Relate Future to Present Values

Lecture 16

Time Value of Money F/P

Problem Examples P/F

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A. Interest compounded yearly

Discount Rate
end

The interest rate used to determine the present value of

future cash flows. When expressed in the form below,
then i is call the discount rate. (See page 333 of Hyman)

P = ( P / F ) F = F (1 + i ) − n

i = Discount Rate

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 B. Interest compounded monthly
Monthly Payment Example
end
Suppose that you deposit $1000 at the end of each month for
a period of one year, i.e., 12 payments total of $1000 each.

A. What is your account balance at the end the 12th month,

one the day that you make your last payment, if the bank
compounds interest annually?

B. What is your account balance at the end the 12th month,

one the day that you make your last payment, if the bank
compounds interest monthly?

Use (F/A,i,n) factor

for all “annualized”,
or payment series,
calculations

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Typical Problem Statement Example 1

P = A(P / A, i %, n ) = 5,000(P / A, 6%, 10)

n 10
(1+i ) − 1 ( 1.06) − 1
(P / A, 6%, 10) = n = 10 = 7.3601
i ( 1+i ) i ( 1.06)
P = 5,000(7.3601) = $36,800

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 Example 3
Example 2

10% per annum = 5% semiannually P = 6,000(P / A, 8%, 6) + 6,000(P / A, 8%, 4 )

or P = 12,000(P / A, 8%, 4 ) + 6,000(P / A, 8%, 2 )(P / F , 8%, 4 )
(F / A, i%, n ) = (F / A, 5%, 16) or P = 12,000(P / A, 8%, 4 ) + 6,000(P / F , 8%, 5) + 6,000(P / F , 8%, 6)
n 16
(F / A, 5%, 16) = (1 + i ) − 1 = (1.05) − 1 = 23.6575 (P / A, 8%, 2 ) = 1.7833, (P / A, 8%, 4) = 3.3121, (P / A, 8%, 6) = 4.6229
i 0.05 (P / F , 8%, 4 ) = 0.7350, (P / F , 8%, 5) = 0.6806, (P / F , 8%, 6) = 0.6302
F = A (F / A, i %, n ) = 8000 (23.6575) = $189,260 P = 6,000(4.6229 ) + 6,000(3.3121) = 47,610
P = 12, 000 ( 3.3121) + 6, 000 (1.7833)( 0.7350 ) = 47, 614
P = 12,000(3.3121) + 6,000(0.6806) + 6,000(0.6302 ) = 47,610

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Example 5
Example 4

A = P ( A / P, i %, n ) = 25,000 ( A / P, 6%, 10) 10% per annum = 5% semiannually

i (1+ i )
n
0.06 ( 1.06)
10
( A / F , i %, n ) = ( A / F , 5%, 16)
( A / P, 6%, 10) = n
= 10
= 0.13587 i 0.05
(1+i ) − 1 (1.06) −1 ( A / F , 5%, 16) = = = 0.04227
(1 + i ) − 1 (1.05)16 − 1
n

A = 25,000(0.13587) = $3,397
A = F ( A / F , i %, n ) = 30,000 (0.04227) = $1,268
Note : Sum of payments = $33,970 Note : Sum of payments = $20,288

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 Example 6 Example 6
You decide to purchase a car for which you finance
You decide to purchase a car for which you finance $30,000 for 4 years. The quoted interest rate is 7.3%.
$30,000 for 4 years. The quoted interest rate is 7.3%. Your payment terms are monthly.
Your payment terms are monthly.
A. What is your monthly payment? Answer = $722.57
A. What is your monthly payment?
A = P ( A / P, i %, n ) = 30,000 ( A / P, 7.3/12%,48)
B. After making 24 payments, you decide to pay off the = 30,000 ( A / P, 0.6083%,48)
contract early with a final payment added to your 24th
payment. What is the amount of the amount that you i(1+i )
n

must add to your final payment to pay off the contract? ( A / P, 0.6083%, 48 ) = n
(1+i ) −1
48
0.006083(1.006083)
= 48
= 0.02409
(1.006083) −1
A = 30,000(0.02409) = $722.57

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Example 6
B. After making 24 payments, you decide to pay off the
contract early with a final payment added to your 24th
payment. What is the amount that you must add to your
final payment to pay off the contract?

Cash Flows:
a) 24 payments of $722.57 from 1 through 24 months
b) One single payment at 24th month of ???

Total of $722.57(P/A,0.6083%,24) + ??? = $30,000

or ??? = $30,000 - $722.57(P/A,0.6083%,24) = $13,910
But this is present value of your payoff, i.e., calculated at t=0.
Thus, to get the actual payment after 24 months

Future Payment = $13,910(F/P, 7.3%/12, 24)

= $13,910(1.0060833)24 = $16,089

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