TIME VALUE OF MONEY

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Agenda
Concepts
Time value of money
Single payment
Cash flows
Uniform series payment
Uniform infinite payments
Arithmetic gradients
Uniform payments every t period
Nominal and effective interest

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 concepts
Engineering Economy: is a collection of mathematical
techniques to simplify economic comparisons
Time Value of Money: means that money has different
value tomorrow than it has today
Interest: is a measure of the increase between original sum
borrowed or invested and the final sum owed or accrued.
Interest = Total amount accumulated – Original investment
The increase over the original amount is the interest
The original investment or loan: is referred to as Principal
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concepts
Interest calculations
When interest is expressed as a percentage of the original
amount per unit time, it is called interest rate
% interest rate = (Interest per time unit/Original sum)×100%
Example: Suppose you invested LE100,000 on May 1, and
withdraw a total of EL106,000 exactly one year later.
Compute the interest and the interest rate.
Interest = LE106,000 - LE100,000 = LE6,000
Percent interest rate = (LE6,000 per year / LE100,000) ×
100% = 6% per year

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 concepts
Equivalence
Equivalence is an essential factor in economic analysis
Different sums of money at different times can be equal in
value
Example: if the interest rate is 6% per year, a LE100 today
(present time) would be equivalent to LE106 one year
from today. Also, LE100 today is equivalent to LE94.34
one year ago. Therefore, LE94.34 last year, LE100 now,
and LE106 one year from now are equivalent when the
interest rate is 6% per year

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concepts
Rate of Return
The rate of return is used when determining the
profitability of a proposed investment or past investment
Rate of return (RR) = (Total amount of money received –
Original investment) / Original investment × 100%
= (Profit / Original investment) × 100%
RR is used to compare between alternatives by
determining how much return each alternative could
produce.

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 Time Value of Money
The value of money is dependent on the time at which it is
received
The money consequences of any alternative occur over a
long period of time, a year or more
When money consequences occur in a short period of
time, we simply add up the various sums of money But we
cannot treat money this way when the time span is longer
Which would you prefer, LE100 cash today or receiving
LE100 a year from now?
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Time Value of Money

To facilitate computations, these notations are used:
i = interest rate per interest period (usually calculated
annually), (e.g., 9% interest is 0.09)
n = number of interest periods
P = A present sum of money
F = A future sum of money
A = A series of periodic, equal amount of money. This is
always paid or received at end of period

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 Time Value of Money
Single Payment
The Future Value of a given present value of money
represents the amount, at some time in the future, that an
investment made today will grow if it is invested at a
specific interest rate
Simple interest: Simple interest is calculated using the
principal only, Thus, if you loan a present sum of money P
at a simple annual interest rate i for a period of n years, the
amount of interest you would receive from the loan:

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Time Value of Money

Single Payment
Total Interest = Principal (P) × Number of periods (n) × Interest
rate (i) = P × n × i
At the end of n years the amount of money F would equal the
amount of the loan P plus the total interest earned,
F = P + P × n × i = P (1 + i × n)
Example: If you borrow LE1,000 for 3-years at 6% per year,
how much money will you owe at the end of three years?
Simple Interest = Principal (P) × Number of periods (n) ×
Interest rate (i) = LE1,000 × 3 × 0.06 = LE180
Amount due after three years = LE1,000 + LE180 = LE1,180
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 Time Value of Money
Single Payment
Compound interest: Compound interest is calculated
using the principal plus the total amount of interest
accumulated in previous periods. Thus, compound interest
means “interest on top of interest”
Example: If you borrow LE1,000 at 6% per year
compound interest, compute the total amount
owed after three year period?

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Time Value of Money

Single Payment
Interest for Year 1 = LE1,000 × 0.06 = LE60
Total amount due after year 1 = 1,000 + 60 = LE1,060
Interest for year 2 = LE1,060 × 0.06 = LE63.60
Total amount due after year 2 = LE1,060 + LE63.60 =
LE1,123.60
Interest for year 3 = LE1,123.60 × 0.06 = LE67.42
Total amount due after year 3 = LE1,123.60 + LE67.42 =
LE1,191.02
Thus, with compound interest, the original LE1,000 would
accumulate an extra LE1,191.02 - LE1,180 = LE11.02
compared to simple interest in the three year period

