Chapter 2 - Interest and Time Value of Money

10/25/2020
Engineering Economics
Er. Santosh K. Shrestha Suman Shrestha Tunisha Gyawali Utsav Pradhan Yogesh S. Neupane
Chapter 2: Interest and Time Value of Money

Interest: Additional Amount Paid to Lender by
Borrower [More than PRINCIPAL amount]
Why Interest?
• Liquidity : If I have money, I can use it any
time but if not, I have to forgive SO TO
Compensate this I need Interest
• Risk Premium : If I give money to someone-
s/he might not return it to me – Taking Risk, so
To compensate this risk – I need more money
as Interest
• Inflation Factor : Purchasing Power of
Currency decreases with time so I need more
money to Compensate. . Time Value of Money
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Types of Interest - School Time Formula

a. Simple Interest: Interest on Principal b. Compound Interest: Interest on
Only. Principal as well as Interest after certain
For a deposit of P Rupees at a simple interest Period (one yearly, half yearly, quarterly,
rate of i for T periods, the total earned monthly, weekly etc.); interest is credited at
interest I would be the end of each interest period to next.
I = PTR/100
If there is ‘T' interest period ,then
and A = P + PTR/100
A = P(1 + R/100)T
Where;
I = Interest Amount Similarly; Interest I = A – P
P = Principal Amount So, I = P (1 + R/100)T – P
T = Time Period [Interest Period] Or I = P [(1 + R/100)T – 1]
R = interest Rate
A= Future Amount including Interest
Types of Interest – Contd..

School: P Here also P : Principal Amount
School: R/100 Here i : Interest rate
School : T Here N: No of period (time)
School: A Here F : Future Amount
Simple Interest Formula: Compound Interest Formula:

I = PTR/100 changes to A = P(1 + R/100)T Changes to
I = PN i F = P (1 + i)N
The total amount available at the end of Nth And Interest I can be calculated using:
period, thus would be: I = F – P = P [(1+i)N -1]
F = P + I = P + P N i = P (1 + Ni)
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Example : Deposit Rs 1000 in a Bank now. What will be the Future amount at the
end of Five Years if the interest rate is 10 percent per year?
P = 1000, i= 10% (0.1), N = 5 Years and F = ?
Using Simple Interest Formula Using Compound Interest Formula

F= P+ PN i F = P (1 + i)N
F
F= 1000 + 1000 x 5x 0.1
= 1000 + 500 F= 1000 (1 + 0.1)5
= 1500 N = 1610.51 N
Example : Calculate F if N is 100 years

Simple F = 11000, Compound F= 1,37,80,612.34
[Vast Difference because in Simple Interest it is Straight line while Compound Interest is
Logarithmic and increases exponentially.
Examples
• Suppose you deposit Rs. 1,000 in savings account that pays interest at a rate of 8%
compounded annually. Assume that you don't withdraw the interest earned at the end
of each period (year), but let is accumulate. How much would you have at the end of
year 3?
Solution: F = Rs. 1,000 (1 + 0.08)3 = 1,259.71 Ans
• You have just purchased shares @ Rs. 100 per share. If you expect the stock price
to increase 20% per year, how long do you expect it to double its market price?
Solution: F = 2 x P, I = 20% (0.2), N =?
• Given: F = 2 P and also F = P (1 + i) = P (1 + 0.2)N
N
So,
• P(1 + 0.2)N = 2P
• 1.2N = 2
• Taking log on both sides
• N log 1.2 = Log 2
• N = Log2/Log 1.2 = 3.80 = 4 years Ans
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Bank- Deposit Rs X now, will be 4 X in 10 years;

i=?
Solution : P = X and F = 4 P = 4 X
i=?
N= 10
F = P (1+i)N
4P = P (1+i)10
i= 41/10 -1
Solving, i = 14.86 % Ans
Example: Mr. X deposits Rs. 10,000 now in a bank which gives 8% interest per year.
He draws Rs. 4,000 at the end of 2nd year. What will be the remaining amount at the end
of 5th year?
Solution: At the end of the 2nd year, the accumulated
amount will be = 10,000 (1 + 0.08)2 = Rs. 11,664
After drawing 4000, the remaining deposit amount at the

end of 2nd year will be equal to 11,664 – 4,000 = Rs. 7,664.
At the end of the fifth year the total accumulated amount

CASHFLOW
will be equal to 7,664 (1 + 0.08)3 DIAGRAM
= Rs. 9,654.43 Ans
Alternatively,
F = {10,000 (1.08)2 – 4,000} (1.08)
= Rs. 9,654.5 Ans
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Economic Equivalence
Which is better option for you ?

• Option 1: get Rs 20,000 now
• Option 2: get Rs 50 000 at the end of 10 ears
• Option 3: get Rs 30000 at the end of six years
WHY?
Time value of money
Assume, Interest rate (i) = 5% (0.05) per year
Comparison between 1 and 2

Option 1: Get Rs 20,000 Now
F 10 = 20000 X (1 + .05)10 = 32577.89 So, Getting 20000 now is equivalent to Getting Rs
32577.89 in ten years from Now
Option 2: Get Rs 50,000 at the end of 10 years which is better than option 1 = Get Rs 32577.89
at the end of 10 years.
Select 2 from 1 & 2
Comparison between 1 and 3 [Since 1 is already out, it is not required : just for practice]
Option 3: Get Rs 30000 at the end of Six years which is equal to
Option 1: Get 20,000 now is equal to = 20000 X (1 + .05)6 = 26801.91 at the end of Six years.
Option 3 (Get Rs 30000 at the end of 6 years) is better than option 1 (Get Rs 26801.91)
Select 3 from 1 & 3
Comparison between 2 and 3

Getting Rs 30000 at the end of 6 years (Option 3) is equal to getting = 30000 (1 + .05)4 = Rs
36465 at the end of 10 years. So option 2 is getting Rs 50000 at the end of 10 years.
So, Option 2 isK. better
Er. Santosh Shrestha than both
Suman option
Shrestha Tunisha1Gyawali
and Option 3: Option
Utsav Pradhan 2 is Best
Yogesh S. Neupane
10/25/2020
Example of Economic Equivalence

Deposit Rs 10,000 in a bank now. Draw Rs 4000 at the end of 3 years. What will be the
amount at the end of five Years? Draw cashflow diagram also. i= 0.1 (10%)
Solution: F = P (1+i)N F =?
4000
F = {10000x(1+i)3 - 4000} x (1+i)2=11265.1 0

