Chapter 2

Chapter 2
Factors: How Time

and Interest Affect
Money
Lecture slides to accompany
Engineering Economy
7th edition
Leland Blank
Anthony Tarquin
© 2012 by McGraw-Hill, New York, N.Y All Rights Reserved

2-1
LEARNING OUTCOMES
1. F/P and P/F Factors

2. P/A and A/P Factors
3. F/A and A/F Factors
4. Factor Values
5. Arithmetic Gradient
6. Geometric Gradient
7. Find i or n
2-2
Types of Common Cash Flows in Engineering
Economics
Contemporary Engineering Economics, 4th edition, © 2007

Equivalence Relationship Between P and F

Single Cash Flow Formula- Compound-Amount Factor
 Single payment compound F

amount factor (growth F  P(1  i ) N
factor)
F  P( F / P, i, N )
 Given:
i  12%
0
N  8 years
P  $5, 000 N
 Find: F
P
F  $5, 000(1  0.12)8
 $5, 000( F / P,12%,8)
 $12,380
Practice Problem
 If you had $2,000 now and invested it at

10%, how much would it be worth in 8
years?
F=?
i = 10%
0
8
$2,000
Solution
Given:
P  $2, 000
i  10%
N  8 years
Find: F
F  $2, 000(1  0.10) 8

 $2, 000( F / P,10%, 8)
 $4, 287.18
EXCEL command:
=FV(10%,8,0,2000,0)
=$4,287.20
Excel Command Future Value
Syntax
 =FV (rate, nper, pmt, [pv], [type])
Arguments
 rate - The interest rate per period.
 nper - The total number of payment periods.
 pmt - The payment made each period. Must be entered as a negative
number.
 pv - [optional] The present value of future payments. If omitted,
assumed to be zero. Must be entered as a negative number.
 type - [optional] When payments are due. 0 = end of period, 1 =
beginning of period. Default is 0.
1-8
Single Cash Flow Formula – Present-Worth
Factor
 Single payment P  F(1  i )  N F
present worth factor
(discount factor) P  F( P / F, i, N )
 Given:
i  12% 0
N  5 years N
F  $1,000
 Find:
P
5
P  $1,000(1  0.12)
 $1,000( P / F,12%,5)
 $567.40
Practice Problem
You want to set aside a lump sum amount today

in a savings account that earns 7% annual interest
to meet a future expense in the amount of $10,000
to be incurred in 6 years. How much do you need
to deposit today?

Solution
$10,000
0
6
P P  $10, 000(1  0.07) 6

 $10, 000( P / F , 7%, 6)
 $6, 663

Solving for i

Solution
EXCEL Solution using RATE Function
$20  $10(1  i )5
2  (1  i )5
i  14.87%
=RATE(5,0,-10,20)=14.87%
Syntax
=RATE (nper, pmt, pv, [fv])
nper - The total number of payment periods.
pmt - The payment made each period.
pv - The present value, or total value of all loan payments now.
fv - [optional] The future value, or a cash balance you want
after the last payment is made. Defaults to 0 (zero)
Rule of 72 – Number of Years Required to
Double Your Investment

Solution – Analytical Approach
2P
F  2 P  P (1  0.20) N
2  1.2 N
log 2  N log1.2
0
log 2
N=? N
log1.2
P
 3.80 years

Solution - Rule of 72
Approximating how 72
N
long it will take for a interest rate (%)
sum of money to
double 72

20
 3.6 years

Number of Years Required to Double an Initial
Investment at Various Interest Rates

Uneven Payment Series
 How much do you need to
deposit today (P) to withdraw
$25,000 $25,000 at n =1, $3,000 at n
= 2, and $5,000 at n =4, if
$3,000 $5,000
0 your account earns 10%
1 2 3 4 annual interest?