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 Time Value of Money
Single Payment: Compound interest
Therefore, if an amount of money P is invested at some
time t = 0, the total amount of money (F) that would be
accumulated after one year : F1 = P + Pi = P(1 + i)
At the end of the second year, the total amount (F2)
F2 = F1 + F1 i = P(1 + i) + P(1 + i)i = P(1 + i) (i +i)
F2 = P(1 + i)2
The total amount accumulated at the end of year 3 (F3)
F3 = F2 + F2 i = P(1 + i)2 + P(1 + i)2 i = P(1+ i)2 (1 + i)
F3 = P(1 + i)3
The total amount of money (F) after (n) number of years,
using compound interest (i); F = P(1 + i)n

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Time Value of Money

Single Payment: Compound interest
F = P(1 + i)n , this equation is named
“single-payment compound amount formula”
The term (1 + i)n “single-payment compound amount
factor” “‫د وا دة‬ ‫ا‬ ‫” لا‬
This equation could be written in the functional notation as:
F = P (F/P, i, n); reads as: find a future sum “F” given a
present sum “P” at an interest rate “i” per period and “n”
interest periods
A present sum P can be determined, easily, knowing a future
sum F :
P = F / (1 + i)n = F (1 + i)-n

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 Time Value of Money
Single Payment: Compound interest
P = F / (1 + i)n, this equation is named
“single-payment present worth formula”
The term[1/ (1 + i)n] “single-payment present worth factor”
“‫وا دة‬ ‫د‬ ‫ا‬ ‫لا‬ ”
This equation could be written in the functional notation as:
P = F (P/F, i, n); reads as: find a present worth sum “P” given
a future sum “F” at an interest rate “i” per period and “n”
interest periods
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Time Value of Money

Single Payment: Compound interest
Example: If LE500 were deposited in a bank, how much
would be in the account 3-years hence if the bank paid 6% per
year compound interest?
P = LE500 i = 0.06 n = 3 F = unknown
F = P(1 + i)n = 500(1 + 0.06)3 = LE595.5
Example: If you wished to have LE800 at the end of 4 years
from now, and 5% interest was paid annually. How much
would you put into the saving account now?
F = LE800 i = 0.05 n = 4 P = unknown
P = F(1 + i) = 800(1 + 0.065)-3 = LE658.16
-n

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 Time Value of Money
Single Payment: Use of interest tables
To avoid the trouble of writing out each formula and using
calculators, a standard notation is used: (X/Y, i, n).
First letter (X) what you “Want to find”, second letter (Y)
what is “Given”. For example, F/P means “find F when given
P”. “i” is the interest rate in percent and “n” represents the
number of periods involved.
Previous Example:
F = P(F/P, 6%, 3) = = 500(1.191) = LE595.5
P = F(P/F, 5%, 4) = 800(0.8227) = LE658.16

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Time Value of Money

Cash Flow/Time Diagrams
In cash flow diagrams, the amount of F (future sum of
money) and A (periodic equal payments) are considered at
the end of the interest period
Every person or company has cash receipts (income) and
cash disbursement (costs). The results of income and costs
are called cash flows
Cash Flow = Receipts – Disbursements
A positive cash flow indicates net receipts. A negative
cash flow indicates a net disbursement in that period

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 Time Value of Money
Cash Flow/Time Diagrams
A cash flow diagram is simply a graphical representation
of cash flows (in vertical direction) on a time scale (in
horizontal direction). Time zero is considered to be
present, and time 1 is the end of time period 1.
This cash flow diagram is setup for five years.

(LE)

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Time Value of Money

Cash Flow/Time Diagrams
Example: If you buy a printer in 1999 for LE300, and
maintain it for three years at LE20 per year, and then sell it
for LE50, what are your cash flows for each year?

Year Receipts Disbursement Cash Flow

1999 0 LE300 - LE300
2000 0 LE20 -LE20
2001 0 LE20 -LE20
2002 LE50 LE20 + LE30

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 Time Value of Money
Cash Flow/Time Diagrams
Example: If you borrow LE2,000 now and must repay the
loan plus interest (at rate of 6% per year) after five years.
Draw the cash flow diagram n cash flow diagram.

