Reviewer/Interest Factor…

CASH FLOW DIAGRAM AND INTEREST FORMULAS

Notations used in formulas for compound interest calculations:
i = interest rate per interest period
n = number of compounding periods
P = present sum of money; the equivalent worth of one or more
cash flows at a reference point in time called the present
F = future sum of money; the equivalent worth of one or more
cash flows at a reference point in time called the future
A= end-of-period cash flows in a uniform series continuing for a
specified number of periods; starring at the end of the first
period and continuing through the last period
 Reviewer/Interest Factor…
Cash flow diagram:
A cash flow is the difference between total cash receipts (inflows)
and total cash disbursements (outflows) expenditures for a given
period of time.
A cash flow diagram is used to visualized a cash flow;
individual cash flows are presented as vertical arrows along a
horizontal time sale
Positive cash flows (net inflows) are represented by “upward-
pointing ” arrows and negative “cash flows” (net outflows) by
“downward-pointing” arrows. The length of an arrow is proportional
to the magnitude of the corresponding cash flow. Each cash flow is
assumed to occur at the respective time period. The cash flow
diagram is dependent on the point on view (e.g. lender vs. borrower
viewpoint).
 Example of a cash flow diagram:

End –of- Event or transaction

period
0 (now) Outlay of P100,000

1 Additional expenditure of
P25,000
2 Receipts of P60,000

3 to 6 Uniform receipts of
P80,000
7 Receipts of P100,000
 
Reviewer/Interest Factor…
P100,000
P80,000

P60,000

0 1 2
3 4 5 6 7 periods
-P25,000

-P100,000
Reviewer/Interest Formulas
A uniform payment series is one that consists of equal
payments (No. 11, Easy)
a)     starting now up to year n
b)     starting one year from now up to year n
c)   starting one year from now increasing by a
uniform amount up to year n
d)     none of the above
Answer: b
Reviewer/Interest Formulas

1 2 3 4 5 6 7 n-1 n

P
 Table of interest factors for discrete compounding; interest rate of 5%
n (F/P,I%,n) (P/F,I%,n) (F/A,I%,n) (A/F,I%,n) (P/A,I%,n) (A/P,I%,n) (A/G,I%,n)
1 1.0500 0.9524 1.0000 1.0000 0.9524 1.0500 0.0000
2 1.1025 0.9070 2.0500 0.4878 1.8594 0.5378 0.4878
3 1.1576 0.8638 3.1525 0.3172 2.7232 0.3672 0.9675
4 1.2155 0.8227 4.3101 0.2320 3.5460 0.2820 1.4391
5 1.2763 0.7835 5.5256 0.1810 4.3295 0.2310 1.9025
6 1.3401 0.7462 6.8019 0.1470 5.0757 0.1970 2.3579
7 1.4071 0.7107 8.1420 0.1228 5.7664 0.1728 2.8052
8 1.4775 0.6768 9.5491 0.1047 6.4632 0.1547 3.2445
9 1.5513 0.6446 11.0266 0.0907 7.1078 0.1407 3.6758
10 1.6289 0.6139 12.5779 0.0795 7.7217 0.1295 4.0991
11 1.7103 0.5847 14.2068 0.0704 8.3064 0.1204 4.5144
12 1.7959 0.5568 15.9171 0.0628 8.8633 0.1128 4.9219
13 1.8856 0.5303 17.7130 0.0565 9.3936 0.1065 5.3215
14 1.9799 0.5051 19.5986 0.0510 9.8986 0.1010 5.7133
15 2.0789 0.4810 21.5786 0.0463 10.3797 0.0963 6.0973
16 2.1829 0.4581 23.6575 0.0423 10.9378 0.0923 6.4736
17 2.2920 0.4363 25.8404 0.0367 11.2741 0.0887 6.8423
18 2.4066 0.4155 28.1324 0.0355 11.6896 0.0855 7.2034
19 2.5270 0.3957 30.5390 0.0327 12.0853 0.0827 7.5569
20 2.6533 0.3769 33.0660 0.0302 12.4622 0.0802 7.9030
21 2.7860 0.3589 35.7193 0.0280 12.8212 0.0780 8.2416
22 2.9253 0.3418 38.5052 0.0260 13.1630 0.0760 8.5730
23 3.0715 0.3256 41.4305 0.0241 13.4886 0.0741 8.8971
24 3.2251 0.3101 44.5020 0.0225 13.7986 0.0725 9.2140
25 3.3864 0.2953 47.7271 0.0210 14.0939 0.0710 9.5238
30 4.3219 0.2314 66.4388 0.0151 15.3725 0.0651 10.9691
35 5.5160 0.1813 90.3203 0.0111 16.3742 0.0611 12.2498
40 7.0400 0.1420 120.7998 0.0083 17.1591 0.0583 13.3775
50 11.4674 0.0872 209.3480 0.0048 18.2559 0.0548 15.2233
60 18.6792 0.0535 353.5837 0.0028 18.9293 0.0528 16.6062
80 49.5614 0.0202 971.2290 0.0010 19.5965 0.0510 18.3526
100 131.5010 0.0076 2610.025 0.0004 19.8479 0.0504 19.2337
 Reviewer/Interest Formulas
The equal payment series sinking fund factor is used (No.
9, Easy)

