CHAPTER 2

Factors: How Time and

Interest Affect Money

 Covered Topics
1. F/P and P/F Factors
2. P/A and A/P Factors
3. F/A and A/F Factors
4. Interpolate Factor Values
5. P/G and A/G Factors
6. Geometric Gradient
7. Calculate i
8. Calculate “n”
9. Spreadsheets
 SINGLE-PAYMENT FACTORS
(F/P AND P/F)

$20,000 were deposited in a savings account for

three consecutive years. How much would be
there in the account at the end of three years if
the bank pays a 6% interest compounded
annually?

P = $20,000, i = 6%, n = 3, F = ?
 Compound Amount Factor
(F/P)
Find F, given P

+
F=?

i given
0 1 2 … n- 1 n
CF time

P
-
 SINGLE-PAYMENT FACTORS
(F/P AND P/F)

P present worth
F future worth
i interest rate compounded one time
per period
n number of interest periods

(F/P) - Compound Amount Factor

(P/F) - Present Worth Factor
 Derivation of F/P factor
F1: future worth of P after 1 period at
interest rate i

F1 = P + P*i = P*(1+i)

F2 = F1 + F1*i = P*(1+i) + P*(1+i)*i = P*(1+i)2

F3 = F2 + F2*i = P*(1+i)2 + P*(1+i)2*I = P*(1+i)3

Fn = P*(1+i)n

F = P*(1+i)n ...(1)

Compound Amount Factor is (1+i)n

 Example: F/P factor
$20,000 were deposited in a savings account for
three consecutive years. How much would there
be in the account at the end of three years if the
bank pays a 6% interest compounded annually?

P = $20,000, i = 6%, n = 3, F = ?

Which factor formula should we use?

F = P*(1+i)n = $20,000 * (1 + 0.06)3

= $ 23,820.20
 Present Worth Factor
(P/F)

+
F

i given
0 1 2 … n- 1 n
CF time

P=?
-
 Derivation of Present Worth
Factor (P/F)

Notice that P/F is just the reverse of F/P

Hence, by rearranging (1)

P = F/(1+i)n …(2)

Present Worth Factor is 1/(1+i)n

 Example: (P/F) factor
Mr. Boyle opens a savings account for his daughter’s
college money at 5% interest rate. His daughter will start
college 10 years later. Mr. Boyle estimates that her
expenses in the first year will be $30,000. How much
should he put into the savings account today for her to
use in her first year of college?

F = $30,000, i=5%, n = 10, P = ?

Which factor formula should we use?

P = F/(1+i)n = $30,000/(1 + 0.05)10

= $18,417.40
 Uniform-Series Factors

P present worth
F future worth
A annual worth
i interest rate compounded one
time per period
n number of interest periods
 Uniform-Series Factors

(P/A) Uniform-Series Present Worth Factor

(A/P) Capital Recovery Factor

(A/F) Sinking Fund Factor

(F/A) Uniform-Series Compound Amount

Factor
 Uniform-Series Present Worth
Factor (P/A)
Tony borrows some money from a financial
institution. 1% interest rate per month is
charged on this money. Tony can payback his
total debt by making $500 - monthly payments
for 12 months. Find the original amount of
money he borrowed.

A=$500, n=12, i=1%, P=?

 Uniform-Series Present Worth
Factor (P/A)

Find P given A

+ P=?

i given
0 1 2 … n-1 n
CF time

A A … A A
-
 Derivation of P/A factor

 1   1   1 
P  A 1
 A 2 
 ...  A n 
 (1  i )   (1  i )   (1  i ) 

 1 1 1  …(a)
P  A   ...  
n 
 (1  i ) (1  i ) (1  i ) 
1 2

Recall the following identity:

n 1 r (1  r ) n
r  r  r
2
r 
n

1 r
 Derivation of P/A factor

n 1 r (1  r ) n
r  r  r
2
r  n

1 r

 1 
Substitute r by  
 (1  i) 

and apply this identity to (a).

 Derivation of P/A factor

After some simplification, we obtain:

 (1  i )  1
n
…(3)
P  A n 
 i (1  i ) 
Uniform-series present worth factor (P/A) is :

 (1  i )  1
n

 n 
 i (1  i ) 
 Example: (P/A) Factor

Tony borrows some money from a financial

institution. 1% interest rate per month is
charged on this money. Tony can payback his
total debt by making $500 - monthly payments
for 12 months. Find the original amount of
money he borrowed.

A=$500, n=12, i=1%, P=?

 Example: (P/A) Factor
+ P=?

i=1%
0 1 2 … 11 12
CF time

A=$500
-

A=$500, n=12, i=1%, P=?

