MONEY-TIME

RELATIONSHIPS
AND ITS
EQUIVALENCE
INTRODUCTION
CASH FLOW DIAGRAMS
 CASH FLOW is the sum of money recorded as receipts
or disbursements in a project’s financial records.
 A cash flow diagram presents the flow of cash as arrows
on a time line scaled to the magnitude of the cash flow,
where expenses are down arrows and receipts are up
arrows.
Example 1:
A mechanical device will cost $20000 when
purchased. Maintenance will cost $1000 per
year. The device will generate revenues of
$5000 per year for 5 years. The salvage
value is $7000. Draw the Cash Flow
Diagram.
 Solution:
 Cash flow diagram

 Simplified cash flow

diagram
Example 2:
 Consider a truck that is going to be purchased for
$55000. It will cost $9500 each year to operate
including fuel and maintenance. It will need to have its
engine rebuilt in 6 years for a cost of $22000 and will be
sold at year 9 for $6000. Draw the Cash Flow Diagram.
Solution:
Examples
1. What is the present value of $10 to be paid in 3 years at 5%
compounded monthly?
2. Draw the cash flow diagram for the following cash transaction.
At time 0 (beginning of 1st yr) $50000 is paid out
At EOY 3 $23000 is paid out
At EOY 6 $15000 is received
Every year starting at EOY 1 $2000 is received
3. The Big Sheet Printing Company is considering purchasing a new web
printing press, and they have determined the following cash items:
Initial Cost $530000
Annual Revenue $210000
Annual Maintenance $80000
Rebuild Expenses EOY 4 $330000
Salvage Value EOY 7 $70000
INTEREST
 The amount of money earned by a given capital

 From the borrower’s viewpoint, interest is the

amount of money paid for the use of a borrowed
capital

 From the lender’s viewpoint, it is the income

generated by the capital that was lent
INTEREST
 Interest paid or earned is determined by:
𝑰=𝑭 −𝑷
where:
I = interest
F = total amount
P = principal
 Interest Rate or Rate of Return
 When interest over a specific time unit is expressed as
a percentage of the original amount (principal), the
result is called the interest rate or rate of return.

𝒊𝒏𝒕𝒆𝒓𝒆𝒔𝒕 𝒂𝒄𝒄𝒓𝒖𝒆𝒅 𝒑𝒆𝒓 𝒕𝒊𝒎𝒆 𝒖𝒏𝒊𝒕

𝒊𝒏𝒕𝒆𝒓𝒆𝒔𝒕 𝒓𝒂𝒕𝒆 𝒐𝒓 𝒓𝒂𝒕𝒆 𝒐𝒇 𝒓𝒆𝒕𝒖𝒓𝒏 = 𝒙𝟏𝟎𝟎%
𝒐𝒓𝒊𝒈𝒊𝒏𝒂𝒍 𝒂𝒎𝒐𝒖𝒏𝒕

 The time unit of the interest rate is called the interest

period.
Interest Rate or Rate of Return
 Also called the rate of capital growth, it is the rate of
gain received from an investment.
 It is expressed on an annual basis.
 For the lender, it consists of:
 Risk of loss
 Administrative expenses
 Profit or pure gain.
 Forthe borrower, it is the cost of using a capital for
immediately meeting his/her needs
The Time Value of Money
 As a result of the earning power of money (thru
interest), time increases the purchasing power of
money by its increase through earning.
 Money has a time value
 One dollar today is worth more than $1 tomorrow
 Failure to pay the bills results in additional charge
termed interest
The interest, i
 Interest is usually expressed as a percentage of the
amount owed.
 It is due and payable at the close of each period involved
in the agreed transaction (usually every year or month)
 EXAMPLE:
 If $1000 is borrowed at 14% interest, then what is the interest
on the principal after one year?
The interest, i
 EXAMPLE:
 If $1000 is borrowed at 14% interest, then what is the interest
on the principal after one year?
 SOLUTION:
 After 1 year, Interest = $140
 If the borrower pays back the total amount, she will pay
$1140
 If she does not pay owed after a year, the interest will be
added to the principal (compounded); borrower will pay
$1299.6
EQUIVALENCE
 The banker in the previous example does not care
whether the borrower paid $1140 after one year or
$1299.6 after two years.
 The three values $1000, $1140 and $1299.6 are
equivalent
 $1000 today is equivalent to $1140 one year from today
 $1000 today is equivalent to $1299.6 two years from today

NOTE: The three values are NOT equal but equivalent.

