CHAPTER-3: TIME VALUE OF MONEY

3 TIME VALUE OF MONEY

3.1 TIME VALUE OF MONEY

3.1.1 INTRODUCTION TO TIME VALUE OF MONEY
Time value of money is the most importance concepts in finance. It means that the value of a rupee received
in one year from now is not the same as the value of a rupee received today. In other words, most of us would
prefer to received cash sooner rather than later and to spend later rather than sooner. Money has time value
because it earns interest on the principal and also on the previously earned interest. As a result, a rupee
invested today can grow a rupee plus interest and interest on interest at some future date.

For example, if we invest Rs. 1000 at the rate of 10 percent, annually it becomes Rs 1100 in one year later.
Hence, Rs 1000 is called present value of Rs 1100. It means, the future value Rs 1100 is the result of present
value Rs 1000.

Money has time value because

1. Inflation: Money in hand today has more purchasing power.
2. Risk factor: the present is certain as comparing to future, so it is required to compensate the uncertainty.
3. Time preference: it is human behavior that every one prefers to receive money as earlier as possible.
4. Liquidity preference: Capital can be employed productively.
5. Sacrifice of present consumption: For making investment one must save his earning and saving from
current earning is not possible without sacrificing present consumption. And, people do not like to
sacrifice their presence consumption if they do not get reward for it.

3.1.2 SIMPLE INTEREST AND COMPOUND INTEREST

1 SIMPLE INTEREST
Simple interest is interest that is paid (earned) on only the original amount, or principal, borrowed (lent). The
dollar amount of simple interest is a function of three variables: the original amount borrowed (lent), or
principal; the interest rate per time period; and the number of time periods for which the principal is
borrowed (lent). The formula for calculating simple interest is
Simple Interest (SI) = P*i*n
Where, P = Principal or Original amount borrowed
i = Interest rate per time period
n = No. of time Periods (years)
Problem and Solution:
In 2005, total debit (credit cards, auto loans, home mortgages, etc.) amounted to more than 100% of total
disposable income for the average U.S household. If your total disposable income is $50,000, how much sum
can you expect to pay at the end of one year period when the average interest rate on your debit is 12% per
year?
SI = (P).(i).(n)
= $50,000*X(0.12)*1
Therefore, SI = $ 6,000

MGTS 301 (ENGINEERING ECONOMY), Kathmandu University

By Punya Ram Sujakhu (9841395153)
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 CHAPTER-3: TIME VALUE OF MONEY

2 COMPOUND INTEREST
Compound interest is the interest which is calculated on the both of initial principal and on any interest
earned. It considers all of the accumulated interest of previous periods of a deposit or loan while calculating
interest. The equation to find the compound interest is
n
Interest = P (1+i) – P

Where, P = Principal or Present Value

i = Interest rate
n = No. of Periods (years)

Let, Assume the Principal amount be $1,000 on which interest charge at10%.

(1)
(2)=(1)x10% (3)=(1)+(2)
Period Amount owed at beginning of
Interest amount for period Amount owed at end of period
period

1 $1,000 $100 $1,100

2 $1,100 $110 $1,210

3 $1,210 $121 $1,331

3.1.3 CONCEPT OF EQUIVALENCE

In general, compounding is the process of finding future value of a cash flow or a series of cash flow. The
compounded amount equals to the present value plus the interest earned. The interest rate and time
period is known compounding rate and compounding period which is used to convert the present
value into future value.

Whereas, discounting is the process to findings present value of a cash flow or a series of cash flow.
Discounting is the reciprocal or reverse of compounding. The interest rate is called discounts rate and time
period is called discounts period which is used to convert the future value into present value .

An annuity is a series of equal amount of payment made of each year. It is popularly known as
installment .If equal amount of payment is made at the end of the year it is called simply annuity or
ordinary annuity. If equal amount of payment is made at the beginning of each year then it is called
annuity due . An annuity whose payments occur forever is called perpetuity.

3.1.4 CASH FLOW DIAGRAM (CFD)

1. CASH FLOW
Cash flows are described as the inflows and outflows of money. Every person or company has cash receipts-
revenue and income (inflows); and cash disbursements expenses, and costs (outflows). These receipts and
disbursements are the cash flows, with a plus sign representing cash inflows and a minus sign representing
cash outflows. The cash flow is fundamental to every economic study.

