CHAPTER 3

MONEY-TIME
RELATIONSHIPS
AND EQUIVALENCE
 WHAT IS MONEY?
Medium
Medium ofof Exchange
Exchange
Means
Means of
of payment
payment for
for goods
goods or
or services
services
What
What sellers
sellers accept
accept and
and buyers
buyers pay
pay

Store
Store of
of Value
Value
AA way
way to
to transport
transport buying
buying power
power from
from one
one time
time
period
period to
to another
another

Unit
Unit of
of Account
Account
A
A precise
precise measurement
measurement of of value
value or
or worth
worth
Allows
Allows for
for tabulating
tabulating debits
debits and
and credits
credits
 WHAT IS CAPITAL?

Capital is wealth in the form of

money or property that can be
used to produce more wealth
 KINDS OF CAPITAL
Equity
Equity capital
capital is is that
that owned
owned by by individuals
individuals whowho have
have
invested
invested their
their money
money or or property
property inin aa business
business project
project
or
or venture
venture in in the
the hope
hope ofof receiving
receiving aa profit.
profit. The
The value
value
of
of equity
equity capital
capital is is computed
computed by by estimating
estimating thethe
current
current market
market value
value ofof everything
everything thethe company
company ownsowns
MINUS
MINUS allall liabilities.
liabilities. On
On the
the balance
balance sheet
sheet of
of the
the
company,
company, equity
equity capital
capital is
is listed
listed as
as stockholder
stockholder
equity
equity or
or owners
owners equity.
equity.

Debt
Debt capital
capital often
often called
called borrowed
borrowed capital,
capital, is
is
obtained
obtained from
from lenders
lenders for
for investment
investment (bank
(bank loans,
loans,
overdrafts,
overdrafts, etc)
etc)
 What is Bond?
A bond is a written and signed promise
to pay a certain sum of money on a
certain date, or on fulfillment of a
specified condition.

All documented contracts and loan

agreements are bonds.
 What is Stock? What is Share?
Stock
Stock is
is the
the equity
equity capital that is raised
through
through the
the sale
sale of
of shares
shares

A
A share
share is
is aa unit
unit of
of ownership
ownership that that
represents
represents an an equal
equal proportion
proportion of of a
companys
companys capital.
capital. ItIt entitles
entitles its
its holder
holder (ie.
(ie.
the
the shareholder)
shareholder) to to an
an equal
equal claim
claim onon the
the
company's
company's profits
profits and
and an an equal
equal obligation
obligation for
for
the
the companys
companys debts and losses losses
 Financing Definition Instrument Description

Debt Borrow Bond Promise to

financing money pay
principle &
interest;
Exchange
Equity Sell partial Stock money
Exchangefor
financing ownership of shares
sharesofof
company; stock
stockasfor
proof of
ownership of
partial
company;
ownership
 WHAT IS INTEREST?
Interest is the fee that a borrower pays to a
lender for the use of her/his money. It is a
rental amount charged for the use of money

WHAT IS INTEREST RATE?

Interest rate is the percentage of the money
borrowed that is paid to the lender on some
time basis. Money has time value because
of interest
 Interest from Religious Perspective
Through the mechanism of interest, unjust
gains in trade is acquired through
exploitation

Interest existed since 2000 B.C. in Babylon.

Interest rates of 6-40% have been recorded

The Bible mentioned usury in Exodus. In

1536, John Calvin established the Protestants
theory of usury
Interest from Religious Perspective
In Islam, interest is considered riba, and hence
is strictly forbidden in Islamic economic
jurisprudence (fiqh). It is a major sin

There are two types of riba - an increase in

capital without any services provided and
speculation (maisir), and commodity exchanges
in unequal quantities. Both are prohibited in
the Quran.
 SIMPLE INTEREST
The total interest earned or charged is linearly
proportional to the initial amount P of the loan
(principal), the interest rate i and the number of
interest periods N for which the principal is
committed.
When applied, total interest I may be found
by I = ( P ) ( N ) ( i ), where
PP == principal
principal amount
amount lent
lent or
or borrowed
borrowed
NN == number
number ofof interest
interest periods
periods (( e.g.,
e.g., years
years ))
ii == interest
interest rate
rate per
per interest
interest period
period
 Simple interest - example
You need RM1000 to pay for tuition
fees. You want to borrow the money,
and return it over 3 years. The
interest rate is 10% (simple interest).

How much is the amount of interest

you have to pay? How much is the
overall amount that you have to pay?
 COMPOUND INTEREST
The interest charged for a given period is
based on the remaining principal amount
plus any accumulated interest charges up to
the beginning of that period
Period
Period Amount
Amount Owed
Owed Interest
Interest Amount
Amount Amount
Amount Owed
Owed
at
at beginning
beginning of
of for
for Period
Period atat end
end of
of
period
period (( @
@ 10%
10% )) period
period
11 $1,000
$1,000 $100
$100 $1,100
$1,100
22 $1,100
$1,100 $110
$110 $1,210
$1,210
33 $1,210
$1,210 $121
$121 $1,331
$1,331
 Compound interest - example
A
A loan
loan of
of $1,000
$1,000 is
is made
made at
at an
an interest
interest of
of 12%
12% for
for 55
years.
years. The
The principal
principal and
and interest
interest are
are due
due atat the
the end
end
of
of the
the 55thth year
year
Year Amount at Interest at Amount Payment,
start of year, end of year, owed at end RM
RM RM of year, RM
1 1000.00 120.00 1120.00 0
2 1120.00 134.40 1254.40 0
3 1254.40 150.53 1404.93 0
4 1404.93 168.59 1573.52 0
5 1573.52 188.82 1762.34 1762.34
 ECONOMIC EQUIVALENCE
Things
Things are
are equivalent
equivalent when
when they
they have
have the
the same
same effect
effect

