Combining factors

Combining factors

I Most estimated cash flow series do not fit exactly the series
for which the factors and equations were developed.
I For a given sequence of cash flows, there are usually several
correct ways to determine the equivalent present worth P ,
future worth F , or annual worth A.
Calculations for uniform series that are shifted

I P of this uniform series can be determined by any of the

following methods:
I (1). Use the P/F factor to find the present worth of each
disbursement at year 0 and add them.
I P = 50(P/F, i, 4) + 50(P/F, i, 5) + ... + 50(P/F, i, 13)
Calculations for uniform series that are shifted

I (2). Use the F/P factor to find the future worth of each
disbursement in year 13, add them, and then find the
present worth of the total, using P = F (P/F, i, 13).
I P =
[50(F/P, i, 9) + 50(F/P, i, 8) + ... + 50(F/P, i, 1) + 50] ×
(P/F, i, 13)
Calculations for uniform series that are shifted

I (3). Use the F/A factor to find the future amount

F = A(F/A, i, 10), and then compute the present worth,
using P = F (P/F, i, 13).
I P = 50(F/A, i, 10)(P/F, i, 13)
I Note: the future worth is always located in the same period
as the last uniform series amount.
Calculations for uniform series that are shifted

I (4). Use the P/A factor to compute the ‘present worth’

P3 = A(P/A, i, 10) (which will be located in year 3, not
year 0), and then find the present worth in year 0 by using
the (P/F, i, 3) factor.
I P = 50(P/A, i, 10)(P/F, i, 3)
I Typically this last method is used for calculating the
present worth of a uniform series that does not begin at the
end of period 1.
Calculations for uniform series that are shifted

I Note: the present worth is always located one period prior

to the first uniform series amount. (Why?)
I Because the P/A factor was derived with P in time period
0 and A beginning at the end of period 1.
I Remember that the number of periods n in the P/A or
F/A factor is equal to the number of uniform series values.
I Re-number the cash flow diagram to avoid errors in
counting.
Example

I The offshore design group at Bechtel just purchased

upgraded 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 in
year 0 of the payments if the interest rate is 8% per year?
Example

I i = 8% per year
I PT =?
0
I PA = A(P/A, 8%, 6) = 500 (4.6229) = $2,311.45
0
I PA = PA (P/F, 8%, 2) = $2,311.45 (0.8573) = $1981.6
I PT = PA + P0 = $1981.6 + $5000 = $6981.6
Example

I Alternatively (just for fun):

I Extend the uniform series to years 1 and 2, and subtract a
uniform series consisting of years 1 and 2 only:
I PA = A(P/A, 8%, 8) − A(P/A, 8%, 2)
Example

I Recalibration of sensitive measuring devices costs $8000

per year. If the machine will be recalibrated for each of 6
years starting 3 years after purchase, calculate the 8-year
equivalent uniform series at 16% per year.
Example

0
I i = 16%; equivalent A =? over 8 years.
I Present worth approach:
0
I PA = A(P/A, 16%, 6) = 8000 (3.6847) = $29,477.6
0
I PT = PA (P/F, 16%, 2) = $29,477.6 (0.7432) = $21,907.75
0
I A = PT (A/P, 16%, 8) = $5043.6
I Future worth approach:
I F = 8000(F/A, 16%, 6) = $71,820
0
I A = $71,820 (A/F, 16%, 8) = $5043.2
Example

I A design-build-operate engineering company in Texas that

owns a sizable amount of land plans to lease the drilling
rights (oil and gas only) to a mining and exploration
company. The contract calls for the mining company to
pay $20,000 per year for 20 years beginning 3 years from
now (i.e., beginning at the end of year 3 and continuing
through year 22) plus $10,000 six years from now and
$15,000 sixteen years from now. Determine the five
equivalent values listed below at 16% per year.
I 1. Total present worth PT in year 0
I 2. Future worth F in year 22
I 3. Annual series over all 22 years
I 4. Annual series over the first 10 years
I 5. Annual series over the last 12 years
Example

I 1. Total present worth PT in year 0

0
I PA = 20,000 (P/A, 16%, 20)
0
I PT = PA (P/F, 16%, 2) + 10,000 (P/F, 16%, 6) + 15,000
(P/F, 16%, 16)
I PT = $93,625
Example

I 2. Future worth F in year 22

I F = 20,000 (F/A, 16%, 20) + 10,000 (F/P, 16%, 16) +
15,000 (F/P, 16%, 6)
I F = $2,451,626
Example

I 3. Annual series over all 22 years

I A1−22 = PT (A/P, 16%, 22) = $93,625 (0.16635) = $15,575
I Alternatively,
I A1−22 = F (A/F, 16%, 22) = $15,575
Example

