Time Value

of Money
02.03.202
1
EKONOMI TEKNIK – 02 ENGE 600 0011

NABILA PUTRIYANDRI ALIFA S.T., M.SC

 ❑Refresher on Previous Meeting

❑F/P and P/F Factor

❑P/A and A/P Factor

Outline
❑F/A and A/F Factor

❑Factor Values

❑Arithmetic Gradient

❑Geometric Gradient

❑Find i and n
Refresher pertemuan sebelumnya
silahkan akses www.kahoot.it

Pin 1237810
F/P and P/F
Factor
Basic Derivations: F/P
factor
F/P Factor To find F given P
Fn

To Find F given P

………….

Compound forward in time

P0

5
Basic Derivations: F/P factor
F/P Factor To find F given P
Fn

To Find F given P

………….

Compound forward in time

P0

7
Derivation by Recursion: F/P factor
F1 = P(1+i) In general:
F2 = F1(1+i)…..but: FN = P(1+i)n
F2 = P(1+i)(1+i) = P(1+i)2
FN = P(F/P,i%,n)
(F/P,i%,n) = (1+i)n → F/P factors
F3 =F2(1+i) =P(1+i)2 (1+i)
= P(1+i)3

8
P/F factor – discounting back in time
Discounting back from the future

Fn

………….

P/F factor brings a single future sum back to a

specific point in time.
P

9
Present Worth Factor (P/F Factor)
from F/P
Since FN = P(1+i)n
We solve for P in terms of FN
P = F{1/ (1+i)n} = F(1+i)-n
Thus:
P = F(P/F,i%,n) where
(P/F,i%,n) = (1+i)-n P/F factor
10
Example- F/P Analysis
Example: P= $1,000;n=3;i=10%

What is the future value, F?

F = ??

0 1 2 3
P=$1,000
i=10%/year

F3 = $1,000[F/P,10%,3] = $1,000[1.10]3
= $1,000[1.3310] = $1,331.00

12
Example – P/F Analysis
Assume F = $100,000, 9 years from now. What is the present worth
of this amount now if i =15%? F9 = $100,000

i = 15%/yr

0 1 2 3 ………… 8 9

P= ??
P0 = $100,000(P/F, 15%,9) = $100,000(1/(1.15)9)
= $100,000(0.2843) = $28,426 at time t = 0

14
P/A and A/P
Factors
Uniform Series Present Worth and Capital
Recovery Factors

Desire an expression for the present worth – P of a stream of equal, end of

period cash flows - A

P = ??

0 1 2 3 n-1 n

A = given

Assuming each A is F
16
Uniform Series Present Worth and Capital
Recovery Factors
Write a Present worth expression

1
𝑃=𝐹 → Assuming each A is F
(1+𝑖)𝑛

[1]
 1 1 1 1 
P = A + + .. + n −1
+ n 
 (1 + i )1
(1 + i ) 2
(1 + i ) (1 + i ) 

Term inside the brackets is a geometric progression.

Mult. This equation by 1/(1+i) to yield a second equation

17
Uniform Series Present Worth and Capital
Recovery Factors
The second equation

[2]
P  1 1 1 1 
= A + + .. + + n +1 
1+ i  (1 + i ) 2
(1 + i ) 3
(1 + i ) n
(1 + i ) 

To isolate an expression for P in terms of A, subtract Eq [1] from Eq. [2]. Note that
numerous terms will drop out.

18
Uniform Series Present Worth and Capital
Recovery Factors
Setting up the subtraction

P  1 1 1 1  [2]
= A + + .. + + n +1 
1+ i  (1 + i ) 2
(1 + i ) 3
(1 + i ) n
(1 + i ) 
 1 1 
- P = A 1 + 1
+ .. +
1
n −1
+ n 
[1]
 (1 + i ) (1 + i ) 2
(1 + i ) (1 + i ) 

−i  1 1 
= P = A n +1
−  [3]
1+ i  (1 + i ) (1 + i ) 
19
 Uniform Series Present Worth and Capital
Recovery Factors
Simplifying Eq. [3] further

−i  1 1 
P = A n +1
− 
1+ i  (1 + i ) (1 + i ) 

𝐴 1  (1 + i ) n − 1 
𝑃= −1 P = A n 
for i  0
− 𝑖 (1 + 𝑖) 𝑛  i (1 + i ) 

20
Uniform Series Present Worth and Capital
Recovery Factors
This expression will convert an annuity cash flow to an equivalent present
worth amount one period to the left of the first annuity cash flow.

