Concepts from the

example problems
( F / P, i, N)
( P / F, i, N)
( F / A, i, N)
( A / F, i, N)
( P / A, i, N)
( A / P, i, N)
( P / G, i, N)
( A / G, i, N)

Problem 1
Problem 2
Problem 3
Problem 4
Problem 5
Problem 6
Problem 7
Problem 8
1

Example 1
How much would you have to
deposit today to have $2000 in 4
years if you can get a 12% interest
rate compounded annually?
GIVEN:
F4 = $2 000
i = 12%

DIAGRAM:
$2 000
0

3
n=4

P?

FIND P:
P = F4(P/F,i,n)
= 2 000(P|F,12%,4)
= 2 000(0.6355) = $1 271

Different Ways
of Looking at P/F
From previous example, if you can earn
12% compounded annually, you need to
deposit $1271 to have $2000 in 4
years.
You are indifferent between $1271
today and $2000 in 4 years, assuming
you can earn a return on your money of
12%.
The present worth of $2000 in 4 years
is $1271 (i = 12% cpd annually).

my abbreviation for compounded

If you could get 13% on your money,

3
would you rather have the $1271 today,

Example 2
Tuition costs are expected to
inflate at the rate of 8% per year.
The first years tuition is due one
year from now and will be $10,000.
To cover tuition cost for 4 years, a
fund is to be set up today in an
account that will earn interest at
the rate of 5% per year,
compounded annually. How much
must be deposited into the fund
today in order to pay the 4 years of
4
tuition expenses?

Present Given Gradient (Geometric)

g is the geometric gradient over the time period

(time period: Time 0 to Time n, 1st flow at Time 1)

P is the present value of the flow at Time 0

(n periods in the past)

i is the effective interest rate for each period

Note: cash flow starts with A1 at Time 1, increases by constant g% per period

P?
0

1
A1

g=%
P = A1(P/A,g,i,n)

( P / A, g , i , n)

(1 g )
1

(1 i )
ig

when i g

n
(1 i )

when i g

Example 2
Tuition costs are expected to inflate at the rate
of 8% per year. The first years tuition is due
one year from now and will be $10,000. To cover
tuition cost for 4 years, a fund is to be set up
today in an account that will earn interest at the
rate of 5% per year, compounded annually. How
much must be deposited into the fund today in
order to pay the 4 years of tuition expenses?

Example 2 - Concept
If your rich Aunt Edna wanted to
put a sum of money in the bank
today to pay for your next four
years of tuition, that sum would be
$39,759 assuming 5% return on
investment and tuition that begins
at $10,000 increasing by 8% per
year. This problem assumes
tuition is due at the end of the
year.
7

Complex Cash Flows

Complex Cash Flows Break
apart (or separate) complex
cash flows into component
cash flows in order to use the
standard formulas.
Remember: You can only
combine cash flows if they
occur at the same point in
time.
(This is like building with

Problem 3
A construction firm is considering the
purchase of an air compressor.
The compressor has the following expected
end of year maintenance costs:
Year 1
$800
Year 2
$800
Year 3
$900
Year 4 $1000
Year 5 $1100
Year 6 $1200
Year 7 $1300
Year 8 $1400
What is the present equivalent maintenance
cost if the interest rate is 12% per year
compounded annually?
9

Problem 3 Alt Soln 1

GIVEN:
MAINT COST1-8 PER DIAGRAM
i = 12%/YR, CPD ANNUALLY
P = PA + PG + PF = A(P/A,i,n) + G(P/G,i,n) + F(P/F,i,n)
FIND P:
= $700(P/A,12%,8) + $100(P/G,12%,8) + $100(P/F,12%,1)
DIAGRAM:
P?
1

= $700(4.9676) + $100(14.4715) + $100(0.8929) = $5014

PA ?
1
2
3
4
n=8
n=8

$700

PF ?
n=1

0
$700

$100 $100 $200

$300

PG ?
1

$700
0

NOTE: CAN BREAK INTO 3 CASH FLOWS:

ANNUAL, LINEAR GRADIENT, AND FUTURE

$100 $200

n=8

$300

$100

$700
10

Problem 3 Alt Soln 2

GIVEN:
MAINT COST1-8 PER DIAGRAM
i = 12%/YR, CPD ANNUALLY
P = PA + PG(PPG) = A(P/A,i,n) + G(P/G,i,n-1)(P/F,i,1)
FIND P:
= $800(P/A,12%,8) + $100(P/G,12%,7)(P/F,12%,1)
DIAGRAM:
P?
1
2

= $800(4.9676) + $100(11.6443)(0.8929) = $5014

PA ?
1
2
3
4
n=8
n=8

0
$800
$100

$800
PPG ?

$200

PG ?
0

$600
0
NOTE: PG MUST BE OFFSET ONE YEAR SO
BRING THE OFFSET YEAR BACK TO TIME ZERO

1
PG ? $100

n=7
$200
$600
11

Problem 4
A young couple has decided to make advance
plans for financing their 3 year old daughters
college education. Money can be deposited at 8%
per year, compounded annually.

DIAGRAM:
4
0

What annual deposit on each birthday, from the 4 th

to the 17th (inclusive), must be made to provide
$7,000 on each birthday from the 18th to the 21st
(inclusive)?
$7 000

17
18 21 yrs
A?

GIVEN:
WITHDRAWALS18-21 = $7 000
i = 8%/YR, CPD YEARLY
FIND A4-17:
P17 = A(F/A,i,n) = A(P/A,i,n)

STRATEGY: CAN BREAK INTO 2 CASH FLOWS,

SO PICK A CONVENIENT POINT IN TIME AND SET
DEPOSITS EQUAL TO WITHDRAWALS

= A(F/A,8%,14) = 7 000(P/A,8%,4)
= A(24.2149) = 7 000(3.3121)
A = $957
12