ECONOMIC EQUIVALENCE
Established when we are indifferent between a future payment, or a series of future payments, and a present sum of money .
Considers the comparison of alternative options, or proposals, by reducing them to an equivalent basis, depending on:
interest rate;
amounts of money involved;
timing of the affected monetary receipts and/or expenditures;
manner in which the interest , or profit on invested capital is paid and the initial capital is recovered
ECONOMIC EQUIVALENCE FOR FOUR REPAYMENT PLANS OF AN $8,000 LOAN
Plan #1: $2,000 of loan principal plus 10% of BOY principal paid at the end of year; interest paid at the end of each year is reduced by $200 (i.e., 10% of remaining principal)
Year Amount Owed Interest Accrued Total Principal Total end at beginning for Year Money Payment of Year of Year owed at Payment ( BOY ) end of Year
1 $8,000 $800 $8,800 $2,000 $2,800
2 $6,000 $600 $6,600 $2,000 $2,600
3 $4,000 $400 $4,400 $2,000 $2,400
4 $2,000 $200 $2,200 $2,000 $2,200
Plan #2: $0 of loan principal paid until end of fourth year; $800 interest paid at the end of each year
ECONOMIC EQUIVALENCE FOR FOUR REPAYMENT PLANS OF AN $8,000 LOAN
Year Amount Owed Interest Accrued Total Principal Total end at beginning for Year Money Payment of Year of Year owed at Payment ( BOY ) end of Year
1 $8,000 $800 $8,800 $0 $800
2 $8,000 $800 $8,800 $0 $800
3 $8,000 $800 $8,800 $0 $800
4 $8,000 $800 $8,800 $8,000 $8,800
Total interest paid ($3,200) is 10% of total dollar-years ($32,000)
ECONOMIC EQUIVALENCE FOR FOUR REPAYMENT PLANS OF AN $8,000 LOAN
Plan #3: $2,524 paid at the end of each year; interest paid at the end of each year is 10% of amount owed at the beginning of the year.
Year Amount Owed Interest Accrued Total Principal Total end at beginning for Year Money Payment of Year of Year owed at Payment ( BOY ) end of Year
1 $8,000 $800 $8,800 $1,724 $2,524
2 $6,276 $628 $6,904 $1,896 $2,524
3 $4,380 $438 $4,818 $2,086 $2,524
4 $2,294 $230 $2,524 $2,294 $2,524
ECONOMIC EQUIVALENCE FOR FOUR REPAYMENT PLANS OF AN $8,000 LOAN
Plan #4: No interest and no principal paid for first three years. At the end of the fourth year, the original principal plus accumulated (compounded) interest is paid.
Year Amount Owed Interest Accrued Total Principal Total end at beginning for Year Money Payment of Year of Year owed at Payment ( BOY ) end of Year
1 $8,000 $800 $8,800 $0 $0
2 $8,800 $880 $9,680 $0 $0
3 $9,680 $968 $10,648 $0 $0
4 $10,648 $1,065 $11,713 $8,000 $11,713
Total interest paid ($3,713) is 10% of total dollar-years ($37,128)
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