10/1/2024

MS-291: Engineering Economics

(3 Credit Hours)

Chapter 1
Foundations Of
Engineering Economy

MS291: Engineering Economics

Week 3

Course Instructor: Dr. Muhammad Sabir

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Basic Concepts
❑ Various cost concepts
❑ Time value of money (TVM)
❑ Interest rate and Rate of Returns
❑ Cash Flow
❑ Economic Equivalence
❑ Simple and compound interest rates
❑ Source of Firms Capital
❑ Minimum Attractive Rate of Return

Basic Concepts
❑ Various cost concepts
❑ Time value of money (TVM)
❑ Economic Equivalence
❑ Interest rate and Rate of Returns
❑ Cash Flow
❑ Minimum Attractive Rate of Return
❑ Source of Firms Capital
❑ Simple and compound interest rates

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Sources of Capital for firms

• Equity financing: uses of its own funds from cash
on hand, stock sales, or retained earnings.
Individuals can use their own cash, savings, or
investments. When firm use its own money its called
equity financing.

• Debt financing: borrowing from outside sources and

repays the principal and interest according to some
schedule. Sources of debt capital may be bonds,
loans etc. Individuals, too, can utilize debt sources,
such as the credit card (15% rate) and bank options
(9% rate) described above.
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Weighted Average Cost of

Capital (WACC)
• If capital is used from more than one source ….. Such as
combinations of debt-equity financing …then the cost of
capital is a weighted average cost of capital (WACC)
• If the HDTV is purchased with 40% credit card money at 15%
per year and 60% savings account funds earning 5% per
year,
• the Weighted Average Cost of Capital is:
• 0.4(15%) + 0.6(5%) = 9% per year.
• While making decisions for investment firms compares
weighted average capital costs with its expected rate of
returns…. Return on project should be “greater” than
Weighted average Cost of Capital (WACC)
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Class Practice
A large multinational
corporation is considering
following six projects.
They are using 10% equity
financing costing 9% per year
and 90% debt financing with a
cost of debt capital of 16% per Solution
year, which projects should Return on project should
be “greater” than Weighted
the company undertake in average Cost of Capital
given projects Inventory, (WACC)
technology, warehouse, WACC = 10%(0.09) + 90%(0.16) = 15.3%
products, energy, shipping? Which one company should undertake ?
should undertake the inventory, technology, and
warehouse projects

Basic Concepts
❑ Various cost concepts
❑ Time value of money (TVM)
❑ Economic Equivalence
❑ Interest rate and Rate of Returns
❑ Cash Flow
❑ Minimum Attractive Rate of Return
❑ Source of Firms Capital
❑ Simple and compound interest rates

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Commonly used Symbols

t = time (time period), usually in periods such as years
or months
P = value or amount of money at a time t (principle)
designated as present or time 0
F = value or amount of money at some future
time (Future value), such as at t = n periods in
the future
A = series of consecutive, equal, end-of-period
amounts of money (Annuity)
n = number of interest periods; years, months
i = interest rate or rate of return per time period;
percent per year or month
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Simple Interest

– Interest is calculated using principal only

– Mathematically:
Simple Interest = (principal) x (interest rate) x (number of periods)
I= P x i x n
P= principle amount
n = number of period
i = interest rate

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Example
Green Tree Financing lent an engineering
company $100,000 to retrofit an
environmentally unfriendly building. The loan
is for 3 years at 10% per year simple
interest. How much money will the firm
repay at the end of 3 years?
Solution

I=Pxixn I=Pxixn
P= principle amount = $100,000 I = $100,000 x 3 x 0.1
n = number of period = 3 I = $30,000
i = interest rate = 10% or 0.1 Total due = $100,000 + 30,000= $130,000

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Compound Interest Rate

• It must be noted that …. Banks do not use Simple

Interest instead they use “Compound Interest rate”

• Most of the time, we talk about interest we mean

compound interest rate

• So when ever you are said to calculate interest rate

and it is not specified …it will always mean
COMPOUND Interest rate. So be careful with this
distinction.

