Chapter 2

Factors: How Time and

Interest Affect Money

Lecture slides to accompany

Engineering Economy
7th edition

Leland Blank
Anthony Tarquin

© 2012 by McGraw-Hill, New York, N.Y All Rights Reserved 2-1

 Learning Outcomes
1. Understand and apply financial factors: the compound amount (F/P)
and present worth (P/F) factors for single amounts.
2. Utilize uniform series factors: the present worth (P/A) and capital
recovery (A/P) factors for uniform series.
3. Master additional uniform series factors: the compound amount (F/A)
and sinking fund (A/F) factors for uniform series.
4. Perform factor interpolation (linear interpolation within factor tables or
spreadsheet functions)
5. Work with arithmetic gradients: the present worth (P/G) and uniform
annual series (A/G) factors).
6. Analyze geometric gradients: the geometric gradient series factor
(P/A,g) to find the present worth of geometric gradient cash flows.
7. Solve for interest rates and periods (the interest rate (i) or number of
periods (n) for a given cash flow series).
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 Single Payment Factors (F/P and P/F)

§ The most fundamental factor in engineering economy is the one

that determines the amount of money F accumulated after n
years (or periods) from a single present worth P, with interest
compounded one time per year (or period). Recall that compound
interest refers to interest paid on top of interest.

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 Single Payment Factors (F/P and P/F)
If an amount 𝑃 is invested at time 𝒕 = 𝟎, the amount 𝑭𝟏 accumulated
1 year hence at an interest rate of 𝒊 percent per year will be
𝐹! = 𝑃 + 𝑃 ∗ 𝑖
𝐹! = 𝑃(1 + 𝑖)

At the end of the second year, the amount accumulated 𝑭𝟐 is the

amount after year 1 plus the interest from the end of year 1 to the end
of year 2 on the entire 𝑭𝟏

𝐹" = 𝐹! + 𝐹! ∗ 𝑖
𝐹" = 𝑃 1 + 𝑖 + 𝑃 1 + 𝑖 * 𝑖 (2.1)

The amount 𝑭𝟐 can be expressed as

𝐹" = 𝑃 1 + 𝑖 + 𝑖 + 𝑖 "
𝐹" = 𝑃 1 + 2𝑖 + 𝑖 "
"
𝐹" = 𝑃 1 + 𝑖 1-4
Original content by Leland Blank and Anthony Tarquin, modifications by Dr. Çiğdem Sıcakyüz, IE-345, Week_2
 Single Payment Factors (F/P and P/F)
Similarly, the amount of money accumulated at the end of year 3, using
will be

𝐹# = 𝐹" + 𝐹" ∗ 𝑖

Substituting 𝑃 1 + 𝑖 # for 𝐹# and simplifying, we get

#
𝐹# = 𝑃 1 + 𝑖

From the preceding values, it is evident by mathematical induction that

the formula can be generalized for 𝑛 years. To find F, given P,

𝒏 (2.2)
𝑭𝒏 = 𝑷 𝟏 + 𝒊

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 Single Payment Factors (F/P and P/F)

What if we know how much we want to

accumulate in the future and want to determine
how much we need to invest today?

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 Single Payment Factors (F/P and P/F)
The factor 1 + 𝑖 % is called the single-payment compound amount factor
(SPCAF), but it is usually referred to as the F/P factor. This is the
conversion factor that, when multiplied by P, yields the future amount F of
an initial amount P after n years at interest rate i.

Reverse the situation to determine the P value for a stated amount F that
occurs n periods in the future. Simply solve Equation (2.2) for P.

1
𝑃=𝐹
(1 + 𝑖)% (2.3)
𝑃 = 𝐹(1 + i)$%

The expression (1 + i)$% is known as the single-payment present worth

factor (SPPWF), or 𝑃/𝐹 factor.

