Interest Formulas for Compounding

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Equivalence Calculations: General
Principles
• Equivalence Calculation made to compare alternatives require
a common time basis
• Equivalence depends on interest rate
• Equivalence calculations may require the conversion of
Multiple Payment cash flow into single cash flow
• Equivalence is maintained regardless of point of view

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 CONTENTS

• Single payment series compound amount

• Single payment series present worth

• Practice Problems

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Types of Compound Interest Formulas

1. Single payment compound amount:

• Here the objective is to find the single future sum (F) of initial
payment P after n period at interest rate i % compounded every
period.

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Q1. A person deposits a sum of Rs.50000 at an interest rate of 18 % compounded
annually for a period of 10 years. Find maturity value after 10 years.

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Q2. How much money will be accumulated in 25 years if Rs. 800 is deposited one year
from now, Rs. 2400 six years from now, and Rs. 3300, 8 years from now all at an
interest rate of 18 % p.a.?

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• Jay has become more conscientious about paying off his credit
card bill promptly to reduce the amount of interest paid. He
was surprised to learn that he paid $400 as interest penalty in
2007 and the amounts are shown in table over several years. If
he made his payments to avoid interest charges, he would
have these funds plus earned interest available in the future.
What is the equivalent amount 5 years from now that jay
could have made had he not paid the interest penalties if the
i= 5% per year.
Year 2002 2003 2004 2005 2006 2007

Interest 600 0 300 0 0 400

paid in 7
$
 F=?

i=5%

300
400

600

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Solution
• F= 600(F/P,5%,10)+300(F/P,5%,8)+400(F/P,5%,5)
• F= $1931.11

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Types of Compound Interest Formulas

2. Single Payment Present Worth Amount:

• Here the objective is to find the present worth amount (P) of a single
future sum (F) which will be received after n periods at an interest
rate of i% compounded at the end of every interest period.

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Q3. A person wishes to have a sum of Rs. 500000 to purchase a car 10 years from now. If
he plans to deposit a lump sum amount which will fetch an interest at the rate of 6%
p.a., Determine the sum.

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Q4. What is the present worth of Rs.7000 now, Rs. 15000 four years from now and. Rs.
9000 six years from now at an interest rate of 8% p.a.?

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 Tutorial Problems
1. IDBI came out with an issue of deep discount bonds in the year 2000. The bonds
were offered at a deep discounted rate of Rs. 12750. The maturity period of the
bonds was 30 years with a maturity value of Rs. 500000. Determine the rate of return
on the investment.

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 500000

И
30

12750

F=P(1+i)n
500000=12750(1+i)30
i= 13%
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• 2. A company is planning to make two equal deposits such
that 10 years from now the company will have $49000 to
replace a small machine. If the first deposit is made one year
from now and the second nine years from now, how much
must be deposited each time if the interest rate is 15%p.a.

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 49000

x x

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• 49000 = x(f/P, 15%, 9) +x (f/P,15%,1)
• X= $10497

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• A person is planning to invest 50000 now and also an amount
of 15000 in the 3rd year and 4000 in the 5th year. He is
expected to withdraw an amount of 2500 every alternate year
with first withdrawl on year 2. How much money will left out
in the account at the end of tenth year if the interest rate is
10%

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 F=?

2500 10%

4000
15000

50000
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• F={50000(F/P, 10%,10)+15000(F/P,10%,7)+4000(F/P,10%,5)} –
{2500(F/P,10%, 8)+ 2500(F/P,10%, 6)+ 2500(F/P,10%, 4)+
2500(F/P,10%, 2)+ 2500}
• F=145798.65

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Practice Problem:
If $500 were deposited in a bank savings account, how much would be in the
account for three years hence if the bank paid 6 % interest compounded annually?

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 CONTENTS

• Equal Payment Series (Derivation)

• Equal Payment Series Compound Amount

• Equal Payment Series Sinking Fund

• Practice Problems

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 Types of Compound Interest Formulas
Equal Payment Series- Compound-Amount Factor:
• Suppose we are interested in the future amount F of a fund to which we contribute A
amount each period and on which we earn interest at a rate of i per period. The
contributions are made at the end of each of N equal periods

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 Types of Compound Interest Formulas

• The $A we put into the fund at the end of the first period will be worth

• The $A we put into the fund at the end of the second period will be worth

and so forth…

• Finally, the last $A that we contribute at the end of the Nth period will be worth
exactly $A at that time.
• This means that there exists a series of the form

Or

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 Types of Compound Interest Formulas

• Multiplying by (1 + i) results in

• Subtracting 1 from 2

• Solving for F

• The bracketed term is called the equal payment series compound-amount factor, or the
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uniform series compound-amount factor; its factor notation is (F/A, i, N).
Types of Compound Interest Formulas

3. Equal Payment Series Compound Amount:

• Here the objective is to find the future worth of n equal payments
which are made at the end of every interest period till the end of nth
interest period at an interest rate of i % compounded at the end of
each interest period.

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Q1. A man deposits $500 in a credit union at the end of each year for 5 years. The
credit union pays 5% interest compounded annually. At the end of 5 years,
immediately after the fifth deposit, how much does the man have in his account?

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Q2. Formasa Plastics has major fabrication plants in Texas and Hong Kong. The
president wants to know the equivalent future worth of a $1000 capital investment
each year for 8 years, starting 1 year from now. Formasa capital earns at a rate of 14%
per year.

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Types of Compound Interest Formulas

4. Equal Payment Series Sinking Fund:

• Here the objective is to find the equal amount (A) that should be
deposited at the end of every interest period for n period to realize a
future sum (F) at the end of nth period at an interest rate of i %.

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Q3. 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?

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Q4. Jim Hayes read that out west, a parcel of land could be purchased for $1000 cash.
Jim decided to save a uniform amount at the end of each month so that he would have
the required $1000 at the end of one year. The local credit union pays 0.5% interest.
How much would Jim have to deposit each month?

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 Practice Problems
1. A company deposits $2000 in a bank at the end of every year for 10 years. The
company makes no deposits during the subsequent 5 years. If the bank pays 8%
interest, how much would be in the account at end of 15 years?
Sol: $42560

2. A student wants to have $30000 at graduation 4 years from now to buy a new car.
His grandfather gave him $10000 as a high school graduation present. How much
must the student save each year if he deposits $10000 today and can earn 12% on
both $10000 and his earnings in a mutual fund as his grandfather recommends?
Sol: $2984

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Practice Problem 1 CFD
F=?

15%

10 15
0

2000

F= (2000*F/A,15, 10) * (F/P, 15,5)

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PP CFD 2
30000

12%

10000

30000 = 10000(F/P, 12%, 4)+X(F/A, 12%,4)

30000= 10000*1.5735 +X*4.7793
X= (30000 – 15735)/4.7793=2984.74
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 Types of Compound Interest Formulas
5. Equal Payment Series Present Worth:
•Objective is to the find present worth of an equal payment made at end of every interest period for n
periods.

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 Solved Problems
Determine the amount P that you should deposit into an account 2 years
from now, in order to be able to withdraw Rs. 4000/- per year for 5 years
starting 3 years from now, at an interest rate of 15% per year ? Also find
the investment’s current value?
P = ? ; i = 15% ; n=5 ; A= 4000 ;
Notation: P= A(P/A, i, n) = 4000 * (P/A, 15, 5) = 4000 * (3.3522) = Rs
13408.80/-
P1 = P (P/F, 15%, 2) = Rs13408.8 *0.7561 = Rs10138.39
i= 15% n=5 years

4000

0 1 2 3 4 5 6 7 8
P
P
1

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A company wants to set up a reserve which will help the company to have an annual equivalent amount of Rs
100,000 for next 15 years towards its employee welfare activities. If the welfare activities starts from the
beginning of year 4, and continued till end of year 15 then find the single payment amount that needs to be
invested today. The reserve is assumed to grow at a rate of 15%. Per annum.

