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CHAPTER 3

PRINCIPLES OF
MONEY-TIME
RELATIONSHIPS

MONEY
Medium of Exchange -Means of payment for goods or services;
What sellers accept and buyers pay ;
Store of Value -A way to transport buying power from one time
period to another;
Unit of Account -A precise measurement of value or worth;
Allows for tabulating debits and credits;

CAPITAL
Wealth in the form of money or
property that can be used to
produce more wealth.

KINDS OF CAPITAL
Equity capital is that owned by individuals who
have invested their money or property in a
business project or venture in the hope of
receiving a profit.
Debt capital, often called borrowed capital, is
obtained from lenders (e.g., through the sale
of bonds) for investment.

Financing

Definition

Instrument Description

Debt
financing

Borrow
money

Bond Promise to
pay
principle &
interest;

Equity
financing

Sell partial Stock Exchange


ownership of
shares of
company;
stock for
ownership of
company;

Financing

Definition

Instrument Description

Debt
financing

Borrow
money

Bond Promise to
pay
principle &
interest;

Equity
financing

Sell partial Stock Exchange


ownership of
shares of
company;
stock for
ownership of
company;

Financing

Definition

Instrument Description

Debt
financing

Borrow
money

Bond Promise to
pay
principle &
interest;

Equity
financing

Sell partial Stock Exchange


Exchange
ownership of
sharesfor
of
money
company;
stock for
shares
of
ownership
of
stock
as
company;
proof of
partial
ownership

INTEREST
The fee that a borrower pays to a lender for the use of his or her
money.

INTEREST RATE
The percentage of money being borrowed that is paid to the lender
on some time basis.

HOW INTEREST RATE IS


DETERMINED
Interest
Rate

Quantity of Money

HOW INTEREST RATE IS


DETERMINED
Interest
Rate

Money Demand
Quantity of Money

HOW INTEREST RATE IS


DETERMINED
Interest
Rate

Money Supply
MS1

Money Demand
Quantity of Money

HOW INTEREST RATE IS


DETERMINED
Interest
Rate

Money Supply
MS1

ie
Money Demand
Quantity of Money

HOW INTEREST RATE IS


DETERMINED
Interest
Rate

Money Supply
MS1 MS2

ie
i2

Money Demand
Quantity of Money

HOW INTEREST RATE IS


DETERMINED
Interest
Rate

Money Supply
MS3 MS1 MS2

i3
ie
i2

Money Demand
Quantity of Money

SIMPLE INTEREST
The total interest earned or charged is linearly
proportional to the initial amount of the loan
(principal), the interest rate and the number of
interest periods for which the principal is committed.
When applied, total interest I may be found by I =
( P ) ( N ) ( i ), where
P = principal amount lent or borrowed
N = number of interest periods ( e.g., years )
i = interest rate per interest period

COMPOUND INTEREST
Whenever the interest charge for any interest period is
based on the remaining principal amount plus any
accumulated interest charges up to the beginning of that
period.
Period Amount Owed Interest Amount Amount Owed
Beginning of
for Period
at end of
period
( @ 10% )
period
1 $1,000
$100 $1,100
2 $1,100
$110 $1,210
3 $1,210
$121 $1,331

ECONOMIC EQUIVALENCE
Established when we are indifferent between a
future payment, or a series of future payments,
and a present sum of money .
Considers the comparison of alternative options,
or proposals, by reducing them to an equivalent
basis, depending on:
interest rate;
amounts of money involved;
timing of the affected monetary receipts and/or
expenditures;
manner in which the interest , or profit on invested
capital is paid and the initial capital is recovered.

ECONOMIC EQUIVALENCE FOR FOUR


REPAYMENT PLANS OF AN $8,000 LOAN

Plan #1: $2,000 of loan principal plus 10% of BOY


principal paid at the end of year; interest paid at the end
of each year is reduced by $200 (i.e., 10% of remaining
principal)
Year Amount Owed Interest Accrued Total Principal Total end
at beginning
for Year
Money Payment of Year
of Year
owed at Payment ( BOY )
end of
Year
1 $8,000
$800
$8,800 $2,000 $2,800
2 $6,000
$600
$6,600 $2,000 $2,600
3 $4,000
$400
$4,400 $2,000 $2,400
4 $2,000
$200
$2,200 $2,000 $2,200
Total interest paid ($2,000) is 10% of total dollar-years ($20,000)

ECONOMIC EQUIVALENCE FOR FOUR


REPAYMENT PLANS OF AN $8,000 LOAN
Plan #2: $0 of loan principal paid until end of fourth
year; $800 interest paid at the end of each year
Year Amount Owed Interest Accrued Total Principal Total end
at beginning
for Year
Money Payment of Year
of Year
owed at Payment ( BOY )
end of
Year
1 $8,000
$800
$8,800 $0
$800
2 $8,000
$800
$8,800 $0
$800
3 $8,000
$800
$8,800 $0
$800
4 $8,000
$800
$8,800 $8,000 $8,800
Total interest paid ($3,200) is 10% of total dollar-years ($32,000)

