ECC 426 ENGINEERING ECONOMY

Prof.Dr. Cavit Atalar

#ECC426.3
CHAPTER II

Factors: How Time and

Interest Affect Money

1
Overview
1. F/P and P/F Factors
2. P/A and A/P Factors
3. F/A and A/F Factors
4. Interpolate Factor Values
5. P/G and A/G Factors
6. Geometric Gradient
7. Spreadsheets

2
CHAPTER II Section 1

F/P and P/F Factors

3
2.1 Basic Derivations: F/P factor

F/P Factor To find F given P

Fn
To Find F given P

………….
n

Compound forward in time

P0

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

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2.1 Present Worth Factor from F/P

Since Fn = P(1+i)n
We solve for P in terms of FN
P = F{ 1/ (1+i)n} = F(1+i)-n
Thus:
P = F(P/F,i%,n) where
(P/F,i%,n) = (1+i)-n
Thus, the two factors are:
1. F = P(1+i)n finds the future worth of P;
2. P = F(1+i)-n finds the present worth from F
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 2.1 P/F factor – discounting back in
time

Discounting back from the future

Fn

………….
n
P/F factor brings a single
future sum back to a specific
P point in time.

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 Example: P= $1,000;n=3;i=10% What is
the future value, F?
F = ??

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

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

1
0
 Assume F = $100,000, 9 years from now. What is the present worth
of this amount now if i =15%?
P=100,000(1/(1+0.15)9)=100,000(0.2843)= $ 28,430
F9 = $100,000

i = 15%/yr

0 1 2 3 ………… 8 9

P= ??
P0 = $100,000(P/F, 15%,9) = $100,000(1/(1.15)9)
= $100,000(0.2843) = $28,430 at time t = 0

1
1
CHAPTER II Section 2

P/A and A/P Factors

10
2.2 Uniform Series Present Worth and
Capital Recovery Factors

Annuity Cash Flow

P = ??

1 2 3
…………..
.. .. n-1 n
0

$A per period

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2.2 Uniform Series Present Worth and
Capital Recovery Factors

Desire an expression for the

present worth – P of a stream of
equal, end of period cash flows - A
P = ??

0 1 2 3 n-1 n

A = given

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2.2 Uniform Series Present Worth and
Capital Recovery Factors

Write a Present worth expression

[1]

Term inside the brackets is a geometric progression.

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

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 2.2 Uniform Series Present Worth and
Capital Recovery Factors

The second equation

[2]

To isolate an expression for P in terms of A, subtract

Eq [1] from Eq. [2]. Note that numerous terms will
drop out.

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2.2 Uniform Series Present Worth and
Capital Recovery Factors

Setting up the subtraction

[2]

- [1]

= [3]

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2.2 Uniform Series Present Worth and
Capital Recovery Factors

Simplifying Eq. [3] further

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2.2 Uniform Series Present Worth and
Capital Recovery Factors

This expression will convert an annuity

cash flow to an equivalent present
worth amount one period to the left of
the first annuity cash flow.

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2.2 Capital Recovery Factor A/P,
i%, n
The present worth point
of an annuity cash flow is
always one period to the
left of the first A amount
Given the P/A factor

Solve for A in terms of P

Yielding….

A/P,i%,n factor

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CHAPTER II Section 3

F/A and A/F Factors

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2.3 F/A and A/F Derivations $F

Annuity Cash Flow

…………..
N
0

Find $A given the

$A per period Future amt. - $F

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2.3 Sinking Fund and Series Compound
amount factors (A/F and F/A)

Take advantage of what we already

have
Recall: Substitute “P” and
simplify!

Also:

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2.3 A/F Factor

By substitution
we see:

Simplifying we
have:
Which is the
(A/F,i%,n) factor

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2.3 F/A factor from the A/F Factor

Given:

Solve for F in
terms of A

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2.3 F/A and A/F Derivations $F

Annuity Cash Flow

…………..
N
0

Find $F given the $A

$A per period amounts

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2.3 Example 2.5

Formosa Plastics has major

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

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2.3 Example 2.5

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

•F8 = ??

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 2.3 Example 2.5
Solution:
The cash flow diagram shows the annual payments starting at the end of year 1 and
ending in the year the future worth is desired. Cash flows are indicated in $1000 units.
The F value in 8 years is

F = l000(F/A,14%,8) = 1000( 13.23218)

= $13,232.80 = 13.232 million 8 years from now.

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2.3 Example 2.6

How much money must Carol deposit every

year starting, l year from now at 5.5% per
year in order to accumulate $6000 seven
years from now?

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2.3 Example 2.6

Solution
The cash How diagram from Carol's
perspective fits the A/F factor.
A= $6000 (A/F,5.5%,7) = 6000(0.12096)
= $725.76 per year
The A/F factor Value 0f 0.12096 was
computed using the A/F factor formula

41
0.12282+0.11915=0.24196/2=0.12098
CHAPTER II

Interpolation in
Tables

30
2.4 Interpolation of Factors
• All texts on Engineering economy will provide
tabulated values of the various interest factors
usually at the end of the text in an appendix
• Refer to the back of your text for those tables.

44
2.4 Interpolation of Factors
• Typical Format for Tabulated Interest Tables

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

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2.4 An Example
• Assume you need the value of the A/P factor
for i = 7.3% and n = 10 years.
• 7.3% is most likely not a tabulated value in
most interest tables
• So, one must work with i = 7% and i = 8% for
n fixed at 10
• Proceed as follows:

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2.4 Basic Setup for Interpolation

•Work with the following basic relationships

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2. 4 i = 7.3% using the A/P factor
• For 7% we would observe:

COMPOUND PRESENT SINKING COMPOUND CAPITAL

N AMT. FACTOR WORTH FUND AMOUNT RECOVERY

F/P P/F A/F F/A A/P
10 1.9672 0.5083 0.0724 13.8164 0.14238

A/P,7%,10) = 0.14238

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2. 4 i = 7.3% using the A/P factor
• For i = 8% we observe:
COMPOUND PRESENT SINKING COMPOUND CAPITAL

N AMT. FACTOR WORTH FUND AMOUNT RECOVERY

F/P P/F A/F F/A A/P
10 2.1589 0.4632 0.0690 14.4866 0.14903

(A/P,8%,10) = 0.14903

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2. 4 Estimating for i = 7.3%
• Form the following relationships

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2.4 Final Estimated Factor Value

• Observe for i increasing from 7% to 8% the

A/P factors also increases.
• One then adds the estimated increment to the
7% known value to yield:

52
8% 0.14903
7% 0.14238
TOTAL 0.00665
0.00665x0.1= 0.000665
0.14238+0.000665=0.143045
0.00665x0.2= 0.00133
0.14238+0.00133=0.14371
0.000665x0.3= 0.0199
0.14238+0.0199=0.144375
2.4. The Exact Value for 7.3%
• Using a previously programmed spreadsheet
model the exact value for 7.3% is:

54
References

[1] Leland Blank and Anthony Tarquin (2011)Engineering Economy 7.th Edition,
McGraw Hill
[2] Leland Blank and Anthony Tarquin (2018)Engineering Economy 8.th Edition,
McGraw Hill
[3] William G. Sullivan, Elin M. Wicks and C. Patrick Koelling (2018) Engineering
Economy 17.th Edition, Pearson