It is always in the general form (𝑋/𝑌, 𝑖, 𝑛)

𝐹/𝑃 means find 𝐹 when given 𝑃 1-7
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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:

𝑭𝒏 = 𝑷 𝟏 + 𝒊 𝒏 𝑷 = 𝑭(𝟏 + 𝐢)$𝒏

Note that the two factors derived here are for single payments; that is,
they are used to find the present or future amount when only one payment
or receipt is involved.
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 Single Payment Factors (F/P and P/F)

Factor

Standard
Find/ Equation with Excel
Notation Name Notation
Given Factor Formula Function
Equation
Single-
payment !
(𝐹/𝑃, 𝑖, 𝑛) 𝐹 = 𝑃(𝐹/𝑃, 𝑖, 𝑛) 𝐹 =𝑃 1+𝑖 =𝐹𝑉(𝑖%, 𝑛, , 𝑃)
compound 𝐹/𝑃
amount

Single-
payment
𝑃 = 𝐹(𝑃/𝐹, 𝑖, 𝑛) 𝑃 = 𝐹(1 + i)"! =𝑃𝑉(𝑖%, 𝑛, , 𝐹)
(𝑃/𝐹, 𝑖, 𝑛) present 𝑃/𝐹
worth

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 F/P and P/F For Spreadsheets

Future value F is calculated using FV function:

= FV(i%,n,,P)

Present value P is calculated using PV function:

= PV(i%,n,,F)

Note the use of double commas in each function

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 Compound Interest Factor Tables

☛ help simplify financial

calculations related to the
time value of money.
☛ are used to find factors for
future value, present
value, annuities, and
gradients at different
interest rates and time
periods.
☛ save time by eliminating
the need to calculate
complex exponential terms
manually.
☛ are especially useful in
project evaluations, loan
and investment
calculations, and cost
comparisons in
engineering projects. 2-
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 Compound Interest Factor Tables

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 Example: Finding Future Value
A person deposits $5000 into an account which pays interest at a
rate of 8% per year. The amount in the account after 10 years is
closest to:
(A) $2,792 (B) $9,000 (C) $10,795 (D) $12,165

The cash flow diagram is: Manual Solution:

F = P(F/P,i,n )
= 5000(F/P,8%,10 )
= 5000(2.1589)
= $10,794.50
Answer is (C)

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 Example: Finding Future Value
A person deposits $5000 into an account which pays interest at a
rate of 8% per year. The amount in the account after 10 years is
closest to:
(A) $2,792 (B) $9,000 (C) $10,795 (D) $12,165

Solution with spread sheet:

= FV(i%,n,,P)

= $10,794.50
Answer is (C)

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 Example: Finding Future Value
A person deposits $5000 into an account which pays interest at a
rate of 8% per year. The amount in the account after 10 years is
closest to:
(A) $2,792 (B) $9,000 (C) $10,795 (D) $12,165

Solution with table:

F = 5000(F/P,8%,10 )
= 5000(2.1589)
= $10,794.50
Answer is (C)
2.1589
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 Example: Finding Present Value
A small company wants to make a single deposit now so it will have enough
money to purchase a backhoe costing $50,000 five years from now. If the
account will earn interest of 10% per year, the amount that must be
deposited now is nearest to:

(A) $10,000 (B) $ 31,050 (C) $ 33,250 (D) $319,160

The cash flow diagram is: Solution:

P = F(P/F,i,n )
= 50,000(P/F,10%,5 )
= 50,000(0.6209)
= $31,045

Answer is (B)
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 Example: Finding Present Value
A small company wants to make a single deposit now so it will have enough
money to purchase a backhoe costing $50,000 five years from now. If the
account will earn interest of 10% per year, the amount that must be
deposited now is nearest to:

(A) $10,000 (B) $ 31,050 (C) $ 33,250 (D) $319,160

Excel Solution: PV(i%,n,,F)

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

Answer is (B) 2-
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 Example: Finding Present Value
A small company wants to make a single deposit now so it will have enough
money to purchase a backhoe costing $50,000 five years from now. If the
account will earn interest of 10% per year, the amount that must be
deposited now is nearest to:

(A) $10,000 (B) $ 31,050 (C) $ 33,250 (D) $319,160

Table Solution:
P = F(P/F,i,n )
P = F* 0.6209

P=31,050

Answer is (B)
(P/F,i,n )=0.6209 2-
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 Example: Finding Future Value

If you had $2,000 now and invested it at 10%,

how much would it be worth in 8 years?