Data Given : A = 100,000; i : 15%, n= 15, P : ?

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

P2

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• P2 : A ( P/A, i, n) : 100000 (P/A, 15%, 13)
• : 100000*5.5831
• : Rs.558310
• P : P1(P/F, 15%, 2)
• : 558310*0.7561
• P : Rs. 422138.825

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 Types of Compound Interest Formulas

6. Equal Payment Series Capital Recovery Amount:

Objective of this mode of investment is to find the annual equivalent amount (A) which is
to be recovered at the end of every interest period for n interest periods for a loan (P)
which is sanctioned now at an interest rate i% compounded every period.

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 Solved Problems
Q1. Rs. 1000/- invested now at 5% interest compounded annually, provided for 8
equal future year end payments. Determine A
Data Given
P = 1000; i = 5% ; n=8 ; A= ?
Notation A= P(A/P, i, n)
= 1000 (A/P , 5 , 8)
= 1000 (0.1547) = Rs. 154.72/-

P = 1000 i= 5%

0 1 2 3 4 5 6 7 8

A= ?

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 Q2. A bank gives a loan to a company to purchase an equipment worth $10,00,000 at an
interest rate of 18% compounded annually. This amount should be repaid in 11 years equal
installments. Find the installment amount that company has to pay to the bank ?

• P : 10,00,000, i: 18%, n : 11 years. A : ?

P=10,0000
0 10 11
1 2 3 4 5 6 7 8 9
0

A=?

A = P ( A/P, I, N)
= 10,00,000 ( A/P, 18%, 11)
= 10,00,000 * 0.2148
= $ 214800 per year
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• An interest rate of 10% compounded annually is desired on an
investment of 30,000. How many years will be required to
recover at least the investment with the desired return if 8000
is received each year
• Ans: 5 years

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• The Houston American Cement plant may generate a
revenue base of $50 million per year. The president of the
Brazilian parent company Votorantim Cimentos may have
reason to be quite pleased with this projection for the
simple reason that over the 5-year planning horizon, the
expected revenue would total $250 million, which is $50
million more than the initial investment. With money
worth 10% per year, address the following question from
the president:
Will the initial investment be recovered over the 5-year
horizon with the time value of money considered? If so, by
how much extra in present worth funds? If not, what is the
equivalent annual revenue base required for the recovery
plus the 10% return on money?
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 P 50( P/A ,10%,5) 50(3.7908)

$189.54 ($189,540,000)

The present worth value is less than the investment plus a 10% per year
return, so the president should not be satisfied with the projected annual
revenue.

200( A/P ,10%,5) = 200(0.26380)

$52.76 per year

The plant needs to generate $52,760,000 per year to realize a 10%

per year return over 5 years.
Now the president would like the answers to a
couple of new questions about the estimated annual
revenues.
( a ) What is the equivalent future worth of the
estimated revenues after 5 years at 10% per year?
( b ) Assume that, due to the economic downturn,
the president predicts that the corporation will earn
only 4.5% per year on its money, not the previously
anticipated 10% per year. What is the required
amount of the annual revenue series over the 5-year
period to be economically equivalent to the amount
calculated in ( a )?
 F = 50( F/A ,10%,5)
50(6.1051) = $305.255
($305,255,000)
The A/F factor will determine the required A for 5
years.

Since the factor tables do not include 4.5%, use

the formula to answer the question.
• An investor holds a time payment purchase contract on
some machine tools. The contract calls for the payment
of $140 at the end of each month for a 5 year period.
The first payment is due in one month. He offers to sell
you the contract for $6800 cash today. If you otherwise
can make 1 % per month on your money, would you
accept or reject the investors offer? Suppose we decided
to pay the $6800 for the time purchase contract, what
monthly rate of return would we obtain on our
investment?

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