ECONOMIC EQUIVALENCE FOR FOUR


REPAYMENT PLANS OF AN $8,000 LOAN
Plan #3: $2,524 paid at the end of each year; interest
paid at the end of each year is 10% of amount owed at
the beginning of the year.
Year Amount Owed Interest Accrued Total Principal Total end
at beginning
for Year
Money Payment of Year
of Year
owed at Payment ( BOY )
end of
Year
1 $8,000
$800
$8,800 $1,724 $2,524
2 $6,276
$628
$6,904 $1,896 $2,524
3 $4,380
$438
$4,818 $2,086 $2,524
4 $2,294
$230
$2,524 $2,294 $2,524
Total interest paid ($2,096) is 10% of total dollar-years ($20,950)

ECONOMIC EQUIVALENCE FOR FOUR


REPAYMENT PLANS OF AN $8,000 LOAN
Plan #4: No interest and no principal paid for first three
years. At the end of the fourth year, the original principal
plus accumulated (compounded) interest is paid.
Year Amount Owed Interest Accrued Total Principal Total end
at beginning
for Year
Money Payment of Year
Year
owed at Payment ( BOY )
end of
Year
1 $8,000
$800
$8,800 $0
$0
2 $8,800
$880
$9,680 $0
$0
3 $9,680
$968
$10,648 $0
$0
4 $10,648 $1,065
$11,713 $8,000 $11,713
Total interest paid ($3,713) is 10% of total dollar-years ($37,128)

of

CASH FLOW DIAGRAMS / TABLE


NOTATION
i = effective interest rate per interest period
N = number of compounding periods (e.g., years)
P = present sum of money; the equivalent value of one or more cash
flows at the present time reference point
F = future sum of money; the equivalent value of one or more cash
flows at a future time reference point
A = end-of-period cash flows (or equivalent end-of-period values ) in
a uniform series continuing for a specified number of periods,
starting at the end of the first period and continuing through the last
period
G = uniform gradient amounts -- used if cash flows increase by a
constant amount in each period

CASH FLOW DIAGRAM NOTATION


1

5=N

Time scale with progression of time moving from left to


right; the numbers represent time periods (e.g., years,
months, quarters, etc...) and may be presented within a
time interval or at the end of a time interval.

CASH FLOW DIAGRAM NOTATION


1
P =$8,000

1
2

5=N

Time scale with progression of time moving from left to


right; the numbers represent time periods (e.g., years,
months, quarters, etc...) and may be presented within a
time interval or at the end of a time interval.

Present expense (cash outflow) of $8,000 for lender.

CASH FLOW DIAGRAM NOTATION


A = $2,524 3
1
P =$8,000

1
2

5=N

Time scale with progression of time moving from left to


right; the numbers represent time periods (e.g., years,
months, quarters, etc...) and may be presented within a
time interval or at the end of a time interval.

Present expense (cash outflow) of $8,000 for lender.

Annual income (cash inflow) of $2,524 for lender.

CASH FLOW DIAGRAM NOTATION


A = $2,524 3
1
P =$8,000

1
2

4
4

5=N

i = 10% per year

Time scale with progression of time moving from left to


right; the numbers represent time periods (e.g., years,
months, quarters, etc...) and may be presented within a
time interval or at the end of a time interval.

Present expense (cash outflow) of $8,000 for lender.

Annual income (cash inflow) of $2,524 for lender.

Interest rate of loan.

CASH FLOW DIAGRAM NOTATION


A = $2,524 3
5
1
P =$8,000

1
2

4
4

5=N

i = 10% per year

Time scale with progression of time moving from left to


right; the numbers represent time periods (e.g., years,
months, quarters, etc...) and may be presented within a
time interval or at the end of a time interval.

Present expense (cash outflow) of $8,000 for lender.

Annual income (cash inflow) of $2,524 for lender.

Interest rate of loan.

Dashed-arrow line indicates


amount to be determined.

