En Ec 3

7-Jan-2015
Engineering Economy
By: Dr. M. E. Abu Goukh ,
Dr. Dina Belal &
Eng. Mohammed Alsaeed
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Chapter 3
MONEY-TIME RELATIONSHIPS
INTEREST FACTORS AND FORMULAS
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CONTENTS
1. Classification of Interest P(193)
2. Cash flow Diagram P(194)
3. Compound Interest Factors P(195-219)
4. Nominal and Effective Interest Rates P(220-231)
5. Continuous Compounding Interest P(232-240)
6. CONTINUOUS PAYMENT OR FUNDS-FLOW PROCESS
P(240-257)
7. Summary of Interest Formulas P(257-261)
8. LIMITING VALUES OF INTEREST FACTORS P(274)
9. STANDARD PAYMENTS FORMATS P(275-315)
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1. CLASSIFICATION OF INTEREST
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1. Classification of Interest
• Regarding Calculation Procedures, interest can
be classified into two main types:
– Simple Interest
• and
– Compounded Interest
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3.1 Classification of Interest

Interest
Type
Simple Compounded
Interest is paid when it is due. All interest is accumulated until
Interest is charged only on the the loan is due.
principal sum. Interest is charged on the total
amount owed (Principal plus
Definition
Interest). The borrower has to pay

interest on the interest.
I= p×i×n Different formulas are available

𝑤ℎ𝑒𝑟𝑒 for different types of compound
P = present principal sum interest.
i = interest rate over periods
Formulas
n = number of interet periods

(𝑒. 𝑔. 𝑦𝑒𝑎𝑟𝑠, 𝑚𝑜𝑛𝑡ℎ𝑠, 𝑤𝑒𝑒𝑘𝑠, . . 𝑒𝑡𝑐. )
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Example
• A person wishes to borrow $1,000 for 5 years
at an interest rate of 10% . Describe his
payments in the following cases:
i) Simple interest,
ii) Compound interest.
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Solution
i. Simple Interest:
– According to the basic
formula:
𝐈= 𝐏×𝐢×𝐧 $1,000
= $𝟏, 𝟎𝟎𝟎 𝟎. 𝟏 𝟏
= $𝟏𝟎𝟎
– He must pay $100 1 2 3 4 5
every year and repay 0
the principal at the $100
end of the 5th year.
– Total interest paid: $1,000
𝐈= 𝐏×𝐢×𝐧
= $𝟏, 𝟎𝟎𝟎 𝟎. 𝟏 𝟓 Cash Flow Diagram
= $𝟓𝟎𝟎
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Solution
ii. Compound Interest:
$1,000
– He pays nothing until
the loan is due at the
end of the 5th year.
– At that time he must 5
pay:
𝐅𝟓 = 𝐏 𝟏 + 𝐢 𝐧 0 1 2 3 4
= $𝟏, 𝟎𝟎𝟎 𝟏 + 𝟎. 𝟏 𝟓
= $𝟏, 𝟔𝟏𝟎. 𝟓𝟏
$1,610.51
– Total interest paid:
𝐈 = $𝟏, 𝟔𝟏𝟎. 𝟓𝟏 − $𝟏, 𝟎𝟎𝟎 Cash Flow Diagram
= $𝟔𝟏𝟎. 𝟓𝟏
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Question:
In case of compound interest, why this person
had to pay this amount of $1,610.51?
 Answer:
 $1,000 = the borrowed amount (the principal),
 $500 = interest on principal ( $100 x 5 ),
 Sum =$1,000 + $500 = $1,500.
Question: What is about the amount:

$1,610.51 - $1,500 = $110.51?
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Answer:
• This amount of $110.51 is the interest on the
interest.
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3.2 CASH FLOW DIAGRAM
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In the previous example, the whole problem was

summarized in the following two diagrams, which are
called CASH FLOW DIAGRAMS
Simple Interest Compound Interest
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2. Cash Flow Diagram

• A cash flow diagram is a graphic or pictorial
description of an investment opportunity.
• It provides all the information necessary for
analyzing an investment proposal and it is the
first step for solving an economy problem.
• In the cash flow diagram all the receipts,
disbursements are represented by vertical
arrows (up and down) located at the end of
the period on a horizontal time axis.
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2. Cash Flow Diagram

• It is important to identify the point of view
being taken when preparing cash- flow
diagram (i.e. borrower’s view or the lender’s
view).
• The borrower’s cash flow diagram is obtained
simply by inverting the lender’s cash flow on
the horizontal axis, and vice versa.
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3.2 CASH FLOW DIAGRAM
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3.3 Compound Interest Factors
i. Single-Payment Compound-Amount Factor

ii. Single-Payment Present-Worth Factor
iii. Equal-Payment-SeriesCompound-Amount Factor
iv. Equal-Payment-Series Sinking-Fund Factor
v. Equal-Payment-Series Present-Worth Factor
vi. Equal-Payment-Series Capital-Recovery Factor
vii. Uniform-Gradient-Series Factor
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i) Single-Payment Compound-Amount
Factor
• If the amount ‘P’ is taken as a loan for ‘n’ years
as a compound interest rate, ‘i’, per year,
sketch the cash flow diagram, then determine
the accumulated, ‘F’, at the end of nth year.
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Factor
F
0
1 2 3 4 n-1 n
Figure 3.5: Cash Flow Diagram Single-Payment Process
n
Fn = P 1 + i 3.3 − 1 P(196)
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i) Single-Payment Compound −
Amount Factor
• The financial arrangement consists of a single-
present amount, P, (received by the borrower)
and a single-future amount, F, (received by the
lender), and for this reason it is known as:
“Single-Payment Process”.
n
1+i ≡ Single − Payment Compound − Amount Factor
• The functional Symbols:
𝐹/𝑃 𝑖, 𝑛 n
= 1+i
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Factor
• Example 3.1 P(197):
– If a $5000 is borrowed now at a rate of 15% per
year for 5 years, determine the amount due at the
end of the period.
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i ) Single-Payment Compound-Amount Factor
Solution for Exp. 3.1

Step (1) : Cash Flow Diagram:
F=?
0
1 2 3 4 5 years
i=15%
P = $5,000
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Step (2) : Solution in the General Format:
The General solution using symbolic designation is

given as:
𝐹/𝑃 𝑖, 𝑛
• F=P
– Substituting values for ‘P’, ‘i’ and ‘n’ yields:

𝐹/𝑃 15,5
• F = $5,000
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Step (3) : The Numerical Solution
– Now the specific or numerical solution is obtained be

evaluating the interest factor involved, 𝑭/𝑷 𝟏𝟓, 𝟓 ,
using either the Interest Formulae or Interest Table.
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i. Single-Payment Compound − Amount

Factor
• Numerical Values for Interest Factors:
– Can be obtained using either Interest Formulae or Interest
Tables.
a) Interest Formulae:
– Are mathematical expressions developed for the various
interest factors
b) Interest Tables:
– Quite often solution of problems in engineering economy
is greatly facilitated by using interest tables.
– For each interest rate, i, there is a separate table which
lists numerical values for the various interest factors as
function of ‘n’, where ‘n’ represents the number of
compounding period.
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i) Single-Payment Compound-Amount Factor
• Solution Example 3.1: (cont.)

– Approach (a): Formulae Solution
• = 1+i
𝐹/𝑃 15,5 5
• = 1 + 0.15 = 𝟐. 𝟎𝟏𝟏𝟒
– Substituting value in the general solution format gives:
𝐹/𝑃 15,5
• ∴ F = $5,000 = $𝟏𝟎, 𝟎𝟓𝟕
𝟐. 𝟎𝟏𝟏𝟒
– Which is the amount due, that the borrower has to
pay at the end of the 5th year.
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Solution Example 3.1: (cont.)

Approach (b): Table Solution P(515)
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i) Single-Payment Compound-Amount Factor

– Approach (b): Table Solution
– Using Interest Tables for i=15% at n=5 the single-
payment compound-amount factor is given as:
𝐹/𝑃 15,5
• = 𝟐. 𝟎𝟏𝟏𝟒
– Substituting value in the general solution format
gives:
𝐹/𝑃 15,5
• ∴ F = $5,000 = $𝟏𝟎, 𝟎𝟓𝟕
𝟐. 𝟎𝟏𝟏𝟒
• This is the same amount as obtained before
using formulae approach.
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ii) Single-Payment Present-Worth Factor
• The amount, P (the present-worth), that

should be invested now at the interest rate, ‘i’,
in order to accumulate amount ‘F’ at the end
of ‘n’ years can be found by solving Eq.(3.3-1)
for ‘P’ as follows:
F=P 1+i n 3.3 − 1
1
∴P=F 3.3 − 2 P(199)
1:i n
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ii) Single-Payment Present-Worth

Factor
• ‘P’ may be thought of as the principal that will
give a required amount ‘F’ in ‘n’ years, in
other words, ‘P’ is present-worth of a
payment of ‘F’, ‘n’ years hence.
1
n
≡ Single − Payment Present − Worth Factor
1+i
𝑃/𝐹 𝑖, 𝑛 1
= n
1+i
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ii) Single-Payment Present-Worth

Factor
• Example 3.2 P(199):
– How much would you have to invest at 12% on
first January, 2013, in order to have accumulated
$10,000 on first January, 2019?
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• Example 3.2:
• Step(1): Cash Flow Diagram
F = $10,000
0=31/12/2012 = 1/1/2013 6 years=

1 2 3 4 5 31/12/2018 = 1/1/2019
i=12%
P=?
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• Solution Example 3.2:

• Step (2) : Solution in the General Format:
given as:
𝑃/𝐹 𝑖, 𝑛
• P=F
– Substituting values for ‘F’, ‘i’ and ‘n’ yields:

𝑃/𝐹 12,6
• P = $10,000
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Step (3) : The Numerical Solution
– Now the specific or numerical solution is obtained
be evaluating the interest factor involved,
𝑷/𝑭 𝟏𝟐, 𝟔
, using either the Interest Formulae
or Interest Table.
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𝑃/𝐹 𝑖, 𝑛 1
• =
1:i n
𝑃/𝐹 12,6 1
• = = 𝟎. 𝟓𝟎𝟔𝟔
1:0.12 6
𝑃/𝐹 15,5
• ∴ P = $10,000 = $𝟓, 𝟎𝟔𝟔
𝟎. 𝟓𝟎𝟔𝟔
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payment present-worth factor is given as:
𝑃/𝐹 12,6
• = 𝟎. 𝟓𝟎𝟔𝟔

gives:
𝑃/𝐹 15,5
• ∴ P = $10,000 = $𝟓, 𝟎𝟔𝟔
𝟎. 𝟓𝟎𝟔𝟔
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iii. Equal-Payment-Series Compound-

Amount Factor
F
0 1 2 3 4 n-1 n
A A A A A A
Figure 3.6: Equal-Payment-Series with Single-Future Amount
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iii. Equal-Payment-Series Compound-

Amount Factor
• The single-future amount, F, that would
accumulated from a series of equal payments, A,
occurring at the end of succeeding periods.
• If ‘A’ is invested at the end of each year for ‘n’
years, the total amount at the end of ‘n’ years, F,
will be obviously the sum of the compound
amount of individuals investment and expressed
as:
1:i n ;1
F=A 3.3 − 3 P(201).
i
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iii) Equal-Payment-Series Compound-

Amount Factor
1+i n−1
i
≡
Equal − Payment − Serise Compound − Amount Factor
𝐹/𝐴 𝑖, 𝑛 1+i n−1
=
i
• The equal payment series also known as
“uniform series” and quite often is referred to
as a “annuity”
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Amount Factor
• Example 3.3 P(202):
– A grand father arranges to deposit $100 in a
saving account annually for a baby from her 1st
birthday.
– Determine the amount that the young lady will
collect on her 18th birthday, assuming that the
average interest rate is 10% over the whole
period, and that the grandfather will make his last
deposit on the girl’s 18th birthday.
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iii) Equal-Payment-Series Compound-Amount

