Chapter 4

More Interest Formulas

EGN 3615
ENGINEERING ECONOMICS
WITH SOCIAL AND GLOBAL
IMPLICATIONS

1
Chapter Contents
Uniform Series Compound Interest Formulas
Uniform Series Compound Amount Factor
Uniform Series Sinking Fund Factor
Uniform Series Capital Recovery Factor
Uniform Series Present Worth Factor
Arithmetic Gradient
Geometric Gradient
Nominal Effective Interest
Continuous Compounding

2
Uniform Series Compound Amount Factor
A A A A F1+F2+F3+F4 =F

0 1 2 3 4 0 1 2 3 4
A F1

0 1 2 3 4 F1  A (1  i )3
A F2

0 1 2 3 4 F2  A (1  i ) 2

A F3

0 1 2 3 4 F3  A (1  i )
A=F4

0 1 2 3 4
F4  A
3
Uniform Series Compound Amount Factor
That is, for 4 periods,

F = F1 + F 2 + F 3 + F 4

= A(1+i)3 + A(1+i)2 + A(1+i) + A

= A[(1+i)3 + (1+i)2 + (1+i) + 1]

4
Uniform Series Compound Amount Factor
F
For n periods with interest (per period),
A A A A A A

0 1 2 3 4 n-1 n

F = F1 + F2 + F3 + … + Fn-1 + Fn

= A(1+i)n-1 + A(1+i)n-2 + A(1+i)n-3 + … + A(1+i) + A

= A[(1+i)n-1 + (1+i)n-1 + (1+i)n-3 + …+ (1+i) + 1]

5
Uniform Series Compound Amount Factor

 (1  i ) n  1
F A   A ( F / A, i, n)
 i 
Notation
Uniform Series
Compound Amount Factor
i = interest rate per period
n = total # of periods
6
 Uniform Series Formulas (Compare to slide 25)
(1) Uniform series compound amount: Given A, i, & n, find F
F = A{[(1+i)n – 1]/i} = A(F/A, i, n) (4-4)
(2) Uniform series sinking fund: Given F, i, & n, find A
A = F{i/[(1+i)n – 1]} = F(A/F, i, n) (4-5)
(3) Given F, A, & i, find n
n = log(1+Fi/A)/log(1+i)
(4) Given F, A, & n, find i
There is no closed form formula to use.
But rate(nper, pmt, pv, fv, type, guess)
7
 Uniform Series Compound Amount Factor
 Question: If starting at EOY1, five annual deposits of $100 each are
made in the bank account, how much money will be in the account
at EOY5, if interest rate is 5% per year?
F= 552.6
i=0.05
0 1 2 3 4 5

$100 $100 $100 $100 $100

 (1  i ) n  1  (1  0.05) 5  1
F A   100    100(5.526)
 i   0.05 
8
QUESTION CONTINUES (USING INTEREST TABLE)
F= 552.6
i=0.05
0 1 2 3 4 5

$100 $100 $100 $100 $100

 (1  i ) n  1
F A   A ( F / A, i %, n)  100 (5.526)
 i 

9
QUESTION CONTINUES(SPREADSHEET)

A= ($100) $552.6
i= 5%
n= 5
Go to XL
--Chap 4 extended examples-A1
Use function: FV(rate, nper, pmt, pv, type)
10
Uniform Series Compound Amount Factor
 Question: Five annual deposits of $100 each are made into an
account starting today. If interest rate is 5%, how much money
will be in the account at EOY5?
F1 F2= 580.2
i=5%
0 1 2 3 4 5

$100 $100 $100 $100 $100

 (1  i ) n  1  (1  0.05) 5  1
F1  A    100    100 (5.526)  552.6
 i   0.05 
F2  F1 (1  i ) n  552.6 (1  0.05)1 11
QUESTION CONTINUES(INTEREST TABLE)
F1 F2= 580.2
i=5%
0 1 2 3 4 5

$100 $100 $100 $100 $100

 (1  i ) n  1
F1  A    A ( F / A, i %, n)
 i 
 A ( F / A, 5%, 5)
 100 (5.526)  552.6
F2  F1 ( F / P, 5%, 1)  552.6 (1.050) 12
QUESTION CONTINUES(SPREADSHEET)