 (1  i ) n  1  (1.01)12  1 
P  A n 
 $500 12 
 $5627.54
 i (1  i )   0.01(1.01) 
 Capital Recovery Factor (A/P)

Jane’s mother deposits $120,000 to her

savings account on January 1st, 2004. Jane will
use this money for the next 5 years. She plans
to withdraw equal amounts of money on the
first day of each year starting from 2005. If the
bank pays a 5% annual interest, how much can
Jane withdraw each year?

P=$120,000, i=5%, n=5, A=?

Capital Recovery Factor (A/P)

Find A given P
+ P

i given
0 1 2 … n-1 n
CF time

A=?
-
 Capital Recovery Factor (A/P)

A/P is the reverse of P/A

Recall that the P/A factor formula is:

 (1  i ) n  1
P  A n 
 i (1  i ) 
In order to derive (A/P) we just write
A in terms of P.
 Capital Recovery Factor (A/P)
In order to derive (A/P) we just write
A in terms of P:

 i(1  i) 
n
A  P  …(4)
 (1  i)  1
n

Capital Recovery Factor (A/P) is:

 i(1  i) n 
 
 (1  i)  1
n
 Example: Capital Recovery
Factor (A/P)
Jane’s mother deposits $120,000 to her
savings account on January 1st, 2004. Jane will
use this money for the next 5 years. She plans
to withdraw equal amounts of money on the
first day of each year starting from 2005. If the
bank pays a 5% annual interest, how much can
Jane withdraw each year?

P=$120,000, i=5%, n=5, A=?

 Example: Capital Recovery
Factor (A/P)
P=$120,000, i=5%, n=5, A=?

+ P=$120,000

i=5%
0 1 2 3… 4 5
CF time

A=?
-
 Example: Capital Recovery
Factor (A/P)

P=$120,000, i=5%, n=5, A=?

Which factor formula should we use?

Use A/P

 i (1  i ) n   0.05(1.05)5 
A  P   $120,000   $27716.98
 (1  i )  1  (1.05)  1 
n 5
 Sinking Fund Factor (A/F)

John plans to buy a house 10 years from now

for $200,000. He plans to open a savings
account in a bank that pays 8% interest
compounded annually and deposit equal
amounts of money at the end of each year for
the next 10 years. How much should he deposit
each year?

F=$200,000, i=8%, n=10, A=?

 Sinking Fund Factor (A/F)

Find A given F
+ F

i given
0 1 2 … n-1 n
CF time

A=?
-

Note: The uniform series A begins at the end of period 1 and

continues through the last period when F is given.
 Derivation of A/F factor

From (1) and (4), we have:

F  i (1  i ) n 
P A  P 
(1  i ) n
 (1  i )  1
n

Substitute for P in the above equation:

F  i (1  i ) 
n
 i 
A n    F 
(5)
(1  i )  (1  i )  1
n
 (1  i )  1
n
 Derivation of A/F factor

Sinking Fund Factor (A/F) is :

 i 
 (1  i) n  1
 
Example: Sinking Fund Factor (A/F)

John plans to buy a house 10 years from now

for $200,000. He plans to open a savings
account in a bank that pays 8% interest
compounded annually and deposit equal
amounts of money at the end of each year for
the next 10 years. How much should he deposit
each year?

F=$200,000, i=8%, n=10, A=?

 F=$200,000, i=8%, n=10, A=?

+ F=$200K

i=8%
0 1 2 … 9 10
CF time

A=?
-

 i   0.08 
A  F   $200,000   $13,805.90
 (1  i )  1  (1.08)  1
n 10
 Uniform-Series Compound
Amount Factor (F/A)

A man deposits $2,400 in a savings account at 4%

compounded annually at the end of each year for the
next 6 years. At the end of 6th year, he plans to buy a
car. He can either buy BMW at $15,800 or Ford at
$16,000. Assuming he won’t be using any other funds,
determine which car he can buy with the money in his
savings account?

A=$2,400, i=4%, n=6, F=?

 Uniform-Series Compound
Amount Factor (F/A)

+ Find F, given A. F=?

i given
0 1 2 … n-1 n
CF time

A A … A A
-

Note: Future amount F occurs in the same

period as the last A
 Derivation of F/A factor

By rearranging equation (5), we obtain:

 (1  i )  1
n
F  A  …(6)
 i 
Uniform-Series Compound Amount Factor (F/A) is:

 (1  i)  1
n

 
 i 
 Example: Factor (F/A)

A man deposits $2,400 in a savings account at

4% compounded annually at the end of each
year for the next 6 years. At the end of 6th
year, he plans to buy a car. He can either buy
BMW at $15,800 or Ford at $16,000. Assuming
he won’t be using any other funds, determine
which car he can buy with the money in his
savings account?