Factor
• Cash Flow Example 3.3:

F=?
0 1 2 3 4 17
18 years
A=$100 i=10%
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iii) Equal-Payment-Series Compound-Amount

Factor
• Step (2) : Solution in the General Format:
given as:
𝐹/𝐴 𝑖, 𝑛
• F=A
𝐹/𝐴 10,18
• F = $100
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Amount Factor
𝐹/𝐴 𝑖, 𝑛 1:i n ;1
• =
i
𝐹/𝐴 10,18 1:0.1 18 ;1

• = = 𝟒𝟓. 𝟓𝟗𝟗𝟐
0.1
gives:
𝐹/𝐴 10,18
• ∴ F = $100 = $𝟒, 𝟓𝟓𝟗. 𝟗𝟐
𝟒𝟓. 𝟓𝟗𝟗𝟐
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Amount Factor
– Using Interest Tables for i=10% at n=18 the equal-
payment compound-amount factor is given as:
𝐹/𝐴 10,18
• = 𝟒𝟓. 𝟓𝟗𝟗𝟐
𝐹/𝐴 10,18
• ∴ F = $100 = $𝟒, 𝟓𝟓𝟗. 𝟗𝟐
𝟒𝟓. 𝟓𝟗𝟗𝟐
• N.B. : ($100)(18 yrs) = $1,800.
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iv. Equal-Payment-Series Sinking-Fund

Factor
• The end-of-year payment, A, required to
accumulated as certain future amount, F, can
be determined by solving Eq.(3.3-3) for ‘A’ as
follows:
1+i n−1
F=A 3.3 − 3
i
i
A=F 3.3 − 4 P(203).
1:i n ;1
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iv) Equal-Payment-Series Sinking-Fund

Factor
i
= 1:i n ;1
• The Functional Symbol:
𝐴/𝐹 𝑖, 𝑛 i
=
1+i n−1
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iv. Equal-Payment-Series Sinking-Fund

Factor
• Example 3.4 P(203):
– The construction of a certain project is to be
completed by the end of 2020. The total
estimated cost of the project 6 million dollars,
and should be available on December 31, 2018.
– Determine the minimum equal annual payment
that should be invested at 8% starting by the end
of 2013, to cover the project cost.
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iv) Equal-Payment-Series Sinking-Fund

Factor
Solution of Exp.3.4
Step(1): Cash Flow Diagram
F = $ 6x106
31 Dec 2013
0 1 2 3 4 5
6 years =
31 Dec 2018
A=? i=8%
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iv) Equal-Payment-Series Sinking-Fund Factor
• Solution Example 3.4 (con.):

Step (2) : Solution in the General Format:
given as:
𝐴/𝐹 𝑖, 𝑛
• A=F
𝐴/𝐹 8,6
• A = $ 6 × 106
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iv. Equal-Payment-Series Sinking-

Fund Factor
𝐴/𝐹 𝑖, 𝑛 i
• =
1:i n ;1
𝐴/𝐹 8,6 0.08
• =
1:0.08 6 ;1
= 𝟎. 𝟏𝟑𝟔𝟑
gives:
𝐴/𝐹 8,6
• ∴ 𝐴 = $6 × 106 = $𝟖𝟏𝟕, 𝟖𝟎𝟎
𝟎. 𝟏𝟑𝟔𝟑
• N.B.:($817,800)(6) = $4,906,800
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iv. Equal-Payment-Series Sinking-

Fund Factor
payment-series sinking-fund factor is given as:
𝐴/𝐹 8,6
• = 𝟎. 𝟏𝟑𝟔𝟑
𝐴/𝐹 8,6
• ∴ 𝐴 = $6 × 106 = $𝟖𝟏𝟕, 𝟖𝟎𝟎
𝟎. 𝟏𝟑𝟔𝟑
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v. Equal-Payment-Series Present-
Worth Factor
A A A A A A
0
1 2 3 4 n-1 n
P=?
Figure 3.7:Equal-Payment-Series with Single-Present Amount
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v. Equal-Payment-Series Present-Worth
Factor
• It may be necessary to find what single amount,
‘P’, must be deposited now so that equal end-of-
year payment, A, can be made for ‘n’ years.
• Eqs. (3.3-1 and 3.3-3) can be used to develop a
relationship that links ‘P’ and ‘A’ as follows:
F=P 1+i n 3.3 − 1
1+i n−1
F=A 3.3 − 3
i
1+i n−1
P=A 3.3 − 5. P(205).
i 1+i n
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Factor
1+i n−1
i 1+i n
≡
Equal − Payment − Serise Present − Worth Factor
𝑃/𝐴 𝑖, 𝑛 1+i n−1

=
i 1+i n
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Factor
• Example 3.5 P(205):
– How much would you need to deposit at 15% on
January 1st, 2013 in order to withdraw $1,500 at
the end of each year for 7 years, leaving nothing in
the fund at the end?
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Factor
A=$1,500
0
1 2 3 4 5 6 7 years
i=15%
P=?
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Worth Factor
– The General solution using symbolic designation is
given as:
𝑃/𝐴 𝑖, 𝑛
• P=A
𝑃/𝐴 15,7
• P = $1,500
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Worth Factor
𝑃/𝐴 𝑖, 𝑛 1:i n ;1
• =
i 1:i n
𝑃/𝐴 15,7 1:0.15 7 ;1
• =
(0.15) 1:0.15 7
= 𝟒. 𝟏𝟔𝟎𝟒

gives:
𝑃/𝐴 15,7
• ∴ 𝑃 = $1,500 = $𝟔, 𝟐𝟒𝟎. 𝟔𝟎
𝟒. 𝟏𝟔𝟎𝟒
• N.B.: ($1,500)(7) = $10,500.
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Worth Factor
payment-series present-worth factor is given as:
𝑃/𝐴 15,7
• = 𝟒. 𝟏𝟔𝟎𝟒
𝑃/𝐴 15,7
• ∴ 𝑃 = $1,500 = $𝟔, 𝟐𝟒𝟎. 𝟔𝟎
𝟒. 𝟏𝟔𝟎𝟒
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Vi. Equal-Payment-Series Capital-

Recovery Factor
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vi. Equal-Payment-Series Capital-

Recovery Factor
• The end-of-year payment, A, which can be
secured for ‘n’ years from a present
investment, P, Eq.(3.3-5) can be resolved for
‘A’ as follows:
1:i n ;1
–P=A i 1:i n
3.3 − 5
i 1:i n
–A=P 1:i n ;1
3.3 − 6 P(204).
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Recovery Factor
i 1+i n
≡ Equal − Payment − Serise Sinking − Fund Factor
1+i n−1

𝐴/𝑃 𝑖, 𝑛 i 1+i n
=
1+i n−1
• The capital-recovery factor, 𝐴/𝑃 𝑖, 𝑛 , and
the series present-worth factor, 𝑃/𝐴 𝑖, 𝑛 ,
are reciprocal.
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Recovery Factor
• The capital-recovery factor as shown in
Eq.(3.3-6), can be written as:
𝐴/𝑃 𝑖, 𝑛 i 1:i n i
– = = + i
1:i n ;1 1:i n ;1
𝐴/𝑃 𝑖, 𝑛 𝐴/𝐹 𝑖, 𝑛
– = +i
• i.e. the capital-recovery factor is always equal

to the sinking-fund factor plus the interest
rate ‘i’.
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Recovery Factor
• The capital- recovery factor is used in the
following situations:
a) Recovery of Capital Investments
b) Recovery of Debt (e.g. Installment Plan )
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Recovery Factor
• Example 3.6:
– A sum of $750,000 is invested in equipment
whose service life is estimated to be 7 years, with
a negligible salvage value.
– Determine the annual amount that should be
withdraw from the equipment’s net receipt in
order to recover the invested capital together with
returns, assuming that money can be invested at
12%.
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Recovery Factor
A=?
0
1 2 3 4 5 6 7 years
i=12%
P=$750,000
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Recovery Factor
given as:
𝐴/𝑃 𝑖, 𝑛
• A=P
𝐴/𝑃 12,7
• A = $750,000
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Recovery Factor
n
7
𝐴/𝑃 𝑖, 𝑛 i 1:i 0.12 1:0.12
• = n = 7 = 𝟎. 𝟐𝟏𝟗𝟏𝟐
1:i ;1 1:0.12 ;1
– The year-end withdrawal, A, is given by:

𝐴/𝑃 12,7
• ∴ 𝐴 = $750,000 = $𝟏𝟔𝟒, 𝟑𝟒𝟎
𝟎. 𝟐𝟏𝟗𝟏𝟐
• N.B.: ($164,340)(7) = 1,150,380.

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Recovery Factor
payment-series capital-recovery factor is given as:
𝐴/𝑃 12,7
• = 𝟎. 𝟐𝟏𝟗𝟏𝟐
𝐴/𝑃 12,7
• ∴ 𝐴 = $750,000 = $𝟏𝟔𝟒, 𝟑𝟒𝟎
𝟎. 𝟐𝟏𝟗𝟏𝟐
WM-EnEc-3 71

Recovery Factor
• Example 3.7:
– The cash price for a car is $25,000. If the car is
purchased using monthly payment for 𝟐 𝟏 𝟐 years
at a nominal rate, r=12%, find the monthly
installment.
WM-EnEc-3 72
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Recovery Factor
A=? A
0
1 2 3 4 29 30 months
r=12% annually
𝟏𝟐%
P = $25,000 𝐢= = 𝟏% 𝐦𝐨𝐧𝐭𝐡𝐥𝐲
𝟏𝟐
WM-EnEc-3 73

Recovery Factor
– Monthly interest, i, is given as:
– Since periods are in months (i.e. 30 months) the interest
rate should be consistent with the interest period. In the
present case, the interest rate, i, should be month.
12%
• i= = 1%
12
– The General solution using symbolic designation is given
as:
• A=P
𝐴/𝑃 1,30
• A = $25,000
WM-EnEc-3 74
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Recovery Factor
n
𝐴/𝑃 𝑖, 𝑛 i 1:i
• = n
1:i ;1
30
𝐴/𝑃 1,30 0.01 1:0.01
• = 30 = 𝟎. 𝟎𝟑𝟖𝟕
1:0.01 ;1

𝐴/𝑃 1,30
• ∴ 𝐴 = $25,000 = $𝟗𝟔𝟕. 𝟓𝟎
𝟎. 𝟎𝟑𝟖𝟕
WM-EnEc-3 75

Recovery Factor
𝐴/𝑃 1,30
• = 𝟎. 𝟎𝟑𝟖𝟕
𝐴/𝑃 1,30
• ∴ 𝐴 = 25,000$ = 𝟗𝟔𝟕. 𝟓𝟎$
𝟎. 𝟎𝟑𝟖𝟕
– Total amount paid=30 $967.50 =$29,025
– Total Interest paid=$29,025−$25,000=$4,025
WM-EnEc-3 76
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Recovery Factor
• Example 3.8:
– If $9,000 is invested at 9% on January 1st, 2014,
what equal year-end withdrawals can be made
each year for 10 years, which will leave nothing in
the fund after the tenth withdrawal?
WM-EnEc-3 77

Recovery Factor
A=? A
0
1 2 3 4 9 10 years
i=9%
P = $9,000
WM-EnEc-3 78
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Recovery Factor
given as:
• A=P
𝐴/𝑃 9,10
• A = 9,000$
WM-EnEc-3 79

Recovery Factor
n
𝐴/𝑃 𝑖, 𝑛 i 1:i
• = n
1:i ;1
10
𝐴/𝑃 9,10 0.09 1:0.09
• = 10 = 𝟎. 𝟏𝟓𝟓𝟖
1:0.09 ;1