$25,000
Uneven $3,000 $5,000

0
Payment Series 1 2 3 4
P
$25,000
$3,000 $5,000
0 0 0
1 2 3 4
+ 1 2 3 4
+ 1 2 3 4
P2
P4
P1
P1  $25, 000( P / F ,10%,1) P2  $3, 000( P / F ,10%, 2) P4  $5, 000( P / F ,10%, 4)
 $22, 727  $2, 479  $3, 415
P  P1  P2  P4  $28, 622

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

F = P(1 + i ) n P = F[1 / (1 + 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

2-20
F/P and P/F for Spreadsheets
Future value F is calculated using FV function:
= FV(i%,n,,P)
Present value P is calculated using PV function:

= PV(i%,n,,F)
Note the use of double commas in each function

2-21
Example: Finding Future Value
A person deposits $5000 into an account which pays interest at a rate of 8% per
year. The amount in the account after 10 years is closest to:
(A) $2,792 (B) $9,000 (C) $10,795 (D) $12,165
The cash flow diagram is:

Solution:
F = P(F/P,i,n )
= 5000(F/P,8%,10 )
= 5000(2.1589)
= $10,794.50
Answer is (C)
2-22
Example: Finding Present Value
A small company wants to make a single deposit now so it will have enough money to
purchase a backhoe costing $50,000 five years from now. If the account will earn
interest of 10% per year, the amount that must be deposited now is nearest to:
(A) $10,000 (B) $ 31,050 (C) $ 33,250 (D) $319,160
The cash flow diagram is: Solution:

P = F(P/F,i,n )
= 50,000(P/F,10%,5 )
= 50,000(0.6209)
= $31,045
Answer is (B)
2-23
Equal Payment Series
F
0 1 2 N
A A A
P
0 1 2 N
0 N

Equal Payment Series – Compound Amount
Factor
F
A A A
0 1 2 N
0 1 2 N
F
=
0 1 2
N
A A A
Process of Finding the Equivalent Future
Worth, F F
A
A(1+i)N-2
A A A
A(1+i)N-1
0 1 2 N 0 1 2 N
N 1 N 2  (1  i ) N
 1
F  A(1  i)  A(1  i)    A  A  
 i 
Another Way to Look at the Compound
Amount Factor

Equal Payment Series Compound Amount Factor
(Future Value of an Annuity)
F
(1  i ) N  1
0 1 2 3 FA
N i
A
 A( F / A, i , N )
Example:
 Given: A = $5,000, N = 5 years, and i = 6%
 Find: F
 Solution: F = $5,000(F/A,6%,5) = $28,185.46

Validation
$5,000(1  0.06) 4  $6,312.38 F =?
$5,000(1  0.06)3  $5,955.08 i = 6%
$5,000(1  0.06) 2  $5,618.00 0 1 2 3 4 5
$5,000(1  0.06)1  $5,300.00

$5,000 $5,000 $5,000 $5,000 $5,000
$5,000(1  0.06)  $5,000.00
0
$28.185.46

Finding an Annuity Value
F
i
A F
0 1 2 3 (1  i ) N  1
N
A=?  F ( A / F , i, N )
Example:
 Given: F = $5,000, N = 5 years, and i = 7%
 Find: A
 Solution: A = $5,000(A/F,7%,5) = $869.50

Handling Time Shifts in a Uniform Series
F=?
First deposit occurs at n = 0
i = 6%
0 1 2 3 4 5
$5,000 $5,000 $5,000 $5,000 $5,000

 Annuity Due
F5  $5,000( F / A,6%,5)(1.06)
 $29,876.59
 Excel Solution
Beginning period
=FV(6%,5,5000,0,1)

Sinking Fund Factor
0 1 2 3
N
Example: College Savings Plan

 Given: F = $100,000, N = 8 years, and i = 7%
 Find: A
 Solution:
A = $100,000(A/F,7%,8) = $9,746.78

Excel Solution
 Given:
 F = $100,000 $100,000
 i = 7%
 N = 8 years
Current age: 10 years old
• Find:
0
1 2 3 4 5 6 7 8
=PMT(i,N,pv,fv,type)
=PMT(7%,8,0,100000,0) A=?
=$9,746.78 i = 8%

Example 3.15 Combination of a Uniform Series and
a Single Present and Future Amount

