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Module 3 Lecture Note 2 Equation of Value: (Source: Mathematics of Investment by Ong and San Gabriel Page 44-50)

The document discusses equation of value, which involves replacing debts owed at different times with a single payment on a specified date. It provides formulas for accumulating and discounting values to calculate future and present values. Sample problems demonstrate using the formulas and time diagrams to solve for single payment amounts that can settle multiple debts. Debts are accumulated or discounted to the comparison date using the appropriate interest rate applied over the time period. The payment amount is calculated by setting the equation equal to the sum of the accumulated and discounted debt values.

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Gian Luigi Katigbak
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37 views3 pages

Module 3 Lecture Note 2 Equation of Value: (Source: Mathematics of Investment by Ong and San Gabriel Page 44-50)

The document discusses equation of value, which involves replacing debts owed at different times with a single payment on a specified date. It provides formulas for accumulating and discounting values to calculate future and present values. Sample problems demonstrate using the formulas and time diagrams to solve for single payment amounts that can settle multiple debts. Debts are accumulated or discounted to the comparison date using the appropriate interest rate applied over the time period. The payment amount is calculated by setting the equation equal to the sum of the accumulated and discounted debt values.

Uploaded by

Gian Luigi Katigbak
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Module 3 Lecture Note 2

Equation of Value

Sometimes there is a need to replace a set of debts by another set of different amounts due at
different times. In equation of value, the sum of the values of one set of debts on the same
date. The sum of the comparison date is obtained by either accumulating or discounting,
depending on when the obligation and the comparison dates fall. (source: Mathematics of Investment by
Ong and San Gabriel page 44-50)

In solving problems involving equation of value, it is useful to make a time diagram to clearly
visualize the worded problem. We will be using the same formula as before.

Formula
1. F = P (1 + i)n (when looking for the accumulated value or future value)
2. P = F (1 + i)-n (when looking for discount value or present value)

Sample problems.
1. Marlon owes P50,000, due in 4 years and P20,000 due in 9 years. He is allowed to settle
these obligations by a single payment on the 7th year. Find how much he has to pay on the 6th
year if money is worth 14% (m=2).
Given:

Given:
Debts
a. Accumulate (F) 50,000 by 4 years, , t= 4, j=14%, m=2, i = 14%/2 = 7%, n = 4x2= 8
b. Discount (P) 20,000 by 2 years, t=2, j= 14%, m =2, i = 14%/2 = 7%, n = 2x2=4
Payment
a. let x be the amount he has to pay on the 6th year (meaning in the future, so F), at 14%
(m=2), i = 14%/2 = 7%, n = 6x2 = 12

Solution
Payment = Debts
x(1+ i)n = P(1 + i)n + F(1 + i)-n
x (1 + .07)12 = 50,0 00(1 + .07)8 + 20,000 (1 + .07)-4
x (2.252191589) = 50,000(1.71818618) + 20,000 (.762895212)
2.252191589x = 85,909.309 + 15,257.90424
2.252191589x = 101,167.2132
x = 101,167.2132/2.252191589
x = 44,919.45
This means that the indebtedness amounting to P50,000 and P20,000 can be settled or paid by
a single payment of P44,919.45

2. If money is worth 8% effective rate, what single payment at the end of 7 years would replace
the following debts?
a. P12,000 due in 2 years without interest.
b. P15,000 due in 9 years with accumulated interest from today of 10% (m=2)
c. P10,000 due in 4 years and 6 months with accumulated interest from today at 15% (m=2)

Given
Debts
a. Accumulate P12,000, however since this is a non-interest bearing loan it will remain as
P12,000.
b. Discount P15,000 by 2 years, t=2, j = 10%, m = 2, i = 10%/2 = 5%, n = 2 x 2 = 4
c. Accumulate P10,000 by 4 years and 6 months, t=4.5, j = 15%, m = 2, i = 15%/2=7.5%, n =
4.5 x2 = 9

Payment
a. let x be the amount he has to pay on the 7th year (meaning in the future, so F), at 8%
(m=1), i = 8%/1 = 8%, n = 7x1 = 7 note: m = 1 because the problems says “effective rate”
which is always equivalent to one year or annual rate.

Solution:
x(1+ i)n = P + F(1 + i)-n + P(1 + i)n
x(1 + .08)7 = 12,000 + 15,000 (1 +.05)-4 + 10,000 (1 +.075)9
x(1.713824269) = 12,000 + 15,000 (.822702474) + 10,000 (1.917238662)
x(1.713824269) = 12,000 + 12,340.53711 +19,172.38662
x(1.713824269) = 43,512.92373
1.713824269x = 43,512.92373
x = 43,512.92373/1.713824269
x = 25,389.37

This means that the indebtedness amounting to P12,000, P15,000 and P10,000 can be settled
or paid by a single payment of P25,389.37

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