Lecture 2 – Time

ENGINEERING ECONOMICS Value of Money

DRAW CASH FLOW

NCF=Revenues ( Cash in) – Disbursements (Cash out)

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EXAMPLE
Plot observed cash flows over last 8 years and estimated sale for the next
year for $150. Show present worth (P) arrow at present time, t = 0

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SOLUTION

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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:

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

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EXAMPLE
❑Find the present value of $100,000 to be received 10 years
from now at a discount rate of 10%
F= $100,000
i = 10%
n = 10

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 A STANDARD NOTATION
❑Instead of writing the full formulas of SPCAF and SPPWF for simplicity
there is a standard notation. This notations includes two cash flows
symbols, interest rate and number of periods

❑General form is: (X/Y, i, n) which means “X” represents what is sought,
Y is given, i is interest rate and n is number of periods
Name Equation with Notation Standard Notation Find/
factor formula Equation Given

Single-payment compound F= P(1+i)n (F/P, i, n) F= P(F/P, i, n) F/P

amount
Single-payment present worth P= F(1+i)-n (P/F, i, n) P= F(P/F, i, n) P/F
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USING STANDARD NOTATION EXAMPLE

F= P(F/P, i, n)
F= 100,000(F/P, 10%, 17) That value you get
F= 100,000 (5.054) from“Table”
F= $505,400

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 SINGLE PAYMENTS TO ANNUITY
❑ Normally, in real world we do not face Single payments mostly
instead faces cash flows such as home mortgage payments and
monthly insurance payments etc.
❑ An annuity is an equal annual series of cash flows. It may be equal
annual deposits, equal annual withdrawals, equal annual
payments, or equal annual receipts.

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 UNIFORM SERIES PRESENT WORTH FACTOR
(USPWF)

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 CAPITAL RECOVERY FACTOR (CRF)

Name Equation with Notation Standard Notation

factor formula Equation
UniformSerie (P/A, i, n) P=A(P/A, i, n)
s Present
Worth
Capital Recovery (A/P, i, n) A= P(A/P, i, n)

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 EXAMPLE: UNIFORM SERIES PRESENT WORTH
A Biomedical engineer believes that by modifying the structure of a
certain department, the hospital would earn an extra $8,000 per year.
At an interest rate of 10% per year, how much could the hospital afford
to spend now to just break even over a 5 year project period?

Solution: A = 8,000 i =10% n=5

The cash flow diagram is as follows:
P = A(P/A, i, n)
A= $8,000

P= 8,000(P/A,10%,5)
4 5
0 1 2 3 = 8,000(3.7908)
i =10%
P= ? = $30,326

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UNIFORM SERIES CAPITAL RECOVERY
A chemical product company is considering investment in cost saving
equipment. If the new equipment will cost $220,000 to purchase and
install, how much must the company save each year for 3 years in
order to justify the investment, if the interest rate is 10%per year?
Solution:
P = 220,000
I = 10%
n=3
The cash flowdiagramis as follows: A = P(A/P, i, n)
A= ?
A= 220,000(A/P,10%,3)
= 220,000(0.40211)
0 1 2 3
i =10% = $88,464
P= $220,000
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UNIFORM SERIES COMPOUND AMOUNT FACTOR

Name Equation with Notation Standard Notation

factor formula Equation
Uniform (F/A, i, n) F=A(F/A, i, n)
Series
Compound
Amount
Factor
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 SINKING FUND FACTOR (SFF)

Name Equation with Notation Standard Notation

factor formula Equation
Sinking Fund (A/F, i, n) A=F(A/F, i, n)
Factor (SFF)

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EXAMPLE: UNIFORM SERIES COMPOUND
AMOUNT FACTOR
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? F=?
A = $10,000
The cash flow diagram is:
0 1 2 3 4 5 6 7

Solution: F = A(F/A, i, n)
i = 8%

A=10,000
i =8%
F = 10,000(F/A,8%,7)
n=7 = 10,000(8.9228)
= $89,228 16
 ARITHMETIC GRADIENT FACTORS (P/G, A/G)
Cash flows that increase or decrease by a constant amount
are considered arithmetic gradient cash flows.

The amount of increase (or decrease) is called the gradient

Cash FlowFormula CFn = base amount + (n-1)G
A+(n-1)G (n-1)G
A A A A A
A+3G 3G
A+2G
2G
A+G
A G
=
+ 0

0 1 2 3 4 n 0 1 2 3 4 n
0 1 2 3 4 n

PT = PA + PG

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 SOLVING ARITHMETIC GRADIENT PROBLEM
Present value of the Arithmetic Gradient series can be calculated as follows:
1.Find the gradient and base
2.Cash flow diagram maybe helpful if u draw it : CFi=A+(n-1) G
3.Break the gradient series into a Uniform series and a Gradient Series as shown on next slide
4.The formula for calculating present value of the Arithmetic Gradient series
5.Calculate PA and PG and use the above formula to get the present value of the Arithmetic
Gradient

PT = PA + PG

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 ARITHMETIC GRADIENT FACTORS (P/G, A/G)

❑ PA = A(P/A, i, n) or Uniform Series Present worth Factor

❑ PG = G(P/G, i, n) or Arithmetic Gradient Present Worth Factor

❑ Alternatively, PG can also be calculated by following formula

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 EXAMPLE -ARITHMETIC GRADIENT
Profits from recycling paper, cardboard, aluminium, and glass at a liberal arts
college have increased at a constant rate of $1,100 in each of the last 3
years. If this year’s profit (end of year 1) is expected to be
$6,000 and the profit trend continues through year 5,

(a)what will the profit be at the end of year 5 and

(b)what is the present worth of the profit at an interest rate of 8%per year?

