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TOPIC # 3

MONEY-TIME RELATIONSHIPS AND


EQUIVALENCE

ARIATE, JOHN AIRO


DOMANAIS, GIAN CARLO O.
HERNANDEZ, ELMER B.
PETATE, JOMAR B.
POBLETE, MAC JOHN T.
OUTLINE

• Interest and the Time Value of Money


• The Concept of Equivalence
• Cash Flows
LEARNING OBJECTIVES

1. Understand the concept of interest and the


time value of money, concept of equivalent
and cash flow
2. Able to solve related problems
TIME VALUE OF MONEY

Congratulations!!! You have won a cash prize!


You have two payment options:
A. Receive $10,000 now
B. Receive $10,000 in three years.
Which option would you choose?
TIME VALUE OF MONEY

Two Dimensions of Money


1. How much?
2. When?
TIME VALUE OF MONEY

Why we need to measure the time value of


money?
You need to chart how well you are doing,
how effective is your approach, is the option A
is better than the option B? and others.
CONCEPT OF EQUIVALENCE

The Concept of Equivalence


• Established when we are indifferent between a
future payment, or a series of future payments,
and present sum of money.
• Considers the comparison of alternative options,
proposal, by reducing them to an equivalent
basis, depending on:
1. Interest
2. Amount
3. Timing
4. Period
CONCEPT OF EQUIVALENCE

For example, if the interest rate is 14%, then M.U, of 100 today
would be equivalent to M.U. of 114 one year from to day and
M.U. of 87.719 one year ago.
Ago
87.719

Today
87.719+(87.719x0.14)
= 99.99966

Future
100+(100x0.14)
=114
CONCEPT OF EQUIVALENCE

The Basic Parts of Concept of Equivalence


1. Years
2. Amount owned at the Beginning of the Years
3. Interest
4. Total Money Owned at the End of the Year
5. Principal Payment
6. Total End of the Year Payment
CONCEPT OF EQUIVALENCE

Example:
Plan No. 1: $2000 of loan principle plus 10% of principal
paid at the end of the year; interest paid at the end of each
year is reduced by $200. What is the economic equivalence in
four(4) repayment plans?
Year Amount Interest Total Money Principal Total End of
Owned at Accrued for Owned at End Payment Year Payment
Beginning of Years of Year
Year

1 $8,000 $800 $8,800 $2000 $2,800

2 $6,000 $600 $6,600 $2000 $2,600

3 $4,000 $400 $4,400 $2000 $2,400

4 $2,000 $200 $2,200 $2000 $2,200


CONCEPT OF EQUIVALENCE

The Total Interest paid which is $2000 is equal to $20,000 on


the total dollars in the four repayment years.
INTEREST AND INTEREST RATE

Capital Interest Interest


wealth in the increase Rate
form of money between an
or property
percentage
original sum
that can be of money of the
used to borrowed and original
produce more the final amount per
wealth amount owed time unit
INTEREST AND INTEREST RATE

Simple Interest
the total interest earned or charged is linearly
proportional to the initial amount of the loan, the
interest rate and the number of interest periods
 Formula: I = Pin

I Interest
P Principal
i Interest
n number of
interest
Amount rate
period
SIMPLE INTEREST

The total amount F to be repaid is equal to


the sum of the principal and the total interest
and is given by the formula:
SIMPLE INTEREST

Sample Problem:
$2,000 is deposited in a savings
account that pays 10% simple
interest. How much will the
account be worth in 5 years?
SIMPLE INTEREST

Given:
P = $2000 i=10% n=5
Formula:
Solution:
SIMPLE INTEREST

a) Ordinary simple interest is computed on the


basis of one banker’s year which is
1 banker’s year = 12 months, each consisting
of 30 days = 360 days
b) Exact simple interest is based on the exact
number of days, 365 days for an ordinary
year. The leap years are those which are
exactly divisible by 4, but excluding the
century years such as the years 1900, 2100,
etc.
SIMPLE INTEREST

If d is the number of days in the interest


period, then:
 Ordinary Simple Interest =
 Exact Simple Interest
 (for ordinary year)
 (for leap year)
ORDINARY SIMPLE INTEREST

