Chapter2Factors:howtimeand

interestaffectmoney
TheFactors:

SinglePaymentFactors(F/PandP/F)

UniformSeriesPresentWorthFactor(P/A)
andCapitalRecoveryfactor(A/P)

SinkingFundFactor(A/F)andUniform
SeriesCompoundAmountFactor(F/A)

ArithmeticGradientFactors(P/GandA/G)

GeometricGradientSeriesFactors

SinglePaymentFactors

themostfundamentalfactorinengineering
economy
determinetheamountofaccumulatedmoney
Fafternyears
singlepresentworthP
interestcompoundedonetimeperyear

IfanamountPisinvestedattimet=0,
theamountF1accumulated1yearhenceat
interestrateofipercentperyearwillbe

F 1 =P Pi P 1i
F 2 =F 1 F 1 i P 1i P 1i i

F =P 1i n

P =F

1
1i

CashFlowDiagram
P=given

i=given

n2 n1

n
F=?

P=?

i=given

n2 n1

n
F=given

(1+i) isthesinglepaymentcompound
amountfactororF/Pfactor
n

[1/(1+i) ]knownasthesinglepayment
presentworthfactororP/Ffactor
Note

Formulasforsinglepaymentonly

tofindpresentorfutureamountwhenonly
onepaymentisinvolved

NotationandEquationsforF/Pand
P/Ffactors
Notation

FactorName

Find/
Given

StandardNotation Equationwith ExcelFunctions

(F/P,i,n)

Singlepayment
compoundamount

F/P

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

F=P(1+i)

FV(i%,n,,P)

(P/F,i,n)

Singlepayment
presentworth

P/F

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

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

PF(i%,n,,F)

Solutionbycomputer

TheFvalueiscalculatedbytheFVfunction
FV(i%,n,,P)

TheamountPisdeterminedusingPV
function
PV(i%,n,,F)

Example2.1
Anindustrialengineerreceivedabonusof$12,000that
hewillinvestnow.Hewantstocalculatethe
equivalentvalueafter24years,whenheplanstouse
alltheresultingmoneyasthedownpaymentonan
islandvacationhome.Assumearateofreturnof8%
peryearforeachofthe24years.
(a)Findtheamounthecanpaydown,usingboththe
standardnotationandthefactorformula.
(b)Useacomputertofindtheamounthecanpaydown

Solution
(a)solutionbyhand
thesymbolsandtheirvaluesare
P=$12,000
F=?
i=8%peryear
n=24years
P=$12,000

024
F=?

ToprovidethefactorvalueofF/Pfor8%and24years,
weusetable13.
F=P(F/P,1,n)=12,000(F/P,8%,24)
=$12,000(6.3412)=$76,094.40

FactorFormula:
TocalculatethefutureworthF:
F=P(1+i) =$12,000(1+0.08)
=$12,000(6.341181)=$76,094.17
n

24

(b)Solutionbycomputer
TofindthefuturevalueusetheFVfunctionthathasthe
formatFV(i%,n,A,P).Thespreadsheetwilllooklike:

Example2.2
HewlettPackardhascompletedastudy
indicatingthat$50,000inreduced
maintenancethisyear(i.e.,yearzero)on
oneprocessinglineresultedfromimproved
integratedcircuit(IC)fabricationtechnology
basedonrapidlychangingdesigns.
(a)IfHewlettPackardconsidersthesetypesof
savingsworth20%peryear,findthe
equivalentvalueofthisresultafter5years.

(b)Ifthe$50,000maintenancesavingsoccurs
now,finditsequivalentvalue3yearsearlier
withinterestat20%peryear.
(c)Developaspreadsheettoanswerthetwoparts
aboveatcompoundratesof20%and55per
year.AdditionallydevelopanExcelcolumn
chartindicatingtheequivalentvaluesatthe
threedifferenttimesforbothrateofreturnval
ues.

