320 4320 1000 13203 3000 240 3240 1000 12404 2000 160 2160 1000 11605 1000 80 1080 1000 1080 $1200 $6200
(IRR '(-5000 1400 1320 1240 1160 1080)) 8%
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Re-Payment PlansRe-Payment Plans
APR = 8%
n owed interest total principal total for year owed owed payment paid1 $5000 $400 $5400 $0 $4002 5000 400 5400 0 4003 5000 400 5400 0 4004 5000 400 5400 0 4005 5000 400 5400 5000 5400 $2000 $7000
(IRR '(-5000 400 400 400 400 5400)) 8%
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Re-Payment PlansRe-Payment Plans
APR = 8%
n owed interest total principal total for year owed owed payment paid1 $5000 $400 $5400 $ 852 $1252.282 4148 331 4479 921 1252.283 3227 258 3484 994 1252.284 2233 178 2411 1074 1252.285 1159 93 1252 1159 1252.28 $1260 $ 6261.40
(IRR '(-5000 1252.28 1252.28 1252.28 1252.28 1252.28)) 8%
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Re-Payment PlansRe-Payment Plans
APR = 8%
n owed interest total principal total for year owed owed payment paid1 $5000 $400 $5400 $ 0 $ 02 5400 432 5832 0 03 5832 467 6299 0 04 6299 504 6803 0 05 6803 544 7347 5000 7347 $2347 $5000 7347
(IRR '(-5000 0 0 0 0 7347)) 8%
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EquivalenceEquivalence
-5000 -5000 -5000 -50001400 400 1252 .28 01320 400 1252 .28 01240 400 1252 .28 01160 400 1252 .28 01080 5400 1252 .28 7347
8 .000% 8.000% 8.000% 8.001%
(IRR '(-5000 1400 1320 1240 1160 1080)) 8%(IRR '(-5000 400 400 400 400 5400)) 8%(IRR '(-5000 1252.28 1252.28 1252.28 1252.28 1252.28)) 8%(IRR '(-5000 0 0 0 0 7347)) 8%
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Simple vs. Compound InterestSimple vs. Compound Interest
Fs = P(1 + ni) Simple interest
Fc = P(1 + i)n Compound interest
Given P = $24, i = 5%, n = 20 years vs. compounded annually.
Fs = 24(1 + 20 * 0.05) = $48
Fc = 24(1.05)20 = $63.68.
In 1626 Peter Minuit paid $24 for Manhattan Island.
In Year 2008: Fs = 24(1 + 382 * 0.05) = $482.40
Fc = 24(1.05)381 = $2,982,108,814.51
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Annual Percentage Rate (APR) r; for example, 12% per year
Effective interest rate ieff APY ~ annual percent yield
ieff = , where m is the number of pay periods
Example: APR is 12% compounded monthly.
ieff = = 12.68% effective yearly rate.
All interest rates is formulas are effective interest rates commensurate with the pay periods.
Effective Interest RateEffective Interest Rate
mr(1+ ) -1
m
120.12(1+ ) -1
12
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Effective Interest RateEffective Interest Rate
Annual Percentage Rate (APR) is 12%
If compounded monthly,
effective monthly rate is 1% 12/12
effective quarterly rate is 3.03% (1 + 0.03/3)3 - 1
effective yearly rate is 12.68% (1 + 0.12/12)12 - 1
If compounded quarterly, effective quarterly rate is 3% 12/4
effective yearly rate is 12.55% (1 + 0.12/4)4 - 1
ieff = mr
(1+ ) -1m
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Effective Interest RateEffective Interest Rate
$1000 is invested for 5 years at 12% APR compounded monthly. Compute its future worth using effective
a) annual rate b) quarterly rate c) monthly rate and d) 3-year rate.
F5 years = 1000(1 + 0.126825)5 = $1816.70F20 qtrs = 1000(1 + 0.030301)20 = $1816.70F60 mths = 1000(1 + 0.01)60 = $1816.70F2.5yrs = 1000(1 + 0.2697)2.5 = $1816.70
Effective 3 year rate is (1 + 0.36/36)36 – 1 = 43.07688%F3 yrs = 1000(1 + 0.4307688)5/3 = $1816.70
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Interest RatesInterest RatesYou borrow $1000 and agree to repay with 12 equal monthly payments of $90.30.
Find the a) effective monthly interest rate.
b) nominal annual interest rate
c) effective annual interest rate.
a) 1000 = 90.30(P/A, i%, 12) => P/A factor = 11.0742
=> imonth-eff = 1.25%
b) APR = 12 * 1.25% = 15%
c) Annual effective rate = (1 + 0.15/12)12 – 1 = 16.08%.