Sample Problem:
On May 30, 2012, a businessman
loans $15000 in the bank for the
expansion of his restaurant. It was
agreed that he will pay the amount
of 6% rate of interest on August
10, 2012. What is the ordinary
simple interest to be paid?
SIMPLE INTEREST

Given:
P = $15000 i=6% n=?
Formula:
Solution:
Since May 30 is the beginning date, it is not
included in counting.
Total number of days = 72
SIMPLE INTEREST

Continuation:

Therefore, the businessman will pay $180


interest.
EXACT SIMPLE INTEREST

Sample Problem:
Louie borrowed $1800 from his
aunt last December 25, 2010. He
promised that he will pay his aunt
on February 14, 2011 at 8%
interest. Find the exact simple
interest to be paid by Louie.
EXACT SIMPLE INTEREST

Given:
P = $1800 i=8% n=?
Formula:
Solution:
Total number of days = 51
EXACT SIMPLE INTEREST

Continuation:

Therefore, Louie will pay $20.12 interest/


CASHFLOW

Cash flow is the movement of money in


and out of a company. Cash received
signifies inflows, and cash spent signifies
outflows. The cash flow statement is a
financial statement that reports on a
company's sources and usage of cash
over some time.
CASHFLOW

Simple Cashflow Diagram


INTEREST AND INTEREST RATE

Compound Interest
interest accrued is calculated on the principal plus the
total amount of interest accumulated in the previous
periods

 Formula:
COMPOUND INTEREST

Sample Problem:
An investment earns 3%
compounded annually. Find the
value of an initial investment of
$5000 after 6 years.
COMPOUND INTEREST

Given:
P = $5000 i=
Formula:
Solution:
RATE OF INTEREST

a) Nominal rate of interest is expressed on an


annual basis and is determined by multiplying
the actual or effective interest rate per
interest period by the number of
compounding periods per year.

i rate of
interest per
r nominal
m number of
compounding
interest interest rate periods per
period year
RATE OF INTEREST

b) Effective rate of interest is the actual rate of


interest on the principal for one year. It is
equal to nominal rate of interest if the interest
is compounded annually, but it is bigger than
the nominal rate of interest if the interest is
compounded semi-annually, quarterly or
monthly.
Formula:
RATE OF INTEREST

Sample Problem:
A credit card company charges
21% interest per year,
compounded monthly. What
effective annual interest rate does
the company charge?
RATE OF INTEREST

Given:
m=12 r=21%
Formula:
Solution:

The company charges 23.14% compounded


annually per year.
EQUATION OF VALUES

• An equation of value is obtained by setting the


sum of the values on a certain comparison or
focal date of one set of obligations equal to the
sum of the values on the same date of another
set of obligations.
• An Equation of Value can represent a
mathematical manipulation, a lender and
borrower scenario, a savings scenario, a
withdrawal scenario, or an agreement
between two investors. The equations can
even represent phenomena in nature.
EQUATION OF VALUES

• Example:

Christian owes 20 000 due in 3 years and * 30


000 due in 6 years. He is allowed to settle these
obligations by a single payment on the 5th year.
How much should he pay on the 5th year if the
money is worth 12% compounded semi-
annually? Use 5 years as comparison date.
EQUATION OF VALUES
EQUATION OF VALUES
EQUATION OF VALUES

Given:
If money is worth 12% compounded semi-annually
j= 12% = 0.12
m=2
Solution : payment/s = obligation/s
x = P 20 000 (1+0.12) *4 + P 30 000 (1+0.12) *-2
= P 25 249.54 + P 26 699.89
= P 51 949.43
CONTINUOUS COMPOUNDING AND
DISCRETE PAYMENTS.

• In discrete compounding, the interest is


compounded at the end of each finite-length
period, such as month, a quarter or a year.
• In continuous compounding, it is assumed that
cash payments occur once per year, but the
compounding is continuous throughout the
year.
CONTINUOUS COMPOUNDING AND
DISCRETE PAYMENTS.

• r = nominal rate of interest per year


• r/m = rate of interest per period
• m = number of interest periods per year
• mn = number of interest periods in n years
• FORMULA:
F= P(1+r/m)*mn
Let m/r = k, then m = rk, as m increases so
must k
CONTINUOUS COMPOUNDING AND
DISCRETE PAYMENTS.