A= ($100) $552.6
i= 5% $580.2
n= 5

13
Uniform Series Compound Amount Factor
 Question: If starting at EOY1, five annual deposits of $100 each are
made in the bank account, how much money will be in the account
at EOY5, if interest rate is 6.5% per year?
F= ?
i=6.5%
0 1 2 3 4 5

$100 $100 $100 $100 $100

( F / A,6.5%,5)  ?
( F / A,6%,5)  5.6371
( F / A,7%,5)  5.7507
14
 ( F / A,6%,5)  5.6371
INTERPOLATION ( F / A,7%,5)  5.7507

6.0 5.6371
0.5 X
1 6.5 0.1136

7.0 5.7507
0. 5 X

1 0.1136
X  0.0568
(F/A, 6.5%, 5)  5.6371  0.0568  5.6939
F  100(F/A, 6.5%, 5)  100 (5.6939)  569.39
Interpolation
15
Uniform Series Sinking Fund Factor
F=Given
i=Given
0 1 2 3 4 5
n=Given

A=?

A= Equal Annual Dollar Payments

F= Future Some of Money
i = Interest Rate Per Period
n= Number of Interest Periods
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Uniform Series Sinking Fund Factor

 i 
AF   F (A / F , i %, n)
 (1  i )  1
n

Notation
Uniform Series
Sinking Fund
Factor

17
 Uniform Series Sinking Fund Factor
Question: A family wishes to have $12,000 in a bank account
by the EOY 5. to accomplish this goal, five annual deposits
starting at the EOF year 1 are to be made into a bank account
paying 6% interest. what annual deposit must be made to
reach the stated goal?
F=$12,000
i=5%
0 1 2 3 4 5
n=5

A =$2172
 i   0.05 
AF   12,000    12,000 (0.1810)
 (1  i )  1  (1  0.05)  1
n 5
18
QUESTION CONTINUES(INTEREST TABLE)
F=$12,000
i=5%
0 1 2 3 4 5
n=5

A = $2172
 i 
AF   F ( A/F, i%, n)
 (1  i )  1
n

 F ( A/F, 5%, 5)
 12,000 (0.1810)
19
 Uniform Series Sinking Fund Factor
 Question: A family wishes to have $12,000 in a bank account by the
EOY 5. to accomplish this goal, six annual deposits starting today
are to be made into a bank account paying 5% interest. What
annual deposit must be made to reach the stated goal?
F=$12,000
i=5%
0 1 2 3 4 5
n=6

A = $1764
 i   0.05 
AF   12,000    12,000 (0.1470)
 (1  i )  1  (1  0.05)  1
n 6
20
 $1764
QUESTION CONTINUES(INTEREST TABLE)
F=$12,000
i=5%
0 1 2 3 4 5
n=6

A = $1764
 i 
AF   F ( A/F, i%, n)
 (1  i )  1
n

 F ( A/F, 5%, 6)
 12,000 (0.1470)
21
Uniform Series Sinking Fund Factor
 Example: the current balance of a bank account is $2,500. starting
EOY 1 six equal annual deposits are to be made into the account.
The goal is to have a balance of $9000 by the EOY 6. if interest rate
is 6%, what annual deposit must be made to reach the stated goal?
F=$9000
i=6%
0 1 2 3 4 5 6

P=$2,500 A = $796.23
FPvalue  2,500 (F/P, 6%, 6)  2,500 (1.419)  3547.50
FTotal  9000  3547.50  5452.50
A  5452.50 (A/F, 6%, 6)
A  5452.50 (0.1434) 22
Uniform Series Capital Recovery Factor
P=Given
i=Given
0 1 2 3 4 5
n