1. Cash inflows, or receipts, may be comprised of the following

1. Revenues (usually incremental resulting from an alternative).
2. Operating cost reductions (resulting from an alternative).
3. Asset salvages value.
4. Receipt of loan principal.
5. Income tax savings.
6. Receipts from stock and bond sales.
7. Construction and facility cost savings.
8. Saving or return of corporate capital funds.

MGTS 301 (ENGINEERING ECONOMY), Kathmandu University

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 CHAPTER-3: TIME VALUE OF MONEY

2. Cash outflows, or disbursements, may be comprised of the following,

1. First cost of assets.
2. Engineering design costs.
3. Operating costs (annual and incremental).
4. Periodic maintenance and rebuild costs.
5. Loan interest and principal payments.
6. Major expected/unexpected upgrade costs.
7. Income taxes.
8. Expenditure of corporate capital funds.

2. CASH FLOW DIAGRAM (CFD)

A cash flow diagram is a very important tool for clarifying and visualizing a series of cash flows. The costs and
benefits of engineering projects occur over time. It means, Engineering projects generally have cash inflow
(receipts) or cash outflow (disbursements) at different points in time. Specifically, a CFD illustrates the size,
sign, and timing of individual cash flows.

Components to show in a CFD

1. A CFD is created by first drawing a segmented time-based horizontal line, divided into appropriate
time unit.
2. Each time when there is a cash flow, a vertical arrow is added - pointing down for costs and up for
revenues or benefits. The cost flows are drawn to relative scale.
An Example of Cash Flow Diagram:
A man borrowed $1,000 from a bank at 8% interest. Two end-of-year payments: at the end of the first year, he
will repay half of the $1000 principal plus the interest that is due. At the end of the second year, he will repay
the remaining half plus the interest for the second year.

Cash flow for this problem is:

End of year (EOY) Cash flow (CF)
0 +$1000
1 -$580 (-$500 - $80)
2 -$540 (-$500 - $40)

3. TYPES OF CASH FLOW

The cash flow is fundamental to every economic analysis. Cash flows occur in many configurations and
amounts isolated single values, series that are uniform, and series that increase or decrease by constant
amounts or constant percentages. There are no any rules to classify the cash flow but we can find the
following types of cash flow in engineering economy.
1. Single payment Cash flow
2. Uniform payment cash flow
3. Linear (Arithmetic) gradient cash flow
4. Geometric gradient cash flow
5. Irregular (random) cash flow

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 CHAPTER-3: TIME VALUE OF MONEY

14

1. SINGLE PAYMENT or ONE TIME CASH FLOW or SINGLE CASH FLOWS

If an investment offers only one lump sum cash flow at the given time period then it is called single cash flow.
It may be the case to find future value (F) or may be to find Present Value (P). For example, today you
deposited Rs. 1000 in saving account for 10 years at the interest rate of 12%. How much money will you have
after 10 year?

Formula for single payment

1. Single Payment Compound Amount Factor
i. F/P factor = (F/P,i%,n) = 1 + i
ii. Future Value (F)= P (F/P,i%,n)
2. Single Payment Present Worth Factor
 
i. P/F factor = (P/F,i%,n)=  
or 1 + i or
/, %,

ii. Present Value (P)= F(P/F,i%,n)

MGTS 301 (ENGINEERING ECONOMY), Kathmandu University

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 CHAPTER-3: TIME VALUE OF MONEY