𝐴/𝑃 9,10
• ∴ 𝐴 = $9,000 = $𝟏, 𝟒𝟎𝟐. 𝟐𝟎
𝟎. 𝟏𝟓𝟓𝟖
WM-EnEc-3 80
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Recovery Factor
𝐴/𝑃 9,10
• = 𝟎. 𝟏𝟓𝟓𝟖
𝐴/𝑃 9,10
• ∴ 𝐴 = $9,000 = $𝟏, 𝟒𝟎𝟐. 𝟐𝟎
𝟎. 𝟏𝟓𝟓𝟖
WM-EnEc-3 81
• In many cases, annual payments do not occur in

an equal payment series. Engineering economy
problems frequently involve disbursements or
receipts that increase or decrease each year by
varying amounts.
• Example: the maintenance expense for a piece of
mechanical equipment may lend to increase each
year.
• If the increase or decrease is in same every year,
this series is known as “Uniform Gradient”, ‘G’.
WM-EnEc-3 82
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• Using the end of year payments, the payment

of the first year is ‘A1’, the payment of the
second year is greater than that of the first
year by a gradient, G, and the payment of the
third year is ‘G’ greater than that for the
second year, and so on.
• Thus the annual payment for ‘n’ periods will
be expressed as:
A1 , A1 + G, A1 + 2G, ⋯ , A1 + n − 1 G
WM-EnEc-3 83
A1+(n-1)G
A1+G
A1
0 1 2 3 4 n-1 n
Figure 3.8: Uniform-Gradient-Series
WM-EnEc-3 84
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A1+(n-1)G
A +G
A1 1 A A A A A A
0 1 2 3 4 n-1 n 0 1 2 3 4 n-1 n
Uniform Increasing Series The Equivalent Equal Series
𝐴/𝐺 𝑖, 𝑛
A = A1 + G
Figure 3.9: Uniform Increasing Series and its Equivalent Equal Series
WM-EnEc-3 85

• A general expression for both uniformly
increasing and uniformly decreasing series can
be written as:
1 n
A = A1 ± G − 3.3 − 7 P(213).
i 1:i n ;1
• Where:
1 n
− ≡ Gradient Factor
i 1+i n−1
𝐴/𝐺 𝑖, 𝑛 1 n
= −
i 1+i n−1
WM-EnEc-3 86
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A1 A1-G
A1-(n-1)G
A A A A A A
0 1 2 3 4 n-1 n 0 1 2 3 4 n-1 n
Uniform Decreasing Series The Equivalent Equal Series
A = A1 − G
Figure 3.10: Uniform Decreasing Series and its Equivalent Equal Series
WM-EnEc-3 87
• Example 3.9:
– A person is planning to save $1,000 of his income
this year and feels he can increase this amount by
$200 for each of the following 9 years. If interest
is 8% compounded annually, what equal-annual
series beginning at the end of year 1 and ending
at year 10 would produce the same accumulation
at the end of year 10 as would be realized from
the greatest series?
WM-EnEc-3 88
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2,800$
2,600$
1,600$
1,400$
1,200$
1,000$ A=? A
0 1 2 3 4 9 10 years 0 1 2 3 4 9 10 years
i=8%
WM-EnEc-3 89

– The General solution using symbolic designation is given as:
• A = A1 + G
– Where:
• A1 = intial payment in the gradient serise = $1,000
• G = the gradient = $200
• n = number of periods = 10 years
• i = interest rate per period = 8%
– Substituting these values, the general solution will be:
𝐴/𝐺 8,10
• A = $1,000 + $200
WM-EnEc-3 90
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• =
i
− 1:i n ;1
𝐴/𝐺 8,10 1 10
• =
0.08
− 1:0.08 10 ;1
= 𝟑. 𝟖𝟕𝟏𝟐𝟖

𝐴/𝐺 8,10
• ∴ A = $1,000 + $200 = $𝟏, 𝟕𝟕𝟒. 𝟐𝟓𝟔
𝟑. 𝟖𝟕𝟏𝟐𝟖
WM-EnEc-3 91

– Using Interest Tables for i=8% at n=10 the
uniform-gradient-series factor is given as:
𝐴/𝐺 8,10
• = 𝟑. 𝟖𝟕𝟏𝟑
𝐴/𝐺 8,10
• ∴ A = $1,000 + $200 = $𝟏, 𝟕𝟕𝟒. 𝟐𝟔𝟎
𝟑. 𝟖𝟕𝟏𝟑
– Which is almost the same as before! The error is
negligible.
WM-EnEc-3 92
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• Example 3.10:
– A person wishes to make an initial lump sum
investment, that will provide for a series of
withdrawals beginning with $3000 at the end of
the first year and decreasing by $250 a year to a
final withdrawal of $750.
– How much must the initial investment be of it
earns 10% annually?
WM-EnEc-3 93
$3,000 $2,750
$2,500
$2,250
$1,000
$750
0 1 2 3 4 9 10 years
i=10% annually
P=?
WM-EnEc-3 94
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3,000$;750$
– Number of periods = + 1 = 10 years
250$
– Since the series of withdrawals starts at the end of
the first year, it will determinate at the end of the
10th year as shown in the cash flow diagram.
WM-EnEc-3 95

– The General solution using symbolic designation is given as:
𝑃/𝐴 𝑖, 𝑛
• P=A
– Where ‘A’ is the element of the equal-payment-series and is given by”
• A = A1 − G
– i.e. the first step is to convert the uniformly decreasing series into an
equivalent equal-payment-series with element ‘A’:
𝐴/𝐺 𝑖, 𝑛 𝑃/𝐴 𝑖, 𝑛
• P = A1 − G
– Substituting the given values:
𝐴/𝐺 10,10 𝑃/𝐴 10,10
• P = $3,000 − $250
WM-EnEc-3 96
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n
𝑃/𝐴 𝑖, 𝑛 1:i ;1
• = n
i 1:i
10
𝑃/𝐴 10,10 1:0.1 ;1
• ∴ = 10 = 𝟔. 𝟏𝟒𝟒𝟓𝟔
(0.10) 1:0.1
• =
i
− 1:i n;1
𝐴/𝐺 10,10 1 10
• ∴ = 0.1 − 1:0.1 10;1 = 𝟑. 𝟕𝟐𝟓𝟒𝟓
• ∴P = $3,000 − $250 𝐴/𝐺 10,10 𝑃/𝐴 10,10 = $𝟏𝟐, 𝟕𝟏𝟎. 𝟖𝟕

𝟑. 𝟕𝟐𝟓𝟒𝟓 𝟔. 𝟏𝟒𝟒𝟓𝟔
WM-EnEc-3 97

– Using Interest Tables for i=10% at n=10
– The equal-payment-series present-worth factor is given
as:
𝑃/𝐴 10,10
• = 𝟔. 𝟏𝟒𝟒𝟔
– the uniform-gradient-series factor is given as:
𝐴/𝐺 10,10
• = 𝟑. 𝟕𝟐𝟓𝟓
𝐴/𝐺 10,10 𝑃/𝐴 10,10
∴ P = $3,000 − $250 = $𝟏𝟐, 𝟕𝟎𝟗. 𝟔𝟑
𝟑. 𝟕𝟐𝟓𝟓 𝟔. 𝟏𝟒𝟒𝟔
WM-EnEc-3 98
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4. NOMINAL AND EFFECTIVE INTEREST RATES
WM-EnEc-3 99
Reviewing Question
• Name fully the following interest factors:

• i) (P/F i, n).
• ii) (A/F i, n).
• iii) (P/A i, n).
• iv) (A/G i, n).
• v) (F/A i, n).
• vi) (A/P i, n).
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6. Nominal and effective interest rates
• An interest period is not necessarily to be a

year. An interest period may be any duration
e.g. a year, a month, a week, a day …etc.
• When interest is compounded (i.e. computed
and added to the deposit balance) more
frequently than once a year, it is usually
quoted on yearly basis as ‘nominal interest
rate’, r.
WM-EnEc-3 101
• For example if a nominal interest rate, r, of

12% compounded monthly means that an
𝟏𝟐%
interest, i, of = 𝟏% is charged every
𝟏𝟐
month.
• It is desirable to recognize that there is a real
difference between 1% per month
compounded monthly, ad 12% per annum
compounded annually.
WM-EnEc-3 102
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Problem:
• A person wants to borrow $1,000 for one year.
• He approached the following banks:
– Bank A: asks for 12% interest compounded annually.
– Bank B: asks for 1% interest compounded monthly.
• Which bank do you recommend to finance this
loan? Why?
WM-EnEc-3 103
Answer:
• in both cases the amount owed at the end of
the year, F, is given by:
 F = P 1 + i n = $1,000 1 + i n
WM-EnEc-3 104
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In case of Bank A:
• Number of periods, n = 1 (year)
• Interest rate per period, i = 12% per year
n 1
• ∴F=P 1+i = $1,000 1 + 0.12 =
$𝟏, 𝟏𝟐𝟎. 𝟎𝟎
• I = ($1120 -$1000)/ ($1000)x(100%) = 12.000 %
In case of Bank B:
• Number of periods, n = 12 (months)
• Interest rate per period, i = 1% per month
• ∴ F = P 1 + i n = 1,000$ 1 + 0.01 12 = $𝟏, 𝟏𝟐𝟔. 𝟖𝟑
• I = (1126.83 – 1000) / (1000)x(100%) = 12.683 %
• It is clear the borrowing from Bank A is better.

WM-EnEc-3 105
• Also, it is obvious that monthly compounded

at 1% has the same effect as charging a rate
of 12.683%, compounded annually.
• In the language of financial mathematics, the

“effective interest” rate, ieff, for Bank B is
12.683%.
WM-EnEc-3 106
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• In case of Bank A, the nominal interest rate, r, is

equal to 12%, since interest is originally given on
yearly basis.
• In case of Bank B, the nominal interest rate, r, is
given by: r= i x c =1% x 12 =12%.
–r=i×c 3.4 − 1
where:
– i=the interest rate per period
– c=the number of periods per year, (i.e. frequency of
compounding)
WM-EnEc-3 107
• Thus, Banks: ‘A’ and ‘B’ both have the same

nominal interest rate, r.
• They differ only on the compounding frequency.
• Bank ‘A’ charges a nominal interest, r, of 12%,
compounded annually, while Bank ‘B’ charges the
same nominal interest rate of 12%, but
compounded monthly.
• The difference in compounding frequency results
in a real difference in the actual amount of
interest paid i.e. the effective interest.
WM-EnEc-3 108
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• For a fixed nominal interest rate, r, the amount of
interest charged, I, increases as the compounding
frequency, c, increases.
• In mathematical notation this can be stated as:
– i = f r, c 3.4 − 3
or
– ieff = f r, c 3.4 − 4
where:
– ieff = the effective interest rate
– r = the nominal interest rate
– c = the compounding frequency
WM-EnEc-3 109
The annual effective interest rate

The annual effective interest rate, ieff,ann.,can be
evaluated as:
r c
ieff = 1 + −1
c
Where:
• ieff = annual effective interest rate
– r = the nominal interest rate
c = the compounding frequency
See Eq. 3.4−10, P(222).
WM-EnEc-3 110
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.
• Example 3.11, P(222):

– Find the compounded amount of $5000 for 7
years from now at a nominal interest rate for 9%
compounded quarterly.
WM-EnEc-3 111

• Approach (a):
• Basis: 3-month period.
Match the interest rate to the interest period using
conditions specified in the original arrangement
• Original (compounding) period = quarter-year
• Number of periods, n=(7)(4)=28 periods (3 months
each)
𝒓 𝟗%
• Interest rate per period 𝒊𝒐 = 𝒄 = = 𝟐. 𝟐𝟓%
𝟒
(quarterly)
WM-EnEc-3 112
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• Cash Flow (a) Example 3.11:

• Basis: 3-month period. F=?
0
1 2 3 4 28
n= 28 periods
P = $5,000 r= 9%
i= 2¼% quarterly
WM-EnEc-3 113
• Example 3.11 (cont.):
• The compounded-amount, F, is given by:

– F=P =P 1+i
28
– = $5,000 1 + 0.0225 = $𝟗, 𝟑𝟐𝟐. 𝟕𝟐
WM-EnEc-3 114
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• Approach (b):
b) Basis : one-year period. Using the effective interest rate:
The effective annual interest rate can be found, then this
applied using annual compounding.
The effective annual interest rate, ieff, is given by:
𝒄 𝟒
𝒓 𝟎. 𝟎𝟗
𝒊𝒆𝒇𝒇 = 𝟏+ −𝟏= 𝟏+ − 𝟏 = 𝟎. 𝟎𝟗𝟑𝟎𝟖 = 𝟗. 𝟑𝟎𝟖%
𝒄 𝟒
The number of (effective) periods, n=7 (once-yearly periods)
WM-EnEc-3 115

Example 3.11:
• Approach (b): Using, ieff.
• Cash Flow Diagram:
F=?
0
1 2 3 4 5 6 7
n= 7 periods (years)
P = $5,000 r= 9%
i= ieff =9.308%
WM-EnEc-3 116
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b) Using the effective interest rate:
• The compounded-amount, F, is given by:
F=P =P 1+i
7
F = $5,000 1 + 0.09308 = $𝟗, 𝟑𝟐𝟐. 𝟕𝟐
WM-EnEc-3 117
• Example 3.13:
– Determine whether it is more desirable to receive
16% compounded annually, or 15% compounded
monthly.
WM-EnEc-3 118
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– The effective annual interest rate is determined for
each case, then they are compared with one other.
– Case (i): When interest is compounded annually, the
effective (annual) interest rate, ieff, will be identical
with the nominal interest rate, r, i.e.:
• ieff = r = 16%
– Case (ii): For nominal interest rate, r, of 15%
compounded monthly, the effective (annual) interest
rate, ieff, is given by:
𝟏𝟐
𝒓 𝒄 𝟎. 𝟏𝟓
𝒊𝒆𝒇𝒇 = 𝟏 + −𝟏= 𝟏+ − 𝟏 = 𝟎. 𝟏𝟔𝟎𝟕𝟓
𝒄 𝟏𝟐
= 𝟏𝟔. 𝟎𝟕𝟓%
– Therefor, 15% compounded monthly, is better than
16% compounded annually.
WM-EnEc-3 119
• As mentioned before:
• ieff = f ( r, c )
• i.e. ieff increases as the compounding frequency,
• C, increases, as it can be seen from the following
• Example.
WM-EnEc-3 120
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• Demonstrated Example:
• Determine the annual effective interest rate,
ieff ,when a nominal interest rate, r = 18%, is
compounded using the following frequencies:
• i) annual compounding, i.e. c=1.

• ii) quarterly compounding, i.e. c=4.
• iii) monthly compounding, i.e. c=12.
• iv) daily compounding, i.e. c=365.
• WM-EnEc-3 121
Demonstrated Example Solution:

i) For annual compounding, c = 1
r c 0.18 1.0
ieff = 1 + −1 = 1+ 1.0
− 1 = 0.18
c
ii) For quarterly compounding, c = 4
0.18 4
ieff = 1 + − 1 = 0.19252 = 19.252 %
4
iii) For monthly compounding, c = 12
0.18 12
ieff = 1 + − 1 = 0.19562 = 19.562 %
12
iv) For daily compounding, c = 365
0.18 365
ieff = 1 + − 1 = 0.19716 = 19.716 %
365
WM-EnEc-3 122
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The Limiting Values of the Annual Effective

Interest Rate
The annual effective interest rate, ieff,ann., is given as:
r c
ieff = 1 + −1
c
Regarding compounding frequency ,c, this equation
has two limiting cases:
i) C = 1, annual compounding.
r 1.0
ieff = 1 + − 1 = 1 + 𝑟 − 1 = 𝑟.
1.0
ii) C ∞, continuous compounding.
𝑟 𝑐
ieff = lim 1 + − 1 = 𝑒 𝑟 − 1.
𝑐→∞ 𝑐
WM-EnEc-3 123
Formulae Proof:
But
Therefore
= 𝑒𝑟
And
= 𝑒𝑟 − 1
WM-EnEc-3 124
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The Limiting Values of the Annual Effective

Interest Rate
• Therefore, as frequency, c, increases from
unity to infinity, the effective annual interest
rate, ieff, increases from ‘r’, to ‘er-1’, as shown
below:
WM-EnEc-3 125
er-1
ieff
1 Compounding frequency, c
Figure 3.11: Variation of the Effective Annual Interest Rate, ieff,

with the Compounding frequency, c, for a fixed Nominal Rate, r.
WM-EnEc-3 126
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The extended from of the

annual effective interest rate
1. The extended from of the equation:
– It may be advisable, not to confine ourselves to the
annual effective interest rate only.
– This concept interest rate can be extended to cover
other cases, such as: semi-annual effective interest
rate, quarterly effective interest rate and so on.
– The number of original compounding periods per year
NOT EQUAL the number of original compounding
periods per effective period
WM-EnEc-3 127

• NOTE: (cont.)
1. The extended from of the equation: (cont.)
– Equation 3.4-10 can be put in the following general
form:
m
• ieff = 1 + io −1 3.4 − 11 See P(223).
– Where:
• io=the actual interest rate per compounding period, as
stated in the original agreement, 𝐢𝐨 = 𝐫 𝐜, where ‘r’ is the
nominal interest rate, and ‘c’ is the number of compounding
periods per year.
• m=the number of original compounding periods per
effective period
WM-EnEc-3 128
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• Example 3.14: See P(226-231).
– A sum of $1,000 is borrowed at a nominal interest
rate, r, of 18% for 4 years compounded monthly.
a) Determine the following rates:
i. The effective annual interest rate.
ii. The effective semi annual interest rate.
iii. The effective quarterly interest rate.
iv. The effective monthly interest rate
b) Using the original interest rate, together with the
various effective interest rate in part (a) to
determine the total amount due at the end of the
4th year. Any comments?
WM-EnEc-3 129

• Cash Flow (a) Example 3.14 P(226):
– From Borrower’s Viewpoint, showing both Original Compounding
Periods (months) in Solid Lines, and the Effective Compounding
Periods (years) in Dotted Lines.
P = $1,000
12 24 36 48 months
0
(original periods)
4 year
1 2 3
(effective periods)
F=?
WM-EnEc-3 130
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• Cash Flow (b) Example 3.14:
– From Borrower’s Viewpoint, showing both Original Compounding
Periods (one-month periods) in Solid Lines, and the Effective
Compounding Periods (6-months periods) in Dotted Lines (red).
P = $1,000
6 12 18 24 30 36 42 48 months
0 (original periods)
1 2 3 4 5 6 7 8 effective periods
(6-month periods)
F=?
WM-EnEc-3 131

– In this case, the actual or original interest rate, io,
as stated in the original financial arrangement, is
as given:
r 18%
• io = c = = 1.5% every month
12
– The original compounding period is one month.
WM-EnEc-3 132
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– Part (a):
m
• ieff = 1 + io −1
– Where in the present case:
r 18%
• io = c = 12
= 1.5% every month
i. For effective annual interest rate:
• Effective period = 1 year
𝑒𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝑝𝑒𝑟𝑖𝑜𝑑 (𝑜𝑛𝑒 𝑦𝑒𝑎𝑟) 12 𝑚𝑜𝑛𝑡𝑕𝑠
• ∴ m = 𝑜𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑝𝑒𝑟𝑖𝑜𝑑 (𝑜𝑛𝑒 𝑚𝑜𝑛𝑡𝑕) = 1 𝑚𝑜𝑛𝑡𝑕
= 12
12
• ∴ ieff = 1 + 0.015 − 1 = 0.19562 = 𝟏𝟗. 𝟓𝟔𝟐%
WM-EnEc-3 133

– Part (a): (cont.)
ii. For effective semi-annual interest rate:
• Effective period = half-year = 6 months
𝑒𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝑝𝑒𝑟𝑖𝑜𝑑 (𝑕𝑎𝑙𝑓;𝑦𝑒𝑎𝑟) 6 𝑚𝑜𝑛𝑡𝑕𝑠
• ∴m= = =6
𝑜𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑝𝑒𝑟𝑖𝑜𝑑 (𝑜𝑛𝑒 𝑚𝑜𝑛𝑡𝑕) 1 𝑚𝑜𝑛𝑡𝑕
6
• ∴ ieff = 1 + 0.015 − 1 = 0.09344 = 𝟗. 𝟑𝟒𝟒%
WM-EnEc-3 134
WM-EnEc-3 67
7-Jan-2015

iii. For effective quarterly interest rate:
• Effective period = quarter-year = 3 months
𝑒𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝑝𝑒𝑟𝑖𝑜𝑑 (𝑞𝑢𝑎𝑟𝑡𝑒𝑟;𝑦𝑒𝑎𝑟) 3 𝑚𝑜𝑛𝑡𝑕𝑠
• ∴m= 𝑜𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑝𝑒𝑟𝑖𝑜𝑑 (𝑜𝑛𝑒 𝑚𝑜𝑛𝑡𝑕)
= 1 𝑚𝑜𝑛𝑡𝑕
=3
3
• ∴ ieff = 1 + 0.015 − 1 = 0.04568 = 𝟒. 𝟓𝟔𝟖%
WM-EnEc-3 135

iv. For effective monthly interest rate:
• Effective period = 1 month = original period
𝑒𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝑝𝑒𝑟𝑖𝑜𝑑 (𝑜𝑛𝑒 𝑚𝑜𝑛𝑡𝑕) 1 𝑚𝑜𝑛𝑡𝑕𝑠
• ∴m= = =1
𝑜𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑝𝑒𝑟𝑖𝑜𝑑 (𝑜𝑛𝑒 𝑚𝑜𝑛𝑡𝑕) 1 𝑚𝑜𝑛𝑡𝑕
1
• ∴ ieff = 1 + 0.015 − 1 = 0.015 = 𝟏. 𝟓%
WM-EnEc-3 136
WM-EnEc-3 68
7-Jan-2015

– Part (b):
– Using Original Interest Rate:
• Original arrangement specifies an interest rate, io, of 1.5%
to be charged monthly.
• The Number of periods, n=(4)(12)= 48 periods (months)
• The total amount due at the end of the 4th year, F, is given
by:
– F=P =P 1+i
4
– F = $1,000 1 + 0.19562 = $𝟐, 𝟎𝟒𝟑. 𝟒𝟗
WM-EnEc-3 137

– Part (b): (cont.)
– Using Effective Annual Interest Rate:
• The Number of periods, n = 4 periods (one-year each)
• The Interest Rate per period, I = ieff_ann = 19.562%
• The total amount due at the end of the 4th year, F, is
given by:
– F=P =P 1+i
4
– F = $1,000 1 + 0.19562 = $𝟐, 𝟎𝟒𝟑. 𝟒𝟗
WM-EnEc-3 138
WM-EnEc-3 69
7-Jan-2015

– Using Effective Semi-Annual Interest Rate:
• The Number of periods, n=(4)(2)=8 periods (6-months each)
• The Interest Rate per period, I = ieff, semi_ann = 9.344%
• The total amount due at the end of the 4th year, F, is given
by:
– F=P =P 1+i
8
– F = $1,000 1 + 0.09344 = $𝟐, 𝟎𝟒𝟑. 𝟒𝟑
WM-EnEc-3 139