EQUIVALENCE
 It is noted that:
 The concept of equivalence involves time and a specified
rate of interest.
 The three preceding values are only equivalent for an
interest rate of 14%, and then only at the specified times.
 EQUIVALENCE means that one sum or series differs from
another only by the accumulated interest at rate i for n
periods of time.
Example
AC-Delco makes auto batteries available to General Motors dealers
through privately owned distributorships. In general, batteries are stored
throughout the year, and a 5% cost increase is added each year to cover
the inventory carrying charge for the distributorship owner. Assume you
own the City Center Delco facility. Make the calculations necessary to
show which of the following statements are true and which are false about
battery costs.
1. The amount of ₱98 now is equivalent to a cost of ₱105.60 one year
from now.
2. A truck battery cost of ₱200 one year ago is equivalent to ₱205 now.
3. A ₱38 cost now is equivalent to ₱39.90 one year from now.
4. A ₱3,000 cost now is equivalent to ₱2,887.14 one year ago.
5. The carrying charge accumulated in 1 year on an investment of
₱2,000 worth of batteries is ₱100.
SIMPLE INTEREST
Simple Interest
 In simple interest, the interest earned is computed at
the end of the investment period, and thus it varies
directly with time.
𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕 = 𝑷𝒓𝒊𝒏𝒄𝒊𝒑𝒂𝒍 ∗ 𝑹𝒂𝒕𝒆 ∗ 𝑻𝒊𝒎𝒆
𝑰 = 𝑷𝒓𝒕

 Two ways to calculate simple interest:

 Ordinary simple interest
 Exact simple interest
Ordinary vs Exact
ORDINARY SIMPLE INTEREST
 The interest is computed on the basis of one banker’s year.
 1 banker’s year = 12 months
 12 mos = 30 days each month = 360 days

EXACT SIMPLE INTEREST

 The interest is based on the exact number of days of the
year.
 Ordinary year = 365 days
 Leap year = 366 days
Elements of Simple Interest
 P = Principal or Present Worth
 I = Interest earned
𝑰 = 𝑷𝒓𝒕
 F = Future Worth
𝑭=𝑷+𝑰
𝑭 = 𝑷(𝟏 + 𝒓𝒕)

 r = simple interest rate (per year)

 t = time in years or fraction of a year
Value of t
EXAMPLE:
 4 years; t = 4
 3 months; t = 3/12 =1/4
 90 days;
 Ordinary Simple Interest, t = 90/360
 Exact Simple Interest, t = 90/365
t = 90/366 (leap year)
 2 years & 4 months;
t = 2 + 4/12 = 2.333
Examples
1. How much must be invested now at 6% simple interest
to accumulate $1000 at the end of 5 years?
𝑭 1000
𝑷= = = $𝟕𝟔𝟗. 𝟐𝟑
(𝟏 + 𝒓𝒕) 1 + 0.06 ∗ 5

2. Suppose that $100 is invested for 20 years. How much

will be in the account after 20 years.
𝑭 = 𝑷 𝟏 + 𝒓𝒕 = 100 ∗ 1 + 0.05 ∗ 20 = $𝟐𝟎𝟎. 𝟎𝟎
Examples
3. How long must a ₱40000 note bearing 4% simple
interest run to amount to ₱41350?
𝑰 1350
𝒕= = = 0.84375;
𝑷𝒓 40000∗0.04

