Chapter 2

Factors: How Time

and Interest Affect
Money

Lecture slides to accompany

Engineering Economy
7th edition

Leland Blank
Anthony Tarquin

1-2
 2-1 Single Payment Factors (F/P and P/F)
Single payment factors involve only P and F. Cash flow diagrams are as follows:

F = P(1 + i ) n Formulas are as follows: P = F[1 / (1 + i ) n]

F  PF P , i, n  P  FP F , i, n 
Terms in parentheses or brackets are called factors. Values are in tables for i and n values
 Factors are represented in standard factor notation such as (F/P, i, n).
 where letter to left of slash is what is sought; letter to right represents what is given

2-2
 Example 1

 Sandy, a manufacturing engineer, just received a year-

end bonus of $10000 that will be invested immediately.
With the expectation of earning at the rate of 8% per year,
Sandy hopes to take the entire amount out in exactly 20
years to pay for a family vacation when the oldest
daughter is due to graduate from college. Find the amount
of funds that will be available in 20 years
 solution
 By formula : F  P (1  i )  100001  0.08 = $46610
n 20

 By table :
F  P F P ,i,n  10000F P ,8% ,20   10000(4.6610)  $46610

2-3
 2-2 Uniform Series Involving P/A and A/P
The uniform series factors that involve P and A are derived as follows:
(1) Cash flow occurs in consecutive interest periods
(2) Cash flow amount is same in each interest period

Note: P is one period Ahead of first A value

P = A(P/A,i,n) Standard Factor Notation A = P(A/P,i,n)

 1  i   1   i 1  i  
n n

P  A  i0 A  P 
 i 1  i    1  i   1 
n n

2-4
 Example 2

 How much money should you be willing to pay now for

a guaranteed $600 per year for 9 years starting next year,
at a rate of return of 16% per year?
 solution
 By formula :
 1  i   1   1  0.16   1 
n 9

P  A   600    $2763.93
 i 1  i    0.161  0.16  
n 9

 By table :
P  AP A ,i,n   600P A ,16% ,9   600( 4.6065)  $2763.90

2-5
 2-3 Uniform Series Involving F/A and A/F
The uniform series factors that involve F and A are derived as follows:
(1) Cash flow occurs in consecutive interest periods
(2) Last cash flow occurs in same period as F
Note: F takes place in the same period as last A

F = A(F/A,i,n) Standard Factor Notation A = F(A/F,i,n)

 1  i   1   i 
n

F  A  i0 A  F 
 1  i   1 
n

 i 
2-6
 Example 3

 The president of Ford Motor Company wants to know the

equivalent future worth of a $1 million capital investment
each year for 8 years, starting 1 year from now. Ford
capital earns at a rate of 14% per year.
 solution
 By formula :

 1  i   1   1  0.14   1 
n 8

F  A   1M    $13.2327 M
 i   0.14 
 By table :

F  AF A ,i,n   1M F A ,14% ,8   1M(13.2328)  $13.2328 M

2-7
 2-4 Factor Values for Untabulated i or n

2 ways to find factor values for untabulated i or n values

Use formula
Linearly interpolate in interest tables

Formula function is fast and accurate Interpolation

is only approximate

2-8
  Example 4

Determine the P/A factor value for i = 7.75% and n = 10 years.

 Solution
 By formula :
 
 
 1  i   1   1  i   1   1  0.0775   1 
n n 10

  P  A   P A       6.78641
 

 i 1 i  n
  
 i 1  i   0.075 1  0.0775 
n

10

2-9
 2-5 Arithmetic Gradients
Arithmetic gradients change by the same amount each period

The cash flow diagram for the PG G starts between periods 1 and 2
(not between 0 and 1)
of an arithmetic gradient is:
 This is because cash flow in year 1
PG = ?
is usually not equal to G and is
1
handled separately as a base
2 3 4 n
amount (shown on next slide)
0  Increasing gradient (G positive)
 Decreasing gradient (G negative)
G
2G
3G
(n-1)G Note that PG is located Two Periods Ahead
of the first change that is equal to G
PG = G(P/G,i,n)
G  1  i   1 n 
n

P   
G
i  i 1  i 
n
1  i  
n

2-10
 Typical Arithmetic Gradient Cash Flow
PT = ?

i = 10%
0 1 2 3 4 5

400
450
Amount in year 1 500
is base amount 550
600

This diagram = this base amount plus this gradient

PA = ? PG = ?
i = 10% i = 10%
+
0 1 2 3 4 5
0 1 2 3 4 5

Amount 400 400 400 400 400

50
in year 1 100
PA = 400(P/A,10%,5) PG = 50(P/G,10%,5) 150
is base 200
amount PT = PA + PG = 400(P/A,10%,5) + 50(P/G,10%,5)
2-11
 Converting Arithmetic Gradient to A
Arithmetic gradient can be converted into equivalent A value using G(A/G,i,n)
i% i%
0 1 2 3 4 5 0 1 2 3 4 5

base amount A1
A1+G
A1+2G
A1+3G
A=?
A1+4G

General equation when base amount is involved is

A = base amount + G(A/G,i,n)= A  A 1 G

0 1 2 3 4 5 For decreasing gradients,

change plus sign to minus
A1-4G
A1-3G
A1-2G
base amount A1 A1-G A = base amount - G(A/G,i,n)
1 n  A A  A
  G  A G ,i,n
1 G
A  G 
G
 i 1  i   1 
n

2-12
 

Example 5

Neighboring parishes in Louisiana have agreed to pool road tax

resources already designated for bridge refurbishment. At a
recent meeting, the engineers estimated that a total of $500000
will be deposited at the end of next year into an account for the
repair of old and safety-questionable bridges throughout the area.
Further, they estimate that the deposits will increase by $100000
per year for only 9 years thereafter, then cease. if public funds
earn at a rate of 5% per year, Determine the equivalent
(a) present worth
(b) annual series amounts

2-13
 Example 5: Solution

a)
P = P  P  500( P/A,5%,10)  100( P/G ,5%,10)  500(7.7217 )  100(31.6520 )  $7026.05
T A G

b)
A  P ( A/P ,5%,10)  7026.05 0.12950  $909.873
T T

or
A = A  A  500  100( A/G ,5%,10)  500  1004.0991  $909.91
T A G

2-14
 2-6 Geometric Gradients

Geometric gradients change by the same percentage each period

Cash flow diagram for present worth
of geometric gradient
 There are no tables for geometric factors
Pg = ?
 Use following equation for g ≠ i:
1 2 3 4 n
Pg = A1{1- [(1+g)/(1+i)]n}/(i-g)
0
A1 where: A1 = cash flow in period 1
A 1(1+g)1

A 1(1+g)2 g = rate of increase

Note: g starts between If g = i, Pg = A1n/(1+i)

A 1(1+g) n-1
periods 1 and 2

Note: If g is negative, change signs in front of both g values

2-15
 Example 6
 

A coal-fired power plant has upgraded an emission

control valve. The modification costs only $8000 and is
expected to last 6 years with a $200 salvage value. The
maintenance cost is expected to be high at $1700 the
first year, increasing by 11% per year thereafter.
Determine the equivalent present worth of the
modification and maintenance cost at 8% per year.
 
 
 
 

2-16
Example 6: Solution

2-17
 2-7 Unknown Interest Rate i

Unknown interest rate problems involve solving for i,

Example 7:
 

If Laurel made a $30000 investment in a friend’s

business and received $50,000 after 5 years.
determine the rate of return.
 
 
 

2-18
Example 7: Solution

2-19