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Compound Interest
With Compound Interest, you work out the interest for the first period,
add it to the principle, and then calculate the interest for the next period,
and so on ..., like this:

Let suppose You deposited $1000 in a bank with compound interest rate
of 10%

Period Period
Period 3
2
1

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Simple and Compound Interest:

Comparison
Example: $100,000 lent for 3 years at interest rate i
= 10% per year. What is repayment after 3 years ?
Simple Interest Compound Interest
Here • Interest, year 1: I1 = 100,000(0.10) = $10,000
• Total due, year 1: F1 = 100,000 + 10,000
P=$100,000
=$110,000
n= 3
i= 10% • Interest, year 2: I2 = 110,000(0.10) = $11,000
Simple interest = P X i x n • Total due, year 2: F2 = 110,000 + 11,000
= $121,000
Interest = 100,000(3)(0.10)
= $30,000 • Interest, year 3: I3 = 121,000(0.10) = $12,100
Total due = 100,000 + • Total due, year 3: F3 = 121,000 + 12,100
30,000 = $133,100
= $130,000

Simple: $130,000: Compounded: $133,100

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Comparison of Simple and

Compound Interest

Simple Interest Case Compound Interest Case

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So far …..
❖ What is Economics?
❖ Why Economics for Engineers?
❖ What is Engineering Economy?
❖ How to perform an Engineering Economy Study?
❖ Some Basic Concepts
– Time value of money (TVM)
– Interest rate and Rate of Returns
– Cash Flow
– Economic Equivalence
– Minimum Attractive Rate of Return
– Sources of Firms Capital
– Simple and compound interest rates

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Chapter 2
Factors: How Time and Interest
Affect Money

MS291: Engineering Economics

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Content of the Chapter

❖ Single-Payment Compound Amount Factor (SPCAF)

❖ Single-Payment Present Worth Factor (SPPWF)

❖ Uniform Series Present Worth Factor (USPWF)

❖ Capital Recovery Factor (CRF)

❖ Uniform Series Compound Amount Factor

❖ Sinking Fund Factor (SFF)

❖ Arithmetic Gradient Factor

❖ Geometric Gradient Series Factor

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Simple and Compound Interest:

Comparison
Example: $100,000 lent for 3 years at interest rate i
= 10% per year. What is repayment after 3 years ?
Simple Interest Compound Interest
Here • Interest, year 1: I1 = 100,000(0.10) = $10,000
• Total due, year 1: F1 = 100,000 + 10,000
P=$100,000
=$110,000
n= 3
i= 10% • Interest, year 2: I2 = 110,000(0.10) = $11,000
Simple interest = P X i x n • Total due, year 2: F2 = 110,000 + 11,000
= $121,000
Interest = 100,000(3)(0.10)
= $30,000 • Interest, year 3: I3 = 121,000(0.10) = $12,100
Total due = 100,000 + • Total due, year 3: F3 = 121,000 + 12,100
30,000 = $133,100
= $130,000

Simple: $130,000: Compounded: $133,100

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Single Payment Compound

Amount Factor (SPCAF)
If an amount “P” is invested at time “t=0” the amount accumulated after a year is
given as
P = 1000@5%
After one year ?
F1 = P + Pi F1 = 1000 + 50
= P(1 + i) ………. (1)
At the end of second year, the accumulated amount F2 is given as;
After two year ?
F2 = F1 + F 1 i F2 = 1050 + 52.5
= P(1+i) + P(1+i)i (from Eq. 1)
= P + Pi + Pi+ Pi2
= P + 2Pi + Pi2
= P (1 + 2i + i2)
= P(1+i)2 …………(2)
Similarly; F3 = F2 + F2 i
= P(1+i)3 ………..(3)
to generalize the process for period “n” we can write as;

F = P(1+i)n
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Single Payment Compound

Amount Factor (SPCAF)

F = P(1+i)n

• The term “(1+i)n” is known as Single Payment

Compound Amount Factor (SPCAF)
Please note:
Inflation = 0
• It is also refer as F/P factor Deprecation /Appreciation = 0

• This is a converting factor, when multiplied by “P”

yields the future amount “F” of initial amount “P” Do not forget
… i .. Refers to
after “n” years at interest rate “i” compound
interest rate

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Calculating Compound Interest

Example: $100,000 lent for 3 years at interest rate i = 10%
per year. What is repayment after 3 years?

What we Know…. Using SPCAF

• Interest, year 1: I1 = 100,000(0.10) = $10,000 Now we have F = P(1+i)n
• Total due, year 1: F1 = 100,000 + 10,000
P = $100,000
=$110,000
n=3
• Interest, year 2: I2 = 110,000(0.10) = $11,000 i=10%
• Total due, year 2: F2 = 110,000 + 11,000 So F = 100,000 (1+0.10)3
= $121,000
F= 100,000 (1.331)
• Interest, year 3: I3 = 121,000(0.10) = $12,100
F = 133100
• Total due, year 3: F3 = 121,000 + 12,100
= $133,100

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From SPCAF to SPPWF

• Now we have the formula how to “convert” single
present amounts into future amount at a given
interest rate i.e. F = P(1+i)n

• What if we are given a future amount (F) and we

are asked to calculate present amount/value (P) ?