A=$2,400, i=4%, n=6, F=?

 A=$2,400, i=4%, n=6, F=?
+ F=?

i=4%
0 1 2 … 5 6
CF time

A=$2,400
-

 (1  i ) n  1  (1.04) 6  1
F  A   $2,400   $15,919.14
 i   0.04 

He can only afford to buy the BMW!

 Summary
(F/P) Compound AmountFactor (1+i)n

(P/F) Present Worth Factor 1/(1+i)n

(P/A) Uniform-Series Present  (1  i ) n  1

Worth Factor  n 
 i (1  i ) 
 i(1  i) n 
(A/P) Capital Recovery Factor
 
 (1  i ) n
 1 
 i 
(A/F) Sinking Fund Factor  (1  i ) n  1 
 

(F/A) Uniform-Series Compound  (1  i) n  1

Amount Factor  
 i 
 Standard Factor Notation
General Form (X/Y, i, n)

That notation should be read as:

“find X given Y at i interest rate for n periods”

Factor Name Standard Notation

Single-Payment Present Worth (P/F, i, n)

Single-Payment Compound Amount (F/P, i, n)

Uniform-Series Present Worth (P/A, i, n)

Capital Recovery (A/P, i, n)

Sinking Fund (A/F, i, n)

Uniform-Series Compound Amount (F/A, i, n)

 Standard Factor Notation

To Find Given Factor Equation

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

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

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

F A (F/A, i, n) F=A*(F/A, i, n)
 Interest Tables
Examples:

(P/A, 10%,14)=

(A/F, 5%, 21) =

(P/F, 8%, 5) =

(A/P, 7%, 15) =

1. What is the future worth of $4,000 invested for 8

years at interest rate 9% per year?

P=$4,000, i=9%, n=8, F=?

Which factor should we use?

 Interest Tables

P=$4,000, i=9%, n=8, F=?

F=P*(F/P,9%,8)

From Table 14, (F/P,9%,8) is 1.9926

F=4,000*1.9926=$7,970.25

Alternately, we can solve this problem by using the

formulas that we derived earlier:

F=P*(1+i)n =$4,000*(1.09)8 = $7,970.25

 Interest Tables
Examples:

How much money should you be willing to spend now in

order to avoid spending $20,000 six years from now if
the interest rate is 12% per year?

F=$20,000, i=12%, n=6, P=?

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

From Table 17, (P/F,12%,6) is 0.5066

P = $20,000*0.5066 = $10,132.00
 Interest Tables
Examples:

How much money should Carol deposit every year

starting 1 year from now at 5 % per year in order to
accumulate $6000 seven years from now?

F=$6000, i=5%, n=7, A=?

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

From Table 10, (A/F,5%,7) = 0.12282

A = $6000*0.12282 = $736.29
 Review Problem # 1

Which one would you choose, if your MARR

is 5% per year?
1) receive $10K today, and $5K 10
years from now
2) Receive $1,500 at the end of each
year starting one year from now and
continuing for 10 years.
 Review Problem #2
Calculate the future value of the CF diagram
given below at year 10:
F=?
i = 5%

0 2 5 10

$300
$400
$600
 Arithmetic Gradient Factors

A cash flow series that either increases or

decreases by a constant amount.

Example:
Sam buys used equipment. He spends $400 on
repairs and maintenance during the first year
of operation. After the first year, he estimates
that the repair and maintenance cost will
increase by $100 every year.
 Arithmetic Gradient Factors
+

0 1 2 3 … n
CF time
Base
$400 Gradient
$400+$100
Gradient
$400+ 2*$100

$400+(n-1)*100

-
Note: the first gradient occurs at the end of year 2!!
 Arithmetic Gradient Factors

The cash flow in year n (CFn) may be calculated as:

CFn = base amount + (n-1)G

G = constant arithmetic change in the magnitude of

receipts or disbursements from one time period to
the next (or, it’s the arithmetic gradient); G may be
positive or negative.
 Arithmetic Gradient Present Worth

Arithmetic gradient present worth factor (P/G) is:

1  (1  i) n  1 n 
  n 
i  i(1  i ) n
(1  i ) 

To convert an arithmetic gradient G (not including the base

amount) for n years into a present worth at year 0 use:

G  (1  i ) n  1 n 
PG    
i  i (1  i ) n
(1  i ) n 
 (1  i ) n  in  1
PG  G  2 
 i (1  i )
n

Arithmetic Gradient Present Worth

To calculate the total present worth PT use:

PT = PA + PG

 (1  i ) n  in  1
( P / G , i, n)   2 
 i (1  i )
n


PA is the present worth of the uniform-series amount

A that begins in year 1 and extends through year n
(magnitude of A is the base amount)
Arithmetic Gradient Present Worth
Example:
David Beckham makes a contract with Real Madrid.
According to the terms of the contract he will receive
$3M at the end of the first year; and this amount will
increase by $250K each year for the following 3
years. Assuming David Beckham always invests his
money with a 14% ROR; find the present value of his
contract.