a) to find F given A c) to find A given F

b) to find A given P d) none of the above

Answer: c
Reviewer/Interest Formulas
F
A

0 1 2 3 4 5 6 7 n
 Reviewer/Interest Formulas
The amount of P65,000 was to be borrowed at an annual
interest rate of 12% to be repaid in 5 years. Two different
plans, both equally desirable, could be selected to repay the
loan. The first plan requires paying 1/5 of the principal each
year + interest due. The second plan requires paying an
equal amount every year. In Plan 1, the amount to be
repaid at the end of year 1 will be closest to (No. 9,
Moderate)
a) P17,680 b) P20,800 c) P18,240 d) P16,120
 Reviewer/Interest Formulas
Given: P = P65,000
i=12%/yr
n = 5 yrs
For Plan 1, 1st payment = I + 1/5P
Find: Amt of 1st payment
Solution:
1st Payment = I + 1/5P = (P×i) + 1/5P
= (65,000×0.12) + (1/5)(65,000)
= 7,800 + 13,000 = P20,800 b
 Reviewer/Interest Formulas
A loan can be repaid in 4 years using any of the 3 following plans: (No. 8,
Moderate)
Plan End-of Interest Total owed at Payment
end of Year
Year for Year
Plan 1 1 7,200 97,200 27,173
  2 5,602 75,629 27,173
  3 3,876 52,332 27,173
  4 2,013 27,173 27,173
Plan 2 1 7,200 97,200 0
  2 7,776 104,976 0
  3 8,398 113, 374 0
  4 9,070 122,444 122,444
Plan 3 1 7,200 97,200 7,200
  2 7,200 97,200 7,200
  3 7,200 97,200 7,200
  4 7,200 97,200 97,200
Reviewer/Interest Formulas
The original amount of the loan is:
a)     P72,000 c) P108,692
b)     P90,000.00 d) P97,200

Given: 3 different plans to pay a loan as shown in the table.

Find: P
Solution: Since interest rate is not given, it is best to look at
interest earned and total amount owed at the end of year 1.
For all plans, total amount owed at year 1, F1 = P97,200.
Interest earned for year 1, I1 = P7,200.
Therefore, P = F1 – I1 = P97,200 – P7,200 = P90,000 b
 Reviewer/Interest Formulas
The value of the interest factor needed to find the
equivalent at time 0 of P155,000 occurring 7 years from
now when interest rate is 9% per year compounded yearly
is (No. 8, Easy)
a) 1.8280 c) 0.0129
b) 0.5470 d) none of the above
 Reviewer/Interest Formulas
Given: F7 = P155,000
n = 7 yrs
i = 9%/yr
Find: Value of interest facto to find P given F
Solution:
Cash flow diagram is as follows:
F = P155,000

(P/F)

i=9%/yr n=7yrs

P?
(P/F,i,n) = (1+i)-n = (1 + 0.09)-7 = 0.5470 b
 Reviewer/Interest Formulas
The value of the interest factor needed to find a series
of equal revenues that must be received every year for
12 years to realize a return of 25% from an initial
investment of P25M is (No. 2, Moderate)
a)     0.2685 c) 0.0687
b)     0.0185 d) none of the
above
Reviewer/Interest Formulas

1 2 3 4 5 6 7 8 9 10 11 12

P = P25M (A/P,i,n) = [i×(1+i)n] = [0.25×(1+0.25)12]

(1+i)n-1 (1+0.25)12-1

(A/P,i,n) = 0.2684 a
 Reviewer/Interest Formulas
Five years ago, P12,000 was deposited into a savings
account that provides an interest of 6.5% compounded
annually. If a uniform amount of P3,000 was withdrawn
yearly starting at the end of the first year after the initial
deposit was made, then (No. 1, Moderate)
a)  all the money will be gone by now
b) an amount greater than P3,000 can still be
withdrawn now
c)  an amount less than P3,000 can still be withdrawn
now
d) none of the above
Reviewer/Interest Formulas
A= P3,000
A5=P3,000?

1 2 3 4 5

i=6.5%/yr

P=P12,000
 Reviewer/Interest Formulas
Solution 1: Step-wise approach

End of P I P+I Amt Remaining

year withdrawn amount after
year n
1 12,000 780 12,780 3,000 9,780
2 9,780 635.7 10,416 3,000 7,416
3 7,416 482 7,898 3,000 4,898
4 4,898 318 5,216 3,000 2,216
5 2,216 144 2,360 3,000? -640

Answer: c
 Reviewer/Interest Formulas
Solution 2: Analytical approach
A  P  ( A / P, i, n)
[i  (1  i ) n ]
A  P
(1  i ) n  1
[0.065  (1  0.065)5 ]
A  12,000 
(1  0.065)5  1
A  P 2,888 Uniform amt to be withdrawn to last 5 years
Since the amount withdrawn for the last 4 years exceeds
the amount of P2,888, then it follows that the amount that
can be withdrawn on the 5th year can not be P3,000.
 Reviewer/Interest Formulas
A loan of P10,000 is to be paid in 3 years at an
interest of 6% per year. Which of the payment plans
below is not equivalent to the others? (No. 1, Difficult)
a) Pay interest payment of P600 each year during the
first 2 years and P10,600 at the end of the third year.
b) Pay P4,600 at the end of the first year, P3,600 at
the end of the second year and P3,600 at the end of the
3rd year.
c) Pay with a single amount of P11,910 at the end of
3 years.
d) Pay with 3 equal payments of P3,741 every year for
3 years.
 Reviewer/Interest Formulas
Given: P = P10,000
n = 3 yrs
i = 6%/yr
Find: Repayment plan that is not equivalent to the others.
Looking over at each plan: (a)