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Time Value of Money

Cash Flow/Time Diagrams
Example: If you start now and make five deposits of
LE1,000 per year (A) in a 7% per year account, how much
money will be accumulated immediately after you have
made the last deposit? Draw the cash flow diagram

A = LE1,000

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 Time Value of Money
Cash Flow/Time Diagrams
Example: Assume that you want to deposit an amount (P)
into an account two years from now in order to be able to
withdraw LE400 per year for five years starting three
years from now. construct the cash flow diagram cash
flow diagram
A = LE400

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Time Value of Money

Cash Flow/Time Diagrams
Example: Assume that you want to deposit an amount (P)
into an account two years from now in order to be able to
withdraw LE400 per year for five years starting three
years from now. construct the cash flow diagram cash
flow diagram
A = LE400

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 Time Value of Money
Cash Flow/Time Diagrams
Example: Suppose that you want to make a deposit into your
account now such that you can withdraw an equal amount
(A1) of LE200 per year for the first five years starting one
year after your deposit and a different annual amount (A2) of
LE300 per year for the following three years. With an
interest rate (i) of 4.5% per year, construct the cash flow
diagram. A = LE300

A = LE200

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Time Value of Money

Uniform Series Payment
there are situations where a uniform series of receipts or
disbursements (A) will be paid or received
The Future Value, F, of a uniform annual payment, A, is
calculated at the end of the period, n, in which the last
payment occurs with an investment rate i
F

n-1 n

A
A(1+i)n-1 A(1+i)2 A(1+i) A

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 Time Value of Money
Uniform Series Payment
F = A(1+ i)n-1 + A(1+ i)n-2 + ........ + A(1+ i)2 + A(1+ i) + A
F(1+ i) = A(1+ i)n + A(1+ i)n-1 + ........ + A(1+ i)3 + A(1+ i)2
+ A(1+ i)
Subtracting 1 from 2
F(1+ i) – F = A(1+ i)n – A
iF = A[(1+ i)n – 1]

 (1 + i ) n − 1 
F = A 
 i 

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Time Value of Money

Uniform Series Payment
 (1 + i ) n − 1 
F = A 
 i 
Named: uniform series compound amount formula
The term within the brackets is called the uniform series
compound amount factor
“ ‫د ت ظ‬ ‫ا را‬ ‫” لا‬
When using the interest tables, it could be represented as
F = A(F/A, i% , n)

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 Time Value of Money
Uniform Series Payment
By reordering the terms of the previous equaiton
 i 
A = F 
 (1 + i ) − 1 
n

Named: uniform series sinking fund formula

The term within the brackets is called the uniform series
sinking fund factor
“‫” ل ا داع و ر راس ا ل‬
When using the interest tables, it could be represented as
A = F(A/F, i% , n)

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Time Value of Money

Uniform Series Payment
The present worth, P, of a future amount of money, F, from
a uniform series payments, A, could be calculated
 (1 + i ) n − 1 
P = A n 
 i (1 + i ) 
Named: uniform series present worth formula
The term within the brackets is called the uniform series
present worth factor
“ ‫د تا ظ‬ ‫ا‬ ‫” لا‬
When using the interest tables, it could be represented as
P = A(P/A, i% , n)
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 Time Value of Money
Uniform Series Payment
the value of a uniform series payment, A, when the present
sum, P, is known could be determined
 i (1 + i ) n 
A = P 
 (1 + i ) − 1 
n

Named: uniform series capital recovery formula

The term within the brackets is called the uniform series
capital recovery factor
“‫” ل ا رداد رأس ا ل‬
When using the interest tables, it could be represented as
A = P(A/P, i% , n)
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Time Value of Money

Uniform Series Payment
Example: On January 1, a man deposits LE5000 in a bank
that pays 8% interest, compounded annually. He wishes to
withdraw all the money in five equal end-of-year sums
beginning December 31st of the first year. How much
should he withdraw each year?
P = LE5000; n = 5; i = 8%; A = unknown

 i (1 + i ) n 
A = P 
 (1 + i ) − 1 
n

A = 5000[(0.08 × 1.085) / (1.085 – 1)] = LE1252

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 Time Value of Money
Uniform Series Payment
Example: A man deposits LE500 in a bank at the end of
each year for five years. The bank pays 5% interest,
compounded annually. At the end of five years,
immediately following his fifth deposit, how much will he
have in his account?
A = LE500; n = 5; i = 5%; F = unknown
 (1 + i ) n − 1 
F = A 
 i 
F = 500[(1.085 – 1) / 0.05] = LE2763

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Time Value of Money

Uniform Series Payment
Example: If a person deposits LE600 now, and LE300 two
year from now, and LE400 five years from now, how much
will be have in his account ten years from now if the interest
rate is 5%?

