148 views

Uploaded by Ryan Aman

Engineering Economics 390. Courtesy of Atre, Sundar V Associate Professor, Oregon State University.

- Chapter 6_Accounting and Time Values Money
- Blankchapter_1
- 08-22-2011
- add math
- Test Bank - TVM1
- Time Value of money Test Banks
- 11-10-2015.pdf
- Grant Thornton Report_Local Government a Financial Snapshot
- Test Bank - TVM1
- Aptitude Questions
- 10-07-2013.pdf
- CCP402
- Chapter 4.pdf
- interest.pdf
- Test Bank - TVM1
- The Reality of International Finance
- 10
- RAS Cash Ledger
- Chambers's Edinburgh Journal, No. 421 Volume 17, New Series, January 24, 1852 by Various
- Brazil’s Enormous Interest Rate Tax: Can Brazilians Afford It?

You are on page 1of 18

Chapter 5: Understanding

Money & Its Management

1. If interest period is other than

annual, how do we calculate

economic equivalence?

2. If payments occur more frequently

than annual, how do we calculate

economic equivalence?

with Different Compounding Periods

Effective Rates

Nominal Rate Compounding Compounding Compounding Compounding Compounding

Annually Semi-annually Quarterly Monthly Daily

4% 4.00% 4.04% 4.06% 4.07% 4.08%

S.V. Atre 1

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

(9% compounded quarterly)

+ Interest (2.25%) + $225

+ Interest (2.25%) +$230.06

+ Interest (2.25%) +$235.24

+ Interest (2.25 %) + $240.53

= Value after one year = $10,930.83

ia = (1 + r / M ) − 1 M

ia = effective annual interest rate

M = number of interest periods per year

S.V. Atre 2

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

Interest Rate

annually, quarterly, monthly

Identify the payment period (e.g., annual,

quarter, month, week, etc), etc)

Find the effective interest rate that

covers the payment period.

Compounding Periods Coincide

Step 1: Identify the number of compounding

periods (M) per year

Step 2: Compute the effective interest rate per

payment period (i)

i = r/M

Step 3: Determine the total number of payment

periods (N)

N = M (number of years)

Step 4: Use the appropriate interest formula

using i and N above

S.V. Atre 3

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

i = [1 + r / CK ]C − 1

C = number of interest periods per

payment period

K = number of payment periods per year

r/K = nominal interest rate per

payment period

Payment Period = Quarter

Interest Period = Quarterly

1st Q

1 interest period Given r = 8%,

K = 4 payments per year

C = 1 interest periods per quarter

M = 4 interest periods per year

i = [1 + r / C K ] C − 1

= [1 + 0 . 0 8 / (1 ) ( 4 ) ] 1 − 1

= 2 . 0 0 0 % p e r q u a r te r

S.V. Atre 4

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

Payment Period = Quarter

Interest Period = Monthly

1st Q

3 interest periods Given r = 8%,

K = 4 payments per year

C = 3 interest periods per quarter

M = 12 interest periods per year

i = [1 + r / C K ] C − 1

= [1 + 0 . 0 8 / ( 3 ) ( 4 ) ] 3 − 1

= 2 . 0 1 3 % p e r q u a r te r

Payment Period = Quarter

Interest Period = Weekly

1st Q

13 interest periods Given r = 8%,

K = 4 payments per year

C = 13 interest periods per quarter

M = 52 interest periods per year

i = [1 + r / C K ] C − 1

= [1 + 0 . 0 8 / (1 3 )( 4 )]1 3 − 1

= 2 . 0 1 8 6 % p e r q u a rte r

S.V. Atre 5

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

Compounding Periods

Step 1: Identify the following parameters

M = No. of compounding periods per year

K = No. of payment periods per year

C = No. of interest periods per payment period

Step 2: Compute the effective interest rate per payment period

•For discrete compounding

i = [1 + r / CK ] C − 1

Step 3: Find the total no. of payment periods

N = K (no. of years)

Step 4: Use i and N in the appropriate equivalence formula

Monthly Compounding

F3 = ?

