CHAPTER 2

Time Value of Money

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3. Linear gradient series: A series of flows increasing or decreasing by a fixed

amount at regular intervals. Excel is one of the most convenient tools to

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solve this type of cash flow series.
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4. Geometric gradient series: A series of flows increasing or decreasing by a
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fixed percentage at regular intervals. Once again, this type of cash flow series is a good candidate for solution by Excel.
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5. Uneven series: A series of flows exhibiting no overall pattern. However,
patterns might be detected for portions of the series.
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Cash flow patterns are significant because thev allow us to develop interest
formulas, which streamline the solution of equivalence problems. Table 2.4
summarizes the important interest formulas that form the foundation for all
other analyses you will conduct in engineering economic analysis.

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Methods of Colculoting Interest
What is the amount of interest earned on $3,000
for five years at 9% simple interest per year?
You deposit $2,000 in a savings account that
earns 8% simple interest per year. How many
years will it take to double your balance? If
instead you deposit the $3,000 in another savings account that earns 7% interest compounded yearly, how many years will it take to
double your balance?

The Concept of Equivalence

Suppose you have the alternative of receiving either $8,000 at the end of five years or P dollars
today. Currently, you have no need for the
money, so you deposit the P dollars into a bank
account that pays 8% interest compounded annually. What value of P would make you indifferent in your choice between P dollars today and
the promise of $8,000 at the end of five years?

2.4 You are considering investing $1,000 at an

Suppose that, to cover some of your college expenses, you are obtaining a personal loan from
your uncle in the amount of $20,000 (now) to be
repaid in two years. If your uncle always earns
10% interest (compounded annually) on his
money invested in various sources, what minimum lump-sum payment two years front now
would make your uncle happy economically?

interest rate of 6% compounded annually for

five years or investing the $1,000 at 7% per
year simple interest for five years. Which
option is better?

Which of the following alternatives would you

rather receive, assuming an interest rate of 8%
compounded annually?

2.3 Compare the interest earned on $10,000 for 20

years at 7% simple interest with the amount of
interest earned if interest were compounded
annually.

You are about to borrow $3,000 from a bank at

an interest rate of 9% compounded annually.
You are required to make three equal annual
repayments in the amount of $1,185.16 per
year, with the first repayment occurring at the
end of year one. For each year, show the interest payment and principal payment.

Alternative 1: Receive $100 today:

Alternative 2: Receive $120 two years from now.
Single Payments (Use of F/P or P/F doctors)
What will be the amount accumulated by each
of the following present investments?

Problems
(a) $7,000 in 8 years at 9% compounded annually.
(b) $1,250 in 12 years at 4% compounded annuallv.
(c) $5,000 in 31 years at 7% compounded annually.
(d) $20.00fJ in 7 years at 6 % compounded annually.

2.10 What is the present worth of the following future payments?

(a) $4,500 6 years from now at 7% compounded annually.

(b) $6,000 15 years from now at 8% compounded annually.
(c) $20,000 5 years from now at 9% compounded annually.
(d) $12,000 8 years from now at 10% compounded annually.
Assuming an interest rate of 8% compounded
annually. answer the following questions:

(a) How much money can be loaned now if

$6,000 is to be repaid at the end of five years?
(b) How much money will be required in four
years in order to repay a $15.000 loan borrowed now?

2.12 How many years will it take an investment to

triple itself if the interest rate is 7% conpounded annually?

You bought 200 shares of Motorola stock at

$3,800 on Decembei 31. 2000. Your intention is
to keep the stock until it doubles in value. If
you expect 12% annual growth for Motorola
stock, how many years do you expect to hold
onto the stock? Compare vour answer with the
solution obtained by the Rule of 72 (discussed
in Example 2.7).

2.14 If you want to withdraw $35,000 at the end of

four years, how much should you deposit now
in an account that pays 9% interest compounded annually ? See the accompanying
cash flow diagram.