End of P I P+I Amt Paid Remaining

year amount after
year n
1 10,000 600 10,600 600 10,000
2 10,000 600 10,600 600 10,000
3 10,000 600 10,600 10,600 0
 Reviewer/Interest Formulas

Looking at plan: (b)

End of P I P+I Amt Paid Remaining

year amount after
year n
1 10,000 600 10,600 4,600 6,000
2 6,000 360 6,360 3,600 2,760
3 2,760 165.6 2925.6 3,600 Overpaid
 Reviewer/Interest Formulas

Looking at plan: (c)

End of P I P+I Amt Paid Remaining

year amount after
year n
1 10,000 600 10,600 0 10,600
2 10,600 636 11,236 0 11,236
3 11,236 674 11,910 11,910 0
 Reviewer/Interest Formulas

Looking at plan: (d)

End of P I P+I Amt Paid Remaining

year amount after
year n
1 10,000 600 10,600 3,741 6859
2 6,859 411.54 7270.54 3,741 3529.54
3 3,529.54 211.77 3741 3,741 0

Answer: Plan b is different from the others

 Reviewer/Interest Formulas
At 10% interest, the cash flow below (No. 12, Moderate)

0 1 2 3 4

P2,000
P2,500
P3,000
P3,500

is equivalent to a uniform yearly cash flow of

a) P3,500 b) P2,780 c) P2,691 d) P3,025
 Reviewer/Interest Formulas
Solution:
i=10%/yr
0 1 2 3 4 0 1 2 3 4

P2,000
P2,500 A=?
P3,000
P3,500
 Reviewer/Interest Formulas
1st approach: First find P, then solve for A algebraically.
P  2,000  (1.1)  2,500  (1.1)  3,000  (1.1)  3500  (1.1)
1 2 3 4

P  8,528.6
P  A  (1.1)  A  (1.1)  A  (1.1)  A  (1.1)
1 2 3 4

P  A(0.9091  0.8264  0.7513  0.683)  A  3.1698

Solving forA :
AP  P8,528.6  P 2691
3.1698 3.1698
Reviewer/Interest Formulas
2nd Approach; Solve for P, then find A using the capital
recovery factor interest formula.
A  P  ( A / P, i , n)
 i 1  i  
n

A  8528.6   
 (1  i )  1
n

 0.11  0.1 
4

A  8528.6   
 (1  0. 1)  1
4

A  P 2,691
 Reviewer/Interest Formulas
3rd Approach: Use the uniform gradient interest factor formula.

A  A  G ( A / G , i, n)
1

1 n
A  A  G [  ]
i (1  i )  1
1 n

1 4
A  2,000  500  [  ]
0.1 (1  0.1)  1 4

A  P 2,691
Reviewer/Interest Formulas
Which of the following interest relationships is
not true? (No. 3, Difficult)
a)  (P/A,i,n) = [1 + (P/F,i,n)](1/i)
b)  (A/P,i,n) = (A/F,i,n) + i
c) (P/F,i,n) = (P/F,i,n1)×(P/F,i,n2) provided n1 + n2 = n
d)  (F/A,i,n ) = 1 + ( F/P,i,1) + (F/P,i,2) + ….. + (F/P,i,n-1)
e)   none of the above
 
 Reviewer/Interest Formulas
Solution: Prove each identity given, starting with (a)
?

(P/A, i, n)  [1  (P/F, i, n)](1/i)

 1  i   1
n
?
1
 i  1  i    [1  (1  i ) ]  i
n
n
 
 1  i   1 1  (1  i )
n n
?

 i  1  i    [
n
i
]
 
 1 
1 
 1  i   1  (1  i )   1  i   1
n n n
?

 i  1  i    
n
i

i  (1  i ) 
     
n

 
 1  i   1  1  i   1
n n

 i  1  i     i  (1  i ) 
n
   
n
Reviewer/Interest Formulas
Proving identity (b).

 A / P, i , n) ( A / F , i , n   i
?

 i  (1  i ) n
  ?
i 
 (1  i )    (1  i )  1  i
   
n n

 i  (1  i ) n
  i  i  ((1  i )  1)   i  i  (1  i )  i 
?
n n

 (1  i )   (1  i )  1  
(1  i )  1 
     
n n n

 i  (1  i )   i  (1  i ) 
n n

 (1  i )    (1  i ) 
   
n n
Reviewer/Interest Formulas
Proving identity c).
F=F2
F1

n=n1+n2
P n1 n2

From the cash flow diagram, we can see that

P  F ( P / F , i, n)  F ( P / F , i, n )  ( P / F , i, n )
2 2 1

Since F  F , then,
2

(P/F, i, n)  ( P / F , i, n )  ( P / F , i, n )
2 1
 Reviewer/Interest Formulas

A
F=?

