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Engineering Economics

Chapter 3
Cash Flow Analysis - II

Sept. 18, 2014

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Example: Uneven Multiple Cash Flows, but we separate


(decompose) these into single cash flows!
How much do you need to deposit today (P) to withdraw $25,000
at n =1, $3,000 at n = 2, and $5,000 at n =4, if your account earns
10% annual interest?
$25,000

$5,000

$3,000
0
1

Decomposition of uneven multiple cash flows

Notice that in this example, using the factor seems to be


easier than using the equation!

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Example: Future Value of an Uneven Cash


Flows with Varying Interest Rates
Given: Deposit series as given over 5 years
Complicated

Find: Balance at the end of year 5=?

Example: Future Value of an Uneven Series


with Varying Interest Rates
Given: Deposit series as given
over 5 years

Find: Balance at the end of year 5

So far, for single cash flow problems, we can


use one of the following approaches:
1. Use the equations

F = P(1 + i)N
P = F/(1 + i)N

2. Use the Compound Interest Factors (the tables)


Compound Amount Factor : (F/P, i, N)
Present Worth Factor:
(P/F, i, N)
3. In addition, we can use the Excel Spreadsheet
Functions
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Compound Interest Factors and Excel Function


(Textbook p.50)

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Single Cash Flow - Finding the Future Value F=?

3-8

In Excel: FV function
Syntax

Rate
Nper
Pmt
Pv
Type

(Future Value function).

FV(rate, nper, [pmt], -pv, [type])

Required. The interest rate per period. (e.g. 10%/12, or 0.83%, or 0.0083)
Required. The number of periods.
Optional. The payment made each period (annuity).
Required. The present value (required if Pmt is omitted).
Optional. The number 0 or 1 and indicates when payments are due. If type is
omitted, it is assumed to be 0.

In Excel: PV function (Present Value function).


Syntax
Rate
Nper
Pmt
Fv
Type

PV(rate, nper, 0, - fv, [type])

Required. The interest rate per period. (e.g. 10%/12, or 0.83%, or 0.0083)
Required. The total number of periods.
Optional. The payment made each period (annuity).
Required. The future value, (required if Pmt is omitted)
Optional. The number 0 or 1 and indicates when payments are due.

Single Cash Flow - Finding the interest rate i=?

Excel: RATE function


Syntax

RATE(nper, pmt, -pv, [fv], [type], [guess])

The RATE function syntax has the following arguments:


Nper
Pmt
Pv
Fv
Type

Required. The total number of periods.


Required. The payment made each period (annuity). If pmt is omitted, you must
include the fv argument.
Required. The present value.
Optional. The future value. If fv is omitted, it is assumed to be 0.
Optional. The number 0 or 1 and indicates when payments are due.

Single Cash Flow - Finding the compounding


periods N=?

Excel: NPER function


Syntax

NPER(rate, pmt, -pv, [fv], [type])

The NPER function syntax has the following arguments:


Rate
Pmt
Pv
Fv
Type

Required. The interest rate per period.


Required if no Fv value specified. If no annuity, Pmt=0.
Required. The present value.
Optional. The future value. If fv is omitted, it is assumed to be 0.
Optional. The number 0 or 1 and indicates when payments are due.

3.5 Compound Interest Factors for Annuities

Annuity: series of N receipts or disbursements that begin


at end of period 1 and continue to end of period N.
Notice that if there is any cash flow occurred at period
0, it can not be considered as part of the series cash
flows, even though the amount is the same as A!
loan payments are classical examples of annuities.

N-1

..
0

..

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3.5 Compound Interest Factors for Annuities

The Sinking Fund Factor: (A/F, I, N)

To find a series of N receipts/disbursements (A) that


should be set aside each period in order to meet a major
financial need in the future (F)

i
( A, F , i, N ) =
N
(1 + i ) 1

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3.5 Compound Interest Factors for Annuities


(contd)

The Capital Recovery Factor: (A/P, i, N)

Is used to compute how much to be set aside each


period to repay a present use of money.
easily derived from the sinking fund factor and the
uniform series compound amount factor:

( A / P, i , N ) = ( A / F , i , N )(F / P, i , N )
=

i (1 + i )N
(1 + i )N 1

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How did we get these equations?


Example: Find the Equation for F, given A, i, N
F

A(1+i)N-2
A

A
A(1+i)N-1

0 1 2

0 1 2

(1 + i) 1
N 1
N 2
F = A(1 + i) + A(1 + i) + + A = A

How did we get these equations?


Example: Find the Equation for F, given A, i, N
N

+
1
(1
i
)
N 1
N 2
F = A(1 + i) + A(1 + i) + + A = A

Based on the above equation, we can also derive the


Equation for finding P, given A, i, N as
N

+
1
(1
i
)
N 1
N 2
F = A(1 + i) + A(1 + i) + + A = A

(1 + i ) N 1
P = A
N

+
i
i
(
1
)

To see how the formula derivation, check appendix 3A (p.82)

Equations
- Find P given F

F
P=
(1 + i ) n

- Find F given P

F = P (1 + i ) n

- Find A given F

i
A = F

n
(1 + i ) 1

- Find A given P

i (1 + i ) n
A = P

n
(
1
+
)

1
i

- Find F given A

(1 + i ) n 1
F = A

(1 + i ) n 1
P = A
n

+
i
(
1
i
)

- Find P given A

Practice Problem 3.5a


A Ford Mustang costs $17 000. It can be financed at
5.9% for 48 months, with monthly compounding. How
much will the monthly payments be?

Answer
i = 0.059/12 = 0.00492 per month
A = P(A/P, i, N) = $17 000(A/P, 0.00492, 48) =
$398.50

i (1 + i ) n
A = P

n
(
1
+
)

1
i

Cannot find values from the Tables!


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3.5 Compound Interest Factors for Annuities (contd)


Uniform Series Compound Amount Factor:
inverse of the sinking fund factor: (A/F, i, N)
used to compute the total amount saved at the end
of a regular savings plan

(1 + i )N 1
(F / A, i , N ) =
i

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Practice Problem 3.5b

What is the present worth of a series of 15 annual


payments of $1000 each, when the first payment is
now and the interest rate is 5%, compounded
monthly?

Answer
An effective annual interest rate must be calculated first:

i e = (1 + 0.05 / 12)12 1 = 0.05116


= 1000 + 1000(P/A, 5.116%, 14)
= 1000 + 1000 (9.82563) = $10 826

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