2.15 John and Susan just opened savings accounts

at two different banks. They each deposited
$1,000. Johns bank pays simple interest at an
annual rate of 10%, whereas Susans bank
pays compound interest at an annual rate of
9.5%. No interest will be taken out of the accounts for a period of three years. At the end
of three years, whose balance will be greater
and by how much (to the nearest dollar)?
Uneven-Payment Series

2. 1 6 If you desire to withdraw the following amounts

over the next five years from a savings account
that earns 6% interest compounded annually,
how much do you need to deposit now?
Year

Amount

$3,000
$3,500

$4,000
$6,000

2.17 If $1,000 is invested now, $1,500 two years

from now, and $2,000 four years from now at
an interest rate of 8% compounded annually,
what will be the total amount in 10 years?
2.18 A local newspaper headline blared, Bo Smith
Signs for $30 Million. The article revealed that,
on April 1, 2002, Bo Smith, the former recordbreaking running back from Football University, signed a $30 million package with the
Nebraska Lions. The terms of the contract were
$3 million immediately, $2.4 million per year for
the first five years (with the first payment after
one year), and $3 million per year for the next

70

CHAPTER 2

Time Value of Money

five years (with the first payment at the end of

year six). If the interest rate is 8% compounded annually, what is Bos contract worth at the
time of contract signing?

2.22 You are prepairing to buy a vacation home five

years front now. The home will cost
$80,000 at that time. You plan on saving three
deposits at an interest rate of 8 %:

How much invested now at an interest rate of

9% compounded annually would be just sufficient to provide three payments as follows: the
first payment in the amount of $3,000 occurring two years from now, the second payment
in the amount of $4,000 five years thereafter,
and the third payment in the amount of $5.000
seven years thereafter?

Deposit 1: Deposit $10,000 today.

Deposit 2: Deposit $12,000 two years from now'.
Deposit 3: Deposit $X three years from now.

2.20 You deposit $2000 today, $3000 one year from

now, and $5000 three years from now. How
much money will you have at the end of year
three if there are different annual compoundinterest rates per period according to the following diagram?

How much do you need to invest in year three

to ensure that you have the necessary funds
to buy the vacation home at the end of year
eight?

2.23 The accompanying diagram shows the anticipated cash dividends for Delta Electronics
over the next four years. John is interested in
buying some shares of this stock for a total of
$100 and will hold them for four years. If
Johns interest rate is known to be 8%
compounded annually, what would be the
desired (mini- mum) total selling price for the
set of shares at the end of the fourth year?

200

$9
Years

200?

A company borrowed $150,000 at an interest

rate of 9% compounded annually over six years.
The loan will be repaid in installments at the end
of each year according to the accompanying
repayment schedule. What will be the size of the
last payment (X) that will pay off the loan?

2004

2005

2006

Years

P $80

Equal-Payment Series

2.24 What is the future worth of a series of equal yearend deposits of $3,000 for 8 years in a savings
account that earns 7% annual compound interest if
What is the future worth of a series of equal for

Years

(a) all deposits are made at the end of each

year?
(b) all deposits are made at the beginning of
each year?
2.25 What is the future worth of the following series of payments?

$20.000

Problems
(a) $5,000 at the end of each year for six years
at 6% compounded annually.
(b) $9,000 at the end of each year for nine
years at 7.25 % compounded annually.
(c) $12,000 at the end of each year for 25
years at 8% compounded annually.
(d) $6,000 at the end of each year for 10 years
at 9.75% compounded annually.
What equal annual series of payments must be
paid into a sinking fund in order to accumulate
the following amounts?

(a) $15,000 in 13 years at 5% compounded

annually.
(b) $20,000 in eight years at 6 % compounded annually.
(c) $5,000 in 25 years at 8% compounded
annually.
(d) $4,000 in eight years at 6.85 % compounded
annually.
Part of the income that a machine generates is
put into a sinking fund to pay for replacement
of the machine when it wears out. If $3,000 is
deposited annually at 6 % interest compounded annually, how many years must the machine
be kept before a new machine costing $35,000
can be purchased?

