EXAMPLE ON SIMPLE INTEREST one year from today.

How much money can be

A student borrows $3000 from his uncle in withdrawn from this bank account immediately
order to finish school. His uncle agrees to after the 15th deposit?
charge him simple interest at the rate of 5.5% F
per year. Suppose the student waits two years Fig.
and then repays the entire loan. How much will 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

he have to repay?
A A A A A A A A A A A A A A A

Solution:
The student will pay his uncle the principal Given:
amount plus the interest. A = $1,000
n = 15 yrs
F = P + I = P + Pni = P(1+ni) i = 5% per year
Thus,
F = $3000[1+ (2)(0.055)] = $3330 Solution:

EXAMPLE ON COMPOUND INTEREST/  (1+i)n − 1 

EXAMPLE ON FINDING F WHEN GIVEN P: F=A  
Suppose that you borrow $8,000 now,  i 
promising to repay the loan principal plus
accumulated interest in four years at i=10% per  (1+0.05)15 − 1 
year. How much would you repay at the end of F=1000  
four years?  0.05 
F= $21,578.56
Solution:
Using the formula for compound interest, EXAMPLE ON FINDING P WHEN GIVEN A:
If a certain machine undergoes a major
F=P (1+ i)n = $8,000[1+0.10]4 = $11,712.80 overhaul now, its output can be increased by
20% - which translates into additional cash flow
EXAMPLE ON FINDING P WHEN GIVEN F: of $20,000 at the end of each year for five
An investor (owner) has an option to purchase a years. If i=15% per year, how much can we
tract of land that will be worth $10,000 in six afford to invest to overhaul this machine?
years. If the value of the land increases at 8%
each year, how much should the investor be Fig. A=$20,000
willing to pay now for this property?

Solution:
The purchase price can be determined from the P
 1 
n Given:
equation, P=F   = F (1+i)-n I = 15%
 1+i 
A = $20,000
P = $10,000(1+.08)-6 = $6,301.69 Solution:
EXAMPLE ON FINDING F WHEN GIVEN A:
Suppose you make 15 equal annual deposits of  (1+i)n − 1 
P=A  
 i(1 + i) 
n
$1,000 each into a bank account paying 5%
interest per year. The first deposit will be made
  (1+0.15)5 − 1  EXAMPLE DEFFERED ANNUITY:
P=$20,000   Suppose that a father, on the day his son is
 0.15(1 + 0.15) 
5
born, wishes to determine what lump amount
would have to be paid into an account bearing
P = $67,043.42 interest of 12% per year to provide withdrawals
of $2000 on each of the son’s 18th, 19th, 20th
EXAMPLE ON FINDING A WHEN GIVEN F: and 21st birthdays.
An enterprising student is planning to have
personal savings totaling $1,000,000 when she Fig.
retires at age 65. She is now 20 years old. If the
annual interest rate will average 7% over the
next 45 years on her savings account, what
equal end-of-year amount must she save to
accomplish her goal.
Given:
Given: i = 7%
F = $1,000,000 n = 21
n = 45 years j = 17
n-j= 4
Solution:
Solution:
 i   (1+i)n − 1 
A=F  
 (1 + i) − 1 
n P17 =A  
 i(1 + i) 
n

 0.07   (1+0.12 )4 − 1 
A=$1,000,000   P17 =$2000  
 0.12(1 + 0.12) 
4
 (1 + 0.07) − 1 
45

P17 = $6,074.60
A = $3,500

EXAMPLE ON FINDING A WHEN GIVEN P: n

 1 
What is A that repays the $17,000 loan, in an P0 =F  
 1+i 
interest rate of 1% per months for 4 months.
17
Given:  1 
P0 =$6,074.6 
P = $17,000  1+0.12 
i = 1%
P0 = $884.46
n = 4 mos.

Solution:
EXAMPLE ON FINDING THE GRADIENT
CONVERSION FACTORS TO FIND P & A
 i (1+i)n 
A=P   Suppose that certain end-of-year cash flows are
 (1 + i) − 1 
n
expected to be $1,000 for the second year,
$2,000 for the third year, and $3,000 for the
 0.01 (1+0.01)4 
A=$17,000   fourth year and that, if interest is 15% per year,
 (1+0.01) − 1 
4
it is desired to find the (a) present equivalent
A = $4,357.10 value at the beginning of the first year, and (b)
uniform annual equivalent value at the end of
each of the four years.

Given:
G=$1,000
n=4

a. Present Equivalent


 1  (1+i) − 1
n
n  
P0 =G   − 
n 
  i(1 + i)
 i n
(1+i)  


 1  (1+0.15) − 1
4
4  
P0 =$1000   − 
4 
 0.15  0.15(1 + 0.15) (1+0.15)  
4
 
P0 = $3,790

b. Annual Equivalent

1 n 
A=G  − 
 i (1 + i) − 1 
n

 1 4 
A=$1000  − 
 0.15 (1 + 0.15) − 1 
4

A = $1,326.30