Solution: A Two-Step Approach
 Step 1: Find the required
FC  $500( F / P,7%,5)  $701.30
savings at n = 5.
FRequired Savings  $5,000  $701.30  $4,298.70
 Step 2: Find the required annual

contribution (A) over 5 years.
A  $4,298.70( A / F ,7%,5)
 $747.55

Comparison of Three Different Investment
Plans – Example 3.16

Solution:
   Balance
 at the end of 10 years
   
Investor A: F65  $2,000( F / A,9.38%,10)(1.0938)( F / P,9.38%,31)
            
$33,845
 $545,216
Investor B: F65  $2, 000( F / P,9.38%,31) (1.0938)

         
$322,159
 $352,377
F65  $2, 000( F / P,9.38%, 41) (1.0938)

Investor C:          
$820,620
 $897,594

How Long Would It Take to Save $1 Million?

Loan Cash Flows

Capital Recovery Factor
P
i (1  i ) N
A P
1 2 3 (1  i ) N  1
0 N
 P( A / P, i , N )
A=?
Example: Paying Off an Educational Loan

 Given: P = $21,061.82, N = 5 years, and i = 6%
 Find: A
 Solution: A = $21,061.82(A/P,6%,5) = $5,000

Example: Loan Repayment

Solution:
 Using Interest Factor:
A  $250,000( A / P,8%,6)
 $250,000(0.2163)
 $54,075
 Using Excel:
 PMT(i, N , P)
 PMT(8%,6, 250000)
 $54,075

Example – Deferred Loan Repayment

A Two-Step Procedure
P '  $250, 000( F / P,8%,1)

 $270, 000
A '  $270, 000( A / P,8%, 6)
 $58, 401
Present Worth factor – Find P, Given A, i, and
N
P=? (1  i )  1 N
P A
i (1  i ) N
1 2 3
0 N
 A( P / A, i , N )
A

Example: Inam Ahmed’s Outing’s Lottery
Problem
 Given:
 A = $280,000
 i = 8%
 N = 19
 Find: P
 Using interest factor:
P =$280,000(P/A,8%,19)
= $2,689,008
 Using Excel:
=PV(8%,19,-280000)
= $2,689,008

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
The cash flow diagrams are:
P = A(P/A,i,n) Standard Factor Notation A = P(A/P,i,n)

Note: P is one period Ahead of first A value
2-48
Example: Uniform Series Involving P/A
A chemical engineer believes that by modifying the structure of a certain water
treatment polymer, his company would earn an extra $5000 per year. At an interest
rate of 10% per year, how much could the company afford to spend now to just
break even over a 5 year project period?
(A) $11,170 (B) 13,640 (C) $15,300 (D) $18,950
The cash flow diagram is as follows: Solution:

P = 5000(P/A,10%,5)
= 5000(3.7908)
= $18,954
Answer is (D)
2-49
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
Cash flow diagrams are:
F = A(F/A,i,n) Standard Factor Notation A = F(A/F,i,n)

Note: F takes place in the same period as last A
2-50
Example: Uniform Series Involving F/A
An industrial engineer made a modification to a chip manufacturing process
that will save her company $10,000 per year. At an interest rate of 8% per
year, how much will the savings amount to in 7 years?
(A) $45,300 (B) $68,500 (C) $89,228 (D) $151,500
The cash flow diagram is:

F=? Solution:
F = 10,000(F/A,8%,7)
i = 8%
= 10,000(8.9228)
0 1 2 3 4 5 6 7
= $89,228
Answer is (C)
A = $10,000
2-51
Factor Values for Untabulated i or n
3 ways to find factor values for untabulated i or n values
Use formula
Use spreadsheet function with corresponding P, F, or A value set to 1
Linearly interpolate in interest tables
Formula or spreadsheet function is fast and accurate

Interpolation is only approximate

2-52
Example: Untabulated i
Determine the value for (F/P, 8.3%,10)
Formula: F = (1 + 0.083)10 = 2.2197 OK
Spreadsheet: = FV(8.3%,10,,1) = 2.2197 OK
Interpolation: 8% ------ 2.1589

8.3% ------ y
9% ------ 2.3674
y = 2.1589 + [(8.3 - 8.0)/(9.0 - 8.0)][2.3674 – 2.1589]

