Concepts from the

example problems
( F / P, i, N) Problem 1
( P / F, i, N) Problem 2
( F / A, i, N) Problem 3
( A / F, i, N) Problem 4
( P / A, i, N) Problem 5
( A / P, i, N) Problem 6
( P / G, i, N) Problem 7
( A / G, i, N) Problem 8
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 Example 1
How much would you have to deposit
today to have $2000 in 4 years if you can
get a 12% interest rate compounded
annually?
GIVEN:
F4 = $2 000
DIAGRAM: i = 12%
$2 000 FIND P:
0 1 2 3
P = F4(P/F,i,n)
n=4
= 2 000(P|F,12%,4)
P?
= 2 000(0.6355) = $1 271

2
 Different Ways
of Looking at P/F
From previous example, if you can earn 12%
compounded annually, you need to deposit
$1271 to have $2000 in 4 years.
You are indifferent between $1271 today and
$2000 in 4 years, assuming you can earn a
return on your money of 12%.
The present worth of $2000 in 4 years is $1271
(i = 12% cpd annually).
my abbreviation for compounded

If you could get 13% on your money, would you

rather have the $1271 today, or $2000 in 4 years ?
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 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?

4
Present Given Gradient (Geometric)
g is the geometric gradient over the time period
(time period: Time 0 to Time n, 1st flow at Time 1)
P is the present value of the flow at Time 0
(n periods in the past)
i is the effective interest rate for each period
(1 g ) n
P? 1

(1 i )
when i g
0 1 2 3 n ig

( P / A, g , i , n)

A1
g=% n
when i g
P = A1(P/A,g,i,n) (1 i )
Note: cash flow starts with A1 at Time 1, increases by constant g% per period

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 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?

6
 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.

7
 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!)
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 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?

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 Problem 3 Alt Soln 1
GIVEN:
MAINT COST1-8 PER DIAGRAM
i = 12%/YR, CPD ANNUALLY
FIND P: P = PA + PG + PF = 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)
DIAGRAM: = $700(4.9676) + $100(14.4715) + $100(0.8929) = $5014
P? PA ?
1 2 3 4 1 2 3 4
n=8 n=8
0 $700 0 PF ?
$700 n=1
PG ?
$100 $100 $200 0
$300 $700 1 2 3 4 $100
n=8
0
$100 $200
NOTE: CAN BREAK INTO 3 CASH FLOWS: $300 $700
ANNUAL, LINEAR GRADIENT, AND FUTURE

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 GIVEN:
Problem 3 Alt Soln 2
MAINT COST1-8 PER DIAGRAM
i = 12%/YR, CPD ANNUALLY
FIND P: P = PA + PG(PPG) = 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)
DIAGRAM: = $800(4.9676) + $100(11.6443)(0.8929) = $5014
P? PA ?
1 2 3 4 1 2 3 4
n=8 n=8
0 0
$800 $800

$100 $200 PPG ? PG ?

0 1 2 3
$600 n=7
0 1
NOTE: PG MUST BE OFFSET ONE YEAR SO PG ? $100 $200
BRING THE OFFSET YEAR BACK TO TIME ZERO
$600
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 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 4th to the
17th (inclusive), must be made to provide $7,000 on each
birthday from the 18th to the 21st (inclusive)?
DIAGRAM: GIVEN:
$7 000 WITHDRAWALS18-21 = $7 000
4 17 i = 8%/YR, CPD YEARLY
FIND A4-17:
0 18 21 yrs
P17 = A(F/A,i,n) = A(P/A,i,n)
A?
= A(F/A,8%,14) = 7 000(P/A,8%,4)
STRATEGY: CAN BREAK INTO 2 CASH FLOWS,
SO PICK A CONVENIENT POINT IN TIME AND SET = A(24.2149) = 7 000(3.3121)
DEPOSITS EQUAL TO WITHDRAWALS
A = $957
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