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Simple and Compound Interest: Simple Interest: Petroleum Economics Tutorial
Simple and Compound Interest: Simple Interest: Petroleum Economics Tutorial
Petroleum Economics
Tutorial (2)
Example (4):
Calculate the present value of $5,000 received at the end
of the sixth year (example 3) if the interest rate is 8% per
year compounded quarterly
(i.e., m = 4).
Solution: In this example, t = 6, in = 0.08, and m = 4.
Therefore
𝑖 0.08
i= 𝑛= = 0.02
𝑚 4
t = t*m =6*4 =24
the present value is
1
𝑃𝑉 = 𝐹𝑉 [ ]
𝑖𝑛 𝑡𝑚
(1 + )
𝑚
1
𝑃𝑉 = 5000 [ 6∗4 ] = 3108.61$
0.08
(1 + 4 )
Future value of present sum
the future value of a present sum is a reciprocal of the
present value of future sum. Here, interest is added to the
cash flows
𝐹𝑉 = 𝑃𝑉 [ (1 + 𝑖𝑒 )𝑡 ]
The factor (1 + 𝑖𝑒 )𝑡 is referred to as the single payment
compound amount factor, represented by the factor F/P
in interest tables
𝑛−1
𝐹𝑉 = ∑ 𝑃𝑉 [(1 + 𝑖𝑒 )𝑡 ]
𝑡=1
Example (5):
Using the royalty payments in example (3) calculate the
future value of these payments at 8% effective interest.
Solution:
Fv = $2,000(1+ 0.08)4 + $2,200(1+ 0.08)3 + $1,900(1+
0.08)2 + $2,500(1+ 0.08)1 + $1,500(1+ 0.08)0
= $2,000(1.3605) + $2,200(1.2597) + $1,900(1.1664)
+ $2,500(1.08) + $1,500 = $11,908.50