𝑡 = 0.84375 ∗ 360 = 303.75 𝑜𝑟 𝟑𝟎𝟒 𝒅𝒂𝒚𝒔

4. If ₱16000 earns ₱480 in 9 months, what is the annual

rate of interest?
𝑰 480
𝒓= = = 𝟎. 𝟎𝟒
𝑷𝒕 16000 ∗ 9 12

𝒓 = 𝟒%
Examples
5. On May 24, 1999, Timothy Jones borrowed $650 and
agreed to repay the loan together with interest at 12% in
90 days. What amount must he repay using exact simple
interest?
90
𝑭 = 𝑷 𝟏 + 𝒓𝒕 = 650 ∗ 1 + 0.12 ∗ = $𝟔𝟔𝟗. 𝟐𝟑
365
6. The tag price of a certain commodity is for 100 days. If
paid in 31 days, there is a 3% discount. What is the
simple interest paid?
𝐹 = 𝑃(1 + 𝑟𝑡)
69
𝑥 = 0.97𝑥 1 + 𝑟
365
𝒓 = 𝟏𝟔. 𝟏𝟐%
COMPOUND INTEREST
 COMPOUND INTEREST
 In compound interest, the interest is computed every end of
each interest period (compounding period), and the interest
earned for that period is added to the principal (interest +
principal)
 Example: Consider an investment of ₱1000 to earn 10%
per year for 3 years.
0 1 2 3 4

₱ 1000
₱ 1100 ₱ 1210 ₱ 1331

𝐼 = 1000 ∗ 0.1 𝐼 = 1100 ∗ 0.1 𝐼 = 1210 ∗ 0.1

𝐼 = ₱100 𝐼 = ₱110 𝐼 = ₱121
Elements of Compound Interest
 P = Principal or Present Worth
 F = Future Worth or compound amount
 i = effective interest per compounding period (per interest
period)
𝒓
𝒊=
𝒎

n = total number of compounding

𝒏 =𝒕∗𝒎
Elements of Compound Interest
I = Interest earned
𝑰=𝑭−𝑷

 r = nominal interest rate

 ER = effective interest
 t = number of years of investment
 m = number of compoundings per year
Future Worth of P
 After n periods, the compound amount F is:

𝒏
𝑭=𝑷 𝟏+𝒊

 The term 𝟏 + 𝒊 𝒏 , also denoted as (F/P, i,n) is called

the single payment compound-amount factor.
Present Worth of F
 The present worth of F is:

𝑭
𝑷= 𝒏
𝟏+𝒊

𝟏
 The term , also denoted as (P/F, i, n) is called the
𝟏+𝒊 𝒏
single payment present worth factor.
Value of t 𝒓
𝒊= 𝒏 = 𝒕∗𝒎
𝒎
Nominal interest rate, r = 12%
Number of years of investment, t = 5 years
0.12
 Compounded annually (m=1) 𝑖= = 𝟎. 𝟏𝟐 𝑛 = 5 ∗ 1 = 𝟓
1
0.12
 Compounded semi-annually (m=2) 𝑖 = = 𝟎.06 𝑛 = 5 ∗ 2 = 𝟏𝟎
2
0.12
 Compounded quarterly (m=4) 𝑖= = 𝟎. 𝟎𝟑 𝑛 = 5 ∗ 4 = 𝟐𝟎
4
 Compounded monthly (m=12) 𝑖 = 0.12 = 𝟎. 𝟎𝟏 𝑛 = 5 ∗ 12 = 𝟔𝟎
12
 Compounded bi-monthly (m=6) 𝑖 = 0.12 = 𝟎. 𝟎𝟐 𝑛 = 5 ∗ 6 = 𝟑𝟎
6
Examples
1. If HP borrows ₱1,000,000 from a different source at
5% per year compound interest, compute the total
amount due after 3 years.

2. Find the present worth of a future payment of

₱100,000 to be made in 10 years with an interest of
12% compounded quarterly.
Examples
3. How many years are required for ₱2,000 to increase by
₱3,000 at 12% compounded semi-annually?

4. Fifteen years ago, ₱1,000 was deposited in a bank

account, and today it is worth ₱2,370. The bank pays
interest semi-annually. What was the interest rate paid in
this account?