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Capitalized Cost
Capitalized Cost
CC = FC = PW WHERE : CC = CAPITALIZED COST FC = FIRST COST PW = PRESENT WORTH OF PERPETUAL OPERATION OR MAINTENACE COST OF
PROPERTY
EX. DETERMINE THE CC OF A BLDG. THAT NEED AN INITIAL CAPITAL OF 1.5 M & A YEARLY MAINTENANCE COST OF 150 K @ 15 % INT.
1 2
SOLN. :
150 150
CC = FC + PW LET : S = AMT. NEEDED TO REPLACE A PROPERTY EVERY K PERIODS. X = AMT. OF P INVESTED @ i RATE . THE INT. W/C WILL AMT. TO S EVERY
Xi = INT. ON X EVERY PERIOD THE PERIODIC DEPOSIT TOWARDS K PERIODS.
THE ACCUMULATION OF S S
0 1 2 3 K-1 K
Xi Xi Xi Xi Xi
X = ( S/i ) [ 1 ] = ( S/i ) [ i ]
k k
{ (1+i ) 1 } (1+i) -1
i
AMORTIZATION
AMORTIZATION = is the gradual extinguishment of any amt. over a period of time . That is the extinction of a debt., principal & interest by means of a sequence of equal
periodic payments or installment payment due @ the end of equal intervals of time.
AMORTIZATION OF A DEBT = when a debt is amortized by equal payments @ equal intervals the debt becomes the present value of an ordinary annuity.
EX. A LOAN OF 4K IS TO BE AMORTIZED BY EQUAL PAMENTS @ THE END OF EACH QUARTR FOR 1 YR. & 6 MOS. IF INT. IS 5 % COMPOUNDED QUARTERLY FIND
THE PERIODIC
PAYMENTS & CONSTRUCT AN AMORTIZATION SCHEDULE.
A = P = 4K = 696.14
-n
[ 1-( 1+i ) ] [ 1 ( 1.0125 )-6 ]
i 0.0125
AMORTIZATION SCHEDULE : Payment # Unpaid bal. Int. paid Periodic payment Principal repaid
OUTSTANDING PRINCIPAL : ( OP )
NOTE : Both the borrower & the lender must be updated on the status of any obligation . They should know the remaining liabilities or OP before or after any given
no. of payments.
PROSPECTIVE METHOD & RETROSPECTIVE METHOD
PROSPECTIVE METHOD OP = A [ 1 ( 1+i )-(n-k) ] WHERE : OP = OUTSTANDING PRINCIPAL A = PERIODIC PAYMENT i = PERIODIC RATE
i n = TOTAL NO. OF PAYMENTS k = NO. OF PAST PAYMENT n-k = NO. OF FUTURE
PAYMENTS THAT REMAINS TO BE MADE
EX. A LOAN IS TO BE AMORTIZED BY EQUAL PAYMENTS OF 500 EACH @ THE END OF EACH 6 MOS. FOR 10 YRS. IF THE INT. RATE IS BASED ON 7 % COMPOUNDED SEMI-
ANNUALLY .
FIND : A. THE PRESENT VALUE OF LOAN B. THE OP JUST AFTER THE 8th PAYMENT. C. THE REMAINING LIABILITY AFTER 8 YRS.
BOND
BOND = A written promise to pay a specified sum of money called REDEMPTION VALUE @ an specified future date called REDEMPTIONDATE . Usually a long
Term obligation.
= An acknowledgement of obligation together w/ an agreement to make periodic payments known as COUPON PAYMENT @ an stated rate & to repay the
Principal on a certain date.
= A bond is said to be REDEEMED when it is bought back by the corporation w/c issued it.
CLASSIFICATION OF BOND :
1. REGISTERED BONDS = Bonds that can only be transferred from one owner to another by proper endorsement & w/ the consent of the issuer. Thus
the owner is protected against loss or theft.
2. UNREGISTERED BONDS = Bonds that can be transferred from one owner to another at will & anytime the owner desires.
FORMULAS :
EXAMPLE : 1. A 5,000 . 6 % BOND W/ QUARTERLY COUPONS IS REDEEMED AT 115% AT THE END OF 10 YRS. FIND THE COUPON PAYMENT & REDEMPTION VALUE.
