Engineering Economy Factors

Outline
Compound amount factor and
Present worth factor for single
payment
Uniform series present worth and
capital recovery factors
Uniform series compound amount
and sinking fund factors
Engineering Economy Factors
Single Payment Factor (F/P and
P/F)
is a fundamental factor,
determines the amount of money, F
accumulated after n years from a
single present worth, P with
compound interest.
Single Payment Factor (F/P and
P/F)
Recall that compound interest
refers to interest paid on top of
interest.
Thus, if an amount P is invested
at time t = 0, the amount F
1

accumulated over 1 year at an
interest rate i will be
F
1
= P + Pi = P(1 + i)

Single Payment Factor (F/P and
P/F)
At the end of the second year, the
amount accumulated F
2
is the amount
after year 1 plus the interest from
the end of year 1 to the end of year 2
on the entire F
1.

F
2
= F
1
+ F
1
i
= P(1+i) + P(1+i)i
= P(1+i)
2

Similarly, the amount of money
accumulated at the end of year 3,
F
3
= P(1+i)
3

Single Payment Factor (F/P and
P/F)
It is evident by mathematical induction
that the formula can be generalized for
n years to
F = P( 1 + i )
n

The factor,(1+i)
n
is called the single-
payment compound amount factor (SPCAF).
It is usually referred to as the F/P
factor.
This is the conversion factor, when
multiplied by P, yields the future
amount F of an initial amount (P) after
n years at interest rate i.
Single Payment Factor (F/P and
P/F)
Use the formula to evaluate the
value of the factor for i=0.06 and
n=12

F = P( 1 + i )
n

Verify the validity of rule of 72
Single Payment Factor (F/P and
P/F)
In a reverse situation, the value P can be
determined for a stated future amount F
that occurs after n periods in the future,
by solving the following equation:
P = F[1/(1+i)
n
]

The factor [1/(1+i)
n
] is known as the single
payment present worth factor (SPPWF), or
the P/F factor.
Relevant cash flow diagrams are shown in
Figure 2-1.
Single Payment Factor (F/P and
P/F)
0 n-1 n-2 2 1
i=given
P=Given
n
F=?
0 n-1 n-2 2 1
i=given
P=?
n
F=Given
Figure 2-1
Cash flow diagram for single-payment factors: (a) find F and (b) find P
(a)
(b)
Single Payment Factor (F/P and
P/F)
Note: The two factors derived
here are for single payments.
They are used to find the
present or future amount when
only one payment or receipt is
involved.
Single Payment Factor (F/P and
P/F)
Factor
Find
/Given
Standard
Notation
Equation
Equation with
factor
formula
Excel
functions
Notation Name
(F/P,i,n) Single-
payment
compound
amount
F/P F=
P(F/P,i,n)
F=P(1+i)
n
FV(i%,n,,P)
(P/F,i,n) Single-
payment
present
worth
P/F P=
F(P/F,i,n)

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

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 is shown:
0 n-1 n-2 2 1
i=given
P=?
n
A=Given
Fig 2-5 (a)
Cash flow diagram used to determine P of a uniform series
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 [Fig
2-5 (b)]
0 n-1 n-2 2 1
i=given
P=given
n
A= ?
Fig 2-5 (b)
Cash flow diagram used to determine A for a present worth
Uniform-series Present Worth Factor and
Capital Recovery Factor (P/A and A/P)
An expression for the present
worth [Fig 2-5 (a)] can be
determined by following the
steps mentioned below:
Consider each A value as a future
worth F,
Calculate its worth with the P/F
factor and
Sum up the results.
Uniform-series Present Worth Factor and
Capital Recovery Factor (P/A and A/P)
The equation is

(

+
+
(

+
+
+
(

+
+
(

+
+
(

+
=
n n
i
A
i
A
i
A
i
A
i
A P
) 1 (
1
) 1 (
1
.....
) 1 (
1
) 1 (
1
) 1 (
1
1
3 2 1
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. By
factoring out A, we can write
(

+
+
+
+ +
+
+
+
+
+
=
n n
i i i i i
A P
) 1 (
1
) 1 (
1
......
) 1 (
1
) 1 (
1
) 1 (
1
1 3 2 1
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).
Uniform-series Present Worth Factor and
Capital Recovery Factor (P/A and A/P)
This results in an equation as given
below:
(

+
+
+
+ +
+
+
+
+
+
=
+
+1 4 3 2
) 1 (
1
) 1 (
1
......
) 1 (
1
) 1 (
1
) 1 (
1
1
n n
i i i i i
A
i
P
Subtracting the previous equation from this one i.e.
(

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

+
+
+
+ +
+
+
+
+
+
=
+
+1 4 3 2
) 1 (
1
) 1 (
1
......
) 1 (
1
) 1 (
1
) 1 (
1
1
n n
i i i i i
A
i
P
Uniform-series Present Worth Factor and
Capital Recovery Factor (P/A and A/P)
Results in
(