Year 1 Year 2 Year 3

r = 12%, 0 1 2 3 4 5 6 7 8 9 10 11 12

Quarters

A = $1,000

Step 1: M = 12 compounding periods/year

K = 4 payment periods/year

C = 3 interest periods per quarter

Step 2: i

i = [1 + 0 .12 /( 3)( 4 )] 3 − 1

= 3 .030 %

Step 3: N = 4(3) = 12

Step 4: F = $1,000 (F/A, 3.030%, 12)

= $14,216.24

S.V. Atre 6

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

Problem 4

You will deposit $1000 every 3 months for

4 years into an account that pays interest

of 8% per year, compounded monthly. The

first deposit will be in 3 months. How

much will be in the account in 4 years?

GIVEN:

A = $1,000 r = 8%/yr i = [1 + 0 .08 /( 3)( 4 )] 3 − 1

C = 3 periods/qr K = 4 payments/yr

M = 12 mo/yr = 2 .0130 %

FIND F:

DIAGRAM: F?

N = 4(4) = 16

0 1 2 3 4 yrs

F = $1,000 (F/A, 2.013%, 16)

= $18,658.12

$1,000

Continuous Compounding

i = [1 + r / CK ]C − 1

where CK = number of compounding periods

per year

i = lim[( 1 + r / CK ) C − 1]

= er /K −1

S.V. Atre 7

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

Payment Period = Quarter

Interest Period = Continuously

1st Q

∞ interest periods

Given r = 8%,

K = 4 payments per year

i = er / K −1

= e 0 .02 − 1

= 2 .0201 % per quarter

quarterly monthly weekly continuously

quarterly quarterly quarterly quarterly

quarter quarter quarter quarter

S.V. Atre 8

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

Compounding Periods

Step 1: Identify the following parameters

M = No. of compounding periods per year

K = No. of payment periods per year

C = No. of interest periods per payment period

Step 2: Compute the effective interest rate per payment period

•For discrete compounding C

i = [1 + r / CK ] − 1

•For continuous compounding

i = er/K − 1

Step 3: Find the total no. of payment periods

N = K (no. of years)

Step 4: Use i and N in the appropriate equivalence formula

with Continuous Compounding

F3 = ?

r = 12%, 0 1 2 3 4 5 6 7 8 9 10 11 12

Quarters

A = $1,000

Step 1: K = 4 payment periods/year

C = ∞ interest periods per quarter

Step 2: i

i = e0.12/ 4 − 1

= 3.045% per quarter

Step 3: N = 4(3) = 12

Step 4: F = $1,000 (F/A, 3.045%, 12)

= $14,228.37

S.V. Atre 9

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

Problem 5

Determine the total amount

accumulated in an account paying

interest at the rate of 10% per year,

compounded continuously if

deposits of $1,000 are made at the

end of each of the next 5 years.

DIAGRAM: F? GIVEN:

A = $1,000 r = 10%/yr

C = ∞ K = 1 payment/yr

0 1 2 3 5 yrs N = 5 yrs

FIND F:

$1,000

Problem 5

GIVEN:

A = $1,000 r = 10%/yr

C = ∞ K = 1 payment/yr

N = 5 yrs

FIND F:

i = e0.10/1 −1

DIAGRAM: F? = 10.517 % per year

0 1 2 3 5 yrs

N=5

F = $1,000 (F/A, 10.517%, 5)

$1,000 = $6,168.25

S.V. Atre 10

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

Problem 6

A firm pays back a $10,000 loan with

quarterly payments over the next 5

years. The $10,000 returns 4% APR

compounded monthly. What is the

quarterly payment amount ?

DIAGRAM:

GIVEN:

$10,000 P = $10,000 r = 4%/yr

C = 3 interest periods/quarter

K = 4 payments/yr

1 2 3 5 yrs = 20 qtr

M = 12 compounding periods/yr

0

FIND A:

$A = ?

Problem 6

GIVEN:

P = $10,000 r = 4%/yr

C = 3 interest periods/quarter

K = 4 payment periods/yr

M = 12 compounding periods/yr

DIAGRAM: FIND A:

$10,000 i = [1 + 0 .04 /( 3)( 4 )] 3 − 1

= 1 .0033 %

1 2 3 5 yrs = 20 qtr

0

$A = ? N = 4(5) = 20

A = $10,000 (A/P, 1.0033%, 20)

= $554.30

S.V. Atre 11

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

Complex Cash Flows – 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.

Problem 1

A construction firm is considering the purchase of an

air compressor.