0 1 2 3 4 5 6 7 n-1 n

A  ( F / A, i, n)  A  (1  i) ( n n )
 A  (1  i) ( n  ( n 1 ))
 A  (1  i) n( n 2 )
....A  (1  i ) ( n 1 )

A  ( F / A, i, n)  A   (1  i)  (1  i )  (1  i)  ...  (1  i) 
?
0 1 2 n 1

A  ( F / A, i, n)  A  [1  ( F / P, i,1)  ( F / P, i,2)  ...(F / P, i, n  1)]

( F / A, i, n)  1  ( F / P, i,1)  ( F / P, i,2)  ...(F / P, i, n  1)
 Reviewer/Effective vs. Nominal rates/Frequent Compounding
Interest rate statement Interpretation Comment

i = 12% per year i = effective 12% per year When no compounding period
  compounded yearly is given, interest rate is an
i = 1% per month i = effective 1% per month effective rate, with
  compounded monthly compounding period assumed
i = 3½% per quarter i = effective 3½% per quarter to be equal to stated time
compounded quarterly period.
i = 8% per year, i = nominal 8% per year When compounding period is
compounded monthly compounded monthly given without stating whether
i = 4% per quarter   the interest rate is nominal or
compounded monthly i = nominal 4% per quarter effective, it is assumed to be
i = 14% per year compounded compounded monthly nominal. Compounding period
semiannually   is as stated.
i = nominal 14% per year
compounded semiannually

i = effective 10% per year i = effective 10% per year If interest rate is stated as an
compounded monthly compounded monthly effective rate, then it is an
i = effective 6% per quarter i = effective 6% per quarter effective rate. If compounding
  compounded quarterly period is not given,
i = effective 1% per month i = effective 1% per month compounding period is
compounded daily compounded daily assumed to coincide with stated
  time period.
Reviewer/Effective vs. Nominal rates/Frequent Compounding
Table 3. Specific examples of interest statements and interpretations.

Interest statement Type of Compounding period

interest

15% per year compounded monthly Nominal Monthly

15% per year Effective Yearly
Effective 15% per year compounded Effective Monthly
monthly    
20% per year compounded Nominal Quarterly
quarterly
Nominal 2% per month Nominal Weekly
compounded weekly    
2% per month Effective Monthly
2% per month compounded Effective Monthly
monthly Effective Quarterly
Effective 6% per quarter Effective Daily
Effective 2% per month
compounded daily Nominal Continuously
1% per week compounded
continuously Nominal Continuously
0.1% per day compounded
continuously
Reviewer/Effective vs. Nominal
rates/Frequent Compounding
In which statement is the interest rate not given as
an effective rate? (No. 12, Easy)
a)    effective 12% per year compounded monthly
b)     10% per year compounded daily
c)      2% per month compounded monthly
d)     none of the above
 
Reviewer/Effective vs. Nominal
rates/Frequent Compounding
Which will provide the largest annual effective
rate? (No. 13, Easy)
a)     effective 18% per year compounded yearly
b)     18% per year compounded daily
c)      17.5% per year compounded weekly
d) nominal 18.5% per year compounded
semi-
annually
 Reviewer/Effective vs. Nominal rates/Frequent
Compounding
Solution: a) 18%
b)
365
 0.18 
i  1    1  19.72%
 365 
a

c)
52
 0.175 
i  1    1  19.09%
 52 
a

d)
2
 0.185 
i  1    1  19.36%
 2 
a

Answer : b
Reviewer/Effective vs. Nominal
rates/Frequent Compounding
If a borrower just made the first quarterly
payment of P700 in interest for a loan that carries
an interest rate of 2% per quarter, the original
amount of loan is: (No. 7, Moderate)
a)     P8,750.00 c) P140,000
b)     P35,000.00 d) P165,000
 Reviewer/Effective vs. Nominal rates/Frequent
Compounding
Given: Iq=P700
iq=2%/quarter
Solution:
For the first interest period,
I=P×i×n, where n=1
P700=P ×0.02 × 1
Solving for P,
P=P700/0.02=P35,000 b
Reviewer/Effective vs. Nominal
rates/Frequent Compounding
Which of the following is not equivalent to 24%
per year compounded monthly? (No. 15, Easy)
a)     2% per month
b)     effective 26.82% per year
c)      6.12% per quarter
d)     12.24% per semi-annual period
Reviewer/Effective vs. Nominal rates/Frequent
Compounding
Given: interest statement: 24%/yr compounded monthly
= 2% /month

a) 2%/month: ia=(1+0.02)12-1=26.82%

b) 26.82%/year
c) 6.12% / quarter: ia=(1+0.0612)4-1=26.82%
d) 12.24%/semiannual period:
ia=(1+0.1224)2-1=25.98%

Answer: d
Reviewer/Effective vs. Nominal
rates/Frequent Compounding
An appliance worth P7,875 is made available for a 1
and ½ year loan, payable in monthly installments of
P500. The effective annual interest rate is closest to
(No. 8, Difficult)
a) 12.6% b) 18.8% c) 13.5% d) 21.6%
 
 
 Reviewer/Effective vs. Nominal rates/Frequent
Compounding
Given: P=7,875
n=1 and ½ yrs = 18 months
A=P500
Find: ia
The equation of value is
P7,875 = P500× (P/A,i,n)
  1  i '  1 
n

7,875  500   
 i '(1  i ' ) 
n

 1  i '  1  7,875
n

   15.75
 i '(1  i ' )  500
n
Reviewer/Effective vs. Nominal rates/Frequent
Compounding
For this type of problem, solution is by trial and error
method, using the values in the multiple choice. It is best
to start trials with values in the middle of the range of
choices.
Try b) 18.8% i  0.188  (1  i )  1
a m
12