Or F = 10000x1.15 – 4000 x 1.12= 11265.1 3 5
Cash flow Diagram
10000
Or F + 4000 x 1.12
= 10000 x 1.15
Timing 5 3 + 2 = 0 + 5
Or 10000 = 4000 /1.13 + F/1.15 1. Make Cash inflow = Cash
Timing 0 3 - 3 5-5 Outflow
2. However, timing needs to
+ is multiply by (1+i)N and – is divide by (1+i)N be same. All are converted
Where, F and 4000 are Cash Inflows and 10000 is Outflow into Year 5 and 0.
So, if interest is Zero, Cash inflow = Cash outflow, F = 6000
But due to interest,

F + 4000 x 1.12 = 10000 x 1.15
5 3 + 2 0 + 5 Convert into same time line of year 5
Or F/ 1.15 + 4000/ 1.13 = 10000

5 -5 =0 3 - 3=0 0 Convert into same time line of year 0 [Now]
Or F / 1.12 + 4000 = 10000 x 1.13

5 -2 = 3 3 0 +3 =3 Covert into same time line of year 3 from now
Convert into any time line and make Cash inflow equal to Cash outflow- This is called
Principle of Economic Equivalence
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Find the Value of F if i = 10%

F =?
Using the Principle of Economic Equivalence:
Cash Inflow = Cash outflow 4000
10000 x (1+i)5= 4000 x (1+i)5 + F 0

0+5 2+3 5 2 5
+ is multiply by (1+i)^N and – is divide by

(1+i)^N 10000
F = 10000x1.1 - 4000x1.13
5
Cash flow Diagram
= 10781 Ans
Economic Equivalence
CASH INFLOW = CASH OUTFLOW
but Timing should be the SAME
Principle 1
• Equivalence calculations made to compare alternatives requires a common time
basis.
For selecting the reference point, commonly present time (present worth) or some point in
future (future worth) is used.The choice of point is as per convenience.
Principle 2
• Equivalence depends on interest rate i and factor used is (1+i)N
The equivalence between two cash flows is a function of both the cash flow pattern and the
interest rate that operates on those cash flows. Change in the interest rate will destroy the
equivalence between those two sums.
Principle 3
• Equivalence Calculations require the conversion of multiple payment cash flows to a
single cash flow.
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Find X Assume i = 10 % = 0.1

10000
A. 8000
5000
0 1 2 3 4 5 6 7 8 9
years
x =-2059.77
15000
2X
100000 25000
X
B. C. 3 3
0 5
2 3 4 5 6 8 10
2 6 3
3
0
500
x x x x x x x
10000 0
X = 25978.99
X =6701.772
Solution: 10000
8000
5000
0 1 2 3 4 5 6 7 8
9 years
x
15000
Using the Principle of Economic Equivalence,
Cash inflow = Cash Out flow
5000 + 8000 + 10000 = 15000 + X if i = 0% ie no interest
Timing 2 4 9 0 6 Bring in same time line
In 6, 2 + 4 4+2 9–3 0 + 6 6 + 0 Remember + = (1+i)N , - = 1/ (1+i)N
So, 5000 x 1.14 + 8000x 1.12 + 10000/ 1.13 = 15000 x 1.16 + X if i = 0.1
X = -2059.77
Calculate the value of X similarly by converting into time line 0 & 9.
Similarly find the value of X in other questions.
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Find X. Assume i = 10 % = 0.1

10000
5000 8000
0 1 2 3 4 5 6 7 8 9 years
x
15000
15000 x 1.14 + X/1.12 = 5000 x1.12 + 8000 + 10000/1.15

0+4 6 -2 2 +2 4 9–5
X = -2059.766
Nominal and Effective Interest Rates

Bank A offers you two options:
a. 1% interest per month and b. 13% interest per year
Which option is better for you: a or b? Choose b
If i = 1% per month then it is equal to ……..% per year?
a.12% b. > 12% c.< 12% or d. None/All of the above
Nominal interest rate is the basic annual interest rate (r) is 1% x 12 = 12% per
year because there are 12 months in a year. It is calculated using the concept of
simple interest.
Other examples:
If i is 2% in three month (Quarterly) , Nominal interest rate, r is 2% x 12/3 = 8%
If i is 5 % semi annually, Nominal interest rate r is 5% x 2 = 10 %
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Effective Interest Rates (contd..)

• But due to compounding effect, the actual interest rate is higher than that
(nominal) i.e. it uses the concept of Compound Interest.
• If i is 1% per month then actual or effective interest rate is > 12%
Concept:
Say P = 100, i = 1% per month, F = ? in a year [ i.e after 12 months]

Using the concept of compound interest, F = P (1 + i)N
F = 100 (1 + .12)12 = 112.68
So Interest I = F – P = 12.68
i = I /P = 12.68/100 = 12.68 %
So, 1% per month = 12.68% per year (Effective)
Relation Between Effective (i) and Nominal (r) interest rate
i = [ 1 + (r / m) ] m - 1
Where,
i = Effective Interest Rate, M = No. of compounding periods per year and r =
nominal interest rate.
If i = 1% per month , r = 12%, M = 12 (1 yr = 12 month)
I effective (i) = (1 + .12/12)12 – 1 = 0.1268 = 12.68%
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Example : If i is 6 % per year but Compounded Daily what is the effective

interest rate?
Solution:
If interest rate is given (and Compounded is mentioned) then it should be considered
as Nominal Interest Rate (r).
So, r = 6%, and M = 365 [Compounded daily] (1yr = 365 days)

and i = Effective Interest rate = ?
Using the Above Formula,
ia = [ 1 + (r / m) ] m - 1
i = (1 + .06/365)365 – 1 = 0.0618= 6.18 %
What is the effective interest rate of the nominal interest rate 9% per year if the
compounding is (a) yearly (b) quarterly (c) monthly (d) daily (e) continuously (M ∞).
Solution:
Given, r = 9%
a) Compounded yearly means M = 1 , so I = (1 + .09/1)1 – 1 = 9%
b) M = 12/3 = 4, Effective Interest rate = (1 + .09/4)4 – 1 = 9.308%
c) M = 12, Effective Interest rate = (1 + .09/12)12 – 1= 9.38%
d) M= 365, , Effective Interest rate = (1 + .09/365)365 – 1 = 9.41%
e) Compounded Continuously means M ∞, Effective Interest rate = (1+9%/∞)∞ - 1
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Derivation of Formula if M tends to Infinite

i = [ 1 + (r / m) ] m– 1
We Know: Calculus
Lim x ∞ (1 + 1/X)X = e
Suppose, r/M = 1/X or M = rX