A=?
P= Present Sum of Money
A= Equal Annual Dollar Payments
i = Interest Rate
n= Number of Interest Periods
23
Uniform Series Capital Recovery Factor
 i  n i 
AF   P(1  i )  
 (1  i )  1  (1  i )  1
n n

 i (1  i ) 
n
AP   P (A / P, i %, n)
 (1  i )  1
n

Notation
Uniform Series
Capital
Recovery Factor 24
 Uniform Series Formulas (Compare to slide 7)
(1) Uniform series present worth: Given A, i, & n, find P
P = A{[(1+i)n – 1]/[i(1+i)n]} = A(P/A, i, n) (4-7)
(2) Uniform series capital recovery: Given P, i, & n, find A
A = P{[i(1+i)n]/[(1+i)n – 1]} = P(A/P, i, n) (4-6)
(3) Given P, A, & i, find n
n = log[A/(A-Pi)]/log(1+i)
(4) Given P, A, & n, find i (interest/period)
There is no closed form formula to use.
But rate(nper, pmt, pv, fv, type, guess)
25
 Uniform Series Capital Recovery Factor
 Example: A person borrows $100,000 from a commercial bank. The
loan is to be repaid with five equal annual payments. If interest rate
is 10%, what should the annual payments be?
P= $100,000
i=10%
0 1 2 3 4 5

A =26,380
 i (1  i ) n   0.1(1  0.1) 5 
AP   100,000  
 (1  i )  1  (1  0.1)  1
n 5

 100,000 (0.2638)
26
Example CONTINUES(INTEREST TABLE)
P= $100,000
i=10%
0 1 2 3 4 5

A =26,380

A  P ( A/P, i%, n)
 100,000 ( A/P, 10%, 5)
 100,000 (0.2638)
27
Uniform Series Capital Recovery (MS EXCEL)
Use function: PMT(rate, nper, pv, fv, type)
rate = interest rate/period
nper = # of periods
pv = present worth
fv = balance at end of period n (blank means 0).
type = 1 (payment at beginning of each period) or
0 (payment at end of a period)(blank means 0)

See spreadsheet

28
Uniform Series Capital Recovery Factor
Example: At age 30, a person begins putting $2,500 a
year into account paying 10% interest. The last deposit
is made on the man’s 54th birthday (25 deposits).
Starting at age 55, 15 equal annual withdrawals are
made. How much should each withdrawal be?
Solution
Step 1: First A will be converted into F.
Step2: F will be considered as P.
Step3: P will be converted into Second A

29
EXAMPLE CONTINUES
F = 245,868
i=10%
0 1 2 3 21 22 23 24

A=$2500
F  2500 ( F/A, 10%, 25)  2500 (98.347)
i=10%

0 1 2 3 12 13 14 15

A =$32,332
P= $245,868
A  245,868 ( A/P, 10%, 15)  245,868 (0.1315)
30
Uniform Series Present Worth Factor

A=Given

0 1 2 3 4 5
n=Given
i=Given
P=?

A= Equal Annual Dollar Payments

P= Present Sum of Money (at Time 0)
i = Interest Rate/Period
n= Number of Interest Periods
31
Uniform Series Present Worth Factor

 (1  i ) n  1
PA n 
 A ( P / A, i, n)
 i (1  i ) 

Notation
Uniform Series
Present Worth
Factor

32
 Uniform Series Present Worth Factor
 Example: A special bank account is to be set up. Each year, starting
at EOY 1, a $26,380 withdrawal is to be made. After five withdrawals
the account is to be depleted. if interest rate is 10%, how much
money should be deposited today?
A=26,380

0 1 2 3 4 5

i=10%
P= 100,001
 (1  i ) n  1  (1  0.1) 5  1
PA n 
 26,380  5
 26,380(3.791)
 i (1  i )   0.1(1  0.1)  33
EXAMPLE CONTINUES (USING INTEREST TABLE)

A=26,380

0 1 2 3 4 5

i=10%
P= 100,001
P  A ( P/A, i%, n)
 26,380 ( P/A, 10%, 5)
 26,380 (3.791)
34
Uniform Series Present Worth (Using MS EXCEL)
Use function: PV(rate, nper, pmt, fv, type)
rate = interest rate/period
nper = total # of periods (payments)
pmt = constant payment/period
fv = balance at end of period n (blank means 0)
type = 1 or 0
PV(0.1, 5, -26380) = $100,000.95
See spreadsheet

35
 Uniform Series Present Worth Factor
Example: Eight annual deposits of $500 each are made into a
bank account beginning today. Up to EOY 4, the interest rate
is 5%. After that, the interest rate is 8%. What is the present
worth of these deposits?

