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To find future value CVF

To find present value PVF

To find future value if given

annuity CVAF

To find present value if

given annuity PVAF

To find annuity if given present

value (Capital Recovery)
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Engineering Economy MGTS 301

Chapter-4
Time value of money
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Today’s class

Deferred Annuities

Uniform (Arithmetic) Gradient C/F

Nominal & Effective Interest Rates

Interest Formula for Continuous compounding

&Discrete C/F

3
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Deferred Annuities
A Deferred Annuity is a type of annuity contract that delays
income, installment or lump-sum payments until the investor
elects to receive them.
A Deferred annuity is an insurance contract designed for
long-term savings. Unlike an immediate annuity, which starts
annual or monthly payments almost immediately, investors
can delay payments from a deferred annuity indefinitely.
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9. Pause and solve

10 years from now Mr. X will start receiving a
pension of $ 3000 a year for 16 years. How much
the pension worth now if interest rate is 10%.
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10. Pause and solve

Suppose that a father, on the day of his son is born, wishes to

determine what lump amount would have to be paid into an
account bearing interest of 12% per year to provide withdrawals
of $2000 on each of the son’s 18th, 19th, 20th, and 21st birthdays.
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11. Pause and solve

When you take your first job, you decide to start saving right away for
your retirement. You put $5000 per year in the company’s 401 (k) plan
which average interest 8% per year. Five year later, you moved to
another job and start a new 401 (k) plan. You never get around to
merging the funds in the two plans. If the first plan continued to earn
interest @8% per year for 35 years after you stopped making
contribution. How much is the account worth?
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Sometimes cash flows change by a constant amount each period.

We can model these situations as a uniform gradient of
cash flows. The table below shows such a gradient.

End of Period Cash Flows

1 0
2 G
3 2G
: :
N (N-1)G
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It is easy to find the present value of a uniform gradient

series.
Similar to the other types of cash flows, there is a formula
(albeit quite complicated) we can use to find the present value,
and a set of factors developed for interest tables.
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We can also find A or F equivalent to a uniform gradient

series.
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The annual equivalent of End of Year Cash Flows ($)

this series of cash flows can 1 2,000
be found by considering an
2 3,000
annuity portion of the cash
flows and a gradient 3 4,000
portion. 4 5,000

End of Year Annuity ($) Gradient ($)

1 2,000 0
2 2,000 1,000
3 2,000 2,000
4 2,000 3,000
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Sometimes cash flows change by

a constant rate, ,each period--this
is a geometric gradient series.

This table presents a

End of Year Cash Flows ($)
geometric gradient series. It
begins at the end of year 1 1 1,000
and has a rate of growth, , 2 1,200
of 20%. 3 1,440
4 1,728
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We can find the present value of a geometric

series by using the appropriate formula
below.

Where is the initial cash flow in the series.

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Present Equivalent of an Increasing Arithmetic Gradient Series

As further example of the use of arithmetic gradient formulas, suppose that
we have cash flows as follows:

End of Year Cash Flows ($)

1 5,000
2 6,000
3 7,000
4 8,000
Also, assume that we wish to calculate their present equivalent at i = 15%
per year, using gradient conversion factors.
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Present Equivalent of a Decreasing Arithmetic Gradient Series

As further example of the use of arithmetic gradient formulas, suppose that
we have cash flows as follows:

End of Year Cash Flows ($)

1 8,000
2 7,000
3 6,000
4 5,000
Also, assume that we wish to calculate their present equivalent at i = 15%
per year, using gradient conversion factors.
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Nominal and Effective Interest Rates

In finance and economics, The effective annual interest rate is
the nominal interest rate or the interest rate that is actually
nominal rate of interest is earned or paid on an investment, loan
either of two distinct or other financial product due to the
things: the rate of interest result of compounding over a given
before adjustment for time period. It is also called
inflation; or, for interest the effective interest rate,
rates "as stated" without the effective rate or the annual
adjustment for the full equivalent rate.
effect of compounding.
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Nominal and effective interest rates.

• More often than not, the time between successive compounding, or
the interest period, is less than one year (e.g., daily, monthly,
quarterly).
• The annual rate is known as a nominal rate.
• A nominal rate of 12%, compounded monthly, means an interest of
1% (12%/12) would accrue each month, and the annual rate would be
effectively somewhat greater than 12%.
• The more frequent the compounding the greater the effective interest.
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Rs. 10000 (1+0.1)1 = Rs. 11000

Rs. 10,000 (1+0.1/2)2= Rs, 11,025

Rs. 10,000 (1+0.1/4)4= Rs. 11,038.13
Rs. 10000 (1+0.1/12)12= 11,047.13

= (1+ 0.1/2)2 – 1

= 10.25%
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Interest can be compounded continuously.

• Interest is typically compounded at the end of discrete
periods.
• In most companies cash is always flowing, and should be
immediately put to use.
• We can allow compounding to occur continuously
throughout the period.
• The effect of this compared to discrete compounding is
small in most cases.
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We can use the effective interest

formula to derive the interest
factors.

As the number of compounding periods gets larger (M gets

larger), we find that
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Continuous Compounding and Single Amounts

You have $10,000 to invest for two years. Your bank offers 5% interest,
compounded continuously for funds in a money market account.
Assuming no additional deposits or withdrawals, how much money will
be in that account at the end of two years?

F = $10,000 (F/P, r=5%, 2 yrs) = $10,000 e (0.05)(2) = $10,000 (1.1052) = $11,052

Comment
If the interest rate was 5% compounded annually, the account would have been
worth

F = $10,000 (F/P, 5%, 2 yrs) = $10,000 (1.1025) = $11,025

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Calculation of Interest and Annuity for Discrete Compounding by using Calculator

PVF 1 . 0 7 ➗ = = = = =
Y1 Y2 Y3 Y4 Yn
PVAF 1 . 0 7 ➗ = = = = = GT
Y1 Y2 Y3 Y4 Yn
CVF 1 . 0 7 ✖️ = = = = =
Y2 Y3 Y4 Yn

CVAF 1 . 0 7 ✖️ = = = = =
Y3 Y4 Y5 Y6 GT + 2 . 0 7 Y7