If X ∞ then M ∞
So, I Effective = Lim X ∞ (1 + 1/X)rX - 1
So, I effective = er -1
So, In above Case, e.09 – 1 = (0.0941)
Similarly, 9.41%
F = P (1 + i)N , if i= er – 1 then F= P erN
How many deposits of Rs. 25,000 each should Dr. Thakur make each month so that the
final accumulated amount will be Rs. 10,00,000 if the bank interest rate is 12% per year?
Solution:
A = 25,000 per month,
F = 10,00,000, i = 12% per year
We know,
Monthly interest rate( im )= (1 + iyear)1/12 – 1
im = (1+0.12)1/12 – 1
im = 0.0094 = 0.94%
∗
Annuity(A)=( )
, , [ . ]
Or,25000= [ . ]
Solving N = …….. Month will be > 34 and < 40 times
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If in 2042 BS I came to Kathmandu after passing SLC and I have Rs 5000

saving, What will be its worth as per now? Take interest rate as 10%.
• F = P(1+i)N , here N = 77-42 = 35 years

= 5000 (1.1)35 = 140512.
which bank would you prefer? NBL, RBB, etc
Remember, different banks can have different interest rates. Along with interest
rate , we also look for their service and security
If interest rate = 6%, Compounded Daily : What would be effective interest

rate?
[this means daily interest rate is 6/365%]
r= 6%,
M = 365, i.e 1 year.
I eff =(1+0.06/365)365 -1 = 6.18%
daily interest rate

The population of Kathmandu is supposed to be 50 Lakh including

floating population, What will be the population in 10 years from now?
If Growth rate r = 2.5% per year.
F = P(1+i)N
= 50*(1.025)10 = Rs 64Lakh
Growth is not continuous
But if growth is continuous, what would be the population for same year
time?
F = P*erN
Remember, the growth rate is compounded continuously
= 50 *e(0.025x10)
= 64.201 lakh
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Alternatively
iN = (1+ i)N – 1
Example :
1. If i = 1% in three month Yearly interest 3.if I = 6 % in a year, monthly interest
is rate is ?
= (1+1%)4 – 1 = 1.01 4 – 1 = 4.06 % iN = (1+ i) N – 1
(Nominal r = 4%) or iN + 1= (1+ i) N
Because there are four three months is a year
Or, (1+ i) N = 1+ iN
2. If i = 3% in six month, yearly interest Or, i = (1+ iN )1/N – 1

rate is …
= (1+0.03)2 – 1 So iN = I year = 6%, monthly interest
Because there are two six months in a year. rate is
i month = (1+0.06)1/12 – 1 = 0.486%
imonth ------> iyear iyear ------> imonth
A bank offers 0.5% per month or 1.1 % in two month. Which one is
better for you?
SOLUTION b. 1.1 % in two month

a. 0.5 % per month r = 1.1 x 6 = 6.6 %,
r = 0.5 x 12 % = 6%, M = 6,
M = 12, ieff = (1+6.6%/6)6 – 1
ieff = (1+6%/12)12 – 1 = 6.784%
= 6.168%
So option b Is better
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Which one of this options is better?

0.5% per month, 1.1% in two month, 1.61% in three month,
3.25% in six month, 6.6% in a year or 35% in 5 year
Converting all into yearly equivalent interest rates!
1. 0.5% in month = (1+0.005)12 – 1 = 6.16% Minimum so best for Bank

2. 1.1% in 2 month = (1+0.011)6 – 1 = 6.78% maximum- best for depositor
3. 1.61 % in 3 mo = (1+0.0161)4 – 1= 6.59%
4. 3.25% in 6 mo = (1+0.0325)2 – 1 = 6.605%
5. 6.6 % per year = 6.6%
6 35% in 5 yr = (1+0.35) (1/5) – 1 =6.18%
(If ,Ignoring compounding effect i = 35/5 = 7% )
Deposit Rs 1000 in a bank now which gives 10% interest per year
but monthly, what will be the amount at the end of 5 years?
Option 1
• P = 1000, r = 10% per year but monthly
so i = 10/12% per month= .833%
• N = 5 years = 5*12 = 60 months
• So F = 1000 [1+.833÷ 100]60 = 1645.31
Option 2
• P = 1000, N = 5 years, I = ? …. Years
• I = (1+r/M)M – 1 ,where M = 12
so, ieff = (1+10%/12)12 – 1= 10.47%
• F = 1000 (1+10.47%)5 = 1645.30
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Deposit Rs 5000 now. What will be the amount at the end of 10 years if
interest rate is 1% per month?
Option A:
P = 5000;
i= 1%(0.01) per month;
N = 10x12 = 120 ;
F=P(1+i)N = 5000*(1.01)120
= 16501.93
Option B:
P = 5000
i= 12.68% per year (1% per month= 12.68 per yeari i.e,ieff);
N= 10
F = 5000 (1.1268….)10
= 16498.
Deposit Rs 10000 now. What will be the amount at the end of 5 years if
interest rate is 2% in three month?
Option A:
P = 10000;
i= 2 % (0.02) per 3 month;
N = 5x12/3 = 20 ;
F=P(1+i)N = 10000(1.02)20
= 14859.47
Option B:
P = 5000
i= (1+0.02)4 – 1 = 8.24 % per year (2% per 3 month= ……. per year);
N= 5 year
F = 10000 (1+8.24%)5
= 14857.27
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Deposit Rs 5000 at the beginning of year 4 from now. What will be

the amount at the end of 10 years if bank interest rate is 6%
compounded i) monthly ii) Continuously ?
• Solution:
Using the Principle of economic
Equivalence F=?
F = 5000 x (1+i)7
10 3 + 7
0 3
10
i =?
5000
a. (1+6%/12)12 -1 = 6.17%
So, F = 5000 x(1+….) 7 = 7601.45
b. i= e0.06 – 1 = 6.183%
So, F = 5000 x(1+……) 7 = 7609.8
Deposit Rs 5000 at the end of first year, second year, 3rd, 4th, and 5th
yr. Continuously. What will be the amount at the end of 5 years if
bank interest rate is 10% per year?
Solution;
F = 5000 x1.14 + 5000x1.13 + 5000x1.12 + 5000 x1.11+ 5000