A cash flow diagram from the investor’s point of view

Original content by Leland Blank and Anthony Tarquin, modifications by Dr. Çiğdem Sıcakyüz, IE-345, Week_2
 Example: Finding Future Value
Given: P=2,000, i=10% per year, and n=8 years. Find: F.
We can solve this problem in any of three ways:
1. Using a calculator
You can simply use a calculator to evaluate the 1 + 𝑖 𝑛 term (financial calculators
are preprogrammed to solve most future-value problems):
𝐹 = $2,000 1 + 0.10 8 𝐹 = $4,287.18

2. Using compound-interest tables

The interest tables can be used to locate the compound-amount factor
for i=10% and n=8. The number you get can be substituted into the equation.
From the tables, we obtain:
F=$2000(𝐹/𝑃, 10%, 8) F=$2000*(2.1436) F=$4.287.20

3. Using Excel
Many financial software programs for solving compound interest problems are
available for use with personal computers. Excel provides financial functions to
evaluate various interest formulas, where the future-worth calculation looks like the
following:
=FV(10%,8,0,−2000)
Original content by Leland Blank and Anthony Tarquin, modifications by Dr. Çiğdem Sıcakyüz, IE-345, Week_2
 Finding Future Value

Original content by Leland Blank and Anthony Tarquin, modifications by Dr. Çiğdem Sıcakyüz, IE-345, Week_2
 Example: Finding Future Value
What future sum is equivalent to a present sum of $1000.
after 4 years at an interest rate of 6% compounded annually.

By Formula
F=P(1+i)n=1000(1+0.06)4=$1262.47696.

Using Interest Table

§ F=P(F/P, i, n)

§ (F/P, i, n): single-payment compound-amount factor

§ F=1000(F/P, 6%, 4)=1000(1.2625)=$1262.5.

(1+0.06)4=1.26247696 (using calculator)

Original content by Leland Blank and Anthony Tarquin, modifications by Dr. Çiğdem Sıcakyüz, IE-345, Week_2
 Example: Finding Future Value

Original content by Leland Blank and Anthony Tarquin, modifications by Dr. Çiğdem Sıcakyüz, IE-345, Week_2
 Example: Finding Present Value
§ Example:
Suppose that $1262.5. is to be received in 4 years at an
annual (compound) interest rate of 6% what is the present
worth of this amount?
Answer
P=F/(1+i)n
P=1262.5 (P/F, 0.06,4)
=1262(0.7921)
=$1000.0262

NOTE THAT: you should realize that the compounding and

discounting processes are reciprocals of one another
1/0.7921=1.262

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 Example:
the HBNA plant will require an investment of $200 million to construct. Delays
beyond the anticipated implementation year of 2020 will require additional money to
construct the plant. Assuming that the cost of money is 10% per year compound
interest, use both tabulated factor values and spreadsheet functions to determine the
following for the board of directors of the Italian company that plans to develop the
plant.
(a) The equivalent investment needed in 2023 if the plant is delayed for 3 years.
(b) The equivalent investment needed in 2023 if the plant is constructed sooner than
originally planned.

Original content by Leland Blank and Anthony Tarquin, modifications by Dr. Çiğdem Sıcakyüz, IE-345, Week_2
 Example :
the HBNA plant will require an investment of $200 million to construct. Delays
beyond the anticipated implementation year of 2020 will require additional money to
construct the plant. Assuming that the cost of money is 10% per year compound
interest, use both tabulated factor values and spreadsheet functions to determine the
following for the board of directors of the Italian company that plans to develop the
plant.
(a) The equivalent investment needed in 2023 if the plant is delayed for 3 years.
(b) The equivalent investment needed in 2023 if the plant is constructed sooner than
originally planned.

