Chapter 2

Factors: How Time and Interest Affect

Money

PURPOSE
Learn engineering economy
factors and use them to account
for the time value of money
Factors
TOPICS
 Single amount factors – F/P, P/F
 Uniform series factors – P/A, A/P, F/A, A/F
 Gradients and factors
 Shifted cash flows
 Spreadsheet use
 Standard Notation
(X/Y,i,n) • Tables are prepared (given at the end
X= Sought (P or F) of the book) for different (i & n)
Y= Given (F or P) combinations and provides F/P and
P/F factors.
i= interest rate
• n=years (period) • (P/F, 6%, 10) = 0.5584
• (F/P, 6%, 10) = 1.7908
(F/P, 6%, 20)

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 Interest Table
Example page of compound interest factors for i = 6% per year
 Single Payment Factors (F/P, P/F)

Fundamental equation determines amount F accumulated after

t = 1, 2, …, n years for a single present amount P

F5 = ?
F1 = P + Pi = P(1 + i)
F2 = F1 + F1i 0 1 2 3 4 5

= P(1 + i) + P(1 + i)i

= P(1 + i)2
$1,000
t
Ft = P(1 + i)

Fn = P(1 + i)n F5 = 1,000(1 + i)5

 Single Payment Factors (F/P, P/F)
Find F, given P Find P, given F
Formula: F = P(1 + i)n P = F[1/(1 + i)n]
Notation: F=P(F/P,i%,n) Notation: P=F(P/F,i%,n)

(1+i)n =single-payment compound 1/(1+i)n = single-payment present worth factor

amount factor

Excel function: = PV(i%,n,,F)

Excel function: = FV(i%,n,,P)
 Single Payment Factors
Example: Ada, Inc. can pay $10,000 now or $15,000 five years from now for power back-up equipment.
Are these P and F values equivalent at 5% per year?

Find F in n = 5 years for Find P now for F = $15,000 five

P = $10,000 now at i = 5% years in the future at i = 5% F = $15,000
F=?

0 1 2 3 4 5 0 1 2 3 4 5

P= P=?
$10,000
F = 10,000(F/P,5%,5) P = 15,000(P/F,5%,5)

= 10,000(1.2763) = 15,000(0.7835)
= $11,753 (≠ $10,000)
= $12,763 (≠ $15,000)
 Example
Sandy, a manufacturing engineer, just received a year-end bonus of
$10,000 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.

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 Example
Solution:
P = $10,000, F = ?, i = 8% per year, n = 20 years

F = P(1 + i)n = 10,000(1.08)20 = 10,000(4.6610) = $46,610

Also by using the compound interest tables we can solve this example as
follows:
F = P(F/P,8%,20) = 10,000(4.6610) = $46,610

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 Example
Hewlett-Packard has completed a study indicating that $50,000 in
reduced maintenance this year (i.e., year zero) on one processing line
resulted from improved wireless monitoring technology.
a. If Hewlett-Packard considers these types of savings worth 20% per
year, find the equivalent value of this result after 5 years.
b. If the $50,000 maintenance savings occurs now, find its equivalent
value 3 years earlier with interest at 20% per year.

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 Example

• A) Given
• P=$50,000
• i=20%
• n=5
• Find
• F=?
• Solution
• F=50,000 * (2.4883)…page 409
• F= $124,415

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 Example
b) Given
• F=$50,000
• i=20%
• n=3
• Find
• P=?
• Solution
• P=50,000 * (0,5787)…….table pg 409
• P=$28,935

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 Example
• The Houston American Cement factory will require an investment of $200 million
to construct. Delays beyond the anticipated implementation year of 2012 will
require additional money to construct the factory. Assuming that the cost of
money is 10% per year, compound interest, determine the following for the board
of directors of the Brazilian company that plans to develop the plant.
(a) The equivalent investment needed if the plant is built in 2015.
(b) The equivalent investment needed had the plant been constructed in the year
2008.
 Example
Jamie has become more conscientious about paying off his credit card bill promptly
to reduce the amount of interest paid. He was surprised to learn that he paid $400
interest in 2007 and the amounts shown in Figure 2.3 over the previous several
years. If he made his payments to avoid interest charges, he would have these
funds plus earned interest available in the future. What is the equivalent amount 5
years from now that Jamie could have available had he not paid the interest
penalties? Let i 5% per year.

