[size=12][font=Times New Roman]Tips for Doing Problems

When doing engineering economy problems, make sure:

"TIME FRAMES" MATCH:

If one period equals one quarter, then the interest rate should be quarterly and compounded quarterly. For example, if a yearly interest rate is given but interest is compounded monthly, divide the interest rate by 12.

ANSWER IS REASONABLE

ANSWER IS ROUNDED TO THE NEAREST PENNY

Sinking Fund

Definition: A sinking fund differs from compound interest in that we now have uniform payments over time in addition to the compound interest.

Sinking Fund Time Line

Example #1

Example: If you deposit $50 per month into an account that pays 6% interest, compounded monthly, for 2 years, how much is in the account immediately after the last deposit?

Please Note: Yearly interest in the equation is divided by 12 since payments are on a per-month basis.

Also Note: There are 24 payments, not 23 months.

Sinking Fund Time Line

Example #2

Example: Which is of more value to receive:

(a) $8000 today or

(b) 5 annual payments of $2000, beginning in 1 year?

(Assume 8% interest compounded annually.)

Sinking Fund Time Line

Example #3

Example: Which is of more value to receive:

(a) $8000 today or

(b) 5 annual payments of $2000, beginning in 1 year?

(c) 5 annual payments of $2000, beginning today?

(Assume 8% interest compounded annually.)

Annuity

NOTE: Follow the algebraic steps used to find the present value of a sinking fund. This is the formula for an annuity.

http://www.eng.iastate.edu/efmd/Captures/annline1.gifAPPLICATION: The first application of the annuity formula is to find the present value of a sinking fund. The second is using the formula in situations like the following example.

EXAMPLE: You borrow $5000 to buy a car. If you repay the loan with 36 monthly installments at 18% interest, what is the amount of each payment?

Summary

Compound InterestEquation: S = P (1 + I)^N

Sinking Fund