5 1 +4 2 +3 3+2 4 +1 5
F=
F = 30525.5 ?
F = A [(1+i)N -1]/i 0 1 2 3 4 5
A= 5000; i= 10% (0.1)

N= 5 5000
F = 5000 x (1.15-1)/0.1
= 30525.5
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2.5 DEVELOPMENT OF INTEREST FORMULAS
Types of cash flow
A. Single Cash flow:

Only one cash flow.
B. Equal (uniform) series Cash flow:

Series of Cashflow at equal interval of time
ANNUITY – Equal amount of cashflow at equal Interval of
1 ,0 0 0 1 ,0 0 0 1 ,0 0 0 1 ,0 0 0 1 ,0 0 0
time- EMI
Eg: payment of loan in equal periodic installments
0
Ye a rs
Er. Santosh K. Shrestha Suman Shrestha Tunisha Gyawali Utsav1 Pradhan 2 Yogesh S.3Neupane 4 5
C. Linear Gradient Series:

No cashflow in year 0, and in year 1 and increasing
by equal amount G for remaining years.
Increasing by Rs 50 per year G = 50
Year Cashflow(X1) Cashflow(X2)
1 0 500
2 50 550
3 100 600
4 150 650
D. Geometric gradient series:

Increasing or decreasing the cashflow by certain
percentage yearly. Below is increasing
Year 1 = 100
Year 2 = 110 (increase by 10%)
Year 3 = 110x1.1 = 121K. Shrestha
Er. Santosh Suman Shrestha Tunisha Gyawali Utsav Pradhan Yogesh S. Neupane
10/25/2020
E. Irregular Series:
A series of cash flow may be irregular. It doesn't exhibit an overall
regular pattern.
Interest Formulas
Interest formula relating a uniform (equal) series.
1. To find F when A is given
Let's consider the following cash flow as shown at the end of each period.
P = Cash flow in year 0,

F is the Cashflow at the end of Nth year and
A is ANNUITY (Uniform cashflow/equal cashflow at the equal interval if time
which starts at the end of year 1 and ends at Nth year)
F = A {(1 + i)N–1 + (1 + i)N–2 + (1 + i)N–3 + ............ + (1 + i)1 + 1}
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50
Find the Value of F; i = 10% (0.1) 5

0 1 2 3 4
F = 50x1.14 + 50 x1.13 + 50x1.12 + 50x1.11+ 50

5 1 +4 2 +3 3+2 4 +1 5
F = 294.755
Or, Alternatively
F = A [(1+i) N -1]/i
where A = 50; N = 5 and i= 0.1 (10%)
F = 50 [(1.1) 5 -1]/0.1
F = 294.755
Derivation of the Formula

50
0 1 2 3 4 5
F = 50x1.14 + 50 x1.13 + 50 x 1.12 + 50x1.1+ 50 … I

Multiplying Both sides by (1+i) i.e. (1+.1) or (1.1), We get
F x 1.1 = 50x1.15 + 50x1.14 + 50 x1.13 + 50 x 1.12 + 50x1.1 …II
Subtracting I from II, we get
F = Future Value
Fx1.1 – F = 50x1.15 – 50 A = Annuity (Equal cash flow at
F x 0.1 = 50 [1.15 -1] equal interval of time)
5
F = 50 [1.1 -1]/0.1 N = No of Cashflow (A)
= A [(1+i)N -1] / i I = interest rate
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Find the Value of F; i = 10% (0.1)

50
F = A [(1+i) N – 1)]/I
A = 50, N = 5, I = 0.1
0 1 2 3 4 5
F = 294.755
F
F= 50x1.14 + 50 x 1.13+50 x1.12+ 50x1.1+ 50 x1.1^0

5 1 +4 2 +3 3 +2 4+ 1 5+0
F = 50 (1.14 +1.13 +1.12 +1.1+1) in Geometric series r,
• F = A [ (1+i) 4 + (1+i) 3 + (1+i) 2 + …..+ (1+i) +1] : A = 50, I = 0.1 , 5 = N

• F = A [ (1+i)N-1 + (1+i)N-2 + (1+i) N-3 +…..+ (1+i) +1]
F = A (1 + i)N–1 + A (1 + i)N–2 + .......... + A(1 + i) + A ........ (i)

Multiplying both sides by (1 + i)
F(1 + i) = A (1 + i)N + A (1 + i)N–1 + ........... + A(1 + i)2 + A(1 + i) ......... (ii)
Subtracting equation (i) from equation (ii), we get
F(1 + i) – F = A(1 + i)N – A
F + Fi - F = A {(1 + i)N – 1}
A starts at the end of year 1 and ends
at Year N
F = A ((1 + i)N – 1)
i
The quantity in a bracket is called the uniform series compound amount factor.
Functionally, F = A (F/A, i % , N)
Note:
F (Future worth) coincides with last annuity ‘A’ and A (Annuity) occurs at the end
of each period starts at year 1 and end at N th year.
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F = A [(1+i)N – 1] A A A A A
i
F = A [F/A, i%, N] where 0 1 2 3 N-1 N
[F/A, i%, N] = [(1+i)N – 1]
i
F=?
Or
F=?
A= Fxi
[(1+i)N -1]
0 1 2 3 N-1 N
A = F x [A/F, i%. N]
[A/F, i%. N] = i A
[(1+i) N -1]
Example
If a woman deposits Rs. 15,000 at the end of each year for 10
continuous period years, how much money is accumulated at the end of
10 years? i = 10% compound annually.
Solution: F =? , A = 15000, N = 10, i=10% (0.1) F=?
i = 10%
0 1 2 3 4 5 6 7 8 9 10
15000 15000 15000 15000 15000 15000 15000 15000 15000 15000
Using uniform series compound amount factor.
F = A [(1+i)N -1]/i= F {(F/A, 10%, 10) or
F = 15,000 {((1+0.1)10 – 1)/0.1}
F = Rs. 2,39,061.36 (Ans)
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Mr. Ramesh wants to have Rs. 10,00,000 for the studies of his
daughter after the period of 10 years. How much rupees does he has
to deposit each year for 10 continuous years in saving account that
earns 8% interest annually.
1000000
Solution: 0 1 2 3 8 9 10
A = F x i / [(1+i)N -1] A= ?
Given F = 10,00,000 ; N = 10, I = 8%; A = ?
A = 69,029.48
To find P when A is given