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Continuous CompoundingContinuous Compounding
F = Pern where r is the APR and n is the number of years
(1 + 0.0001)10000 = 2.7181
The effective rate for continuous compounding is given by
er - 1.
Substitute er - 1 for i in the formulas.
For example, F = P(1 + i)n = P(1 + er – 1)n = Pern
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1/
0lim(1 ) x
xe x
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Continuous CompoundingContinuous Compounding
Traffic is currently 2000 cars per year growing at a rate of 5% per year for the next 4 years. How much traffic is expected at the end of 2 years?
F = 2000 e2*0.05 = 2210.34 cars
Investment is currently $2000 per year growing at a rate of 5% per year for the next 4 years. How much investment is expected at the end of 2 years?
F = 2000 e2*0.05 = $2210.34
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Problem Problem
$100 at time 0 is $110 at time pay period 1 and was $90 at time pay period –1. Find the APR for year –1 to 0 and for 0 to 1.
100 = 90(1 + i) => i = 11.11% 90 100 110
110 = 100(1 + i) => i = 10%;
If $90 is invested at time –1 returns $110 at time +1, find i. 110 = 90(1 + i)2 => i = 10.55%.
-1 0 1
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You plan to make 2 deposits, $25K now and $30K at the end of year 6. You draw out $C each year for the first 6 years and C + 1000 each year for the next 6 years. Find C at 10% interest compounded annually.
C(P/A, 10%, 12) + 1000(P/A, 10%, 6)(P/F, 10%, 6) = [25K + 30K(1.1)-6]
C = $5,793.60.
1 6 12
ProblemProblem
25K 30K
C + 1K
$C
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How many years until an investment doubles at 5% compounded annually?
F = 2P = P(1 + 0.05)n => 2 = 1.05n => Ln 2 = n Ln 1.05
n = Ln 2 / Ln 1.05 = 14.20669 years
CheckF = 1000 (1.05)14.21 = $2000
(NGPFI 1 2 5) 14.2067 years
Time to DoubleTime to Double
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F = P(1 + i)n
i = (F/P)1/n – 1
Example: What interest rate generates $3456 in 5 years by investing $1000 now?
i = 3.4561/5 – 1 = 28.14886%.
(IGPFN 1000 3456 5) 28.14886
Computing i given P, F and nComputing i given P, F and n
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Computing n given P, F and iComputing n given P, F and i
F = P(1 + i)n
n = Ln (F/P) / Ln (1 + i)
How many years for $1000 deposited now to accumulate to $3465 at an APR of 28.14886%?
n = Ln 3.465 / Ln 1.2814886
= 5 years
(NGPFI 1000 3465 28.1488) 5
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Arithmetic GradientArithmetic Gradient
0 1 2 3 . . . n -1 n
Gradient begins in Year 2
= A(P/A, i%, n) + G(P/G, i%, n)
G2G
(n -1)G
P
A
(n – 2)G
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11.Given the cash flow in the diagram below, find the present worth value at time 0 with interest rate 5% per year.
PW(5%) = [1000(P/A, 5%, 4) + 100(P/G, 5%, 4)](P/F, 5%, 2)
= $3679.12 (P/F (PGG 1000 100 5 4) 5 2) 3679.12
0 1 2 3 4 5 6
1000
1100
1200
1300
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Arithmetic GradientArithmetic Gradient
Find the present worth of the following cash flow at 7% compounded annually: A = 50, G = 20
n 1 2 3 4 5 6cf 50 70 90 110 130 150
P = A(P/A, i%, n) + G(P/G, i%, n)
= 50(P/A, 7%, 6) + 20(P/G, 7%, 6)
= 238.326 + 219.567 = $457.89
(PGG A G i n) (PGG 50 20 7 6) $457.89
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Geometric GradientGeometric Gradient
A1; A2 = A1 + gA1 = A1(1 + g);
A3 = A2 +gA2 = A1(1 + g) + gA1(1 + g) = A1(1 + g)2
An = A1(1 + g)n-1
Pn = An(P/F, i%, n) = An(1 + i)-n
= A1(1 + g)n-1(1 + i)-n
P = A1(1 + i)-n
(P/A1, i, g, n) =
1
1 (1 ) (1 )n ng iA
i g
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Geometric GradientGeometric Gradient
Find the present worth of a cash flow beginning at $10K and increasing at 8% for 4 years at 6% per year interest.
