Chapter 2

Factors: How Time

and Interest Affect
Money
Lecture slides to accompany

Engineering Economy
7th edition

Leland Blank
Anthony Tarquin

2-1

2012 by McGraw-Hill, New York, N.Y All Rights Reserved

TOPIC OUTCOMES
1. F/P and P/F Factors
2. P/A and A/P Factors
3. F/A and A/F Factors
4. Factor Values
5. Arithmetic Gradient
6. Find i or n
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Single Payment Factors (F/P and P/F)

Single payment factors involve only P and F.

Cash flow diagrams are as follows:

Formulas are as follows:

P = F[1 / (1 + i ) n]

F = P(1 + i ) n

Terms in parentheses or brackets are called factors. Values are in tables for i and n values
Factors are represented in standard factor notation such as (F/P,i,n),
where letter to left of slash is what is sought; letter to right represents what is given
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F/P and P/F for Spreadsheets

Future value F is calculated using FV function:

= FV(i%,n,,P)
Present value P is calculated using PV function:

= PV(i%,n,,F)
Note the use of double commas in each function
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Example: Finding Future Value

A person deposits $5000 into an account which pays interest at a rate of 8%
per year. The amount in the account after 10 years is closest to:
(A) $2,792

(B) $9,000

(C) $10,795

(D) $12,165

Try this now.

1-5

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Example: Finding Future Value

A person deposits $5000 into an account which pays interest at a rate of 8%
per year. The amount in the account after 10 years is closest to:
(A) $2,792

(B) $9,000

(C) $10,795

(D) $12,165

The cash flow diagram is:

Solution:
F = P(F/P,i,n )
= 5000(F/P,8%,10 )
= 5000(2.1589)
= $10,794.50

2-6

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Example: Finding Present Value

A small company wants to make a single deposit now so it will have enough money to
purchase a backhoe costing $50,000 five years from now. If the account will earn
interest of 10% per year, the amount that must be deposited now is nearest to:
(A) $10,000

(B) $ 31,050

(C) $ 33,250

(D) $319,160

Try this now.using the table

1-7

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Example: Finding Present Value

A small company wants to make a single deposit now so it will have enough money to
purchase a backhoe costing $50,000 five years from now. If the account will earn
interest of 10% per year, the amount that must be deposited now is nearest to:
(A) $10,000

(B) $ 31,050

(C) $ 33,250

(D) $319,160

Solution:

The cash flow diagram is:

P = F(P/F,i,n )
= 50,000(P/F,10%,5 )
= 50,000(0.6209)
= $31,045

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Uniform Series Involving P/A and A/P

The uniform series factors that involve P and A are derived as follows:
(1) Cash flow occurs in consecutive interest periods
(2) Cash flow amount is same in each interest period
The cash flow diagrams are:

A= ?

A = Given

P = Given

P=?
P = A(P/A,i,n)

Standard Factor Notation

A = P(A/P,i,n)

Note: P is one period Ahead of first A value

2-9

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Example: Uniform Series Involving P/A

A chemical engineer believes that by modifying the structure of a certain water
treatment polymer, his company would earn an extra $5000 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 5 year project period?
(A) $11,170

(B) 13,640

(C) $15,300

Solution:

The cash flow diagram is as follows:

P = 5000(P/A,10%,5)
= 5000(3.7908)
= $18,954

A = $5000

P=?

(D) $18,950

i =10%

Answer is (D)
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Uniform Series Involving F/A and A/F

The uniform series factors that involve F and A are derived as follows:
(1) Cash flow occurs in consecutive interest periods
(2) Last cash flow occurs in same period as F
Cash flow diagrams are:

A=?

A = Given

F = Given

F=?

F = A(F/A,i,n)

Standard Factor Notation

A = F(A/F,i,n)

Note: F takes place in the same period as last A

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Example: Uniform Series Involving F/A

An industrial engineer made a modification to a chip manufacturing
process that will save her company $10,000 per year. At an interest rate
of 8% per year, how much will the savings amount to in 7 years?
(A) $45,300

(B) $68,500

(C) $89,228

(D) $151,500

Try it out...

1-12

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Example: Uniform Series Involving F/A

An industrial engineer made a modification to a chip manufacturing
process that will save her company $10,000 per year. At an interest rate
of 8% per year, how much will the savings amount to in 7 years?
(A) $45,300

(B) $68,500

(C) $89,228

(D) $151,500

F=?

