Scribd Logo
Upload

Welcome to Scribd!

  • 40 views

    Exercise 3 - Solution

    Uploaded by

    韩思嘉
    This document provides the solutions to several engineering economics practice problems involving present value calculations with different interest rates and compounding periods. It finds the effective interest rates to use for each scenario and calculates payment amounts, balances, and breakdowns of principal and interest. Key conclusions are that the appropriate effective interest rate to use depends on the nominal rate, compounding frequency, and cash flow frequency.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd

    Exercise 3 - Solution

    Uploaded by

    韩思嘉
    40 views3 pages
    This document provides the solutions to several engineering economics practice problems involving present value calculations with different interest rates and compounding periods. It finds the effective interest rates to use for each scenario and calculates payment amounts, balances, and breakdowns of principal and interest. Key conclusions are that the appropriate effective interest rate to use depends on the nominal rate, compounding frequency, and cash flow frequency.

    Original Title

    Exercise 3 - solution

    Copyright

    © © All Rights Reserved

    Available Formats

    PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    This document provides the solutions to several engineering economics practice problems involving present value calculations with different interest rates and compounding periods. It finds the effective interest rates to use for each scenario and calculates payment amounts, balances, and breakdowns of principal and interest. Key conclusions are that the appropriate effective interest rate to use depends on the nominal rate, compounding frequency, and cash flow frequency.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    40 views3 pages

    Exercise 3 - Solution

    Uploaded by

    韩思嘉
    This document provides the solutions to several engineering economics practice problems involving present value calculations with different interest rates and compounding periods. It finds the effective interest rates to use for each scenario and calculates payment amounts, balances, and breakdowns of principal and interest. Key conclusions are that the appropriate effective interest rate to use depends on the nominal rate, compounding frequency, and cash flow frequency.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    You are on page 1of 3

    SEEM2440: Engineering Economics

    Exercise 3 Solution

    1. Solve the following questions:


    a) When 1) nominal annual interest rate r, 2) monthly compounding, and 3) semi-annual cash flows
    are given, which rate should we find to calculate the present value of the cash flows and how can
    we derive the rate?
    b) When 1) nominal annual interest rate r, 2) semi-annual compounding, and 3) monthly cash flows
    are given, which rate should we find to calculate the present value of the cash flows and how can
    we derive the rate?
    c) When 1) nominal monthly interest rate r, 2) continuously compounding, and 3) annual cash
    flows are given, which rate should we find to calculate the present value of the cash flows and
    how can we derive the rate?
    Solution:
    a) We should find the effective semi-annual interest rate is . Since the effective annual rate iy is
    iy = (1 + r/12)12 − 1,
    6
    r
    
    1/2
    is = (1 + iy ) −1= 1+ −1
    12
    b) We should find the effective monthly interest rate im . Since the effective annual rate iy is iy =
    (1 + r/2)2 − 1,
    r 1/6
     
    1/12
    im = (1 + iy ) −1= 1+ −1
    2
    c) We should find the effective annual interest rate iy . Since the effective monthly rate im is im =
    er − 1,
    iy = (1 + im )12 − 1 = e12r − 1

    Remark: One conclusion that can be drawn from the above questions is as follows: When
    • r s the nominal interest rate per period,
    • M is the compounding frequency per period, and
    • k is the cash-flow frequency per period,
    we should find the following effective interest rate i to discount cash flows:
    i = (1 + r/M )M/k − 1
    since the effective interest rate per period is (1 + i)k − 1 = (1 + r/M )M − 1.

    1
    2. A person needs $18,000 immediately as a down payment on a new home. Suppose that she can borrow
    this money from her company credit union. She will be required to repay the loan in equal payments
    made semi-annually over the next 12 years. The annual interest rate being charged is 10% compounded
    continuously. What is the amount of each payment?
    Solution: Since r = 10% and M = 2, the effective semi-annual interest rate is
    i = e10%/2 − 1 ≈ 5.127%.
    The down payment $18,000 should be the same with the present value of the payments for the whole
    period. Thus,
    1 1 1 1 − (1 + i)−24
     
    $18, 000 = A + 2
    + ··· + =A .
    1 + i (1 + i) (1 + i)24 i
    Then,
    $18, 000i
    A= ≈ $1, 320.6.
    1 − (1 + i)−24

    3. You plan to borrow a loan of $120,000 and find two options. Bank A offers a 5-year constant amor-
    tization mortgage which requires monthly payments with annual interest rate of 5% compounded
    continuously. Bank B offers a 3-year constant payment mortgage which requires monthly payments
    with annual interest rate of 3% compounded monthly.
    Assume that you choose Bank A’s loan.
    a) What is the effective monthly interest rate?
    b) What is the final balance at the end of the 7th month?
    c) What are the principal payment and the interest payment at the end of the 8th month?
    Assume that you choose Bank B’s loan.
    d) (10pt) What is the amount of the payment at the end of the 8th month?
    e) (10pt) What is the final balance at the end of the 8th month?
    f) (10pt) What are the principal payment and the interest payment at the end of the 9th month?
    Solution:
    • Bank A’s loan: P = $120, 000, r = 5%, N = 60, conti. comp., CAM
    a) What is the effective monthly interest rate?
    i = er/12 − 1 = e5%/12 − 1 ≈ 0.4175%.
    b) What is the final balance at the end of the 7th month?
    60 − 7
    B7 = P = $106, 000.
    60
    c) What are the principal payment and the interest payment at the end of the 8th month?
    P8 = P/N = $120, 000/60 = $2, 000.
     
    I8 = iB7 = e5%/12 − 1 ($106, 000) ≈ $442.6.

    2
    • Bank B’s loan: P = $120, 000, r = 3%, N = 36, monthly comp., CPM
    d) (10pt) What is the amount of the payment at the end of the 8th month?
    Monthly interest rate i = r/12 = 3%/12 = 0.25%. Because it is a CPM, the payment is
    constant over time. We have
    A 1 − (1 + i)−36
    
    1 1 1
     
    P =A + 2
    + ··· + = .
    1 + i (1 + i) (1 + i)36 i

    Thus,
    iP
    A= ≈ $3, 489.75.
    1 − (1 + i)−36
    e) (10pt) What is the final balance at the end of the 8th month?

    A (1 + i)8 − 1
      
    8 7 8
    B8 = P (1+i) −A (1 + i) + · · · + (1 + i) + 1 = P (1+i) − ≈ $94, 257.6.
    i

    Bank B’s loan: P = $120, 000, r = 3%, N = 36, monthly comp., CPM
    f) (10pt) What are the principal payment and the interest payment at the end of the 9th month?

    I9 = iB8 = 0.25% × $94, 257.6 ≈ $235.64.

    P9 = A − I9 ≈ $3, 489.75 − $235.64 = $3, 254.11.

    You might also like