P = LE600 P = LE300 P = LE400

F = LE600(F/P, 5%, 10) + LE300(F/P, 5%, 8) + LE400(F/P, 5%, 5)

= 600(1.6289) + 300(1.4774) + 400(1.2763) = LE1931.08

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 Time Value of Money
Uniform Series Payment
Example: How much money would a person have after
eight years if he deposited LE100 per year for eight years at
4% starting one year from now?

A = LE100

F = LE100(F/A, 4%, 8) = LE100(9.214)

= LE921.40

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Time Value of Money

Uniform Series Payment
Example: How much money would you be willing to pay
now for a note that will yield LE600 per year for nine years
if the interest rate is 7%?
A = LE600

P = LE600(P/A, 7%, 9) = LE600(6.5152) = LE3909.12

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 Time Value of Money
Uniform Series Payment
Example: A couple wishing to save money for their child’s
education purchased an insurance policy that will yield
LE10,000 15 years from now. The parent must pay LE500
per year for the 15 years starting one year from now. What
will be the rate of return on their investment?
F = LE10,000

A = LE500

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Time Value of Money

Uniform Series Payment
A = F(A/F, i%, n)
LE500 = LE10,000(A/F, i%, 15)
(A/F, i%, 15) = 0.0500
From the interest tables under the A/F column for 15 years,
the value of 0.0500 is found to lie between 3% and 4%.
(A/F, i%, 15) = 0.0500
By interpolation, i = 3.98%
Or solve using trial and error using the following equation

 i 
A = F 
 (1 + i ) − 1 
n

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 Time Value of Money
Uniform Series Payment
Example: How long would it take for LE1,000 to double if
the interest rate is 5%?
F = LE2,000

P = LE1,000

P = F(P/F, i%, n); LE1000 = LE2,000(P/F, 5%, n)

(P/F, 5%, n) = 0.500
From the 5% interest table, the value of 0.500 under the P/F
column lies between 14 and 15 years. By interpolation, n = 14.2
years
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Time Value of Money

Multiple Factors
It is very important to remember that the present worth is
always located One year prior to the first annual payment
when using the uniform-series present-worth factor (P/A,
i%, n).
The uniform-series compound-amount factor (F/A, i%, n)
was derived with the future worth “F” located in the same
year as the last payment.
It is always important to remember that the number of years
n that should be used with the P/A or F/A factors is equal to
the number of payments.
It is generally helpful to re-number the cash-flow diagram to
avoid counting errors
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 Time Value of Money
Multiple Factors
Example: A person buys a piece of property for LE5,000
down-payment and deferred annual payments of LE500 a
year for six years starting three years from now. What is
present worth of the investment if the interest rate is 8%?

A = LE500
P1 = LE5,000

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Time Value of Money

Multiple Factors

PA1 = the present worth of a uniform-series.

PA = the present worth at a time other than zero
PT = total present worth at time zero.
PA1 = 500 (P/A, 8%, 6) = 500 (4.623) = LE2311.5
PA = PA1 (P/F, 8%, 2) = 2311.5 (0.8573) = LE1981.65
PT = P1 + PA
PT = LE5,000 + LE1981.60 = LE6,981.6

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 Time Value of Money
Multiple Factors
Example: Calculate the present worth (P) ?

LE10,000 LE15,000
A = LE20,000

Find the present worth of the uniform-series and add it to the

present-worth of the two individual payments:
P = LE20,000 (P/A, 6%, 20) + LE10,000 (P/F, 6%, 6) + LE15,000
(P/F, 6%, 16) = LE242,352
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Time Value of Money

Multiple Factors
Example: Calculate the equivalent uniform annual series (A’)?
LE10,000 LE15,000
A = LE20,000

Present worth method

A’ = LE20,000 + LE10,000(P/F, 6%, 6) (A/P, 6%, 20) +
LE15,000(P/F, 6%, 16) (A/P, 6%, 20) = LE21,129 per year
Future worth method
A = LE20,000 + LE10,000(F/P, 6%, 14) (A/F, 6%, 20) +
LE15,000(F/P, 6%, 4) (A/F, 6%, 20) = LE21,129 per year
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 Time Value of Money
Uniform Infinite Series
Civil engineering projects (roads, bridges, dams, etc.) are
generally design and constructed to last for a long periods that
may exceed 100 years
These projects are naked as long aged projects
In the uniform infinite series payments, uniform payments are
invested at the end of each period for a very long time that
may be considered as infinite times
A’ i

1 2 3 4 ∞

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Time Value of Money

Uniform Infinite Series
 (1 + i ) n − 1 
This equation could be rewritten P = A n 
 i (1 + i ) 
A  (1 + i ) n − 1  A 1 
P=  = 1−
i  (1 + i ) n  i  (1 + i ) n 

Substituting for n as infinite number (∞), then

P’ = A’ / i
We could calculate the uniform infinite series payments (A’)
considering as follows:
A’ = P’ × i

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 Time Value of Money
Uniform Infinite Series
Example: The construction of a bridge costs LE10,000,000,
the annual maintenance cost LE40,000 at the first 10 years.
Then, the maintenance cost increases to LE50,000 after that. It
is required to calculate the present worth of the costs and the
equivalent annual cost if the interest rate is 8%?