Solving for i :
m

0.188  1  (1  i ) m
12

1  i  (1.188)
m
( 1 / 12 )

i  1.0144595  1  1.44595%
m

Use this in the equation of value, and if it gives an

answer of 15.75, then it is the answer. Otherwise, try
the others.
Reviewer/Effective vs. Nominal rates/Frequent
Compounding

  1  i '  1 
n

7,875  500   
 i '(1  i ' ) 
n

 1  i '  1  7,875
n

   15.75
 i '(1  i ' )  500
n

 1  0.144594   1   7,875  15.75

18

 
 0.144594  (1  0.144594)  500
18

Answer: b
Reviewer/Effective vs. Nominal
rates/Frequent Compounding
How much money will be accumulated in 3 years if a
person made a monthly deposit of P2000 every month
up to the 3rd year when the account pays interest of
1% per month? (No. 11, Moderate)
a) P81,406 b) P90,028 c) P115,112 d) P86,154
 
Reviewer/Effective vs. Nominal rates/Frequent
Compounding

Given: n = 3 yrs = 36 months

Am=P2,000
i=1%/mo
Find: F F  A( F / A, i, n)
 (1  i )  1 
n

F  A 
 i 
 (1  i )  1 
n

FA m
 where n  no. of months
 i 
m

 (1  .01)  1 
36

F  P2,000     P86,154
 0.01 
Answer : d
Reviewer/Effective vs. Nominal
rates/Frequent Compounding
How many years will be required for a given sum
of money to triple, if it is deposited in a bank
account that pays 8% per year compounded
quarterly? (No. 3, Moderate)
a)     14 c) 13
b)     15 d) 16
Reviewer/Effective vs. Nominal
rates/Frequent Compounding
Given: P
F = 3P
i=8%/yr compounded quarterly = 2%/q

Find: n such that F=3P at 2%/q

Reviewer/Effective vs. Nominal rates/Frequent
Compounding

F  3P  P  ( F / P, i , n )q q

3  (1  1 )
nq
q

3  (1  .02)
nq

To solve for n , take the natural log of both sides

q

n ln(1.02)  ln 3
q

1.0986123
n   55.48q
0.0198026
q

55.48 q  13.87 yrs  14 yrs

Reviewer/Effective vs. Nominal rates/Frequent
Compounding
Alternatively, we can solve for nyears directly by 1st
obtaining ia: i  (1  i )  1 4
a q

i  (1  .02)  1  8.2432% / yr
a
4

F  3P  P  ( F / P, i , n ) a

3  (1  1 )
n
a

3  (1  0.082432)
n

To solve for n , take the natural log of both sides

n ln(1.082432)  ln 3
1.09886123
n   13.86 yrs  14 yrs
0.0792105
yrs
 Reviewer/Effective vs. Nominal
rates/Frequent Compounding
If you invest P1,500,000 now in a house and lot,
how much must you rent your property per month
for 20 years if you want an annual return of 20% on
your investment? (No. 10, Moderate)
a) P18,400 b) P21,450 c) P25,670 d) P30,000
 Reviewer/Effective vs. Nominal
rates/Frequent Compounding
Given: P=P1.5M
n = 20 yrs
i=20%/yrs Find: Am
First, find A year

A year
 P ( A / P, i , n)
 i (1  i )  n

A  P1.5M   
 (1  i )  1 
n

 0.20(1  0.20)  20

A  P1.5M     P308,034.8
 (1  0.20)  1 
20

A P308,034.8
A   year
 P 25,670 / mo
12 12
m
 Reviewer/Effective vs. Nominal
rates/Frequent Compounding
A series of equal payments of P500 is received semi-
annually for 4 years. After the first 4 years, the semi-
annual payments are doubled in size, and these larger
payments are received for 10 more years. If the
interest rate is 12% compounded quarterly, the single
present amount equivalent to the series of payments
received over the 14-year period is (No. 9, Difficult)
a) P10,075 b) P10,114 c) P10,190 d) P11,400
 Reviewer/Effective vs. Nominal
rates/Frequent Compounding
Cash flow diagram:

A2s

A1s

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14

i=12% compounded quarterly

 Reviewer/Effective vs. Nominal
rates/Frequent Compounding
Given: A1s=P500 semi-annual payments during the first 4 yrs;
n1s=8
A2s = P1,000 semi-annual payments during the next 10 yrs;
n2s=20
Find P:
Since cash flows are semi - annual, we have to first solve for i :
s

i  (1  i )  1
s q
2

0.12
i  (1  )  1  0.0609  6.09%
2

4
s
 Reviewer/Effective vs. Nominal
rates/Frequent Compounding
P  A  ( P / A, i , n )  A  ( P / A, i , n )( P / F , i , n )
1s s 1s 2s s 2s s 1s

 (1  i )  1
n1 s
 (1  i )  1 n2 s

P  A    A     (1  i )  n1 s

 i  (1  i )   i  (1  i ) 
1s n1 s 2s n2 s

 (1  0.0609)  1  8
 (1  0.0609)  1  20

P  P500     P 1, 000     (1.0609) 8

 0.0609  (1  0.0609)   0.0609  (1  0.0609) 

8 20

P  P10,190

Answer: c
 Reviewer/Methods of Evaluating Investment
Alternatives

Interest earned by an investment:

P=P1,000

0
1
i earned = ?