Solution
(a)Thecashflowdiagram
P=$50,000
05
F=?
i=20%peryear

n=5years

UsetheF/PfactortodetermineFafter5years
F=P(F/P,i,n)=$50,000(F/P,20%,5)
=$50,000(2.4883)
=$124,415.00

(b)Thecashflowdiagram
P=?

i=20%peryear

n=3years

F=$50,000

Fplacedattimet=0andthePvalueplaced3years
earlieratt=3
UsetheP/FfactortodeterminePthreeyearsearlier.
P=F(P/F,i,n)=$50,000(P/F,20%,3)
=$50,000(0.5787)=$28,935.00
Anequivalencestatementisthat$28,935threeyears
agoisthesameas$50,000today,whichwillgrowto
$124,415fiveyearsfromnow,provideda20%per
yearcompoundinterestrateisrealizedeachyear.

Spreadsheetforexample2.2aandb

Solutionbycomputer
c)Figure2.2isacompletespreadsheetsolutiononone
worksheetwiththechart.Twocolumnsareusedfor20%
and5%computationsprimarilysothegraphcanbe
developedtocomparetheFandPvalues.Row14
showstheFvaluesusingtheFVfunctionwiththeformat
FV(i%,5,0,50000)wheretheivaluesaretakenfromcells
C5andD5.ThefutureworthF=$124,416incellC14is
thesame(roundoffconsidered)asthatcalculatedabove.
Theminussignon50,000makestheresultapositive
numberforthechart.
ThePVfunctionisusedtofindthePvaluesinrow6.
Forexample,thepresentworthat20%inyear3is
determinedincellC6usingthePVfunction.Theresult
P=$28,935isthesameasthatobtainedusingthePV
function.

UniformseriesPresentWorthFactor

TheequivalentpresentworthPissought
auniformseriesAisgiven
P=?

12n2n1n
A=given

CashflowdiagramtodeterminePofa
uniformseries

TheequationtofindP
n

P =A [

1i 1

i0
n

i 1i

TheP/Afactororuniformseriespresentworth
factor
calculatetheequivalentPvalueinyear0
uniformendofperiodseries
Avaluesbeginattheendofperiod1
extendfornperiod

CapitalrecoveryFactor

presentworthPisknown
equivalentuniformseriesamountAissought
oneyearperiodapart
presentworthPmustalwaysoneperiodprior
firstA
A/Pfactororcapitalrecoveryfactor

CapitalrecoveryFactor
Thecashflowdiagram
P=given
012n2n1n

A=?

EquationforA/Pfactor
A=P [i

1i

1i 1

P/AandA/Pfactors:notationandequations
Factor
Notation

Name

(P/A,i,n) Uniformseries
presentworth
(A/P,i,n) Capitalrecovery

Find/ FactorFormula
Standard
Given
NotationEquation
n

P/A

[(1+i) 1]/[i(1+i)

A/P

[i(1+i) ]/[(1+i) 1]

ExcelFunction

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

PV(i%,n,A)

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

PMT(i%,n,P)

Example2.4
Howmuchmoneyshouldyoubewillingtopayfora
guaranteed$600peryearfor9yearsstartingnextyear,
atarateofreturnof16%peryear?
Solution
A=$600

123456789

P=?

i=16%

Thepresentworthis:
P=$600(P/A,16%,9)=$600(4.6065)=$2763.90

SinkingFundFactor

SinkingFundfactororA/F
UniformseriesAbeginsattheendofperiod1
ContinuesthroughtheperiodofthegivenF

Thecashflowdiagram
i=given

F=given

012n2n1n

A=?

UniformseriesCompoundAmountFactor
F/Afactororuniformseriescompoundamount
factor

Aisgiven

FutureamountFoccursinthesameperiodas
thelastA
F=?
i=given

012n2n1n

A=given

TheEquationforA/FandF/Afactors
SinkingFundFactor
i
A=F
n
1i 1

Uniformseriescompoundamountfactor
n

1i 1
F=A
i

F/AandA/FFactors:notationand
Equations
Notation
(F/A,i,n)

(A/F,i,n)

Factor
Name

Find/
Given

Factor
Formula

Standard
ExcelFunctions
NotationEquation

Uniformseries
F/A [(1+i) 1]/i
F=A(F/A,i,n)

compoundamount
SinkingFund

A/F

i/[(1+i) 1]

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

FV(i%,n,A)

PMT(i%,n,F)

Example2.5
FormasaPlasticshasmajorfabricationplantsin
TexasandHongKong.Thepresidentwantsto
knowtheequivalentfutureworthofa$1milion
capitalinvestmenteachyearfor8years,
starting1yearfromnow.Formasacapital
earnsatarateof14%peryear
Solution
i=14%F=?
12345678

