GEN TECH 3EE3

WEEK 2 LECTURE

CASH FLOW ANALYSIS

Compounding for Discrete Payments

and Uniform Annuities

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 Administrative Items
• Course Content is Pre-Built, except for the weekly online evening lectures
o PPT slides, course readings, videos, online articles

• Three Case Study Discussions on selected weeks (not graded)

o Weeks 4, 7 & 11
o No participation marks for online discussion

• Weekly Online Evening Lectures - Wed 6:30-9:30PM EST (WebEx)

• Weekly Self-Assessment
o There is an online self-assessment quiz available on Pearson's website for each chapter of Fraser's textbook. 
The registration link for the Companion website for Fraser is: http://pearsoned.ca/highered/Fraser_6e/.
(You MUST purchase the book for access)

• Five Quizzes on Weeks 3, 4, 7, 10 and 11

o Multiple choice
o Pre-built randomized quizzes for academic integrity

• Mid-term Test:
o Scheduled for Wednesday June 10th 7:00 – 9:00 PM, Location: Online

• Final Exam: 2
o Final examination date: Wednesday, August 5th, 7:00 – 9:30 PM, Location: Online
 Administrative Items
• Online Quiz 1:
o Starts, Wednesday May 20 at 11:00 PM
o Ends, Wednesday May 27 at 11:59 PM
o Chapters 1, 2 and up to annuities in Chapter 3 (not including mortgages, bonds
and non-uniform annuities).
o Chapters 1, 2 & 3 including general concept of EE, decision making, time
value of money, interest rate calculations, cash flow diagram, and annuities.

• Online Quiz 2:
o Starts, Wednesday May 27 at 11:00 PM
o Ends, Wednesday June 3 at 11:59 PM
o Chapters 3
o Chapter 3 including non-uniform annuities, bonds and mortgages; there
will also be a small number of 'review-type' questions from Chapter 2.

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 Nominal and Effective Interest Rate Recap

ie - effective interest rate/year “Equivalent to base period from sub

compounding period interest rate”

r - nominal interest rate /year “Conventional annual interest rate”

m - number of compounding periods in one year

“The period used with compound interest method of computing interest”

Equating the future worth after 1 year

F = P(1 + ie) = P(1 + r/m)m

Thus, effective interest rate/year is

ie = (1 + r/m)m - 1 4
 Nominal and Effective Interest Rate Recap
You have calculated the effective 6 month interest
rate as 4.2483%, based on a nominal interest rate
compounded monthly. What was the nominal
interest rate?
Solution
ie = (1 + r/m)m - 1
0.042483 = (1 + r/12)6 - 1
(1 + r/12)6 = 0.042483 + 1 = 1.042483
r/12 = (1.042483)1/6 - 1 = 0.006958
Therefore, r = 12(0.006958) = 0.0835 = 8.35%
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 Effective Interest Rate and Cash Flow Period

r - nominal interest rate

m - number of compounding periods in one year
k - number of compounding periods in one cash flow period

Cash Flow Period: “Base unit of time over which

an effective interest rate is calculated, which may not be
one year”

Thus, “effective interest rate” per cash

flow period is

ie = (1 + r/m) - 1
k 6
 What Interest Rate to Use

Are the cash flows Yes

and the compounding
period the same? i = r/m

no

Are the cash flows

occurring more
frequent than the
compounding?

Move all cash flows

yes no
to the compounding
period and use i = ieff
i = r/m
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 Compounding period and payment period are
the same…
What interest rate is applied for monthly payments
and 6% compounded monthly?
Solution

i = r/m
= 0.06/12
= 0.005
= 0.5%

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 Compounding is less frequent than
payments…
What interest rate is applied for monthly payments
and 6% compounded semi annually?
Solution

i = r/m
= 0.06/2
= 0.03
= 3.0%

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 Compounding is more frequent than
payments…
An investment earns a 6% nominal interest rate,
compounded daily. What is the effective interest
rate for a “cash flow period” of 1 month (30 days)?
Solution

ie = (1 + r/m)k - 1
= (1 + 0.06/365)30 - 1
= 0.004943 = 0.494%

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 Learning Objectives
• Introduction to cash flows
• Timing of cash flows and modeling
• Compound interest factors
• Single payment compound interest formulas
• Uniform series compound formulas
• Compound interest factors tables
• White board problems
o uniform annuities

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 Introduction to cash Flows

• Compound interest factors can be used to evaluate

different patterns of cash flows.
• This chapter presents four common discrete cash flow
patterns:
1. Single Disbursement or Receipt
2. Annuity
3. Arithmetic Gradient Series
4. Geometric Gradient Series

• We evaluate each to compare projects

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 Timing of Cash Flows and Modeling

• Timing of cash flows can be complicated / irregular

• work with simplified models and assumptions
• Assume that cash flows and compounding of cash
flows occur at the end of conventionally defined
periods (e.g. months / years).
• Models that make this assumption are called
discrete models.

