ENGINEERING ECONOMY

WORKSHEET #2: TIME VALUE OF MONEY 1: INTRODUCING THE FACTORS

For each of the following problems, (a) draw the cash flow diagram; (b) present clean and clear manual solutions to the
problem; (c) highlight the final answer (only the final answer as required by the problem) by enclosing it within a box.

1. The Department of Traffic Security of a city is considering the purchase of a new drone for aerial surveillance of traffic on
its most congested streets. A similar purchase 5 years ago cost $1,500,000. At an interest rate of 15% per year, what is
the equivalent value today?

Given: Required:
P = $1,500,000 F
i = 15%
N=5

Cash Flow Diagram:

For the Department of Traffic Security

i = 15%
-5 -4 -3 -2 -1 0

$1,500,000

F?

Solution:

𝐹 = 𝑃(1 + 𝑖)𝑁
𝐹 = $ 1,500,000(1 + 0.15)5

𝑭 = $ 𝟑, 𝟎𝟏𝟕, 𝟎𝟑𝟓. 𝟕𝟖

Using the F/P factor from the interest table

𝐹
𝐹 = 𝑃 ( , 𝑖%, 𝑁)
𝑃
𝐹
𝐹 = $ 1,500,000 ( , 15%, 5)
𝑃
𝐹 = $ 1,500,000(2.011)
𝑭 = $ 𝟑, 𝟎𝟏𝟔, 𝟓𝟎𝟎

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2. How much money should a bank be willing to loan a real estate developer who will repay the loan by selling seven
lakefront lots at $100,000 each 3 years from now? Assume the bank’s interest rate is 5% per year.

Given: Required:
𝐹 = 7 × $ 100,000 = $ 700,000 P
i = 5%
N=3

Cash Flow Diagram:

For the bank

$ 700,000

i = 5%
0 1 2 3

P?

Solution:

𝑃 = 𝐹(1 + 𝑖)−𝑁
𝑃 = $ 700,000(1 + 0.05)−3

𝑷 = $ 𝟔𝟎𝟒, 𝟔𝟖𝟔. 𝟑𝟐

Using P/F factor from the interest table

𝑃
𝑃 = 𝐹( , 𝑖%, 𝑁)
𝐹
𝑃
𝑃 = $ 700,000( , 5%, 3)
𝐹
𝑃 = $ 700,000(0.8638)
𝑷 = $ 𝟔𝟎𝟒, 𝟔𝟔𝟎

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3. How much could BTU Oil and Gas Fracking afford to spend on new equipment each year for the next 5 years if it expects
a profit of $60 million 5 years from now? Assume the company’s MARR is 18% per year.

Given: Required:
F = $ 60 million A
i = 18%
N=5

Cash Flow Diagram:

For BTU Oil and Gas Fracking

$ 60 million

A?

i = 18%

0 1 2 3 4 5

Solution:

𝑖
𝐴 =𝐹[ ]
(1 + 𝑖)𝑁 − 1
0.18
𝐴 = $ 60,000,000 [ ]
(1 + 0.18)5 − 1

𝑨 = $ 𝟖, 𝟑𝟖𝟔, 𝟔𝟕𝟎. 𝟓𝟏

Using A/F factor from the interest table

𝐴
𝐴 = 𝐹 ( , 𝑖%, 𝑁)
𝐹
𝑃
𝑃 = $ 60,000,000( , 18%, 5)
𝐹
𝑃 = $ 60,000,000(0.1398)
𝑷 = $ 𝟖, 𝟑𝟖𝟖, 𝟎𝟎𝟎

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4. Atlas Long-Haul Transportation is considering installing Valutemp temperature loggers in all of its refrigerated trucks for
monitoring temperatures during transit. If the systems will reduce insurance claims by $100,000 in each of the next 4
years, how much should the company be willing to spend now if it uses an interest rate of 10% per year?

Given: Required:
A = $ 100,000 P
i = 10%
N=4

Cash Flow Diagram:

For BTU Oil and Gas Fracking

$ 100,000

i = 10%

0 1 2 3 4

P?
Solution:

(1 + 𝑖)𝑁 − 1
𝑃 = 𝐴[ ]
𝑖(1 + 𝑖)𝑁
(1 + 0.1)4 − 1
𝑃 = $ 100,000 [ ]
0.1(1 + 0.1)4

𝑷 = $ 𝟑𝟏𝟔, 𝟗𝟖𝟔. 𝟓𝟒

Using P/A factor from the interest table

𝑃
𝑃 = 𝐴 ( , 𝑖%, 𝑁)
𝐴
𝑃
𝑃 = $ 100,000( , 10%, 4)
𝐴
𝑃 = $ 100,000(3.170)
𝑷 = $ 𝟑𝟏𝟕, 𝟎𝟎𝟎

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5. A cash flow sequence starts in year 1 at $6,000 and decreases by $100 each year through year 9. Determine the present
worth of the sequence. Use an interest rate of 10%.

