ENGR 3360U Winter 2014

Unit 4.4
Annual Payments
Dr. J. Michael Bennett, P. Eng., PMP,
UOIT,
Version 2014-I-01

Unit 4 Interest and Equivalence

Change Record
2014-I-01 Initial Creation
Text references: Chapters 3 and 4

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

4.4 Uniform Series Compound Interest Formulas

Uniform series (A) is defined as:

An end-of-period cash receipt or disbursement in a

uniform series, continuing for n periods, the entire
series equivalent to P or F at an interest rate i

Unit 4 Interest and Equivalence

Uniform-Series:
Present Worth Factor (P/A)

If you need $A/year for n years, what do you have

to pay now, at i%?

Capital Recovery Factor (A/P)

4-4

If you buy a machine now for $P, what must it make

to pay off the debt in n years, at i%?

2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

(P/A) Factor Derivation

Setup the following:

1
1
1
1
P A

..

1
2
n 1
n
(1

i
)
(1

i
)
(1

i
)
(1

i
)

(1)

Multiply by 1/(1+i) to obtain a second equation

P
1
1
1
1
A

..

2
3
n
n 1
1 i
(1

i
)
(1

i
)
(1

i
)
(1

i
)

(2)

Subtract (1) from (2) to yield

i
1
1
P A

n 1
1 i
(1

i
)
(1

i
)

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(3)

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

(P/A) and (A/P) Factor Formulas

Simplify (3) to
yield
(1 i ) n 1
P A
for i 0
n
i (1 i )

Solve (4) for A to get

(A/P) factor
i (1 i ) n

A P

(1 i ) 1

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(5)

(4)

(P/A,i%,n) factor
Excel: =PV(i%,n,A)

(A/P,i%,n) factor
Excel: =PMT(i%,n,P)

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Example 4-3
An energy-efficient machine costs $5,000.
It has a useful life of 5 years. What is the
minimum it must save annually to be a good
investment at 8%?

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

answer
1

P
P = 5000 A = ? i = 8% n = 5
A = P(A/P, 8%, 5) = 5000(0.2505) = 1,252

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Example 4-4
An investor holds a time purchase contract
on some machine tools. The contract calls
for a monthly payment of $140 at the end of
each month for 5 years. The first payment is
due in a month. He offers to sell you the
contract for $6,800. If you can otherwise
make 1% per month, is it a good deal for
you?

0.1-9

2013-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

answer
P = A(P/A, i, n) = 140(P/A, 1% 60)
= 140(44.955) = 6,293.70
DONT DO IT!

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Part 2
Suppose we took the deal. What is the
effective interest rate?

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

answer
P = A(P/A, i, 60)
6800 = 140(P/A, i, 60)
(P/A, i, 60) = 48.571
At .5%, = 51.726 at .75 = 48.174
i = .5% + .25(51.726-48.571)
/(51.726-48.174)
= .5 + .22 = .72%
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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Uniform-Series:
Sinking Fund Factor (A/F)

If you need $F in years, what do you have to set

aside annually for the next n years, at i%?

Compound Amount Factor (F/A)

4-13

If you deposit $A annually for the next n years, what

will it be worth in n years, at i%?

2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Sinking Fund Factor and Uniform Series

Compound Amount Factor (A/F and F/A)
F = given

Cash flow diagram for (A/F) factor

i% per interest period

....
0
n

A=? per interest period

Find A, given F

n-2

n-1

Start with what has already been developed

1 i (1 i ) n
AF
(1 i ) n 1
n
(1

i
)

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i
AF

n
(1

i
)

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

(F/A) factor from (A/F)

Given:

i
AF

n
(1

i
)

(A/F,i%,n) factor
Excel: =PMT(i
%,n,,F)

Solve for F in terms of A to yield

(1 i ) n 1
F A

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(F/A,i%,n) factor
Excel: =FV(i%,n,A)

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Example 4.1
You deposit $500 annually in the bank for 5
years. How much do you have them at 5%?
F = 500(F/A, 5%, 5) = 500(5.526)= 2,763

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Example 4.2
Jim wants to buy a notebook for $1,000 but
he wants to pay cash. He decides to deposit
a fixed sum monthly in the bank for 12
months and then buy the notebook. If the
bank pays 6% compounded monthly, how
much must he deposit each month?
A = 1000(A/F, 0.5%, 12) = 81.10

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Interpolation in Interest Tables

When using tabulated interest tables one might be
forced to approximate a factor that is not tabulated
Can apply linear interpolation to approximate
See Table foo-foo1
Factors are nonlinear functions; hence linear
interpolation will yield errors in the 2-4% range
Use a spreadsheet model to calculate the factor
precisely

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Table FOOFOO1 10% and 20%

10
%

20
%

4-19

F/P

P/F

A/F

A/P

F/A

P/A

A/G

P/G

1.100

.9091

1.000

1.100

1.000

0.909

1.210

.8264

.4762

.5762

2.100

1.736

0.476

0.826

1.331

.7513

.3021

.4021

3.310

2.487

0.937

2.329

1.464

.6830

.2155

.3155

4.641

3.170

1.381

4.378

1.611

.6209

.1638

.2638

6.105

3.791

1.810

6.862

F/P

P/F

A/F

A/P

F/A

P/A

A/G

P/G

1.200

.8333

1.000

1.200

1.000

0.833

1.440

.6944

.4545

.6545

2.200

1.528

0.455

0.694

1.728

.5787

.2747

.4747

3.640

2.106

0.879

1.852

2.074

.4823

.1863

.3863

5.368

2.589

1.274

3.299

2.488

.4019

.1344

.3344

7.442

2.991

1.641

4.906

2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 4 Interest and Equivalence

Suppose you did not have 15% tables

You needed (F/P, 1, 15%)
Take (F/P, 1, 10%) and (F/P, 1, 20%)
Therefore (F/P, 1, 15%) = (1.1+1.2)/2 = 1.15

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco