G6 L2.2. Concept Equivalence L2.3. Cash Flows

Engineering
E C ONOM I C S
Group 6 - BSME 3-1
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Economic Equivalence
Economic equivalence is a combination of
interest rate and time value of money to
determine the different amounts of money
at different points in time that are equal in
economic value.
Example:
If the interest rate is 6% per year, $100
today (present time) is equivalent to $106
one year from today.
Amount accrued = 100 + 100(0.06) = 100(1 +

0.06) = $106
Interest
Interest is defined as the cost of
borrowing money as in the case of
interest charged on a loan balance.
Conversely, interest can also be the rate
paid for money on deposit as in the case
of a certificate of deposit. Interest can
be calculated in two ways, simple
interest or compound interest.
Simple Interest
Is calculated on the principal, or original,
amount of a loan.
SAMPLE PROBLEM
FORMULA 1. Robert purchased a car worth 480,000, he
The formula for calculating simple borrowed the money from the bank at 10% per
annum for a period of 4 years. How much amount he
interest is:
has to pay after the period.
Simple interest=P×R×T
2. Michael's father had borrowed 10,000 from the
where: bank and the rate of interest was 5%. What would
P= Principal the simple interest be if the amount is borrowed for
R= Interest rate 1 year? Similarly, calculate the simple interest if
T= Time period the amount is borrowed for 2 years, 3 years, and 10
years?
Compound Interest
is calculated on the principal amount and also on the accumulated
interest of previous periods, and can thus be regarded as "interest
on interest."
FORMULA EXAMPLE
The formula for calculating compound Continuing with the simple interest
interest in a year is:
example, what would be the amount
Compound interest=[P(1+i) n]−P
Compound interest=P[(1+i) n −1] of interest if it is
where: charged on a compound basis? In this
P=Principle case, it would be:
i=interest rate in percentage terms $10,000 [(1 + 0.05)3 – 1] = $10,000
n=number of compounding periods for a year
[1.157625 – 1] = $1,576.25.
Compound Interest
Compounding
Periods
Sample Problem
David invested $5000 in a savings account that

offers an annual interest rate of 6%,
compounded quarterly. How much money will
David have after 3 years?
When calculating compound interest, the number of compounding
periods makes a significant difference. Generally, the higher the
number of compounding periods, the greater the amount of
compound interest. So for every $100 of a loan over a certain
period, the amount of interest accrued at 10% annually will be
lower than the interest accrued at 5% semi-annually, which will,
in turn, be lower than the interest accrued at 2.5% quarterly.
In the formula for calculating compound interest, the variables "i"

and "n" have to be adjusted if the number of compounding periods
is more than once a year. That is, within the parentheses, "i" or
interest rate has to be divided by "n," the number of compounding
periods per year. Outside of the parentheses, "n" has to be
multiplied by "t," the total length of the investment.
Therefore, for a 10-year loan at 10%, where interest is
compounded semi-annually (number of compounding periods
= 2), i = 5% (i.e., 10% / 2) and n = 20 (i.e., 10 x 2).
To calculate total value with compound interest, you would

use this equation:
Total value with compound interest=[P( n1+i ) nt ]−P
Compound interest=P[( n1+i ) nt −1]
where:
P=Principle
i=interest rate in percentage terms
n=number of compounding periods per year
t=total number of years for the investment or loan
Types of
Cash Flow
Cash Flow
• refers to the
movement of money
into and out of a
business or project
over a specific period
of time.
1. Uniform Series
A uniform series represents
cash flows that remain
constant over time. It's a series
of equal payments or receipts
that occur at regular intervals.
This could be monthly,
quarterly, annually, etc.
FORMULA
Where:
•P=Principal Amount
•A=Monthly installment
•r=interest rate per period
•n=number of periods
Example
Peter borrow Php 10,000 from a friend, and agree to pay it
back in equal installments every month for 5 months, with
an interest rate of 5% per month.
Given:
P = Principal amount (Php 10,000)
A = Monthly installment (what we're trying to find)
r = Interest rate per period (5% per month expressed as
0.05)
n = Number of periods (5 months)
2. Linear Gradient Series
Linear gradient series
represent cash flows that
increase or decrease by a
constant amount over time. It's
a series where the cash flow
changes by a fixed amount
each period.
Formulas
Example
A textile mill has just purchased a lift truck that has a useful
life of 5 years. The engineer estimates that maintenance
costs for the truck during the first year will be 1000 USD. As
the truck ages maintenance cost are expected to increase at
a rate of 250 USD per year over the remaining life. Assume
that the maintenance cost occur at the end of each year. The
firm wants to set up a maintenance account that earns 12%
annual interest. All fture maintenance expenses will be paid
out of this account. How much does the firm have to deposit
in the account now?
3. Geometric Gradient Series
Geometric gradient series
represent cash flows that grow
or decline at a constant rate
over time. It's a series where
the cash flow changes by a
constant percentage each
period.
Geometric gradient series present worth
Geometric series present worth,
where i ≠ g
Where:
P = present worth
A= base amount
g = growth rate
Geometric series present worth,.
i = interest rate
where i = g
n = time period
Example
A contractor is trying to calculate the present worth of
personnel salaries over the next ten years. He has five
employees whose combined salaries thru the end of this
year are 1,000,000 pesos. If he expects to give each
employee a raise of 6% each year, the present worth of his
employees’ salaries at an interest of 12% per year is nearest
to?
Thank you!
References
https://www.slideserve.com/bronwen/conversion-for-arithmetic-gradient-series-conversion-for-geometric-
gradient-series-quiz-review-project-reviewt
https://openpress.usask.ca/engecon/chapter/3-4-equations-of-economic-equivalence/?
fbclid=IwAR1Uqm2lXd9NrkE41ZyGKi4hVa_M_J_xVWvzgMNkI9zjl4et0iPFikpLJZA#:~:text=The%20geom
etric%20gradient%20series%20is,geometric%20gradient%2C%20denoted%20by%20g
https://en.wikipedia.org/wiki/Cash_flow
https://openpress.usask.ca/engecon/chapter/3-4-equations-of-economic-equivalence/
https://www.thebalancemoney.com/simple-interest-overview-and-calculations-315578

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Engineering

Amount accrued = 100 + 100(0.06) = 100(1 +

David invested $5000 in a savings account that

In the formula for calculating compound interest, the variables "i"

To calculate total value with compound interest, you would

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