In
In engineering
engineering economics,
economics, we
we areare usually
usually not
not too
too
concerned
concerned about
about the
the timing
timing of
of aa project's
project's cash
cash flow.
flow.
Instead,
Instead, we
we are
are concerned
concerned about
about the
the profitability
profitability of
of that
that
project
project

This
This means
means we
we need
need to
to compare
compare projects
projects involving
involving
receipts
receipts and
and disbursements
disbursements occurring
occurring at
at different
different times,
times,
with
with the
the goal
goal of
of identifying
identifying an
an alternative
alternative having
having the
the
largest
largest eventual
eventual profitability
profitability
 ECONOMIC EQUIVALENCE
Equivalence
Equivalence is is established
established when
when we we are
are indifferent
indifferent
about
about making
making aa future
future payment,
payment, or or aa series
series of of future
future
payments,
payments, and and aa present
present sum
sum of of money
money
Equivalence
Equivalence is is needed
needed to to compare
compare alternative
alternative options
options
or
or proposals,
proposals, byby reducing
reducing them
them to to an
an equivalent
equivalent
basis,
basis, depending
depending on: on:
interest
interest rate
rate
amounts
amounts of of money
money involved
involved
timing
timing of
of the
the affected
affected monetary
monetary receipts
receipts and/or
and/or
expenditures
expenditures
manner
manner in in which
which the
the interest
interest or or profit
profit onon invested
invested
capital
capital is
is paid
paid and
and the
the initial
initial capital
capital isis recovered
recovered
 ECONOMIC EQUIVALENCE FOR FOUR
REPAYMENT PLANS OF AN $8,000 LOAN
Plan
Plan #1:
#1: $2,000
$2,000 ofof loan
loan principal
principal plus
plus 10%
10% atat BOY
BOY
paid
paid at
at end
end of
of year.
year. Notice
Notice -- interest
interest paid
paid at
at the
the end
end
of
of each
each year
year is
is reduced
reduced byby $200
$200 (i.e.,
(i.e., 10%
10% ofof
remaining
remaining principal)
principal)
Year
Year Amount
Amount Owed
Owed Interest
Interest Accrued
Accrued Total
Total Principal
Principal Total
Total end
end
at
at beginning
beginning for
for Year
Year Money
Money Payment
Payment of of Year
Year
of
of Year
Year owed
owed at
at Payment
Payment (( BOYBOY ))
end
end of
of Year
Year
11 $8,000
$8,000 $800
$800 $8,800
$8,800 $2,000
$2,000 $2,800
$2,800
22 $6,000
$6,000 $600
$600 $6,600
$6,600 $2,000
$2,000 $2,600
$2,600
33 $4,000
$4,000 $400
$400 $4,400
$4,400 $2,000
$2,000 $2,400
$2,400
44 $2,000
$2,000 $200$200 $2,200
$2,200 $2,000
$2,000 $2,200
$2,200

ECONOMIC
ECONOMIC EQUIVALENCE
EQUIVALENCE FOR
FOR FOUR
FOUR REPAYMENT
REPAYMENT
PLANS
PLANS OF
OF AN
AN $8,000
$8,000 LOAN,
LOAN, 10%
10% interest
interest rate
rate

Plan
Plan #2:
#2: $0
$0 of
of loan
loan principal
principal paid
paid at
at end
end of
of fourth
fourth
year;
year; $800
$800 interest
interest paid
paid at
at the
the end
end of
of each
each year
year
Year
Year Amount
Amount Owed
Owed Interest
Interest Accrued
Accrued Total
Total Principal
Principal Total
Total end
end
at
at beginning
beginning for
for Year
Year Money
Money Payment
Payment of of Year
Year
of
of Year
Year owed
owed at
at Payment
Payment (( BOYBOY ))
end
end of
of Year
Year
11 $8,000
$8,000 $800
$800 $8,800
$8,800 $0$0 $800
$800
22 $8,000
$8,000 $800
$800 $8,800
$8,800 $0$0 $800
$800
33 $8,000
$8,000 $800
$800 $8,800
$8,800 $0$0 $800
$800
44 $8,000
$8,000 $800
$800 $8,800
$8,800 $8,000
$8,000 $8,800
$8,800

ECONOMIC
ECONOMIC EQUIVALENCE
EQUIVALENCE FOR
FOR FOUR
FOUR REPAYMENT
REPAYMENT
PLANS
PLANS OF
OF AN
AN $8,000
$8,000 LOAN,
LOAN, 10%
10% interest
interest rate
rate
Plan
Plan #3:
#3: Pay
Pay interest
interest at
at end
end of
of each
each year,
year, plus
plus some
some premium.
premium.
A
A total
total of
of $2,524
$2,524 paid
paid at
at the
the end
end of
of each
each year
year

Year
Year Amount
Amount Owed
Owed Interest
Interest Accrued
Accrued Total
Total Principal
Principal Total
Total end
end
at
at beginning
beginning for
for Year
Year Money
Money Payment
Payment of of Year
Year
of
of Year
Year owed
owed at
at Payment
Payment (( BOYBOY ))
end
end of
of Year
Year
11 $8,000
$8,000 $800
$800 $8,800
$8,800 $1,724
$1,724 $2,524
$2,524
22 $6,276
$6,276 $628
$628 $6,904
$6,904 $1,896
$1,896 $2,524
$2,524
33 $4,380
$4,380 $438
$438 $4,818
$4,818 $2,086
$2,086 $2,524
$2,524
44 $2,294
$2,294 $230
$230 $2,524
$2,524 $2,294
$2,294 $2,524
$2,524

ECONOMIC
ECONOMIC EQUIVALENCE
EQUIVALENCE FOR
FOR FOUR
FOUR REPAYMENT
REPAYMENT
PLANS
PLANS OF
OF AN
AN $8,000
$8,000 LOAN,
LOAN, 10%
10% interest
interest rate
rate
Plan
Plan #4:
#4: No
No interest
interest and
and no
no principal
principal paid
paid for
for first
first three
three
years.
years. At
At the
the end
end of
of the
the fourth
fourth year,
year, the
the original
original principal
principal
plus
plus accumulated
accumulated (compounded)
(compounded) interest
interest is
is paid.
paid.