Also known as uniform series present worth (P/A factor)

 (1 + i ) n − 1 
P = A n 
for i  0
 i (1 + i ) 

P / A i %, n factor
21
 Capital Recovery Factor (A/P, i%, n)
Given the P/A factor

 (1 + i ) n − 1  The present worth point of an annuity cash flow is

P = A n 
for i  0 always one period to the left of the first A amount
 i (1 + i ) 
Solve for A in terms of P
Yielding….

 i (1 + i )  n
A= P 
A/P,i%,n factor

 (1 + i ) − 1 
n

22
Sinking Fund Factor and Uniform Series
Compound Amount Factor

A/F AND F/A FACTORS

23
A/F Derivations $F

Annuity Cash Flow (F known)

…………..
N
0

$A per period Find $A given the Future

amt. - $F

24
Sinking Fund factors (A/F)
Take advantage of what we already have

 1 
Recall: P=F n   1   i (1 + i ) n 
 (1 + i )  A= F n  
 (1 + i )   (1 + i ) − 1 
n

Substitute “P” and

Also: Simplifying we have:
simplify!
Which is the (A/F,i%,n) factor (red colored font)

 i (1 + i ) n   i 
A= P  A= F 
 (1 + i ) − 1 
 (1 + i ) − 1 
n
n
25
Uniform Series Compound Amount Factor
(F/A )factor from the A/F Factor

Given:
 i 
A= F 
 (1 + i ) − 1 
n

Solve for F in terms of A

 (1 + i ) − 1  n (F/A,i%,n) in red color font

F=A  
 i 
26
 Example

Formasa Plastics has major fabrication plants in Texas and Hong Kong.
It is desired to know the future worth of $1,000,000 invested at the end
of each year for 8 years, starting one year from now. The interest rate is
assumed to be 14% per year.

•A = $1,000,000/yr; n = 8 yrs, i = 14%/yr

•F8 = ??

F = l000(F/A,14%,8) = 1000( 13.2328) = = 13.232

million 8 years from now/
27
 Example
How much money must Carol deposit every year starting, l year from now at 5% per
year in order to accumulate $6000 seven years from now?

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

28
Factor Values for
untabulated i or n

29
 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.
30
What if i or n untabulated

Using Formula.

Using Excel using stated formula. P,F,A assumed to be 1

Linear Interpolation

31
 Interpolation (Estimation Process)
• At times, a set of interest tables may not have the
exact interest factor needed for an analysis
• One may be forces to interpolate between two
tabulated values
• Linear Interpolation is not exact because:
• The functional relationships of the interest factors
are non-linear functions
• Hence from 2-5% error may be present with
interpolation.

32
Basic Setup for Interpolation
•Work with the following basic relationships

33
 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:

34
 the A/P factor
• For 7% we would observe: A/P,7%,10) = 0.14238

COMPOUND PRESENT SINKING COMPOUND CAPITAL

N AMT. FACTOR WORTH FUND AMOUNT RECOVERY
F/P P/F A/F F/A A/P
10 1.9672 0.5083 0.0724 13.8164 0.14238

• For i = 8% we observe: (A/P,8%,10) = 0.14903

COMPOUND PRESENT SINKING COMPOUND CAPITAL

N AMT. FACTOR WORTH FUND AMOUNT RECOVERY
F/P P/F A/F F/A A/P
10 2.1589 0.4632 0.0690 14.4866 0.14903

35
 Estimating for i = 7.3%
• Form the following • Using spreadsheet model
relationships (excel) the exact value
for 7.3% is:

→ SImilar

36
Arithmetic Gradient Factors (P/G
and A/G Factors)

37
Arithmetic Gradient Factors
• In applications, the annuity • An arithmetic (linear) Gradient is a cash
cash flow pattern is not the only flow series that either increases or decreases
type of pattern encountered by a constant amount over n time periods.

