LESSON 14 (SECTION 9.
5) EQUIVALENT VALUES Parts I and II
The time value of money
Amounts of money have different values at different times because of their
ability to earn interest.
When sums of money fall due or are payable at different times, they are not
directly comparable.
To make sums of money comparable, a point in time, a comparison date or
a focal date must be chosen.
Any point in time may be chosen as the focal date; the choice does not
affect the final answer.
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LESSON 14 (SECTION 9.5) EQUIVALENT VALUES Parts I and II
I Finding the Equivalent Single Payment
Exercise 9.5 page 381
#2 A debt of $5500 is due in 27 months. If money is worth 8.4%
compounded quarterly,
d) what is the equivalent payment 36 months from now?
Solution
The maturity value of the debt is $5500 and the due date is 27
months from now.
If the debt is not paid on the due date and it will be paid 36
months from now or 9 months after it was due, what should the
replacement payment be? The replacement payment must
include interest for the 9 months that it is late.
Let X, represent the replacement payment. To find the value of
X, we will use the future value formula as we are finding an
equivalent single replacement payment 9 months after it was
due.
0.084 3
𝑋 = 𝑃(1 + 𝑖)𝑛 = 5500(1 + ) = $5853.83
4
A payment of $5853.83 at 36 months is equivalent to a
payment of $5500 at 27 months if money is worth 8.4%
compounded quarterly.
2
LESSON 14 (SECTION 9.5) EQUIVALENT VALUES Parts I and II
b) what is the equivalent payment 15 months from now?
Solution
The maturity value of the debt is $5500 and the due date is 27
months from now.
If the debt is to be paid 15 months from now which is before the
due date, there should be a discount. We need to find the
discounted value 12 months earlier.
0.084 −4
𝑋 = 𝑆(1 + 𝑖)−𝑛 = 5500(1 + ) = $5061.27
4
A payment of $5061.27 at 15 months is equivalent to a
payment of $5500 at 27 months if money is worth 8.4%
compounded quarterly.
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LESSON 14 (SECTION 9.5) EQUIVALENT VALUES Parts I and II
Example Scheduled payments of $1000 due in 9 months and $1200 due
in 18 months are to be replaced by a single payment 3 years
from now. Determine the size of the replacement payment if
money is worth 8.8% compounded quarterly.
Solution
Let the size of the final payment be X.
While any date may be selected as the focal date, a logical
focal date is 3 years from now as the single payment is due in 3
years.
At the focal date, an equation of value is set up.
We need to find the equivalent value of the $1000 debt, twenty-
seven months later and the equivalent value of the $1200 debt,
eighteen months later. In both cases, we need to use the future
value formula.
The value of the new replacement payment must equal the
equivalent values of the old scheduled payments.
At the focal date of 3 years,
the value of the new replacement payment = the value of the
original scheduled payments.
0.088 9 0.088 6
𝑋 = 1000(1 + ) + 1200(1 + )
4 4
𝑋 = 1216.35 + 1367.37
𝑋 = $2583.72
The equivalent single replacement payment at 3 years is
$2583.72.
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LESSON 14 (SECTION 9.5) EQUIVALENT VALUES Parts I and II
Example Scheduled payments of $2000 due in 20 months and $1500
due in 40 months are to be replaced by a single payment 9
months from now. Determine the size of the replacement
payment if money is worth 10.5% compounded monthly.
Solution
Let the size of the final payment be X.
Use 9 months from now as the focal date.
We need to find the equivalent value of the $2000 debt, eleven
months earlier and the equivalent value of the $1500 debt,
thirty-one months earlier. In both cases, we need to use the
present value formula.
At the focal date, an equation of value is set up.
At the focal date of 9 months,
the value of the new replacement payment = the value of the
original scheduled payments.
0.105 −11 0.105 −31
𝑋 = 2000(1 + ) + 1500(1 + )
12 12
𝑋 = 1817.23 + 1144.99
𝑋 = $2962.22
The equivalent single replacement payment at 9 months is
$2962.22.
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LESSON 14 (SECTION 9.5) EQUIVALENT VALUES Parts I and II
Exercise 9.5 page 382
#4 Scheduled payments of $600, $800 and $1200 are due in one year,
three years, and six years respectively. What is the equivalent single
replacement payment two-and-a-half years from now if money is
worth 7.5% compounded monthly?
Solution
Let the size of the single replacement payment be X.
Use two-and-a-half years from now as the focal date.
We need to find the equivalent values of each of the scheduled
payments at the focal date. For the debt of $600, we will use the
future value formula and for the debts of $800 and $1200, we will use
the present value formula.
At the focal date, an equation of value is set up.
At the focal date of two-and-a-half years,
the value of the new replacement payment = the value of the
original scheduled payments.
0.075 18 0.075 −6 0.075 −42
𝑋 = 600(1 + ) + 800(1 + ) + 1200(1 + )
12 12 12
𝑋 = 671.21 + 770.65 + 923.71
𝑋 = $2365.57
The single equivalent replacement, two-and-a-half years from
now, is $2365.57 if money is worth 7.5% compounded monthly.
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LESSON 14 (SECTION 9.5) EQUIVALENT VALUES Parts I and II
II Finding the Balance Payment
#8 Scheduled payments of $2000 due now and $2000 scheduled in
four years are to be replaced by a payment of $2000 due in two
years and a second payment due in seven years. Determine the
size of the second payment if interest is 10.5% compounded
annually and the focal date is seven years from now.
Solution
Let the size of the final payment be X.
The focal date is given as seven years from now.
At the focal date, the equivalent values of the original scheduled
debt payments must equal the equivalent values of the replacement
payments.
The equation of value is
2000(1 + 0.105)7 + 2000(1 + 0.105)3 = 𝑋 + 2000(1 + 0.105)5
4023.15 + 2698.47 = 𝑋 + 3294.89
6721.62 = 𝑋 + 3294.89
𝑋 = 3426.73
The size of the second payment is $3426.73 to be paid in seven
years.
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LESSON 14 (SECTION 9.5) EQUIVALENT VALUES Parts I and II
#6 Scheduled payments of $1200 due one year ago and $1000 due six
months ago are to be replaced by a payment of $800 now, a second
payment of $1000 nine months from now, and a final payment
eighteen months from now. What is the size of the final payment if
interest is 10.8% compounded quarterly?
Solution
Let the size of the final payment be X.
The logical focal date is 18 months from now when the final payment
is due.
At the focal date, the equivalent values of the original scheduled
debt payments must equal the equivalent values of the replacement
payments. There are two original scheduled payments and three
replacement payments.
The original scheduled payments are both overdue.
For the debt of $1200 which was due one year ago, we need to find
the equivalent value 18 months from now. That is an interval of time
of 30 months.
For the debt of $1000 which was due 6 months ago, we need to find
the equivalent value 18 months from now. The interval of time is 24
months.
At the focal date of 18 months, the equation of value is
0.108 10 0.108 8 0.108 3
1200(1 + ) + 1000(1 + ) = 𝑋 + 1000(1 + ) +
4 4 4
0.108 6
800(1 + )
4
1566.34 + 1237.55 = 𝑋 + 1083.21 + 938.67
2803.89 = 𝑋 + 2021.88
𝑋 = $782.01
The final payment is $782.01
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