(1+r/m)*mn = (1+1/k)*rkn =[(1+1/k)*k]*m


The limit of (1+r/m)*k as k approaches infinite
is e
[(1+r/m)*k]*rn = e*rn
THUS,
F = Pe*rn
P = Fe*-rn
CONTINUOUS COMPOUNDING AND
DISCRETE PAYMENTS.

• Sample

A savings bank offers long-term savings


certificates at 7.5%p per year, compounded
continuously. If a 10years certificate cost Php
50,000.00, what will be its value at maturity?
Compose with the value that would be
obtained if the interest where compounded
annually rather than continuously.
CONTINUOUS COMPOUNDING AND
DISCRETE PAYMENTS.

• Given
P= 50,000 r= 7.5% / 0.075 n= 10
Formula:
F= Pe*rn
F=(50,000.00)*(0.075)(10)
F= Php 105,850.00

b. compounded annually
Formula:
F= P(1+n)*n
F= 50,000(1+0.075)
F= Php 103,051.5781
DISCOUNT

Discount
- A discount is the reduction of either the
monetary amount or a percentage of the
normal selling price of a product or
service. For example, a discount of $10
may be offered from the list price of a
product, or as a 10% discount from the list
price.
DISCOUNT

Procedure
- The rate is usually given as a percent.
- To find the discount, multiply the rate by
the original price.
- To find the sale price, subtract the
discount from original price.
DISCOUNT

Example Problem 1:
 In a video store, a DVD that sells for
$15 is marked "10% off." What is
the discount? What is the sale price
of the DVD?
DISCOUNT

Given: Solution:
Original Price - $15.00 x .10 = $1.5
$15.00 $15.00 - $1.5 = $13.5
Discount – 10% off
The discount is $1.50
Sale Price - ?
and the sale price is
$13.50.
DISCOUNT

Example Problem 2:
- Mr. J Dela Cruz borrowed money from a
bank. He received P1,342 from the bank
promises to pay P1,500 at the end of 9
months. Determine the simple interest and
the corresponding discount rate or often
offered to as the "Banker's discount."
DISCOUNT

Given: Solution:
Discount - P1500 - d = discount/principal
P1342 = 158/1500 = 0.1053
Discount - P158 or 10.53%
Principal – P1500 i = d/1-d = 0.1053/1 –
0.1053 = 0.1177 or
11.77%
Required:
d – rate of discount
i – rate of interest
INFLATION

Inflation is the rate of increase in


prices over a given period of time. Inflation is
typically a broad measure, such as the overall
increase in prices or the increase in the cost of
living in a country. But it can also be more
narrowly calculated—for certain goods, such as
food, or for services, such as a haircut, for
example. Whatever the context, inflation
represents how much more expensive the
relevant set of goods and/or services has become
over a certain period, most commonly a year.
INFLATION

Formula:
FC = PC(1+f)^n

FC = future cost of a commodity


PC = present cost of a commodity
f = annual inflation rate
n = number of years
INFLATION

In an inflationary economy, the buying power of


money decreases as cost increases:

F = P/(1+f)^n

If interest is computed as the same time that


inflation is occuring:

F = P(1+i/1+f)^n
INFLATION

If the uninflated present worth is to


be determined:
P = F/(1+i)^n+(1+f)^n
= F/(1+icf)^n
Icf = i + f + if
Where:
f = annual inflation rate
i = interest of rate
Icf = rate of interest that can take care of the cost money
and inflation
INFLATION

Example Problem:
A man invested P130,000 at an
interest rate of 10% compounded anually.
What will be the final amount of his
investment, in terms of today’s peso after
5 years, if inflation remains the same at
the rate of 8% per year?
INFLATION

Given: Formula:
P = P130,000 F = P (1+i/1+f)^n
i = 0.10
Solution
n = 5 years = 130000
f = 0.08 (1+.10/1+0.08)^5
= 130000 (1.10/1.08)^5
= P142,491
INFLATION

Problem:
What is the uninflated present
worth of a P200,000 future value in two
years if the average inflation rate is 6%
and interest rate is 10%.
INFLATION

Given: Formula:
F = 200,000
P=? P = F/(1+icf)^n
f = 0.06 Solution:
i = 0.10
n = 2 years P = 200000/(icf)^2
icf = 0.10 + 0.06 + (0.10)(0.06)
icf = 0.166
P = 200000/(0.166)^2
P = P147,107
ANNUITIES