NUMERICAL EXAMPLE ON SINGLE CASH FLOW

1. Find F when given P (Annually) 2. Find F when given P (Quarterly)

3. Find P when given F (Annually) 4. Find P when given F (uneven)

5. Decision on F and P 6. Decision on F and P

Which amount is worth more at 14 percent; Rs 1000 in Lottery officials offer the choice of following
hand today or Rs 2000 due in 6 years?[1000 and alternative payments. Which would you choose if
911.16] the interest rate is 10 percent? [9091 & 12418.50]
Alt. 1 Rs.10, 000 one year from now
Alt. 2 Rs.20, 000 five years from now
7. Find i when given F & P 8. Find n when given F & P
If Laurel can make an investment in a friend's business How long will it takes to grow from $5,000 to $8,500
of $3000 now in order to receive $5000 five years from at the interest rate of 9% quarterly? [5.96 years]
now, determine the rate of return. [10.76%]
9. Find i when given F & P 10. Find n when given F & P
What interest rate makes your money treble (3 times) How long will it take for an investment to double at
in 10 years using (a) simple interest concept (b) 5% per year (a) simple interest and (b) compound
interest? [a. 20 years b. 14.2 years]
compound interest concept? [20% and11.61%]

2. UNIFORM SERIES or EVEN CASH FLOWS or ANNUITY

An annuity is a special cash flow pattern in which equal payments or receipts occurring over a specified
number of periods. For example, Equal monthly installment (EMI) and insurance premium are the example of
annuity. It is popularly known as annuity and annuity is two types

1. Ordinary Annuities
A series of equal amount of payments made at the end of specified number of periods. Then it is called
ordinary annuity.

2. Deferred Annuities
Deferred annuities are uniform series that do not begin until sometime in the future. If the annuity is
deferred J periods then the first payment (cash flow) begins at the end of period J+1.

MGTS 301 (ENGINEERING ECONOMY), Kathmandu University

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 CHAPTER-3: TIME VALUE OF MONEY

Formula for uniform series

1. Uniform Series Compound Amount Factor
1+in -1
i. F/A factor = (F/A,i%,n)=
i
ii. Future Value (F)= A(F/A,i%,n)
2. Uniform Series Sinking Fund Factor

i. A/F factor = (A/F,i%,n)= 
 

ii. Annual Amount (A)= F(A/F,i%,n)

3. Uniform Series Present Worth Factor
1
1+in -1 1+in
i. P/A factor = (P/A,i%,n)= or 1-
i1+in i

ii. Present Value (P)= A(P/A,i%,n)

4. Uniform Series Capital Recovery Factor
i1+in
i. A/P factor = (A/P,i%,n)= 1+in
-1

ii. Annual Amount (A)= P(A/P,i%,n)

NUMERICAL EXAMPLE ON UNIFORM SERIES

1. Find F when given A (Annually) 2. Find A when given F (Annually)

3. Find P when given A (Annually) 4. Find A when given P (Annually)

5. Find i when given F and A (Formula) 6. Find i when given P and A (Interpolation)

MGTS 301 (ENGINEERING ECONOMY), Kathmandu University

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 CHAPTER-3: TIME VALUE OF MONEY

TR-LR HR-LR TR-LR

= ∴TRi = LR+ (HR-LR)
TRF-LRF HRF-LRF TRF-LRF
7. Find n when given P and A 8. Find i when given A and P (Interpolation)

9. Find n when given P and A 10. Find n when given P and A (Interpolation)
You need to accumulate Rs 10,000. To do so, you plan While steve Bouchard was a student at the
to make deposits of Rs 1750 per year, with the first University of Florida, he borrowed Rs.12, 000 in
payment being made a year from today, in a bank student loans at an annual interest rate of 9 percent.
account which pays 6 percent annual interest. How If Steve repays Rs.1500 per year, how long to the
many years will it take out to reach your goal? [5years] nearest year, will it take you to repay the loan?
[15 years]

3. ARITHMETIC GRADIENT SERIES or LINEAR GRADIENT CASH FLOW

Cash flows that increase or decrease by a constant amount are considered arithmetic gradient series. The
amount of increase (or decrease) is called the gradient. Sometimes cash flows change by a constant amount
each period. Arithmetic gradient series is linear gradient cash flow in nature. The first cash flow in the
arithmetic gradient series becomes zero (i.e. G=0 in year1). Since the gradient (G) series normally is used along
with a uniform series (A).