INTEREST FORMULAS FOR ALL OCCASIONS


relating present and future values of single cash flows;
relating a uniform series (annuity) to present and
future equivalent values;
for discrete compounding and discrete cash flows;
for deferred annuities (uniform series);
equivalence calculations involving multiple interest;
relating a uniform gradient of cash flows to annual and
present equivalents;
relating a geometric sequence of cash flows to present
and annual equivalents;

INTEREST FORMULAS FOR ALL OCCASIONS


relating nominal and effective interest rates;
relating to compounding more frequently than
once a year;
relating to cash flows occurring less often than
compounding periods;
for continuous compounding and discrete cash
flows;
for continuous compounding and continuous
cash flows;

RELATING PRESENT AND FUTURE


EQUIVALENT VALUES OF SINGLE CASH
FLOWS
Finding F when given P:
Finding future value when given present value
F = P ( 1+i ) N
(1+i)N single payment compound amount factor
functionally expressed as F = ( F / P, i%,N )
predetermined values of this are presented in
column 2 of Appendix C of text.
P

N=

0
F=?

RELATING PRESENT AND FUTURE


EQUIVALENT VALUES OF SINGLE CASH
FLOWS
Finding P when given F:
Finding present value when given future value
P = F [1 / (1 + i ) ] N
(1+i)-N single payment present worth factor
functionally expressed as P = F ( P / F, i%, N )
predetermined values of this are presented in
column 3 of Appendix C of text;
0

N=
P=?

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding F given A:

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding F given A:
Finding future equivalent income (inflow) value given
a series of uniform equal Payments

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding F given A:
Finding future equivalent income (inflow) value given
a series of uniform equal Payments
(1+i)N-1
F=A
i

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding F given A:
Finding future equivalent income (inflow) value given
a series of uniform equal Payments
(1+i)N-1
F=A
i
uniform series compound amount factor in [ ]

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding F given A:
Finding future equivalent income (inflow) value given
a series of uniform equal Payments
(1+i)N-1
F=A
i
uniform series compound amount factor in [ ]
functionally expressed as F = A ( F / A,i%,N )

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding F given A:
Finding future equivalent income (inflow) value given
a series of uniform equal Payments
(1+i)N-1
F=A
i
uniform series compound amount factor in [ ]
functionally expressed as F = A ( F / A,i%,N )
predetermined values are in column 4 of Appendix
C of text

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES

Finding F given A:
Finding future equivalent income (inflow) value given a
series of uniform equal Payments
(1+i)N-1
F=A
i
uniform series compound amount factor in [ ]
functionally expressed as F = A ( F / A,i%,N )
predetermined values are in column 4 of Appendix C of
text
F=?
1 2 3 4 5 6 7 8

A=

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


N

( F / A,i%,N ) = F / P,i,N-k )
k=1

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding P given A:

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding P given A:
Finding present equivalent value given a series of
uniform equal receipts

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding P given A:
Finding present equivalent value given a series of
uniform equal receipts
(1+i)N-1
P=A
i(1+i)N

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding P given A:
Finding present equivalent value given a series of
uniform equal receipts
(1+i)N-1
P=A
i(1+i)N
uniform series present worth factor in [ ]

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding P given A:
Finding present equivalent value given a series of
uniform equal receipts
(1+i)N-1
P=A
i(1+i)N
uniform series present worth factor in [ ]
functionally expressed as P = A ( P / A,i%,N )

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding P given A:
Finding present equivalent value given a series of
uniform equal receipts
(1+i)N-1
P=A
i(1+i)N
uniform series present worth factor in [ ]
functionally expressed as P = A ( P / A,i%,N )
predetermined values are in column 5 of Appendix
C of text

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding P given A:
Finding present equivalent value given a series of
uniform equal receipts
(1+i)N-1
P=A
i(1+i)N
uniform series present worth factor in [ ]
functionally expressed as P = A ( P / A,i%,N )
predetermined values are in column 5 of Appendix
C of text
A= 1 2 3 4 5 6 7 8
P=?

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

k=1

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding A given F:

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding A given F:
Finding amount A of a uniform series when given the
equivalent future value

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding A given F:
Finding amount A of a uniform series when given the
equivalent future value
i
A=F
( 1 + i ) N -1

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding A given F:
Finding amount A of a uniform series when given the
equivalent future value
i
A=F
( 1 + i ) N -1
sinking fund factor in [ ]

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding A given F:
Finding amount A of a uniform series when given the
equivalent future value
i
A=F
( 1 + i ) N -1
sinking fund factor in [ ]
functionally expressed as A = F ( A / F,i%,N )

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding A given F:
Finding amount A of a uniform series when given the
equivalent future value
i
A=F
( 1 + i ) N -1
sinking fund factor in [ ]
functionally expressed as A = F ( A / F,i%,N )
predetermined values are in column 6 of Appendix
C of text

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding A given F:
Finding amount A of a uniform series when given the
equivalent future value
i
A=F
( 1 + i ) N -1
sinking fund factor in [ ]
functionally expressed as A = F ( A / F,i%,N )
predetermined values are in column 6 of Appendix
F=
C of text
1 2 3 4 5 6 7 8

A =?

