04 - Money-Time Relationship and Equivalence CHE40

MONEY-TIME
RELATIONSHIP AND
EQUIVALENCE
CHE40: Engineering Economy
Simple Interest
Compound Interest
Cash Flow Diagrams
Money-Time Relationship and Equivalence

Interest Tables
Single Payment Factors
Uniform Series Factors
Use of Multiple Factors
2
Outline
Uniform Gradient Factors
Geometric Series
Nominal and Effective Interest Rates

Continuous Compounding and Discrete
Cash Flows
Differences in PP and CP
Outline
wealth in the form of money or property
Capital that can be used to produce more wealth
increase between an original sum of

money borrowed and the final amount
Interest owed
percentage of the original amount per

Interest time unit
Rate
Introduction
the total interest earned or charged is
linearly proportional to the initial amount
of the loan, the interest rate and the
number of interest periods

I PNi ( 4-1 )
I simple
P principal
N number of
interest
i interest
interest amount rate
periods
Simple Interest
$2,000 is deposited in a savings account that pays 10% simple
interest. How much will the account be worth in 5 years?
I PNi

Worth of account in 5 years = P + I
P I P PNi P1 Ni
P I 20001 50.10
P I $ 3,000
Simple Interest
$2,000 is deposited in a savings account that pays 10% simple
interest. How much will the account be worth in 5 years?
EOY P I Amount at EOY
1 2,000 200 2,200

2 2,000 200 2,400
3 2,000 200 2,600
4 2,000 200 2.800
5 2,000 200 3,000
Simple Interest
interestaccrued is calculated on the
principal plus the total amount of interest
accumulated in the previous periods
1 P Pi P+Pi = P(1+i)

2 P(1+i) P(1+i)i P(1+i)+P(1+i)i = [P(1+i)](1+i) = P (1+i)2
3 P (1+i)2 P (1+i)2i P (1+i)2+P (1+i)2i = P (1+i)3
4 P (1+i)3 P (1+i)3i P (1+i)3+P (1+i)3i = P (1+i)4
5 P (1+i)4 P (1+i)4i P (1+i)4+P (1+i)4i = P (1+i)5
For compound interest
I C P1 i
N
Compound Interest
interestaccrued is calculated on the
principal plus the total amount of interest
accumulated in the previous periods

If $2,000 is placed in an account that earns 10% compounded
annually, what will its worth be in 5 years?
I C P1 i
N
I C 20001 0.10
5
I C $ 3,221.02
9
Compound Interest
1 2,000 200 2,200

2 2,200 220 2,420
3 2,420 242 2,662
4 2,662 266.20 2.928.20
5 2,928.20 292.82 3,221.02
10
Compound Interest
11
Simple vs. Compound Interest

P
0 1 2 N-2 N-1 N

F
i effective
interest rate
per interest
N number of
compounding
P present sum of
money
periods
period
F future sum
A uniform
series cash
of money flow
12
Cash Flow Diagrams

Cash Flow Conventions
horizontal line
arrows
point of view (lender or borrower)

end-of-period cash flows
P
0 1 2 N-2 N-1 N
Markings are as of EOY F

Direction of cash flow is point of view 13
dependent
Cash Flow Diagrams
14
Cash Flow Diagram lenders viewpoint

Discrete Compounding; i = 10%
Single Payment Uniform Series Uniform
Gradient
N F/P P/F F/A P/A A/F A/P P/G A/G
1 1.1000 0.9091 1.0000 0.9091 1.0000 1.1000 0.000 0.000

5 1.6105 0.6209 6.1051 3.7908 0.1638 0.2638 6.862 1.8101

15
Interest Tables (Appendix C-13)

SinglePayment Compound Amount Factor
F given P
F P1 i
P
N

0 1 2 N-2 N-1 N
F PF P , i, N
16

SinglePayment Present Worth Factor
P given F
P F 1 i
P
N

0 1 2 N-2 N-1 N
P F P F , i, N
F
17

A future amount, F, is equivalent to $1,500 now when eight
years separate the amounts and the annual interest rate is 10%.
What is the value of F?
P = 1500

