Engineering Economy

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IE307

Factors: How Time and

Interest Affect Money
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Chapter outline

➢ Single-Amount Factors (F/P and P/F Factors)

➢ Uniform Series Present Worth Factor and Capital Recovery Factor
(P/A and A/P Factors)
➢ Sinking Fund Factor and Uniform Series Compound Amount Factor
(F/A and A/F Factors)
➢ Arithmetic Gradient Factors (P/G and A/G)
➢ Geometric Gradient Series Factors

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Single Payment Factors (F/P and P/F)

➢ Single payment factors involve only P and F.

➢ How to calculate F from P in case of compound interest?
✓ F1 = P + Pi = P (1+i)
✓ F2 = F1 + F1i = P (1+i)+ P (1+i) i =
= P (1+i+i+i2)= P (1+2i +i2)= P (1+i)2
✓ F3 = F2 + F2i= P (1+i)3
✓ F = P (1+i)n

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Single Payment Factors (F/P and P/F)

Cash flow diagrams are as follows:

Formulas are as follows:

F = P(1 + i ) n
P = F[1 / (1 + i )n]
(F/P) Factor P = F (1 + i )-n (P/F) Factor

▪ General (standard) form (X/Y , i , n); X = Unknown, Y=Know.

▪ A standard notation Equations: F= P(F/P, i, n) & P= F(P/F, i, n).
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Single-Amount Factors (F/P and P/F)

➢ Example: Finding Future Value

If you had $2,000 now and invested it at 10%, how much would it be worth in
eight years?

The cash flow diagram is:

F=? Solution:
i =10% ▪ F = P(1 + i )n
= 2000(1 + 0.1 )8
0 1 2 3 4 5 6 7 8 = $4,287.18
P = 2000

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Single-Amount Factors (F/P and P/F)

Solution:
Or
▪ F =P(F/P,10%,8)
=2000(2.1436)
= $4,287.2

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Uniform Series Involving P/A and A/P

Cash flow diagrams are as follows:

➢ Uniform Series Present Worth Factor and Capital Recovery P = A(P/A,i,n)

Factor ( P /A and A /P )
➢ An expression for the present worth P can be
determined by considering each A value as a future
worth F.
1 1 1 1 1 A = P(A/P,i,n)
𝑃=𝐴 1
+𝐴 2
+𝐴 3
+ ⋯+ 𝐴 𝑛−1
+𝐴 𝑛
1+𝑖 1+𝑖 1+𝑖 1+𝑖 1+𝑖

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Uniform Series Involving P/A and A/P

Cash flow diagrams are as follows:

1 1 1 1 1 P = A(P/A,i,n)
𝑃=𝐴 1
+𝐴 2
+𝐴 3
+ ⋯+ 𝐴 𝑛−1
+𝐴 𝑛
1+𝑖 1+𝑖 1+𝑖 1+𝑖 1+𝑖

1 1 1 1 1
𝑃=𝐴 1
+ 2
+ 3
+ ⋯+ 𝑛−1
+ [2.6]
1+𝑖 1+𝑖 (1 + 𝑖) 1+𝑖 (1 + 𝑖)𝑛

𝑃 1 1 1 1 1
=𝐴 2
+ 3
+ 4
+ ⋯+ 𝑛
+ [2.7]
1+𝑖 1+𝑖 1+𝑖 (1 + 𝑖) 1+𝑖 (1 + 𝑖)𝑛+1

Subtract [2.6] from [2.7]: A = P(A/P,i,n)

𝐴 1
𝑃= −1 (P/A) Factor (A/P) Factor
−𝑖 1 + 𝑖 𝑛

1+𝑖 𝑛−1 𝑖 1+𝑖 𝑛

𝑃=𝐴 𝐴=𝑃
𝑖 1+𝑖 𝑛 1+𝑖 𝑛−1

P must always be located one period prior to the first A

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Uniform Series Involving P/A and A/P

➢ Example: Uniform Series Involving P/A

How much money should you be willing to pay now for a guaranteed $600 per
year for 9 years starting next year, at a rate of return of 16% per year?