( A / F,i%,N ) = 1 / ( F / A,i%,N )
( A / F,i%,N ) = ( A / P,i%,N ) - i

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding A given P:

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding A given P:
Finding amount A of a uniform series when given the
equivalent present value

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding A given P:
Finding amount A of a uniform series when given the
equivalent present value
i ( 1+i )N
A=P
( 1 + i ) N -1

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding A given P:
Finding amount A of a uniform series when given the
equivalent present value
i ( 1+i )N
A=P
( 1 + i ) N -1
capital recovery factor in [ ]

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding A given P:
Finding amount A of a uniform series when given the
equivalent present value
i ( 1+i )N
A=P
( 1 + i ) N -1
capital recovery factor in [ ]
functionally expressed as A = P ( A / P,i%,N )

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding A given P:
Finding amount A of a uniform series when given the
equivalent present value
i ( 1+i )N
A=P
( 1 + i ) N -1
capital recovery factor in [ ]
functionally expressed as A = P ( A / P,i%,N )
predetermined values are in column 7 of Appendix
C of text

RELATING A UNIFORM SERIES (ORDINARY


ANNUITY) TO PRESENT AND FUTURE EQUIVALENT
VALUES
Finding A given P:
Finding amount A of a uniform series when given the
equivalent present value
i ( 1+i )N
A=P
( 1 + i ) N -1
capital recovery factor in [ ]
functionally expressed as A = P ( A / P,i%,N )
predetermined values are in column 7 of Appendix
P=
C of text
1 2 3 4 5 6 7 8

A =?

( A / P,i%,N ) = 1 / ( P / A,i%,N )

RELATING A UNIFORM SERIES (DEFERRED


ANNUITY) TO PRESENT / FUTURE
EQUIVALENT 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)

EQUIVALENCE CALCULATIONS INVOLVING


MULTIPLE INTEREST
All compounding of interest takes place once per time
period (e.g., a year), and to this point cash flows also occur
once per time period.
Consider an example where a series of cash outflows
occur over a number of years.
Consider that the value of the outflows is unique for each
of a number (i.e., first three) years.
Consider that the value of outflows is the same for the last
four years.
Find a) the present equivalent expenditure; b) the future
equivalent expenditure; and c) the annual equivalent
expenditure

PRESENT EQUIVALENT EXPENDITURE


Use P0 = F( P / F, i%, N ) for each of the unique years:
-- F is a series of unique outflow for year 1 through year 3;
-- i is common for each calculation;
-- N is the year in which the outflow occurred;
-- Multiply the outflow times the associated table value;
-- Add the three products together;
Use A ( P / A,i%,N - j ) ( P / F, i%, j ) -- deferred annuity -- for
the remaining (common outflow) years:
-- A is common for years 4 through 7;
-- i remains the same;
-- N is the final year;
-- j is the last year a unique outflow occurred;
-- multiply the common outflow value times table values;
-- add this to the previous total for the present equivalent
expenditure.

RELATING A UNIFORM GRADIENT OF CASH


FLOWS TO FUTURE EQUIVALENTS
Find F when given G:

RELATING A UNIFORM GRADIENT OF CASH


FLOWS TO FUTURE EQUIVALENTS
Find F when given G:
Find the future equivalent value when given the
uniform gradient amount

RELATING A UNIFORM GRADIENT OF CASH


FLOWS TO FUTURE EQUIVALENTS
Find F when given G:
Find the future equivalent value when given the
uniform gradient amount
(1+i)N-1 -1 (1+i)N-2 -1
(1+i) 1 -1
F=G
+
+ ... +

RELATING A UNIFORM GRADIENT OF CASH


FLOWS TO FUTURE EQUIVALENTS
Find F when given G:
Find the future equivalent value when given the
uniform gradient amount
(1+i)N-1 -1 (1+i)N-2 -1
(1+i) 1 -1
F=G
+
+ ... +

Functionally represented as (G/ i) (F/A,i%,N) - (NG/ i)

RELATING A UNIFORM GRADIENT OF CASH


FLOWS TO FUTURE EQUIVALENTS
Find F when given G:
Find the future equivalent value when given the
uniform gradient amount
(1+i)N-1 -1 (1+i)N-2 -1
(1+i) 1 -1
F=G
+
+ ... +

Functionally represented as (G/ i) (F/A,i%,N) - (NG/ i)


Usually more practical to deal with annual and present
equivalents, rather than future equivalent values

Cash Flow Diagram for a Uniform Gradient


Increasing by G Dollars per period
i = effective interest rate
per period

(N-1)G
(N-2)G
(N-3)G

3G
2G
G
1

End of Period

N-2 N-1 N

RELATING A UNIFORM GRADIENT OF CASH


FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
Find A when given G:

RELATING A UNIFORM GRADIENT OF CASH


FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
Find A when given G:
Find the annual equivalent value when given the
uniform gradient amount

RELATING A UNIFORM GRADIENT OF CASH


FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
Find A when given G:
Find the annual equivalent value when given the
uniform gradient amount
1
N
A=G
i
(1 + i ) N - 1

RELATING A UNIFORM GRADIENT OF CASH


FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
Find A when given G:
Find the annual equivalent value when given the
uniform gradient amount
1
N
A=G
i
(1 + i ) N - 1
Functionally represented as A = G ( A / G, i%,N )

RELATING A UNIFORM GRADIENT OF CASH


FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
Find A when given G:
Find the annual equivalent value when given the
uniform gradient amount
1
N
A=G
i
(1 + i ) N - 1
Functionally represented as A = G ( A / G, i%,N )
The value shown in [ ] is the gradient to uniform series
conversion factor and is presented in column 9 of
Appendix C (represented in the above parenthetical
expression).