A= $3M, G= $0.25M, i=14%, n=4, P=?

Arithmetic Gradient Present Worth

A= $3M, G= $0.25M, i=14%, n=4, P=?

$3.75M
$3.5M
P=?
$3.25M
$3M

CF time
0 1 2 3 4

i=14%
Arithmetic Gradient Present Worth
The previous CF diagram is equivalent to the sum of the
two CF diagrams below:

PA=?

A=$3M

CF time
0 1 2 3 4
i=14%

PA = $3M (P/A,14%,4) = $3M*2.9137 = $8.7411M

Arithmetic Gradient Present Worth

$0.75M
PG=? $0.5M

$0.25M

CF time
0 1 2 3 4

i=14%

PG = $0.25M (P/G,14,4) = $0.25M*3.8957=$0.9739M

P = PA + PG =$9.715M
Geometric Gradient Series Factors

A cash flow series with gradients where the

gradients change geometrically.

$40*(1.1)n-1

$40*(1.1)3

$40*(1.1)2

$40*1.1
$40
A1
0 1 2 3 4 … n
Geometric Gradient Series Factors
g – constant rate of change, in decimal form, by which
amounts increase or decrease from one period to the
next (it’s the geometric gradient).

Geometric gradient series present worth factor

(P/A, g, i, n) is:

 1  g n
1   
  1 i  ; g  i
( P / A, g , i, n)   ig
 n
 ;g  i
 1 i
 Geometric Gradient Series Factors
To convert a geometric gradient g with a basis
A1 for n years at i interest rate into a present
worth at year 0 use:

Pg = A1(P/A,g,i,n)

The Future and Annual Worth equivalents of the

geometric gradients can be derived directly or
can be calculated by using Pg and (F/P) and
(A/P) factors.
 Geometric Gradient Series Factors
Example 1:
Assuming the interest rate is 5%, calculate the present
worth of the cash flows in the below CF diagram.

$40*(1.1)3

$40*(1.1)2

$40*1.1
$40

0 1 2 3 4
 Geometric Gradient Series Factors
Example 1:

A1 = $40, g=0.1, n=4, i=5%, Pg=?

1  (1.10 / 1.05) 4 
P  $40  
g  0.05  0.10 

Pg = $40 * 4.09037 = $163.62

 Geometric Gradient Series Factors

Example 2:
Engineers at seaWorld modified an existing
boat. The modifications costs $8000 and it is
expected to last 6 years with a salvage value
$1300. The maintenance cost is expected to be
$1700 the first year and increasing by 11% per
year thereafter. Determine the equivalent
present worth at 8% annual interest rate.
 Unknown interest Rate

Example:
John can make investment of $3000 now in
order to receive $5000 five years from now.
- Determine the rate of return
- If John can receive 7% per year on a
certificate of deposite, which investment should
he make?
 Basic Sensitivity Analysis
Example:
A company invested $500,000 in a project this year (t=0),
and it expects to spend $500,000 annually for the next 4
years, and possibly for more years. Use the spreadsheet
to answer the following questions:
(a) Assume the $500,000 is spent for 4 years only. If the
company sells the project at the end of 5 years for $5
million. What is ROR of this project.
(b) How many years they have to finish the project and
receive $5 million to make at least 10% per year?
 Interpolation
If you need to obtain the value of a compounding factor from the
tables but you could not find the required i or n, then you have
to use interpolation.
Example:
Find the (F/P,14%,62) from the tables.
The tables include n = 60 and 65 but it does not include n = 62.
Hence, we find the (F/P,14%,60) and (F/P,14%,65). Then,
(F/P,14%,62) should be in between their values and we use
interpolation to find it. The graph and the equations on the next
slide will show you how to find it.
 Interpolation
(F/P,14%,65) = 4998.22, (F/P,14%,60) = 2595.92, (F/P,14%,62) = ?

Slope = tan () = (F/P,14%, n)

(4998.22-2595.92) 4998.22
(65 – 60)

(x-2595.92)
= x
(62 – 60)


(2402.3) (x-2595.92) 2595.92
=
(5) (2)

X = 3556.84
60 62 65
(F/P,14%,62) = 3556.84
n
Please keep in mind that this an approximated value not the
exact value because the exact value is 3373.65