Year
Year Amount
Amount Owed
Owed Interest
Interest Accrued
Accrued Total
Total Principal
Principal Total
Total end
end
at
at beginning
beginning for
for Year
Year Money
Money Payment
Payment of of Year
Year
of
of Year
Year owed
owed at
at Payment
Payment (( BOYBOY ))
end
end of
of Year
Year
11 $8,000
$8,000 $800
$800 $8,800
$8,800 $0 $0 $0$0
22 $8,800
$8,800 $880
$880 $9,680
$9,680 $0 $0 $0$0
33 $9,680
$9,680 $968
$968 $10,648
$10,648 $0$0 $0$0
44 $10,648
$10,648 $1,065
$1,065 $11,713
$11,713 $8,000
$8,000 $11,713
$11,713
 What is Cash Flow?
Cash flowisthemovement of money intoorout
ofabusiness,project,orfinancialproduct

Itisusuallymeasuredduringaspecified,limited
period of time

Measurementofcashflowcanbeusedfor
calculatingotherparametersthatgiveinformation
aboutacompany'svalueandsituation.
 What is Cash Flow?
In
In an
an ideal
ideal business
business cycle,
cycle, there
there will
will be
be more
more cash
cash
flowing
flowing in
in than
than flowing
flowing out.
out.

In
In reality,
reality, however,
however, most
most businesses
businesses have
have to
to produce
produce
or
or deliver
deliver goods/services
goods/services toto their
their customers
customers while
while also
also
paying
paying their
their staff
staff and
and suppliers
suppliers before
before they
they get
get paid
paid
themselves
themselves

This
This lag
lag in
in payments-in
payments-in andand payments-out
payments-out is is aa major
major
challenge
challenge forfor businesses.
businesses. How
How well
well itit is
is managed
managed isis
critical
critical to
to the
the business'
business' immediate
immediate financial
financial health
health and
and
long
long term
term sustainability.
sustainability.
 Cash Inflows
Cash inflows are any receipts of cash to a
business and can include:

Payment for goods or services from

customers
Receipt of a bank loan
Interest on savings and investments
Shareholder investments
Tax returns
 Cash Outflows
Cash outflows are any cash outgoings and
can include:

Purchase of stock, raw materials or equipment

Wages, rents, daily operating expenses
Loan repayments, maintenance cost
payments
Income tax, payroll tax, other taxes
Asset purchases
 What is Cash Flow Diagram?
It is a tool to represent cash transactions in a
given time duration

It includes information on cash inflows and

cash outflows

Outflow is placed UNDER the line, while

inflow is placed OVER the line
 CASH FLOW DIAGRAM NOTATION

1
1 2 3 4 5=N

1 Time scale with progression of time

moving from left to right

The numbers represent time periods

(e.g., years, months, quarters, etc...)
 CASH FLOW DIAGRAM NOTATION

1
1 2 3 4 5=N
P =$8,000 2

2 Present expense (cash outflow) of $8,000

 CASH FLOW DIAGRAM NOTATION
A = $2,524 3
1
1 2 3 4 5=N
P =$8,000 2

3 Annual income (cash inflow) of $2,524

 CASH FLOW DIAGRAM NOTATION
A = $2,524 3
1
1 2 3 4 5=N
P =$8,000 2 4 i = 10% per year

4 Interest rate of loan

 CASH FLOW DIAGRAM NOTATION
A = $2,524 3 5
1
1 2 3 4 5=N
P =$8,000 2 4 i = 10% per year

Dashed-arrow line indicates

5
amount to be determined
 Problem to Solve
The
The heating,
heating, ventilation,
ventilation, and
and air
air conditioning
conditioning
system
system (HAVC)
(HAVC) used
used inin the
the shop
shop floor
floor needs
needs to
to
be
be upgraded.
upgraded. There
There are
are 22 alternatives
alternatives

(1)
(1) Alternative
Alternative A:
A: rebuild
rebuild the
the existing
existing HAVC
HAVC
system
system

(2)
(2) Alternative
Alternative B:B: Install
Install aa new
new HAVC
HAVC system
system that
that
utilizes
utilizes existing
existing ductwork
ductwork

Which
Which alternative
alternative would
would you
you choose?
choose? Why?
Why?
 Alternative
Alternative A
A rebuild
rebuild existing
existing HAVC
HAVC system
system
Equipment,
Equipment, labor,
labor, materials
materials -- RM18,000
RM18,000
Annual
Annual electricity
electricity cost
cost RM32,000
RM32,000
Annual
Annual maintenance
maintenance RM2,400
RM2,400

Alternative
Alternative B B Install
Install new
new HAVC
HAVC system
system
Equipment,
Equipment, labor,
labor, materials
materials RM60,000
RM60,000
Annual
Annual electricity
electricity cost
cost RM9,000
RM9,000
Annual
Annual maintenance
maintenance RM16,000
RM16,000
Replacement
Replacement of of major
major component
component atat the
the end
end
of
of 44 years
years RM9,400
RM9,400