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 Solution

• F=600(F/P,5%,10)+300(F/P,5%,8)+400(F/P,5%5)
• F=600*1.6289+300*1.4775+400*1.2763=$1932.11

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 Uniform Series Factors

• Four factors involve a uniform series A

• A is the same amount in consecutive interest periods

Find P, given A Find A, given P

Formula: Formula:

Notation: P = A(P/A,i%,n) Notation: A = P(A/P,i%,n)

Excel function: = PV(i%,n,A,F) Excel function: = PMT(i%,n,P,F)
 Uniform Series Factors

Example: Carla needs $600 each year for 9 years starting next year.
If i = 16% per year, find the equivalent amount now

P = 600(P/A,16%,9) = 600(4.6065) = $2764

 Uniform Series Factors
Remember
 When using the P/A factor, the present worth P is always located
ONE period prior to the first uniform-series amount A

 When using the A/P factor, the uniform-series amount A starts

ONE period after the present worth P value and continues for n
consecutive periods
 Uniform Series Factors

Find F, given A Find A, given F

Formula:
Formula:

Notation: F = A(F/A,i%,n) Notation: A = F(A/F,i%,n)

Excel function: = PMT(i%,n,P,F)

Excel function: = FV(i%,n,A,P)
 Uniform Series Factors
Example: General Contractors, Inc. is establishing a sinking fund to accumulate $60,000
after 7 years. What is the required annual deposit ? Assume i = 5.5% per year.

F = $ 60,000

Use A/F factor

A = 60,000(A/F,5.5%,7) = 60,000(0.12096) = $7258 per year
 Factor Values for Untabulated i or n Values

Determine the P/A factor value for i = 7.75% and n = 10 years, using the
linear interpolation.
 Example
Formasa Plastics has major fabrication plants in Texas and Hong Kong. The
president wants to know the equivalent future worth of $1 million capital
investments each year for 8 years, starting 1 year from now. Formasa capital earns
at a rate of 14% per year.
Solution
A=1,000,000 n=8 i= 14% Find : F=?

F= A(F/A, 14%, 8)
F= 1,000,000*(13.2328) =13,232,800

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 Gradient Formulas
• GRADIENT
When payments at the end of each interest period are not equal

Arithmetic gradient:
• Cash flow increases/decreases by the same amount compared to
the previous one
e.g. 800, 900, 1000,
Geometric gradient:
• Cash flow changes by a constant percentage of each period
e.g. increase 3%

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 Gradient Formulas
Arithmetic gradient series – Starts at base amount and increases by
constant gradient G in years 2 through n

Base
Amount
A

P = A(P/A,i%,n) + G(P/G,i%.n)
This total present worth of base and gradient
 Arithmetic Gradients
P/G factor formula for gradient only

A/G factor for annual equivalent of gradient only

P/G and A/G factors are in the tables at the rear of text
 Arithmetic Gradients
Example: Estimated annual revenue is $5,000 increasing by $500 per year
starting next year. Find P and A equivalent over an 8-year period at i = 10%.

$8500

$8000
Gradient, G = $500 $7500
$7000
$6500
$6000
$5500
Base $5000

A = $5000

0 1 2 3 4 5 6 7 8
 Arithmetic Gradients
P = $34,689 $8500
$8000
$7500 A = $6502
$7000
$6500
$6000
$5500
$5000

0 1 2 3 4 5 6 7 8

P = A(P/A,i%,n) ± G(P/G,i%.n)
= 5000(P/A,10%,8) + 500(P/G,10%,8) = $34,689

A = 5000 + 500(A/G,10%,8)
= 5000 + 500(A/G,10%,8) = $6502 per year
 Example
The Highway Department expects the cost of maintenance for a piece of heavy
construction equipment to be $5000 in year 1, to be $5500 in year 2, and to
increase annually by $500 through year 10. At an interest rate of 10% per year,
determine the present worth of 10 years of maintenance costs.
• Given: A=$5,000, G=$500, n=10 years, i= 10% Find: P=?

P=A(P/A, i, n) + G(P/G, i, n)
P=5000*(6.1446) + 500*(22.8913)
P=$42,169

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 Arithmetic gradient series with the base amount A.

Equivalent A
1 𝑛
• 𝐴𝐺 =G −
𝑖 1+𝑖 𝑛 −1
• 𝐴 𝑇 = 𝐴1 ± 𝐴𝐺
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 Example
The cash flow associated with a strip mining operation is expected
to be $200,000 in year 1, $180,000 in year 2 and amount decreasing
by $20,000 annually through year 8. At an interest rate of 12% per
year, calculate the annual equivalent cash flow.