= 2.2215 (Too high)
Absolute Error = 2.2215 – 2.2197 = 0.0018

2-53
Interpolation
y-yo/x-xo = y1-yo/x1-xo

1-54
Arithmetic Gradients
Arithmetic gradients change by the same amount each period
The cash flow diagram for the PG

of an arithmetic gradient is: G starts between periods 1 and 2
(not between 0 and 1)
This is because cash flow in year 1 is

usually not equal to G and is handled
separately as a base amount
(shown on next slide)
Note that PG is located Two Periods Ahead

of the first change that is equal to G
Standard factor notation is
PG = G(P/G,i,n)
2-55
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)
2-56
Converting Arithmetic Gradient to A
Arithmetic gradient can be converted into equivalent A value using G(A/G,i,n)
i = 10% i = 10%
0 1 2 3 4 5 0 1 2 3 4 5
G
2G A=?
3G
4G
General equation when base amount is involved is

A = base amount + G(A/G,i,n)
For decreasing gradients,
0 1 2 3 4 5
change plus sign to minus
4G
3G
2G A = base amount - G(A/G,i,n)
G

2-57
Linear Gradient Series
P
Gradient Series as a Composite Series of a Uniform Series
of N Payments of A1 and the Gradient Series of Increments
of Constant Amount G.

Example – Present value calculation for a gradient
series $2,000
$1,750
$1,500
$1,250
$1,000
0
1 2 3 4 5
How much do you have to deposit

now in a savings account that
earns a 12% annual interest, if
P =? you want to withdraw the annual
series as shown in the figure?

Method 1: Using the (P/F, i, N) Factor
$2,000
$1,750
$1,500
$1,250
$1,000
0
1 2 3 4 5
$1,000(P/F, 12%, 1) = $892.86

$1,250(P/F, 12%, 2) = $996.49
$1,500(P/F, 12%, 3) = $1,067.67
P =? $1,750(P/F, 12%, 4) = $1,112.16
$2,000(P/F, 12%, 5) = $1,134.85
$5,204.03

Method 2: Using the Gradient Factor
P1  $1,000( P / A,12%,5)
 $3,604.80
P2  $250( P / G,12%,5)
P  $3,604.08  $1,599.20  $1,599.20
 $5,204

Gradient-to-Equal-Payment Series
Conversion Factor, (A/G, i, N)

Example 3.22 Declining Linear Gradient
Series

Solution:
F  F1  F2
Equivalent Present Worth at n = 0
       
 A1 ( F / A,10%,5)  $200( P / G,10%,5) ( F / P,10%,5)
 $1,200(6.105)  $200(6.862)(1.611)
 $5,115

1-66
1-67
1-68
1-69
1-70
Arithmetic Gradient Uniform Series Factor
If the arithmetic gradient factor is multiplied by the sinking fund factor
(A/F), the result is called the Arithmetic Gradient Uniform Series
Factor:
A=G [ (1 + i)n – in - 1
i {(1 + i)n - 1}
] = G (A/G, i, n)
(gives the uniform series cash flow payment equivalent to that of an

arithmetic gradient cash flow)
Example 3.21 – Find the Equivalent
Uniform Deposit Plan

Solution:
Given : A1  $1,000, G  $300, i  10%,and, N  6

Find : A
A  $1,000  $300( A / G,10%,6)
 $1,000  $300(2.22236)
 $1,667.08

Example: Arithmetic Gradient
Solution:
PT = 400(P/A,12%,5) + 30(P/G,12%,5)
= 400(3.6048) + 30(6.3970)
= $1,633.83
Answer is (B)
The cash flow could also be converted
into an A value as follows:
A = 400 + 30(A/G,12%,5)
= 400 + 30(1.7746)
= $453.24
2-74
1-75
1-76
Types of Geometric Gradient Series
g 0
Present Worth Factor

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)
periods 1 and 2 A 1(1+g) n-1
Note: If g is negative, change signs in front of both g values