– Using Effective Quarterly Interest Rate:
• The Number of periods, n=(4)(4)=16 periods (3-months each)
• The Interest Rate per period, I = ieff, semi_ann = 4.568%
• The total amount due at the end of the 4th year, F, is given by:
– F=P =P 1+i
16
– F = $1,000 1 + 0.04568 = $𝟐, 𝟎𝟒𝟑. 𝟓𝟑
WM-EnEc-3 140
WM-EnEc-3 70
7-Jan-2015

– It can be concluded that instead of compounding
interest every month using io=1.5%, as specified in the
original arrangement, it is possible to carry out any
one of the following approaches:
1) To compute and compound interest every 3-months
period, using the effective quarterly interest rate of
4.568%
2) To compute and compound interest every 6-months
period, using the effective semi-annual interest rate of
9.344%
3) To compute and compound interest only once a year,
using the effective annual interest rate of 19.562%
WM-EnEc-3 141
5. Continuous compounding of interest
ii. Continuous Compounding: 𝐜 → ∞

• Continuous compounding represents a limiting
case, where frequency of compounding, c, tends
to infinity.
• In continuous compounding, the interest earned is
instantaneously added to the principal, at the end of
each infinitesimal interest period (the number of
interest periods per year is considered to be infinite).
• In this case, the effective annual interest rate, ieff, is
given by the following equation:
𝐢𝐞𝐟𝐟 = 𝐢𝐜𝐨𝐧 = 𝐞𝐫 − 𝟏, 𝐰𝐡𝐞𝐫𝐞 𝐜 → ∞ 𝟑. 𝟒 − 𝟏𝟎
WM-EnEc-3 142
WM-EnEc-3 71
7-Jan-2015
Continuous Compounding
er-1
ieff
1 Compounding frequency, c
Figure 3.11: Variation of the Effective Annual Interest Rate, ieff,

with the Compounding frequency, c, for a fixed Nominal Rate, r.
WM-EnEc-3 143

• The assumption of continuous compounding
may represent the true situation more nearly
than does either annual or discrete
compounding.
• Also, it may be more convenient, from a
computational standpoint, in some
applications.
Two applications can be pointed out here.
WM-EnEc-3 144
WM-EnEc-3 72
7-Jan-2015
• In some economy studies, it may be desired to

recognize that certain receipts or
disbursements will be spread throughout a
year rather than concentrated at a particular
date.
This situation of funds flow process can be
handled easily by using continuous
compounding rather than discrete
compounding.
WM-EnEc-3 145
• Continuous compounding is well adapted to the

assumption of a continuous flow of funds at
uniform rate throughout a stated period of time.
• In the development of certain mathematical

models, intended as aids to decision making, the
mathematical treatment is facilitated by the use
of continuous compounding rather than periodic
compounding.
WM-EnEc-3 146
WM-EnEc-3 73
7-Jan-2015
• Although continuous compounding assumes that

interest is computed and added to principal every
moment throughout the year, the results obtained
using continuous compounding are very close to the
results obtained using weekly compounding with
nominal rate r, i.e. compounding frequency in excess of
52 times per year (weekly compounding) differ only
slightly from the assumption of continuous
compounding.
• Nowadays some banks use daily compounding which
is very close to continuous compounding.
WM-EnEc-3 147
• Formulas for Continuous Compounding:

– Formulas for continuous compounding, can easily be
derived from formulas for discrete compounding,
Equations 3.3-1→ 3.3-7,P(194-213) using the following
substitution for ‘i’:
𝐢 = 𝐢𝐞𝐟𝐟 = 𝐢𝐜𝐨𝐧 = 𝐞𝐫 − 𝟏, 𝐰𝐡𝐞𝐫𝐞 𝐜 → ∞ 𝟑. 𝟒 − 𝟏𝟎
– It can be seen that, in case of continuous

compounding, square brackets, [ ], rather than
circular brackets, ( ), are used to designate the
interest factor.
WM-EnEc-3 148
WM-EnEc-3 74
7-Jan-2015
• Formulas for Continuous Compounding: (cont.)

i) Single-Payment Compound-Amount Factor:
For Discrete Compounding For Continuous Compounding
Functional 𝐹/𝑃 𝑖, 𝑛 𝐹/𝑃 𝑟, 𝑛

Symbol
ern
Multiply Given 1+i n
Fn = Pern
Fn = P 1 + i n 3.3 − 1
Formula 3.5 − 1
WM-EnEc-3 149

ii) Single-Payment Present-Worth Factor:
𝑃/𝐹 𝑖, 𝑛 𝑃/𝐹 𝑟, 𝑛
Functional
Symbol
Multiply Given 1
1+i n e;rn
1
Formula
P=F n 3.3 − 2 P = Fe;rn 3.5 − 2
1+i
WM-EnEc-3 150
WM-EnEc-3 75
7-Jan-2015

iii) Equal-Payment-Series Compound-Amount Factor:
Functional 𝐹/𝐴 𝑖, 𝑛 𝐹/𝐴 𝑟, 𝑛

Symbol
Multiply 1+i n−1 ern − 1

Given i
er − 1
Formula 1+i n−1 ern − 1
F=A 3.3 − 3 F=A 3.5 − 3 3
i er − 1
WM-EnEc-3 151

iv) Equal-Payment-Series Sinking-Fund Factor:
Functional 𝐴/𝐹 𝑖, 𝑛 𝐴/𝐹 𝑟, 𝑛

Symbol
Multiply i er − 1
Given 1+i n−1
ern − 1
Formula i er − 1
A=F 3.3 − 4 A=F 3.5 − 4
1+i n−1 ern − 1
WM-EnEc-3 152
WM-EnEc-3 76
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v) Equal-Payment-Series Present-Worth Factor:
Functional 𝑃/𝐴 𝑖, 𝑛 𝑃/𝐴 𝑟, 𝑛

Symbol
Multiply 1+i n−1 1 − e;rn

Given i 1+i n er − 1
Formula 1+i n−1 1 − e;rn

P=A 3.3 − 5 P = A 3.5 − 5
i 1+i n er − 1
WM-EnEc-3 153

vi) Equal-Payment-Series Capital-Recovery Factor:
Functional 𝐴/𝑃 𝑖, 𝑛 𝐴/𝑃 𝑟, 𝑛

Symbol
Multiply i 1+i n er − 1
Given 1+i n−1
1 − e;rn
Formula i 1+i n er − 1
A=P 3.3 − 6 A=P 3.3 − 6
1+i n−1 1 − e;rn
WM-EnEc-3 154
WM-EnEc-3 77
7-Jan-2015

vii) Uniform-Gradient-Series Factor:
Functional 𝐴/𝐺 𝑖, 𝑛 𝐴/𝐺 𝑟, 𝑛

Symbol
Multiply Given 1 n 1 n
− −
i 1+i n−1 er − 1 ern − 1
Formula 1 n 1 n
A = A1 ± G − A = A1 ± G − rn
i 1+i n−1 er
−1 e −1
3.3 − 7 3.5 − 7
WM-EnEc-3 155
• Example 3.15:
– A sum of $100,000 is borrowed for 5 years, at a
nominal interest rate, r, of 15%.
– Determine the amount due at the end of the 5th
year when the interest is compounded
a) Annually
b) Continuously
WM-EnEc-3 156
WM-EnEc-3 78
7-Jan-2015

F=?
0
1 2 3 4 5 years
i. Annual compounding, i=15%

ii. Continuous compounding, r=15%
P=$100,000
WM-EnEc-3 157

a) Annual Compounding:
given as:
𝐹/𝑃 𝑖, 𝑛
• F=P
– Substituting values for ‘P’, ‘i’ and ‘n’ yields:

𝐹/𝑃 15,5
• F = $100,000
WM-EnEc-3 158
WM-EnEc-3 79
7-Jan-2015

a) Annual Compounding: (cont.)
• = 1+i
𝐹/𝑃 15,5 5
• = 1 + 0.15 = 𝟐. 𝟎𝟏𝟏𝟒

𝐹/𝑃 15,5
• ∴ F = $100,000 = $𝟐𝟎𝟏, 𝟏𝟒𝟎
𝟐. 𝟎𝟏𝟏𝟒
WM-EnEc-3 159

a) Annual Compounding: (cont.)
payment compound-amount factor for discrete
compounding is given as:
𝐹/𝑃 15,5
• = 𝟐. 𝟎𝟏𝟏𝟒
𝐹/𝑃 15,5
• ∴ F = $100,000 = $𝟐𝟎𝟏, 𝟏𝟒𝟎
𝟐. 𝟎𝟏𝟏𝟒
WM-EnEc-3 160
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7-Jan-2015

b) Continuous Compounding:
given as:
𝐹/𝑃 𝑟, 𝑛
• F=P
– Substituting values for ‘P’, ‘r’ and ‘n’ yields:

𝐹/𝑃 15,5
• F = $100,000
WM-EnEc-3 161

b) Continuous Compounding : (cont.)
𝐹/𝑃 𝑟, 𝑛
• = ern
𝐹/𝑃 15,5 0.15 5
• =e = 𝟐. 𝟏𝟏𝟕𝟎

𝐹/𝑃 15,5
• ∴ F = $100,000 = $𝟐𝟏𝟏, 𝟕𝟎𝟎
𝟐. 𝟏𝟏𝟕𝟎
• Instead of $201,140 , with a difference of $10,560.
WM-EnEc-3 162
WM-EnEc-3 81
7-Jan-2015

b) Continuous Compounding : (cont.)
– Using Interest Tables for r=15% at n=5 the single-
payment compound-amount factor for continuous
compounding is given as:
𝐹/𝑃 15,5
• = 𝟐. 𝟏𝟏𝟕𝟎
𝟐. 𝟏𝟏𝟕𝟎
𝐹/𝑃 15,5
• ∴ F = $100,000 = $𝟐𝟏𝟏, 𝟕𝟎𝟎
𝟐. 𝟏𝟏𝟕𝟎
WM-EnEc-3 163
• Example 3.16:
– A man plans to save $600 at the end of this year,
and to increase his saving by $200 for 10 more
years. If the nominal interest rate, r=7% is
compounded continuously, what will be the
present-worth of his saving be?
WM-EnEc-3 164
WM-EnEc-3 82
7-Jan-2015

P=?
1 2 3 4 10 11 years
0
$600
$1,000
$1,200
$2,400
r=8%, compounded continuously $2,600
WM-EnEc-3 165

– The first step, in solving a uniform-gradient-series is to
convert it into an equal-payment-series, with an
element, A, given by:
𝐴/𝐺 𝑟, 𝑛
• A = A1 + G
– Then the present-worth, P, is given by:
𝑃/𝐴 𝑟, 𝑛
• P=A
– or
𝐴/𝐺 𝑟, 𝑛 𝑃/𝐴 𝑟, 𝑛
• P = A1 + G
WM-EnEc-3 166
WM-EnEc-3 83
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– Method 1: Using Tables for Continuous Compounding:
𝐴/𝐺 𝑟, 𝑛
• A = A1 + G
𝐴/𝐺 7,11
• ∴ A = $600 + $200 = $𝟏, 𝟒𝟔𝟏. 𝟑𝟕𝟖
4.3089
– The original saving is equivalent to an equal annual saving
of 1,461.378$ every year, starting from the end of this year
(the first year until the end of the 11th year.
𝑃/𝐴 𝑟, 𝑛
• P=A
𝑃/𝐴 7,11
• ∴ P = $1,461.378 = $𝟏𝟎, 𝟖𝟐𝟐. 𝟖𝟏𝟗
7.4059
WM-EnEc-3 167

– Method 2:Using Formulas for Continuous
Compounding:
1 n
• A = A1 + G er ;1
− ern ;1
1 11
• = $600 + $200 e0.07 ;1 − e 0.07 11 ;1
• ∴ A = $600 + $200 13.79120 − 9.48464 = $1,461.312
1;e−rn
• P=A er ;1
1;e− .07 11
• = $1,461.312 e0.07 ;1
• ∴ P = $1,461.312 7.4057 = $𝟏𝟎, 𝟖𝟐𝟐. 𝟎𝟑𝟐
WM-EnEc-3 168
WM-EnEc-3 84
7-Jan-2015

