Module 3 – Time Value of

Money
 SIMPLE INTEREST
• An interest is said to be simple when the total interest
earned or charged is linearly proportional to the initial
amount of the loan.
• This is not used frequently in modern commercial
practice.
Where:

I  P(n)(i)
I = total interest earned/paid
P = principal amount
n = number of interest periods
i = interest rate per interest period

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 SIMPLE INTEREST
EXACT SIMPLE INTEREST

 n 
I  P (i )
 365 
NOTE: n is given in days
ORDINARY SIMPLE INTEREST
 n 
I  P (i )
 360 
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 SIMPLE DISCOUNT

I  F (d )(t )
Where:
I = interest earned
F = amount due at the end of time t
d = discount rate

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 COMPOUND INTEREST
• An interest is said to be compound when the interest
charge for any interest period is based on the
remaining principal amount plus any accumulated
interest charges up to the beginning of the period.
Where:
F  P(1  i) n
F = Future amount
P = principal amount
nm n = number of interest periods
 i  m = compounding term
F  P1   i = interest rate per interest period
 m
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 COMPOUND INTEREST
COMPOUNDING PERIODS
Annual (m=1)
• there is only 1 interest period in a year
Semi-Annual (m=2)
• there are 2 interest periods in a year
Quarterly (m=4)
• there are 4 interest periods in a year (1 quarter = 3 months)
Monthly (m=12)
• there are 12 interest periods in a year

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 Example 3.1
Jenny loaned $2,000 from her friend to add as capital
for her business. They have agreed that Jenny will
pay the loan back in 2 years.
(a) How much will Jenny pay at the end of 2 years if
her friend allowed to have a simple interest rate
of 3% per year?
(b) How much will Jenny pay at the end of the second
year if the loan is compounded at 3% per year?

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 Example 3.2
Mandy invested Php10,000 on a bank
offering a simple interest rate of 12%
per year. She plans on withdrawing this
investment after 128 days. How much is
the lump sum of her investment?

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 Example 3.3
A man promised to pay 36,000 pesos at
the end of 90 days. He was offered 10%
discount if he pays in 30 days. Find the
rate of interest.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 Example 3.4
A price tag of 1,200 pesos is payable in
60 days. A 3% discount is offered if paid
in 40 days. What is the rate of interest?

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 Example 3.5
Steph loaned P15,000 from her friend
at a simple interest of 10%. How much
will she pay her friend if she decides to
return the loan after 75 days? Use exact
simple interest rate.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 Effect of different interest periods

Show the effect on the interest rate and the

number of periods for the given conditions
below for an investment worth $100,000.
• 6% compounded semi-annually for 5 years
• 6% compounded quarterly for 5 years
• 6% compounded monthly for 5 years

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 Equivalence in compound interest
1. What rate in percent compounded semi-
annually is equivalent to 20% compounded
annually?
2. What rate in percent that is compounding
monthly is equivalent to 17% compounding
quarterly?
3. Compare the future equivalent of Php1,500
using the converted interest rates.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 Cash Flows
Conventions:
1. The horizontal line is the time scale, with the
progression of time moving from left to right. The
period labels can be applied to intervals of time rather
than to points on the time scale.
2. The arrows signify cash flows and are placed at the
end of the period. A downward arrow represents
expenses and upward arrows represent receipts.
3. The cash-flow diagram is dependent on the point of
view.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 Single Cash Flows
Example 3.6: An investor has an option to purchase a
tract of land that will be worth $10,000 in six years. If the
value of the land increases at 8% each year, how much
should the investor be willing to pay now for the
property? Draw the appropriate cash flow diagram.
Example 3.7: You borrowed $8,000 now, promising to
repay the loan principal plus the accumulated interest in
four years at i = 10% per year. Draw the cash flow
diagram. How much will you repay at the end of four
years?
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 Uniform Series Cash flows
Example 3.8 ABC Corporation had an investment
of $10,000 produces an annual revenue of $5,310
for five years and then have a market value of
$2,000 at the end of year five. Annual expenses
will be $3,000 at the end of each year for
operating and maintaining the project. Draw a
cash flow diagram for the five-year life of the
project. Use the corporation’s viewpoint.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 Uniform Series Cash flows
Example 3.9 If a certain machine undergoes a
major overhaul now, its output can be increased
by 20%- which translates into additional cash flow
of $20,000 at the end of each year for five years.
Draw a cash flow diagram for the five-year life of
the project.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 Uniform Series Cash flows
Example 3.10 You borrowed $15,000 from your
credit union to purchase a used car. The interest
rate on your loan is 0.25% per month and you will
make a total of 18 monthly payments. Draw the
cash flow diagram.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 Other useful formula
Finding Interest rate given P, F, and N

i  F / P 1
n

Finding N when given P, F, and i

log( F / P)
N
log(1  i)
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 Seatwork #2
Problem 1: What is the future equivalent of $1,000
invested at 8% simple interest per year of 2.5 years?

Problem 2: An investment earns 20% compounded semi-

annually. After how many years will it triple?

Problem 3: A man is required to pay P57,500 at the end

of 15 days for P60,000 at the end of 60 days. Determine
the rate of interest.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130
 Seatwork #2
Problem 4: How much should you deposit in an account
5% interest semi-annually if you want to have $25,000
after 10 years?

Problem 5: How much should Jane return at the end of

60 days if she loaned P10,000 from a friend at a simple
interest of 10%?

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. P104-130