I 4. Annual series over the first 10 years

I To determine the equivalent A series for years 1 through 10
only, the PT value must be used.
I A1−10 = PT (A/P, 16%, 10) = $93,625 (0.2069) = $19,371
Example

I 5. Annual series over the last 12 years

I The F value must be used.
I A11−22 = F (A/F, 16%, 12)
I A11−22 = $2,451,626 (0.03241) = $79,457
Calculations for shifted gradients

I The present worth of an arithmetic gradient will always be

located two periods before the gradient starts.
I The n value in the factors for a shifted gradient is
determined by re-numbering the time scale. The period in
which the gradient first appears is labeled period 2.
Example

I Fujitsu, Inc. has tracked the average inspection cost on a

robotics manufacturing line for 8 years. Cost averages were
steady at $100 per completed unit for the first 4 years, but
have increased consistently by $50 per unit for each of the
last 4 years. Analyze the gradient increase, using the P/G
factor. Where is the present worth located for the
gradient? What is the general relation used to calculate
total present worth in year 0?
Example

I A = $100, and G = $50

I PG3 = G(P/G, i, 5) = 50(P/G, i, 5)
I PG0 = PG3 (P/F, i, 3) = 50(P/G, i, 5)(P/F, i, 3)
I PA = 100(P/A, i, 8)
I PT = PA + PG0 = 100(P/A, i, 8) + 50(P/G, i, 5)(P/F, i, 3)
Example

I Set up the engineering economy relations to compute the

equivalent annual series in years 1 through 7 for the cash
flow estimates in the figure below.
Example

I A1−7 = AT = ?
I AT = 50 + AG
I To find AG :
I PG2 = G(P/G, i, 5) = 20(P/G, i, 5)
I PG0 = PG2 (P/F, i, 2) = 20(P/G, i, 5)(P/F, i, 2)
I AG = PG0 (A/P, i, 7) = 20(P/G, i, 5)(P/F, i, 2)(A/P, i, 7)
I Thus, AT = 50 + 20(P/G, i, 5)(P/F, i, 2)(A/P, i, 7)
Example

I 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 thereafter for the next 8 years. 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.
Example

I i = 15% per year; g = 0.12 6= i

I PT =?
1+g n 1 + 0.12 9
   
1− 1−
1+i 1 + 0.15
I Pg = A1 = 7000 = $49,400
i−g 0.15 − 0.12
Example

I Pg0 = Pg (P/F, 15%, 4) = $49,400 (0.5718) = $28,247

I PT = 35,000 + Pg0 + 7000 (P/A, 15%, 4)
I PT = 35,000 + 28,247 + 7000 (2.855) = $83,232
I Note that n = 4 in the (P/A,15%,4) factor because the
$7000 in year 5 is the cash flow of the initial amount A1 .
Example

I Find PT
Example

I G = −100 (decreasing gradient; opposing A)

I PG1 = G(P/G, i, 5) = −100(P/G, i, 5)
I PG0 = PG1 (P/F, i, 1) = −100(P/G, i, 5)(P/F, i, 1)
I PA = 800(P/A, i, 6), or alternatively (in textbook):
I PA = 800(P/F, i, 1) + 800(P/A, i, 5)(P/F, i, 1)
I PT = PG0 + PA = −100(P/G, i, 5)(P/F, i, 1) + 800(P/A, i, 6)
Example
I 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 electrochrome 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.
I Years 1 through 5: Invest $7000 in year 1, decreasing by
$1000 per year through year 5.
I Years 6 through 10: No new investment and no
withdrawals.
I Years 11 through 15: Withdraw $20,000 in year 11,
decreasing 20% per year through year 15.
Example

I 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 of
the initial withdrawal series to result in PT = 0?
Example

I G = −1000; g = −0.2; i = 8% 6= g; A1 = 20,000

I Investment series at time 0:
I PG = G(P/G, 8%, 5) + A(P/A, 8%, 5)
I PG = −1000(P/G, 8%, 5) + 7000(P/A, 8%, 5) = $20,577
(pointing down), i.e. PG = $−20,577
Example

I Withdrawal series at time 0:

1+g n 1 − 0.2 5
   
1− 1−
1+i 1 + 0.08
I Pg,10 = A1 = 20,000
i−g 0.08 − (−0.2)
I Pg,10 = $20,000 (2.775) = $55,500
Example

I Pg,0 = Pg,10 (P/F, 8%, 10)

I Pg,0 = $55,500 (0.4632) = $25,707 > $20,577
I Thus withdrawal is under-funded.
Example

I To find A1 such that PT = 0:

I PT = 0 ⇐⇒ Pg,0 = 20,577
I A1 (2.775) (0.4632) = 20,577
I A1 = $16,009 in year 11.