PTotal  ?
i=5% i=8%

0 1 2 3 4 5 6 7

P3 P2 A=500 P1
36
 EXAMPLE CONTINUES
PTotal
i=5% i=8%

0 1 2 3 4 5 6 7

P3 P2 A=500 P1
P3  500 P2  500(P/A, 5%, 4) P1  500 (P/A, 8%, 3)
 500(3.546)  1773  (P/F, 5%, 4)
 500(2.577)(0.8227)
PTotal  P1  P2  P3  3333.05
 1060.05
37
 EXAMPLE CONTINUES (Using MS EXCEL)
P1 = PV(0.08, 3, -500)(1+0.05)–4
= (1288.55)(0.8227)
= $1,060.09

P2 = PV(0.05, 4, -500)
= $1,772.98

PTotal  P1  P2  P3  $3,333.07

38
Arithmetic Gradient
Arithmetic Gradient series (G): each annual amount differs
from the previous one by a fixed amount G.
A+4G
A+3G
A+2G
A+G A A A A A
A

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

+
P  A( P / A, i, n) 2G
3G 4G
G
 G ( P / G , i , n) 0
0
1 2 3 4 5

39
Arithmetic Gradient Present Worth Factor
Given G, i, & n, find P (4-19)

 (1  i ) n  in  1
PG 2   G ( P / G, i %, n)
 i (1  i )
n

Notation
Arithmetic Gradient
Present Worth Factor

40
 Arithmetic Gradient Present Worth Factor
 Question: You has purchased a new car. the following maintenance
costs starting at EOY 2 will occur to pay the maintenance of your car
for the 5 years. EOY2 $30, EOY3 $60, EOY4 $90, EOY5 $120. If
interest rate is 5%, how much money you should deposit into a
bank account today? $120
$30 $60 $90
0
0 1 2 3 4 5 i=5%
G=$30
P= $247.11
 (1  i ) n  in  1  (1  0.05) 5  0.05(5)  1
PG 2   30    30(8.237)
 i (1  i )  0.05 (1  0.05)
n 2 5
  41
QUESTION CONTINUES (INTEREST TABLE)

$90 $120
$30 $60
0
0 1 2 3 4 5 i=5%
G=$30
P= $247.11
P  G (P/G, i%, n)
 30 (P/G, 5%, 5)
 30(8.237)
42
Arithmetic Gradient Present Worth Factor
Question: If interest rate is 8%, what is the present worth of
the following sums?
600
550
500
450 400 400 400 400 400
400

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

+
150 200
100
50
0
0 1 2 3 4 5

43
QUESTION CONTINUES
400 400 400 400 400 ATotal  A1  A2
0 1 2 3 4 5
 400  92
A1  400  492
200 P  492 ( P / A, 8%, 5)
150
100
50  492 (3.9927)
0
0 1 2 3 4 5
 1,964.41
A2  50 ( A / G, 8%, 5)  50 (1.8465)
 92.33  92
44
Arithmetic Gradient Uniform Series Factor

Convert an arithmetic gradient series into a uniform series

Given G, i, & n, find A (4-20)

 (1  i ) n  in  1
AG   G ( A / G, i %, n)
 i (1  i )  i 
n

Notation
Arithmetic Gradient
Uniform Series Factor

45
 Arithmetic Gradient Uniform Series Factor
 Question: Demand for a new product will decrease as competitors
enter the market. What is the equivalent annual amount of the
revenue cash flows shown below? (interest 12%)
3000 3000 3000 3000 3000 3000
2500
2000
1500
1000

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

+
AEQIV  3000  500 ( A / G, 12%, 5) 0 1 2 3 4 5
0
 3000  500(1.775) 500
1000
1500 2000
 2112 .50 46
 Geometric Series Present Worth Factor
Geometric series: Each annual amount is a fixed percentage
different from the last. In this case, the change is 10%.
We will look at this problem in a few slides.
?
?
?
g=10% ?
?
$133 ?
$100 $110 $121
0 1 2 3 4 5 6 7 8 9 10

i=5%
P=? 47
Geometric Gradient
 Unlike the Arithmetic Gradient where the amount of period-by-
period change is a constant, for the Geometric Gradient, the period-
by-period change is a uniform growth rate (g) or percentage rate.