(c) $8,000 in three years at 11% interest compounded annually.

(d) $25,000 in 20 years at 6 % interest compounded annually.

2.31 You have borrowed $20,000 at an interest

rate of 10% compounded annually. Equal
payments will be made over a three-year
period, with each payment made at the end of
the corresponding year. What is the amount of
the annual payment? What is the interest
payment for the second year?
2.32 What is the present worth of the following
series of payments?
(a) $5,000 at the end of each year for
years at 6% compounded annually.
(b) $7,000 at the end of each year for 10
at 9% compounded annually.
(c) $1,500 at the end of each year for six
at 7.25 % compounded annually.
(d) $9,000 at the end of each year for 30
at 8.75 % compounded annually.

eight
years
years
years

2.33 From the interest tables in Appendix B,

determine the value of the following factors by
interpolation, and compare the results with
those obtained from evaluating the A/P and
P/A interest formulas:

A no-load (commission-free) mutual fund has

grown at a rate of 7% compounded annually
since its beginning. If it is anticipated that it
will continue to grow at this rate, how much
must be invested every year so that $10,000
will be accumulated at the end of five years?

(a) The capital-recovery factor for 36 periods

at 6.25 % compound interest.
(b) The equal-payment-series present-worth
factor for 125 periods at 9.25 % compound
interest.

You open a bank account, making a deposit of

$500 now and deposits of $1000 every 2
years. What is the total balance at the end of 10
years from now if your deposits earn 10% interest compounded annually?

2.34 If $400 is deposited in a savings account

2.30 What equal-annual-payment series is required in

order to repay the following present amounts?
(a) $15,000 in five years at 8% interest compounded annually.
(b) $3,500 in four years at 9.5 % interest compounded annually.

at the beginning of each year for 15 years and

the account earns 9% interest compounded
annually. What will be the balance on the
account the end of the 15 years (F)?

Linear Gradient Series

2.35 Kim deposits her annual bonus into a savings

account that pays 8% interest compounded
annually. The size of the bonus increases by
$2,000 each year, and the initial bonus
amount is $5,000. Determine how much will

CHAPTER 2

Time Value of Money

be in the account immediately after the fifth

(c) C = $394.65.

deposit.

(d) C = $458.90.

2.36 Five annual deposits in the amounts of $1,200,

$1,000, $800, $600, and $400 are made into a
fund that pays interest at a rate of 9% compounded annually. Determine the amount in
the fund immediately after the fifth deposit.

End of
Period

Withdrawal

$1,000

800

Compute the value of P for the accompanying

cash flow diagram. Assume i = 8%
$350 $350

Deposit

600
400
4

200

6
$150 $150

6
7
Years

10

36

4C

10

SC

11

Geometric Gradient Series

What is the equal-payment series for 10 years

that is equivalent to a payment series starting
with $15,000 at the end of the first year and
decreasing by $3,000 each year over 10 years?
Interest is 9% compounded annually.

2.39 The maintenance expense on a machine is expected to be $1000 during the first year and to increase
$250 each year for the following seven
years. What present sum of money should be
set aside now to pay for the required maintenance expenses over the eight-year period?
(Assume 9% compound interest per year.)
2.40 Consider the cash flow series given in the accompanying table. Which of the following values of C makes the deposit series equivalent
to the withdrawal series at an interest rate of
12% compounded annually?
(a) C = $200.00.
(b) C $282.70.

