Chapter 4

More nterest Formulas

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EGR 403 Capital Allocation Theory
Dr. Phillip R. Rosenkrantz
Industrial & ManuIacturing Engineering Department
Cal Poly Pomona
EGR 403 - Cal Poly Pomona - SA6 2
EGR 403 - The Big Picture
Framework: Accounting & Breakeven Analysis
'Time-value oI money concepts - Ch. 3, 4
Analysis methods
Ch. 5 - Present Worth
Ch. 6 - Annual Worth
Ch. 7, 8 - Rate oI Return (incremental analysis)
Ch. 9 - BeneIit Cost Ratio & other techniques
ReIining the analysis
Ch. 10, 11 - Depreciation & Taxes
Ch. 12 - Replacement Analysis
EGR 403 - Cal Poly Pomona - SA6 3
Components oI Engineering
Economic Analysis
Calculation oI P and F are Iundamental.
Some problems are more complex and
require an understanding oI added
components:
UniIorm series.
Arithmetic or geometric gradients.
Nominal and eIIective interest rates (covered in
presentation #5 on Chapter 3).
Continuous compounding.
EGR 403 - Cal Poly Pomona - SA6 4
UniIorm Payment Series
Capital Recovery Factor
The series oI uniIorm payments that will
recover an initial investment.
A P(A/P, i, n)
EGR 403 - Cal Poly Pomona - SA6 5
UniIorm Payment Series
Compound Amount Factor F
The Iuture value oI an investment based on
periodic, constant payments and a constant
interest rate.
A(/A, i, n)
EGR 403 - Cal Poly Pomona - SA6 6
Example 4-1
0 0
$500
$500
$500
$500
$500
Cash in
-$2763 5
4
3
2
1
Cash out Year
F $500(F/A, 5, 5) $500(5.526) $2763
At 5/year
4 5

5 5 5 5 5

4 5
Year Cash n Cash Out
EGR 403 - Cal Poly Pomona - SA6 7
UniIorm Payment Series
Sinking Fund Factor
The constant periodic amount, at a constant interest
rate that must be deposited to accumulate a Iuture
value.
A F(A/F, i, n)
EGR 403 - Cal Poly Pomona - SA6 8
UniIorm Payment Series
Present Worth Factor
The present value oI a series oI uniIorm
Iuture payments.
P A(P/A, i, n)
EGR 403 - Cal Poly Pomona - SA6 9
Example 4-6
F` $100(F/A, 15, 3) $347.25
F`` $347.25(F/P, 15, 2) $459.24
F 5
$0 4
$100 3
$100 2
$100 1
Cash Ilow Year
EGR 403 - Cal Poly Pomona - SA6 10
Example 4-7
Finding the Present
Value (P) Ior each
cash Ilow is
sometimes the easiest
way to Iind the
equivalent P.
P $20(P/F, 15, 2) $30(P/F, 15, 3)
$20(P/F, 15, 4) $46.28
$ 20 4
$ 30 3
$ 20 2
0 1
P 0
Cash Ilow Year
EGR 403 - Cal Poly Pomona - SA6 11
Arithmetic Gradient
A uniIorm increasing
amount.
The Iirst cash Ilow is
always equal to zero.
G the diIIerence
between each cash
amount.
G $10
EGR 403 - Cal Poly Pomona - SA6 12
Arithmetic Gradient combined
with a UniIorm Series
Decompose the cash Ilows into a uniIorm series and a
pure gradient. Then add or subtract the Present Value oI
the gradient to the Present Value oI the UniIorm series
Example 4-8: Use P/G Iactor to Iind present value oI
the pure gradient portion oI the cash Ilow
EGR 403 - Cal Poly Pomona - SA6 13
Arithmetic Gradient
UniIorm Series Factor
A pure gradient (uniIormly increasing amount) can
also be converted into the equivalent present value
oI uniIorm series:
A
G
G(A/G, i, n)
See Example 4-9: Notice that the uniIorm series
portion oI the cash Ilow was subtracted to separate
the pure gradient.
EGR 403 - Cal Poly Pomona - SA6 14
Geometric Series
Present Worth Factor
Sometimes cash Ilows increase at a constant rate
rather than a constant amount. InIlation, Ior
example, could be reIlected in a cash Ilow
diagram that way. The equivalent present value oI
a geometrically increasing amount. g the rate oI
increase (e.g., .05)
P A(P/A, g, i, n) where (P/A, g, i, n) must be
computed Irom equation 4-30 or 4-31
Example 4-12 uses g .10 and i .08