+
= 1
) 1 (
1
n
i i
A
P
(

+
=
+

+ 1 1
) 1 (
1
) 1 (
1
1 i i
A P
i
i
n
Or
(

+
+
=
n
n
i i
i
A P
) 1 (
1 ) 1 (
Or
For, i = 0
Uniform-series Present Worth Factor and
Capital Recovery Factor (P/A and A/P)
(

+
+
n
n
i i
i
) 1 (
1 ) 1 (
The term,
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. Cash flow diagram is in Fig 2-5(a)
Uniform-series Present Worth Factor
and Capital Recovery Factor (P/A and
A/P)
In a reverse situation, the present worth P
is known and the equivalent uniform-series
amount A is sought (Fig 2-5 (b).
The first A value occurs at the end of period
1, that is, one period after P occurs. Solve
previous equation for A to obtain:
(

+
+
=
1 ) 1 (
) 1 (
n
n
i
i i
P A
The term in brackets is called the capital recovery factor
(CRF), or A/P factor. It calculates the uniform annual
worth A over n years for a given P in year 0, when the
interest rate is i.
Table 2-2: P/A and A/P Factors:
Notations and Equations
Factor
Find/
Given
Standard
Notation
Equation
Equation
with factor
formula
Excel
Function
Notation Name
(P/A,i,n) Uniform-
series
present
worth
P/A P=
A(P/A,i,n)

PV(i%,n,A)
(A/P,i,n) Capital
recovery
A/P A=
P(A/P,i,n)


PMT(i%,n,P)

(

+
+
1 ) 1 (
) 1 (
n
n
i
i i
(

+
+
n
n
i i
i
) 1 (
1 ) 1 (
Example 2.4
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 flow diagram is
7 5 4 3 0 6 8 2 1
i=16%
P=?
9
A=$600
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.
We already know

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

+
+
=
1 ) 1 (
) 1 (
n
n
i
i i
P A
Now if P from the first equation is
substituted in the second equation, we get
the equation as follows: (next slide)
Sinking fund factor and Uniform-series
compound amount factor (A/F and F/A)
(

+
+
(

+
=
1 ) 1 (
) 1 (
) 1 (
1
n
n
n
i
i i
i
F A
After simplification, the following equation is developed
(

+
=
1 ) 1 (
n
i
i
F A
The expression in brackets in the above equation is
the A/F or sinking fund factor. It determines the
uniform annual series that is equivalent to a
given future worth F.
The cash flow diagram can be
shown as (ex. Investing in Pension Scheme)
Sinking fund factor and Uniform-series
compound amount factor (A/F and F/A)
0 n-1 n-2 2 1
i = given
A = ?
n
F = Given
The uniform-series A begins at the end of
period 1 and continues through the period of
the given F.
Sinking fund factor and Uniform-series
compound amount factor (A/F and F/A)
(

+
=
1 ) 1 (
n
i
i
F A
Refer to the following equation (already developed)
The term in brackets is called uniform-series
compound amount factor (USCAF) or F/A factor.
This equation can be rewritten as
(

+
=
i
i
A F
n
1 ) 1 (
The cash flow diagram can be
shown as
Sinking fund factor and Uniform-series
compound amount factor (A/F and F/A)
0 n-1 n-2 2 1
i = given
A = ?
n
F = Given
When F/A factor is multiplied by A, it yields
the future worth of the uniform series, F.
Sinking fund factor and Uniform-series
compound amount factor (A/F and F/A)
Remember that the future amount
F occurs in the same period as
the last A.
Table 2-3 summarizes the
notations and equations.

Sinking fund factor and Uniform-series
compound amount factor (A/F and F/A)
Table 2-3: F/A and A/F Factors:
Notations and Equations
Factor
Find/
Given
Standard
Notation
Equation
Equation with
factor formula
Excel
Function
Notation Name

(F/A,i,n)
Uniform-
series
compound
amount

F/A

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

FV(i%,n,,A)

(A/F,i,n)

Sinking
fund

A/F

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


PMT(i%,n,F)

(

+
i
i
n
1 ) 1 (
(

+ 1 ) 1 (
n
i i
i
Sinking fund factor and Uniform-series
compound amount factor (A/F and F/A)
Example 2.5
Formasa Plastics has major fabrication
plants in Texas and Hong Kong. The
president wants to know the equivalent
future worth of $1 million capital
investment cash for 8 years, starting 1
year from now. Formasa capital earns at
a rate of 14% per year.
Sinking fund factor and Uniform-series
compound amount factor (A/F and F/A)
Example 2.5 (continued)
Solution: The cash flow diagram shows the
annual payments starting at the end of
year 1 and ending in the year the future
worth is desired.
1 5 4 3 2
i = 14%
A = $1,000,000
6
F = ?
0 7 8
Sinking fund factor and Uniform-series
compound amount factor (A/F and F/A)
Example 2.5 (continued)
Solution: The F value in 8 years is
1 5 4 3 2
i = 14%
A = $1,000,000
6
F = ?
0 7 8
F = $1,000,000 (F/A,14%,8) = $1,000,000 (13.23281)
= $13,232,810
Sinking fund factor and Uniform-series
compound amount factor (A/F and F/A)
Example 2.6
How much money must Carol deposit every year
starting 1 year from now at 5% per year in order
to accumulate $6000 seven years from now?
Solution: The cash flow diagram
1 2 0 5 4 3
i = 5%
A = ?
6
F = $6000
7
Sinking fund factor and Uniform-
series compound amount factor (A/F
and F/A)
A = $6000(A/F,5%,7) = $6000(0.12096)
= $725.76 per year.
The A/F factor value of 0.12096 was
computed using the factor formula
(