Given: Required:
A = $ 6,000 P
G = -100
N=9
i = 10%

Cash Flow Diagram:

P?
$ 6,000

G = -100

i = 10%
0 1 2 3 4 5 6 7 8 9

Solution:

𝑃 = 𝑃𝐴 + 𝑃𝐺
(1 + 𝑖)𝑁 − 1
𝑃𝐴 = 𝐴 [ ]
𝑖(1 + 𝑖)𝑁
𝐺 (1 + 𝑖)𝑁 − 1 𝑁
𝑃𝐺 = [ 𝑁
− ]
𝑖 𝑖(1 + 𝑖) (1 + 𝑖)𝑁
(1 + 𝑖)𝑁 − 1 𝐺 (1 + 𝑖)𝑁 − 1 𝑁
𝑃 = 𝐴[ 𝑁
]+ [ − ]
𝑖(1 + 𝑖) 𝑖 𝑖(1 + 𝑖)𝑁 (1 + 𝑖)𝑁
(1 + 0.1)9 − 1 (1 + 0.1)9 − 1 9
𝑃 = $ 6,000 [ ] + (−100) [ − ]
0.1(1 + 0.1)9 0.1(1 + 0.1)9 (1 + 0.1)9

𝑷 = $ 𝟑𝟐, 𝟔𝟏𝟐. 𝟎𝟎

Using P/A and P/G factors from the interest table

𝑃 = 𝑃𝐴 + 𝑃𝐺
𝑃 𝑃
𝑃 = 𝐴 ( , 𝑖 % , 𝑁) + 𝐺 ( , 𝑖 % , 𝑁)
𝐴 𝐺
𝑃 𝑃
𝑃 = $ 6,000 ( , 10 %, 9) + (−100) ( , 10 %, 9)
𝐴 𝐺
𝑃 = $ 6,000 (5.759) + (−100) (19.421)
𝑷 = $ 𝟑𝟐, 𝟔𝟏𝟏. 𝟗

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6. The future worth in year 8 of an arithmetic gradient cash flow series for years 1 through 8 is $500,000. If the gradient
increases each year is $3,000, determine the cash flow in year 1 at an interest rate of 9% per year.

Given: Required:
CF8 = $ 500,000 CF1
G = $ 3,000
N=8
i = 9%

Cash Flow Diagram:

$ 500,000

G = $ 3,000

A?

i = 9%

0 1 2 3 4 5 6 7 8

Solution:

𝐶𝐹𝑁 = 𝑏𝑎𝑠𝑒 𝑎𝑚𝑜𝑢𝑛𝑡 + (𝑁 − 1)𝐺

$ 500,000 = 𝐶𝐹1 + (8 − 1)$ 3,000

𝑨 = $ 𝟒𝟕𝟗, 𝟎𝟎𝟎. 𝟎𝟎

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7. Calculate the present worth of a geometric gradient series with a cash flow of $40,000 in year 1 and increases of 6% each
year through year 6. The interest rate is 9% per year.

Given: Required:
A = $ 40,000 P
g = 6%
N=6
i = 9%

Cash Flow Diagram:

g = 6%
P?
i = 9%

$ 40,000

0 1 2 3 4 5 6

Solution:

(1 + 𝑔)𝑁
1−
(1 + 𝑖)𝑁
𝑃𝐺 = 𝐴1 [ ]
𝑖−𝑔

(1 + 0.06)6
1−
(1 + 0.09)6
𝑃𝐺 = $ 40,000 [ ]
0.09 − 0.06

𝑷𝑮 = $ 𝟐𝟎𝟓, 𝟓𝟕𝟕. 𝟖𝟕

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8. A northern California consulting firm wants to start saving money for replacement of network servers. If the company
invests $10,000 at the end of year 1 but decreases the amount invested by 5% each year, how much will be available 4
years from now at an earning rate of 8% per year?

Given: Required:
A = $ 10,000 F
g = -5%
N=4
i = 8%

Cash Flow Diagram:

F?
$ 10,000

g = 5%
i = 8%

0 1 2 3 4

Solution:

(1 + 𝑔)𝑁
1−
(1 + 𝑖)𝑁
𝑃𝐺 = 𝐴1 [ ]
𝑖−𝑔

(1 − 0.05)4
1−
(1 + 0.08)4
𝑃𝐺 = $ 10,000 [ ]
0.08 + 0.05

𝑃𝐺 = $ 30,870.28
𝐹 = 𝑃(1 + 𝑖)𝑁
𝐹 = $30,870.28 (1 + 0.08)4

𝑭 = $𝟒𝟏, 𝟗𝟗𝟖. 𝟔𝟕

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9. A start-up company that make robotic hardware for CIM (computer integrated manufacturing) systems borrowed $1
million to expand its packaging and shipping facility. The contract required the company to repay the lender through an
innovative mechanism called “faux dividends”, a series of uniform annual payments over a fixed period of time. If the
company paid $300,000 per year for 5 years, what was the interest rate on the loan?

Given: Required:
P = $ 1 million i
A = $ 300,000
N=5

Cash Flow Diagram:

For the start-up company

$ 1 million

i=?

0 1 2 3 4 5

$ 300,000

Solution:

(1 + 𝑖)𝑁 − 1
𝑃 = 𝐴[ ]
𝑖(1 + 𝑖)𝑁
(1 + 𝑖)5 − 1
$1,000,000 = $300,000 [ ]
𝑖(1 + 𝑖)5

𝒊 = 𝟎. 𝟏𝟓𝟐𝟒 = 𝟏𝟓. 𝟐𝟑𝟖𝟐 %

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10. RKE & Associates is considering the purchase of a building it currently leases for $30,000 per year. The owner of the
building put it up for sale at a price of $170,000, but because the firm has been a good tenant, the owner offered to sell
it to RKE for a cash price of $160,000 now. If purchased now, how long will it be before the company recovers its
investment at an interest rate of 12% per year?

Given: Required:
P = $ 160,000 N
A = $ 30,000
i = 12%

Cash Flow Diagram:

For RKE & Associates

$ 30,000

i = 12%

0 N

$ 160,000

Solution:

(1 + 𝑖)𝑁 − 1
𝑃 = 𝐴[ ]
𝑖(1 + 𝑖)𝑁
(1 + 0.12)𝑁 − 1
$160,000 = $30,000 [ ]
0.12(1 + 0.12)𝑁

𝑵 = 𝟗. 𝟎𝟏𝟓 𝒚𝒆𝒂𝒓𝒔 ≈ 𝟗 𝒚𝒆𝒂𝒓𝒔

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