We know, F = A [(1+i)N -1] /i :Also, F = P (1 + i)N A A A A A
P(1 + i)N = A [(1+i) N -1] /i
P = A [(1+i) N -1] 0 1 2 3 N-1 N
[i*(1+i) N]
P=?
P = A [P/A, i%. N] Where
[P/A, i%. N] = [(1+i) N -1] P
[i*(1+i) N]
Or,
A = P [i*(1+i) N ] 0 1 2 3 N-
1 N
[(1+i) N -1]
A = P [A/P, i%, N] A
Where; [A/P, i%, N] = [i*(1+i) N ]
[(1+i) N -1]
10/25/2020
How much money should you deposit now in a saving account

earning 10% interest rate compounded annually so that you may
make end of year withdrawal of Rs. 2000 each?
Solution:
Given : Rs. 2,000, N = 8, i = 10% per years.
P = A [(1+i)N -1]/[i*(1+i)N]
P = 2000 [1.18 -1]/[0.1*1.18]
P = Rs. 10,669.85 (Ans)
Mr X takes loan of Rs 500,000 now from a Bank and wish to Repay the
loan in monthly installment in 5 Years. How much Rupees should he
pay in each installment if bank interest rate is 1% per month?
Solution: if no interest = 500000/60 = 8333.33

P = 500,000 ; N = 12x5 = 60; i= 1% per month i= 0.01; A = ?
This is also called EMI; Equal monthly Payment
A = P [ix(1+i)N]/[(1+i)N -1]
= 500000 [0.01x1.0160 ]
[1.0160 -1] 500000
A = Rs 9083
0 1 2 3 58 59 60
9083 x 60 = 544980>500000
Er. Santosh K. Shrestha Suman Shrestha Tunisha Gyawali A Pradhan

Utsav =? Yogesh S. Neupane
10/25/2020
How many deposits of Rs. 25,000 each should Dr. Thakur make each month
so that the final accumulated amount will be Rs. 10,00,000 if the bank
interest rate is 1% per month?
Solution :
If no interest , N = 1000000/25000 = 40 Times, N < 40 because of interest
A = 25000; F = 1000000; i=1% (0.01) per month N= …..? Month
A = F x i/[(1+i)N -1]
25000-[10,00,000 x0.01/(1.01N -1)]=0
1/40 = [0.01/[1.01N -1]
1/[40x0.01] = 1/[1.01N -1]
[1.01]N = .4 +1 = 1.4
N log [1.01] = log [1.4]
N = Log[1.4]/Log [1.01] = 33.8
Taking log both sides;
N = 33.89 Times (Month)
Er. Santosh K. Shrestha
= 34 Months
Suman Shrestha Tunisha Gyawali Utsav Pradhan Yogesh S. Neupane
A man in 35 years now. He wish to deposit 20% of his Salary in a bank until
he retires at the age of 58. His salary is 50000 Rs per month. What will be the
total amount at the time of retirement if Bank gives 12% interest per year?
Solution: F = ?
Given: A = 10,000 per month; N = (58-35)x12 month = 276
If no interest, Future Amount is equal to 276x10000 = 27,60,000
If i= 12% per year

Hint: convert yearly interest rate into monthly interest rate first.
We know,
I month = [I + Iyear]1/12 – 1
=1.12(1/12) -1 = 0.0094
So, 12% per year is same as 0.94% (0.0094) per month
then use F = A [(1+i)N -1]/i = 10000[1.0094276 -1]/0.0094

= 1,30,07,756.44 which is vastly different from 27,60,000 (i=0%)
10/25/2020
10/25/2020
50
Find the value of P; i= 0.1
0 0
1 2 3 4 5 1 2 3 4 5
P F=
305.255 p
F=A
F = P (1+i)N
Also, P=( )
P=( )
So, P=A ( )
P= 305.255/ 1.15
( . )
P=189.539 P=50X . ( . )
P=189.539
This shows that if u keep Rs189.539 at bank now then you can withdraw Rs305.255 after 5
yrs or can withdraw Rs 50 every year
for 5 yrs.
10/25/2020
Multiplying both sides by 1/(1+i) we get 2.7

below and then subtracting 1 from 2.7 we get:
Example : If a woman deposits Rs. 15,000 at the end of each year for 10 continuous
period/years, how much money is accumulated at the end of 10 years?
i = 10% compound annually (10% per year).
Solution:
F= ? ; A = 15000; N = 10 and
i= 10% (0.1)
We Know:
F=A
Putting the values of A, N and i
we get:
F = 15,000x[(1+0.1)10 – 1]/0.1
F = Rs. 2,39,061.36 Ans
10/25/2020
Mr. Ramesh wants to have Rs. 10,00,000 for the studies of his daughter after the
period of 15 years. How much rupees does he has to deposit each year for 10
continuous years in saving account that earns 8% interest annually.
Solution: Given F = Rs. 10,00,000 at 15 years, N = 10 (Deposits) ,i = 8% per year,
A=?
Solution:
Ramesh needs Rs 10,00,000 at the End of 15
years. Which is equivalent to
= Rs 10,00,000/1.08 5 using P = F/(1+i)N
= Rs. 6,80,583.197 at the End of 10 years
Now we can use the formula easily

F= 680583.197
∗
A =( )
A = 680583.197 x [0.08/(1.08)10 – 1)] 1
0 5 10
A = Rs. 46,980.31 . Ans.
So he has to deposit Rs 46980.31 Rs each year
A= ?
for 10 years continuously
10/25/2020
OR Alternatively
We know,
F=A
As we know, Timing of Last A should be same as
Timing of F to use this formula.
But here,
10,00,000 = A x [(1 + i)10 – 1)/i]
Timing: 15yrs 10yrs
Mismatch
Make both same (Say 10)
10,00,000/1.085 = A x [(1.08)10 – 1)/0.08]
(15 – 5)yrs 10yrs
A= Rs. 46,980.31
So he has to deposit Rs 46980.31 continuously
for 10 years from now.
F = ?, N = 8 (No of cashflow )
I = 10%
10/25/2020
Find P , i = 10%
4 5 6 7 8 11 12 13 14 15 16
0
A1= 5000
A2 = 8000
Solution:
P=A ( )
A1 – 5 Nos and ends at 8th year ; A2 – 6 Nos and ends at 16 years
P = A1x[(1.15 -1)/0.1] + A2x [(1.16 -1)/0.1]
0 8 16 Timing needs to be adjusted
P = 5000 {(1.15 -1)/0.1}/ 1.18 + 8000{(1.16 -1)/0.1}/1.116