Year First year maintenance cost Cash Flow

1 100 Uniform growth rate (g)  100  A1
2 100  10%(100)  100(1  0.1)1  110  A 2
3 110  10%(110 )  100(1  0.1) 2  121  A 3
. . . .
. . . .
. . . .
n A n -1  10%( A n -1 )  100(1  g ) n 1  An
48
Geometric Series Present Worth Factor
Given A1, g, i, & n, find P (4-29) & (4-30)

1  (1  g ) n (1  i )  n 
P  A1   where i  g
 ig 

Geometric Series
Present Worth Factor
When Interest rate equals the growth rate,
1
P  A1n(1  i ) where i  g
49
 Geometric Series Present Worth Factor
Question: What is the present value (P) of a geometric
series with $100 at EOY1 (A1), 5% interest rate (i), 10%
growth rate (g), and 10 interest periods (n)?
?
?
?
g=10% ?
?
$133 ?
$100 $110 $121
0 1 2 3 4 5 6 7 8 9 10

i=5%
P=? 50
 Geometric Series Present Worth Factor
$236
$214
g=10% $195
$177
$133 $146 $161
$110 $121
$100
0 1 2 3 4 5 6 7 8 9 10
i=5%
P= $1184.67
1  (1  g ) n (1  i )  n  1  (1  0.1)10 (1  0.05) 10 
P  A1    100  
 ig   0.05  0.1 
 100(11 .8467) 51
Time for a Joke!
What is Recession?
Recession is when your neighbor loses his or her job.

What is Depression?
Depression is when you lose yours.

By Ronald Reagan

52
Problem 4-7
Purchase a car: $3,000 down payment
$480 payment for 60 months

If interest rate is 12% compounded monthly, at what

purchase price P of a car can one buy?
Solution
i = 12.0%/12 = 1.o% per month, n = 60, and A = $480
P = 3000 + 480(P/A, 0.01, 60)
= 3000 + 480(44.955)
= $24,578

Important: P = $3000 + $480(60) = $31,800, if i = 0.

53
Problem 4-9
$25 million is needed in three years.
Traffic is estimated at 20 million vehicles per year.
At 10% interest, what should be the toll per vehicle?

(a) Toll receipts at end of each year in a lump sum.

(b) Traffic distributed evenly over 12 months, and

toll receipts at end of each month in a lump
sum.

54
Problem 4-9
Solution
(a) Let x = the toll/vehicle. Then
F = $25,000,000 i = 10%/year, n = 3 years
Find A (=20,000,000x).
A = F(A/F, 0.1, 3)
20,000,000x = 25,000,000(0.3021)
x = $0.3776 = $0.38 per vehicle

55
Problem 4-9
Solution
(b) Let x = the toll/vehicle. Then
F = $25M i = (1/12)10%/month, n = 36 months
Find A (=20,000,000x/12).
A = F{i/[(1+i)n–1]}
20,000,000x/12 = 25,000,000{(0.1/12)/(1+0.1/12) 36–
1}
x = $0.359 = $0.36 per vehicle

56
Problem 4-32
If i = 12%, for what value of B is the PW = 0?
Solution
Consider now = time 1. Then
PW = B+800(P/A, 0.12, 3) – B(P/A, 0.12, 2) – B(P/F, 0.12, 3)
= 1921.6 – 1.758B
Letting PW = 0 yields B = $1,093.06

For any cash flow diagram,

if PW = 0, then its worth at anytime = 0!