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

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Single Payment Present

Worth Factor (SPPWF)
P = F(1+i) −n

▪ The term “(1+i)‒n” is known as the Single Payment

Present Worth Factor (SPPWF)

▪ It is also referred as the P/F factor

▪ This is a converting factor, when multiplied by “F”

yields the present amount “P” of the initial amount “F”
after “n” years at interest rate “i”

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Compounding and
Discounting
• When we convert a “P” value into a “F” using some
rate … we call this process …. COMPOUNDING
and the rate use is called “Interest rate”

• When we convert “F” into “P” using some rate …we

call the process … Discounting …and the rate we
use is called “Discount rate”

• Compounding increase your amount (as its

compounded)….discounting decrease your amount
as its (discounted)
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Example
Find the present value of $10,000 to be
received 10 years from now at a discount rate
of 10%
F = $10,000
i or r = 10%
n = 10
P = F (1+i)-n
=> P = 10,000 (1+0.1)-10
= 10,000 x 0.385
= $3850

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Class Practice:
Allowed time 5 minutes
Sandy, a manufacturing engineer, just received a year-
end bonus of $10,000 that will be invested
immediately. With the expectation of earning at the
rate of 8% per year.

Sandy hopes to take the entire amount out in exactly

20 years to pay for a family vacation when the oldest
daughter is due to graduate from college. Find the
amount of funds that will be available in 20 years?

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Solution
• You have to calculate the future value of
10,000 @ 8 % per year for 20 years
• Simply solve this equation

• F = P(1 + i)n
• F = 10,000 (1 + 0.08)20
• F = 10,000 (1 + 0.08)20
• F = 46609.57

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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 notation includes two cash flow 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 the interest rate and n is the number of
periods
• Examples:
Name Equation with Notation Standard Notation Find/
factor formula Equation Given
Single-payment compound F = P(1+i)n F = P(F/P, i, n) F/P
amount (F/P, i, n)
Single-payment present (P/F, i, n) P = F(P/F, i, n) P/F
worth
P = F(1+i)-n

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Using Standard Notation

Example
• What will be the future value of Rs. 100,000
compounded for 17 years at rate of interest
10% ? (F/P, i, n)

• F= (1+ i)n or F = P(1+0.1)n now writing that

in standard notation we have
Minimum Three
• F = P(F/P, i, n) steps required to
do every time
• F = 100,000(F/P, 10%, 17)
• F = 100,000 (5.054) That value you
get from “Table”
• F= 505400

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SPCAF and SPPWF

F = P(1+i)n P = F(1+i)-n
• The term “(1+i)n” is known
as Single Payment ▪ The term “(1+i)‒n” is known as
Compound Amount Factor Single Payment Present Worth
(SPCAF) Factor (SPPWF)

• It is also refer as F/P factor ▪ It is also refer as P/F factor

• This is a converting factor, ▪ This is a converting factor, when

when multiplied by “P” multiplied by “F” yields the present
yields the future amount amount “P” of initial amount “F”
“F” of initial amount “P” after “n” years at interest rate “i”
after “n” years at interest
rate “i”

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From Single Payments to

Annuity
• Normally, in the real world we do not face
Single payments mostly instead face cash
flows such as home mortgage payments and
monthly insurance payments etc

• An annuity is an equal annual(periodic)

series of cash flows. It may be equal annual
deposits, equal annual withdrawals, equal
annual payments, or equal annual receipts.
The key is equal, annual cash flows
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Uniform Series Present Worth

Factor (P/A factor)
A A A A A
Can we use Single
t=0 Payment Present Worth
1 2 3 n‒1 n Factor (P/F, i%, n), to get
t = given “P” for this cash flow ?
A = given

P=?
1 1 1 1 1
𝑷= 𝐴 +𝐴 𝐴 ………. + 𝐴 + 𝐴
(1 + 𝑖) (1 + 𝑖)2 + (1+𝑖)3 + (1 + 𝑖)𝑛−1 (1 + 𝑖)𝑛

1 1 1 1 1
𝑃 = 𝐴[ + + + ……….+ + ] … … … … … . (1)
(1+𝑖) (1+𝑖)2 (1+𝑖)3 (1+𝑖)𝑛−1 (1+𝑖)𝑛