The cash flow diagram is:

Solution:
F = 10,000(F/A,8%,7)

i = 8%
0

= 10,000(8.9228)
= $89,228
Answer is (C)

A = $10,000
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Factor Values for Untabulated i or n

3 ways to find factor values for untabulated i or n values
Use formula
Use spreadsheet function with corresponding P, F, or A value set to 1
Linearly interpolate in interest tables

Formula or spreadsheet function is fast and accurate

Interpolation is only approximate

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Example: Untabulated i
Determine the value for (F/P, 8.3%,10)

Formula: F = (1 + 0.083)10 = 2.2197

OK

Spreadsheet: = FV(8.3%,10,,1) = 2.2197

OK

Interpolation: 8% ------ 2.1589

8.3% -----x
9% ------ 2.3674
x = 2.1589 + [(8.3 - 8.0)/(9.0 - 8.0)][2.3674 2.1589]
(Too high)
= 2.2215

Absolute Error = 2.2215 2.2197 = 0.0018

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Arithmetic Gradients
Arithmetic gradients change by the same amount each period
The cash flow diagram for the PG
of an arithmetic gradient is:
PG = ?
1

This is because cash flow in year 1 is

usually not equal to G and is handled
separately as a base amount
(shown on next slide)

0
G

G starts between periods 1 and 2

(not between 0 and 1)

2G
3G

Note that PG is located Two Periods

Ahead of the first change that is equal
to G

(n-1)G

Standard factor notation is

PG = G(P/G,i,n)
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Typical Arithmetic Gradient Cash Flow

PT = ?

i = 10%
0

400

Amount in year 1
is base amount

450
500
550

600

This diagram = this base amount plus this gradient

PA = ?

PG = ?
i = 10%

Amount
in year 1
is base
amount

i = 10%

400

400

400

400

400

50
PG = 50(P/G,10%,5)

PA = 400(P/A,10%,5)

100

150

200

PT = PA + PG = 400(P/A,10%,5) + 50(P/G,10%,5)
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Converting Arithmetic Gradient to A

Arithmetic gradient can be converted into equivalent A value using G(A/G,i,n)
i = 10%
0

G
2G

3G

i = 10%
2
3

A= ?
4G

General equation when base amount is involved is

A = base amount + G(A/G,i,n)

For decreasing gradients,
3
4
5
change plus sign to minus
3G

4G

A = base amount - G(A/G,i,n)

2G
G

2-18

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Example: Arithmetic Gradient

The present worth of $400 in year 1 and amounts increasing by $30 per year
through year 5 at an interest rate of 12% per year is closest to:
(A) $1532

(B) $1,634

(C) $1,744

(D) $1,829

Try it out...

1-19

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Example: Arithmetic Gradient

The present worth of $400 in year 1 and amounts increasing by $30 per year
through year 5 at an interest rate of 12% per year is closest to:
(A) $1532

(B) $1,634

(C) $1,744

(D) $1,829

Solution:

PT = ?
0

PT = 400(P/A,12%,5) + 30(P/G,12%,5)
= 400(3.6048) + 30(6.3970)
= $1,633.83

i = 12%

Year

Answer is (B)
400
430

The cash flow could also be converted

into an A value as follows:

460

G = $30

490
520

A = 400 + 30(A/G,12%,5)
= 400 + 30(1.7746)
= $453.24
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Geometric Gradients
Geometric gradients change by the same percentage each period
Cash flow diagram for present worth
of geometric gradient

There are no tables for geometric factors

Pg = ?

Use following equation for g i:

1

Pg = A1{1- [(1+g)/(1+i)]n}/(i-g)

0
A1

where: A1 = cash flow in period 1

g = rate of increase

A 1(1+g)1
A 1(1+g)2

Note: g starts between

periods 1 and 2

If g = i, Pg = A1n/(1+i)
A 1(1+g)n-1

Note: If g is negative, change signs in front of both g values

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Example: Geometric Gradient

Find the present worth of $1,000 in year 1 and amounts increasing
by 7% per year through year 10. Use an interest rate of 12% per year.
(a) $5,670

(b) $7,333

(c) $12,670

(d) $13,550

Try it out...

1-22

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Example: Geometric Gradient

Find the present worth of $1,000 in year 1 and amounts increasing
by 7% per year through year 10. Use an interest rate of 12% per year.
(a) $5,670

Pg = ?
1

(b) $7,333

(c) $12,670

Solution:
i = 12%
2
3

Pg = 1000[1-(1+0.07/1+0.12)10]/(0.12-0.07)
= $7,333

10

0
1000

(d) $13,550

Answer is (b)

1070
1145

g = 7%

To find A, multiply Pg by (A/P,12%,10)

1838

2-23

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Unknown Interest Rate i

Unknown interest rate problems involve solving for i,
given n and 2 other values (P, F, or A)
(Usually requires a trial and error solution or interpolation in interest tables)

Procedure: Set up equation with all symbols involved and solve for i
A contractor purchased equipment for $60,000 which provided income of $16,000
per year for 10 years. The annual rate of return of the investment was closest to:

(a) 15%

(b) 18%

(c) 20%

(d) 23%

Try it out...