Formula for arithmetic gradient series

1. Arithmetic Gradient Present worth Factor
1+i n -in-1 1 1+in -1
or  - 1+in 
n
i. P/G factor = (P/G,i%,n)=
i2 1+in i i1+in

ii. Present Worth of Arithmetic Gradient (PG) = G (P/G,i%,n)

iii. Total Present Worth of Arithmetic Gradient (P  =  ±  or [A(P/A,i%,n) + G(P/G,i%,n)]
iv. Total Future Worth of Arithmetic Gradient (FT )=PT (F/P,i%,n) or AT (F/A,i%,n)
v. Annual Amount of Arithmetic Gradient (A   = PT A⁄P,i%,n or # ± #
2. Arithmetic Gradient Uniform series Factor (Optional)
A/G factor = (A/G,i%,n)= P⁄G ,i%,nA⁄P ,i%,n or - 1+in
1 n
i.
i -1

ii. Annual Amount of Arithmetic Gradient (A  = $A/G, i%, n

iii. Total Annual Series of Arithmetic Gradient (A   = # ± #
3. Arithmetic Gradient Future worth Factor (Optional)
1 1+in -1
i. F/G factor = (F/G,i%,n)= P⁄G ,i%,nF⁄P ,i%,n or  -n
i i
ii. Future Worth of Arithmetic Gradient (FG) = G(F/G,i%,n)
iii. Total Future Worth of Arithmetic Gradient (F   = ( ± (

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 CHAPTER-3: TIME VALUE OF MONEY

NUMERICAL EXAMPLE ON ARITHMATIC GRADIENT SERIES (LINEAR)

1. Find P when given G (+ve) Find A when given G (-ve)

Suppose that certain EOY cash flows are expected to be $1,000 for the second year, $2,000 for the third year,
and $3,000 for the fourth year and that, if interestis 15% per year, it is desired to find
(a) present equivalent value at the beginning of the first year [P0 = G(P/G, 15%, 4) = $1,000(3.79) = $3,790.]
(b) uniform annual equivalent value at the end of each of the four years.[ A = P0(A/P, 15%, 4) = $3,790(0.3503)
= $1,326.30.]

4. GEOMETRIC GRADIENT SERIES or PERCENTAGE GRADIENT CASH FLOW

Cash flow which changes by a constant percentage from one interest period to the next is called geometric
gradients series. The arithmetic gradient is applicable where the period by- period change in a cash receipt or
payment is a uniform amount but geometric gradient is applicable where the period-by-period change is a
uniform rate, g. For example, if the maintenance costs for an automobile are $100 for the first year and it
increases at a uniform rate (g) of 10% per year.

1. Geometric Gradient Present worth Factor

+,- 
)* +,. / 0
i. P/g factor =(P/A,g,i%,n)= 2ℎ45 6 ≠ 8
1
9
ii (P/A,g,i%,n)=   2ℎ45 6 = 8
 
2. Geometric Gradient Uniform series Factor
   1
i. (F/g,i%,n)= #   2ℎ45 6 ≠ 8
1

ii (F/g,i%,n)= # . 51 + 8 9

2ℎ45 6 = 8

MGTS 301 (ENGINEERING ECONOMY), Kathmandu University

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 CHAPTER-3: TIME VALUE OF MONEY

NUMERICAL EXAMPLE ON GEOMETRIC GRADIENT SERIES (PERCENTAGE)

1. Find F when given g (+ve) 2. Find P when given g (-ve)
Determine the P, A, and F equivalent values. The rate
of increase is 20% per year after the first year, and the
interest rate is 25% per year.

Suppose the yearly interest rate is 10%.

a. Find the present worth of a geometric gradient
series with base amount 100 and gradient 10
assuming the first payment (base amount)
occurs at the end of period 5 and the last
payment is made at the end of period 25.
b. What is the equivalent uniform series which has
a total of 25 consecutive payments and starts in
period 1?
c. What is the equivalent annuity to the series in
part (a) such that the annuity consists of 10
payments and its first payment occurs at the
end of period 8?
[(a) n=25 – 5 + 1=21 so P4 = 100(P/A,10%,21) + 10 (P/G, 10%, 21)
& P = (P4) (P/F,10%,4) = 987.594]
[(b) A = (987.594)(A/P,10%,25) = 108.80324]
[(c) A = (987.594)(F/P,10%,7)(A/P,10%,10) = 313.21365]

MGTS 301 (ENGINEERING ECONOMY), Kathmandu University

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 CHAPTER-3: TIME VALUE OF MONEY

5. IRREGULAR PAYMENT SERIES or UNEQUAL SERIES

Irregular cash flows are series of received or payment which provides different from year to year. They are
unexpected by the project and thus not taken into account in their predictions.