•Two other types of end of •A linear gradient is always comprised of

period patterns are common TWO components:

•The Linear or arithmetic •The Gradient component

gradient •The base annuity component (base
•The geometric (% per amount)
period) gradient •The objective is to find a closed form
expression for the Present Worth of an
arithmetic gradient

38
Arithmetic Gradient Example A1+n-1G
Assume the following:
A1+n-2G

G = the amount change = gradient

A1+2G

A1+G

0 1 2 3 n-1 N

This represents a positive, increasing arithmetic gradient

39
Example: Arithmetic (Linear)
Gradient
• Typical Negative, Increasing Gradient: G=$50, How to find the Present Worth of
this cash flow?

The Base Annuity /Base amount

= $1500

40
 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,
•Two periods to the left of the first gradient cash flow!

41
Derivation: Gradient Component
Only A1+n-1G

Focus Only on the gradient Component “0” G A1+n-2G

G = the amount change = gradient

A1+2G

A1+G

0 1 2 3 n-1 N

This represents a positive, increasing arithmetic gradient

Gradient Component
$600
$500
$400
$300
$200
$100

$0

X0 1 2 3 4 5 6 7

The Present Worth Point of the

Gradient

43
 Present Worth Point…
$700
$600 2 periods to the left of the “1G” point
or,
$500
1 period to the left of the very first
$400 cash flow in the gradient series
$300
$200
$100
DO NOT FORGET THIS!
X0 1 2 3 4 5 6 7

The Present Worth Point of the

Gradient

44
 Present Worth Point…

•PW of the Base Annuity is at t = 0

•PWBASE Annuity=$100(P/A,i%,7)

Base Annuity – A = $100

X0 1 2 3 4 5 6 7

The Present Worth Point of the

Gradient

45
Present Worth: Arithmetic
Gradient

The present worth of a linear gradient (PT) is the present worth of the two components:

1. The Present Worth of the Gradient Component and (PG), and

◦ 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

2. The Present Worth of the Base Annuity flow (PA) :

◦ The PW of the Base Annuity is simply the Base Annuity –A{P/A, i%, n} factor

◦ Requires 2 separate calculations!

◦ PT = PA ± PG

46
Present Worth: Gradient Component
General CF Diagram – Gradient Part Only

(n-1)G
(n-2)G
3G
2G
1G

0G

We want the PW at time t = 0 (2 periods to the left of 1G)

0 1 2 3 4 ……….. n-1 n

47
To Begin- Derivation of P/G,i%,n

P = G ( P / F , i %, 2) + 2G ( P / F , i %, 2) + ...
...+ [(n-2)G](P/F,i,n-1)+[(n-1)G])P/F,i,n)
Next Step:
Factor out G and re-write as …..

48
Factoring G out…. P/G
factor

P = G{( P / F , i %, 2) + 2( P / F , i %, 2) + ...
...+ [(n-2)](P/F,i,n-1)+[(n-1)])P/F,i,n)}

49
Replace (P/F’s) with
closed-form

[1]
 1 2 n-2 n-1 
P=G  2
+ 3
+ ... + n-1
+ n 
 (1+i) (1+i) (1+i) (1+i) 

Multiply both sides by (1+i)

50
Mult. Both Sides By (n+1)…..
[2]
 1 2 n-2 n-1 
1
P(1+i) =G  1
+ 2
+ ... + n-2
+ n-1 
 (1+i) (1+i) (1+i) (1+i) 

We have 2 equations [1] and [2].

Next, subtract [1] from [2] and work with the resultant equation.