– Method 3: Using the Effective Interest Rate with
Formulas for Discrete Compounding:
• i = ieff = er − 1 = e0.07 − 1 = 0.07251 = 𝟕. 𝟐𝟓𝟏%
– A nominal interest rate, r, of 7%, compounded
continuously, is equivalent to an interest rate, i, of
7.251%, compounded annually.
– Using this effective (annual) interest rate, together
with formulas for discrete (annual) compounding, the
original saving series can be converted into an equal
saving series with an element, A, given by:
WM-EnEc-3 169

– Method 3: Using the Effective Interest Rate with
Formulas for Discrete Compounding: (cont.)
1 n
• A = A1 + G −
i 1:i n ;1
1 11
• A = $600 + $200 −
0.07251 1:0.07251 11 ;1
• ∴ A = $600 + $200 4.306889 = $1,461.378
1:i n ;1
• P=A
i 1:i n
1:0.07251 11 ;1
• P = $1,461.378
0.07251 1:0.07251 11
• ∴ P = $1,461.378 7.405824 = $𝟏𝟎, 𝟖𝟐𝟐. 𝟕𝟎𝟖
WM-EnEc-3 170
WM-EnEc-3 85
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– Method 4: Using the Effective Interest Rate
together with Table for Discrete Compounding:
– Interest Tables for discrete (or annual)
compounding can be used, but in the present
case, since 𝐢 = 𝐢𝐞𝐟𝐟 = 𝟕. 𝟐𝟓𝟏% is not a round
figure, linear interpolation is required.
– Although this methods is feasible, it is time
consuming, and there is no justification for its use.
WM-EnEc-3 171
6.A DIVISION OF INTEREST FORMULAS
WM-EnEc-3 172
WM-EnEc-3 86
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6.a Division of Interest Formulae

• The interest factors can be divided into three
groups, based on assumptions about:
– The nature of payments,
and
– The compounding of interest.
• Payments may be
– Discrete (i.e. concentrated at specific points in time).
or
– Continuous ( i.e. distributed uniformly thorough time).
WM-EnEc-3 173

• Compounding, also, may be discrete or
continuous.
• Discrete Payments can use either discrete
compounding or continuous compounding.
• Hence, this gives rise to two divisions.
• On the other hand, continuous payments can
only use continuous compounding. This leads
to the third & last division.
WM-EnEc-3 174
WM-EnEc-3 87
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Payments
Discrete Continuous Payments, or

Payments Fund-Flow Process
(i) (ii) (iii)

Discrete Continuous Continuous
Compounding Compounding Compounding
Figure 3.38: Various Groups of Interest Factors P(257).

WM-EnEc-3 175
Figure 3.38: Various Groups of Interest Factors P(257).

176
WM-EnEc-3 88
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3.6 CONTINUOUS PAYMENT OR

FUNDS-FLOW PROCESS
i) Funds-Flow Compound-Amount Factor
The amount ΔP is given as: ΔP = 𝐴 Δt, i.e. it is an area!

WM-EnEc-3 177
3.6 FUNDS-FLOW PROCESS

• When money flows continuously, with a of uniform or flow rate of
'𝐴' per period (e.g. $ /yr), then the total amount of money, or the
principal sum, ΔP, that flows during a short period of time, Δt, is given
by:
• ΔP = 𝐴 Δt ………………(i) see Eq. 3.6-13 P(246).
Notice that the amount of money, ΔP , is represented now by an
area in the cash flow diagram rather than by an arrow.
Also we have:
F = P er n ………… (ii) see Eq. 3.5-1 P(233).
Hence, it follows from Eq.(ii) that, the compound amount, ΔF, due to
a principal sum, ΔP, is given by:
• ΔF = ΔP e r t …………… (iii) see Eq. 3.6-14P(246).
Where 't' is the time span separating 'ΔP' from 'ΔF' as
shown in Figure 3.29. WM-EnEc-3 178
• .
WM-EnEc-3 • 89
7-Jan-2015

• Substituting for 'ΔP' in Eq. (iii) from Eq.(i) gives:
• ΔF = 𝐴 er t Δt ..............(iv) see Eq. 3.6-15 P(246).
• By letting 'Δt' approaches zero, Eq.(iv), which is in
difference from, takes the following differential from:
• dF= 𝐴 er t dt ………..(v) see Eq. 3.6-16 P(246). This
equation can be integrated, for the entire interval: 0 to n
as follows:
𝑛 𝑛
F = 0 dF = 𝐴 0 ert dt … vi see Eq. 3.6−17 P(246)
𝑛
𝑒 𝑟𝑡 𝑒 𝑟𝑛 ;1
which gives: F= 𝐴 = 𝐴 …..(vii).
𝑟 0 𝑟
• see Eq. 3.6−18 P(247).
WM-EnEc-3 179

𝑒 𝑟𝑛 ;1
F=𝐴 …... (vii) see Eq. 3.6−18 P(247).
𝑟
𝑒 𝑟𝑛 ;1
In Equation (vii) above, the factor is known as the
𝑟
'funds–flow compound-amount factor', and is designate as
F/A 𝑟,𝑛
. Numerical values for this factor are given
in Tables C.
WM-EnEc-3 180
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ii) Funds-Flow Singing-Fund Factor
WM-EnEc-3 181

• In Figure 3.30, when the flow rate, 𝐴 , is

known, Eq. 3.6-12 can be used to find the
compound–amount, F. On the other hand when
'F' is known, Eq.3.6-18 can be used to evaluate
the sinking–fund, 𝐴, as can be shown below.
WM-EnEc-3 182
WM-EnEc-3 91
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We have already obtained the following relation:
𝑒 𝑟𝑛 ;1
F=𝐴 …... (vii) see Eq. 3.6−18 P(247)
𝑟
This equation can be solved for '𝐴' as follows:

𝑟
𝐴 = 𝐹 see Eq. 3.6−19 P(247)
𝑒 𝑟𝑛 ;1
𝑟
Here the factor is known as the ‘Funds-
𝑒 𝑟𝑛 ;1
Flow Sinking-Fund Factor’, and is designated as:
A/F 𝑟,𝑛
. Numerical values for this factor are
given in Tables C.
WM-EnEc-3 183

iii) Funds-flow present-worth factor
WM-EnEc-3 184
WM-EnEc-3 92
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iii) Funds-flow present-worth factor
• The continuous payment process of Figure
3.31 below, can be solved using Eqs: 3.6-12 and
3.5 -1:
𝑒 𝑟𝑛 ;1
• F = 𝐴 3.6-12
𝑟
• F = Per n 3.5-1
Substituting for 'F' from Eq. 3.5-1 into Eq.3.6-12 gives:
𝑒 𝑟𝑛 ;1
Per n = 𝐴 3.6-20
𝑟
From Eq. 3.6-20, the present–worth, P, is given as:
𝑒 𝑟𝑛 ;1
• P =𝐴 3.6.21
𝑟𝑒 𝑟𝑛
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•
•
•

iii) Funds-Flow Present-Worth Factor
• We have already obtained the present–worth, P, as:

𝑒 𝑟𝑛 ;1
• P =𝐴 3.6.21
𝑟𝑒 𝑟𝑛
𝑒 𝑟𝑛 ;1
• The factor is known as the ‘Funds–Flow
𝑟𝑒 𝑟𝑛
Present–Worth Factor' and is designated as: P/A 𝑟,𝑛 .
Numerical values for this factor are given in the fourth
column of the Tables in Appendix C for a wide range of
values of 'i' and 'n'.
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iv) Funds- Flow Capital- Recovery Factor
Eq. 3.6-21 is given a
𝑒 𝑟𝑛 ;1
P =𝐴 3.6 − 21
𝑟𝑒 𝑟𝑛
• In Eq. 3.6-21, the flow rate, 𝐴, is known as 'capital-recover
and is
𝑟𝑒 𝑟𝑛
• A =P 3.6- 22
𝑒 𝑟𝑛 ;1
•
𝑟𝑒 𝑟𝑛
• The factor is known as the Funds-Flow Capital-
𝑒 𝑟𝑛 ;1
Recovery Factor' and is designated as: A/P 𝑟,𝑛 . It is the factor
used to determine the capital-recovery, 𝐴 , in a funds- flow
process.
•  Tables for the funds-flow process are given in Appendix C.
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Summary of Funds-Flow Factors

𝑒 𝑟𝑛 ;1
F=𝐴 … (i)
𝑟
𝑟
𝐴 = 𝐹 … (ii)
𝑒 𝑟𝑛 ;1
… (iii)
𝑟𝑒 𝑟𝑛
A =P … (iv)
𝑒 𝑟𝑛 ;1
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P(248)
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Example 3.18
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Example 3.18
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Example 3.18
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Example 3.18
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Example 3.18
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Example 3.18

Example 3.18
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Example 3.18
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3.7 FUNDS-FLOW CONVERSION FACTOR:
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Figure 3.34: Conversion of Funds-Flow into Discrete Payments.
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• Since funds flow uniformly (Ā is constant), then:

• A1 = A2 =………. = An =A 3.7-2
• And the year-end amount 'A' is given by Eq. 3.7-1 as:
𝑒 𝑟 ;1
• A=𝐴 3.7-3
𝑟
𝑒 𝑟 ;1
• The factor is known as the 'funds-flow
𝑟
𝐴/𝐴 𝑟
conversion factor', and is designated as:
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3.8 Summery of Interest Formulae

• See P(257-261).
• Exam.’s Allowed Material = P(261), which

represents an Overall Summery of Interest Factors.
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Table3.5: Overall Summery of Interest Factors
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3.9 Relationships between Interest Factors
• P(262-270).
Example 3.20 P(271-273).
• Self-study Materials.
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3.10 Limiting Values of Interest Factors
• We have 18 Interest Factors.

• Each factor has 4 limiting values:
• n = 1 & n ∞.
• i = 1 & i ∞.
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3.A STANDARD PAYMENTS FORMAT
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• An Introductory Example:
• Sketch the cash flow diagram, then determine
the present-worth amount , P, for an equal-
payment- series of $500 annually, which starts
now and continues until the end of the
seventh year, assuming an annual investment
rate of 15%.
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Cash Flow Diagram

P/A 15, 7
P= $500
P/A 15, 8
P= $500
P= ?
Which one is the correct answer ?
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• Answer:
• Unfortunately Both expressions are wrong !!!
Why ??
• n = number of payments = 8
• The second expression does not conform to the
‘ Standard Payment Formats’ , on which all
Interest Factors & Tables are based.
• According to these Formats ‘P’in case of discrete
• payments must occur at the ‘relative zero` i.e.
one period before the first payment:’ A` or 'A1' ,
as can be seen in the figures below.
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• According to the ’ Standard Payment Formats`

The compound-amount, ‘ F ` , in all cases of
payments(discrete or continuous payments)
must occur at the end of the payments i.e. at
the same time as the last payment, as can be
seen in the figures below.
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3.11 Standard Payments Format

• When interest factors are used, it is essential
that the monetary transactions, or the cash
flow diagrams conform to the formants for
which the factors are derived, as mentioned
before.
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• The following points, regarding the uniform-gradient
series should be noted:
For the uniform-gradient-series the first payment ‘A1’,

occurs at the end of the first period and the gradient,
‘G’, starts at the end of the second period; then
continues until the end of the nth period.
 It should be noted that 'A1' can be zero. In this case,

the uniform-gradient- series has zero payment at the
end of the first period, and it starts with the element
'G' at the end of the second period , as shown below.
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Uniform-Gradient-Series A1+(n-1)G
A1+G
A1
0
1 2 3 4 n-1 n
When = 0.0, P
the cash flow diagram

Will look like the
figure below.
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Continuous-Payments (Funds-Flow)
A
0 1 2 3 4 n-1 n
For continuous payments, or funds-flow process,

the flow starts at the present (n = 0), and proceeds
until the end of the nth period.
The beginning of the funds-flow process coincides, in its
time location, with the present-worth, P; while its
termination coincides with the location of the
compound-amount, F.
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• Going back to the Introductory Example.