NUMERICAL EXAMPLE ON IRREGULAR SERIES

1. Find F when given A (Uneven) 2. Find P when given F (Uneven)

An engineering company in Wyoming that owns 50

hectares of valuable land has decided to lease the
mineral rights to a mining company. The primary
objective is to obtain longterm income to finance
ongoing projects 6 and 16 years from the present time.
The engineering company makes a proposal to the
mining company that it pay $20,000 per year for 20
years beginning 1 year from now, plus $ 10,000 six
years from now and $ 15,000 sixteen years from now.
If the mining company wants to payoff its lease
immediately, how much should it pay now if the
investment should make 16% per year? [124,075]

MGTS 301 (ENGINEERING ECONOMY), Kathmandu University

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 CHAPTER-3: TIME VALUE OF MONEY

FORMULA ON INTEREST FACTORS for DISCRET COMPOUNDING

FOR SINGLE PAYMENT CASH FLOW
1. Single Payment Compound Amount Factor
i. F/P factor = (F/P,i%,n) = 1 + i
ii. Present Value (P)= F (F/P,i%,n)
2. Single Payment Present Worth Factor

i. P/F factor = (P/F,i%,n)= 


ii. Future Value (F)= P(F/P,i%,n)

FOR UNIFORM CASH FLOW

1. Uniform Series Compound Amount Factor
1+in -1
i. F/A factor = (F/A,i%,n)=
i
ii. Future Value (F)= A(F/A,i%,n)
2. Uniform Series Sinking Fund Factor

i. A/F factor = (A/F,i%,n)= 
 
ii. Annual Amount (A)= F(A/F,i%,n)
3. Uniform Series Present Worth Factor
1
1+in -1 1+in
i. P/A factor = (P/A,i%,n)= or 1-
i1+in i
ii. Present Value (P)= A(P/A,i%,n)
4. Uniform Series Capital Recovery Factor
i1+in
i. A/P factor = (A/P,i%,n)= 1+in
-1

ii. Annual Amount (A)= P(A/P,i%,n)

FOR ARITHMETIC GRADIENT CASH FLOW

1. Arithmetic Gradient Present worth Factor
1+i n -in-1 1 1+in -1
or  - 1+in 
n
i. P/G factor = (P/G,i%,n)=
i2 1+in i i1+in

ii. Present Worth of Arithmetic Gradient (P) = G (P/G,i%,n)

iii. Total Present Worth of Arithmetic Gradient (P  =  ± 
2. Arithmetic Gradient Uniform series Factor
A/G factor = (A/G,i%,n)= P⁄G ,i%,nA⁄P ,i%,n or - 1+in
1 n
i.
i -1

ii. Annual amount of Arithmetic Gradient (A  = $A/G, i%, n

iii. Total Annual Series of Arithmetic Gradient (A   = # ± # ;< A  = PT A⁄P,i%,n
3. Arithmetic Gradient Future worth Factor
1 1+in -1
i. F/G factor = (F/G,i%,n)= P⁄G ,i%,nF⁄P ,i%,n or  -n
i i
ii. Future Worth of Arithmetic Gradient (F) = G(F/G,i%,n)
iii. Total Future Worth of Arithmetic Gradient (P  =  ± 

MGTS 301 (ENGINEERING ECONOMY), Kathmandu University

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 CHAPTER-3: TIME VALUE OF MONEY

FOR GEOMETRIC GRADIENT CASH FLOW

1. Geometric Gradient Present worth Factor
=,> @
)=* =,? / 0
i. P/g factor =(P/A,g,i%,n)= ABC@ > ≠ ?
?>
@
ii (P/A,g,i%,n)=   ABC@ > = ?
= ?
2. Geometric Gradient Uniform series Factor
= ?@== >@
i. (F/g,i%,n)= D=   ABC@ > ≠ ?
=>

ii (F/g,i%,n)= D= . @= + ?@= ABC@ > = ?

