Compound Interest

:Compound interest factors

Based on the concept of time value of money and bound to the mechanism of
compound interest, it is often required to interrelate some of the following quantities:
P is the value or sum of money at a time denoted as the present.
F is the value or sum of money at a future time.
A is the series of consecutive, equal, end-of-period amounts of money.
n is the number of interest periods.
i is the interest rate.
The transformation multipliers (or time-value conversions) are called the Compound
Interest Factors" or the Engineering Economy Factors".
 Compound Interest Factors
Discrete Cash Flow, Discrete Compounding

To Find

A
Given

F
Name of Factor
Compound Amount
Factor (single payment)
Present Worth Factor
(single payment)

Compound Amount
Factor (uniform series)

Sinking Fund Factor

1
((1ii)nn)
Factor

3
n1
Compound Interest Factors
Discrete Cash Flow, Discrete Compounding

To Find

P
Given

G
Name of Factor

Capital Recovery Factor

Present Worth Factor

(uniform series)
Arithmetic Gradient
Conversion Factor (to
uniform series)
Arithmetic Gradient
Conversion Factor (to
present value)
i(
(1
1
Factor

)[i)nn
n1
(21
n]i)n
n
4
Factor name

PA///FPFPAA
,,i%
Table 1. Standard factor notations

Single-payment present worth (SPPWF)

Single-payment compound amount (SPCAF)

Uniform series present worth (USPWF)

Capital recovery (CRF)

Sinking fund (SFF)

Uniform series compound amount (USCAF)

,,ii%
Standard notation

n
%
n
n
%
 AP///PPFAF,,,iii%
Table 4.2: Computations using standard notation

To find

F
given

A
factor

%
%
n
formula

P
F

nnP
A
/AP
,F/F
PP
A,i%
n
A/FA,i%
i
%
n
,n
 F//P1,inn1in

SINGLE-PAYMENT COMPOUND
AMOUNT FACTOR (SPCAF)

F P
(S P C A F )
P = g ive n

0 1 2 3 4 n-2 n-1 n

F = ??

.This factor was implicitly derived previously

 Example 1

If you have $2000 now and invest it at 10%, how much will it be
?worth in 8 years
F = ??

i = 10 %

0 1 2 3 4 5 6 7 8

ye ars

2000
 Solution

Given: P = $2000, i = 10% per year, and n = 8 years

Find: F

Using a calculator: Use a calculator to evaluate the (1+i) n term

F = $2000 (1 + 0.10)8
$4287.18 =
Using a spreadsheet package as Excel, the future worth calculation could be
:determined from FV Function
FV returns the future value of an investment based on periodic, constant
.payments and a constant interest rate
Syntax
FV (rate, nper, pmt, pv, type)
 Example 2

The following sums are to be invested at 5 % interest rate:

6x105 m.u. now, 3x105 m.u. two years from now and 4x105
m.u. five years from now. How much will be accumulated ten
? years from now
 Solution

F =
??

i= 5 %

0 y e a rs

1 2 3 4 5 6 7 8 9 10

5
3 x1 0
5
m .u . 4 x10
5 m .u .
6 x 1 0 m .u .

F = P1 (F/P, 5, 10) + P2 (F/P, 5, 8) + P3 (F/P, 5, 5)

= 6 105 (1.05)10 + 3105 (1.05)8 + 4105
(1.05)5
= 1.9311106 m.u.
 P//F,1nin1in

SINGLE-PAYMENT PRESENT
WORTH FACTOR (SPPWF)

P
F/
(SPPW F)
P= ??

0 1 2 3 4 n-2 n- 1 n

F = given
 Example 3

Suppose that $1000 is to be received after 5 years. At an

annual interest rate of 12%,
What is the present worth of this amount?
 Solution
1 0 0 0 L .E .

i = 12 %

0 1 2 3 4 5

y e a rs

P = ??

:This example could be solved by one of three ways

Using a calculator (Mathematical Formulas)-1

P = 1000 (1 + 0.12)-5 = 1000 (0.5674) = $567.40
In order To have L.E.1000 in your savings account at the end of 5 years,
.you must deposit $567.40 now
 P
=
1,0(P
/F
,12%
,5)=
L
.E
567.40
Using interest tables. 2

%Interest Table For Discrete Compounding; i = 12

(
0.
56
74
)
Compound Present Compound Present
Periods Amount Worth Amount Worth
Factor Factor Factor Factor

n F/P P/F F/A P/A

4 1.5735 0.6355 4.7793 3.0373
5 1.7623 0.5674 6.3528 3.6048
6 1.9738 0.5066 8.1152 4.1114

Note: this method might be obsolete as it requires lots of data tables. These tables are
formed using the simple formulae developed here in this lecture
 UNIFORM-SERIES COMPOUND-
AMOUNT FACTOR (USCAF)
(U S C A F )
F= ??

0 1 2 3 4 n-2 n-1 n

A = g iv e n

A series of equal installments paid at the ends of consecutive interest periods

.will accumulate to a certain future value after n periods
M
F
g
A
ui1ltipyFng1bAyin
1 iiii 1FAi

nnn
123 iiiii
nnnF1A,in11
1 1211
1in1
1

The future compound amount is the summation of the right-hand column.
Thus,

Subtractin
 Example 5

Suppose you make 15 equal annual deposits of $1000 each into a

bank account paying 5% interest per year. The first deposit will be
made one year from today. How much money can be withdrawn
from this bank account immediately after the 15th deposit?
 Solution:

The value of A is $1000, n = 15 years, and i = 5% per year. Immediately

after the 15th payment, the future equivalent amount is.
F = l000 (F/A, 5%, 15) = 1000 (1.0515 1) / 0.05
= 1000 (21.5786)
= $21578.60
0 1
A
2

F
FAiF,i1nn1in1
3
i
SINKING FUND FACTOR (SFF)

(S S F )

A = ??
n-2 n-1
F = g iv e n

n
 Example

An enterprising student is planning to have personal savings

totaling $1000000 when she retires at age 65. She is now 20 years
old. If the annual interest rate will average 7% over the next 45
years on her savings account, what equal end-of-year amount must
she save to accomplish her goal?
 Solution

The future amount, F, is $1000000. The equal annual amount this student
must place in a sinking fund that grows to $1000000 in 45 years at 7%
annual interest

A = 1000000 (A/ F, 7%, 45)

A= 1000000 (0.07/((1+0.07)45 1))
A= 1000000(0.0035) = $3500
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