Annuity

• a series of equal
payments made at
equal intervals of time.
ELEMENTS OF ANNUITY

• A = amount of periodic payment


• P = present amount of all periodic payments
• F = future worth of all periodic payments after
the last payment is made
• i = interest rate per compounding period
• n = total number of payments
• m = nominal rate (see compounded interest)
• t = number of years
TYPES OF ANNUITY

a) Ordinary Annuity
 the equal payments are made at the end of each
compounding period starting from the first
compounding period.
ORDINARY ANNUITY
ORDINARY ANNUITY

Future amount of ordinary annuity, F

The factor called the “uniform series compound


amount factor” and is designated by the
functional symbol , read as “F given A at i
percent in n interest periods.” The equation can
be expressed as
ORDINARY ANNUITY

Present amount of ordinary annuity, P

• The factor called the “uniform series present


worth factor” and is designated by the
functional symbol , read as “P given A at i
percent in n interest periods.” The equation can
be expressed as
ORDINARY ANNUITY

Periodic payment of annuity, A, if F is known

• The factor called the “equal-payment-series


sinking-fund factor” and is designated by the
functional symbol , read as “A given F at i
percent in n interest periods.” The equation can
be expressed as
ORDINARY ANNUITY

Value of A, if P is known

• The factor called the “equal-payment-series


capital-recovery factor” and is designated by
the functional symbol , read as “A given P at i
percent in n interest periods.” The equation can
be expressed as
ORDINARY ANNUITY

Sample Problem:
For having been loyal, trustworthy and efficient, the
company has offered a supervisor a yearly gratuity
pay of P20,000.00 for 10 years with the first payment
to be made one year after his retirement. The
supervisor, instead, requested that he be paid a lump
sum on the date of his retirement less interest that
the company would have earned if the gratuity is to
be paid on yearly basis. If interest is 15%, what is the
equivalent lump sum that he could get?
ORDINARY ANNUITY

Given:
A= Php 20000 i=15% n=10
Formula:
Solution:

The equivalent lump sum that he will get is


Php 100375.373.
TYPES OF ANNUITY

b) Deferred Annuity
 is also an ordinary annuity but the payment of the
first amount is deferred a certain number periods
after the first
DEFERRED ANNUITY
DEFERRED ANNUITY

Future amount of deferred annuity, F

Present amount of deferred annuity, P


DEFERRED ANNUITY

Sample Problem:
A man pays P15,000 annually starting at the end
of the 5th year until at the end of the 10th year.
P20,000 at the end of the 11th year until at the
end of the 15th year. P35,000 annually for the
succeeding 5 years. With 10% compounding
annually, what annual payment should he pay
for 20 years to settle the amount equally?
DEFERRED ANNUITY

Given:

Formula:
DEFERRED ANNUITY

Solution:
DEFERRED ANNUITY

Continuation:
TYPES OF ANNUITY

c) Annuity due
the equal payments are made at the beginning of
each compounding period starting from the first
period. The diagram below shows the cash flow in
annuity due.
ANNUITY DUE
ANNUITY DUE

Future amount of annuity due, F

Present amount of annuity due, P


ANNUITY DUE

Sample Problem:
A farmer bought a tractor costing P12,000 if paid
in cash. The tractor may also be purchased by
installment to be paid within 5 years. Money is
worth 8% compounded annually. Determine the
amount of each annual payment if all payments
are made
a) at the end of each of the 5 years
b) at the beginning of each of the 5 years
ANNUITY DUE

a) at the end of each of the 5 years


Given:

Formula:
Solution:
ANNUITY DUE

b) at the beginning of each of the 5 years


Given:

Formula:
Solution:
TYPES OF ANNUITY

d) Perpetual annuity (Perpetuity)


an annuity where the payment period extends
forever, which means that the periodic payments
continue indefinitely.
PERPETUITY
PERPETUITY

Present amount of annuity due, P


From the present amount of ordinary annuity:

When , Thus,
ANNUITY DUE

Sample Problem:
Company “Rich” pays $2 in dividends annually
and estimates that they will pay the dividends
indefinitely. How much are investors willing to
pay for the dividend with a required rate of return
of 5%?
ANNUITY DUE

Given:

Formula:
Solution:

An investor will consider investing in the


company if the stock price is $40 or less.
ANNUITY DUE

b) at the beginning of each of the 5 years


Given:

Formula:
Solution:
CAPITALIZED COST

Capitalized Cost

As a natural extension and application of perpetuity we


have capitalized cost of any structure or property ( equipment,
machinery, building, etc.) is the sum of its first cost and the
present worth of all costs for replacement, operation, and
maintenance for a long time or forever, that is, Capitalized
cost = First cost + Cost of Perpetual Maintenance. To derive
the formulas for capitalized cost, let FC = first cost of the
structure, S = the amount needed to replace or maintain the
property every k periods, X = the amount of principal invested
at i% per period, the interest on which will amount to S every
k periods.
CAPITALIZED COST

Sample Problems
1. A manufacturing plant installed a new boiler at a total cost of
P150,000 and is estimated to have a useful life for 10 years. It is estimated
to have a scrap value at the end of its useful life of P5,000. If interest is
12% compounded annually, determine its capitalized cost.
2. A heat exchanger is needed in a chemical process. If interest is 9%
compounded annually, determine which of the following heat exchanger is
cheaper by comparing the capitalized costs:
Exchanger A costs P22,000 with a scap value of P1,000 and a useful life
for 7 years;
Exchanger B costs P28,000 with a scap value of P1,500 and a useful life
of 10 years.
CAPITALIZED COST

3. A dam will have a first cost of P5,000,000 and an annual


maintenance cost of P25,000 and minor reconstruction costs
of P100,000 every 5 years. What is the capitalized cost if the
interest is 8%.
CAPITALIZED COST

SOLUTIONS:

1.Given:
Co= P150,000
S= P5,000
I= 12% or 0.12
K= 10yrs.

Cc=Co + Cc=152,374.3402

Cc=150,000 +
CAPITALIZED COST

SOLUTIONS:

2)A.Given:
Co= P22,000
S= P1,000
I= 9% or 0.9
K= 7 yrs.

Cc=Co + Cc=22,011.31386

Cc=22,000 +
CAPITALIZED COST

SOLUTIONS:

2)B.Given:
Co= P28,000
S= P1,500
I= 9% or 0.9
K= 10 yrs.

Cc=Co + Cc=28,002.4465

Cc=28,000 +
CAPITALIZED COST

SOLUTIONS:

2. We can say that the cheaper capitalized cost is Exchanger


A Cc=22,011.31386
CAPITALIZED COST

SOLUTIONS:

3. Given:
Co= P5,000,000
S= P25,000
Rc=100,000
I= 8% or 0.08
K=5

Cc=Co + + Cc=5,525,570

Cc=5,000,000+ +
AMORTIZATION

Amortization
- Amortization is paying off a debt over
time in equal installments. Part of each
payment goes toward the loan principal,
and part goes toward interest. As the loan
amortizes, the amount going toward
principal starts out small, and gradually
grows larger month by month.
AMORTIZATION

Amortization Schedule
- An amortization schedule is a table that
provides the details of the periodic
payments for an amortizing loan. The
principal of an amortizing loan is paid
down over the life of the loan. Typically,
an equal amount of payment is made
every period.
AMORTIZATION

- An amortization schedule can be


generated by an amortization calculator,
with the inputs of the amount, periodic
terms, and interest rate of the loan.
Through amortization schedules,
borrowers can better plan and track how
much they still owe and how they will be
repaid.
AMORTIZATION

Example Problem:
Consider a $30,000 fully amortizing loan
with a term of five years and a fixed
interest rate of 6%. Payments are made
on a monthly basis.
AMORTIZATION

First and Last 6 months


AMORTIZATION
AMORTIZATION

The loan is fully amortized with a fixed


total payment of $579.98 every month.
The interest payment for each month can
be calculated by multiplying the periodic
interest rate with the ending balance from
the last month. The remaining portion of
the total monthly payment is thus the
principal repayment.
AMORTIZATION

In the first month, $150 of the total


payment is the interest, and $429.98 is the
repayment for the principal, which reduces
the balance of the loan. As time passes,
the interest portion decreases, and greater
values of principal are repaid gradually.
The balance of the loan, therefore,
diminishes at an increasing speed.
UNIFORM ARITHMETIC GRADIENT