The expected investment of

$200 million ($200 M)
in 2020, which we will identify
as time t = 0. The required
investments 3 years in the
future and 4 years in the past
are indicated by F3 = ? and
P−4 = ?, respectively.

Original content by Leland Blank and Anthony Tarquin, modifications by Dr. Çiğdem Sıcakyüz, IE-345, Week_2
 Example :
(a) To find the equivalent investment required in 3 years, apply the F/P factor. Use $1
million units and the tabulated value for 10% interest.
F = P(F/P,i,n) = 200(F/P,10%,3) = 200(1.3310)
= $266.2 ($266,200,000)

Now, use the FV function on a

spreadsheet to find the same
answer, F = $266.20 million.

b)The year 2016 is 4 years prior to the planned construction date of 2020. To
determine the equivalent cost 4 years earlier, consider the $200 M in 2020 (t= 0) as
the future value F and apply the P⁄F factor for n = 4 to find P−4.

P−4 = F(P∕F,i,n) = 200(P∕F,10%,4) = 200(0.6830)

= $136.6 ($136,600,000)

The PV function = PV(10%,4,,200) will

display the same amount as shown in
Figure 2–3, right side.

Original content by Leland Blank and Anthony Tarquin, modifications by Dr. Çiğdem Sıcakyüz, IE-345, Week_2
 Uniform Series Involving P/A and A/P
The uniform series factors that involve P and A are derived as follows:
(1) Cash flow occurs in consecutive interest periods
(2) Cash flow amount is same in each interest period
The cash flow diagrams are:

A = Given A=?

0 1 2 3 4 5 0 1 2 3 4 5

P=? P = Given

P = A(P/A,i,n) Standard Factor A = P(A/P,i,n)

Notation
Note: P is one period Ahead of the first A value
Example: If you will start paying $1000 per year for 5 years starting next year, the 2-
present value (P) is calculated today— which is before the first $1000 payment. 34
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 Uniform Series Involving P/A and A/P
§ The P/A and A/P factors are derived with the present worth P
and the first uniform annual amount A one year (period) apart.
That is, the present worth P must always be located one period
prior to the first A.
§ In financial calculations, the Present Value (P) represents the
value today of all the future payments (A). To accurately calculate
this, we look at the time just before the first payment starts, which
is why there is this one-period gap.
§ If you calculate the present value at the same time as the first
payment, the time value of money wouldn’t be correctly
accounted for. That’s why P must always be ahead of A by one
period

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 Uniform Series Involving P/A and A/P

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

( ( ( ( (
𝑃=𝐴
((+,)%
+𝐴 ((+,)&
+𝐴 ((+,)'
+…+ 𝐴 ((+,)()%
+𝐴 ((+,)(

The terms in brackets are the P/F factors for years 1

through n , respectively. Factor out A .

1 1 1 1 1 (2.6)
𝑃=𝐴 + + + ⋯+ %$( + (1 + 𝑖)%
(1 + 𝑖)( (1 + 𝑖)# (1 + 𝑖)) 1+𝑖

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 Uniform Series Involving P/A and A/P
Multiply the n -term geometric progression in brackets
by the ( P / F , i% ,1) factor, which is 1/(1 + i).
𝑃 1 1 1 1 1
=𝐴 + + + ⋯+ (2.7)
1+𝑖 (1 + 𝑖)( (1 + 𝑖) # (1 + 𝑖) ) 1+𝑖 % + (1 + 𝑖)%+(

1 1 1 1 1 1
𝑃=𝐴 + + + ⋯+ % + (1 + 𝑖)%+(
1+𝑖 (1 + 𝑖)( (1 + 𝑖)# (1 + 𝑖)) 1+𝑖

1 1 1 1 1
−𝑃 =𝐴 ( + # + ) + ⋯+ %$( + (1 + 𝑖)%
(1 + 𝑖) (1 + 𝑖) (1 + 𝑖) 1+𝑖
𝐴 1
𝑃= −1
−𝑖 (1 + 𝑖)%