A=$1000

Thecashflowdiagramshowstheannual
paymentsstartingattheendofyear1andin
theyearthefutureworthisdesired.Cashflows
areindicatedin$1000units.TheFvaluein8
yearsis
F=1000(F/A,14%,8)=$1000(13.2328)
=$13,232.80
Theactualfutureworthis$13,232,800.TheFVfunction
isFV(14%,8,1000000)

Example2.6
HowmuchmoneymustCaroldepositeveryyear
starting1yearfromnowat5%peryearinorderto
accumulate$6000sevenyearsfromnow?
Solution
ThecashflowdiagramfromCarol'sperspectivefitsthe
A/Ffactor
F=$6000
i=5%

01234567

A=?

A=$6000(A/F,5.5%,7)
=$6000(0.12096)=$725.76peryear
TheA/Ffactorvalueof1.2096wascomputed
usingthefactorformula.Alternatively,usethe
PMTfunctionasshownbelowtoobtain
A=$725.79peryear

InterpolationinInterestTables

Tolocateafactorvaluenotinthetables
usingformulas
bylinearlyinterpolating
setuptheknownvaluesandunknown
Aratioequation:
a c
=
b d

or

a
c= d
b

wherea,b,c,anddrepresentthedifferences

LinearInterpolationSetup

iorn

tabulated

desired
b
tabulated

Factor
c

value1

unlisted
d
value2

Example2.7
DeterminethevalueoftheA/Pfactorforan
interestrateof7.3%andnof10years,that
is(A/P,7.3%,10)
Solution
ThevaluesoftheA/Pfactorforinterestrates
of7%and8%andn=10arelistedintables
12and13respectively,

tabulated:7%
desired:7.3%
tabulated:8%

knownvalue:0.14238
unlistedvalue:X
knownvalue:0.14903

TheunknownXisthedesiredfactorvalue.
a
c= d
b
c=

7.37
0.149030.14238=0.00199
87

Sincethefactorisincreasinginvalueasthe
interestrateincreasesfrom7to8%,thevalue
ofcmustbeaddedtothevalueofthe7%,
thus:X=0.14238+0.00199=0.14437

Commenttoex.2.7
Itisgoodpracticetocheckthereasonableness
ofthefinalanswerbyverifyingthatXlies
betweenthevaluesoftheknownfactorsin
approximatelythecorrectproportions.Inthis
case,since0.14437islessthen0.5ofthe
distancebetween0.14238and0.14903,the
answerseemsreasonable.Ifequation[2.7]is
applied,theexactfactorvalueis0.144358

ArithmaticGradientFactors
acashflowseries
eitherincreasesordecreasesbyaconstant
amount
theamountisthegradient
cashflowattheendofyear1isabase
amount

Example:
Youpurchaseausedcarwitha1yearwarranty.
Assumethatgasolineandinsurancecostis
$1500;thatis$1500isthebaseamount.
Afterthefirstyear,youabsorbthecostofrepair,
isexpectedtoincreaseeachyear.
Ifyouestimatethatthetotalcostswillincrease
by$50eachyear,theamountthesecondyear
is$1550,thethird$1600,andsoontoyearn,
whenthetotalcostsis1500+(n1)50

Thecashflowdiagram:
01234n1n

$1500
$1550$1600
$1650
$1500$1500+(n1)50
+(n2)50

Thecashflowinyearn
0

2G

3G

4G

n1

5G
(n2)G

(n1)G

Thecashflowinyearn(CFn)maybecalculatedas
CFn=baseamount+(n1)G

Example2.9
Asportapparelcompanyhasinitiatedalogolicensing
program.Itexpectstorealizearevenueof$80,000
infeesnextyearfromthesaleofitslogo.Feesare
expectedtoincreaseuniformlytoalevelof
$200,000in9years.Determinethearithmetic
gradientandconstructthecashflowdiagram.
Solution
Thebasicamountis$80,000andthetotalrevenue
increaseis
Increasein9year=$200,000$80,000=$120,000

increase
Gradient =
n1

120,000
Gradient =$
=$ 15,000 per year
91

$200,000
$185,000

$155,000

$125,000
$110,000
$95,000
$80,000

year