2-79
Example: Geometric Gradient
Pg = ? Solution:
i = 12%
1 2 3 4 10 Pg = 1000[1-(1+0.07/1+0.12)10]/(0.12-0.07)
= $7,333
0
1000
1070 Answer is (b)
1145
g = 7%
1838 To find A, multiply Pg by (A/P,12%,10)

2-80
Unknown Interest Rate i
(Usually requires a trial and error solution or interpolation in interest tables)
Procedure: Set up equation with all symbols involved and solve for i
Solution: Can use either the P/A or A/P factor. Using A/P:
60,000(A/P,i%,10) = 16,000
(A/P,i%,10) = 0.26667
From A/P column at n = 10 in the interest tables, i is between 22% and 24% Answer is (d)
2-81
Unknown Recovery Period n
Unknown recovery period problems involve solving for n,
given i and 2 other values (P, F, or A)
(Like interest rate problems, they usually require a trial & error solution or interpolation in interest tables)
Procedure: Set up equation with all symbols involved and solve for n
A contractor purchased equipment for $60,000 that provided income of $8,000

per year. At an interest rate of 10% per year, the length of time required to recover
the investment was closest to:
(a) 10 years (b) 12 years (c) 15 years (d) 18 years
Solution: Can use either the P/A or A/P factor. Using A/P:
60,000(A/P,10%,n) = 8,000
(A/P,10%,n) = 0.13333
From A/P column in i = 10% interest tables, n is between 14 and 15 years Answer is (c)

2-82
Pg = A1{1- [(1+g)/(1+i)]n}/(i-g)

1-83
1-84
1-85
1-86
Summary of Important Points
In P/A and A/P factors, P is one period ahead of first A
In F/A and A/F factors, F is in same period as last A
To find untabulated factor values, best way is to use formula or spreadsheet
For arithmetic gradients, gradient G starts between periods 1 and 2
Arithmetic gradients have 2 parts, base amount (year 1) and gradient amount
For geometric gradients, gradient g starts been periods 1 and 2

In geometric gradient formula, A1 is amount in period 1
To find unknown i or n, set up equation involving all terms and solve for i or n

2-87

Chapter 2 - Factors, Effect of Time & Interest On Money Final0

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 2 - Factors, Effect of Time & Interest On Money Final0

Uploaded by

Copyright:

Available Formats

Factors: How Time

Lecture slides to accompany

© 2012 by McGraw-Hill, New York, N.Y All Rights Reserved

1. F/P and P/F Factors

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

 Single payment compound F

 If you had $2,000 now and invested it at

F  $2, 000(1  0.10) 8

You want to set aside a lump sum amount today

Contemporary Engineering Economics, 4th edition, © 2007

P P  $10, 000(1  0.07) 6

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

Uneven $3,000 $5,000

Contemporary Engineering Economics, 4th edition, © 2007

Formulas are as follows:

© 2012 by McGraw-Hill, New York, N.Y All Rights Reserved

Present value P is calculated using PV function:

Note the use of double commas in each function

(A) $2,792 (B) $9,000 (C) $10,795 (D) $12,165

The cash flow diagram is:

(A) $10,000 (B) $ 31,050 (C) $ 33,250 (D) $319,160

The cash flow diagram is: Solution:

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

$5,000(1  0.06) 4  $6,312.38 F =?

$5,000(1  0.06)3  $5,955.08 i = 6%

$5,000(1  0.06) 2  $5,618.00 0 1 2 3 4 5

$5,000(1  0.06)1  $5,300.00

Contemporary Engineering Economics, 4th edition, © 2007

 Solution: A = $5,000(A/F,7%,5) = $869.50

Contemporary Engineering Economics, 4th edition, © 2007

$5,000 $5,000 $5,000 $5,000 $5,000

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

Example: College Savings Plan

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

 Step 2: Find the required annual

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

Investor B: F65  $2, 000( F / P,9.38%,31) (1.0938)

F65  $2, 000( F / P,9.38%, 41) (1.0938)

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

Example: Paying Off an Educational Loan

 Solution: A = $21,061.82(A/P,6%,5) = $5,000

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

Contemporary Engineering Economics, 4th edition, © 2007

P '  $250, 000( F / P,8%,1)

Contemporary Engineering Economics, 4th edition, © 2007