2.41 Suppose that an oil well is expected to produce

300,000 barrels of oil during its first production year.
However, its subsequent production (yield) is expected
to decrease by 10% over the previous years
production. The oil well has a proven reserve of
3,000,000 barrels.
(a) Suppose that the price of oil is expected to
be $30 per barrel for the next several years.
What would be the present worth of the
anticipated revenue stream at an interest
rate of 12% compounded annually over
the next seven years?
(b) Suppose that the price of oil is expected to

start at $30 per barrel during the first year,

but to increase at the rate of 5 % over the
previous years price. What would be the
present worth of the anticipated revenue
stream at an interest rate of 12% compounded annually over the next seven
years?
Assume the conditions of part (b). After
three years of production, you decide to
sell the oil well. What would be the fair
price for the oil well?

Problems
(b) P

2.42 A city engineer has estimated the annual toll

revenues from a newly proposed highway construction over 20 years as follows:

i. 4) ( P / F, i, 7).

(d) P $ 100[(f'/ F, i, 4) + (P/F, i, 5)

A ( $2,000,000)( < ) (1.06)" ',

n = 1, 2, . . . , 20.
To determine the amount of debt financing
through bonds, the engineer was asked to
present the estimated total present value of
toll revenue at an interest rate of 6 %. Assuming annual compounding, find the present
value of the estimated toll revenue.

2.43 What is the amount of 10 equal annual deposits that can provide five annual withdrawals, where
a first withdrawal of $3,000 is made at the end of year
11 and subsequent withdrawals increase at the rate of
6 % per year over the previous years. if
(a) the interest rate is 8 O compounded annually?
(b) the interest rate is 6% compounded annually?
Equivalence Calculations

2.44 Find the present worth of the cash receipts in the

accompanying diagram if i = 10% compounded annually, with only four interest factors.

Years

2.46 Find the equivalent present worth of the cash

receipts in the accompanying diagram. Where
i = 10% compounded annually. In other words,
how much do you have to deposit now (with
the second deposit in the amount of
$200 at the end of the first year) so that you
will be able to withdraw $200 at the end of
second year, $120 at the end of third year. and
so forth, where the bank pays you 10% annual
interest on your balance?

Years

Years

2.45 In computing the equivalent present worth

of the following cash flow series at period
zero, which of the following expressions is
incorrect?
(a) P $100(P/S, i, 4)('/f, i, 4).

What value of A makes the two annual

cash flows shown in the accompanying diagram equivalent at 10% interest compounded annually?

74

CHAPTER 2

Time Value of Money

2.50 From the accompanying cash flow diagram.

find the value of C that will establish economic
equivalence between the deposit series and
the withdrawal series at an interest rate of 8%
compounded annually.

Years

$5,000 $5,000
2

Years

2.48 The two cash flow transactions shown in the

accompanying cash flow diagram are said to be
equivalent at 10% interest compounded annually. Find the unknown N value that satisfies
the equivalence.

$100

The following equation describes the conversion of a cash flow into an equivalent equalpayment series with N 10:

$100

Years

Given the equation, reconstruct the original

cash flow diagram.

Years

2.52 Consider the accompanying cash flow diagram. What value of C makes the inflow series
equivalent to the outflow series at an interest
rate of 12% compounded annually?

2.49 Solve for the present worth of the cash flow

shown in the accompanying diagram, using at
most three interest factors at 10% interest
compounded annually.

$1.200 $1,200 $1,200 $1.200

$b00

$60

$800

$800

$40

Years

2.53

Find the value of X so that the two cash

flows in the accompanying figure are
equivalent for an interest rate of 10%
compounded annually.

Problems
$400

$400
$200

Find the equivalent equal-payment series C,

using an W factor, such that the two accompanying cash flow diagrams are equivalent at
10% compounded annually.

Years

2s

$100

Years

2.54 What single amount at the end of five years is

equivalent to a uniform annual series of $5,000
per year for 5 years if the interest rate is 10%
compounded annually?

Years

On the day his baby was born. a father decided

to establish a savings account for his childs
college education. Any money that is put into
the account will earn an interest rate of 8%
compounded annually. The father will make a
series of annual deposits in equal amounts on
each of his childs birthdays from the 1st birthday through the 18th birthday. so that the child
can make four annual withdrawals front the
account in the amount of $20,000 on each of
his 18th. 19th. 20th, and 21st birthdays. Assuming that the first withdrawal will be made on
the childs lath birthday, which of the following statements are correct to calculate the required annual deposit A?