RELATIONSHIP BETWEEN INTEREST FACTORS


1. P/F, i%, n =
/, %,

2. A/P, i%, n =
/E, %,

3. F/A, i%, n = P/A, i%, nF/P, i%, n

4. A/P, i%, n = A/F, i%, n + i%
5. F/G, i%, n = P/G, i%, nF/P, i%, n

CONTINUOUS COMPOUNDING INTEREST FACTORS

1. Single Payment Compound Amount Factor
(F/P,r%,N) = 4 FG
2. Single Payment Present Worth Factor

(P/F,r%,N)=
H IJ
3. Uniform Series Compound Amount Factor
H IJ 
(F/A,r%,N)=
H I 
4. Uniform Series Present Worth Factor
H IJ 
(P/A,r%,N)=
H IJ H I  

MGTS 301 (ENGINEERING ECONOMY), Kathmandu University

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 CHAPTER-3: TIME VALUE OF MONEY

I. Construct the CASH FLOW DIAGRAM from the given data.

1. Where P = $10,000 is borrowed at 8% per year and F is sought after 5 years. Construct the cash flow
diagram.
2. A father wants to deposit an unknown lump-sum amount into an investment opportunity 2 years from
now that is large enough to withdraw $4000 per year for state university tuition for 5 years starting 3
years from now. If the rate of return is estimated to be 15.5% per year, construct the cash flow diagram.
3. An electrical engineer wants to deposit an amount P now such that she can withdraw an equal annual
amount of A I = $2000 per year for the first 5 years starting 1 year after the deposit, and a different annual
withdrawal of A2 = $3000 per year for the following 3 years. How would the cash flow diagram appear if i
= 8.5% per year?
4. Construct a cash flow diagram for the following cash flows: $10,000 outflow at time zero, $3000 per year
outflow in years 1 through 3 and $9000 inflow in years 4 through 8 at an interest rate of 10% per year, and
an unknown future amount in year 8.
5. Construct a cash flow diagram to find the present worth of a future outflow of $40,000 in year 5 at an
interest rate of 15% per year.
6. A sports apparel company has initiated a logo-licensing program. It expects to realize revenue of $80,000
in fees next year from the sale of its logo. Fees are expected to increase uniformly to a level of $200,000 in
6 years. Determine the arithmetic gradient and construct the cash flow diagram.
7. Before evaluating the economic merits of a proposed investment, the XYZ Corporation insists that its
engineers develop a cash-flow diagram of the proposal. An investment of $10,000 can be made that will
produce uniform annual revenue of $ 5,310 for five years and then have a market (recovery) value of $
2000 at the end of the year five. Annual expenses will be $3000 at the end of each year for operating and
maintaining the project. Draw a cash-flow diagram for the five year life of the project.

II. Problems on INTEREST FACTOR

1. Find the correct numerical value for the following factors from the interest tables.
a. (F/P,8%,25)
b. (P/A,3%,8)
c. (P/G,9%,20)
d. (F/A,15%,18)
e. (A/P,30%,15)
[a. (F/P,8%25) = 6.8485; b. (P/A,3%,8) = 7.0197; c. (P/G,9%,20) = 61.7770; d. (F/A,15%,18) = 75.8364; e.
(A/P,30%,15) = 0.30598]

2. Find the correct numerical value for the following interest factors from applying formula.
a. (P/A ,3%,8)
b. (P/G,9%,20)
c. (F/A , 15%,18)
d. (A/P,30%,15)

3. Find the value of the (P/F,4%,48) factor. [0.1522]

4. Determine the value of the A/P factor for an interest rate of 7.3% and n of 10 years, that is, (A/P,7.3%,10).
[0.1444]
III. Problems on SINGLE PAYMENT
1. If you deposited Rs. 20,000 in a bank that pays 10 percent interest annually. How much money
will be in your bank account after 5 years? [F=32,210]

2. You will require Rs. 700,000 in 5 years. If you earn 5 percent interest on your fund. How much
will you to invest today in order to reach your goal? [P=548,460]