(PGGG-table 10000 8 6 4)
n Cash-flow 8% PW-factor 6% PWorth
1 10000.00 0.9434 9433.96 2 10800.00 0.8900 9611.96 3 11664.00 0.8396 9793.32 4 12597.12 0.7921 9978.10
$38,817.54
PW = 10K[1 – (1.08)4/(1.06)4(0.06 – 0.08)] = $38,817.54
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Geometric GradientGeometric Gradient
Example: Calculate the present worth of a contract awarded at $1000 per year and increasing at a uniform rate of 10% per year for 5 years at 7% APR compounded annually.
P = A1[1 – (1 + g)n(1 + i)-n]/(i – g)
= 1000[1 – 1(1 + 0.1)5(1 + 0.07)-5 ]/(0.07 - 0.10)
= $4942.38.
(PGGG A g i n) ~ (PGGG 1000 10 7 5) $4942.38
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Geometric GradientGeometric Gradient
A modification costs $8K, expected to last 6 years with a $1300 salvage value. Maintenance is $1700 the first year and increasing 11% per year thereafter. The interest rate is 8%. Find the present worth.
PW = -8K – 1700[1- (1.11/1.08)6/(0.08 – 0.11)] =1300(1.06)-6
= -$17,305.88
(+ 8000 (PGGG 1700 11 8 6) (PGF -1300 8 6)) 17305.88
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Problem 3-11Problem 3-11
n 0 1 2 3 4cf -100 25 45 45 30
Find the compound annual interest rate.
Guess and test or
(IRR '(-100 25 45 45 30)) 16.189%
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Problem 3-12Problem 3-12
Compute the difference in borrowing $1E9 at 4.5% for 30 years versus at 5.25%.
Diff = 1E9[(F/P, 5.25%, 30) – (F/P, 4.5%, 30)]
= $896,232,956.47
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Problem 3-15Problem 3-15
1903 painting valued at $600
1995 painting valued at $29,152,000
Find i.
29152000 = 600(F/P, i%, 92) = 600(1 + i)92
48586.7 = (1 + i)92
1.12445066 = 1 + i
12.45% = i
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Manhattan IslandManhattan Island
Manhattan Island was bought for $24 in 1626 from the native Americans. Compute the present day worth if they had invested the money in an 8% APR compounded yearly.
F = 24 (1 + 0.08)2008-1626 = $140,632,545,502,000
Today each of the 300 millions Americans could be given $468,775.15. F is considerably more than what Manhattan Island is now worth.
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Learning CurveLearning Curve
The time to make the first unit is $1000 and the learning curve is 90%. What is the cost to make the 2nd, 4th and 8th units?
T2 = 1000 * 2(log 0.90 2) = 1000 *2 -0.1520 = $900
T4 = 0.90 * $900 = $810
T8 = 0.90 * $810 = $729.
(sim-lc 1000 8 90) Unit Hours Cumulative 1 1000.00 1000.00 2 900.00 1900.00 3 846.21 2746.21 4 810.00 3556.21 5 782.99 4339.19 6 761.59 5100.78 7 743.95 5844.73 8 729.00 6573.73
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Cost of a MortgageCost of a Mortgage
Interest Rate
Loan Amount
Payment Frequency
Points (Prepaid interest of 1% of loan)
Fees (application, loan origination)
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Principal Reduction and Interest Paid for Principal Reduction and Interest Paid for each paymenteach payment
A = P(A/P, i%, N)
PRn = A(P/F, i%, N – n + 1); Interestn = A - PRn
PR5 = 1627.45(P/F, 10%, 10 – 5 + 1)
= $918.65
(P/F, i%, n) = (P/A, i%, n) – (P/A, i%, n - 1)
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Pay Num Payment Principal Interest Balance Total Interest 1 1627.45 627.45 1000.00 9372.55 1000.00 2 1627.45 690.19 937.26 8682.36 1937.26 3 1627.45 759.21 868.24 7923.15 2805.50 4 1627.45 835.13 792.32 7088.02 3597.82 5 1627.45 918.65 708.80 6169.37 4306.62 6 1627.45 1010.51 616.94 5158.86 4923.56 7 1627.45 1111.56 515.89 4047.30 5439.45 8 1627.45 1222.72 404.73 2824.58 5844.18 9 1627.45 1344.99 282.46 1479.59 6126.64 10 1627.45 1479.49 147.96 0.10 6274.60
Mortgage Payments Loan = $10,000 Interest 10%/year N = 10 years
A = 10K(A/P, 10%, 10) = $1627.45
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Computing the BalanceComputing the Balance
On a loan of $10,000 for 10 years at 10% per year, determine the annual payment and the balance after 6 years.
1 2 3 4 5 6 7 8 9 10
A = P(A/P, i%, N) = 10K(A/P, 10%, 10) = $1627.45
B6 = 1627.45(P/A, 10%, 4) = $5158.81
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Points or No PointsPoints or No Points
You finance a home for $100K at 15 year interest rate. You can either pay one point with 6.375% interest or no points with 6.75% interest compounded monthly.