((+,)( $(
𝑃=𝐴 𝑖 ≠0 (2.8)
,((+,)( 1-
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 Uniform Series Involving P/A and A/P

(1 + 𝑖)% −1 (2.8)
𝑃=𝐴
𝑖(1 + 𝑖)%
The Uniform Series Present
Worth Factor (USPWF)

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 Uniform Series Involving P/A and A/P

(1 + 𝑖)% −1 (2.8)
𝑃=𝐴 𝑖≠0
𝑖(1 + 𝑖)%

Solve Equation (2.8) for A to obtain

𝑖(1 + 𝑖)%
𝐴=𝑃 (2.9)
(1 + 𝑖)% −1

Capital Recovery Factor (CRF), or A/P factor

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 Uniform Series Involving P/A and A/P

(1 + 𝑖)% −1 (2.8)
𝑃=𝐴 𝑖≠0
𝑖(1 + 𝑖)%

Solve Equation (2.8) for A to obtain

𝑖(1 + 𝑖)%
𝐴=𝑃 (2.9)
(1 + 𝑖)% −1

P/A factor used to calculate the To reverse the situation, the

equivalent P value in year 0 for a present worth P is known and the
uniform end-of-period series of A equivalent uniform series amount
A is sought 1-
values 40
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 Uniform Series Involving P/A and A/P

(1 + 𝑖)% −1 (2.8)
𝑃=𝐴 𝑖≠0
𝑖(1 + 𝑖)%

Solve Equation (2.8) for A to obtain

𝑖(1 + 𝑖)%
𝐴=𝑃 (2.9)
(1 + 𝑖)% −1

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 Uniform Series Involving P/A and A/P

(P/A,15%,25) = 6.4641 1-
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 Uniform Series Involving P/A and A/P
Spreadsheet functions can determine both P and A values in lieu of
applying the P/A and A/P factors. The PV function calculates the P
value for a given A over n years and a separate F value in year n, if
it is given. The format is = PV(i%,n,A,F) Similarly, the A value is
determined by using the PMT function for a given P value in year 0
and a separate F, if given. The format is = PMT(i%,n,P,F)

How much money should you be willing

to pay now for a guaranteed $600 per
year for 9 years starting next year, at a
rate of return of 16% per year?
Solution
The cash flows follow the pattern of
Figure 2–4a, with A = $600, i = 16%, and
n = 9. The present worth is
P = 600(P/A,16%,9)
= 600(4.6065)
= $2763.90 1-
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 Example:
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?
(A) $11,170 (B) 13,640 (C) $15,300 (D) $18,950
(1 + 𝑖)% −1
The cash flow diagram is as follows: 𝑃=𝐴
𝑖(1 + 𝑖)%
A = $5000 Solution:
P = 5000(P/A,10%,5)
4 5
= 5000(3.7908)
0 1 2 3
i =10% = $18,954
P=?
Answer is (D)
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 Sinking Fund Factor and Uniform Series
Series Compound Amount Factor F/A and A/F
• A/F (Sinking Fund Factor) is used to calculate the
annual or periodic savings required to accumulate a
specific future amount.
• F/A (Uniform Series Compound Amount Factor)
determines the total future value that results from a
series of uniform payments made at regular intervals.
• The standard notation for these factors is
Ø (A/F, i, n) for the Sinking Fund Factor and
Ø (F/A, i, n) for the Uniform Series Compound Amount Factor,
where:
Ø A/F find A (given F),
Ø F/A find F (given A),
Ø i is the interest rate (in decimal form),
Ø n is the number of periods.