0 8–8 16 -16 All At 0
= 27673.5
10/25/2020
Find F, Given i = 10% F=?
3000
5
0 1 2 3 4 8
5000
10000
Solution:
F + 3000x [(1.14 -1)/0.1] = 10000 + 5000
8 4 0 5 Timing mismatch
F = – 3000 {(1.14 -1)/0.1} x 1.14 + 10000 x 1.18 + 5000 x 1.13
8 4 + 4 0 + 8 5 +3
F = 7706.22
10/25/2020
Example: A man is at 35 now. So No Pension – TENSION . He wishes to deposit

Rs 5000 per month until he retires at 58 yrs so that he get certain amount as
pension for 22 more years (Till he is 80). How much Rs can he get per month if
Bank gives him 6% interest rate compounded monthly?
F=A
i= 6% per year= 6%/12 per month,N=(58-35)X12= 276months
• F = 5000 [(1.005)276 -1]/0.005 = 29,61, 257
• F becomes P for remaining years.
• P = 2961257, A =?, N = 22x12 = 264 times, I = 0.005
∗( )
A=Px( )
= 2961257 {0.005 x1.005264}/(1.005284 -1)
= 20227.1
Find X, i =10%
8500
7500
6
2 3 4 5 8 9 10 11
X=
?
Solution:
X = 7500 (1.14 -1)/0.1 x 1.1 + 8500 {(1.14-1)/0.1 }/1.15
6 5+1 11 - 5
=62782.66
10/25/2020
18
Uniformly Increasing
16 Cashflow
Cashflow 14 increasing by
Find F = ?153 12
Rs 2 each year
i = 10 % 10
0 1 2 3 4 5
F =?
Cash inflow = Cash outflow (In same time line)

F = 10 x1.14 +12x1.13+14x1.12 +16x1.1 + 18
5 1+4 2+3 3+2 4 +1 5 Now at 5
F = 83.153
Find F, I = 10% 18 ( )
F=G
16
14 G = 2 (increasing amount)
12
N = 4 + 1 = 5 i = 0.1
10
F = 2 [(1.15 – 5x0.1 -1)/0.12]
F2 = 22.102
0 1 2 3 4 5
8
F =? 6
4
10
2
0 1 2 4 0 1 2 3 4 5
3 5
F1 F2
F1 = 10 x[1.15-1]/0.1 = 61.051
Er. Santosh K. Shrestha F = f1 + f2Tunisha

Suman Shrestha = 83.153
Gyawali Utsav Pradhan Yogesh S. Neupane
10/25/2020
Or alternatively 18 ( )
F=G
16
14 G=2
12
10
N = 5 + 1 = 6 i = 0.1
F2 = 2 [(1.16 – 6x0.1 -1)/0.12]
0 1 2 3 4 5 = 34.312
10
8
6
F =? 4
8
2
1 2 4 0 1 2 3 4 5
0 3 5
F1 = 48.84 F1 F2
F = f1 + f2 = 83.153
My Salary is Rs 100,000 per month. I want to deposit 20% of my salary per

month [Rs 20000 at the end of first month] and wish to increase the deposit
amount by Rs 500 per month continuously for 10 years.
What will be the amount at the end of 10 years if bank interest rate is 1%
per month?
Hint: Draw Cashflow diagram and use the formula correctly

Use this formula for uniformly increasing cash flow
( )
F=G
10/25/2020
F= ?
i=0.01=1%
0 1 120
20000 G = 500
F= F1 + F2 = 10102708.26
F1=
F2=
i=0.01=1% 1 2 120
0 1 120
500
20000 N= 119+1 =120

F1 = 20000 x[1.01120-1]/0.01 F2 = Gx[(1.01120- 120x0.01-1]/0.01120
= 4600773.789 = 5501934.47
Deposit Rs 18 at the end of First year, Rs 16 at the end of 2 yr, 14 at the end
of 3 yr, 12 at the end of 4 yr and 10 at the end of 5 year. What will be the
amount at the end of 5 years? I = 10%
Solution Hint: Draw Cashflow diagram and Calculate

a. Directly Cashflow
b. Using F = A x….. + F = G x …. Formula increasing by
Rs 2 each year
18
16
a. Direct 14
Cash inflow = Cash outflow (In same time line) –
12
Now at 5 10
F = 18 x1.14 +16x1.13+14x1.12 +12x1.1 + 10 =
5 1+4 2+3 3 +2 4 0 1 2 3 4 5
+1 5
F = 87.789 F =?
10/25/2020
Find F = 3 , I = 10 %
( )
18 F=G
16
G = 2 (increasing amount)
14
12 N = 4 + 1 = 5 i = 0.1
10
F = 2 [(1.1^5 – 5x0.1 -1)/0.1^2]
F2 = 22.102
0 1 2 3 4 5
8
F =? 6
4
18
2
0 1 2 4 0 1 2 3 4 5
3 5
F1 F2
F1 = 18 x[1.15-1]/0.1 = 109.89
F = f1 - f2 = 109.89-22.102= = 87.789
Derivation of the formula

Relation of F and G
Year Cash flow
0 -
8 1 0
6
4 2 2
2
3 2+2 = 4
2 3 4 5n 4 4+2 = 2+2+2 = 6
5 6+2 = 2+2+2+2 = 8
F = 22.102
F = G x [(1+i)N – N * i – 1]/ i2
i = 10%
F = 2 [(1.15 – 5 * 0.1 - 1) / 0.12] G=2
F = 22.102 N=5
10/25/2020
6 8
4
2
n
2 3 4 5
F = 22.102 This is equivalent to:
2 5
F1 = 2x{ (1.14 – 1 } / 0.1 = 9.282 = G {(1+i) (N-1) -1 }/i
f1
2
F2 = 2x{ (1.13 – 1 }/0.1 = 6.62 = G {(1+i)(N-2) -1 }/i
3 f2 5
2
4 F3 = 2x{ (1.12 – 1 }/0.1 = 4.2 = G {(1+i)(N-3) -1 }/i
f3 5
2
F4 = 2x{ (1.11 – 1 }/0.1 = 2 = G {(1+i)(N-4) -1 }/i
f4 5
F = F1 + F2+F3 + F4 = 9.282 + 6.62 + 4.2 +2 =22.102
So Generalizing we get:
F = G/i * [ (1+i)(N-1) + (1+i)(N-2) + (1+i)(N-3) + …..………..+(1+i)1 – (N-1) }
-------------1
Multiplying both sides by (1+i) we get;
F (1+i) = G/i * [ (1+i)N + (1+i)(N-1) + (1+i)(N-2) + …..………..+(1+i)2 + (1+i) – N (1+i)} ]