Solution:
1+𝑖 𝑛 −1 1.16 9 −1
▪𝑃=𝐴 = 𝑃 = 600 0.16 1.16 9
= $2763.90
𝑖 1+𝑖 𝑛

Or
▪ P =600( P/A ,16%,9) 600(4.6065) = $2763.90

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Uniform Series Involving F/A and A/F

➢ Sinking Fund Factor and Uniform Series Compound Cash flow diagrams are as follows:
Amount Factor ( A/F and F/A ) A = F(A/F, i, n)
1
✓ If P from Equation 𝑃 = 𝐹
1 + 𝑖 n is substituted into
𝑛
𝑖 1+𝑖
Equation 𝐴 = 𝑃 ,result: (A/F) Factor
1+𝑖 𝑛−1

1 𝑖 1+𝑖 𝑛 𝑖
𝐴=𝐹 𝐴=𝐹
1 + 𝑖 𝑛 − 1 =˃
F = A(F/A, i, n)
1+𝑖 𝑛 1+𝑖 𝑛 −1

✓ The uniform series A begins at the end of year (period) 1

and continues through the year of the given F.

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Uniform Series Involving F/A and A/F

✓ The last A value and F occur at the same time. Cash flow diagrams are as follows:

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

(F/A) Factor
1+𝑖 −1 𝑛
𝐹=𝐴
𝑖

F = A(F/A, i, n)
✓ F/A = ( F/P )( P/A ) =

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Uniform Series Involving F/A and A/F

➢ Example:
The president of Ford Motor Company wants to know the equivalent
future worth of a $1 million capital investment each year for 8 years,
starting 1 year from now. Ford capital earns at a rate of 14% per year.

Solution:
F = 1000(F/A,14%,8)
= 1000(13.2328)
= $13.232.80

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Factor Values for Untabulated i or n Values

➢ There are several ways to obtain any factor value with (i or n) value that is not
listed in the compound interest tables :
✓ Use the Formula listed in this book.
✓ Use linear Interpolation in the interest tables.
Interpolation introduces some level of inaccuracy, depending upon the distance
between the two boundary values selected for i or n , as the formulas themselves
are nonlinear functions.

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Factor Values for Untabulated i or n Values

➢ Interpolation procedure:
1. select two tabulated values (x1 and x2) ensuring that the two values
surround and are not distant from the required value x .
2. find the corresponding tabulated factor values (f1 and f2).
3. solve for the unknown, linearly interpolated value f using
the formulas below,
𝑥 − 𝑥1
𝑓 = 𝑓1 + (𝑓 − 𝑓1 )
𝑥2 − 𝑥1 2

𝑎
𝑓 = 𝑓1 + 𝑐 = 𝑓1 + 𝑑
𝑏 14
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Factor Values for Untabulated i or n Values

➢ Example:
Determine the P/A factor value for i = 7.75% and n =10 years, use the previous
methods described previously.
Solution:
1+𝑖 𝑛−1 1.0775 10 − 1 1.10947
✓ Formula: (P/A, 7.75%,10) = = = = 6.78641
𝑖(1 + 𝑖)𝑛 0.0775(1.0775)10 0.16348
𝑖 − 𝑖1
✓ Interpolation: 𝑓 = 𝑓1 + (𝑓 − 𝑓1 )
𝑖2 − 𝑖1 2
7.75 − 7
= 7.0236 + (6.7101 − 7.0236)
8−7
= 7.0236 + (0.75)(-0.3135) =7.0236-0.2351= 6.7885 15
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Arithmetic Gradient Factors (P/G and A/G)

➢ An arithmetic gradient is a cash flow series that either increases or

decreases by a constant amount each period.
➢ The amount of the increases or decreases is called the gradient (G).
➢ Assume that the cash flow at the end of year 1 is the base amount of
the cash flow series and, therefore, not part of the gradient series

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Arithmetic Gradient Factors (P/G and A/G)

Cash flow diagram of an arithmetic
gradient series :
➢ For example, if you purchase a used car with a 1-year
warranty, you might expect to pay the costs ($2500) during
the first year. $2500 is the base amount. If you estimate that
total costs will increase by $200 each year, the amount the
second year is $2700, the third $2900, and so on to year n ,
when the total cost is 2500+( n - 1)200.
Conventional arithmetic gradient series
without the base amount.
CFn = base amount + ( n - 1) G
➢ It is important to realize that the base amount defines a uniform
cash flow series of the size A that occurs each time period.
➢ Note that the gradient begins between years 1 and 2. This is
called a conventional gradient .
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Arithmetic Gradient Factors (P/G and A/G)

➢ Example:
Estimated fees (revenues) are $80,000 for the first year with uniform increases to a
total of $200,000 by the end of year 9. Determine the gradient(G) and construct a
cash flow diagram(CFD) that identifies the base amount and the gradient series.