Multiply Eq(1) by (P/F, i, n) factor and subtract the equation(1) from Eq (2)
𝑃 1 1 1 1 1 1
= 𝐴[ + + + ……….+ + ]
(1+𝑖) (1+𝑖) (1+𝑖) (1+𝑖)2 (1+𝑖)3 (1+𝑖)𝑛−1 (1+𝑖)𝑛
𝑃 1 1 1 1 1
= 𝐴[ + + + ……….+ + ] …… ..(2)
(1+𝑖) (1+𝑖)2 (1+𝑖)3 (1+𝑖)4 (1+𝑖)𝑛 (1+𝑖)𝑛+1

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Uniform Series Present Worth

Factor (P/A factor)
Subtracting Eq(1)
from Eq(2)
𝑃 1 1 1 1 1
= 𝐴[ + + + ……….+ + ] … ..(2)
(1+𝑖) (1+𝑖)2 (1+𝑖)3 (1+𝑖)4 (1+𝑖)𝑛 (1+𝑖)𝑛+1
1 1 1 1 1
𝑃 = 𝐴[ + + + ……….+ + ] … … … … … . (1)
(1+𝑖) (1+𝑖)2 (1+𝑖)3 (1+𝑖)𝑛−1 (1+𝑖)𝑛

𝑃 1 1
− 𝑃 = 𝐴[ 𝑛+1
− ]
(1 + 𝑖) 1+𝑖 (1 + 𝑖) 1
−𝑖𝑃 = 𝐴[ −1]
(1+𝑖)𝑛
𝑃 −𝑃−𝑃𝑖 1 1
= 𝐴[ − ]
(1+𝑖) (1+𝑖)𝑛+1 1+𝑖 1 1
𝑃 = − 𝐴[ −1]
𝑖 (1+𝑖)𝑛
−𝑖 1 1
𝑃 = 𝐴[ − ]
(1+𝑖) (1+𝑖)𝑛+1 1+𝑖
−𝑖 1 1 (1 + 𝑖)𝑛 −1
𝑃 = 𝐴[ −1] 𝑃=𝐴
(1+𝑖)𝑛
(1+𝑖) 1+𝑖
𝑖(1 + 𝑖)𝑛
USPWF
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Uniform Series Present Worth Factor

(USPWF)
A A A A A

t=0
1 2 3 n‒1 n
t = given
A = given
P=?
• To find “P” of such series of A …we cannot use P=F(P/F, i, n) because we
do not have a single amount but a uniform series in which cash flows
occurs in equal amounts (in each period) and in consecutive interest
periods.

• Yes P/F can be use for each A separately…but that’s a lengthy process

• Uniform Series Present Worth Factor (USPWF) represented as P/A is

used to calculate the equivalent P value in year 0 for uniform end-of-period
series of A values beginning at the end of period 1 and extend
(1 + 𝑖)𝑛 −1
• Mathematically: 𝑃=𝐴
𝑖(1 + 𝑖)𝑛
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Capital Recovery Factor (CRF)

(1 + 𝑖)𝑛 −1 A=?
𝑃=𝐴
𝑖(1 + 𝑖)𝑛 t=0 1 2 3 n-1 n
t = given
𝑛
𝑖(1 + 𝑖) P = given
𝐴=𝑃
(1 + 𝑖)𝑛 −1
• The term in bracket is called Capital Recovery Factor (CRF)
or A/P factor and it calculates the equivalent uniform annual
worth A over n years for a given P in year 0, when the
interest rate is i
Name Equation with factor Notation Standard Notation
formula Equation

Uniform Series (1 + 𝑖)𝑛 −1

Present Worth 𝑃=𝐴 (P/A, i, n) P = A(P/A, i, n)
𝑖(1 + 𝑖)𝑛

𝑖(1 + 𝑖)𝑛 A = P(A/P, i, n)

Capital Recovery 𝐴=𝑃
(1 + 𝑖)𝑛 −1
(A/P, i, n)

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Summary Slide
Factors Formula Standard Notation
F/P factor F = P(1+i)n F = P(F/P, i, n)

P/F factor P = F(1+i) −n P = F(P/F, i, n)

(1 + 𝑖)𝑛 −1
P/A factor 𝑃=𝐴 P = A(P/A, i, n)
𝑖(1 + 𝑖)𝑛
𝑖(1 + 𝑖)𝑛
A/P factor 𝐴=𝑃
(1 + 𝑖)𝑛 −1
A = P(A/P, i, n)

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Example 1: Uniform Series

Present Worth (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?
The cash flow diagram is as follows: Solution:
A = 5000 i = 10% n=5
A = $5000
Which factor should be used ?
P = A(P/A, i, n)
0 1 2 3 4 5 P = 5000(P/A,10%,5)
i =10% = 5000(3.7908)
P=? = $18,954

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Spread Sheet Functions

• Our course book (Blank and Tarquin) from time to time refers to
“Spread sheet functions”

• You will also be come across various Spread sheet formulas

while reading the book

• We are going to “Ignore” that parts because you cannot use it in

exams. Yes you will need it while doing projects in real life, but
applying that from EXCEL is not difficult if you know what it
mean.