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 ∞

A = LE40,000 A’ = LE50,000
P = LE10,000,000

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Time Value of Money

Uniform Infinite Series
1 2 3 4 5 6 7 8 9 10

A = LE40,000
P = LE10,000,000
P1 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 ∞

A’ = LE50,000

P2
P’
PT = P + P1 + P2
P1 = 40,000(P/A, 8% , 10) = LE268404
P’ = A’ / i = 50,000/0.08 = LE625,000
P2 = 625,000(P/F, 8% ,10) = 625,000 (0.4632) = LE289,500
PT = 10,000,000 + 268,404 + 289,500 = LE10,557,904
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 Time Value of Money
Arithmetic Gradient Uniform Series
In case of the cash flow or payments is not of constant amount
A, there is a uniformly increasing series. The uniformly
increased payments may be resolved into two components

A + (n-1)G
(n-1)G

A + 3G
A + 2G 3G
2G
A+G
A A G
0
= +

P’ P’’

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Time Value of Money

Arithmetic Gradient Uniform Series
It could be dealt with as a series of individual payments. The
value of “F” for the sum of all payments at time n is:
F = G(1 + i)n-2 + 2G(1 + i)n-3 + ...... + (n– 2)(G)(1+ i) + (n–1)G
F = G[(1 + i)n-2 + 2(1 + i)n-3 + ...... + (n – 2)(1 + i) + n – 1]
(1 + i)F = G[(1 + i)n-1 + 2(1 + i)n-2 + ...... + (n – 2)(1 + i)2 + (n
– 1)(1 + i)]
Subtract 1 from 2
iF = G[(1 + i)n-1 + (1 + i)n-2 + ...... + (1 + i)2 + (1 + i) + 1] – nG
term between the brackets was proven to equal: [(1+i)n-1/i]
 (1 + i ) n − 1
iF = G   − nG
 i 
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 Time Value of Money
Arithmetic Gradient Uniform Series
G  (1 + i ) n − 1 
F= − n
i  i 
the present worth of F could be determined
 (1 + i ) n − in − 1 
P = G 
 i (1 + i )
2 n

The term within the brackets is called the arithmetic gradient
present worth factor
“‫رة‬ ‫د ت ظ‬ ‫” لا ما‬
When using the interest tables, it could be represented as
P = G(P/G, i% , n)

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Time Value of Money

Arithmetic Gradient Uniform Series
Multiplying by the sinking fund factor, [1/(1+i)n-1], we could
determine the uniform series payments, A, from arithmetic
gradient payments, G.
 (1 + i ) n − in − 1 1 n 
A = G  = G − 
 i (1 + i ) − i   i (1 + i ) − 1
n n

The term within the brackets is called the arithmetic gradient

uniform series factor
“‫رة‬ ‫” لا ما ظ د ت ظ‬
When using the interest tables, it could be represented as
A = G(A/G, i% , n)

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 Time Value of Money
Arithmetic Gradient Uniform Series
Example: A man purchased a new automobile. He wishes to
set aside enough money in a bank account to pay the car
maintenance for the first five years. It has been estimated that
the maintenance cost of an automobile is s follows:

Year 1 2 3 4 5
Cost (LE) 120 150 180 210 240

Assume the maintenance costs occur at the end of each year

and that the bank pays 5% interest. How much he should
deposit in the bank now.