P=P1,000

P1=P500 P2=P500

0 i earned = ?
1 2

P=P1,000
 Reviewer/Methods of Evaluating Investment
Alternatives

Interest earned by an investment:

F1=P500 F2=P500 F3=P500

0
3
i earned = ?
1 2
F=P1,500
P=P1,000

0
i earned = ?
3

P=P1,000
 Reviewer/Methods of Evaluating Investment
Alternatives
The actual interest earned on an investment is the
interest rate that makes (No. 14, Easy)
a) the equivalent amount of receipts equal to the
equivalent amount of disbursements at time 0.
b) the equivalent amount of receipts equal to the
equivalent amount of disbursements at t = n.
c) the equivalent yearly amount of receipts equal to
the equivalent yearly amount of disbursements
d)  all of the above
 
 Reviewer/Methods of Evaluating Investment
Alternatives
Calculations involving bonds:
A bond is a financial instrument setting forth the conditions
under which money borrowed.
Par value or face value is the value stated on the bond (as in
a check, note, bill or other paper security), usually in multiples of
P1,000.
A bond’s yield to maturity is the effective annual interest rate
earned by a bond, taking into consideration periodic interest
payments and disposal or redemption price of the bond at
maturity.
Maturity refers to the time that a bond or note is payable.
 Reviewer/Methods of Evaluating Investment
Alternatives
A P10,000 bond that will mature in 20 years is currently
sold for P7,500. It provides 10% interest payments paid
quarterly. The face value of the bond is (No. 2, Difficult)
a)     P7,500 c) P2,500
b)     P10,000 d) none of the above
 
 
 Reviewer/Methods of Evaluating Investment
Alternatives
After passing the board exam, you plan to set up a business
that requires a P2.5 M initial investment of which 25% is
working capital. The P2.5 M also includes an amount of
P575,000 for equipment, with no salvage value. The
business is good for 7 years and is projected to provide
yearly net cash flows of P600,000. In addition, you will
recover 80% of your working capital at the end of 7 years.
At 16% interest per year, the present worth of this
investment is closest to (No. 13, Moderate)
a) P80,000 b) P100,060 c) P150,040 d) P224,360
 
 Reviewer/Methods of Evaluating Investment
Alternatives
Given: P=P2.5M WC = 25% of P = 0.25 × P2.5M
n = 7 yrs WC = P625,000
A = P600,000
i= MARR = 16%/yr
SV = 80% of working capital = 0.8×P625,000=P500,000
Find: Present Worth (PW) = Net present value (NPV)

PW   P  A  ( P / A, i, n)  SV  ( P / F , i, n)
 (1  i ) n  1 n
PW   P  A     SV  (1  i )
 i  (1  i ) 
n

 (1  0.16) 7  1  7
P   P 2.5M  P 600T   7
 P 500T  (1  0.16)
 0.16  (1  0.16 ) 
P  P100,040
 Reviewer/Methods of Evaluating Investment
Alternatives
Given the following cash flow for an investment and a MARR
 

  of 12%: (No. 20, Easy)

End of              
Year 0 1 2 3 4 5 6
Cash              
Flow -30,000 -19,000 10,000 10,000 10,000 20,000 20,000

The simple payback period is

a) 3 years b) 4 years c) 5 years d) 6 years
   
 
 Reviewer/Methods of Evaluating Investment
Alternatives
Simple payback period: The smallest value for which the relationship
below is satisfied: n

F  0
t 0
t

Sequentially solving for the value of ΣFt

At t  1,
1 ?

 F   P30,00  (  P19,000)  0
0
t

At t  2,
2 ?

 F   P30,000  ( P19,000)  ( P10,000)  0

0
t

At t  3,
3 ?

 F   P30,000  ( P19,000)  ( P10,000)  (10,000)  0

0
t

At t  4,
4 ?

 F   P30,000  ( P19,000)  ( P10,000)  (10,000)  (10,000)  0

0
t
 Reviewer/Methods of Evaluating Investment
Alternatives

At t  5,
5 ?

 F   P30,000  ( P19,000)  ( P10,000)  (10,000)  (10,000)  ( P 20,000)  0

0
t

5
At t  5,  F  0; n  5 yrs.
t
0
 Reviewer/Methods of Evaluating Investment
Alternatives
Given the following cash flow for an investment and a
MARR of 12%: (No. 15, Moderate)
End of              
Year 0 1 2 3 4 5 6
Cash              
Flow -30,000 -19,000 10,000 10,000 10,000 20,000 20,000

  The internal rate of return is closest to

a) 8.6% b) 9.4% c) 10.8% d) 11.3%
 
 Reviewer/Methods of Evaluating Investment
Alternatives
Given: MARR = 12%
n = 6 yrs
Cash flow – as given in the Table
Find: IRR
IRR is the value of the interest rate, i’, that will make the
equivalent amount of receipts equal to the equivalent amount
of disbursements:
n n

 R  ( P / F , i '%, k )   E  ( P / F , i '%, k )
k 0
k
k 0
k
 Reviewer/Methods of Evaluating Investment
Alternatives
n n

 R  ( P / F , i'%, k )  E
k 0
k
k 0
k  ( P / F , i '%, k )

10,000  ( P / A, i' ,3)  ( P / F , i' ,2)  20,000  ( P / A, i' ,2)  ( P / F , i ' ,4) 
 P30,000  P19,000  ( P / F , i' ,1)
Sequentially try the interest rate given as choices,
starting with values in the middle of the range.
 Reviewer/Methods of Evaluating Investment
Alternatives
n n