51
Subtracting [1] from [2]…..

 1 2 n-2 n-1 
1
P(1+i) =G  1
+ 2
+ ... + n-2
+ n-1 
 (1+i) (1+i) (1+i) (1+i) 
 1 2 n-2 n-1 
- P=G  2
+ 3
+ ... + n-1
+ n 
 (1+i) (1+i) (1+i) (1+i) 

G  (1 + i ) − 1 N
N 
P=  − N 
i  i (1 + i ) N
(1 + i ) 
52
Further Simplification on
P/G

(1 + i) − iN − 1 N
( P / G, i%, N ) =
i (1 + i)
2 N

Remember, the present worth point of any linear gradient is 2 periods to

the left of the 1-G cash flow or, 1 period to the left of the “0-G” cash
flow.

PG=G(P/G,i,n)
53
Extension – The A/G factor
Beside Total Present Worth (PT), there is the corresponding annual
worth (AT). Consist :
◦ Base amount annual AT worth (AA)
◦ Gradient series of annual worth (AG)
AT = AA ± AG
A/G converts a arithmetic gradient to an equivalent annuity cash
flow.
Remember, at this point one is only working with gradient
component
There still remains the annuity component that you must also handle
separately!
54
A/G factor using A/P with
P/G

A = G( P / G, i, n)( A / P, i, n)
𝐺 1+𝑖 𝑛 −1 𝑛 𝑖 (1 + 𝑖)𝑛
𝐴𝐺 = 𝑛
− 𝑛
𝑖 𝑖 1+𝑖 1+𝑖 (1 + 𝑖)𝑛 −1
The results follow….. (A/P,i,n)

1 n 
𝑨𝑮 =
G −  (A/G,i%,n) = inside

 i (1 + i) − 1 
N bracket

55
Gradient Example
• Consider the following cash flow

$500
$400
$300
$200
$100

0 1 2 3 4 5

Present Worth Point is here!

And the G amt. = $100/period

Find the present worth if i = 10%/yr; n = 5 yrs

56
 Gradient Example- Base
Annuity
• First, The Base Annuity of $100/period

A = +$100

0 1 2 3 4 5

•PW(10%) of the base annuity (PA)= $100(P/A,10%,5)

•PWBase (PA)= $100(3.7908)= $379.08
•Not Finished: We need the PW of the gradient component and then add
that value to the $379.08 amount

57
The Gradient Component
$400
$300
$200
$100
$0

0 1 2 3 4 5

We desire the PW of the Gradient Component (PG) at t = 0

PG@t=0 = G(P/G,10%,5) = $100(P/G,10%,5) = 100 (6.8618)

= $686.18 for the gradient PW

58
Gradient Example: Final Result
• PW(10%)Base Annuity (PA)= $379.08

•PW(10%)Gradient Component (PG)= $686.18

•Total PW(10%) = $379.08 + $686.18

•Equals $1065.26

•Note: The two sums occur at t =0 and can be added together –

concept of equivalence

59
 Example Summarized
$500
$400
This Cash Flow…
$300
$200
$100

0 1 2 3 4 5

Is equivalent to $1065.26 at time 0 if the interest rate is 10% per

year!

60
Geometric Gradient

61
 Geometric Gradients
Annual revenue and annual cost (tax, O&M, labour, rent, etc) fluctuate in constant
percentage

• 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
•Define A1 as initial cash flow in the geometric series
• Define Pg is present worth of all in geometric series including A1

62
 Geometric Gradients: Increasing
• Typical Geometric Gradient Profile
•Let A1 = the first cash flow in the series

0 1 2 3 4 …….. n-1 n

A1
A1(1+g)
A1(1+g)2
A1(1+g)3

A1(1+g)n-1

63
 Geometric Gradients: Decreasing
• Typical Geometric Gradient Profile
•Let A1 = the first cash flow in the series

0 1 2 3 4 …….. n-1 n

A1(1-g)n-1
A1(1-g)3
A1(1-g)2

A1(1-g)

A1

64
Geometric Gradients: Derivation

• First Major Point to Remember:

•A1 does NOT define a Base Annuity/
•There is No BASE ANNUITY for a Geometric Gradient!
•The objective is to determine the Present Worth one period to the left of
the A1 cash flow point in time
•Remember: The PW point in time is one period to the left of the first
cash flow – A1!