57
Problem 4-46
Solution
FW = FW
[1000(F/A, i, 10)](F/P, i, 4) = 28000
By try and error:
At i = 12%, LHS = [1000(17.549)](1.574) = $27,622 too low
At i = 15%, LHS = [1000(20.304)](1.749) = $35,512 too high

Using linear interpolation:

i = 12% + 3%[(28000 – 27622)/(35512 – 27622)]
= 12.14%
58
 Use of MS EXCEL
pmt(i, n, P, F, type) returns A, given i, n, P, and F

sinking fund (P=0) A = F{i/[(1+i)n – 1]} (4-

5)
capital recovery (F=0) A = P{[i(1+i)n]/[(1+i)n – 1]} (4-6)
or combined (P ≠ 0, and F ≠ 0)

rate(n, A, P, F, type, guess) returns i, given n, A, P, and F

59
 Use of MS EXCEL
pv(i, n, A, F, type) returns P, given i, n, A, and F

present worth (A=0) P = F/(1+i)n (3-5)

series present worth (F=0) P = A{[(1+i)n – 1]/[i(1+i)n]} (4-7)
or combined (A ≠ 0, and F ≠ 0)

fv(i, n, A, P, type) returns F, given i, n, A, and P

compound amount (A=0) F = P(1+i)n (3-3)

series compound amount (P=0) F = A{[(1+i)n – 1]/i} (4-4)
or combined (A ≠ 0, and P ≠ 0)

60
 Use of MS EXCEL
nper(i, A, P, F, type) returns n, given i, A, P, and F.

If A = 0, n = log(F/P)/log(1+i) single payment

If P = 0, n = log(1+Fi/A)/log(1+i) uniform series
If F = 0, n = log[A/(A-Pi)]/log(1+i) uniform series

effect(r, m) returns ia, given r and m.

effective annual interest rate ia = (1+r/m)m –1 (3-
7)

nominal(ia, m) returns r, given ia and m.

nominal annual interest rate r = m[(ia – 1)1/m + 1] 61
 A Real Life Case
Mr. Goodman set up a trust fund of $1.5M for his 2
children in 1991. It is worth more than $300M today
(January 2012).
What is the effective annual interest rate?

Solution
P = $1.5M, F = $300M, n = 20 years
ia = (F/P)1/n – 1 = (300/1.5)1/20 – 1 = 30.332%
ia = rate(20, 0, 1.5, –300) = 30.332%
ia = rate(20, 0, -1.5, 300) = 30.332%
62
 End of Chapter 4
Uniform Series Compound Interest Formulas
Uniform Series Compound Amount Factor: F/A
Uniform Series Sinking Fund Factor: A/F
Uniform Series Capital Recovery Factor: A/P
Uniform Series Present Worth Factor: P/A
Arithmetic Gradient
Geometric Gradient
Spreadsheet Solutions

63
Interpolation-1
Given: F(X1); F(X2)
What is F(X3) where X1 < X3 < X2?
Assuming linearity so that a linear equation will do:
Basic equation: y = mx + b so
1. F(X1) = mX1 + b
2. F(X2) = mX2 + b
Subtract 2 from 1:
F(X1)-F(X2) = m (X1-X2)  m = (F(X1)-F(X2))/(X1-X2)
From 1 we get b = (F(X1) - mX1)

64
Interpolation-2
F(X1)-F(X2) = m (X1-X2)  m = (F(X1)-F(X2))/(X1-X2)
From 1 we get b = (F(X1) - mX1)
Now
F(X3) = m X3 + b
= m X3 + F(X1) - mX1 = m (X3 - X1) + F(X1)
= (X3 - X1) (F(X1)-F(X2))/(X1-X2) + F(X1)
= F(X1) + (F(X1)-F(X2)) (X3 - X1) /(X1-X2)

65
Interpolation-3
F(X3) = F(X1) + (F(X1)-F(X2)) (X3 - X1) /(X1-X2)

Suppose that the Xs are interest rates, i, and the Fs are

the functions (F/A,i,n), then
F(i3) = F(i1) + (F(i1)-F(i2)) (i3 - i1) /(i1-i2)

Return
66