Professional Documents
Culture Documents
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6
Example 2
Tuition costs are expected to inflate at the rate of 8% per
year. The first years tuition is due one year from now and
will be $10,000. To cover tuition cost for 4 years, a fund is
to be set up today in an account that will earn interest at
the rate of 5% per year, compounded annually. How much
must be deposited into the fund today in order to pay the 4
years of tuition expenses?
7
Example 2 - Concept
If your rich Aunt Edna wanted to put a
sum of money in the bank today to pay
for your next four years of tuition, that
sum would be $39,759 assuming 5%
return on investment and tuition that
begins at $10,000 increasing by 8% per
year. This problem assumes tuition is
due at the end of the year.
8
Complex Cash Flows
Complex Cash Flows Break apart
(or separate) complex cash flows
into component cash flows in order
to use the standard formulas.
Remember: You can only combine
cash flows if they occur at the same
point in time.
(This is like building with LEGOs!)
9
Problem 3
A construction firm is considering the purchase of an
air compressor.
The compressor has the following expected end of
year maintenance costs:
Year 1 $800
Year 2 $800
Year 3 $900
Year 4 $1000
Year 5 $1100
Year 6 $1200
Year 7 $1300
Year 8 $1400
What is the present equivalent maintenance cost if the
interest rate is 12% per year compounded annually?
10
Problem 3 Alt Soln 1
GIVEN:
MAINT COST
1-8
PER DIAGRAM
i = 12%/YR, CPD ANNUALLY
FIND P: P = P
A
+ P
G
+ P
F
= A(P/A,i,n) + G(P/G,i,n) + F(P/F,i,n)
= $700(P/A,12%,8) + $100(P/G,12%,8) + $100(P/F,12%,1)
= $700(4.9676) + $100(14.4715) + $100(0.8929) = $5014
P
A
?
0
1 2 3
n=8
$700
4
NOTE: CAN BREAK INTO 3 CASH FLOWS:
ANNUAL, LINEAR GRADIENT, AND FUTURE
DIAGRAM:
P ?
0
1 2 3
n=8
$700
$100
$700
4
$200
$300
$100
P
G
?
0
1 2 3
n=8
$100
$700
$200
$300
4
0
$100
P
F
?
n=1
11
Problem 3 Alt Soln 2
GIVEN:
MAINT COST
1-8
PER DIAGRAM
i = 12%/YR, CPD ANNUALLY
FIND P: P = P
A
+ P
G
(P
PG
) = A(P/A,i,n) + G(P/G,i,n-1)(P/F,i,1)
= $800(P/A,12%,8) + $100(P/G,12%,7)(P/F,12%,1)
= $800(4.9676) + $100(11.6443)(0.8929) = $5014 DIAGRAM:
P ?
0
1 2 3
n=8
$800
$100
$600
4
$200
P
A
?
0
1 2 3
n=8
$800
4
P
G
?
0 1 2
n=7
3
$100
$600
$200
NOTE: P
G
MUST BE OFFSET ONE YEAR SO
BRING THE OFFSET YEAR BACK TO TIME ZERO
0
P
G
?
P
PG
?
1
12
Problem 4
A young couple has decided to make advance plans for
financing their 3 year old daughters college education.
Money can be deposited at 8% per year, compounded
annually.
What annual deposit on each birthday, from the 4
th
to the
17
th
(inclusive), must be made to provide $7,000 on each
birthday from the 18
th
to the 21
st
(inclusive)?
GIVEN:
WITHDRAWALS
18-21
= $7 000
i = r = 8%/YR, CPD YEARLY
FIND A
4-17
:
17
21 yrs
$7 000
A ?
DIAGRAM:
4
18
0
P
17
= A(F/A,i,n) = A(P/A,i,n)
= A(F/A,8%,14) = 7 000(P/A,8%,4)
= A(24.2149) = 7 000(3.3121)
A = $957
STRATEGY: CAN BREAK INTO 2 CASH FLOWS,
SO PICK A CONVENIENT POINT IN TIME AND SET
DEPOSITS EQUAL TO WITHDRAWALS