65
Geometric Gradients: Derivation
• For a Geometric Gradient the following parameters are
required:
•The interest rate per period – i
•The constant rate of change – g
•No. of time periods – n
•The starting cash flow – A1

66
Geometric Gradients: Starting
1
• Pg = The Aj’s time the respective (P/F,i,j) factor 𝑃=𝐹
1+𝑖 𝑛
•Write a general present worth relationship to find Pg….

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

Now, factor out the A1 value and rewrite as..

67
Geometric Gradients

 1 (1 + g )1 (1 + g ) 2 (1 + g ) n −1 
Pg = A1  + + + ... + n 
(1)
 (1 + i ) (1 + i ) (1 + i) (1 + i) 
2 3

(1+g)
Multuply both sides by to create another equation
(1+i)

(1+g) (1+g)  1 (1 + g )1 (1 + g ) 2 (1 + g ) n −1  (2)

Pg = A1  + + + ... + 
(1+i) (1+i)  (1 + i ) (1 + i ) 2
(1 + i) 3
(1 + i) n 

Subtract (1) from (2) and the result is…..

68
Geometric Gradients

 1+g   (1 + g ) 1 
n
Pg  − 1 = A1  n +1
− 
 1+i   (1 + i ) 1+ i 

Solve for Pg and simplify to yield….   1 + g n 

1 −   
1+ i  
Pg = A1   gi
 i−g 
 
 

69
Geometric Gradient P/A factor

  1 + g n 
1 −   
  1+ i  
Pg = A1 gi
 i−g 
 
 
• This is the (P/A,g,i,n) factor and is valid if g not equal to i.

70
 Geometric Gradient:
i = g Case  1
Pg =A1  +
1
+
1
+ ... +
1 

 (1+i) (1+i) (1+i) (1+i) 

•Note: If g = i we have a division by “0” – undefined.

•For g = i we can derive the closed form PW factor for this special
case.
•We substitute i for g into the Pg relationship to yield:

nA1
Pg =
(1 + i )
For the case i = g

71
Geometric Gradients: Summary
•Pg = A1(P/A,g,i,n)
  1 + g n 
1 −    g ≠i
1+ i  
Pg = A1   gi
 i−g 
 
 

nA1 Case: g = i
Pg =
(1 + i )
72
Geometric Gradient: Notes
•The geometric gradient requires knowledge of:
•A1, i, n, and g
•There exist an infinite number of combinations for i, n, and g: Hence
one will not find tabulated tables for the (P/A, g,i,n) factor.
•You have to calculated either from the closed form for each problem or
apply a pre-programmed spreadsheet model to find the needed factor
value
•No spreadsheet built-in function for this factor!

73
 Geometric Gradient Example (+g)
PW(8%) = ??

•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. 0 1 2 3 4 5 6 7

•If the interest rate is 8% per year, determine

the present worth of the future expenses at $1700 $1700(1.11)1
time t = 0. $1700(1.11)2
$1700(1.11)3
•First, draw a cash flow diagram to represent
$1700(1.11)4
the model.
$1700(1.11)5

•g = +11% per period; A1 = $1700; i = 8%/yr $1700(1.11)5

74
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:

Information Known
Geometric Gradients
Intrest Rate (i) 8%
Gradient Cost (g%) 11%
Period of Time (n) 7   1 + g n 
(P/A,g,i,n) factor 7.04732 1 −   
+
Pg = A1     gi
1 i
 i−g 
Innitial Cash Flow (A1) 1700  
Pg 11980.44  

75
 Geometric Gradient ( -g )
• Consider the following problem with a negative growth rate – g.

g = -10%/yr; i = 8%; n = 4

A1 = $1000
$900
$810
$729

0 1 2 3 4
P0=??