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

interest rate is 12% per year compounded annually?

S.V. Atre 12

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

GIVEN:

MAINT COST1-8 PER YEAR TABLE

i = 12%/YR, CPD ANNUALLY

FIND P: P = PA + PG + PF = A(P|A,i,N) + G(P|G,i,N) + F(P|F,i,N)

= $700(P|A,12%,8) + $100(P|G,12%,8) + $100(P|F,12%,1)

DIAGRAM: = $700(4.9676) + $100(14.4715) + $100(0.8929) = $5,014

P?

PA ?

1 2 3 4

N=8 1 2 3 4

N=8

0 $700 PF ?

0

N=1

$700

$100 $100 $200 PG ? 0

$300 $700 $100

1 2 3 4

N=8

0

NOTE: CAN SEPARATE INTO 3 CASH FLOWS: $100 $200

ANNUAL, LINEAR GRADIENT, AND FUTURE $300 $700

GIVEN:

Problem 1 – Alt Soln 2

MAINT COST1-8 PER DIAGRAM

i = 12%/YR, CPD ANNUALLY

FIND P: P = PA + PG(PPG) = A(P|A,i,N) + G(P|G,i,N-1)(P|F,i,1)

= $800(P|A,12%,8) + $100(P|G,12%,7)(P|F,12%,1)

DIAGRAM: = $800(4.9676) + $100(11.6443)(0.8929) = $5,014

P? PA ?

1 2 3 4 1 2 3 4

N=8 N=8

0 0

$800 $800

$100 $200 PPG ? PG ?

0 1 2 3

$600 N=7

0 1

NOTE: PG MUST BE OFFSET ONE YEAR – SO PG ? $100 $200

BRING THE OFFSET YEAR BACK TO TIME ZERO $600

S.V. Atre 13

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

Problem 2

A young couple has decided to make advance plans for

financing their 3 year old daughter’s college education.

Money can be deposited at 8% per year, compounded

annually.

What annual deposit on each birthday, from the 4th to the

17th (inclusive), must be made to provide $7,000 on each

birthday from the 18th to the 21st (inclusive)?

DIAGRAM: GIVEN:

$7,000

WITHDRAWALS18-21 = $7 000

4 17 i = r = 8%/YR, CPD YEARLY

FIND A4-17:

0 18 21 yrs

P17 = A(P|A,i,N) = A(F|A,i,N)

A?

= 7 000(P|A,8%,4) = A(F|A,8%,14)

STRATEGY: CAN BREAK INTO 2 CASH FLOWS,

SO PICK A CONVENIENT POINT IN TIME AND SET = 7 000(3.3121) = A(24.2149)

DEPOSITS EQUAL TO WITHDRAWALS…

A = $957

Problem 3

Anita Plass-Tuwurk, who owns an engineering consulting

firm, bought an old house to use as her business office. She

found that the ceiling was poorly insulated and that the heat

loss could be cut significantly if 6 inches of foam insulation

were installed. She estimated that with the insulation she

could cut the heating bill by $40 per month and the air

conditioning cost by $25 per month. Assuming that the

summer season is 3 months (June, July, August) of the year

and the winter season is another 3 months (December,

January, and February) of the year, how much can she

spend on insulation if she expects to keep the property for 5

years? Assume that neither heating nor air conditioning

would be required during the fall and spring seasons. She is

making this decision in April about whether to install the

insulation in May. If the insulation is installed, it will be paid

for at the end of May. Anita’s interest rate is 9%,

compounded monthly.

S.V. Atre 14

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

GIVEN:

Problem 3

SAVINGS = $40/MO(DEC,JAN, FEB); $25/MO (JUN, JUL, AUG)

r = 9%/YR, CPD MONTHLY

FIND P(SAVINGS OVER 5 YEARS):

1ST YR DIAGRAM: 5 YR DIAGRAM:

$40 PA

$25

0

0

1 2 3 4 5 6 7 8 9 10 11 12 MO 1 2 3 4 5 YRS

PA ? α β P?

i = r = 0.09 = 0.75% / MO

M 12

= $25(P|A,0.75%,3) + $40(P|A,0.75%,3)(P|F,0.75%,6)

= $25(2.9556) + $40(2.9556)(0.9562) = $186.94

GIVEN:

Problem 3

SAVINGS = $40/MO(DEC,JAN, FEB); $25/MO (JUN, JUL, AUG)

r = 9%/YR, CPD MONTHLY

FIND P(SAVINGS OVER 5 YEARS):

5 YR DIAGRAM: $186.94 $186.94

$186.94 +

= 0 0

1 2 3 4 5 YRS 1 2 3 4 5 YRS

0

1 2 3 4 5 YRS P0 ? PA ?