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 EXAMPLE -ARITHMETIC GRADIENT (SOLUTION)
$10,400
$9,300 $4,400
$8,200 $6,000
$3,300
$2,200
$7,100 $1,100
$6,000
= +
0 1 2 3 4 5 0 1 2 3 4 5

Find the cash flows as follows:

CF= Base + G(n-1) P = A(P/A, i, n) + G(P/G, i, n)
CF1 = 6,000 + 1,100(1-1)= 6,000
P = 6,000(P/A, 8%, 5)+ 1,100(P/G, 8%, 5)
CF2 = 6,000 + 1,100(2-1)= 7,100
CF3 = 6,000 + 1,100(3-1)= 8,200 P=6,000(3.9927) + 1,100(7.3724)
CF4 = 6,000 + 1,100(4-1)= 9,300
CF5 = 6,000 + 1,100(5-1)= 10,400 P = 32,066
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 ARITHMETIC GRADIENT FUTURE/ANNUAL WORTH
The following formula is used for calculating future value of arithmetic gradient given the values of gradient
(the term in bracket is called Arithmetic gradient future worth factor)
(n-1)G
3G
2G
G
Converting Arithmetic Gradient (G) into Uniform Series
(A) (to convert G into (A/G, i, n) 0

Formula for conversation from G to (A/G, i, n)

F?
Also AT =AA +AG
Where AA = P(A/P, i, n) and AG = G(A/G, i, n)

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EXAMPLE
The profit of a company is expected increase at a constant rate of $1,500
in each of the next five years.

If this year’s profit (end of year 1) was

$10,000 and the profit trend continues through year 5,

what will the future worth of the profit at an interest rate of 12%per
year?

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EXAMPLE - SOLUTION
G= $1,500 Base = $10,000
$6,000
$16,000 $4,500
$10,000 $3,000
$14,500 $1,500
$13,000
=> +
$11,500 0 1 2 3 4 5
0 1 2 3 4 5
$10,000

0 1 2 3 4 5 F = A(F/A, i, n) + G(F/G, i, n)
F = 10,000(F/A, 12%, 5) + 1,500(F/G, 12%, 5)

F=10,000(6.3528) + 1,500(11.61587)

F= 80,951

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 GEOMETRIC GRADIENT FACTORS (PG /A)
A Geometric gradient is when the periodic payment is
increasing (decreasing) by a constant percentage:
A1 is the initial cash in Year 1
Pg is the sum of whole series including A1
It maybe noted that A1 is not considered separately in
geometric gradients

For g = i

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

where: A1 = cash flow in period 1 and g = rate of increase 25
EXAMPLE: GEOMETRIC GRADIENT
Determine the present worth of a geometric gradient series with a cash flowof
$50,000 in year 1 and increases of 6%each year through year 8. The interest
rate is 10%per year.

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THANK YOU
SEE YOU NEXT WEEK

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12% Discrete Cash Flow: Compou nd Interest FactorsTABLE 17 12%
n Single Payments Uniform Series Payments Arithmetic Gradients

Compound Present Sinking Compound Capital Present Gradient Present Gradient

Amount Worth Fund Amount Recovery Worth Worth Uniform Series
F/P P/F A/F F/A A/P P/A P/G A/G

1 1.1200 0.8929 1.00000 1.0000 1.12000 0.8929

2 1.2544 0.7972 0.47170 2. 1200 0.59170 1 .6901 0.7972 0.4717
3 1.4049 0.7 118 0.29635 3.3744 0.41635 2.4018 2.2208 0.9246
4 1.5735 0.6355 0.20923 4 .7793 0.32923 3.0373 4 .1273 1.3589
5 1.7623 0.5674 0.15741 6.3528 0.27741 3.6048 6.3970 1.774 6
6 1.9738 0.5066 0.12323 8.1152 0.24323 4 .1114 8.9302 2.1720
7 2.2107 0.4523 0.09912 10.0890 0.21912 4.5638 11.644 3 2.5512
8 2.4760 0.4039 0.08130 12.2997 0.20 130 4.9676 14.4714 2.9131
9 2.7731 0.3606 0.06768 14.7757 0.18768 5.3282 17.3563 3.2574
10 3.1058 0.3220 0.05698 17.5487 0.17698 5.6502 20.2541 3.5847
11 3.4785 0.2875 0.0484 20.6546 0.16842 5.9377 23.1288 3.8953
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12 3.8960 0.2567 0.04 24.1331 0.16144 6.1944 25.9523 4 .1897
144
13 4 .3635 0.2292 0.03568 28.0291 0.15568 6.4235 28.7024 4.4683
14 4 .8871 0.2046 0.03087 32.3926 0.15087 6.6282 31.3624 4 .7317
15 5.4736 0.1827 0.02682 37.2797 0.14682 6.8109 33.9202 4.9803
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USING FACTOR TABLES

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Using Factor Tables

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