Picking a Time Interval for a Cash Flow

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# Picking a Time Interval for a Cash Flow - PowerPoint PPT Presentation

Picking a Time Interval for a Cash Flow. Need to Get the Cash Flow. Usually starts as a story problem with a bunch of situation data Need to decide who’s pocket you are keeping track of to keep positives and negatives straight Another decision is the degree of detail

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### Picking a Time Interval for a Cash Flow

Need to Get the Cash Flow
• Usually starts as a story problem with a bunch of situation data
• Need to decide who’s pocket you are keeping track of to keep positives and negatives straight
• Another decision is the degree of detail
• Ie – daily, weekly, monthly, quarterly, annual?
How Do You Decide?
• Look at the data – does it tell about monthly, yearly or what interval data?
• What can you realistically forecast?
• Is predicting daily expenses 10 years in advance realistic?
• What is the interest compounding period
• Problems are easier if interest compounding period matches the detail of the cash flow
• You would like a cash flow that matches the interest compounding period and is realistic for what you have to predict or the data you have available
Make a Decision
• With time interval specified all expenses in an interval will be lumped at one point in the interval
• What time in the interval
• In this class always at the end (year one expenses all occur exactly at 1 year from time 0)
• The Beginning
• Another common choice is the mid point
• Makes more sense but makes for nasty math
• IRS does taxes this way
• We won’t go there.
The Time Interval Match
• Nice if time interval and interest compounding period match
• For basic engineering econ books they almost always do
• When I set up problems for you they most always do.
• Remember – by law interest rates are reported on a one year basis in the U.S.
• If the compounding period is less then you just get the period interest rate
• Yearly Rate / # of compounding periods each year
• Two Cases
• Time interval is shorter than the interest compounding period
• Time interval is longer than the interest compounding period
Time Interval is Shorter than the compounding period
• Often means cash flow has too much detail and is trying to predict expenses when they don’t change interest.
• Can ask how interest behaves
• May only count what is in there at the end and then charge on all of it
• Definitely favors reducing detail of cash flow
• May apply a linear fraction of the interest rate to it
• May make you do a problem with different effective interest rates for each quarter etc.
• Probably only significant with very short cash flows.
Time Interval Is Longer than the Compounding Period
• Compute the Yield for the time interval and use that as an interest rate
• Example – a loan with daily compounding and monthly payments
• Say interest rate is 11% compounded daily
• Get Aprox. Period Interest Rate
• 11%/ 360 = 0.030556%
• Now Get Monthly Yield (I’ll model a 30 day month)
• (1+0.00030556)^30 = 1.009207
• Subtract the 1 that preserves principle 0.009207
• Multiply 100 0.9207% monthly