MECHANICAL ENGINEERING

DEPARTMENT
2nd Year

Engineering Economy & Accounting

MEC210

Lecture #05
Time value of money,
Cash flow & effects of
inflation
Prepared By: Dr. Sayed Ali Zayan 1st Term 2023/2024
Example :
For the cash-flow diagram shown below, calculate the
amount of money in year 3 that would be equivalent to all
of the cash flows shown, using an interest rate of 11% per
year.
Solution:
Po = -200 + 92.4075 = - $107.5925
Pt = -Po + 100(P/F,11%, 1) +125 (P/F,11%, 2) – 130 (P/F, 115, 5) +
30 (P/F,11%,7)
= -107.5925 + 100(0.9009) + 125(0.8116) – 130 (0.5935) + 30 ( 0.4817)
=-107.5925 + 90.09 + 101.45 – 77.155 + 14.451
= - $ 21.2435
at year 3 :
F3 = Pt ( F/P, 11%, 3)
= - 21.2435 ( 1.3676 )

= - $ 29.053
Uniform Series Present Worth Factor and Capital
Recovery Factor (P∕A and A∕P)
The equivalent present worth P of a uniform series A of end-of-period cash flows
(investments) is shown in Figure

An expression for the present worth can be determined by considering each A value as a
future worth F, calculating its present worth with the P∕F factor, and summing the results.
Uniform Series Present Worth Factor and Capital
Recovery Factor (P∕A and A∕P)
The terms in brackets are the P∕F factors for years 1 through n, respectively. Factor out A.

To simplify the above equation and obtain the P∕A factor, multiply the n-term geometric
progression in brackets by the (P∕F,i%,1) factor, which is 1∕(1 + i). This results the following
equation:

Now subtract the two equations:

Uniform Series Present Worth Factor and Capital
Recovery Factor (P∕A and A∕P)
Simplify to obtain the expression for P when i ≠ 0:

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

 The term in brackets or (P/A, i%, n) in above equation is the

conversion factor referred to as the Uniform Series Present Worth
Factor (USPWF).
 It is the P∕A factor used to calculate the equivalent P value in year 0
for a uniform end-of-period series of A values beginning at the end of
period 1 and extending for n periods.
Uniform Series Present Worth Factor and Capital
Recovery Factor (P∕A and A∕P)
To reverse the situation, the present worth P is known and the equivalent uniform
series amount A is sought (Figure).

The first A value occurs at the end of period 1, that is, one period after P occurs. Solve
(P/A) Equation for A to obtain

= P (A/P, i%, n)
Uniform Series Present Worth Factor and Capital
Recovery Factor (P∕A and A∕P)
The term in brackets is called the capital recovery factor (CRF), or A∕P
factor. It calculates the equivalent uniform annual worth A over n years
for a given P in year 0, when the interest rate is i.
Sinking Fund Factor and Uniform Series Compound
Amount Factor (A∕F and F∕A)

The simplest way to derive the A∕F factor is to substitute into factors
already developed. If P from (P/F) equation is substituted into (P/A)
equation, the following formula results.

or = F (A/F, i%, n)
Sinking Fund Factor and Uniform Series Compound
Amount Factor (A∕F and F∕A)
The expression in brackets in the previous equation is the A∕F or sinking
fund factor. It determines the uniform annual series A that is equivalent
to a given future amount F.
 The uniform series A begins at the end of year (period) 1 and continues
through the year of the given F. The last A value and F occur at the
same time.
To find F for a stated A series in periods 1 through n, rearrange the
previous equation:

= A (F/A, i%, n)
Sinking Fund Factor and Uniform Series Compound
Amount Factor (A∕F and F∕A)
The term in brackets is called the Uniform Series Compound Amount
Factor (USCAF), or F∕A factor. When multiplied by the given uniform
annual amount A, it yields the future worth of the uniform series. It is
important to remember that the future amount F occurs in the same
period as the last A.

As a matter of interest, the uniform series factors can be symbolically determined

by using an abbreviated factor form. For example, F∕A = (F∕P)(P∕A), where
cancellation of the P is correct.
Example:

The president of Ford Motor Company wants to

know the equivalent future worth of a $1 million
capital investment each year for 8 years, starting 1
year from now. Ford capital earns at a rate of 14%
per year.
Solution:

A = 1,000,000 $/yr

F = A (F/A, i%, n)
= 1,000,000 (F/A, 14%, 8)
= 1,000,000 (13.2328)
= $13,232,800
Example:
A company buys a machine for $12,000,
which it agrees to pay for in five equal
annual payments, beginning one year after
the date of purchase, at an interest rate of
4% per annum. Immediately after the
second payment, the terms of the
agreement are changed to allow the
balance due to be paid off in a single
payment the next year. What is the final
single payment?
Solution:

Annual payments: (A)