You
You have
have been
been told
told that
that at
at the
the end
end of
of 88 years,
years, the
the estimated
estimated
market
market value
value of
of Alternative
Alternative AA is
is RM2,000
RM2,000 and
and for
for Alternative
Alternative B,
B, the
the
value
value is
is RM8,000.
RM8,000. Which
Which alternative
alternative would
would you
you choose?
choose? Why?
Why?
End of year Alternative A (RM) Alternative B (RM)
0 (now) 18,000 60,000
1 34,400 25,000
2 34,400 25,000
3 34,400 25,000
4 34,400 34,400
5 34,400 25,000
6 34,400 25,000
7 34,400 25,000
8 34,400 2,000 = 25,000 8,000 =
32,400 17,000
TOTAL 291,200 261,400
 NOTATION

ii == effective
effective interest
interest rate
rate per
per interest
interest period
period

N
N == number
number of
of compounding
compounding periods
periods (e.g.,
(e.g., years)
years)

P
P == present
present sum
sum of
of money;
money; the
the equivalent
equivalent value
value of
of
one
one or
or more
more cash
cash flows
flows at
at the
the present
present time
time

FF == future
future sum
sum of
of money;
money; the
the equivalent
equivalent value
value of
of
one
one or
or more
more cash
cash flows
flows at
at aa future
future time
time
 RELATING PRESENT AND FUTURE
EQUIVALENT VALUES OF SINGLE CASH
FLOWS
(a) Find F (future value) when given P
(present value)
F = P ( 1+i ) NN
(1+i)
(1+i)NN single
single payment
payment compound
compound amount
amount factor
factor
functionally
functionally expressed
expressed asas F
F == P
P (F
(F // P,
P, i%,
i%, N
N ))
predetermined
predetermined values
values of
of this
this can
can be
be found
found inin
standard
standard interest
interest factor
factor tables
tables
P
N=
0
F=?
 RELATING PRESENT AND FUTURE
EQUIVALENT VALUES OF SINGLE CASH
FLOWS
(b) Find P when given F:

P = F [1 / (1 + i ) ] NN
(1+i) -N single payment present worth factor
(1+i)-N single payment present worth factor
functionally
functionally expressed
expressed asas PP == F
F (( P
P // F,
F, i%,
i%, N
N ))
predetermined
predetermined values
values of
of this
this can
can bebe found
found inin
standard
standard interest
interest factor
factor tables
tables
F
0 N=

P=?
 Example (a) find F, given P
(single cash flow)
Your
Your company
company borrows
borrows RM1000
RM1000 for
for 88 years.
years. How
How
much
much mustmust itit repay
repay in
in aa lump
lump sum
sum at
at the
the end
end of
of the
the
88thth year?
year? (use
(use interest
interest rate
rate 10%
10% per
per year)
year)

The
The question
question above
above can
can be
be written
written this
this way:
way: What
What
is
is the
the future
future equivalence
equivalence at
at the
the end
end of
of 88 years
years of
of
RM1000
RM1000 at at the
the beginning
beginning of
of the
the 88 years?
years?
 Example (a) find F, given P
(single cash flow)
Your
Your company
company borrows
borrows RM1000
RM1000 for
for 88 years.
years. How
How
much
much mustmust itit repay
repay in
in aa lump
lump sum
sum at
at the
the end
end of
of the
the
88thth year?
year? (use
(use interest
interest rate
rate 10%
10% per
per year)
year)

The
The question
question above
above can
can be
be written
written this
this way:
way: What
What
is
is the
the future
future equivalence
equivalence at
at the
the end
end of
of 88 years
years of
of
RM1000
RM1000 at at the
the beginning
beginning of
of the
the 88 years?
years?

F
F == PP (F
(F // P,
P, i%,
i%, N
N ))
== RM1000
RM1000 (2.1436)
(2.1436)
== RM
RM 2,143.60
2,143.60
 Example (b) find P, given F
(single cash flow)
Your
Your company
company would
would like
like to
to have
have RM2,143.60
RM2,143.60 eight
eight
years
years from
from now.
now. What
What amount
amount should
should be
be deposited
deposited
now
now to
to get
get that
that amount
amount inin 88 years
years time?
time? (10%
(10%
annual
annual interest
interest rate)
rate)

What
What is
is the
the present
present equivalence
equivalence ofof RM2,143.60
RM2,143.60
that
that will
will be
be received
received 88 years
years from
from now?
now?

P
P == F
F (( P
P // F,
F, i%,
i%, N
N )) (try
(try it!)
it!)
 NOTATION
A
A == end-of-period
end-of-period cash
cash flows
flows (or(or equivalent
equivalent
end-of-period
end-of-period values
values )) in
in aa uniform
uniform series
series
continuing
continuing for
for aa specified
specified number
number of of periods,
periods,
starting
starting at
at the
the end
end of
of the
the first
first period
period and
and
continuing
continuing through
through the
the last
last period
period

Ordinary
Ordinary annuity
annuity the
the first
first cash
cash flow
flow is
is made
made
at
at the
the end
end of
of the
the first
first period
period