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Time Value of Money

Arithmetic Gradient Uniform Series
240
120
210
180 90
60
150
120 120 30
0
= +

P P’ P’’

Note that the value of n in the gradient series payments is 5 not

4 where there are 4 terms containing G, (n – 1)
P = 120(P/A, 5%, 5) + 30(P/G, 5%, 5)
= 120(4.329) + 30(8.237) = 59 + 247 = LE766

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 Time Value of Money
Arithmetic Gradient Uniform Series
Example: Calculate the equivalent uniform annual cost (A) of
the following schedule of payments

Since payments repeat every five years, analyze for 5 years

only.
In this case, G = LE100
A = 100 + 100(A/G, 8%, 5) = LE284.60

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Time Value of Money

Arithmetic Gradient Uniform Series
Example: A couple wants to save money for their child's
education. They estimate that LE10,000 will be needed on the
17th birthday, LE12,000 on the 18th birthday, LE14,000 on the
19th birthday, and LE16,000 on the 20th birthday. Annual
interest rate 8%.
(a) How much would have to be deposited into the account on
the child's first birthday (first birthday is celebrated one year
after the child is born) to accumulate enough money to cover
the estimated college expenses?
(b) What uniform annual amount would the couple have to
deposit each year on the child's first birth through seventeenth
birthdays to accumulate enough money to cover the estimated
college expenses?
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 Time Value of Money
Arithmetic Gradient Uniform Series

Let F = the LE’s needed at the beginning of year 16

= 10,000(P/A, 8%, 4) + 2,000(P/G, 8%, 4)
= LE42,420
The amount needed today P = 42,420(P/F, 8%, 15) = LE13,370.8

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Time Value of Money

Arithmetic Gradient Uniform Series

13,370.80

P' = 13,370.80(P/F, 8%, 1) = LE12,380.00

A = 12,380.00(A/P, 8%, 17) = LE1,356.85

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 Time Value of Money
Uniform Series Infinite Payments Every t Periods

In this case, equal payments, A’, are invested at the end of

equal periods, t (not one year) for an infinite time
 A' 
P=  
 (1 + i ) − 1
t

Example: The maintenance of a bridge costs LE15,000

every 3-years. Calculate the equivalent uniform annual cost
if the interest rate is 5%. Consider this is an aged project
P = [15000/(1 + 0.05)3 -1] = LE95, 162
Then, A’ = P’r = 95,162 (0.05) = LE4,758
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Time Value of Money

Nominal and Effective Interest
Example: Consider the situation of a person depositing LE100
into a bank that pays 5% interest, compounded semi-annually.
How much would be this amount at the end of one year?
5% interest, compounded semi annually, means that 2.5%
every six month. This, the initial amount P = LE100 would be
at the end of 6 month: 100(1 + 0.025) = LE102.5 and the end
of the second 6 month, this amount will be = 102.5(1.025) =
LE105.06 or, this could be calculated as follows:
F = 100(1 + 0.025)2 = LE105.06
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 Time Value of Money
Nominal and Effective Interest
Nominal interest rate /year, r, is the annual interest rate
without considering the effect of compounding. Effective
interest rate per year, ia, is the annual interest rate taking
into account the effect of compounding during the year
r = Nominal interest year per period (usually one year)
i = Effective interest rate per period
ia = Effective interest rate per year
m = Number of compounding sub-periods per time period
Then, i = r/m
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Time Value of Money

Nominal and Effective Interest
The future value, F, of P considering ia is
F = P(1 + ia)
While using i compounded over all periods, m
F = P(1 + i)m
Consider of the F value for a present worth P of LE1 and
equating the two expressions for F and substituting LE1 for P
1 + ia = (1 + i)m
Then: ia = (1 + i)m – 1 or ia = (1 + r/m)m - 1
then: i = (1 + ia)1/m –1
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 Time Value of Money
Nominal and Effective Interest
Example: Consider r = 13% compounded monthly. Find
effective interest rate per year
r = 13; then, i = r/m = 13/12 = 1.08333% = 0.018333
ia = (1 + i)m –1 = (1 + 0.0108333)12 – 1= 13.80% per year

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Time Value of Money

Nominal and Effective Interest
Example: A bank lends money on the following terms: “If I
give you LE50 on Monday, you owe me LE60 on the
following Monday.” What nominal interest rate per year (r)
this bank charging? What effective interest rate per year (ia) is
the charging? If the bank started with LE50 and was able to
keep it, as well as the money received, out in loans at all
times, how much money would have at the end of one year?

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 Time Value of Money
Nominal and Effective Interest
60 = 50 (1 + r)
(1 + r) = 1.2; then r = 0.2 = 20% per week
Then, nominal interest rate per year = 52 weeks × 0.2 = 10.4 =
1040%
Effective interest rate per year, ia = (1 + r/m)m – 1 = (1 + 0.2)52
-1= 13104 = 1310400%
F = P(1 + i)n = 50(1 + 0.2)52 = LE655,200

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