2-24
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A contractor purchased equipment for $60,000 which provided income of $16,000

per year for 10 years. The annual rate of return of the investment was closest to:

(a) 15%
Solution:

(b) 18%

(c) 20%

(d) 23%

Can use either the P/A or A/P factor. Using A/P:

60,000(A/P,i%,10) = 16,000
(A/P,i%,10) = 0.26667

From A/P column at n = 10 in the interest tables, i is between 22% and 24%

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Answer is (d)

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Unknown Recovery Period n

Unknown recovery period problems involve solving for n,
given i and 2 other values (P, F, or A)
(Like interest rate problems, they usually require a trial & error solution or interpolation in interest tables)

Procedure: Set up equation with all symbols involved and solve for n
A contractor purchased equipment for $60,000 that provided income of $8,000
per year. At an interest rate of 10% per year, the length of time required to recover
the investment was closest to:
(a) 10 years

(b) 12 years

(c) 15 years

(d) 18 years

Try it out...

2-26

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A contractor purchased equipment for $60,000 that provided income of $8,000

per year. At an interest rate of 10% per year, the length of time required to recover
the investment was closest to:
(a) 10 years
Solution:

(b) 12 years

(c) 15 years

(d) 18 years

Can use either the P/A or A/P factor. Using A/P:

60,000(A/P,10%,n) = 8,000
(A/P,10%,n) = 0.13333

From A/P column in i = 10% interest tables, n is between 14 and 15 years

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Answer is (c)

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Summary of Important Points

In P/A and A/P factors, P is one period ahead of first A
In F/A and A/F factors, F is in same period as last A
To find untabulated factor values, best way is to use formula or spreadsheet
For arithmetic gradients, gradient G starts between periods 1 and 2
Arithmetic gradients have 2 parts, base amount (year 1) and gradient amount
For geometric gradients, gradient g starts been periods 1 and 2
In geometric gradient formula, A1 is amount in period 1
To find unknown i or n, set up equation involving all terms and solve for i or n

2-28

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Problem 2.54
Calculate the amount of money that Diamond
Systems can spend now for improving
productivity in lieu of spending $30,000 three
years from now at an interest rate of 12% per
year.

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Problem 2.55
A manufacturing company spent $30,000 on a
new conveyor belt resulted in cost savings of
$ 4200 per year. How long does it take to
recover its investment at 8% rate of return per
year?

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Problem 2.60
A small construction company is considering
the purchase of a used bulldozer for $61,000. If
the company purchases the dozer now, what
is the equivalent future amount in year 4 that
the company is paying for the dozer at 4% per
year interest?

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Problem 2.62
An enthusiastic new engineering graduate
plans to start a consulting firm by borrowing
$100,000 at 10% per year interest. Calculate
the loan payment each year to pay off the loan
in 7 years.

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Problem 2.64

The cost of a border fence is $3 million per

mile. If the life of such a fence is assumed to
be 10 years. Calculate the equivalent annual
cost of 10-mile long fence at interest rate of
10% per year.

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Problem 2.65
An investment of $75,000 in equipment that
will reduce the time for machine self-locking
fasteners will save $20,000 per year. How
many years does it takes to recover the initial
investment at an interest rate of 10% per year.

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Problem 2.67
Aero Serve, Inc., manufactures cleaning
nozzles for reverse-pulse jet dust collectors.
The company spent $40,000 on a production
control system that will increase profits by
$13,400 per year for 5 years. Determine the
rate of return per year for this investment.

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Problem 2.68
Energy cost for a green chemical treatment
have been increasing uniformly for 5 years. If
the cost in year 1 was $26,000 and it increased
by $2000 per year through year 5, calculate the
present worth of the costs at an interest rate of
10% per year.

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Problem 2.69
In planning for your retirement, you expect to
save $5000 in year 1, $6000 in year 2, and
amounts increasing by $1000 each year
through year 20. Calculate the amount you will
have at the end of year 20 if your investments
earn 10% per year.

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Problem 2.70
Income from a precious metals mining has
been decreasing uniformly for 5 years. If
income in year 1 was $300,000 and it
decreased by $30,000 per year through year 4,
calculate the annual worth of the income at
10% per year.

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Solution
2.54
P = 30,000(P/F,12%,3)
= 30,000(0.7118)
= $21,354
2.55
30,000 = 4200(P/A,8%,n)
(P/A,8%,n) = 7.14286
n is between 11 and 12 years

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2.67 40,000 = 13,400(P/A,i,5)

(P/A,i,5) = 2.9851
By interpolation or RATE function, i = 20.0 % per year
2.68 P = 26,000(P/A,10%,5) + 2000(P/G,10%,5)
= 26,000(3.7908) + 2000(6.8618)
= $112,284
2.69 F = [5000(P/A,10%,20) + 1000(P/G,10%,20)](F/P,10%,20)
= [5000(8.5136) + 1000(55.4069)](6.7275)
= $659,126

2.70 A = 300,000 30,000(A/G,10%,4)

= 300,000 30,000(1.381
= $258,564
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