• However, to get familiar with it, I will give you one take home
assignment to do it with help of Excel sheet, after doing a
session on it in class
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Factor Values for

Untabulated i or n

There are 3 ways to find factor values for

untabulated i or n values
1. Use formula
2. Use spreadsheet function
3. Linearly interpolate in interest tables

• Formula or spreadsheet function is fast & accurate

• Interpolation is only approximate

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Factor Values for Untabulated i

or n
Linear Interpolation
𝑥−𝑥1
formula 𝑓 = 𝑓1 + (𝑓 −𝑓1 )
𝑥2 −𝑥1 2
Factor value
axis Example
f2 Determine the value of (F/P, 8.3%, 10)
We have value of 8% and 9% only in
Tables
Linear from Factor Tables for F/P
unknown assumption
X f(x)
f
8 % ………... 2.1589
8.3% (x)……….. unknown
9 % …….….. 2.3674
f1 𝑥−𝑥1
𝑓 = 𝑓1 + (𝑓 −𝑓1 )
𝑥2 −𝑥1 2
8.3−8.0
𝑓 = 2.1589 + (2.3674 − 2.1589)
9−8
Required 𝑓 = 2.2215
X1 X2
X
Original value for 8.3% is 2.2197
i or n axis Absolute Error = 2.2215 – 2.2197
= 0.0018
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Uniform Series Compound Amount

Factor (USCAF) F = ?
t = given and i = given
0 1 2 3 n-1 n

A = given

• Similar to Uniform Series Present Worth Factor we have

Uniform Series Compound Amount Factor which is given
as follows (only the term in the parenthesis)
(1 + 𝑖)𝑛 −1
𝐹=𝐴
𝑖

• The term in the parenthesis is called Uniform Series

Compound Amount Factor (USCAF) represented as F/A, to
multiply with a given uniform amount gives the future value of
a uniform series

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• What is meant by Sinking Fund ?

65

Sinking Fund Factor (SFF)

t = given and i = given F = given
0 1 2 3 n-1
n
A=?

• Sinking Fund Factor (A/F) can be obtained from USCAF and given as :

(1 + 𝑖)𝑛 −1
𝐹=𝐴
𝑖

𝑖
𝐴=𝐹
(1 + 𝑖)𝑛 −1
• The term in the brackets is Sinking Fund Factor and is used to determines
the uniform annual series A that is equivalent to a given future amount F

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Example
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?
Solution:
The cash flow diagram is:
A =10,000
i = 8% F=? i =8%
A = $10,000 n =7

F = A(F/A, i, n)
0 1 2 3 4 5 6 7 F = 10,000(F/A,8%,7)
= 10,000(8.9228)
= $89,228

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Using Factor Tables

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Class Practice:
4 Minutes
Problem 1
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.

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Solution
Problem 1
• i= 14%
• n = 8 years
• A= 1,000,000 F=?
i = 14%
1 2 3 4 5 6 7 8
A = $10,000
• Which factor should be used ?
• F = A(F/A, i, n)
• F = 1,000, 000( F/A, 14%,8)
= 1,000, 000 (13.2328)
$13,232,800

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Summary Slide
Factors Formula Standard Notation
F/P factor F = P(1+i)n F = P(F/P, i, n)
P = F(1+i) −n P = F(P/F, i, n)
P/F factor
(1 + 𝑖)𝑛 −1
𝑃=𝐴 P = A(P/A, i, n)
𝑖(1 + 𝑖)𝑛
P/A factor
𝑖(1 + 𝑖)𝑛
𝐴=𝑃
(1 + 𝑖)𝑛 −1
A = P(A/P, i, n)
A/P factor
(1 + 𝑖)𝑛 −1
F/A factor 𝐹=𝐴 F = A(F/A, i, n)
𝑖
𝑖
A/F factor 𝐴=𝐹
(1 + 𝑖)𝑛 −1
A = F(A/F, i, n)
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Example
• You bought a used car with one year warranty
• expected costs during first year will be
fuel and insurance that is $2500
• let assume that cost of repair is
increasing by $200 every year
• what will be the amount in Second Year ?
0 1 2 3 n-1 n
Base amount
$2500

$2700
Gradient (G) = $200
$2900
$2500+(n-2)200
$2500+(n-1)200

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Arithmetic Gradient Factors

(P/G)
• Cash flows that increase or decrease constantly are
considered arithmetic gradient cash flows.