Step (1):
Cash Flow Diagram
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The Introductory Example

Shifted Payments
• NOTE: When Interest formulae are used they evaluate
the Present-Worth Amount, P, at the relative zero only.
• Hence, applying the relationship: P= A P/A i, 7 gives

the present – worth of all payments starting at the end of
the first year until the end of the seventh year, but it does
not include the present worth of payment 'A' at time 0, as
indicated in the figure below.
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The Introductory Example- Shifted Payments
P/A i, n
Po = A +A (i)
Substituting numerical values into Eq. (i) gives :
P/A 15, 7
Po = $500 4.16042 + $500 = $ 2,580.21
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Method II: An Alternative Solution

• Alternatively, applying the standard equal –
payment–series present – worth factor, P/A i,n , gives
the present–worth of all annual payments, from time 0
to time 7 (end of the seventh year), but this present–
worth occurs naturally at the relative zero of the
series i.e. one period before the first payment, A.
• In other words, the present–worth, in the

present case, occurs at time -1 as indicated in
Figure 3.45 below.
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P/A i,n P/A 15,8
• P;1 = A = $500 (ii)
P/A 15 , 8
•  P;1 = $500 4.48732 = $ 2,243.66
• Po = P;1 F/P i, n = P;1 F/P 15, 1
(iii)
• = $ 2,243.66 (1.15000) =$ 2,580.21
• Or shortly:
P/A i, n F/P 15, 1
Po = A (iv)
P/A 15 , 8 F/P 15 , 1
• Po = $500 4.48732 1.15000 = $2,580.21
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• Question:
• Is there any other approach to solve the
problem ?
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• Answer:
• Yes, the compound- amount, F, at n=7 can be
determined. Then P can easily be evaluated
from F.
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Example 3.23 – Shifted Payments
• Solution
• The cash flow diagram for the problem is shown below :
•
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Example 3.23 – Shifted Payments

P/A 9,5
P/A i,n
P15 = A = $3,000 3.88965 = $11,668.95
• The present-worth, Po at the absolute zero i.e. at time

'0', can be evaluated from 'P15', noting that with respect
to 'Po', 'P15' is a future- worth. Hence:
• P0 = P15 P/F i,n
P/F 9,15
•  P0 = $11,668.95 0.27454 = $3,203.59
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Example 3.25 – Various Approaches
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• Method I
• Since the payments series starts now, i.e. at t = 0,
with the first element, A = $1,500, its relative zero
occurs one period before the first payment, i.e. at t = -1
• . The present-worth of the series at its relative zero,

P-1 as shown in Figure 3.50, can be evaluated as follows,
noting that since there are 8 payments, 'n' should be
taken as '8'.
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• The future – worth F7, is given as.

•
F/P 13, 8
• F7 = $18187.23 2.82922 = $51,455.67
•
• From 'P-1', the present–worth, Po, at the absolute
zero: t = 0, can be evaluated as:
•
F/P 13, 1
• Po = $18,187.23 1.13883 = $20,712.16
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• Method III
• The original payments can be considered as
consisting of an equal-payment-series from
t = 0 until t = 7, together with a uniform
gradient series which starts with the first
element, A1 = $850, and increases with
gradient, G = A1 = $850 until the end of the
7th year, as shown in Figure 3.52.
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• The future–worth, F1, of the equal-payment-series of

Figure 3.52, which consists of 8 equal payments is
given as:
F/A 13, 8
• F1 = $1,500 13.17610 = $ 19,764.15
A/G i,n F/A i,n

• F2 = A o + G
A/G 13, 7 F/A 13, 7
• F2 = $850 + $850 2.48718 10.69180 = $ 31,691.60
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• The future–worth of the original payments, 'F',
is the summation of 'F1' and 'F2' .
• F = F1+ F2 = $19,764.15 + $ 31,691.60 = $ 51,455.75
• From 'F', the present - worth, Po, is evaluated as :

P/F 13, 7
• P0 = $51,455.75 0.40252 $20,711.97
•
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• Method IV
• An alternate method, for solving the problem, is to treat the
seven original payments as single sums of money, and to evaluate
the future–worth, F7, according to the following format:
•
7 F/P 13, 7;t 7
• 𝐹7 = 𝐹 = 𝑡<0 𝑋𝑡 = 𝑡<0 𝑋𝑡 ∗ 𝑒 0.13(7;𝑡)
•
• where 'Xt' represents the payment at the end of any year ' t '.
• Substituting numerical values of : ' t ' and 'Xt' into the above relationship
yields:
•
• F7 = F = $ 51,455.71
• From 'F', the present-worth, Po, can be evaluated as follows:
P/F 13, 7
• P0 = $51,455.71 0.40252 = $ 20,711.95
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• Example 3.25 – Various Approaches

• Method V:
A/G i,n F/A i,n
• F7 = A o + G
A/G 13, 8 F/A 13,8
• F7 = $1500 + $850 2.82968 13.17610
=$51455.68
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• Therefore, the given payments series is
equivalent to a single amount of $51,455.67
at the end of the seventh year, and also is
equivalent to ten equal payments of
$ 3,952.71 each.
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Reviewing Question
• Name fully the following interest factors:
i) (P/A i, n). vi) (A/G i, n).
ii) [A/P i, n]. vii) [P/A 𝑟,𝑛 ].
iii) [A/F 𝑟,𝑛
]. viii) [P/F r, n].
iv) (A/F i, n). ix ) [A/G r, n].
• v) [F/A r, n]. x) [ A/P 𝑟,𝑛 ].
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Exp. 3.21 – Irregular Payments.
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• Since the present-worth of the original cash flow
diagram, the top diagram of Figure 3.42 is equal to the
present – worth of its equivalence (i.e. the middle and
bottom diagrams of Figure 3.42). It follows that:
P/A i,n P/F i,n P/F i,n
• Po = A + X5 + X8 (i)
• Substituting numerical values into Eq. (i) yields:
𝑃/𝐴 11 , 10 𝑃/𝐹 11 , 5 𝑃/𝐹 11 , 8
• Po = $350 5.88923 + $ 250 0.59345 − $150 0.43393
• =$ 2,144.504
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Method II :
10
P/F i, nj
Po < xj (ii)
j<1
•
• Since the first four elements of the original

cash flow diagram are equal, they represent an
equal–payment-series, and Eq. (ii) reduces to the
following form :
•
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• Po < A P/A i,4 + 10

j<5 xj
P/F i,nj
(iii)
• or
• Po = A P/A i,4 + X 5 P/F i,5 + X 6 P/F i,6
+ X 7 P/F i,7 + X 8 P/F i,8 + X 9 P/F i,9
+ X10 P/F i,10 (iv)
•
• Substituting numerical values into Eq. (iv) gives:
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P/A 11, 4 P/F 11 , 5 𝑃/𝐹 11 , 6
Po = $350( 3.10245 ) + $ 600( 0.59345 ) + $350( 0.53464 ) +
• P/F 11 , 7 P/F 11 , 8 P/F 11 , 9
$350( 0.48166 ) + $ 200( 0.43393 ) + $350( 0.39093 ) +
P/F 11 , 10
$350( 0.39093 ) = $ 2,144.504
Now the solution involves seven interest factors

instead of the three which were used before with
the modified cash flow diagram of Figure 3.42.
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• Similarly :
F/P i,10;j
• F10 = 10j<1 xj
•
• =X1 F/P i,9 + X2 F/P i,8
+ ……+
X9 F/P i,1 + X10 =$6,089.15
• Or
F/P 11 , 10
F/P i,n
F10 = Po = $2,144.505 2.83942
= $6,089.15
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• Now the equivalent annual–worth ,A, can be

calculated directly from either the present–worth ,Po,
or the future–worth, F10, as follows:
A/P 11 , 10
A/P i,n
• A = Po = $2,144.505 0.16980
= $364.137
A/F 11 , 10
A/F i,n
• A = F10 = $6,089.150 0.5980
= $364.131
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Exp. 3.27 – Deferred Funds-Flow.
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Deferred Funds-Flow, Exp. 3.27.

Solution:
The general cash flow diagram of the problem is given
in Figure 3.54 below.
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• Part (a): Present –worth Determination:
• There are several ways to work the problem, as
discussed below.
•
• Approach I:
• One way to find the present-worth, Po, is to first
calculate the present-worth of the original funds-
flow process at its relative zero, i.e. at t = 3, as
indicated in Figure 3.55 below.
•
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• On an Annual Basis:
• Ā = ($ 500) (12) = $ 6,000 per year
i = 12%
• On this basis, P3 is given as:
𝑃/𝐴 12,5
𝑃/𝐴 𝑟,𝑛
• 𝑃3 = 𝐴 = $6,000 3.7599 = $22,559.40
• with respect to 'Po', 'P3' is a future-worth. Hence:
𝑃/𝐹 12,3
𝑃/𝐹 𝑟,𝑛
• 𝑃0 = 𝑃3 = = $22,559.40 0.69768
= $15,739.24
•
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• On a Monthly Basis
• 𝐴 = $ 500 per month
12%
• i = = 1% monthly
12
• n = 96 – 36 = 60 months
• On this basis 'P0' is evaluated as:
𝑃/𝐴 1, 60 𝑃/𝐹 1, 36
𝑃0 = $500 45.11880 0.697816 = $15,742.31
(15,742.31;15,739.24)
% difference = 100% = 0.0195%
(15,739.24)
% difference < 0.02%
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• Also, the problem can be solved using Interest

Formulas, instead of Interest Tables, on either: an
annual, or a monthly basis, using the following
relationships:
•
𝑃/𝐴 𝑟,𝑛 𝑃/𝐹 𝑟,𝑛∗
• 𝑃0 = 𝐴
• or
𝑒 𝑟𝑛 ;1 ∗
• 𝑃0 = 𝐴 𝑒 ;𝑟𝑛
𝑟𝑛
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• On an Annual Basis:
• 𝐴 = $ 6,000, n = 5, 𝑛∗ = 3 yrs, and r = 12%
0.12 (5)
𝑒 −1
𝑃0 = $6,000 𝑒 ;0.36 = $15,739.18
0.12 𝑒 0.6
• On a Monthly Basis:
• 𝐴 = $500 , 𝑛 = 60 , 𝑛∗ = 36 month and 𝑟 = 1%
0.01 (60)
𝑒 −1
𝑃0 = $500 𝑒 ;0.36 = $15,739.18
0.01 𝑒 0.6
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• Approach II:
• Referring to Figure 3.55, the present-worth, Po, can be
evaluated through the future-worth, F8, as follows:
𝐹/𝐴 𝑟,𝑛 𝑃/𝐹 𝑟,𝑛
• 𝑃0 = 𝐴 .
• On an annual basis, the following values are obtained:

• 𝐴 = $ 6,000, r = 12%
• n = 5 yrs , and n* = 3 yrs.
• Substituting these numerical values into the above
relationship yields:
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𝐹/𝐴 12, 5 𝑃/𝐹 12, 8
• 𝑃0 = $6,000 6.85099 0.38289
= $15,739.05
• This value 'P0' is almost the same as that obtained through