i = 10% N=8
F=?
F P1 i
N FPF P
, i %, N
F 15001 0.10
8

F 1500 F ,10%,8
P

F $ 3,215.38 F 15002.1436
F $ 3,215.40 18

Suppose that you have $10,000 cash today and can invest it at
an interest rate of 10% compounded each year. How many
years will it take you to become a millionaire?
F =$ 1,000,000
F P1 i
N

i = 10% N=?
P = $ 10,000
1,000,000 10,0001 0.10

N
100 1.1 N
log 100 N 48.32 years

N
log 1.1 49 years 19

Suppose that you have $10,000 cash today and can invest it at
an interest rate of 10% compounded each year. How many
years will it take you to become a millionaire?
F =$ 1,000,000
F P1 i
N

i = 10% N=?
P = $ 10,000
F
P P

F ,10%, N
F/P
72.8905
N
45 P

100 F ,10%, N
100 ??? Look at interest table, 10%
117.5909 50 interest rate, look for F/P
values immediately above or
N 48.05 years
below 100, interpolate using 20
49 years F/P values to get N
In 1971, first-class postage for a one-ounce envelope was $0.08.
In 2001, a first-class stamp for the same envelope costs $0.34.
What compounded annual increase in the cost of first-class
postage was experienced during the 30 years?

P = $ 0.08 F =$ 0.34
i=?
1971 N = 30 2001
F P1 i
N
0.34 0.081 i
30
i 4.9%
21

series of uniform (equal) receipts
Annuity occurring at the end of each period
Notes on Annuities

P occurs one interest period before
the first A
F occurs at the same time as the last
A and N periods after P
A occurs at the end of periods 1 to N,
inclusive
22

Uniform Series Present Worth Factor
P given A
1 i 1 N
P A N
i 1 i

P
0 1 2 N-2 N-1 N
A A A A A
P AP A , i, N
23

Capital Recovery Factor
A given P
i 1 i N
A P
1 i 1

P
N
0 1 2 N-2 N-1 N
A A A A A
A P A P , i , N
24

Uniform Series Compound Amount Factor
F given A
1 i 1
N
P
F A

i
0 1 2 N-2 N-1 N
A A A A A
F AF A , i, N
25

SinkingFund Factor
A given F
i
A F
1 i 1

P N
0 1 2 N-2 N-1 N
A A A A A
A F A F , i, N
26

A present obligation of $20,000 is to be repaid in uniform
annual amounts, each of which includes a repayment of the
debt and interest on the debt, over a period of 5 years. If the
interest rate is 12% per year, what is the amount of the annual

repayment? P = 20,000
i 1 i N
A P
1 i 1
N
i = 12%
A=? N=5
0.121 0.12 5
A 20,000 A P A P , i , N
1 0.12 1
5
A 20,0000.2774
A $5,548.19
27
A $5,548
It is estimated that a certain piece of equipment can save
$22,000 per year in labor and maintenance costs. The
equipment has an expected life of 5 years and no market
value. If the company must earn a 15% annual return on such

investments, how much could be justified now for the purchase
of this equipment?
i = 15?
1 i N 1 A = $ 22,000 N=5
P A
i 1 i P=?
N
1 0.155 1
P 22,000 5
0.151 0.15
P $ 73,747.41
28

P coincides with A
Recall that A occurs one period after P
Break down given into 2 diagrams
A future amount of $150,000 is to be accumulated through
annual payments A over 20 years. The payment of A starts
now and the last payment occurs simultaneously with the
future amount at the end of year 20. If the interest rate is 9%

per year, what is the value of A? F = 150,000
i = 9%
F P F P ,9%,20
A F A
,9%,20 P=A
A=? N = 20
but P A
F AF P ,9%,20 A F A
,9%,20
150,000 A5.6044 A51.1601
A $ 2,642.5
Alternative solution: 29
Designate a period PN-1, change N to
Uniform Series Factors21 years
Laura wants her estate to be worth $200,000 at the end of 10
years. Her net worth now is zero. She can accumulate the desired
value by depositing $14,480 at the end of each year for the next 10
years. At what interest rate per year must her deposits be
invested? F = 200,000