Or, F (1+i) = G/i * [(1+i)N + (1+i)(N-1) + (1+i)(N-2) + …..……..+(1+i)2 + (1+i) – N - Ni) ]
--------- 2
Subtracting 1 from 2
F (1+i) – F = G/i * [ (1+i)N –Ni - 1]

F * i = G/i * [ (1+i)N –Ni - 1] in above case :
F = G/i2 * [ (1+i)N –Ni - 1] F = 2 * [1.15 – 5*0.01 - 1] / 0.12
P = F /(1+i)N = 22.102
P = G/i2 * [ (1+i) N –Ni - 1] / (1+i)N
10/25/2020
A man wants to Deposit Rs 10000 at the end of this month. He wishes to

increase the amount by Rs 100 per month for 10 years. What will be the
amount at the end of 10 years if i = 1% per month
Solution:
1 Here, A = Rs10000, G = Rs100,
0
N = 120 months,
i =1% per month = 0.01
0 1 120 0 1 2 120
100
10000 (120-1)100
F2 = G / i2 [(1+i)N
– Ni -1]
F1 = 10000 (1.01120 -1) / 0.01 F2 = 100 / 0.01 * [(1.01120 – 120*0.01 – 1]
2
= 2300386.895 =1100386.895
F = F1 + F2 = 3400772.789
10/25/2020
A man wants to Deposit Rs 10000 at the end of this month. He wish to

decrease the amount by Rs 100 per month for 10 years. What will be the
amount at the end of 10 years if I = 1% per month
Solution:
1
0 F2 = G/i^2 [(1+i)^N – Ni -1]
G = 100, N = 120 . i=0.01
F2 = 100/0-.1^2[(1.01^120 –
10000 120x0.01 – 1] =1100386.895
0 1 120 0 1 2 120
100
10000 (120-1)100
F = F1 – F2
= 10000 ((1.01)120 -1) / 0.01 - 100 ((1.01120 - 120 * 0.01 -1)/0.012
= 12,00,000.05
10/25/2020
10/25/2020
10/25/2020
F=?
FORMULA FOR GEOMETRIC GRADIENT I =0.08
CASHFLOW (8%)
0 1 2 3 4 5
Here:
A1 = 100
100
N =5
Increasing 110 g =10%
by 10%
121 133.
I = 8%
1 146.41
F = 100 * 1.084 + 110 * 1.083 + 121 * 1.082 + 133.1 * 1.08 + 146.41 = 705.909
F = A1 * (1+i)(N-1) + A1 * (1+g) * (1+i)(N-2) + A1 * (1+g)2 * (1+i)(N-3) + A1 * (1+g)3 *
(1+i)(N-4) + A1 * (1+g)4 --------------------- 1
N N
F = A1 [(1+i) – (1+g) ]/ [i-g]
For given question : F = 100 [(1.085 - 1.15) / (0.08 - 0.1)]
= 705.91
10/25/2020
DERIVATION OF THE FORMULA

F = A1 * (1+i)(N-1) + A1 * (1+g) * (1+i)(N-2) + A1 * (1+g)2 * (1+i)(N-3) ………A1 * (1+g)(N-
3) * (1+i)2 + A1 * (1+g)(N-2) * (1+i) + A1 * (1+g)(N-1) ----------------------------1
which is in Geometric Series with Multiplying Factor (1+g)/(1+i)
So multiplying both sides by (1+g)/(1+i)
F (1+g) / (1+i) = A1 (1+g) (1+i)(N-2) + A1 (1+g)2 (1+i)(N-3) + …..…+ A1 (1+g)(N-2)
(1+i)1 + A1 (1+g)(N-1) + A1 (1+g)N / (1+i) ---------------------2
Subtracting 1 from 2, red part of both equations cancel out so:
F (1+g) / (1+i) – F = A1 (1+g)N / (1+i) - A1 (1+i)(N-1)
F [(1+g)- (1+i)] / (1+i) = A1 (1+g)N / (1+i) - A1 (1+i)N / (1+i)
Or F (g-i) = A1 [(1+g)N – (1+i)N]
Or F = A1 [(1+g)N – (1+i)N] / [g - i] = A1 [(1+i)N – (1+g)N] / [i - g]
If i = g, from equation 3 : F = 0/0 =infinite , then what is the formula for F?
Using equation 1 we get:
F = A1 * (1+i)(N-1) + A1 * (1+g) * (1+i)(N-2) + A1 * (1+g)2 * (1+i)(N-3) + A1 *

(1+g)3 * (1+i)(N-4) + A1 * (1+g)4
When i = g:
F = A1 * (1+i)(N-1) + A1 * (1+i) * (1+i)(N-2) + A1 * (1+i)2 * (1+i)(N-3) + A1 * (1+i)3

* (1+i)(N-4) + A1 * (1+i)4
F = A1 * (1+i)(N-1) + A1 * (1+i)(N-1) + A1 * (1+i)(N-1) + A1 * (1+i)(N-1) + A1 *
(1+i) (N-1)
F = N A1 (1+i)(N-1)
10/25/2020
We know, P = F/(1+i)^N
So,
P = A1 [(1+g)N – (1+i)N] / [(g - i) * (1+i)N]
= A1 [(1+i)N – (1+g)N]/ [(i - g) * (1+i)N]
[ for i ≠ g ]
And,
P = N A1 /(1+i) = N A1 (1+i)-1
[ for i = g ]
P = A1 / (1+i) + A1 (1+g) / (1+i)2 + A1 (1+g)2 / (1+i)3 +…..+ A1 (1+g)(N-2) / (1+i)(N-1) + A1