3. How long will it take for an investment to double at 5% per year (a) simple interest and (b) compound
interest?
[a. 20 years b. 14.2 years]

MGTS 301 (ENGINEERING ECONOMY), Kathmandu University

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 CHAPTER-3: TIME VALUE OF MONEY

4. Calculate the future sum of an initial sum of $100, with an interest rate of %5 per year (compound
interest), and an investment period of 3 years.
[116]

5. Using the formula for compound interest, calculate the future value of a present value of $500, with an
interest rate of 13% per year, after 9 years.
[1502.02]
6. Given a present sum of $400, and an interest rate of 10% per year (simple interest) calculate the value of
this sum after 5 years.
[600]
7. The U.S. Border Patrol is considering the purchase of a new helicopter for aerial surveillance of the New
Mexico–Texas border with Mexico. A similar helicopter was purchased 4 years ago at a cost of $140,000.
At an interest rate of 7% per year, what would be the equivalent value today of that $140,000
expenditure?
[ $183,512]

8. A medium-size consulting engineering firm is trying to decide whether it should replace its office furniture
now or wait and do it 1 year from now. If it waits 1 year, the cost is expected to be $16,000. At an interest
rate of 10% per year, what would be the equivalent cost now?
[ $14,545.45]

9. Hewlett-Packard has completed a study indicating that $50,000 in reduced maintenance this year (i.e.,
year zero) on one processing line resulted from improved integrated circuit (IC) fabrication technology
based on rapidly changing designs. Find the equivalent value of this result after 5 years at 20% [124415].

IV. Problems on UNIFORM SERIES

1. A very well organized engineer wants to be a millionaire by her 60th birthday. She believes she can make
15% per annum on her investments. She wants to deposit a fixed amount starting on her 20th birthday
and continuing through her 59th. What is that fixed amount?
[22296]
2. A company deposits $2,000 in a bank account at the end of every year for 10 years. For the next 5 years, it
deposits nothing. If the bank pays 8%, how much is the account worth at the end of 15 years?
[42562]
3. A company deposits $2,000 in a bank account at the end of every year for 10 years. If the bank pays 8%,
how much is the account worth at the end of 10 years? Use the tables.
[28974]
4. A student wants to have $30,000 when he graduates 4 years from now. His grandfather gave him a gift of
$10,000. How much must he save each year (to the nearest dollar) if he deposits the $10,000 today and
can earn 12% on both the $10,000 and his savings?
[2985]
5. How many months will it take to pay off a $525 loan, with monthly payments of $15 at the end of each
month, if the interest rate is 18%, compounded monthly? Pick the closest.
[50]
6. Lisa buys a car for $18,000 with no money down. She pays for the car in 30 equal monthly payments at
12% per annum, compounded monthly. What is her monthly payment, to the nearest dollar?
[697]
7. Formasa Plastics has major fabrication plants in Texas and Hong Kong. The president wants to know the
equivalent future worth of a $1 million capital investment each year for 8 years, starting 1 year from now.
Formasa capital earns at a rate of 14% per year. [13,232.80]

8. How much money should you be willing to pay now for a guaranteed $600 per year for 9 years starting
next year, at a rate of return of 16% per year? [2,763.93]

MGTS 301 (ENGINEERING ECONOMY), Kathmandu University

By Punya Ram Sujakhu (9841395153)
Page 14 of 16
 CHAPTER-3: TIME VALUE OF MONEY

9. How much money must Carol deposit every year starting 1 year from now at 5% per year in order to
accumulate $6000 seven years from now? [725.76]

V. Problems on GRADIENTS SERIES

10. A set of cash flows begins at $50000 and increases at 10% per annum for the next 15 years. If the interest
rate is 7%, what is the present value of the set (to the nearest dollar)?
[856712]
11. It is estimated that the maintenance cost on a new car will be $400 the first year, increasing $100 a year
for each subsequent year. How much must you set aside when you buy the car, to cover maintenance cost
for 7 years at 5%? Answer to nearest dollar.
[3938]
12. V-Tek Systems is a manufacturer of vertical compactors, and it is examining its cash flow requirements for
the next 5 years. The company expects to replace office machines and computer equipment at various
times over the 5-year planning period. Specifically, the company expects to spend $9000 two years from
now, $8000 three years from now, and $5000 five years from now. What is the present worth of the
planned expenditures at an interest rate of 10% per year?
[P = 9000(P/F,10%,2) + 8000(P/F,10%,3) + 5000(P/F,10%,5) =16553]