1 i N 1 i=?
F A
i A = 14,480 N = 10
1 i 10 1
200,000 14,480
i
i 6.99 7%
30

cash flow that does not begin
Deferred
Annuity until some later date

31

What lump sum of money must be deposited into a bank account
at the present time so that $6,000 per month can be withdrawn
for five years, with the first withdrawal scheduled for 6 years from
today? The interest rate is 8% per month. P
71
1 i 1

N
P71 A i = 8%/month A = 6,000/month
i 1 i N
P
N=72
P71 6000
1.0860 1
P P P ,8%, 71
F
60 0 71

0 .08 1.08
P0 74,259.31 5.61x103
P71 $74,259.31
P0 $ 416.60
32

You purchase a special equipment that reduces defects by $10,000
per year on an item. This item is sold on contract for the next 5
years. After the contract expires, the special equipment will save
approximately $3,000 per year for five years. You assume that
the machine has no market value at the end of 10 years. How

much can you afford to pay for this equipment now if you require
a 20% annual return on your investment?
P P0 based on A1 A1 = 10,000
A2 = 3,000 i = 20%
P0 based on A2 1 5 6 10

P0 A1 10,000 P
A

,20%,5 P=?
P0 A1 10,0002.9906

P0 A2 3,000 P ,20%,5 P ,20%,5
P0 A1 $29,906
A F
P0 A2 3,0002.99060.4019
P0 A2 $3,605.77 33
Use of Multiple Factors P $33,511.77

An expenditure of $20,000 is made to modify a material-
handling system in a small job shop. This modification will result
in first-year savings of $2,000, a second-year savings of $4,000
and a savings of $5,000 per year thereafter. How many years

must the system last if an 18% return on the investment is
required? The system is tailor made for this job shop and has no
market value at any time.
A3 = 5,000
A2 = 4,000
A1 = 2,000 i = 18%
1 2 3 4 N=?
P = 20,000
34

P 20,000

2,000 P ,18%,1 4,000 P ,18%,2 5,000 P ,18%, N P ,18%,2
F F A F

20,000 2,0000.8475 4,0000.7182 5,000 P ,18%, N 0.7182
A

15,432.2 5,000 P ,18%, N 0.7182

A
P ,18%, N 4.29766

A
P/A N
N 8.98 9
4.0776 8
overall N 9 2 11 4.29766 ???

4.3030 9
A3 = 5,000
A2 = 4,000
A1 = 2,000 i = 18%
1 2 3 4 N=? 35
P = 20,000

Uniform Gradient
a cash-flow series which either increases or
decreases uniformly
0 1 2 N-2 N-1 N

Gradient
amount of increase or decrease
0 1 2 N-2 N-1 N
G
(N-3)G
36
(N-2)G
Uniform Gradient Factors (N-1)G

Uniform Gradient Present Worth Factor
P given G
1 1 i 1
N
N
P G

N
i i 1 i 1 i
N
P GP G , i, N
37

Uniform Gradient Annual Worth Factor
A given G
1 N

A G
i 1 i 1
N
A G A G , i, N
38

Uniform Gradient Future Worth Factor
F given G
1 1 i 1N


F G N
i i
39

600
500
400
Gradient = 100
300
Base = 200
200
1 2 3 4 5

400
300
200
100
A = 200
1 2 3 4 5 1 2 3 4 5
40
Uniform Gradient Illustration

Suppose that the parents of a young child decide to make annual
deposits into a savings account, with the first deposit being made
on the childs 5th birthday and the last deposit being on the childs
15th birthday. Then starting on the childs 18th birthday,
withdrawals of $2,000, $2,400, $2,800 and $3,200 will be made.

The effective annual interest rate is 8%. What are the annual
deposits in years 5 through 15?
P17=F 3,200
P15 2,800
2,400
2,000
i = 8%
0 5 15 18
41

P17 A P ,8%,4 G P ,8%,4
A G

P17 2,0003.3121 4004.650
P17 $8,484.20
P15 F P
F
,8%,2
P15 8,484.200.8573

P15 $7,273.50
A F A F
,8%,11
A 7,273.500.0601
A $437.14
Solution:
G P17 42
P17 P15 = F at year 15
Uniform Gradient Factors F at year 15 A
For a repayment schedule that starts at the end year 4 at $Z
and proceeds for years 4 through 10 at $2Z, $3Z, etc.., what is
the value of Z if the principal of this loan is $10,000 and the
interest rate is 7% per year?