A = P (A/P, i%, n) = 12,000 ( A/P, 4%, 5 ) = 12,000 ( 0.22463 )
= $2695.56
The discount cash flow for the remainder payments at year 2:
P = A ( P/A, I%, n ) = 2695.56 ( P/A, 4%, 3) = 2695.56 ( 2.775 ) = 7480.179
Then, the final single payment next year is :
F = P ( F/P, I%, n ) = 7480.179 ( F/P, 4%, 1 ) = 7480.179 ( 1.04) = $7779.4
Example:
A large manufacturing company purchased a
semiautomatic machine for $13,000. Its annual
maintenance and operation cost was $1700. After 5 years
from the initial purchase, the company decided to
purchase an additional unit for the machine which would
make it fully automatic. The additional unit had a first
cost of $7100. The cost for operating the machine in the
fully automatic condition was $900 per year. If the
company used the machine for a total of 16 years and
then sold the automatic addition for $1800, what was the
equivalent uniform annual worth of the machine at an
interest rate of 12% per year?
 Arithmetic Gradient Factors (P∕G and A∕G)
An arithmetic gradient series is a cash flow series that either
increases or decreases by a constant amount each period. The
amount of change is called the gradient.

Cash flow
diagram of an
arithmetic
gradient series

Define the symbols G for gradient and CFn for cash flow in year n as follows.
G = constant arithmetic change in cash flows from one time period to the
next; G may be positive or negative.
 Arithmetic Gradient Factors (P∕G and A∕G)
If the base amount is ignored, a generalized arithmetic (increasing) gradient cash flow
diagram is as shown in Figure. Note that the gradient begins between years 1 and 2.
This is called a conventional gradient.

Conventional
arithmetic
gradient series without
the base amount.

The total present worth PT for a series that includes a base amount A
and conventional arithmetic gradient must consider the present worth of
both the uniform series defined by A and the arithmetic gradient series.
The addition of the two results in PT .
Arithmetic Gradient Factors (P∕G and A∕G)
where
PA is the present worth of the uniform series only,
PG is the present worth of the gradient series only, and
the + or − sign is used for an increasing (+G) or decreasing (−G) gradient,
respectively.
The corresponding equivalent annual worth AT is the sum of the base
amount series annual worth AA and gradient series annual worth AG,
that is,

Three factors are derived for arithmetic gradients: the P∕G factor for present worth,
the A∕G factor for annual series, and the F∕G factor for future worth. There are several
ways to derive them. We use the single-payment present worth factor (P∕F,i,n), but
the same result can be obtained y using the F∕P, F∕A, or P∕A factor.
Arithmetic Gradient Factors (P∕G and A∕G)
The present worth of the gradient series PG :

Or PG = G(P∕G, i%, n)
The above equation is the general relation to convert an arithmetic gradient G (not
including the base amount) for n years into a present worth at year 0. Figure-a is
converted into the equivalent cash flow in Figure-b.
Arithmetic Gradient Factors (P∕G and A∕G)
The arithmetic gradient present worth factor, or P∕G factor, may be expressed in two forms:

or

The equivalent uniform annual series AG for an arithmetic gradient G is

found by multiplying the present worth in Equation [2.26] by the (A∕P,i,n) formula.
In standard notation form, the equivalent of algebraic cancellation of P can be
used.

In equation form,
Arithmetic Gradient Factors (P∕G and A∕G)
Or

The expression in brackets in above equation is called the arithmetic

gradient uniform series factor and is identified by (A∕G, i%, n). This
factor converts Figure-a into Figure-b.
Arithmetic Gradient Factors (P∕G and A∕G)
There is no direct, single-cell spreadsheet function to calculate PG or AG
for an arithmetic gradient. Use the NPV function to display PG and the PMT
function to display AG after entering all cash flows (base and gradient
amounts) into contiguous cells. General formats for these functions are:

An F∕G factor (arithmetic gradient future worth factor) to

calculate the future worth FG of a gradient series can be
derived by multiplying the P∕G and F∕P factors. The resulting
factor, (F∕G, i%, n), in brackets, and engineering economy
relation is
Example 3:
A debt of $5000 can be repaid, with interest at 8%, by the following
payments.
Year Payment
1 $500
2 1000
3 1500
4 2000
5 X
The payment at the end of the fifth year is shown as X. How much is
X?
Solution:

Po = $5,000
P1 = A ( P/A, I%, n)
A = A1 + G(A/G, I%, n)
= 500 + 500 (A/G, 8%, 4 ) = 500 + 500 ( 1.4039 ) = $1201.95
P1 = 1201.95 ( P/A, 8%, 4 ) = 1201.95 ( 3.3121) = 3980.978595
P2 = X ( P/F, I%, n ) = X ( P/F, 8%, 5 ) = X (0.68058)
Then, Po = P1 + P2
5000 = 3980.978595 + 0.68058 X

= $ 1497.3