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

$2000 Gradient
$175 $1500 series
$150 $1000 could be
$125
$100 $500 both: cash
inflow (as
given
0 1 2 3 4 0 1 2 3 4 here) or
Outflows
G = $25 G = -$500
Base = $100 Base = $2000

Cash Flow Formula CFn = base amount + (n-1)G

80

Arithmetic Gradient Factor

(P/G)

• When we have a “Gradient” Series we

cannot apply Single Amount Present
Worth/Future Worth factors or Uniform
Series factors

• We have to use a different methodology to

address problems related to gradient cash
flows.

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Solving Arithmetic Gradient

related problems
Present value of the Arithmetic Gradient series (P/G) can be
calculated as follows:
1. Find the gradient and base
2. Cash flow diagram maybe helpful if you draw it
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 is as follows;

PT = PA + PG
5. Calculate PA and PG and use the above formula to
get the present value of the Arithmetic Gradient
Note: the + sign or “−” sign in point 4, depends if gradient is increasing or
decreasing
82

Arithmetic Gradient Factor

(P/G)
• The base amount is “A” and the “Gradient is “G” in the
following graph
Cash Flow Formula CFn = base amount + (n-1)G
Important!!!
PG series start
A+(n-1) G with year 2
A+3G
(n-1)G
A+2G
3G
A+G 2G
A A A A A A
G
= + 0

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

PT = PA + PG
Note: the + sign or “−” sign in above formula depends if gradient is increasing or
decreasing
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Thank You

84

Arithmetic Gradient Factors

(P/G)

PT = PA + PG
• PA = A(P/A, i, n) or Uniform Series Present worth
Factor
• PG = G(P/G, i, n) or Arithmetic Gradient Present
Worth Factor … you can use table for it too.
• Alternatively, PG can also be calculated by
following formula
G n
 (1 + i ) − 1 − n 

PG =
i  i (1 + i ) n
(1 + i ) n 
 
G n 
 (1 + i ) − in − 1 
PG =
Or i  i 2 (1 + i ) n 
 

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Arithmetic Gradient Factors

(P/G)
Equivalent cash flows:
$175
$150
$125 $75
$100 $100 $50
$25
=> +
0 1 2 3 4
0 1 2 3 4 0 1 2 3 4
Note: Annuity series (PA) Note: the gradient series
G = $25 (PG) by convention starts
starts from year 1.
Base = $100 in year 2.

PT = PA + PG
G  (1 + i )n − 1 n 
PG =  − 
$P = $100(P/A,i,4) + $25(P/G,i,4)
i  i (1 + i ) n
(1 + i )n 

Where PA = Present worth uniform series (P/A, i,n) and PG = present worth of the gradient series (P/G,i, n)

86

Example (Problem 2.25)

Profits from recycling paper, cardboard, aluminium,
and glass at a liberal arts college have increased at a
constant rate of $1100 in each of the last 3 years.

If this year’s profit (end of year 1) is expected to be

$6000 and the profit trend continues for another 4
years ,
(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?
G = $1100, Base = $6000

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Example (Problem 2.25)

(a) what will the profit be at the end of year 5 &
(b) what is the present worth of the profit at an interest rate of 8% per
year?
$4400
G = $1100 Base = $6000 $6000 $3300
$2200
$1100
$10400
$9300 +
=> 0 1 2 3 4 5 0 1 2 3 4 5
$8200
$7100 PT = PA + PG
$6000
P = A(P/A, i, n) + G(P/G, i, n)
P = 6000(P/A, 8%, 5) + 1100(P/G, 8%, 5)
+
0 1 2 3 4 5
Find the cash flows as follows: P = 6000(3.9927) 1100(7.3724)
CF = Base + G(n-1)
CF1 = 6000 + 1100(1-1)= 6000 P = 32,066
CF2 = 6000 + 1100(2-1)= 7100
CF3 = 6000 + 1100(3-1)= 8200
CF4 = 6000 + 1100(4-1)= 9300
CF5 = 6000 + 1100(5-1)= 10400

88

Example (Problem 2.25)

(a) what will the profit be at the end of year 5 &
(b) what is the present worth of the profit at an interest rate of 8% per
year?