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Cash Flow Analysis

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Compound Interest Factors

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Compound Interest Factors

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 Single-Payment
Compound Interest Formulas
• Notation:
o i = interest rate per period
o n = number of interest periods
o P = a present sum of money
o F = a future sum of money

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 Single-Payment
Compound Interest Formulas, cont’d
• If the interest rate’s period is in years:
o After one year the future amount at the end of year one would
be:

o After two years, the future amount at the end of year two
would be the additional interest on year one’s total:

o Rearranging, we get:

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 Single-Payment
Compound Interest Formulas, cont’d
• Generalizing the previous slide:

• The above formula is the “single payment compound

amount formula,” which is written in functional notation
as:

o The notation in brackets meaning future sum “F,” given present

sum “P” at interest rate “i” per interest period for “n” periods.
o Functional notation is written algebraically correct so that:
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 Single-Payment Compound Interest:
Problem
$3000.00 deposited in a bank account at 7% per year
interest would be how much after four years?
Solution
F = P(F/P, 7%, 4)

F = 3000(1+0.07)4

F = $3932.39

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 Single-Payment
Compound Interest Formulas, cont’d
• Suppose you want to find an equivalent value now for a
future value.

o Rearranging:

o The notation becomes:

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 Single-Payment Compound Interest:
Problem
If you want to have $3000.00 in the bank after four years at
7% per year interest, what would you have to deposit
now?
Solution
P=F(P/F, 7%, 4)
P= 3000(1+0.07)-4

P = $2288.69

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Uniform Series Compound Interest Formulas

• Uniform series (A) is defined as:

o An end-of-period cash receipt or disbursement in a uniform
series, continuing for n periods, the entire series equivalent to
P or F at an interest rate i

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 Uniform Series Formulas
• In the general case:
F = A(1+i)n–1 + . . . + A(1+i)2 +A(1+i) +A (1)

• Multiplying by (1+i):

(1+i)F = A(1+i)n + . . . + A(1+i)3 + A(1+i)2 + A(1+i) (2)

• Factoring out A and subtracting (1) from (2):

(1+i)F = A[(1+i)n+ . . . + (1+i)3 + (1+i)2 + (1+i)]

–F = A[(1+i)n–1+ . . . +(1+i)2 + (1+i) + 1]
iF = A[(1+i)n – 1] 24
 Uniform Series Formulas, cont’d.
• Rearranging the previous slide
o The “uniform series compound amount factor” is:

• The notation is F = A(F/A, i%, n)

• Solving for A:

• The notation is A = F(A/F, i%, n)

o “uniform series sinking fund factor” 25
 Uniform Series Formulas, cont’d.
• Taking the sinking fund formula and substituting the
single payment compound formula for F yields:

• Therefore:

• Notation: A = P(A/P, i%, n)

o “uniform series capital recovery factor”

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 Uniform Series Formulas, cont’d.
• Solving the capital recovery formula for P:

• Notation: P = A(P/A, i%, n)

o “uniform series present worth factor”

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Compound Interest Factors Recap

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 Uniform Series Formulas
Problem 1
Joe purchased a dream car for $19,000 on 1 January 2019, just after
he graduated from college. Joe has had a part time job and was
making deposits of $275 each month into an account that pays 9%
compounded monthly since his first deposit on 1 February 2014.
The last deposit was made on 1 January 2019. Determine how much
money he saved to buy the car. Did Joe save enough to buy his
dream car?
Solution

Monthly deposits, A = $275. n = 2/2012

2/2014 to
0 1/2017
to 1/2019 = 60
periods.

F = $275 (F/A, 0.75%, 60) = $275 (75.424) = $20,741.64

Joe will have $20,741.64 available for his purchase.

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 Uniform Series Formulas
Problem 2
You are repaying a debt of $10,000 with equal payments
made at the end of four equal periods. If the interest rate is
10% per period, how much of the original $10,000
principal will be paid in the second payment?

Solution
Principal = $10,000. Number of equal payments (n) = 4. i = 10%
per period.
A = P(A/P, i, n) = 10,000(A/P, 10%, 4) = 10,000 × 0.3155 = $3155
First payment interest on unpaid balance = 10,000 × 0.10 = $1000.
Principal repaid = A – 1,000 = $2155.00
Second payment Principal due = 10,000 – 2155 = $7845
Interest on unpaid balance = 7,845 × 0.10 = $784.50.
Principal paid in the second payment = 3,155 – 784.50 = $2370.50.30
Compound Interest Factors Tables

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Compound Interest Factors Tables

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Compound Interest Factors Tables Problem 3

(With interest tables) What amount deposited today

into an account bearing 12% nominal interest will yield
$5000 at the end of two years? Interest is
compounded monthly.

Solution

From table: (P/F,1%,24) = 0.78757

P = F (P/F, 1%, 24)
= $5000(0.78757)
= $3937.85

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 Uniform Annuities
Problem 4

Solution
P = $5,000 Capital Recovery Factor:
n = 5 years A = P(A/P,i,n)
i = 10% A = P[i(1+i)n/((1+i)n-1)]
A=?

A = 5000(0.26380) = $1,318.99

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 Uniform Annuities
Problem 5

Solution
A = $565 Series Present Worth Factor:
n = 24 months P = A(P/A,i,n)
i = 0.12/12 = 1.0% P = A[((1+i)n-1)/i(1+i)n]
P=?

P = 565(21.243) = $12,002.30

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Questions Period

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