Approach I.
• Similarly, instead of an annual basis, a monthly

basis can be used. Also instead of Interest Tables,
Interest Formulas can be applied using Approach II.
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•
• Approach III:
• The original cash flow as indicated in Figure
3.55 is equivalent to the cash flows shown in
Figure 3.56. Figure 3.56 illustrates graphically
how a deferred funds-flow is represented as a
difference of two ordinary funds-flows that start
from t = 0.
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Figure 3.56 shows that:

𝑃0 = 𝑃𝑥 − 𝑃𝑦
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• Hence, It follows that:
𝑃/𝐴 𝑟,𝑛 𝑃/𝐴 𝑟, 𝑛∗
• P0 = 𝐴 –𝐴 , 𝑜𝑟:
P/A r,n P/A r, 𝑛∗
• P0 = A – ,where:
n = 8 yrs, and n* = 3 yrs
P/A 12, 8 P/A 12, 3
P0 = $500 (12) 5.14256 − 2.51936
• P0 = ($6,000) (2.62320) = $ 15,739.20
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• Part (b): Determination of Future-Worth, F10:

• Future-worth at the end of the tenth year, F10, can
be evaluated using various approaches, similar to
those used for determining the present-worth, P0, in
Part (a).
•
• Approach 1:
•
• Future-worth, F10, can be found from 'F8' as
indicated in Figure 3.57.
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Referring to Figure 3.57, 'F8' represents the future-
worth of a funds-flow for 5 years (i.e. from n = 3,
until n = 8 yrs.). Thus, 'F8' can be evaluated as
follows:
F/A r, n F/A 12, 5
F8 = A = $500 12 6.85099 = $41,105.94
• Now 'F8' with respect to 'F10', is a present-worth. Hence:
𝐹/𝑃 𝑟, 2 𝐹/𝑃 12 , 2
𝐹10 = 𝐹8 = $41,105.94 1.27125 = $52,255.93
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• Approach II:
• The future-worth, F10, can be calculated from the present-
worth of the continuous payment at its relative zero, P3, as
indicated in Figure 3.58.
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• Referring to Figure 3.58, the following values

are obtained:
•
𝑃/A 12, 5
• 𝑃3 = $6,000 3.7599 = $22,559.40
and
𝐹/𝑃 𝑟, 7 𝐹/𝑃 12, 7

𝐹10 = 𝑃3 = $2,259.40 2.31637 = $52,255.92
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• Approach III:
• The future-worth, F10, of the shifted funds-
flow can be obtained from its equivalent
standard cash flows, where the location of the
future-amount coincides with the termination of
the funds flow, as can be seen in Figure 3.59
below.
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WM-EnEc-3 281

• From Figure 3.59 it follows that:
𝐹10 = 𝐹𝑥 − 𝐹𝑦
or
𝐹/𝐴 𝑟, 7 𝐹/𝐴 𝑟, 2
𝐹10 = 𝐴 –𝐴
𝐹/𝐴 𝑟, 7 𝐹/𝐴 12, 2
 𝐹10 = $6,000 10.96970 − 2.26041
= = $ 52,255.74
Comments:
The three approaches discussed above result in almost
the same values within, the rounding-off error.
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3.12 Worked-Out Examples
• V. Important
• Exp.3.28 Exp.3.37.
• P(300 315).
WM-EnEc-3 283
Questions & Problems
• Q.3-1 Q.3-22. P(316-323).
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WM-EnEc-3 285
Exp. 3.22 – Part (b) Shifted Payments
• Part ( b )
• To find the future–worth at the end of the
eighth year, F8, without use of the fact that: P0 =
$ 2,580.21, the first logical step is to calculate
the future–worth at the end of the series at time,
7, i.e. 'F7' as follows:
•
F/A i, n F/A 15, 8
F7 = A = $500 (v)
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286
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Exp. 3.22 – Part (b)
F/A i, n F/A 15, 8

F7 = A = $500 (v)
WM-EnEc-3 287

Shifted Payments
• Note that : n = 8; since there are 8 payments as
depicted in Figure 3.46.
• The next step is to find 'F8' from 'F7'. In this
case, 'F7' becomes a present–worth relative to
'F8', and 'F8' is evaluated as follows:
F/A 15 , 8 F/P 15 , 1
F/P i,n
F8 = F7 = $500 3.7268 1.15000
= $ 7,892.91
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7-Jan-2015

Shifted Payments
• Another, easier way for determining 'F8',
would be to start with $2,243.66 as of time '-1',
or $ 2,580.21 as of time '0', and to calculate the
future–worth at time '8' as follows
P/F i,n:1
• F8 = P;1
F/P 15 , 9
• = $2,243.66 3.51788 = $7,892.93
• or
F/P 15 , 8
F/P i, n
F8 = P0 = $2,580.21 3.05902 = $7,892.91
•
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Table3.5: Overall Summary of Interest Factors

Discrete Payments Continuous Payments
𝑭/𝑷 𝒊,𝒏
𝑭=𝑷 = 𝑷(𝟏 + 𝒊)𝒏 F
Single-Payment
𝑭/𝑷 𝒓,𝒏 1
𝑭=𝑷 = 𝑷𝒆𝒓𝒏
F
0 1 2 3 n-1 n
P
𝑷/𝑭 𝒊,𝒏 𝟏
𝑷=𝑭 =𝑭 (𝟏+𝒊)𝒏
0
n
2
𝑷=𝑭 𝑷/𝑭 𝒓,𝒏
= 𝑭𝒆−𝒓𝒏 𝑨
F A A A A
0 1 2 3 n
0 1 2 3 n Direct Solution Indirect Solution
using either using
A A A
A P Tables or Conversion
Equal-Payment-Series
𝑭/𝑨 𝒊,𝒏 (𝟏+𝒊) 𝒏 −𝟏 Formulas Factors
𝑭=𝑨 =𝑨 𝒊
3
𝑭/𝑨 𝒓,𝒏 𝒆 𝒓𝒏 −𝟏
𝑭=𝑨 =𝑨 𝒆 𝒓 −𝟏
𝑨=𝑭 𝑨/𝑭 𝒊,𝒏

=𝑭
𝒊 𝑨
(𝟏+𝒊) 𝒏 −𝟏
0
4 n
𝑨/𝑭 𝒓,𝒏 𝒆 𝒓 −𝟏
𝑨=𝑭 =𝑭 𝒆 𝒓𝒏 −𝟏
𝑷/𝑨 𝒊,𝒏 (𝟏+𝒊) 𝒏 −𝟏 P

𝑷=𝑨 =𝑨
𝒊(𝟏+𝒊) 𝒏
5
𝑷/𝑨 𝒓,𝒏 𝟏− 𝒆 −𝒓𝒏
𝑷=𝑨 =𝑨 𝑭/𝑨 𝒓,𝒏 𝒆 𝒓𝒏 −𝟏
𝒆 𝒓 −𝟏 𝑭=𝑨 =𝑨
𝒓
𝑨/𝑷 𝒊,𝒏 𝒊(𝟏+𝒊) 𝒏 𝒆 𝒓 −𝟏 𝑭/𝑨 𝒓,𝒏 1
𝑨=𝑷 =𝑷 (𝟏+𝒊) 𝒏 −𝟏 =𝑨 .
𝒓
6
𝑨/𝑷 𝒓,𝒏 𝒆 𝒓 −𝟏
𝑨=𝑷 =𝑷 𝑷=𝑨 𝑷/𝑨 𝒓,𝒏
=𝑨
𝒆 𝒓𝒏 −𝟏
𝟏− 𝒆 −𝒓𝒏
𝒓𝒆 𝒓𝒏
𝒆 𝒓 −𝟏 𝑷/𝑨 𝒓,𝒏
2
=𝑨 .
Uniform-Gradient-Series
A0 – (n-1)G
A0 +G
𝑨/𝑭 𝒓,𝒏 𝒓
𝑨=𝑭 =𝑭 𝒆 𝒓𝒏 −𝟏
A0 - G
𝑨/𝑭 𝒓,𝒏 𝒓 3
A0
=𝑭 . =
A0
𝒆 𝒓 −𝟏
𝑨/𝑷 𝒓,𝒏 𝒓𝒆 𝒓𝒏
0 1 2 3 n-1 n 0 1 2 3 n-1 n 𝑨=𝑷 =𝑷
𝒆 𝒓𝒏 −𝟏
𝑨/𝑷 𝒓,𝒏 𝒓 4
𝟏 𝒏 =𝑷 .
𝑨 = 𝑨𝟎 ± 𝑮 𝑨/𝑮 𝒊,𝒏
= 𝑨𝟎 ± 𝑮 − (𝟏+𝒊) 𝒏 −𝟏 𝒆 𝒓 −𝟏
𝒊
𝑨/𝑮 𝒓,𝒏 𝟏 𝒏 7
𝑨 = 𝑨𝟎 ± 𝑮 = 𝑨𝟎 ± 𝑮 −
𝒆 𝒓 −𝟏 𝒆 𝒓𝒏 −𝟏
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Shifted Payments
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• The equivalent equal-payment-series is shown below and its

end–of–year payment, A, is determined from 'Po' as follows:
A/P 13, 10
• A = $20,712.16 0.19084 = $ 3,952.71
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Deferred Funds-Flow
• Solution:
• The general cash flow diagram of the problem is
given in Figure 3.54.
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Deferred Funds-Flow
WM-EnEc-3 295
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3.1 Classification of Interest

Interest). The borrower has to pay

I= p×i×n Different formulas are available

n = number of interet periods

Question: What is about the amount:

3.2 CASH FLOW DIAGRAM

In the previous example, the whole problem was

Simple Interest Compound Interest

2. Cash Flow Diagram

2. Cash Flow Diagram

3.2 CASH FLOW DIAGRAM

3.3 Compound Interest Factors

i. Single-Payment Compound-Amount Factor

Figure 3.5: Cash Flow Diagram Single-Payment Process

i ) Single-Payment Compound-Amount Factor

Solution for Exp. 3.1

Solution for Exp. 3.1

The General solution using symbolic designation is

– Substituting values for ‘P’, ‘i’ and ‘n’ yields:

Solution for Exp. 3.1

– Now the specific or numerical solution is obtained be

i. Single-Payment Compound − Amount

i) Single-Payment Compound-Amount Factor

• Solution Example 3.1: (cont.)

Solution Example 3.1: (cont.)

Solution Example 3.1: (cont.)

Solution Example 3.1: (cont.)

i) Single-Payment Compound-Amount Factor

ii) Single-Payment Present-Worth Factor

• The amount, P (the present-worth), that

ii) Single-Payment Present-Worth

ii) Single-Payment Present-Worth

ii) Single-Payment Present-Worth Factor

0=31/12/2012 = 1/1/2013 6 years=

ii) Single-Payment Present-Worth Factor

• Solution Example 3.2:

– Substituting values for ‘F’, ‘i’ and ‘n’ yields:

Solution for Exp. 3.1

ii) Single-Payment Present-Worth Factor

ii) Single-Payment Present-Worth Factor

• Solution Example 3.2: (cont.)

– Substituting value in the general solution format

iii. Equal-Payment-Series Compound-

Figure 3.6: Equal-Payment-Series with Single-Future Amount

iii. Equal-Payment-Series Compound-

iii) Equal-Payment-Series Compound-

iii) Equal-Payment-Series Compound-

iii) Equal-Payment-Series Compound-Amount

• Cash Flow Example 3.3:

iii) Equal-Payment-Series Compound-Amount

iii) Equal-Payment-Series Compound-

𝐹/𝐴 10,18 1:0.1 18 ;1

iii) Equal-Payment-Series Compound-

iv. Equal-Payment-Series Sinking-Fund

iv) Equal-Payment-Series Sinking-Fund

• The Functional Symbol:

iv. Equal-Payment-Series Sinking-Fund

iv) Equal-Payment-Series Sinking-Fund

iv) Equal-Payment-Series Sinking-Fund Factor

• Solution Example 3.4 (con.):

iv. Equal-Payment-Series Sinking-