(1+g)(N-1) / (1+i)^N ..i
which is in Geometric Series and multiplying factor is (1+g)/(1+i)
So, Multiplying both sides by (1+g)/(1+i)

P (1+g)/(1+i) = A1 (1+g) / (1+i)2 + A1 (1+g)2 / (1+i)3 + A1 (1+g)3 / (1+i)4 ………..+
A1(1+g)(N-1) / (1+i)^(N) + A1(1+g)N / (1+i)( N+1) ………… ii
Subtracting i from ii
P (1+g) / (1+i) – P = A1 (1+g)N / (1+i)( N+1) - A1 / (1+i)
Or, P [(1+g) / (1+i) - 1] = A1 / (1+i) * [(1+g)N / (1+i)N - 1]
Or, P [1+g -1 –i] / (1+i) = A1 / (1+i) * [(1+g)N / (1+i)N - 1]
Or, P (g – i) = A1 [(1+g)N / (1+i)N - 1]
So, P = A1 [(1+g)N / (1+i)N - 1] / (g –i) = [A1 / (g-i)] * [(1+g)N – (1+i)N] / (1+i)N

Alternatively
We Know F = P (1+i)N so, F = [A1 / (g - i)] * [(1+g)N – (1+i) N]
OR
Er. Santosh K. Shrestha F Suman
= [A1 / (i – Tunisha
Shrestha [(1+i)NUtsav
g) * Gyawali Pradhan N] Yogesh S. Neupane
– (1+g)
10/25/2020
PRACTICE QUESTION
A man earns Rs 50,000 per month now. He wish to deposit Rs 5000 (10% of his salary )
at the end of this month. i)He wish to increase the amount by Rs 100 per month for 20
years ii)He wish to increase the amount by 1% each month for 20 years. What will be
the amount at the End of 20 years in both cases. I = 1% per month.
Answers:
i) Rs. 1,24,38,830.48
ii) Rs. 1,29,41,647.91
SOLUTION
i) 1 240
Here, A = Rs5000, G = Rs100,
0
N = 20 years = 240 months,
5000 i =1% per month = 0.01
0 1 240 0 1 2 240
100
5000 (240-1)100
F1 = A [(1+i)N -1] / i F2 = G / i2 [(1+i)N – Ni -1]

F1 = 5000 (1.01240 -1) / 0.01 F2 = 100 / 0.012 * [(1.01240 – 240*0.01 – 1]
= 4946276.827 = 7492553.654
F = F1 + F2 = 12438830.48
10/25/2020
SOLUTION
ii) 1 240
0
5000
Here, A = Rs5000,
N = 20 years = 240 months,
i = 1% per month = 0.01
g = 1% per month = 0.01
Since g = i, F = N A1 (1+i)(N-1)
F = 240 * 5000 * 1.01(240-1)
= 12941647.91
10/25/2020

Chapter 2 - Interest and Time Value of Money

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Chapter 2 - Interest and Time Value of Money

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10/25/2020

Chapter 2: Interest and Time Value of Money

Types of Interest - School Time Formula

Types of Interest – Contd..

Simple Interest Formula: Compound Interest Formula:

Using Simple Interest Formula Using Compound Interest Formula

Example : Calculate F if N is 100 years

Bank- Deposit Rs X now, will be 4 X in 10 years;

After drawing 4000, the remaining deposit amount at the

At the end of the fifth year the total accumulated amount

Which is better option for you ?

Comparison between 1 and 2

Comparison between 2 and 3

Example of Economic Equivalence

F = {10000x(1+i)3 - 4000} x (1+i)2=11265.1 0

But due to interest,

Or F/ 1.15 + 4000/ 1.13 = 10000

Or F / 1.12 + 4000 = 10000 x 1.13

Find the Value of F if i = 10%

10000 x (1+i)5= 4000 x (1+i)5 + F 0

+ is multiply by (1+i)^N and – is divide by

Find X Assume i = 10 % = 0.1

Find X. Assume i = 10 % = 0.1

15000 x 1.14 + X/1.12 = 5000 x1.12 + 8000 + 10000/1.15

Nominal and Effective Interest Rates

Effective Interest Rates (contd..)

Say P = 100, i = 1% per month, F = ? in a year [ i.e after 12 months]

Relation Between Effective (i) and Nominal (r) interest rate

I effective (i) = (1 + .12/12)12 – 1 = 0.1268 = 12.68%

Example : If i is 6 % per year but Compounded Daily what is the effective

So, r = 6%, and M = 365 [Compounded daily] (1yr = 365 days)

i = (1 + .06/365)365 – 1 = 0.0618= 6.18 %

Derivation of Formula if M tends to Infinite

Suppose, r/M = 1/X or M = rX

If in 2042 BS I came to Kathmandu after passing SLC and I have Rs 5000

• F = P(1+i)N , here N = 77-42 = 35 years

If interest rate = 6%, Compounded Daily : What would be effective interest

daily interest rate

The population of Kathmandu is supposed to be 50 Lakh including

2. If i = 3% in six month, yearly interest Or, i = (1+ iN )1/N – 1

SOLUTION b. 1.1 % in two month

Which one of this options is better?

Converting all into yearly equivalent interest rates!

1. 0.5% in month = (1+0.005)12 – 1 = 6.16% Minimum so best for Bank

Deposit Rs 5000 at the beginning of year 4 from now. What will be

F = 5000 x1.14 + 5000x1.13 + 5000x1.12 + 5000 x1.11+ 5000

A= 5000; i= 10% (0.1)

2.5 DEVELOPMENT OF INTEREST FORMULAS

Types of cash flow

A. Single Cash flow:

B. Equal (uniform) series Cash flow:

C. Linear Gradient Series:

D. Geometric gradient series:

P = Cash flow in year 0,

Find the Value of F; i = 10% (0.1) 5

F = 50x1.14 + 50 x1.13 + 50x1.12 + 50x1.11+ 50

Derivation of the Formula

F = 50x1.14 + 50 x1.13 + 50 x 1.12 + 50x1.1+ 50 … I

Find the Value of F; i = 10% (0.1)

F= 50x1.14 + 50 x 1.13+50 x1.12+ 50x1.1+ 50 x1.1^0

F = 50 (1.14 +1.13 +1.12 +1.1+1) in Geometric series r,

• F = A [ (1+i) 4 + (1+i) 3 + (1+i) 2 + …..+ (1+i) +1] : A = 50, I = 0.1 , 5 = N