Deferred
Deferred annuity
annuity the
the cash
cash flow
flow begins
begins at
at
some
some later
later date
date
 RELATING
RELATING A A UNIFORM
UNIFORM SERIES
SERIES (ORDINARY
(ORDINARY
ANNUITY)
ANNUITY) TO TO PRESENT
PRESENT AND AND FUTURE
FUTURE EQUIVALENT
EQUIVALENT
VALUES
VALUES
(1)
(1) Find
Find F F given
given A A
Finding
Finding future
future equivalent
equivalent income
income (inflow)
(inflow) value
value given
given
aa series
series of of uniform
uniform equal equal payments
payments
(( 11 ++ ii )) NN -- 11
FF == A
A
ii
uniform
uniform series
series compound
compound amount
amount factor
factor inin [[ ]]
functionally
functionally expressedexpressed as as FF == A
A (( F
F // A,
A, i%,
i%, N
N ))
predetermined
predetermined values values are
are given
given inin standard
standard interest
interest
factor
factor tables
tables
F=?
1 2 3 4 5 6 7 8
A=
 RELATING
RELATING A A UNIFORM
UNIFORM SERIES
SERIES (ORDINARY
(ORDINARY
ANNUITY)
ANNUITY) TO TO PRESENT
PRESENT AND AND FUTURE
FUTURE EQUIVALENT
EQUIVALENT
VALUES
VALUES
(2)
(2) Find
Find P P given
given A A
Finding
Finding present
present equivalent
equivalent value
value given
given aa series
series ofof
uniform
uniform equalequal receipts
receipts
(( 11 ++ ii )) NN -- 11
P
P == AA
ii (( 11 ++ ii )) NN
uniform
uniform seriesseries present
present worth
worth factor
factor in
in [[ ]]
functionally
functionally expressed
expressed as as PP == A
A (( P
P // A,
A, i%,
i%, N
N ))
predetermined
predetermined values values given
given inin standard
standard interest
interest
factor
factor tables
tablesA = 1 2 3 4 5 6 7 8
P=?
 RELATING
RELATING A A UNIFORM
UNIFORM SERIES SERIES (ORDINARY
(ORDINARY
ANNUITY)
ANNUITY) TO TO PRESENT
PRESENT AND AND FUTURE
FUTURE EQUIVALENT
EQUIVALENT
VALUES
VALUES
(3) Find A given
(3) Find A given F F
Finding
Finding amount
amount A A of
of aa uniform
uniform series
series when
when given
given the
the
equivalent
equivalent future
future valuevalue
ii
AA == FF
(( 11 ++ ii )) NN -1
-1
sinking
sinking fund
fund factor
factor in in [[ ]]
functionally
functionally expressed
expressed as as A
A == F
F (( A
A // F,
F, i%,
i%, N
N ))
predetermined
predetermined values values are are given
given inin standard
standard interest
interest
factor
factor tables
tables F=
1 2 3 4 5 6 7 8
A =?
 RELATING
RELATING A A UNIFORM
UNIFORM SERIES SERIES (ORDINARY
(ORDINARY
ANNUITY)
ANNUITY) TO TO PRESENT
PRESENT AND AND FUTUREFUTURE EQUIVALENT
EQUIVALENT
VALUES
VALUES
(4)
(4) Find
Find AA given
given P P
Finding
Finding amount
amount A A ofof aa uniform
uniform series
series when
when given
given the
the
equivalent
equivalent present
present value value
ii (( 1+i
1+i ))NN
AA == PP
(( 11 ++ ii )) NN -1
-1
capital
capital recovery
recovery factor factor in
in [[ ]]
functionally
functionally expressed
expressed as as A A == PP (( A
A // P,
P, i%,
i%, NN ))
predetermined
predetermined values values are
are in in standard
standard interest
interest
factor
factor tables
tables P=
1 2 3 4 5 6 7 8
A =?
 Example (1) find F, given A
(uniform series, ordinary annuity)
IfIf 88 annual
annual deposits
deposits of
of RM187.45
RM187.45 eacheach are
are placed
placed
in
in an an account,
account, how
how much
much money
money will
will be
be
accumulated
accumulated immediately
immediately after
after the
the last
last deposit?
deposit?
(use10%
(use10% annual
annual interest
interest rate)
rate)

What
What amount,
amount, atat the
the end
end of
of the
the 88thth year,
year, is
is
equivalent
equivalent to
to 88 end-of-the-year
end-of-the-year payments
payments of of
RM187.45
RM187.45 each?
each?

F
F == A
A (( F
F // A,
A, i%,
i%, N
N )) (try
(try it!)
it!)
 Example (2) find P, given A
(uniform series, ordinary annuity)
How much should be deposited in a fund now
so that at the end of every year, for 8 years, a
sum of RM187.45 can be withdrawn?

What is the present equivalence of 8 end-of-

the-year payments of RM 187.45 each?

P = A ( P / A, i%, N ) (try it!)

 Example (3) find A, given F
(uniform series, ordinary annuity)

What
What uniform
uniform annual
annual amount
amount should
should be
be deposited
deposited
every
every year
year so
so that
that RM2143.60
RM2143.60 can can be
be accumulated
accumulated
at
at the
the time
time of
of the
the 88thth annual
annual deposit?
deposit?

What
What uniform
uniform payment,
payment, made
made at
at the
the end
end of
of every
every
year,
year, isis equivalent
equivalent to
to RM2143.60
RM2143.60 at
at the
the end
end of
of the
the
88thth year?
year?

A
A == F
F (( A
A // F,
F, i%,
i%, N
N )) (try
(try it!)
it!)
 Example (4) find A, given P
(uniform series, ordinary annuity)
What
What is
is the
the size
size of
of 88 equal
equal annual
annual payments
payments to
to repay
repay aa loan
loan
of
of RM1000?
RM1000? TheThe first
first payment
payment is
is due
due one
one year
year after
after
receiving
receiving the
the loan.
loan. (Interest
(Interest 10%
10% per
per year)
year)

What
What isis the
the amount
amount of of the
the uniform
uniform payment
payment that
that must
must be
be
made,
made, such
such that
that at
at the
the end
end of
of 88 successive
successive years,
years, the
the
payment
payment would
would bebe equivalent
equivalent toto RM1000
RM1000 at
at the
the beginning
beginning
of
of the
the first
first year?
year?