4z
3z
2z
z
i = 7%
0 4 5 6 7 8 9 10
P = 10,000
43

P PA PG P
F

,7%,3 10,000

P A z P ,7%,7
A

P A z5.3893

PG z P ,7%,7

G
PG z14.75
P 10,000 z5.3893 z14.750.8163
z $608.28 4z
3z
2z
z
i = 7%
0 4 5 6 7 8 9 10 44
P = 10,000
Suppose that the annual income from a rental property is expected
to start at $1,300 per year and decrease at a uniform amount of
$50 each year after the first of the 15-year expected life of the
property. What should the investment cost be to justify this
investment, if the interest rate is 9% per year. Assume that the

investment occurs now and that the annual income is first received
at the end of year 1.
Decreasing annuity
1,300 Negative gradient
1,250
1,200
1,150
1,100 i = 9%
0 1 2 3 4 5 15 45
P=?

P PA PG
A

P 1300 P ,9%,15 50 P ,9%,15
G

P 13008.0607 5043.807
P $8,288.56

1,300
1,250
1,200
1,150
1,100 i = 9%
0 1 2 3 4 5 15
P=?
46

cash flow series that change by a constant
Geometric percentage in consecutive payment periods
Series

0 1 2 N-2 N-1 N
D
D(1+E)
D(1+E)N-3
D(1+E)N-2
PE D E
D(1+E)N-1
present initial
worth of cash flow geometric
escalating (Y1)
growth
series
47
Geometric Series
48
1 E N

D 1
1 i N

PE Ei

E i
N
PE D E=i
1 E
49
Geometric Series
A geometric gradient increases by 6% per year for 15 years. The
annual interest rate is 12%. What is the present equivalent
value of this gradient?
1 E N

D 1
1 i N

PE
E 15 i
1.06
D 1
1.12 15

PE
0.06 0.12
PE 9.3693D
50
Geometric Series
You are the manager of a large crude oil refinery. As part of the
refining process, a certain heat exchanger operated at high
temperatures and with abrasive material flowing through it must be
replaced every year. The replacement and downtime cost in the first
year is $175,000. This cost is expected to increase due to inflation at a

rate of 8% per year for five years, at which time this particular heat
exchanger will no longer be needed. If the companys cost of capital is
18% per year, how much could you afford to spend for a higher quality
heat exchanger so that these annual replacement and downtime costs
could be eliminated?
0 E = 8% N=5
i = 18%
P=175,000
51
Geometric Series
1 E N (-) Downtime cost
D 1
1 i N

PE
E i
1.085
175,000 1
1.18

5
PE
0.08 0.18
PE $626,050.52
0 E = 8% N=5
i = 18%
175,000
P
52
Geometric Series
Nominal professed annual interest rate
Rate
Effective actual or exact interest rate

Rate
CP
compounding period
PP
payment period
53

m
r
i 1 1
m

i effective
interest
r nominal
m no. of
compounding
rate rate
periods per year
When compounding is annual, r = i

54

Statement Interpretation
effective 12% per year
12% per year
compounded yearly

8% per year, nominal 8% per year
compounded compounded monthly
monthly
effective 10% per effective 10% per year
year compounded compounded monthly
monthly
55

P 100 P 100
F ? F ?
i 12%(effective ) i 12%(no mina lco mpo undedmo nthly)
N 5 years

N 5 years
F P1 i
N
F P1 i
N
F 1001 0.01
60
F 1001 0.12
5
F $182
F $176.23
F P1 i
m N
r
i 1 1
m F 1001 0.127
5
12
0.12
i 1 1 12.7%
F $182 56
12
Find the present equivalent value of $100 at the end of each
month for 72 months at a nominal rate of 15% compounded

monthly. 15
P A P , i, N i 1.25% per montheffective
A

12

P 100 P ,1.25% per month,72months
A
1 i N 1
P 100 N
i1 i
1 0.012572 1
P 100 72
0.01251 0.0125
57
P $4,729.25
What is the annual equivalent value of $125,000 now when 12%
nominal interest per year
m
is compounded 12
monthly? Let N = 10
years. r 0.12
i 1 1 1 1 12.7%

m 12

A P A , i, N

P
A P A ,12.7% per year ,10 years
P
i1 i N
A P

1 i N
1
0.1271.12710
A 125,000

1 .127 10
1 58
A $22,760 per year
What is the annual equivalent value of $125,000 now when 12%
nominal interest per year is compounded monthly? Let N = 10
years. Using 1% per month effective interest rate

