Developed By:

Dr. Don Smith, P.E.

Department of Industrial
Engineering
Texas A&M University
College Station, Texas

Executive Summary Version

Chapter 2
Factors: How Time
and Interest Affect
Money
Slide Sets to accompany Blank & Tarquin, Engineering
Economy, 6th Edition, 2005

2-1

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

LEARNING OBJECTIVES
1. F/P and P/F
factors

5. Geometric
gradient

2. P/A and A/P

factors

6. Calculate i
7. Calculate n

3. Interpolate for
factor values

8. Spreadsheets

4. P/G and A/G

factors

Slide Sets to accompany Blank & Tarquin, Engineering

Economy, 6th Edition, 2005

2-2

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

Sct 2.1 Single-Payment Factors

(F/P and P/F)
Objective:
Derive factors to determine the present or future

worth of a cash flow

Fn

Cash Flow Diagram basic format

0

i% / period
3

n-1

P0 P0 = Fn1/(1+i)n (P/F,i%,n) factor: Excel: =PV(i%,n,,F)

Fn = P0(1+i)n (F/P,i%,n) factor: Excel: =FV(i%,n,,P)
Slide Sets to accompany Blank & Tarquin, Engineering
Economy, 6th Edition, 2005

2-3

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

Sct 2.2 Uniform-Series: Present Worth

Factor (P/A) and
Capital Recovery Factor(A/P)
Cash flow profile for P/A factor
i% per interest period

....
0

$A per interest period

n-2

n-1

Find P

Required: To find P given A

Cash flows are equal, uninterrupted and flow at the end of
each interest period
Slide Sets to accompany Blank & Tarquin, Engineering
Economy, 6th Edition, 2005

2-4

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

(P/A) Factor Derivation

Setup the following:

1
1
1
1
P A

..

1
2
n 1
n
(1

i
)
(1

i
)
(1

i
)
(1

i
)

Multiply by

(1)

1
to obtain a second equation
(1+i)

P
1
1
1
1
A

..

2
3
n
n 1
1 i
(1

i
)
(1

i
)
(1

i
)
(1

i
)

(2)

Subtract (1) from (2) to yield

i
1
1
P A

n 1
1 i
(1

i
)
(1

i
)

Slide Sets to accompany Blank & Tarquin, Engineering

Economy, 6th Edition, 2005

2-5

(3)
2005 by McGraw-Hill, New York, N.Y All Rights Reserved

(P/A) and (A/P) Factor Formulas

Simplify (3) to yield
(1 i ) n 1
P A
for i 0
n
i (1 i )

(4)

(P/A,i%,n) factor
Excel: =PV(i%,n,A)

Solve (4) for A to get

(A/P) factor

i (1 i ) n
A P

n
(1

i
)

Slide Sets to accompany Blank & Tarquin, Engineering

Economy, 6th Edition, 2005

(5)

2-6

(A/P,i%,n) factor
Excel: =PMT(i%,n,P)

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

ANSI Standard Notation for

Interest Factors
Standard notation has been adopted to
represent the various interest factors
Consists of two cash flow symbols, the
interest rate, and the number of time periods
General form: (X/Y,i%,n)
X represents what is unknown
Y represents what is known
i and n represent input parameters; can be known or

unknown depending upon the problem

Slide Sets to accompany Blank & Tarquin, Engineering
Economy, 6th Edition, 2005

2-7

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

Notation - continued
Example: (F/P,6%,20) is read as:
To find F, given P when the interest rate is 6% and

the number of time periods equals 20.

In problem formulation, the standard notation

is often used in place of the closed-form
equivalent relations (factor)
Tables at the back of the text provide
tabulations of common values for i% and n
Slide Sets to accompany Blank & Tarquin, Engineering
Economy, 6th Edition, 2005

2-8

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

Sct 2.3 Sinking Fund Factor and Uniform

Series Compound Amount Factor
(A/F and F/A)
F = given

Cash flow diagram for (A/F) factor

i% per interest period

....
0

A=? per interest period

Find A, given F

n-2

n-1

Start with what has already been developed

1 i (1 i ) n
AF
(1 i ) n 1
n
(1

i
)

Slide Sets to accompany Blank & Tarquin, Engineering

Economy, 6th Edition, 2005

i
A F

n
(1

i
)

2-9

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

(F/A) factor from (A/F)

Given: A F

n
(1 i ) 1

(A/F,i%,n) factor
Excel: =PMT(i%,n,,F)

Solve for F in terms of A to yield

(1 i ) n 1
F A

Slide Sets to accompany Blank & Tarquin, Engineering

Economy, 6th Edition, 2005

2-10

(F/A,i%,n) factor
Excel: =FV(i%,n,A)

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

Sct 2.4 Interpolation in Interest Tables

When using tabulated interest tables one
might be forced to approximate a factor that is
not tabulated
Can apply linear interpolation to approximate
See Table 2-4
Factors are nonlinear functions, hence linear

interpolation will yield errors in the 2-4% range

Use a spreadsheet model to calculate the factor
precisely

Slide Sets to accompany Blank & Tarquin, Engineering

Economy, 6th Edition, 2005

2-11

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

Sct 2.5 Arithmetic Gradient Factors

(P/G) and (A/G)
A1+(n-1)G

Cash flow profile

A1+(n-

2)G

Find P, given gradient cash flow G

A1+2G

Base amount
= A1

0
n-1

A1+G

1
n

Slide Sets to accompany Blank & Tarquin, Engineering

Economy, 6th Edition, 2005

CFn = A1 (n-1)G
2-12

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

Gradient Example

0
6

$30
0

$20
0

$10
0

1
7

$40
0

$50
0

$70
0

$60
0

Gradients have two components:

1. The base amount and the gradient
2. The base amount (above) = $100/time period

Slide Sets to accompany Blank & Tarquin, Engineering

Economy, 6th Edition, 2005

2-13

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

Gradient Components
Find P of gradient series
1G

(n-3)G

(n-2)G

(n-1)G

n-1

2G

0G
Base amount = A / period

..
0

n-2

Present worth point is 1 period to the left of the 0G cash flow

For present worth of the base amount, use the P/A factor (already known)

For present worth of the gradient series, use the P/G factor (to be derived)
Slide Sets to accompany Blank & Tarquin, Engineering
Economy, 6th Edition, 2005

2-14

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

Gradient Decomposition
As we know, arithmetic gradients are
comprised of two components
1. Gradient component

2. Base amount

When working with a cash flow containing a

gradient, the (P/G) factor is only for the
gradient component
Apply the (P/A) factor to work on the base
amount component
P = PW(gradient) + PW(base amount)
Slide Sets to accompany Blank & Tarquin, Engineering
Economy, 6th Edition, 2005

2-15

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

Derivation Summary for (P/G)

Start with:

P G ( P / F , i, 2) 2G ( P / F , i,3) 3G ( P / F , i, 4) ...
(1)
+[(n-2)G](P/F,i,n-1)+[(n-1)G](P/F,i,n)
Multiply (1) by (1+i)1 to create a second equation
Subtract (1) from the second equation and simplify
Yields
G (1 i ) n 1
n
P=

i i (1 i ) n
(1 i ) n

Slide Sets to accompany Blank & Tarquin, Engineering

Economy, 6th Edition, 2005

(1 i ) n in 1
(P/G,i,n) factor

2
n
i (1 i )

No Excel relation exists

2-16

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

Use of the (A/G) Factor

A = G(A/G,i,n)

(n-1)G

(n-

2)G

Find A, given gradient cash flow G

A

...

2G

Equivalent A of
gradient series

0
n-1

1
n

CFn = (n-1)G
Slide Sets to accompany Blank & Tarquin, Engineering
Economy, 6th Edition, 2005

2-17

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

Sct 2.6 Geometric Gradient Series Factor

Geometric Gradient
Cash flow series that starts with a base amount A1
Increases or decreases from period to period by a

constant percentage amount

This uniform rate of change defines
A GEOMETRIC GRADIENT
Notation:

g = the constant rate of change, in decimal form, by which

future amounts increase or decrease from one time
period to the next
Slide Sets to accompany Blank & Tarquin, Engineering
Economy, 6th Edition, 2005

2-18

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

Typical Geometric Gradient

A1(1+g)n-1

Given A1, i%, and g%

A1

A1(1+g)

A1(1+g)2

....
0

n-2

n-1

Required: Find a factor (P/A,g%,i%,n) that will convert future

cash flows to a single present worth value at time t = 0
Slide Sets to accompany Blank & Tarquin, Engineering
Economy, 6th Edition, 2005

2-19

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

Basic Derivation: Geometric Gradient

A1
A1 (1 g ) A1 (1 g ) 2
A1 (1 g ) n 1
Pg

...
(1 i )1
(1 i ) 2
(1 i)3
(1 i ) n

Start with:

(1)

Factor out A1 out and re-write

1
(1 g )1 (1 g ) 2
(1 g ) n 1
Pg A1

...

2
3
(1

i
)
(1

i
)
(1

i
)
(1 i) n

(2)

Multiply by (1+g)/(1+i) to obtain Eq. (3 )

Pg

(1+g)
(1+g)
1
(1 g )1
(1 g ) 2
(1 g ) n 1
A1

...

(1+i)
(1+i) (1 i )
(1 i ) 2
(1 i ) 3
(1 i) n

(3)

Subtract Eq. (2 ) from Eq. (3 ) to yield

(1 g ) n
1
1+g

n 1
1 i
1+i

(1 i )

Pg

1 g
1

1 i
ig

Solve for Pg and simplify to

yield.
Slide Sets to accompany Blank & Tarquin, Engineering
Economy, 6th Edition, 2005

2-20

Pg A1

gi

2005 by McGraw-Hill, New York, N.Y All Rights Reserved

Two Forms to Consider

1 g
1

1 i
ig

Pg A1

nA1
Pg
(1 i )

gi

Case: g = i

Case: g = i

To use the (P/A,g%,i%,n) factor

A1 is the starting cash flow
There is NO base amount associated with a geometric gradient
The remaining cash flows are generated from the A1 starting value
No tables available to tabulate this factortoo many combinations of i% and g
% to support tables
Slide Sets to accompany Blank & Tarquin, Engineering
Economy, 6th Edition, 2005

2-21

2005 by McGraw-Hill, New York, N.Y All Rights Reserved