2. A 10K . 4 % BOND W/ SEMI-ANNUAL COUPON IS REDEEMED @ 95 % AT THE END OF 15 YRS. FIND THE COUPON PAYMENT & THE REDEMPTION
VALUE
GIVEN : FV = 10K Rr = 95 % Br = 4 % m = 2
3. A 4K 5.5 % BOND W/ QUARTERLY COUPON IS REDEEMED AT PAR AT THE END OF 5 YRS. FIND THE COUPON PAYMENT & REDEMPTION VALUE
4. FIND THE PURCHASE PRICE OF A BOND VALUED AT 10K W/ INT. AT 5.5 % PAYABLE QUARTERLY & REDEEMABLE AT 96 % IN 15 YRS. IF THE BOND YIELDS
6 % COMPOUNDED QUATERLY ON INVESTMENT.
INFLATION = Increase in amount of money needed to purchase same amount of goods or services. Inflation results in a decrease in purchasing power, i.e., one unit of
money buys less goods or services.
EXAMPLE : How much would be required today to purchase an item that increased in cost by exactly the inflation rate? The cost 30 years ago was 1000 and
inflation has consistently averaged 4% per year.
Deflation: Opposite of inflation; purchasing power of money is greater in future than at present; however, money, credit, jobs are tighter
= F ( 1 + if )-n
Money in a medium-risk investment makes a guaranteed 8% per year. Inflation rate has averaged 5.5% per year. What is the real rate of return on the investment?
Solution: Solve for the real rate i in relation for i
f
(1) Convert cash flow into constant-value (CV) and use regular i
n n
where: CV = future amt. / (1 + f) = present amt. / (1 + f)
f = inflation rate
(2) Express cash flow in future (then-current ) and use inflated interest rate where : if = i + f + ( i )( f )
6
Solution : a) Determine constant-value and use i in PW equation CV = 25,000 / (1 + 0.05) = 18,655 PW = 18,655 [(1+i f )-n ] = 10,530
if = 10 %
b)Leave as future dollars and use if in PW equation if = 0.10 + 0.05 + (0.10)(0.05) = 15.5% PW = 25,000 [(1+ i f )-n ] = 10,530
i f = 15.5 %
FW Calculations with Inflation : FW values can have four different interpretations ( FW = future worth )
An engineer invests 15,000 in a savings account that pays interest at a real 8% per year. If the inflation rate is 5% per year, determine :
(a) the amount of money that will be accumulated in 10 years,
(b) the purchasing power of the accumulated amount (in terms of todays dollars),
(c) the number of future dollars that will have the same purchasing power as the 15,000 today, and
(d) the amount to maintain purchasing power and earn a real 8% per year return.
SOLUTION : a. ) The amount accumulated is a function of the market interest rate, if if = 0.08 + 0.05 + (0.08)(0.05) = 13.4%
Amount Accumulated = 15,000 ( 1+ 0.134 )10 = 52,750
b.) To find the purchasing power of the accumulated amount deflate the inflated dollars
10
Purchasing power = 15,000( 1+ 0.134 )10 / (1 + 0.05) = 32,384
c.) The number of future dollars required to purchase goods that cost 15,000 now is the inflated cost of the goods
Number of future dollars = 15,000 ( 1+ 0.05 )10 = 24,434
d.) In order to maintain purchasing power and earn a real return, money must grow by the inflation rate and the interest rate, or if = 13.4%, as in
part (a ) FW = 15,000( 1+ 0.134 )10 = 52,750
EXAMPLE : If a small company invests 150,000 in a new production line machine, how much must it receive each year to recover the investment in 5
years? The real interest rate is 10% and the inflation rate is 4% per year.
ANNUAL WORTH METHOD ( AW ) = the excess of annual cash inflows over annual cash outflows is not less than 0 the
proposed investment is justified.
PRESENT WORTH METHOD ( PW ) = the PW of the net cash flows is equal to, or greater than, 0, the project is justified
economically.
FUTURE WORTH ( FW ) = exactly comparable to the present worth method except that all cash inflows & outflows are
compounded forward to a reference point n time called the future. If the FW of the net cash flows is
equal to, or greater than, 0 the project is justified economically.
PAYBACK/PAY-OUT PERIOD ( PPP ) = the length of time reqd. to recover the first cost of an investment from the net cash flow
produced by that investment for an int. rate of zero.
EXAMPLE : LUCIO TAN invested an amt worth 300M for a housing proj. in Palawan that will give him a yearly revenue of 190M for 5 yrs. &
depreciated cost of 10% on his investment. The operation & maint. Cost amounted to 81M annually. Insurances & taxes is @ 4% of its first
cost per year. He expects his investment to earn not less 25 % before income taxes. Det. whether the investment is desirable ? What is the
payback period ?