13. Two methods can be used for producing expansion anchors. Method A costs $80,000 initially and will have
a $15,000 salvage value after 3 years. The operating cost with this method will be $30,000 per year.
Method B will have a first cost of $120,000, an operating cost of $8000 per year, and a $40,000 salvage
value after its 3-year life. At an interest rate of 12% per year, which method should be used on the basis of
a present worth analysis?
[PWA = -80,000 - 30,000(P/A,12%,3) + 15,000(P/F,12%,3)= $-141,377]
[PWB = -120,000 - 8,000(P/A,12%,3) + 40,000(P/F,12%,3)= $-110,742]

14. The Bowmansville Town Council has decided that the dam just upstream of the town must be rebuilt and
strengthened. The town engineer estimates that it will cost $85,000 by the end of the year. Subsequent
annual repair costs will decline by $10,000 per year, making the second year cost $75,000, the third,
$65,000 and so on. Council members want to know the equivalent present cost of the repairs for the next
5 years at 4%. You respond “to the nearest dollar it will be…”
[292857]

15. Engineers at Sea World, a division of Busch Gardens, Inc., have completed an innovation on an existing
water sports ride to make it more exciting. The modification costs only $8000 and is expected to last 6
years with a $1300 salvage value for the solenoid mechanisms. The maintenance cost is expected to be
high at $1700 the first year, increasing by 11% per year thereafter. Determine the equivalent present
worth of the modification and maintenance cost by hand. The interest rate is 8% per year.[17,305.85]

VI. Problems on DEFERRED ANNUITY

1. Recalibrat.ion of sensitive measuring devices costs $8000 per year. If the machine will be recalibrated for
each of 6 years starting 3 years after purchase, calculate the 8-year equivalent uniform series at 16% per
year. [5,043.60]

2. An engineering technology group just purchased new CAD software for $5000 now and annual payments
of $500 per year for 6 years starting 3 years from now for annual upgrades. What is the present worth of
the payments if the interest rate is 8% per year? [6,981.60]
3. Find the P, F and A of the cash flows shown below.

MGTS 301 (ENGINEERING ECONOMY), Kathmandu University

By Punya Ram Sujakhu (9841395153)
Page 15 of 16
 CHAPTER-3: TIME VALUE OF MONEY

3.2CONTINUOUS COMPOUNDING
3.2.1 NOMINAL AND EFFECTIVE INTEREST RATE
Nominal interest rate is the annual quoted interest rate which does not considers the compounding effect. It is
also known as simple interest rate. Nominal annual rate is always given.

Effective interest rate is the annual equivalent interest rate which considers the compounding effect. It gives
the greater interest rate than nominal rate because of compound interest. Effective annual rate is calculated
m
by  i
EAR = 1 +  − 1
 m
Where, m = No. of compounding periods in a year.
Problem and Solution:
You are thinking about buying a car, and a local bank is willing to lend you $20,000 to buy the car. If the
nominal interest rate be 12 percent. What would be the effective rate of interest on the loan?
a. If interest paid annually. ie m =1 [12%]
b. If interest paid semiannually. ie m =2 [12.36%]
c. If interest paid quarterly. ie m =4 [12.55%]
d. If interest paid bimonthly. ie m =6 [12.62%]
e. If interest paid monthly. ie m =12 [12.68%]
f. If interest paid daily. ie m =365 [12.75%]
If interest paid perpetually (continuous). ie m = ∞ [e -1=12.75%]
i
g.

3.2.2EFFECTIVE INTEREST RATE PER PAYMENT PERIOD

3.2.3CONTINUOUS COMPOUNDING

MGTS 301 (ENGINEERING ECONOMY), Kathmandu University

By Punya Ram Sujakhu (9841395153)
Page 16 of 16