P? P = P0 + PA = A + A(P | A, i,N)

C = 12 K =1

C ⎡ (1 + i)N − 1⎤

⎛ r ⎞ = A + A⎢ N ⎥

i = ⎜1 + ⎟ −1

⎝ CK ⎠ ⎣ i(1 + i) ⎦

12 = $186.94 + $186.94(P | A,9.38%,4)

⎛ 0.09 ⎞

= ⎜1 + ⎟ −1 ⎡ (1 + 0.0938 )4 − 1 ⎤

⎝ 12(1) ⎠ = $186.94 + $186.94 ⎢ 4⎥

= 9.38% ⎣ 0.0938(1 + 0.0938 ) ⎦

= $186.94 + $186.94[3.21288 ] = $787.56

S.V. Atre 15

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

Annual fees

Annual

percentage rate

Grace period

Minimum

payment

Finance charge

Method Description Interest You Owe

Adjusted The bank subtracts the amount of Your beginning balance is $3,000.

Balance your payment from the beginning With the $1,000 payment, your

balance and charges you interest on new balance will be $2,000. You

the remainder. This method costs pay 1.5% on this new balance,

you the least. which will be $30.

Average The bank charges you interest on the Your beginning balance is $3,000.

Daily average of the amount you owe each With your $1,000 payment at the

Balance day during the period. So the larger 15th day, your balance will be

the payment you make, the lower the reduced to $2,000. Therefore,

interest you pay. your average balance will be

(1.5%)($3,000+$2,000)/2=$37.50.

Previous The bank does not subtract any Regardless of your payment size,

Balance payments you make from your the bank will charge 1.5% on your

previous balance. You pay interest beginning balance $3,000:

on the total amount you owe at the (1.5%)($3,000)=$45.

beginning of the period. This method

costs you the most.

S.V. Atre 16

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

Option 1 Option 2

Debt Financing Lease Financing

Price $14,695 $14,695

Down payment $2,000 0

APR (%) 3.6%

Monthly payment $372.55 $236.45

Length 36 months 36 months

Fees $495

Cash due at lease end $300

Purchase option at lease end $8.673.10

Cash due at signing $2,000 $731.45

S.V. Atre 17

ENGR 390 Lecture 5: Understanding Money Winter 2007

& Its Management - 2

Debt Financing:

Pdebt = $2,000 + $372.55(P/A, 0.5%, 36)

- $8,673.10(P/F, 0.5%, 36)

= $6,998.47

Lease Financing:

Please = $495 + $236.45 + $236.45(P/A, 0.5%, 35)

+ $300(P/F, 0.5%, 36)

= $8,556.90

Summary

rate based on an APR.

In all financial analysis, we need to

convert the APR into an appropriate

effective interest rate based on a

payment period.

When payment period and interest

period differ, calculate an effective

interest rate that covers the payment

period.