A P A , i, N

P
A P A ,1% per month,120months
P
i1 i N
A P

1 i N
1
0.011.01120
A 125,000

1 .01120
1 59
A $1,793.37 per month $21,520.44
Suppose that you have just borrowed $7,500 at 12% nominal
interest compounded quarterly. What is the total lump-sum,
compounded amount to be paid by you at the end of a 10-
year loan period?

m 4
r 0.12
i 1 1 1 1 12.55%
m 4
FPF
P

, i, N P1 i
N
F 75001 0.1255
10
F $24,463.40
60

Suppose that you have just borrowed $7,500 at 12% nominal
interest compounded quarterly. What is the total lump-sum,
compounded amount to be paid by you at the end of a 10-
year loan period?
r 12% compounded quarterly

i 3% per quarter effective
N 10 years 40quarters
F 75001 0.03
40
F $24,465.28
61

The effective annual interest rate has been determined to be
26.82% based on monthly compounding. Calculate how much
can be spent now to avoid future computer software
maintenance expenses of $1,000 per quarter for the next 5 years.
m
r

i 1
m
4
r
0.2682 1 1; r 24%
4

P A P ,6% per quarter ,20quarters
A

P 100011.4699
P $11,469.90 62

The effective annual interest rate has been determined to be
26.82% based on monthly compounding. Calculate how much
can be spent now to avoid future computer software
maintenance expenses of $1,000 per quarter for the next 5 years.


P A P ,6% per quarter ,20quarters
A
1 i N 1
P A N
i1 i
1 0.0620 1
P 1000 20
0.061 0.06
P $11,469.90 63

h
1
1 e 2.71828
lim
h h
i e 1 r

i effective
continuous
r annual
nominal
interest rate rate
All continuous compounding interests are nominal

interest
64
Continuous Compounding and Discrete Cash Flows

ContinuousCompounding Compound
Amount Factor (Single Payment)
F given P
rN

e
Continuous Compounding Present Equivalent
(Single Payment)
P given F
rN
e
65

ContinuousCompounding Compound
Amount Factor (Uniform Series)
F given A
e 1
rN

e 1
r
Continuous Compounding Present Equivalent

(Uniform Series)
P given A rN
e 1
e rN

e 1
r
66

Continuous Compounding Sinking Fund
Factor
A given F
e 1 r

e 1
rN
Continuous Compounding Capital Recovery

Factor
A given P
e rN
e r
1
e rN
1 67

A man deposited $10,000 in a savings account when his son was
born. The nominal interest rate was 8% per year, compounded
continuously. On the sons 18th birthday, the accumulated sum
was withdrawn from the account. How much was the
accumulated amount?

FPF P

, i, N P1 i
N
F 10,0001 i 10,000 1 e 1
N r
N

F 10,000 e
0.08 18
F $42,206.96
68

A person needs $18,000 immediately as a down payment on a
new home. Suppose that she can borrow this money from her
company credit union. She will be required to repay the loan in
equal payments made every 6 months over the next 12 years.
The annual interest rate being charged is 10% compounded

continuously. What is the amount of each payment?

