CHAPTER 2

Time Value of Money

3. Linear gradient series: A series of flows increasing or decreasing by a fixed
amount at regular intervals. Excel is one of the most convenient tools to
solve this type of cash flow series.
4. Geometric gradient series: A series of flows increasing or decreasing by a
fixed percentage at regular intervals. Once again, this type of cash flow series is a good candidate for solution by Excel.
5. Uneven series: A series of flows exhibiting no overall pattern. However,
patterns might be detected for portions of the series.
Cash flow patterns are significant because thev allow us to develop interest
formulas, which streamline the solution of equivalence problems. Table 2.4
summarizes the important interest formulas that form the foundation for all
other analyses you will conduct in engineering economic analysis.

Methods of Colculoting Interest

What is the amount of interest earned on $3,000
for five years at 9% simple interest per year?
You deposit $2,000 in a savings account that
earns 8% simple interest per year. How many
years will it take to double your balance? If
instead you deposit the $3,000 in another savings account that earns 7% interest compounded yearly, how many years will it take to
double your balance?

The Concept of Equivalence

Suppose you have the alternative of receiving either $8,000 at the end of five years or P dollars
today. Currently, you have no need for the
money, so you deposit the P dollars into a bank
account that pays 8% interest compounded annually. What value of P would make you indifferent in your choice between P dollars today and
the promise of $8,000 at the end of five years?

2.4 You are considering investing $1,000 at an

Suppose that, to cover some of your college expenses, you are obtaining a personal loan from
your uncle in the amount of $20,000 (now) to be
repaid in two years. If your uncle always earns
10% interest (compounded annually) on his
money invested in various sources, what minimum lump-sum payment two years front now
would make your uncle happy economically?

interest rate of 6% compounded annually for

five years or investing the $1,000 at 7% per
year simple interest for five years. Which
option is better?

Which of the following alternatives would you

rather receive, assuming an interest rate of 8%
compounded annually?

2.3 Compare the interest earned on $10,000 for 20

years at 7% simple interest with the amount of
interest earned if interest were compounded
annually.

You are about to borrow $3,000 from a bank at

an interest rate of 9% compounded annually.
You are required to make three equal annual
repayments in the amount of $1,185.16 per
year, with the first repayment occurring at the
end of year one. For each year, show the interest payment and principal payment.

Alternative 1: Receive $100 today:

Alternative 2: Receive $120 two years from now.
Single Payments (Use of F/P or P/F doctors)
What will be the amount accumulated by each
of the following present investments?

Problems
(a) $7,000 in 8 years at 9% compounded annually.
(b) $1,250 in 12 years at 4% compounded annuallv.
(c) $5,000 in 31 years at 7% compounded annually.
(d) $20.00fJ in 7 years at 6 % compounded annually.

2.10 What is the present worth of the following future payments?

(a) $4,500 6 years from now at 7% compounded annually.

(b) $6,000 15 years from now at 8% compounded annually.
(c) $20,000 5 years from now at 9% compounded annually.
(d) $12,000 8 years from now at 10% compounded annually.
Assuming an interest rate of 8% compounded
annually. answer the following questions:

(a) How much money can be loaned now if

$6,000 is to be repaid at the end of five years?
(b) How much money will be required in four
years in order to repay a $15.000 loan borrowed now?

2.12 How many years will it take an investment to

triple itself if the interest rate is 7% conpounded annually?

You bought 200 shares of Motorola stock at

$3,800 on Decembei 31. 2000. Your intention is
to keep the stock until it doubles in value. If
you expect 12% annual growth for Motorola
stock, how many years do you expect to hold
onto the stock? Compare vour answer with the
solution obtained by the Rule of 72 (discussed
in Example 2.7).

2.14 If you want to withdraw $35,000 at the end of

four years, how much should you deposit now
in an account that pays 9% interest compounded annually ? See the accompanying
cash flow diagram.

2.15 John and Susan just opened savings accounts

at two different banks. They each deposited
$1,000. Johns bank pays simple interest at an
annual rate of 10%, whereas Susans bank
pays compound interest at an annual rate of
9.5%. No interest will be taken out of the accounts for a period of three years. At the end
of three years, whose balance will be greater
and by how much (to the nearest dollar)?
Uneven-Payment Series

2. 1 6 If you desire to withdraw the following amounts

over the next five years from a savings account
that earns 6% interest compounded annually,
how much do you need to deposit now?
Year

Amount

$3,000
$3,500

$4,000
$6,000

2.17 If $1,000 is invested now, $1,500 two years

from now, and $2,000 four years from now at
an interest rate of 8% compounded annually,
what will be the total amount in 10 years?
2.18 A local newspaper headline blared, Bo Smith
Signs for $30 Million. The article revealed that,
on April 1, 2002, Bo Smith, the former recordbreaking running back from Football University, signed a $30 million package with the
Nebraska Lions. The terms of the contract were
$3 million immediately, $2.4 million per year for
the first five years (with the first payment after
one year), and $3 million per year for the next