A
A == P
P (( A
A // P,
P, i%,
i%, N
N )) (try
(try it!)
it!)
 RELATING
RELATING UNIFORM
UNIFORM SERIES
SERIES (DEFERRED
(DEFERRED
ANNUITY)
ANNUITY) TO
TO PRESENT
PRESENT // FUTURE
FUTURE
EQUIVALENT
EQUIVALENT VALUES
VALUES
Annuity is deferred for j periods, where j < N

Find P given A
For ordinary annuity: P = A ( P / A, i%, N )
For deferred annuity:
P= A ( P / A, i%, N - j ) at end of period j

P= A ( P / A, i%, N - j ) ( P / F, i%, j )
at time 0 (time present)
 Example deferred annuity
A mother, on the day her daughter is born,
wants to put aside a lump sum of money in an
account bearing a 12%/year interest. The
mother wishes that her daughter withdraws
RM2000 on her 18thth, 19thth, 20thth, and 21stst
birthday. How much should the lump sum be?

P = A ( P / A, i%, N - j ) ( P / F, i%, j )
(j = 17, N = 21)
 F
F == P
P (F
(F // P,
P, i%,
i%, NN ))
P
P == F
F (( P
P // F,
F, i%,
i%, N
N ))
F
F == A
A (( F
F // A,
A, i%,
i%, N
N ))
P
P == A
A (( P
P // A,
A, i%,
i%, N
N ))
A
A == F
F (( A
A // F,
F, i%,
i%, NN ))
A
A == P
P (( A
A // P,
P, i%,
i%, N
N ))
P=
P= AA (( P
P // A,
A, i%,
i%, NN -- jj )) at
at end
end of of period
period jj
P=
P= AA (( P
P // A,
A, i%,
i%, NN -- jj )) (( P
P // F,
F, i%,
i%, jj )) at
at time
time 00
 EQUIVALENCE CALCULATIONS INVOLVING
MULTIPLE PARAMETERS
So
So far,
far, we
we have
have seen
seen that
that all
all compounding
compounding interest
interest
takes
takes place
place once
once per
per time
time period
period (e.g.,
(e.g., aa year),
year), and
and to
to
this
this point,
point, cash
cash flows
flows also
also occur
occur once
once perper time
time period.
period.
However,
However, therethere are
are cases
cases where
where aa series
series ofof cash
cash
outflows
outflows occur
occur over
over aa number
number of of years,
years, and
and that
that the
the
value
value of of the
the outflows
outflows is is unique
unique for
for each
each ofof the
the years
years
(for
(for example,
example, the the first
first three
three years).
years). ItIt could
could be
be that
that
the
the value
value ofof outflows
outflows is is the
the same
same for for the
the last
last four
four
years.
years.
You
You might
might bebe asked
asked to to find
find a)
a) the
the present
present equivalent
equivalent
expenditure;
expenditure; b) b) the
the future
future equivalent
equivalent expenditure;
expenditure;
and
and c) c) the
the annual
annual equivalent
equivalent expenditure
expenditure
 Example - problem involving
multiple parameters
Your company needs to make a series of year-
end payments of equipment maintenance over
8 years RM100 on the 1stst year, RM200 on the
2nd
nd year, RM500 on 3rd rd year, RM400 each year

on the 4thth 8thth year. Find a) the present

equivalent expenditure; b) the future equivalent
expenditure; and c) the annual equivalent
expenditure of these cash flows, given annual
interest rate of 20%
 Present
Present EQUIVALENT
EQUIVALENT EXPENDITURE
EXPENDITURE CALCULATIONS
CALCULATIONS
P
P00 == F( F( PP // F,
F, i%,
i%, NN )) for
for each each of of the
the unique
unique years
years
--
-- FF is is aa series
series of of unique
unique outflow
outflow for for year
year 11 through
through year
year 33
--
-- ii is
is common
common for for each
each calculation
calculation
--
-- NN is is the
the year
year in in which
which the the outflow
outflow occurred
occurred
--
-- Multiply
Multiply the the outflow
outflow withwith the the associated
associated table table value
value
--
-- Add
Add the the three
three products
products together
together
Use
Use A A (( P
P // A,
A, i%,
i%, N N -- jj )) (( P
P // F,
F, i%,
i%, jj )) --
-- deferred
deferred annuity
annuity --
--
for
for the the remaining
remaining (common(common outflow) outflow) years:
years:
--
-- AA isis common
common for for years
years 44 through
through 77
--
-- ii remains
remains the the same
same
--
-- NN is is the
the final
final year
year
--
-- jj is
is the
the last
last year
year the
the unique
unique outflow
outflow occurred
occurred
--
-- multiply
multiply the the common
common outflow outflow value value with
with the
the table
table values
values
--
-- add
add this this to
to the
the previous
previous total total for
for the
the present
present equivalent
equivalent
expenditure.
expenditure.
Present
Present equivalent
equivalent expenditure--
expenditure--
P
Poo == F
F11 (P/F,
(P/F, 20%,
20%, 1)
1) ++ FF22 (P/F,
(P/F, 20%,
20%, 2)
2) ++ F
F33 (P/F,
(P/F, 20%,
20%,
3)
3) ++ A A (P/A,
(P/A, 20%,
20%, 5)5) ** (P/F,
(P/F, 20%,
20%, 3)
3)
P
Poo == RM83.3
RM83.3 ++ RM138.88
RM138.88 ++ RM289.35
RM289.35 ++ RM692.26
RM692.26
== RM1203.82
RM1203.82