• In certain cases, engineering economy


problems involve disbursement or receipts that
increase or decrease each year by varying
amounts. As time goes by, the maintenance
expense for mechanical equipment usually
increase. If this increase is constant then it is
known as a uniform arithmetic gradient.
UNIFORM ARITHMETIC GRADIENT

• Formula
UNIFORM ARITHMETIC GRADIENT

• Sample:

A second hand motorcycle can be purchased


by 5 end-of-month payments. The first
payment would be Php5,000 and would
increase by Php500 every payment. Should a
buyer opt to pay it at once rather than by
installments, how much would it cost him if
money is worth 6% compounded quarterly?
UNIFORM ARITHMETIC GRADIENT

• Diagram
UNIFORM ARITHMETIC GRADIENT

• Given
Formula:
Convert interest rate: j = 6% yearly
compounded quarterly
(1 + i)*m = ( 1 + j/m)*m
(1+i)*12 = ( 1+ 0.6/4)*4
Solution:
FM = F5k+ F500 P(1+i)*5 = A [(1+i)*n-1 /
i] + G/i [(1+i)*n -1 / i - n] M(1+0.005)*5=
5000 [(1+0.005*5 -1 / 0.005 - 5 +
200/0.005 [1+0.005*5 -1/ 0.005 – 5]

M= Php 26,589.00
CONCLUSION

• The time value of money is a financial principle that states the


value of a dollar today is worth more than the value of a dollar
in the future.
• This philosophy holds true because money today can be
invested and potentially grow into a larger amount in the future.
• The present value of a future cash flow is calculated by dividing
the future cash flow by a discount factor that incorporates the
amount of time that will pass and expected interest rates.
• The future value of a sum of money today is calculated by
multiplying the amount of cash by a function of the expected
rate of return over the expected time period.
• The time value of money is used to make strategic, long-term
financial decisions such as whether to invest in a project or
which cash flow sequence is most favorable.
ASSESSMENT

1. Determine the exact simple interest on P500 for the period from January 10
to October 28, 1996 at 16% interest.
2. The sum of P10, 000 was deposited to a fund earning interest 10% per
annum compounded quarterly, what was the principal in the fund at the end
of a year?
3. A man bought a lot worth P1000,000 if paid in cash. On the installment
basis, he paid a down payment of P20,000; P300, at the end of one year,
P400, at the end of three years and a final payment at the end of five years.
What was the final payment if interest was 20%?
4. Compare the accumulated amounts after 5 years of P1,000 invested at the
rate of 10% per year compounded (a) annually, (b) semiannually, (c)
quarterly, (d) monthly, I daily, and (f) continuously.
5. A man borrowed P5,000 from a bank and agreed to pay the loan at the end
of 9 months. The bank discounted the loan and gave him P4,000 in cash.
(a) What was the rate of discount? (b) What was the rate of interest? (c)
What was the rate of interest for one year?
ASSESSMENT

6. What are the present worth and the accumulated amount of a 10-year
annuity paying P10,000 at the end of each year, with interest at 15%
compounded annually?The sum of P10, 000 was deposited to a fund
earning interest 10% per annum compounded quarterly, what was the
principal in the fund at the end of a year?
7. On the day his grandson was born, a man deposited to a trust
company a sufficient amount of money so that the boy could receive
five annual payments of P80,000 each for his college tuition fees,
starting with his 18th birthday. Interest at the rate 12% per annum was
to be paid on all amounts on deposit. There was also a provision that
the grandson could select to withdraw no annual payments and
received a single lump amount on his 25th birthday. The grandson
chose this option.
(a)How much did the boy received as the single payments?
(b)How much did the grandfather deposit?
ASSESSMENT

8. A debt of P5,000 with interest at 12% compounded


semiannually is to be amortized by equal semiannual payments
over the next 3 years, the first due in 6 months. Find the
semiannual payment and construct an amortization schedule.
9. Determine the capitalized cost of a structure that requires an
initial investment of P10,000,000 and an annual maintenance of
P950,000. i = 15%
10. What amount of money invested today at 15% interest can
provide the following scholarship: P30,000 at the end of each
year for 6 years; P40,000 for the next years and P50,000
thereafter?
REFERENCES

Compound interest formula and examples. (2017, September 23).


MathBootCamps. https://www.mathbootcamps.com/compound-interest-
formula/
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---end of presentation---

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