A1=$200,000, G= $20,000, i=12%, n=8

AG=-20,000 *[2,9131]
AG= -$58,262
AT= A1+AG
AT= =200,000-58,262=141,738
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Sec 2.3 – Geometric Gradient Formulas
Geometric gradient series – Starts from base amount A1
and increases by constant percentage g in years 2
through n
A1(1+g)n-1
P=?

A1(1+g)2
A1(1+g)
A1
....
0 1 2 3 n -2 n-1 n
 Sec 2.3 – Geometric Gradients
Example: Payroll totals $250,000 this
• Present worth – No tabulated factors year; expected to grow at 5% per year
for next 5 years. Find P at i = 12%.

Year 1: $250,000
Year 5: 250,000(1.05)5 = 319,070

• This is P for all cash flows, including

A1
= 250,000(3.94005)
• Term in brackets is (P/A,g,i%,n) factor = $985,013
 Example
A mechanical contractor has four employees whose combined salaries
through the end of this year are $250,000. If he expects to give an
average raise of 5% each year, calculate the present worth of the
employees’ salaries over the next 5 years. Let i=12% per year.
1+0,05 𝑛
1−( )
1+0,12
• 𝑃 = 250,000[ ]
0,12−0,05
• P=985,013

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 Example
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.
 Shifted Series
• A series that starts at a time other than the end of year 1.
• To find P: Determine the P one year prior to start, then use P/F
factor to find P0

P0 = ?

Year 0, P = P3(P/F,i%,3) = 50(P/A,i%,10)(P/F,i%,3)

 Shifted Series
• To find F in year n of series: Apply F/A factor for n years

Year 13, F = 50(F/A,i%,10)

• To find F in later year: Determine F in year n,

then apply F/P factor
 Shifted Arithmetic Gradients
• For P - Use P/G factor for PG one year prior to gradient start; then
apply P/F factor for P0

• For A – Use A/P factor on P0

P0 = [50(P/A,6%,5) + PG] (P/F,6%,5) + 10(P/A,6%,5)

= [50(P/A,6%,5) + 15(P/G,6%,5)] (P/F,6%,5) + 10(P/A,6%,5)
= $288
 Example
An engineering technology group just purchased new CAD software for $5000 now and
annual payments of $500 per year for 6 years starting 3 years from now for annual
upgrades. What is the present worth of the payments if the interest rate is 8% per year?
PA = 500(P/A,8%,6)*(P/F,8%,2)
PA = 500(4.6229) * (0.8573) = 1981.61
PT = P0+ PA = 5000 + 1981.61 = $6,981.61

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 Example
Set up the engineering economy relations to compute the equivalent
annual series in years 1 through 7 for the cash flow estimates in Figure
below.
 Example
Chemical engineers at a Coleman Industries plant in the Midwest have
determined that a small amount of a newly available chemical additive will
increase the water repellency of Coleman’s tent fabric by 20%. The plant
superintendent has arranged to purchase the additive through a 5-year
contract at $7000 per year, starting 1 year from now. He expects the annual
price to increase by 12% per year starting in the sixth year and thereafter
through year 13. Additionally, an initial investment of $35,000 was made now
to prepare a site suitable for the contractor to deliver the additive. Use i=15%
per year to determine the equivalent total present worth for all these cash
flows.

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Example

41
Example

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 Example
• Morris Glass Company has decided to invest funds for the next 5 years so that
development of “smart” glass is well funded in the future.
• This type of new-technology glass uses electro chrome coating to allow rapid
adjustment to sun and dark in building glass, as well as assisting with internal
heating and cooling cost reduction.
• The financial plan is to invest first, allow appreciation to occur, and then use the
available funds in the future.
• All cash flow estimates are in $1000 units, and the interest rate expectation is
8% per year. Years 1 through 5: Invest $7000 in year 1, decreasing by $1000 per
year through year 5. Years 6 through 10: No new investment and no
withdrawals. Years 11 through 15: Withdraw $20,000 in year 11, decreasing
20% per year through year 15.
• Determine if the anticipated withdrawals will be covered by the investment and
appreciation plans. If the withdrawal series is over- or underfunded, what is the
exact amount available in year 11, provided all other estimates remain the
same?
Example