Future
Future equivalent
equivalent expenditure
expenditure
F
F88 == P
Poo (F
(F // P,
P, 20%,
20%, 8)
8) == RM1203.82*4.2998
RM1203.82*4.2998 ==
RM5176.19
RM5176.19

Annual
Annual equivalent
equivalent expenditure
expenditure
A
A == FF (( A
A // F,
F, 20%,
20%, 88 )) == RM5176.19*0.0606
RM5176.19*0.0606 == RM313.7
RM313.7
A
A == PP (( A
A // P,
P, 20%,
20%, 88 )) == RM
RM 1203.82*0.2606
1203.82*0.2606 == RM313.7
RM313.7
 Relating Uniform Gradient of Cash Flow
to its Future, Annual and Present
Equivalents

G = uniform gradient amounts -- used if

cash flows increase by a constant
(uniform) amount in each period

Find F given G: (G/ i) (F/A, i%, N) - (NG/ i)

Find A given G: A = G ( A / G, i%, N )
Find P given G: P = G ( P / G, i%, N )
 Example-gradient problem
Payment for a certain technical service is
given as follows: RM1000 in the 2nd nd year of

service, RM2000 in the 3rdrd year of service,

RM3000 in the 4thth year of service. Interest
rate is 15% per year.

Find (a) present equivalence at the

beginning of the 1stst year, (b) annual
equivalent values at the end of each of the
4 years.
 Present equivalence
P = G ( P / G, 15%, 4 )
= 1000*3.786 = RM3789

Annual equivalence
A = G ( A / G, 15%, 4 )
= 1000*1.3263 = RM1,326

(or, use A = P ( A / P, 15%, 4 ) = 3789*0.3503

=RM1,327 )
 RELATING
RELATING GE0METRIC
GE0METRIC SEQUENCE
SEQUENCE OF
OF CASH
CASH
FLOWS
FLOWS TO
TO PRESENT
PRESENT AND
AND ANNUAL
ANNUAL EQUIVALENTS
EQUIVALENTS

Projected
Projected cash
cash flow
flow patterns
patterns changing
changing atat an
an average
average
rate
rate of
of ff each
each period;
period;
The
The resultant
resultant end-of-period
end-of-period cash-flow
cash-flow pattern
pattern is
is
referred
referred toto as
as aa geometric
geometric gradient
gradient series
series

Find
Find P,
P, given
given A:
A: P
P == A
A11N
N (P/F,i%,1)
(P/F,i%,1)
Find
Find A,
A, given
given P:
P: A
A == P
P (A
(A // P,
P, i%,
i%, N
N ),), A
A00 == P
P (( A
A // P,
P, ff %,
%, N
N ))
Find
Find F,
F, given
given P:
P: FF == P
P (( FF // P,
P, i%,
i%, N
N ))
VARYING INTEREST RATES
Sometimes, the interest rate on a loan
varies with time. This must be addressed
when calculating the equivalent values of
the loan

Find P given F; with interest rates that

vary over N

Find F given P; with interest rates that

vary over N
NOMINAL AND EFFECTIVE INTEREST RATES
Sometimes,
Sometimes, the the interest
interest period
period is is less
less than
than aa year
year
Nominal
Nominal Interest
Interest Rate
Rate -- rr -- rates
rates compounded
compounded moremore
than
than once
once aa year;
year; the
the stated
stated annual
annual interest
interest rate
rate
Annual
Annual Percentage
Percentage Rate Rate -- APRAPR percentage
percentage rate
rate
per
per period
period times
times number
number of of compounding
compounding periods.
periods.
APR
APR == rr xx MM
Effective
Effective Interest
Interest Rate
Rate -- ii -- rates
rates compounded
compounded more more
than
than once
once aa year,
year, the
the actual
actual amount
amount of of interest
interest paid.
paid.
The
The actual
actual rate
rate is
is higher
higher than
than the
the nominal
nominal rate
rate because
because compounding
compounding
happens
happens more
more than
than once
once aa year
year
ii == (( 11 ++ rr // M
M ))MM -- 11 == (( F
F // P,
P, rr // M,
M, M
M )) -1
-1
M
M is is the
the number
number of of compounding
compounding periods periods per
per year
year
 Example nominal, APR,
effective interest rates
A credit card company charges an interest rate of
1.375% per month on the unpaid balance of all
accounts. What is the nominal interest rate?
What is the APR? What is the effective interest
rate per year?
Nominal interest rate = 1.375% per month
APR = (12)(1.375) = 16.5%/year
Effective interest rate = i = (( 11 ++ rr // M
M ))MM -- 11
== (( 11 ++ (0.165/
(0.165/ 12
12 ))12
12 - 1
-1
== 0.1781
0.1781 or or 17.81%/year
17.81%/year
 COMPOUNDING
COMPOUNDING MORE
MORE THAN
THAN ONCE
ONCE A
A YEAR
YEAR
Single
Single Amounts
Amounts
Find
Find P,
P, F,
F, A,
A, given
given r,r, M
M