Solution CFn = base amount + ( n - 1) G

Base amount is CF1= $80,000,
Total increase over 9 years is
CF9 - CF1 = 200,000 – 80,000 = $120,000
Arithmetic gradient is
𝐶𝐹9 − 𝐶𝐹1 120,000
𝐺= = = $15,000 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
𝑛−1 9−1
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Arithmetic Gradient Factors (P/G and A/G)

➢ The total present worth PT for a series that includes a base amount A and conventional
arithmetic gradient G must consider the present worth of both (A&G).
PT = ?
PT = P A ± P G
PA = ? i = 10% PG = ?
i = 10%
i = 10%
0 1 2 3 4 5 0 1 2 3 4 5 0 1 2 3 4 5

Amount in year 1
+
400
is base amount 450
500 400 400 400 400 400 50
550 100
600 150
PA = 400(P/A,10%,5) PG = 50(P/G,10%,5) 200

➢ The corresponding equivalent annual worth AT is the sum of the base amount series annual worth
AA and gradient series annual worth AG
AT = AA ± AG
➢ ( + or - ) sign is used for an increasing (+G ) or decreasing (-G ) gradient
➢ Remember: The conventional arithmetic gradient starts in year 2, and P is located in year 0. 19
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Arithmetic Gradient Factors (P/G and A/G)

➢ Three factors will be considered for arithmetic gradient series:

✓ P/G factor for present worth:
Convert an arithmetic gradient G (without the base amount) for n years into a present worth
at year 0
1+𝑖 𝑛 −𝑖𝑛−1 Arithmetic Gradient Present Worth
P = G(P/G,i,n) P= G Factors (AGPWF)
𝑖 2 1+𝑖 𝑛

✓ A/G factor for annual series:

Convert an arithmetic gradient G (without the base amount) for n years into an equivalent
uniform series of A value

1 𝑛 Arithmetic Gradient Uniform Series

A = G(A/G,i,n) 𝐴𝐺 = 𝐺 −
𝑖 (1 + 𝑖)𝑛 −1 Factor (AGUSF).
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Arithmetic Gradient Factors (P/G and A/G)

✓ F/G factor for future worth

Convert an arithmetic gradient G (without the base amount) for n years into an equivalent future
value at year n

1 1+𝑖 𝑛−1 Arithmetic Gradient Future Worth

F = G(F/G,i,n) 𝐹𝐺 = 𝐺 −𝑛
𝑖 𝑖 Factor

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Arithmetic Gradient Factors (P/G and A/G)

➢ Example:
Find the present worth of $400 in year 1 and amounts increasing by $30 per year through
year 5 at an interest rate of 12% per year.

Solution PT = ?
PT = 400(P/A,12%,5) + 30(P/G,12%,5) i = 12%
= 400(3.6048) + 30(6.3970) 0 1 2 3 4 5
= $1,633.83
The cash flow could also be converted 400
into an A value as follows: 430
460
AT = 400 + 30(A/G,12%,5) 490
G = $30 520
= 400 + 30(1.7746)
= $453.24
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Geometric Gradient Series Factors

➢ A geometric gradient series is a cash flow series that either increases or

decreases by a constant percentage each period. The uniform change is called
the rate of change.
✓ g = constant rate of change , in decimal form, by which cash flow values
increase (+) or decrease (-)from one period to the next.
✓ A1 = initial cash flow in year 1 of the geometric series
✓ Pg = present worth of the entire geometric gradient series, including the
initial amount A1
Pg = A1(P/A, g,i,n)
𝑛
1+𝑔
1−
1+𝑖
𝑊ℎ𝑒𝑛 𝑔 ≠ 𝑖
𝑃/𝐴, 𝑔, 𝑖, 𝑛 = 𝑖−𝑔
𝑛
𝑊ℎ𝑒𝑛 𝑔 = 𝑖 23
1+𝑖
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Geometric Gradient Series Factors

➢ Cash flow diagram for present worth of geometric gradient

There are no tables for

geometric factors

Increasing Geometric Series Decreasing Geometric Series

➢ It is possible to derive factors for the equivalent A and F values; however, it is easier
to determine the Pg amount and then multiply by the A/P or F/ P factor.

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Geometric Gradient Series Factors

➢ Example:
Find the present worth of $1,000 in year 1 and amounts increasing by 7% per year through
year 10. Use an interest rate of 12% per year.

Solution
Pg = ? g = 7%
10
1 + 0.07
1− i = 12%
Pg = 1000 1+0.12 0 1 2 3 4 10
0.12−0.07
= $7,333 1000 1070
1145
To find A, multiply Pg by (A/P,12%,10)
1838

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