Engineering Economics & Management

MS490
Time Value of Money

Muhammad Ullah
Assistant Professor
School of Management Sciences GIKI
Contents
• Unform Series / Annuities
– Uniform Series Present Worth Factor (USPWF)
– Capital Recovery Factor (CRF)
– Uniform Series Compound Amount Factor (USCAF)
– Sinking Fund Factor (SFF)
Recap
𝒏 Single Payment Compound Amount
𝑭=𝑷 𝟏+𝒊
Factor (SPCAF), also 𝑭/𝑷 factor

𝑭 𝒏 Single Payment Present

𝑷 = (𝟏 =𝑭 𝟏+𝒊
𝒊)𝒏 Worth Factor, 𝐏/𝑭 factor

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Uniform Series/ Annuities
• Practically, we do not face Single Payments mostly.
• Instead, we have cash flows such as home mortgage payments, fixed lease payments and
monthly insurance payments.
• Annuity is an equal periodic (e.g. monthly, quarterly or annual) series of cash flows.
• It may be equal ‘annual deposit, equal annual withdrawals, equal annual payments, or equal
annual receipts.
• Most important point is equal periodic cash flows.
A Typical Uniform Series and its Present Worth
Present Worth of Uniform Series
Uniform Series Present Worth Factor (USPWF)
1+𝑖 −1
𝑃=𝐴
𝑖 1+𝑖

is Uniform Series Present Worth Factor (USPWF). It is represented by 𝑃/𝐴.

 Example: P/A Factor

An engineer believes that by modifying the structure of a certain water treatment plant, his
company would save Rs. 50,000 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 6 year project period?

P = A(P/A, i, n)
P = Rs. 50,000(P/A,10%,6)
P = Rs. 50,000 (4.3553)
P = Rs. 217,765
 Capital Recovery Factor (CRF or A/P Factor)

1+𝑖 −1
𝑃=𝐴
𝑖 1+𝑖

𝑖 1+𝑖
𝐴=𝑃
1+𝑖 −1

 is called Capital Recovery Factor.

 It calculates the equivalent uniform annual worth over years for a
given in year 0, when the interest rate is .
 Application: Calculating loan installment
Example 2.3: CRF or A/P Factor
Q: 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 # 1
1+𝑖 −1
𝑃=𝐴
𝑖 1+𝑖

1 + 0.16 − 1
𝑃 = 600
0.16 1 + 0.16

𝑃 = 2,763.93
Example 2.3: Using Tables
Q: 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 # 2

Solution
𝑃 = 600 𝑃⁄𝐴, 16%, 9
𝑃 = 600 4.6065
𝑃 = 2,763.90
Example: Calculating P from A
“Make your best deal with us on a new automobile and we’ll change your oil for free for as
long as you own the car!” If you purchase a car from this dealership, you expect to have
four free oil changes per year during the five years you keep the car. Each oil change would
normally cost you $30. If you save your money in a mutual fund earning 2% per quarter,
how much are the oil changes worth to you at the time you buy the car?
Given:
Cost of an oil change = $30
Quarterly interest rate = 2%
Deal validity = 5 years
Total Oil Changes = 20
Solution
Example: Calculating A from P
Q:You borrow $15,000 from a bank to purchase a used car. The interest rate on your loan
is 0.25% per month and you will make a total of 36 monthly payments. What is your
monthly payment?
Solution # 1
Q: Will the initial investment be recovered over the 5-year horizon with the time value of
money considered? If so, by how much extra in present worth funds?

Give: Initial Investment = 200M

Since 𝑃 < 200; the answer is NO.
Solution # 2
Q: If not, what is the equivalent annual revenue base required for the recovery plus the 10%
return on money?

In order to break-even, the cement

factory would need an annual revenue
of at least;
Sinking Fund Factor and Uniform Series Compound Amount
Factor
• So far, we calculated 𝑃/𝐴 and 𝐴/𝑃 factors.
=> Relationship between uniform series and present values

• Now it is time to calculate 𝐹/𝐴 and 𝐴/𝐹 factors.

=> Relationship between uniform series and future values
Sinking Fund Factor
factor relationship is given by;

𝑃=𝐴

𝐴=𝑃

Since

𝐴=

𝐴=𝐹 Sinking Fund Factor

𝐹=𝐴 Uniform Series Compound Amount Factor

and Factors: Notation and Equations
Example: Sinking Fund Factor
An engineering firm has to pay Rs. 1,000,000 for the replacement of production plant by
the end of fifth year from now. The market rate of interest is 10% per year. How much the
company should deposit annually in a saving account to have exactly Rs. 1,000,000 by the
end of fifth year?
Solution:
𝐴 = 𝐹 (𝐴/𝐹, 𝑖, 𝑛)
𝐴 = 𝑅𝑠. 1,000,000(𝐴/𝐹, 10%, 5)
𝐴 = 𝑅𝑠. 1,000,000 (0.16380)
𝐴 = 𝑅𝑠. 163,800
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 Thank You

Any Questions?
Email: Muhammad.ullah@giki.edu.pk