F
F == P
P (( FF // P,
P, i%,
i%, N N ))
i%
i% == (( 11 ++ rr // M
M )) MM 11

Uniform
Uniform and
and // or
or Gradient
Gradient Series
Series
Find
Find P,
P, F,
F, A,
A, given
given r,r, M,
M, and
and the
the existence
existence of
of aa cash
cash
flow
flow at
at the
the end
end of
of each
each period
period -- use
use formulas
formulas andand
tables
tables for
for uniform
uniform annual
annual series
series and
and uniform
uniform gradient
gradient
series
series
 CASH FLOWS LESS OFTEN THAN
COMPOUNDING PERIODS
Find A, given i, k and X, where:
ii is
is the
the effective
effective interest
interest rate
rate per
per interest
interest period
period
kk is
is the
the period
period at
at the
the end
end of
of which
which cash
cash flow
flow occurs
occurs
XX isis the
the uniform
uniform cash
cash flow
flow amount
amount
Use: A = X (A / F, i%, k )
Find A, given i, k and X, where:
ii is
is the
the effective
effective interest
interest rate
rate per
per interest
interest period
period
kk is
is the
the period
period at
at the
the beginning
beginning ofof which
which cash
cash flow
flow
occurs
occurs
XX isis the
the uniform
uniform cash
cash flow
flow amount
amount
Use: A = X ( A / P, i%, k )
 CONTINUOUS
CONTINUOUS COMPOUNDING
COMPOUNDING AND
AND DISCRETE
DISCRETE
CASH
CASH FLOWS
FLOWS

Continuous
Continuous compounding
compounding assumes assumes cash cash flowsflows occur
occur
at
at discrete
discrete intervals,
intervals, but but compounding
compounding is is continuous
continuous
throughout
throughout the the interval.
interval.
Given
Given nominal
nominal per per year
year interest
interest rate rate -- -- r,r, compounding
compounding
per
per year
year -- -- M
M one
one unitunit ofof principal
principal == [[ 11 ++
(r
(r // M
M )) ]] MM
Given
Given M M // rr == p,
p, [[ 11 ++ (r (r // M
M )) ]] MM == [1
[1 ++ (1/p)
(1/p) ]] rprp
Given
Given lim lim [[ 11 ++ (1
(1 // p)
p) ]] pp == ee11 == 2.71828
2.71828
p

(( FF // P,
P, r%,r%, N
N )) == ee rN
rN

ii == ee rr -- 11
 CONTINUOUS COMPOUNDING AND
DISCRETE CASH FLOWS
Single Cash Flow

Find F given P
F = P (e rN
rN)

Functionally expressed as ( F / P, r%, N )

e rN
rN is continuous compounding compound

amount
Predetermined values are in standard
tables.
 CONTINUOUS COMPOUNDING AND
DISCRETE CASH FLOWS
Single Cash Flow
Find P given F
P = F (e -rN-rN)

Functionally expressed as ( P / F, r%, N )

e -rN
-rN is continuous compounding present

equivalent
Predetermined values are given in standard
interest tables
 CONTINUOUS COMPOUNDING AND
DISCRETE CASH FLOWS
Uniform Series
Find F given A
F = A (e rNrN- 1)/(e rr- 1)

Functionally expressed as ( F / A, r%, N )

(e rN
rN- 1)/(e rr- 1) is continuous compounding

compound amount
Predetermined values are in standard interest
tables
 CONTINUOUS COMPOUNDING AND
DISCRETE CASH FLOWS
Uniform Series
Find P given A
Finding present equivalent value given a series
of uniform equal receipts
P = A (e rNrN- 1) / (e rN
rN ) (e rr- 1)

Functionally expressed as ( P / A, r%, N )

(e rN
rN- 1) / (e rN
rN ) (e rr- 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
Find A given F
Finding a uniform series given a future value
A = F (e rr- 1) / (e rNrN - 1)

Functionally expressed as ( A / F, r%, N )

(e rr- 1) / (e rN
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
Find A given P
Finding a series of uniform equal receipts given
present equivalent value
A = P [e rN rN (e rr- 1) / (e rN
rN - 1) ]

Functionally expressed as ( A / P, r%, N )

[e rN
rN (e rr- 1) / (e rN 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
Continuous flow flow of of funds
funds suggests
suggests aa series
series of of cash
cash
flows
flows occurring
occurring at at infinitesimally
infinitesimally short short intervals
intervals of of
time
time
Given:
Given:
aa nominal
nominal interest
interest rate rate or or rr
pp is
is payments
payments per per year year
[[ 11 ++ (r
(r // pp )) ]] pp -- 11
P
P == ------------------------------
------------------------------
rr [[ 11 ++ (( rr // pp )) ]] pp
p --> oo
Given
Given Lim Lim [[ 11 ++ (( rr // pp )) ]] pp == ee rr
For
For oneone year
year (( P P // A,A, r%,
r%, 11 )) == (( ee rr -- 11 )) // re
re rr
 CONTINUOUS COMPOUNDING AND
CONTINUOUS CASH FLOWS
Find F given A
Finding the future equivalent given the
continuous funds flow
F = A [ ( erNrN - 1 ) / r ]

Functionally expressed as ( F / A, r%, N )

( erN
rN - 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
Find P given A
Finding the present equivalent given the
continuous funds flow
P = A [ ( erNrN - 1 ) / rerN
rN ]

Functionally expressed as ( P / A, r%, N )

( erN
rN - 1 ) / rerN
rN is continuous compounding

present equivalent
Predetermined values are found in column 7 of
appendix D of text.
 CONTINUOUS COMPOUNDING AND
CONTINUOUS CASH FLOWS

Find A given F
Finding the continuous funds flow given the
future equivalent
A = F [ r / ( erNrN - 1 )]

Functionally expressed as ( A / F, r%, N )

r / ( erN
rN - 1 ) is continuous compounding

sinking fund
 CONTINUOUS COMPOUNDING AND
CONTINUOUS CASH FLOWS

Find A given P
Finding the continuous funds flow given the
present equivalent
A = F [ rerN rN / ( erN
rN - 1 )]

Functionally expressed as ( A / P, r%, N )

rerN
rN / ( erN
rN - 1 ) is continuous compounding

capital recovery