Original content by Leland Blank and Anthony Tarquin, modifications by Dr. Çiğdem Sıcakyüz, IE-345, Week_2
 Sinking Fund Factor and Uniform Series
Series Compound Amount Factor F/A and A/F
(1) Cash flow occurs in consecutive interest periods
(2) Last cash flow occurs in same period as F
Cash flow diagrams are:

A = Given A=?

0 1 2 3 4 5 0 1 2 3 4 5

F=? F = Given

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

Notation

Note: F takes place in the same period as last A

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. 2-
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 Sinking Fund Factor (A/F Factor)

The uniform series factors that involve F and A are derived as follows:
If P from Equation (2.3) is substituted into Equation (2.9), the following
formula results.
1 𝑖(1 + 𝑖)%
𝐴=𝐹
(1 + 𝑖)% (1 + 𝑖)% −1

𝑖
𝐴=𝐹 (2.10)
(1 + 𝑖)% −1

the A/F or sinking

fund factor.

It determines the uniform annual series A that is equivalent to a given

future amount F.
 Sinking Fund Factor (A/F Factor)

𝑖
𝐴=𝐹 (2.10)
(1 + 𝑖)% −1

The Sinking Fund Factor (A/F) is used when one

knows the future value F that must be accumulated
after a number of periods n, and it is necessary to
find the periodic payment A required to reach that
future amount at a given interest rate i.

“How much must be saved or invested each period

to accumulate a given future amount?”
 Sinking Fund Factor (A/F Factor)
𝑖
𝐴=𝐹 (2.10)
(1 + 𝑖)% −1

Imagine you want to save $10,000 for a future goal 5 years from now,
and you have an interest rate of 6% per year. You want to figure out
how much you need to save each year (uniform series) to reach that
$10,000 goal.
Using the A/F formula:
𝑖
𝐴=𝐹
(1 + 𝑖)% −1

Substitute the values:

0.06
𝐴 = 10000
(1 + 0.06). −1
0.06
𝐴 = 10000
1.3382 − 1
𝐴 = 10000 0.1774
𝐴 = 1,774 invest $1,774 at the end of each year
 Uniform Series Compound Amount Factor
(F/A Factor)
1 𝑖(1 + 𝑖)%
𝐴=𝐹
(1 + 𝑖)% (1 + 𝑖)% −1

the A/F or sinking fund factor

𝑖 (2.10)
𝐴=𝐹
(1 + 𝑖)% −1

When multiplied by the given uniform annual amount A, it yields the future
worth of the uniform series.

((+,)( $(
F=𝐴 ,
the Uniform Series (2.11)
Compound Amount Factor
(USCAF), or F/A factor
The last A value and F occur at the same time.
Original content by Leland Blank and Anthony Tarquin, modifications by Dr. Çiğdem Sıcakyüz, IE-345, Week_2
 Uniform Series Compound Amount Factor
(F/A Factor)
(1 + 𝑖)% −1
F =𝐴
𝑖
Example:
Imagine you decide to invest $1,000 at the end of every year for 5
years in an account that gives a 6% interest rate per year. You want to
know how much money you’ll have accumulated at the end of the 5th
year (the future value F).
Using the F/A formula
(1 + 𝑖)% −1
𝐹=𝐴
𝑖
Substitute the values:
(1 + 0.06). −1
𝐹 = 1000 ∗
0.06
1.3382 − 1
𝐹 = 1000 ∗
0.06
𝐹 = 1,000×5.6367
after 5 years, you will
𝐹 = 5,636.7 have $5,636.70
 Uniform Series Involving F/A and A/F
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?
(A) $45,300 (B) $68,500 (C) $89,228 (D) $151,500

The cash flow diagram is:

F=?
Solution:
i = 8%
F = 10,000(F/A,8%,7)
0 1 2 3 4 5 6 7
= 10,000(8.9228)
= $89,228
A = $10,000 Answer is (C)
2-
53
Original content by Leland Blank and Anthony Tarquin, modifications by Dr. Çiğdem Sıcakyüz, IE-345, Week_2