We simply apply a “g” value = -0.10

76
Geometric Gradient (-g value)
• Evaluate:

Information Known
Geometric Gradients
Intrest Rate (i) 8%   1 + g n 
1 −   
Gradient Cost (g%) -10% +
Pg = A1     gi
1 i
Period of Time (n) 4
(P/A,g,i,n) factor
For a negative g value
2.87637 = -0.10  i−g 
 
 
Innitial Cash Flow (A1) 1000
Pg 2876.37

77
Determination of an
Unknown Interest
Rate

78
When the i – rate is unknown
• A class of problems may deal with all of the parameters know except the
interest rate.
•For many application-type problems, this can become a difficult task
•Termed, “rate of return analysis”
•In some cases:
•i can easily be determined
•In others, trial and error must be used

79
 Example: i unknown using Hand or Calculator
Solution

• Assume on can invest $3000 now in a venture in anticipation of gaining

$5,000 in five (5) years.
•If these amounts are accurate, what interest rate equates these two cash
flows?
(F/P, i%,n) = (1+i)n

$5,000
•F = P(1+i)n
•5,000 = 3,000(1+i)5
0 1 2 3 4 5
•(1+i)5 = 5,000/3000 = 1.6667
•(1+i) = 1.66670.20
$3,000
•i = 1.1076 – 1 = 0.1076 = 10.76%

80
For “i” unknown – using spreadsheet

• 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.
•Use IRR or RATE Function to find i

81
Example of the IRR function

82
Determination of Unknown Number of
Years

83
 Unknown Number of Years
• Some problems require knowing the number of time periods required given
the other parameters
•Example:
•How long will it take for $1,000 to double in value if the discount rate is 5%
per year?
•Draw the cash flow diagram as…. Fn = $2000

i = 5%/year; n is unknown!

0 1 2 ... . . . ……. n

P = $1,000
84
 Unknown Number of Years
• Solving we have…..

Fn =
$2000

0 1 2 . . ……. n
•(1.05)x = 2000/1000 =2

P= •Xln(1.05) =ln(2)
$1,000
•X = ln(2.000)/ ln(1.05)/

•Fn=? = 1000(F/P,5%,x): 2000 = 1000(1.05)x •X = 0.6931/0.0488 = 14.2057 yrs

•Solve for “x” in closed form…… •With discrete compounding it will take 15 years to amass
$2,000 (have a little more that $2,000)
85
No. of Years – NPER function
•Excel one can formulate as:

86
Latihan Soal Per Kelompok
Kalian akan dibagi kedalam beberapa kelompok. Diskusikanlah pemecahan permasalahan
ekonomi teknik dibawah ini

2.28; 2.34;

Kemudian siapkah jawaban kalian untuk didiskusikan di kelas

Hasil diskusi tadi silahkan submit ke Folder Hasil Diskusi Kelompok Kuliah 02 di MS Teams kelas
EKOTEK

Terima Kasih
2.28
P? PA = A(P/A,i%,n) = 60.000 (P/A, 10%,5)

A = 60.000 PG = G (P/G, i%,n) = 10.000 (P/G,10%,5)

G = 10.000 PT = 60.000 (P/A, 10%,5) + 10.000

(P/G,10%,5) =
I = 10%

N=5
2.34
A1 = 50.000 Pg = A1 (P/A1, g, i%, n) = 50.000 (6%, 10%,
8)
g = 6%
=
n=8

i = 10%
  1 + g n 
1 −   
+
Pg = A1     gi
1 i
 i−g 
 
 
PR Individu
Number 2.10; 2.16; 2.22; 2.25; 2.35; 2.39; 2.45

Silahkan diketik atau tulis tangan

Tuliskan cara pemecahan masalahnya step by step dengan notasi yang tepat.

Gambar Cash Flow diagramnya.

Tugas dikumpulkan pada tanggal 09 Maret 2021 pukul 10.00 WIB