RELATING A UNIFORM GRADIENT OF CASH


FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
Find P when given G:

RELATING A UNIFORM GRADIENT OF CASH


FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
Find P when given G:
Find the present equivalent value when given the
uniform gradient amount

RELATING A UNIFORM GRADIENT OF CASH


FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
Find P when given G:
Find the present equivalent value when given the
uniform gradient amount
1
(1 + i ) N-1
N
P=G
i
i (1 + i ) N
(1 + i ) N

RELATING A UNIFORM GRADIENT OF CASH


FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
Find P when given G:
Find the present equivalent value when given the
uniform gradient amount
1
(1 + i ) N-1
N
P=G
i
i (1 + i ) N
(1 + i ) N
Functionally represented as P = G ( P / G, i%,N )

RELATING A UNIFORM GRADIENT OF CASH


FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
Find P when given G:
Find the present equivalent value when given the
uniform gradient amount
1
(1 + i ) N-1
N
P=G
i
i (1 + i ) N
(1 + i ) N
Functionally represented as P = G ( P / G, i%,N )
The value shown in{ } is the gradient to present
equivalent conversion factor and is presented in
column 8 of Appendix C (represented in the above
parenthetical expression).

RELATING GE0METRIC SEQUENCE OF CASH


FLOWS TO PRESENT AND ANNUAL EQUIVALENTS
Projected cash flow patterns changing at an average
rate of f each period;

RELATING GE0METRIC SEQUENCE OF CASH


FLOWS TO PRESENT AND ANNUAL EQUIVALENTS
Projected cash flow patterns changing at an average
rate of f each period;
Resultant end-of-period cash-flow pattern is referred
to as a geometric gradient series;

RELATING GE0METRIC SEQUENCE OF CASH


FLOWS TO PRESENT AND ANNUAL EQUIVALENTS
Projected cash flow patterns changing at an average
rate of f each period;
Resultant end-of-period cash-flow pattern is referred
to as a geometric gradient series;
A1 is cash flow at end of period 1

RELATING GE0METRIC SEQUENCE OF CASH


FLOWS TO PRESENT AND ANNUAL EQUIVALENTS
Projected cash flow patterns changing at an average
rate of f each period;
Resultant end-of-period cash-flow pattern is referred
to as a geometric gradient series;
A1 is cash flow at end of period 1
A k = (A k-1) ( 1 +f ),2 < k < N

RELATING GE0METRIC SEQUENCE OF CASH


FLOWS TO PRESENT AND ANNUAL EQUIVALENTS
Projected cash flow patterns changing at an average
rate of f each period;
Resultant end-of-period cash-flow pattern is referred
to as a geometric gradient series;
A1 is cash flow at end of period 1
A k = (A k-1) ( 1 +f ),2 < k < N
AN = A1 ( 1 + f ) N-1

RELATING GE0METRIC SEQUENCE OF CASH


FLOWS TO PRESENT AND ANNUAL EQUIVALENTS
Projected cash flow patterns changing at an average
rate of f each period;
Resultant end-of-period cash-flow pattern is referred
to as a geometric gradient series;
A1 is cash flow at end of period 1
A k = (A k-1) ( 1 +f ),2 < k < N
AN = A1 ( 1 + f ) N-1
f = (A k - A k-1 ) / A k-1

RELATING GE0METRIC SEQUENCE OF CASH


FLOWS TO PRESENT AND ANNUAL EQUIVALENTS
Projected cash flow patterns changing at an average
rate of f each period;
Resultant end-of-period cash-flow pattern is referred
to as a geometric gradient series;
A1 is cash flow at end of period 1
A k = (A k-1) ( 1 +f ),2 < k < N
AN = A1 ( 1 + f ) N-1
f = (A k - A k-1 ) / A k-1
convenience rate = i cr = [ ( 1 + i ) / ( 1 + f ) ] - 1
=(i-f)/(1+f)

AN =A1(1+f )N - 1

A3 =A1(1+f )2
A2 =A1(1+f )
A1

2
3
4
End of Period

Cash-flow diagram for a Geometric Sequence of


Cash Flows

RELATING A GEOMETRIC SEQUENCE OF


CASH FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
Find P when given A:

RELATING A GEOMETRIC SEQUENCE OF


CASH FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
Find P when given A:
Find the present equivalent value when given the
annual equivalent value ( i = f )and ( icr = 0 )

RELATING A GEOMETRIC SEQUENCE OF


CASH FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
Find P when given A:
Find the present equivalent value when given the
annual equivalent value ( i = f )and ( icr = 0 )
A1
P=

( P / A, iCR%, N )
(1+f)

RELATING A GEOMETRIC SEQUENCE OF


CASH FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
Find P when given A:
Find the present equivalent value when given the
annual equivalent value ( i = f )and ( icr = 0 )
A1
P=

( P / A, iCR%, N )

1+f
Functionally represented as A = P (A / P, i%,N )

RELATING A GEOMETRIC SEQUENCE OF


CASH FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
Find P when given A:
Find the present equivalent value when given the
annual equivalent value ( i = f )and ( icr = 0 )
A1
P=

( P / A, iCR%, N )

1+f
Functionally represented as A = P (A / P, i%,N )
The year zero base of annuity, increasing at
constant rate f % is A0 = P ( A / P, f %, N )

RELATING A GEOMETRIC SEQUENCE OF


CASH FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS
Find P when given A:
Find the present equivalent value when given the
annual equivalent value ( i = f )and ( icr = 0 )
A1
P=

( P / A, iCR%, N )

1+f
Functionally represented as A = P (A / P, i%,N )
The year zero base of annuity, increasing at
constant rate f % is A0 = P ( A / P, f %, N )
The future equivalent of this geometric gradient is F =

RELATING A GEOMETRIC SEQUENCE OF


CASH FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS

Find P when given A:

RELATING A GEOMETRIC SEQUENCE OF


CASH FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS

Find P when given A:


Find the present equivalent value when given the
annual equivalent value ( i = f )and ( icr = 0 )

RELATING A GEOMETRIC SEQUENCE OF


CASH FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS

Find P when given A:


Find the present equivalent value when given the
annual equivalent value ( i = f )and ( icr = 0 )
NA1
P=
1+f

RELATING A GEOMETRIC SEQUENCE OF


CASH FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS

Find P when given A:


Find the present equivalent value when given the
annual equivalent value ( i = f )and ( icr = 0 )
NA1
P=
1+f
Functionally represented as A = P (A / P, i%,N )

RELATING A GEOMETRIC SEQUENCE OF


CASH FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS

Find P when given A:


Find the present equivalent value when given the
annual equivalent value ( i = f )and ( icr = 0 )
NA1
P=
1+f
Functionally represented as A = P (A / P, i%,N )
The year zero base of annuity, increasing at
constant rate f% is A0 = P ( A / P, iCR%, N )

RELATING A GEOMETRIC SEQUENCE OF


CASH FLOWS TO ANNUAL AND PRESENT
EQUIVALENTS

Find P when given A:


Find the present equivalent value when given the
annual equivalent value ( i = f )and ( icr = 0 )
NA1
P=
1+f
Functionally represented as A = P (A / P, i%,N )
The year zero base of annuity, increasing at
constant rate f % is A0 = P ( A / P, f %, N )

The future equivalent of this geometric gradient is F =

INTEREST RATES THAT


VARY WITH TIME
Find P given F and interest rates that vary over
N

INTEREST RATES THAT


VARY WITH TIME
Find P given F and interest rates that vary over
N
Find the present equivalent value given a
future value and a varying interest rate over the
period of the loan

INTEREST RATES THAT


VARY WITH TIME
Find P given F and interest rates that vary over
N
Find the present equivalent value given a
future value and a varying interest rate over the
period of the loan

FN
P = ----------------N (1 + ik)
k+1

NOMINAL AND EFFECTIVE INTEREST RATES


Nominal Interest Rate - r - For rates compounded more
frequently than one year, the stated annual interest rate.
Effective Interest Rate - i - For rates compounded more
frequently than one year, the actual amount of interest
paid.
i = ( 1 + r / M )M - 1 = ( F / P, r / M, M ) -1
M - the number of compounding periods per year

Annual Percentage Rate - APR - percentage rate per


period times number of periods.
APR = r x M

COMPOUNDING MORE OFTEN THAN ONCE A


YEAR
Single Amounts
Given nominal interest rate and total number of
compounding periods, P, F or A can be determined by
F = P ( F / P, i%, N )
i% = ( 1 + r / M ) M - 1
Uniform and / or Gradient Series
Given nominal interest rate, total number of
compounding periods, and existence of a cash flow
at the end of each period, P, F or A may be
determined by the formulas and tables for uniform
annual series and uniform gradient series.