+
=
1 ) 1 (
n
i
i
F A
Example of interest Table (Partial)
Discrete cash flows: Compound interest factors 7%)






n
Single Payment Uniform series Payments Arithmetic Gradients
Compound
Amount
F/P
Present
worth
P/F
Sinking
fund
A/F
Compound
Amount
F/A
Capital
Recovery
A/P
Present
worth
P/A
Gradient
Pres.
worth
P/G
Gradient
uni. series
A/G

9
1.8385 0.5439 0.08349 11.9780 0.15349 6.5152 23.1404 3.5517
10 1.9672 0.5083 0.07238 13.8164 0.14238 7.0236 27.7156 3.9461
11 2.1049 0.4751 0.06338 15.7836 0.13336 7.4987 32.4665 4.3296
Interpolation in interest tables
When it is necessary to locate a factor
value for an i or n in the interest
tables, the desired value can be
obtained in one of the two ways:
(1) by using the formulas derived or
(2) by linearly interpolating between
the tabulated values.
However, the value obtained through linear
interpolation is not exactly correct,
since the equations are nonlinear.
Interpolation in interest
tables
Nonetheless, interpolation is sufficient in most
cases as long as the values of i and n are not
too distant from one another.

In linear interpretation it is necessary to set
up the known (values 1 and 2) and unknown factors
as shown in Table 2-4:



Table 2-4: Linear Interpretation setup
tabulated value 1
desired unlisted
tabulated value 2
a
b
d
c
Interpolation in interest
tables
A ratio equation is then set up and solved for
the value of unknown quantity, C



Or


Where a, b, c, and d represent the differences
between the numbers shown in the interest
tables.
d
c
b
a
=
d
b
a
c =
Example 2.7
Determine the value of the A/P factor for an interest rate of 7.3%
and n of 10 years, that is (A/P,7.3%,10)

Solution


The values of the A/P factor for interest rate of 7 and 8% and n=10
are listed in interest tables (Tables 12 and 13)
7%
7.3%
8%
b
a
x
0.14903
0.14238
c
d
Example 2.7
The unknown X is the desired factor value.
For the ratio equation



= 0.00199
Since the factor is increasing in value as the interest
rate increases from 7 to 8%, the value of c must be
added to the value of the 7% factor. Thus
X = 0.14238+0.00199 = 0.14437.
Compare this with the exact factor value (0.144358)
( ) 14238 . 0 14903 . 0
7 8
7 3 . 7

|
.
|

\
|

= = d
b
a
c
Example 2.8
Find the value of the (P/F,7.3%,10)
factor.

From the interest table, the values of
the P/F factor for 45 and 50 years are
found.


a
45
48
50
b
x
0.1407
0.1712
c
Example 2.8
( ) 0183 . 0 1407 . 0 1712 . 0
45 50
45 48
=
|
.
|

\
|

= = d
b
a
c
From the equation,
Since the value of the factor decreases as n increases, c is
Subtracted from the factor value for n = 45

X= 0.1712 0.0183 = 0.1529
Comment: Though it is possible to perform two-way linear
Interpolation, it is much easier and more accurate to use the
Factor formula or a spreadsheet function.
Table 12 (Partial): Discrete cash
flows: Compound interest factors 7%)






n
Single Payment Uniform series Payments Arithmetic Gradients
Compound
Amount F/P
Present
worth
P/F
Sinking
fund
A/F
Compound
Amount
F/A
Capital
Recovery
A/P
Present
worth
P/A
Gradient
Pres. worth
P/G
Gradient
uni. series
A/G

9
1.8385 0.5439 0.08349 11.9780 0.15349 6.5152 23.1404 3.5517
10 1.9672 0.5083 0.07238 13.8164 0.14238 7.0236 27.7156 3.9461
11 2.1049 0.4751 0.06338 15.7836 0.13336 7.4987 32.4665 4.3296
Table 13 (Partial): Discrete cash
flows: Compound interest factors (8%)






n
Single Payment Uniform series Payments Arithmetic Gradients
Compound
Amount F/P
Present
worth
P/F
Sinking
fund
A/F
Compound
Amount
F/A
Capital
Recovery
A/P
Present
worth
P/A
Gradient
Pres. worth
P/G
Gradient
uni. series
A/G

9
1.990 0.5002 0.08008 12.4876 0.16008 6.2469 21.8081 3.4910
10 2.1589 0.4632 0.06903 14.4866 0.14903 6.7101 25.9768 3.8713
11 2.3316 0.4289 0.06008 16.6455 0.14008 7.1390 30.2657 4.2395