 R  ( P / F , i'%, k )  E
k 0
k
k 0
k  ( P / F , i '%, k )

10,000  ( P / A, i ' ,3)  ( P / F , i' ,2)  20,000  ( P / A, i' ,2)  ( P / F , i ' ,4) 
 P30,000  P19,000  ( P / F , i' ,1)
 (1  i' )3  1 2  (1  i ' ) 2
 1
10,000   3 
 (1  i ' )  20,000   2 
 (1  i ' ) 4

 i' (1  i ' )   i ' (1  i' ) 
P30,000  P19,000  (1  i ' ) 1 
Using i’=9.4%, equivalent receipts equal P47,368 and
equal disbursement equal P47,402. The other choices
do not come close, and the difference could be due to
rounding discrepancies. Therefore, IRR = 9.4%
Reviewer/Methods of Evaluating Investment
Alternatives
Capital Recovery (C.R.) cost defined:

CR  P( A / P, i, n)  S ( A / F , i, n)
 Reviewer/Methods of Evaluating Investment
Alternatives
A machine which costs P100,000 when new has a lifetime
of 15 years and a salvage value equal to 20% of its original
cost. If interest rate is 10% compounded annually, the
capital recovery of the machine is closest to (No. 20,
Moderate)
a)     P12,518 c) P15,324
b)     P14,645 d) P16,846
 
 
Reviewer/Methods of Evaluating Investment
Alternatives
Given: P=P100,000
SV = 20% of P=0.2× P100,000=P20,000
i = 10% compounded annually
n = 15 years
CR  P ( A / P, i, n)  S ( A / F , i, n)
 i (1  i ) n   i 
CR  P100,000     P 20,000   
 (1  i ) n
 1   (1  i ) n
 1 
 0.1(1  0.1)15   0.1 
CR  P100,000     P 20,000   
 (1  0.1)15
 1   (1  0 .1)15
 1 
CR  P12,518

Answer: b
 Reviewer/Comparison Between
Investment Alternatives
You are to make a choice between 2 investment alternatives as follows:
(MARR is 15% per year). The salvage value is 20% of the net cash flow at
the end of each alternative’s useful life. (No. 14, Moderate)
End-of-Year Alternative Prime Alternative Mover
0 -P 160,000 -P240,000
1 50,000 45,000
2 50,000 45,000
3 50,000 45,000
4 130,000 45,000
5   45,000
6   45,000
7   45,000
8   100,000

Using repeatability assumption, what would be the closest

value to the PW of alternative Prime?
a) P30,286 b) P40,648 c) P44,780 d) P52,280
 Reviewer/Comparison Between
Investment Alternatives
Given: MARR = 15%/yr
SV = 20% of net cash flow
Find: PW of alternative Prime using repeatability assumption.
P130,000 P130,000
A=P50T

0 1 2 3 4 5 6 7 8

-P160,000 -P160,000
 Reviewer/Comparison Between Investment
Alternatives

PW   P160T  P50T ( P / A,15%,8)  P80T ( P / F ,15%,4)  P80T ( P / F ,15%,8)

PW  P 44,778

Answer: c
 Reviewer/Comparison Between
Investment Alternatives
Two electric motors are being evaluated for an automated
paint booth application. Each motor must have an output
of 10 horsepower (hp). It is estimated that the booth will
be operated an average of 8 hours per day for 250 days
per year. MARR is 12% per year before taxes and the
machine must return the capital in 5 years. Motor A costs
P68,000 and has a guaranteed efficiency of 85% at the
indicated operating load. Motor B costs P56,000 and has a
guaranteed efficiency of 80% at the same operating load.
Electric energy costs P6.80 per kilowatt-hour and 1hp =
0.746 kw. (Recall that efficiency equals output/input).
The annual cost of electric energy in operating motor A is
closest to (No. 6, Difficult)
a) P119,360 b) P126,820 c) P142,320 d) P163,270
 Reviewer/Comparison Between
Investment Alternatives
Given: For Motor A,
P=P68,000
eff = 85%
output, O = 10 hP
1 hP = 0.746 kw
electric energy cost = P6.80/kw-hr
Avg no. of hours of operation/year =
= 8 hrs/day × 250 days/yr = 2,000 hrs/year
Find: Annual cost of operating Motor A
 Reviewer/Comparison Between
Investment Alternatives
Calculation:

output
eff 
input
output 10hP
Input    11 .764706 hP
eff 0.85
0.746kw hrs P6.80
Annual cost of electricit y  11 .764706 hP   2000  
hP yr kw  hr
Annual cost of electricit y  P119,360

Answer: a
 Reviewer/Comparison Between Investment
Alternatives
SV

Unrecovered capital recovery

cost

Imputed salvage value = SV×(P/F,i,n-n’)+CR×(P/A,i, n-n’)

 Reviewer/Comparison Between Investment
Alternatives
Below is the cash flow of an engineering project: (No. 10,
Difficult)
End of Year              
0 1 2 3 4 5 6

               
Cash Flow -P45,000 8,000 8,000 8,000 8,000 8,000 8,000 + 5,000 salvage

If interest rate is 20% and the required service life is

 
only 4 years, the imputed salvage value is closest to
a)     P27,200
b)     P31,250
c)      P23,370
d)     None of the above
Reviewer/Comparison Between
Investment Alternatives
Given: I=20%; n = 6 yrs, n’ = 4 yrs
Find imputed salvage value at year 4:

Imputed salvage value at end of year 4:

ISV = SV×(P/F,i,n-n’)+CR×(P/A,i, n-n’)
CR  P( A / P, i, n)  S ( A / F , i, n)
CR  P 45,000  ( A / P,20%,6)  P5,000  ( A / F ,20%,6)
CR  P13,028.231

ISV = P5,000×(P/F,20%, 2)+ P13,028.231×(P/A,20%,2)

ISV = P23,376 c
 Reviewer/Depreciation Methods and
Taxation
Among the following depreciation methods, that which
will produce the lowest present worth of taxes paid is
(No. 18, Moderate)
a)     straight-line method
b)     sinking fund method
c)      declining balance method
d)     service-output method
 Reviewer/Depreciation Methods and
Taxation
A contractor imports an equipment for P1.2M. Customs,
installation and other costs initially incurred to make the
equipment serviceable amounted to P200,000. At the end
of 5 years, the equipment will have a market value of
P200,000. If depreciated by the straight-line method,
cumulative depreciation through the end of the second
year will be (No. 19, Moderate)
a)     P240,000 c) P200,000
b)     P480,000 d) P400,000
 Reviewer/Depreciation Methods and
Taxation
Given: B = purchase cost + installation cost
B = P1.2M + P200,000 = P1.4M
n = 5 years
S = P200,000
dep method = SLM
Find: cumulative depreciation through year 2

In the straight line method, the cumulative depreciation equals

depreciation/year times no. of years
Reviewer/Depreciation Methods and
Taxation
[B  S ]
dep / year 
n
where : B  cost basis; S  salvage value; and n  depreciable life
[ P1.4M  P 0.2M ]
dep/year   P 240T
5
depreciation through year 2  dep/year  no. of years
depreciation through year 2  P240T  2  P480,000

Answer: b
 Reviewer/Depreciation Methods and
Taxation
An optical scanning machine that will be used for
reproducing blueprints of engineering drawings can be
purchased for P12M and has an estimated market value
of P2.4M at the end of 10 years. If the machine were to
be depreciated using declining balance method that will
result in book value equal to market value at the end of
10 years, by what rate must the machine be depreciated?
( No. 16, Moderate)
a)     18.62% c) 11.42%
b)     25.31% d) 14.87%
 Reviewer/Depreciation Methods and
Taxation
Given: B=P12M
SV = P2.4M
n = 10 years
Depreciation method = declining balance
Find: R such that MV = BV at the end of 10 years
Solution:
  SV 1/ n    P 2.4 M 1/10 
R  1      1      14.87%
  B     P12M  
 Reviewer/Depreciation Methods and
Taxation
The newly established All-Natural Drug Company is deciding between
two pill-forming machines described below: (No. 7, Difficult)

Round Oval
First Cost P7,200,000 P4,500,000
Salvage Value 1,080,000 900,000
Annual Revenue 1,200,000 1,000,000
Less Expenses
Life, years 6 6

Using the straight line method of depreciation, an effective tax rate of

30%, and an after tax return of 20%, the amount of taxes to be paid for
the first year for the round machine is closest to
a) P80,000 b) P106,000 c) P212,000 d) P54,000
Reviewer/Depreciation Methods and
Taxation
Given: B=P7.2M
S = P1,080,000
R-E=P1,200,000
n = 6 years
depreciation method = SLM
eff tax rate = 30%
after-tax MARR = 20%
Find: Taxes paid for year 1 for the round machine
 Reviewer/Depreciation Methods and
Taxation
To solve this problem, it is convenient to set up a table as
follows:
End-of- Before-tax Dep Taxable Taxes
year cash flow Income Paid
(BTCF)
1 P1,200,000 P1,020,000 P180,000 P54,000

where: Dep = (P7,200,000-P1,080,000)/6=P1,020,000

Taxable Income = BTCF-Dep= P1.2M-P1,020,000=P180,000
and Taxes Paid = Tax Rate × Taxable Income = P180,000 × 0.30 =
= P54,000

Answer: d
 Reviewer/Depreciation Methods and
Taxation
Ferdinand Shipping Company bought a tugboat for
P750,000. This boat is expected to last for 5 years, after which
it could be sold for P120,000. The following revenues and
expenses are expected for the first operating year. (No. 17,
Moderate)
Revenues – P2,000,000
Expenses – P840,000
Depreciation – P40,000.
If the company is taxed at a rate of 30%, what is the net
income at the end of the first year?
a)     P287,000 d) P268,000
b)     P784,000 e) none of the above
c)      P824,000
Reviewer/Depreciation Methods and
Taxation
Given: Revenues – P2,000,000
Expenses – P840,000
Depreciation – P40,000
n = 5 years
S = P120,000
tax rate = 30%

Find: net income at end of year 1

 Reviewer/Depreciation Methods and
Taxation
As in the previous problem, setting up a table is a convenient
way to solve this type of problem:
End-of- BTCF Dep Taxable Taxes ATCF or
year Income Paid Net
Income
after tax
1 P1,160,000 P40,000 P1,120,000 P336,000 P824,000

where: BTCF = Revenue – Expenses = P2M-P840,000 = P1,160,000

Taxable Income = BTCF – Dep = P1,160,000 – P40,000 = P1,120,000
Taxes paid = Taxable Income × tax rate = P1,120,000 × 0.30 = P336,000
And ATCF = BTCF – Taxes Paid = P1,160,000 – P336,000 = P824,000