A P A , i, N
P

A P A ,5% per 6 months,24 6 months
P

i1 i
A P
N

er
1 1 e r
1
N

P
1 i N
1

1 e r
1
N
1

69

Continuation
A person needs $18,000 immediately as a down payment on a
new home. Suppose that she can borrow this money from her
company credit union. She will be required to repay the loan in
equal payments made every 6 months over the next 12 years.
The annual interest rate being charged is 10% compounded

continuously. What is the amount of each payment?
i1 i
A P
N
P

e 1 1 e 1
r r N

N
1 i 1
N

241 e 1 1
r

A 18,000

e 0.05 1 e 0.05

e 0.0524 1

A $1,320.65 70

PP Shorter than CP
(Interperiod Compounding)
money deposited between
compounding periods is regarded as

having been deposited at the end of
the compounding period
money withdrawn between
compounding periods is regarded as
having been withdrawn at the
beginning of the compounding period
71
Compounding period: quarterly
$90 $120 $45
0 1 2 3 4 5 6 7 8 9 10 11 12

$150 $200 $75 $100
$90 $165
0 1 2 3 4 5 6 7 8 9 10 11 12
$150 $200 $175
72
What monthly deposit would be equivalent to a deposit of
$600 every 3 months for 2 years if the interest rate is 6% per
year compounded semi-annually? Assume no interperiod
interest on all deposits.

i = 6% compounded semi-annually
2 years
600 600
600
monthly deposit
3
monthly deposit 200
73
Simple Interest
Compound Interest
Cash Flow Diagrams

Interest Tables
74
Outline
Geometric Series

Continuous Compounding and Discrete
Cash Flows
75
Outline
Wicks and Koellig, Engineering
Sullivan,
Economy, 15th ed, England: Pearson
Education Limited, 2012
Blank,L. and Tarquin, A., Engineering
Cost Concepts and Design Economics

Economy, 4th ed, Singapore: McGraw-Hill
Book Co, 1998
Eschenbach, T., Engineering Economy

Applying Theory to Practice, USA: 1995
76
References
MONEY-TIME
RELATIONSHIP AND
EQUIVALENCE
CHE40: Engineering Economy

04 - Money-Time Relationship and Equivalence CHE40

Загружено:

Сведения о документе

Исходное описание:

Авторское право

Доступные форматы

Поделиться этим документом

Поделиться или встроить документ

Параметры публикации

Этот документ был вам полезен?

Это неприемлемый материал?

Авторское право:

Доступные форматы

04 - Money-Time Relationship and Equivalence CHE40

Загружено:

Авторское право:

Доступные форматы

MONEY-TIME

Money-Time Relationship and Equivalence

Money-Time Relationship and Equivalence

increase between an original sum of

Money-Time Relationship and Equivalence

percentage of the original amount per

Money-Time Relationship and Equivalence

Money-Time Relationship and Equivalence

Money-Time Relationship and Equivalence

Money-Time Relationship and Equivalence

For compound interest

Money-Time Relationship and Equivalence

Money-Time Relationship and Equivalence

Simple vs. Compound Interest

Money-Time Relationship and Equivalence

Cash Flow Diagrams

Money-Time Relationship and Equivalence

Markings are as of EOY F

Cash Flow Diagram lenders viewpoint

Money-Time Relationship and Equivalence

If $2,000 is placed in an account that earns 10% compounded

Interest Tables (Appendix C-13)

Money-Time Relationship and Equivalence

Single Payment Factors

Money-Time Relationship and Equivalence

Single Payment Factors

Money-Time Relationship and Equivalence

Single Payment Factors

Money-Time Relationship and Equivalence

1,000,000 10,0001 0.10

log 100 N 48.32 years

Single Payment Factors

Money-Time Relationship and Equivalence

Money-Time Relationship and Equivalence

Single Payment Factors

Money-Time Relationship and Equivalence

Uniform Series Factors

Money-Time Relationship and Equivalence

Uniform Series Factors

Money-Time Relationship and Equivalence

Uniform Series Factors

Money-Time Relationship and Equivalence

Uniform Series Factors

Money-Time Relationship and Equivalence

Uniform Series Factors

Money-Time Relationship and Equivalence

Money-Time Relationship and Equivalence

Uniform Series Factors

Money-Time Relationship and Equivalence

Money-Time Relationship and Equivalence

Uniform Series Factors

Money-Time Relationship and Equivalence

Use of Multiple Factors

Money-Time Relationship and Equivalence

Use of Multiple Factors

Money-Time Relationship and Equivalence

Use of Multiple Factors P $33,511.77

Money-Time Relationship and Equivalence

Use of Multiple Factors

Money-Time Relationship and Equivalence

overall N 9 2 11 4.29766 ???

Use of Multiple Factors

Money-Time Relationship and Equivalence