The 1 point implies that you get $99K but get charged as if you borrowed $100K
A = 100K(A/P, 6.375/12 %, 180) = $864.2599K = 864.25(P/A, i%, 180) looking for 114.55 P/A factor for 180 pay periods. i = 0.545 % => APR = 6.54%
Thus go with paying the point as 6.54% < 6.75%.
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Monthly PaymentsMonthly Payments
What is the monthly payment for a 5-year car loan of $35,000 at 6% compounded monthly?Find the amount of the principal reduction of the 25th payment.
A = $35,000(A/P, 6% /12, 60) = $676.65.
PR25 = 676.65(P/F, 6%/12, 60 – 25 + 1) = $565.44.
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Mortgage PaymentsMortgage Payments
You take out a loan for $350,000 at 6% APR compounded monthly for 30 years.
a) Your monthly payment is _________.
b) The principal reduction PR225 is ________.
c) The interest paid Int225 at this payment is _______.
d) The total interest paid to date at this payment is _______.
e) The balance at this payment is __________.
f) The per cent of your loan paid by the 225th is ______.
Ans. a) $2098.43 b) $1064.90 c) $1033.53 d) $327,786.21
e) $205,640.17 f) 41.245%
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Compound ContinuouslyCompound Continuously
How long does it take for an investment to triple if interest rate is compounded continuously at i = 7%?
F = Pern
3 = 1e0.07n => n = 15.69 years
You deposit $1000 a year for 5 years at 7% compounded continuously. At the end of 5 years you can withdraw _______. Substitute er – 1 for i into the F/A factor.
ans. $5779.59
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Interest RateInterest Rate
A credit card company charges 1.5% interest on the unpaid balance each month.
Nominal annual interest rate is ________. ans. 18%
Effective annual interest rate is ________.
ans. 19.56%
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1 2 3 4 5
A = $500
Place an amount F3 at year 3 which is equivalent to the cash flow below at 7%.
F3 = 500(P/A, 7%,5)(F/P,7%,3) = $2511.46.
EquivalenceEquivalence
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PreferencePreference
Which alternative would you choose at i = 10%? i = 9%?
1) Receive $100 now.
2) $120 two years from now.
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P/AP/A
Find the exact P/A factor at 9.35% compounded continuously for n = 10 pay periods.
P/A =
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0.935
0.0935 0.935
(1 ) 1 16.1974%
(1 ) ( 1)
n
n
i e
i i e e
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Time Value of MoneyTime Value of Money
a) Joe wants to figure his annual car cost given the following cash flow at i = 7%:
n 1 2 3 4 5cf $45 90 135 180 225
(list-pgf '(0 45 90 135 180 225) 7) $528.61
(A/P 528.61 7 5) 128.92
b) He got the 3rd and 4th year mixed. Refigure.
(list-pgf '(0 45 90 180 135 225) 7) $531.01
(AGP 531.01 7 5) $129.51
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Problem 3-19Problem 3-19
What sum of money is equivalent to $8250 2 years later if interest is 4% compounded semiannually?
8250(1.04)-4 = $7052.13
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Problem 3-23Problem 3-23
A local bank pays 5% annual interest while an out of town bank pays 1.25% compounded quarterly. You have $3000 to deposit for 2 years. In which bank do you deposit your money?
3000(1.05)2 = $3307.50
3000(1.0125)8 = $3313.46
$5.96
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Problem 3-24Problem 3-24
P1 = P2 at interest rate i. Which cash flow is better at 2i?
F1 F2
0 1 2 0 1 2 3
P1 = F1 (1 + i)-2 = F2 (1 + i)-3 = P2 => F2 = F1(1 + i)
P'1 = F1(1 + 2i)-2 P'2 = F2 (1 + 2i)-3 = F1(1 + i)(1 + 2i)-3
P'2 /P'1 = (1 + i)/(1 + 2i) < 1 => P'1 > P'2
For example, try F1 = $100 and F2 = $107.
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Problem 3-27Problem 3-27
A sum of money Q will be received 6 years from now. At 5% annual interest the present worth of Q is $60. At the same interest rate, what would be the value of Q in 10 years?
F = 60(1.05)10 = $97.73
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Find A to equate the series at 10% compounded annually. 120 120 120 100 100
1 2 3 4 5
P0 = 100(P/A,10%,2) + 120(P/A,10%,3)(P/F,10%,2)
A A A A
1 2 3 4 5
P0 = A(P/A,10%,4)(P/F,10%,1) = $420.18 => A = $145.81