2.57 Consider the following cash flow:

Yeor End

Payment

$500
$1,000

(a) f = $1,000(f/ A, 12%. 5)

$500(f/P, 12%, 5).

(c) F [$500 + $ 1,000(PQS, 12%, 5)]

X (F/P, i2 %, 5).

2.58 Consider the cash flow series given in the

ac- companying diagram. In computing the
equivalent worth at u = 4, which of the following
statements is incorrect?

CHAPTER 2

Time Value of Money

You have $10,000 available for investment in

stock. You are looking for a growth stock that
can grow your investment to $35,000 over five
years. What kind of growth rate are you looking for'?

$100

Short Case Studies with Excel

2.63 The state of Florida sold a total of 72.2 million

Years

4)]( F / P, i . 4).

$100( F/ P, i, 2)) (P/ F. i. 2).

2.59 Henry Cisco is planning to make two deposits,

$25,000 now and $30,000 at the end of six yea rs.
He wants to withdraw C each year for the first six
years and (C + $1,000) each year for the next
six years. Determine the value of C the deposits earn 10% interest compounded annually.
Solving for Unknown Interest Rote

2.60 At what rate of interest compounded manually

will an investment double in five years? Find
the answers by using (1) the exact formula and
(2) the Rule of 72.
2.61 Determine the interest rate i that makes the
pairs of cash flows shown in the accompanying
diagrams economically equivalent.

Yeurs

Years

lottery tickets at $1 each during the first week

of January 2003. As pi ize money, a total of
$36.1
million will be distributed over the next 21
years ($1,952,381 at the beginning of each
year). The distribution of the first-year prize
money occurs now. and the remaining lottery
proceeds are put into the states educational
reserve funds, which earn interest at the rate or
6% compounded annually. After the last prize
distribution has been made (at the beginning
of year 21), how much will be left over in the
reserve account?
A newspaper headline reads Millionaire Babies: How to Save Our Social Security Syster. It sounds a little wild, but the concept
expressed in the title of this case study is probably the point of an economic plan proposed
by a member of Congress. Senator Bob Kei rey. DNebraska, has proposed giving even
newborn baby a $1,000 government savings
account at birth, followed by five annual contributions of $500 each. If the funds are left
untouched in an investment account, Kerre;
says, then by the time each baby reaches age
65, his or her $3,500 contribution will have
grown to $600,000 over the years. even at
medium returns for a thrift-savings plan. At
about 9.4 % compounded annually, the balance would grow to be $1,005,132. (He
would you calculate this number?) With about
4 million babies born each year, the proposal
would cost the federal government $4 billion
annually. Kerrey offered this idea in a speech
devoted to tackling Social Security reform.
About 90% of the total annual Social Security
tax collections of more than $300 billion is
used to pay current beneficiaries, which is the
largest federal program. The remaining 10% is

Problems
invested in interest-bearing government bonds
that finance the day-to-day expenses of the
federal government. Discuss the economics of
Senator Bob Kerrey s Social Security savings
plan.

2.65 Kevin Jones. Texas Tigerss quarterback, agreed

to an eight-year, $50 million contract that at the
time made him the highest-paid player in professional football history. The contract included
a signing bonus of $11 million and called for

annual salaries of $2.5 million in 2003, $1.75

million in 2004, $4.15 million in 2005, $4.90 million in 2006, $5.25 million in 2007, $6.2 million
in 2008, $6.75 million in 2009, and $7.5 million
in 2010. The $11-million signing bonus was
prorated over the course of the contract so that
an additional $1.375 million was paid each year
over the eight-year contract period. With the
salary paid at the beginning of each season,
what is the worth of his contract at an interest
rate of 6%?