S.V. Atre 18

- Chapter 6_Accounting and Time Values MoneyUploaded byJamie
- Blankchapter_1Uploaded byPiawai Said Umbara
- 08-22-2011Uploaded byChadd Thompson
- add mathUploaded byChew Hong Lui
- Test Bank - TVM1Uploaded byapple
- Time Value of money Test BanksUploaded byDebbie Cervancia Dimapilis
- 11-10-2015.pdfUploaded bySydney Freedberg
- Grant Thornton Report_Local Government a Financial SnapshotUploaded byNew Zealand Taxpayers' Union
- Test Bank - TVM1Uploaded byEvan Hochman
- Aptitude QuestionsUploaded byRam Keserwani
- 10-07-2013.pdfUploaded bynates280
- CCP402Uploaded byapi-3849444
- Chapter 4.pdfUploaded byYasin Selçuk
- interest.pdfUploaded byPrashant Shukla
- Test Bank - TVM1Uploaded byphitchow
- The Reality of International FinanceUploaded byGerard VI
- 10Uploaded bycristine jagodilla
- RAS Cash LedgerUploaded byLouise Battung
- Chambers's Edinburgh Journal, No. 421 Volume 17, New Series, January 24, 1852 by VariousUploaded byGutenberg.org
- Brazil’s Enormous Interest Rate Tax: Can Brazilians Afford It?Uploaded byCenter for Economic and Policy Research
- The Concept of Mutuum Legal Provisions and CasesUploaded byGerard Tinampay
- FMI10eAbr_ch21Uploaded byNajmul Joy
- Pag-IBIG's State of the Fund AddressUploaded byOVP Media
- Earnings Highlight - Guaranty Trust Bank Plc Fy 2018Uploaded byLaw
- 6_Interest on Securities_AY 2015-16Uploaded byrohanfyaz00
- BANSC-RE-2010-187-Exhibits For Defendants Motion to Disqaulify Opposing CounselUploaded byCharlton Butler
- Obligations and Contracts - Midterm ExamUploaded byedgezy07
- MF_financialmanagment.docUploaded byGovindaGowda
- Notice: Investment Company Act of 1940: Opal Private Equity Fund, L.P., et al.Uploaded byJustia.com
- exh99_1Uploaded byAnonymous Feglbx5

- Lecture 11Uploaded byRyan Aman
- Lecture 13Uploaded byRyan Aman
- Lecture 4Uploaded byRyan Aman
- Exam1 - SolutionsUploaded byRyan Aman
- Lecture 7Uploaded byRyan Aman
- Lecture 2Uploaded byRyan Aman
- Lecture 1Uploaded byRyan Aman
- Lecture 12Uploaded byRyan Aman
- HW3Uploaded byRyan Aman
- HW6Uploaded byRyan Aman
- HW2Uploaded byRyan Aman
- HW4Uploaded byRyan Aman
- Lecture 10Uploaded byRyan Aman
- HW1Uploaded byRyan Aman
- HW5Uploaded byRyan Aman

- Banking-Awareness.pdfUploaded bynilraj89
- Lavanya Ppt MmUploaded byNaga Muthu
- Pocetni kurs EngleskiUploaded byCaribi Caffe
- R52-Fixed-Income-Markets-Issuance-Trading-and-Funding.pdfUploaded byDiego
- 15_01 Swiss National Bank - Negative Interest RatesUploaded bynbilic
- Citibank India_04-10-2017.pdfUploaded bysgpl
- Theories of Money and InterestUploaded byraj kiran
- Financial Crisis - Super Return 20081015Uploaded byShah Jamal
- Goldman Sachs' Heavily Redacted "Confidential" Application to the FRB to Acquire GE Capital Bank DepositsUploaded byMatthew Russell Lee
- Pine Labs Q2 ManualUploaded byAli Warsi
- webdiscoveryanddisclosurefixedfortherecord3vUploaded byYaw Mensah Amun Ra
- The Subprime Trump CardUploaded bydaeonline
- ChequesUploaded byWendy Phua
- 2016 Sante Fe Registration FormUploaded byindiamahesh
- Zeenat FinalUploaded byAtta Ur Rehman
- Example LocUploaded byGraha Teknologi Mandiri
- HDFC Mutual Fund Common Application FormUploaded bydrashti.investments1614
- Balance Interest CalculationUploaded byskl1
- Assignment Prepared by s.a.awaUploaded byQasim Hotiana
- MORGAN STANLEY LETTER TO NEW CENTURY CAPITAL CORPORATION PURCHASE AGREEMENT TO BUY MORTGAGE LOANSUploaded by83jjmack
- 518 Hand-outs 3-Income CollectionUploaded byRALLISON
- I am an attorney so I decided to sue my lender...Uploaded byForeclosure Fraud
- Statements09012812379030 (2)Uploaded byGLEN DAVEY
- International Trade FinanceUploaded bymesba_17
- Auto Receipt in R12Uploaded byRajasekhar Reddy Adam
- Corporate FX Trade Desk OperationsUploaded byfernandesroshandaniel4962
- Basics of BankingUploaded bypallavimorya
- The ECB and the Hidden Cost of Saving the EuroUploaded bymapsinger
- Uma ReportUploaded bySunny Arora
- Role Of Commercial Banks In The Economic Development Of Pakistan.docxUploaded byasmi