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Review CH 02czxczxc
Review CH 02czxczxc
(GE401)
CHAPTER 2
5.
6.
7.
8.
2
3
= P(1+i) 3
In general:
Fn = P(1+i)n
Fn = P(F/P,i%,n)
Thus:
P = F(P/F,i%,n) where
(P/F,i%,n) = (1+i)-n
Thus, the two factors are:
1. F = P(1+i)n finds the future
worth of P;
2. P = F(1+i)-n
finds the present worth
from F
Example:
P= 1,000; n=3; i=10%
What is the future
value, F?
Desire an expression
for the present worth
P of a stream of
equal, end of period
cash flows A
Capital Recovery
Factor A/P, i%, n
A/F Factor
Example:
Formosa Plastics has
major
fabrication plants in
Riyadh and in Jaddh. It is
Solution of Example
The cash flow diagram shows
the annual payments starting
at the end of year 1 and
ending in the year the future
worth is desired.
Cash flows are indicated in $1000
units. The F value in 8 years is
F = l000(F/A,14%,8) =
1000(13.23218)
= $13,232.80 = 13.232 million
8 years
from now.
Example:
How much money must Carol
deposit every year starting, l year
from now at 5.5% per year in
Solution of Example
The cash How diagram from
Carol's perspective fits the A/F
factor.
A= $6000 (A/F,5.5%,7)
=6000(0.12096)
= $725.76 per year
The A/F factor Value 0f 0.12096
was computed using the A/F
factor formula
Interpolation in Interest
Tables
Interpolation of
Factors
All texts on Engineering
economy will provide
tabulated values of the
various interest factors
usually at the end of the text
in an appendix
Refer to the back of your
text for those tables.
Interpolation of
Factors
Typical Format for Tabulated
Interest Tables
Interpolation (Estimation
Process)
At times, a set of interest tables
may not have the exact interest
factor needed for an analysis
One may be forced to interpolate
between two tabulated values
Linear Interpolation is not exact
because:
The functional relationships of the
interest factors are non-linear
functions
An Example
Assume you need the value of
the A/P factor for i = 7.3% and n =
10 years.
7.3% is most likely not a
tabulated value in most
interest tables
So, one must work with i =
7% and i = 8% for n fixed at
10
Proceed as follows
Estimating for i =
7.3%
Form the following
relationships
Using a previously
programmed spreadsheet
model the exact value for
7.3% is:
Arithmetic Gradient
Factors
An arithmetic (linear)
Gradient is a cash flow series
that either increases or
decreases by a constant
amount over n time periods.
A linear gradient is always
comprised of TWO
components:
Arithmetic Gradient
Factors
Example: Linear
Gradient
Typical Negative, Increasing
Gradient:
G=$50
Example: Linear
Gradient
Desire to find the Present
Worth of this cash flow
Arithmetic Gradient
Factors
The G amount is the
constant arithmetic change
from one time period to the
next.
The G amount may be
positive or negative!
The present worth point
is always one time period
to the left of the first
cash flow in the series or,
DO NOT FORGET
THIS!
Present Worth Point
Gradient Component
What is needed is a
present worth expression
for the gradient
component cash flow.
We need to derive a
closed form expression
for the gradient
component.
Present Worth: Gradient
Component
General CF Diagram
Gradient Part Only
Next Step:
Factor out G and re-write
as ..
Factoring G out. P/G
factor
Convert G to an
equivalent A
How to do it
A/G factor using A/P with
P/G
Gradient Example
The Set Up
PW of the Gradient
Component
Calculating or looking up
the
P/G,10%,5 factor yields
the following:
Pt=0 = $100(6.8618) =
$686.18 for the gradient
PW
Example Summarized
Shifted Gradient
Example
Consider the following Cash
Flow
1. This is a shifted
negative, decreasing
gradient.
2. The PW point in time is at t
= 3 (not t = o)
Shifted Gradient
Example
Consider the following Cash
Flow
Shifted Gradient
Example: Base Annuity
PW of the Base Annuity: 2
Steps
Geometric Gradient
Geometric Gradients
An arithmetic (linear)
gradient changes by a fixed
dollar amount each time
period.
A GEOMETRIC gradient
changes by a fixed
percentage each time period.
We define a UNIFORM RATE
OF CHANGE (%) for each time
period
Define g as the constant
rate of change in decimal
form by which amounts
increase or decrease from one
period to the next
Geometric Gradients:
Increasing
Typical Geometric Gradient
Profile
Let A1 = the first cash flow in the
series
Geometric Gradients:
Decreasing
Typical Geometric Gradient
Profile
Let A1 = the first cash flow in the
series
Geometric Gradients:
Derivation
Geometric Gradients:
Derivation
For a Geometric Gradient
the following parameters are
required:
The interest rate per
period i
The constant rate of
change g
Geometric Gradients:
Starting
Pg = The Ajs time the
respective (P/F,i,j) factor
Write a general present
worth
relationship to find Pg.
Geometric Gradients
Geometric Gradients
Geometric Gradient: i = g
Case
Geometric Gradients:
Summary
Geometric Gradient:
Notes
The geometric gradient
requires
knowledge of:
A1, i, n, and g
Geometric Gradient:
Notes
Geometric Gradient:
Example
Assume maintenance
costs for a particular
activity will be $1700 one
year from now.
Assume an annual
increase of 11% per year
over a 6-year time period.
Geometric Gradient:
Example
Solution
P=
$1700(P/A,11%,8%,7)
Need to calculate the P/A
factor from the closed-form
expression for a geometric
gradient.
From a spreadsheet we
see:
Geometric Gradient (
-g )
Consider the following
problem with a negative
growth rate g.
Determination of an
Unknown Interest
Rate
When the i rate is
unknown
Example: i unknown
Assume on can invest $3000
now in a venture in
anticipation of gaining $5,000
in five (5) years.
Example: i unknown
The Cash Flow Diagram
is
Example: i unknown
For i unknown
In general, solving for
i in a time value
formulation is not
straight forward.
More often, one will
have to resort to some
form of trial and error
approach as will be
shown in future sections.
A sample spreadsheet
model for this problem
follows.
Determination of
Unknown Number of
Years
Unknown Number of
Years
Some problems require
knowing the number of time
Unknown Number of
Years
i = 5%/year; n is
unknown!
Unknown Number of
Years
Solving we have..
Fn=? = 1000(F/P,5%,x):
2000 = 1000(1.05)x
Solve for x in closed
form
Unknown Number of
Years
Solving we have..
(1.05)x = 2000/1000
Xln(1.05) =ln(2.000)
X = ln(1.05)/ln(2.000)
X = 0.6931/0.0488 =
14.2057 yrs
With discrete compounding
it will take 15 years to a
mass $2,000 (have a little
more that $2,000)
Chapter Summary
relationships in order to
proceed with more
meaningful analysis that can
impact decision making.
These relationships are
important to you
professionally and in your
personal lives.
Master these concepts!!!