G = $1100 Base = $6000

$10400
$9300
=>
$8200
$7100
$6000

0 1 2 3 4 5
Find the cash flows as follows:
CF = Base + G(n-1)
CF1 = 6000 + 1100(1-1)= 6000
CF2 = 6000 + 1100(2-1)= 7100
CF3 = 6000 + 1100(3-1)= 8200
CF4 = 6000 + 1100(4-1)= 9300
CF5 = 6000 + 1100(5-1)= 10400

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Practice : 5 minutes
Neighboring parishes in Louisiana have agreed to pool
road tax resources already designated for bridge
refurbishment. At a recent meeting, the engineers
estimated that a total of $500,000 will be deposited at
the end of next year into an account for the repair of
old and safety-questionable bridges throughout the area.
Further, they estimate that the deposits will increase
by $100,000 per year for only 9 year thereafter, then
cease. Determine the equivalent: present value, if public
funds earn at a rate of 5% per year.
5% Uniform Series Factors Athematic Gradient
n Sinking Compound Capital Present Gradient Gradient
Fund Amount Recovery Worth Present Worth Uniform
(A/F) (F/A) (A/P) (P/A) (P/G) Series (A/G)
9 0.09069 11.0266 0.14069 7.1078 26.1268 3.6758
10 0.07950 12.5779. 0.12950 7.7217 31.6520 4.0991
91

Solution
• Base = 500,000
• Gradient = 100,000
• Taking units in 1000 P = ?
• Base = 500
• Gradient =100
0 1 2 3 4 5 6 7 8 9 10
• i= 5%
• n=1+9 = 10 $500
$600
$700
$800
$900

PT = PA + PG $1000 $1100
$1200
$1300
$1400

PT = 500(P/A,5%,10) + 100(P/G,5%,10)
= 500(7.7217) + 100(31.6520)
=$7026.05 or ….. ($7,026,050)
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…. What about A/G or F/G?

94

Arithmetic Gradient Uniform

Series Factor (A/G)

• Similar procedure as done for Arithmetic Gradient Present

worth Factor
• Following formula:

AT = AA + AG
AA = A (Annuity Series) Given as base value of G series and AG = G(A/G, i, n)

AG can be get from 1 𝑛

factor tables or through 𝐴𝐺 = 𝐺 −
given formula in box 𝑖 (1 + 𝑖)𝑛 −1

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Example: A/G factor

96

Example: A/G Factor

Neighboring parishes in Louisiana have agreed to pool

road tax resources already designated for bridge
refurbishment. At a recent meeting, the engineers
estimated that a total of $500,000 will be deposited at
the end of next year into an account for the repair of
old and safety-questionable bridges throughout the area.
Further, they estimate that the deposits will increase
by $100,000 per year for only 9 year thereafter, then
cease.
Determine the equivalent: Annual series amount, if
public funds earn at a rate of 5% per year.

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Solution
AT = AA + AG
• Base = 500,000
AT = 500 + 100(A/G,5%,10)
• Gradient = 100,000 = 500 + 100(4.0991)
• Taking units in 1000 =$909.91 or ….. ($909,910)

• Base = 500 0 1 2 3 4 5 6 7 8 9 10

• Gradient =100
• i= 5% $500
$600
• n=1+9 = 10 $700
$800
$900
$1000 $1100
$1200
$1300
$1400
0 1 2 3 4 5 6 7 8 9 10

A= $909,910

98

Arithmetic Gradient Future

Worth Factor (F/G)
• Another factor in “Gradient family” is “Future” value
of an Arithmetic Gradient series (F/G)
• It can be obtained by multiply (P/G) and (F/P) factors
1 (1 + 𝑖)𝑛 −1 𝑃 𝐹 𝐹
𝐹/𝐺 𝑜𝑟 𝐹𝐺 = 𝐺 −𝑛 × =
𝑖 𝑖 𝐺 𝑃 𝐺

No factor table values is available so only formula can be use for calculating “F/G” factor

Note: To get future value of Arithmetic Gradient …. We do not need to

divide the gradient into two separate cash flows like Present value of
Arithmetic gradient series…. This F/G will be the future value of entire
gradient series.