CASH FLOWS LESS OFTEN THAN


COMPOUNDING PERIODS
Find A, given i, k and X, where:
i is the effective interest rate per interest period
k is the period at the end of which cash flow occurs
X is the uniform cash flow amount

Use: A = X (A / F,i%, k )
Find A, given i, k and X, where:
i is the effective interest rate per interest period
k is the period at the beginning of which cash flow
occurs
X is the uniform cash flow amount

Use: A = X ( A / P, i%, k )

CONTINUOUS COMPOUNDING AND DISCRETE


CASH FLOWS

CONTINUOUS COMPOUNDING AND DISCRETE


CASH FLOWS
Continuous compounding assumes cash flows occur
at discrete intervals, but compounding is continuous
throughout the interval.

CONTINUOUS COMPOUNDING AND DISCRETE


CASH FLOWS
Continuous compounding assumes cash flows occur
at discrete intervals, but compounding is continuous
throughout the interval.
Given nominal per year interest rate -- r,
compounding per year -- M
one unit of principal = [ 1 + (r / M ) ] M

CONTINUOUS COMPOUNDING AND DISCRETE


CASH FLOWS
Continuous compounding assumes cash flows occur
at discrete intervals, but compounding is continuous
throughout the interval.
Given nominal per year interest rate -- r,
compounding per year -- M
one unit of principal = [ 1 + (r / M ) ] M
Given M / r = p,
[ 1 + (r / M ) ] M = [1 + (1/p) ] rp

CONTINUOUS COMPOUNDING AND DISCRETE


CASH FLOWS
Continuous compounding assumes cash flows occur
at discrete intervals, but compounding is continuous
throughout the interval.
Given nominal per year interest rate -- r,
compounding per year -- M
one unit of principal = [ 1 + (r / M ) ] M
Given M / r = p,
[ 1 + (r / M ) ] M = [1 + (1/p) ] rp
Given lim [ 1 + (1 / p) ] p = e1 = 2.71828
p

CONTINUOUS COMPOUNDING AND DISCRETE


CASH FLOWS
Continuous compounding assumes cash flows occur
at discrete intervals, but compounding is continuous
throughout the interval.
Given nominal per year interest rate -- r,
compounding per year -- M
one unit of principal = [ 1 + (r / M ) ] M
Given M / r = p,
[ 1 + (r / M ) ] M = [1 + (1/p) ] rp
Given lim [ 1 + (1 / p) ] p = e1 = 2.71828
p
( F / P, r%, N ) = e rN

CONTINUOUS COMPOUNDING AND DISCRETE


CASH FLOWS
Continuous compounding assumes cash flows occur
at discrete intervals, but compounding is continuous
throughout the interval.
Given nominal per year interest rate -- r,
compounding per year -- M
one unit of
principal = [ 1 + (r / M ) ] M
Given M / r = p,
[ 1 + (r / M ) ] M = [1 + (1/p) ] rp
Given lim [ 1 + (1 / p) ] p = e1 = 2.71828
p
( F / P, r%,
N ) = e rN
i=er-1

CONTINUOUS COMPOUNDING AND


DISCRETE CASH FLOWS
Single Cash Flow
Finding F given P
Finding future equivalent value given present
value
F = P (e rN)
Functionally expressed as ( F / P, r%, N )
e rN is continuous compounding compound
amount
Predetermined values are in column 2 of appendix
D of text

CONTINUOUS COMPOUNDING AND


DISCRETE CASH FLOWS
Single Cash Flow

Finding P given F
Finding present equivalent value given future value
P = F (e -rN)
Functionally expressed as ( P / F, r%, N )
e -rN is continuous compounding present equivalent
Predetermined values are in column 3 of appendix
D of text

CONTINUOUS COMPOUNDING AND


DISCRETE CASH FLOWS
Uniform Series
Finding F given A
Finding future equivalent value given a series
of uniform equal receipts
F = A (e rN- 1)/(e r- 1)
Functionally expressed as ( F / A, r%, N )
(e rN- 1)/(e r- 1) is continuous compounding
compound amount
Predetermined values are in column 4 of
appendix D of text

CONTINUOUS COMPOUNDING AND


DISCRETE CASH FLOWS
Uniform Series
Finding P given A
Finding present equivalent value given a series
of uniform equal receipts
P = A (e rN- 1) / (e rN ) (e r- 1)
Functionally expressed as ( P / A, r%, N )
(e rN- 1) / (e rN ) (e r- 1) is continuous
compounding present equivalent
Predetermined values are in column 5 of
appendix D of text

CONTINUOUS COMPOUNDING AND


DISCRETE CASH FLOWS
Uniform Series

Finding A given F
Finding a uniform series given a future value
A = F (e r- 1) / (e rN - 1)
Functionally expressed as ( A / F, r%, N )
(e r- 1) / (e rN - 1) is continuous compounding
sinking fund
Predetermined values are in column 6 of
appendix D of text

CONTINUOUS COMPOUNDING AND


DISCRETE CASH FLOWS
Uniform Series
Finding A given P
Finding a series of uniform equal receipts given
present equivalent value
A = P [e rN (e r- 1) / (e rN - 1) ]
Functionally expressed as ( A / P, r%, N )
[e rN (e r- 1) / (e rN - 1) ] is continuous
compounding capital recovery
Predetermined values are in column 7 of
appendix D of text

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Continuous flow of funds suggests a series of cash
flows occurring at infinitesimally short intervals of
time

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Continuous flow of funds suggests a series of cash
flows occurring at infinitesimally short intervals of
time
Given:
a nominal interest rate or r
p is payments per year

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Continuous flow of funds suggests a series of cash
flows occurring at infinitesimally short intervals of
time
Given:
a nominal interest rate or r
p is payments per year
[ 1 + (r / p ) ] p - 1
P = -----------------------------r[1+(r/p)]p

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Continuous flow of funds suggests a series of cash
flows occurring at infinitesimally short intervals of
time
Given:
a nominal interest rate or r
p is payments per year
[ 1 + (r / p ) ] p - 1
P = -----------------------------r[1+(r/p)]p
Given Lim [ 1 + ( r / p ) ] p = e r
p --> oo

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS

Continuous flow of funds suggests a series of cash


flows occurring at infinitesimally short intervals of time
Given:
a nominal interest rate or r
p is payments per year
[ 1 + (r / p ) ] p - 1
P = -----------------------------r[1+(r/p)]p
Given Lim [ 1 + ( r / p ) ] p = e r
For one year ( P / A, r%, 1 ) = ( e r - 1 ) / re r
p --> oo

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding F given A

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding F given A
Finding the future equivalent given the
continuous funds flow

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding F given A
Finding the future equivalent given the
continuous funds flow
F = A [ ( erN - 1 ) / r ]

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding F given A
Finding the future equivalent given the
continuous funds flow
F = A [ ( erN - 1 ) / r ]
Functionally expressed as ( F / A, r%, N )

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding F given A
Finding the future equivalent given the
continuous funds flow
F = A [ ( erN - 1 ) / r ]
Functionally expressed as ( F / A, r%, N )
( erN - 1 ) / r is continuous compounding
compound amount

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding F given A
Finding the future equivalent given the
continuous funds flow
F = A [ ( erN - 1 ) / r ]
Functionally expressed as ( F / A, r%, N )
( erN - 1 ) / r is continuous compounding
compound amount
Predetermined values are found in column 6 of
appendix D of text.

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding P given A

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding P given A
Finding the present equivalent given the
continuous funds flow

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding P given A
Finding the present equivalent given the
continuous funds flow
P = A [ ( erN - 1 ) / rerN ]

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding P given A
Finding the present equivalent given the
continuous funds flow
P = A [ ( erN - 1 ) / rerN ]
Functionally expressed as ( P / A, r%, N )

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding P given A
Finding the present equivalent given the
continuous funds flow
P = A [ ( erN - 1 ) / rerN ]
Functionally expressed as ( P / A, r%, N )
( erN - 1 ) / rerN is continuous compounding
present equivalent

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding P given A
Finding the present equivalent given the
continuous funds flow
P = A [ ( erN - 1 ) / rerN ]
Functionally expressed as ( P / A, r%, N )
( erN - 1 ) / rerN is continuous compounding
present equivalent
Predetermined values are found in column 7 of
appendix D of text.

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding A given F

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding A given F
Finding the continuous funds flow given the
future equivalent

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding A given F
Finding the continuous funds flow given the
future equivalent
A = F [ r / ( erN - 1 )]

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding A given F
Finding the continuous funds flow given the
future equivalent
A = F [ r / ( erN - 1 )]
Functionally expressed as ( A / F, r%, N )

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding A given F
Finding the continuous funds flow given the
future equivalent
A = F [ r / ( erN - 1 )]
Functionally expressed as ( A / F, r%, N )
r / ( erN - 1 ) is continuous compounding
sinking fund

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding A given P

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding A given P
Finding the continuous funds flow given the
present equivalent

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding A given P
Finding the continuous funds flow given the
present equivalent
A = P [ r / ( erN - 1 )]

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding A given P
Finding the continuous funds flow given the
present equivalent
A = P [ r / ( erN - 1 )]
Functionally expressed as ( A / P, r%, N )

CONTINUOUS COMPOUNDING AND


CONTINUOUS CASH FLOWS
Finding A given P
Finding the continuous funds flow given the
present equivalent
A = F [ rerN / ( erN - 1 )]
Functionally expressed as ( A / P, r%, N )
rerN / ( erN - 1 ) is continuous compounding
capital recovery

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