You can also convert athematic gradient first to Present value using P/G and
then convert that present value to Future value using F/P factor
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Final Words about Arithmetic

Gradient
Present value or Annual value of Arithmetic Gradient (P/G or A/G)
…. Base and Gradient considered separately for both P/G and A/G
…. Get Two series… a PA/AA series and one PG/AG series
….use the factor tables to get values for PA/AA & PG/AG
You can also convert the
…… Add both to get PT/AT. athematic gradient first
to the Present value
using P/G and then
Future value of Arithmetic Gradient (F/G)
convert that present
… Base and Gradient are not considered separately value to the Future value
…. No factor values are available so have to rely on formula using the F/P factor
….formula directly calculates the future value of the Arithmetic Gradient

1 (1 + 𝑖)𝑛 −1
𝐹/𝐺 𝑜𝑟 𝐹𝐺 = 𝐺 −𝑛
𝑖 𝑖

101

Geometric Gradient
Factors
(Pg /A)

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Geometric Gradient Factors

(Pg /A)
• A Geometric gradient is when the periodic payment is increasing
(decreasing) by a constant percentage:
• the rate at which the cash flow is increasing is “g”
• The initial amount of Geometric Gradient is A1
• Pg is the present value of entire Gradient Series including A1

• It is important to note that “Initial amount” is not considered

separately while working with “Geometric Gradient”
for g ≠ i: for g = i:
1+𝑔 𝑛 𝑛
1− 𝑃𝑔 = 𝐴
1+𝑖 1+𝑖
𝑃𝑔 = 𝐴
𝑖−𝑔

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

103

Geometric Gradient Factors

(Pg /A)
• A Geometric gradient is when the periodic payment is
increasing (decreasing) by a constant percentage: A (1+g)n-1
1
A1 = $100, g = 10% or 0.1
A2 = $100(1+g)
A (1+g)2
A3 = $100(1+g)2 A1 (1+g) 1
A1

An = $100(1+g)n-1
0 1 2 3 4 ……n
where: A1 = cash flow in period 1 and g = rate of increase
It maybe noted that A1
for g ≠ i: is not considered
separately in geometric
1+𝑔 𝑛 for g = i: gradients
1− 1+𝑖 𝑛
𝑃𝑔 = 𝐴 𝑃𝑔 = 𝐴
𝑖−𝑔 1+𝑖

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

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Future value (F/G) and Annuity

(A/G) from Geometric Gradient
Series

• We just learned how to get “Present Value” of a

Geometric Gradient

• We can first derive the Present value of the Geometric

Gradient and then can use F/P factor for
calculating future value of a geometric gradient

• Similarly, A/P factor can be applied to P/G factor to

calculate the Annual value/Annuity series from
Geometric Gradient
105

Class Practice: 4 Minutes

Determine the present value of a geometric
gradient series with a cash flow of $50,000 in
year 1 and increases of 6% each year
through year 8. The interest rate is 10% per
year.

for g ≠ i:
1+𝑔 𝑛 for g = i:
1− 1+𝑖 𝑛
𝑃𝑔 = 𝐴 𝑃𝑔 = 𝐴
𝑖−𝑔 1+𝑖

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Class Practice: 4 Minutes

Determine the present value of a geometric
gradient series with a cash flow of $50,000 in
year 1 and increases of 6% each year
through year 8. The interest rate is 10% per
year.
   1 + 0.6  
8
1+ g  1− 
n
1− 
      1 − 0.743 

Pg = A  1+ i   == 50000 1 + 0.10  
 0.10 − 0.06 
== 50,000 
i−g   0.04 
   
   
   

 0.257 
== 50,000  == 50,000(6.425)
 0.04 
= $321,250
107

Summary of all
Factors!!!

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Single payment Factors

F=?
F/P Factor
F= P(F/P, i%, n)

n and i is given

P is given

P/F Factor
P =? P= F(P/F, i%, n)

n and i is given

F = given
109

Uniform Series Factors

P/A Factor A/P Factor

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

F/A Factor A/F Factor

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

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Athematic Gradient

FG = ?
F = PT(F/PT, i%, n)
or
PA = A(P/A, i%, n) 1 (1 + 𝑖)𝑛 −1
𝐹/𝐺 𝑜𝑟 𝐹𝐺 = 𝐺 −𝑛
𝑖 𝑖
PG = G(P/G, i%, n)

111

Athematic Gradient

A = PT(A/PT, i%, n)
or
AT = AA + AG
PA = A(P/A, i%, n) AA = A (Annual value) &
AG = G(A/G, i, n)
PG = G(P/G, i%, n) 1 𝑛
𝐴𝐺 = 𝐺 −
𝑖 (1 + 𝑖)𝑛 −1

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Geometric Gradient

Pg = ?

Fg = ?
for g ≠ i: F = Pg(F/P, i%, n)
𝑛
1+𝑔
1− 1+𝑖 Similarly …
𝑃𝑔 = 𝐴
𝑖−𝑔
for g = i:
𝑛
𝑃𝑔 = 𝐴 A = Pg(A/P, i%, n)
1+𝑖

113

Thank You

115

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