CHAPTER II

Factors: How Time and Interest

Affect Money
 Content
1. Single Payment Formulas (F/P and P/F Factors)
2. Uniform Series Formulas (P/A, A/P, F/A, A/F )
3. Interpolate Factor Values
4. Gradient Formulas (Arithmetic, Geometric)
5. Shifted Cash Flows

2
Cash Flows occur in many configurations and
amounts – single values, uniform series, non-uniform
series.

In this chapter, we discuss commonly used

engineering economy factors that consider the time
value of money for cash flows.

05/29/21 CE 231 Engineering Economy 3

 2.1 Single Payment Formulas (F/P & 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).

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2.1 Basic Derivations: F/P factor

• F/P Factor To find F given P

FN
To Find F given P

………….
N

Compound forward in time

P0

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2.1 Derivation by Recursion: F/P factor

• F1 = P(1+i)
• F2 = F1(1+i)…..in addition:
• F2 = P(1+i)(1+i) = P(1+i)2
• F3 =F2(1+i) =P(1+i)2 (1+i) Single-payment compound
amount factor (SPCAF),
= P(1+i)3 also referred to as the F/P
In general: factor.

FN = P(1+i)n
FN = P (F/P,i%,n)
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2.1 Present Worth Factor from F/P

• Since FN = P(1+i)n
• We solve for P in terms of FN
• P = F{1/ (1+i)n} = F(1+i)-n
• Thus:
P = F(P/F,i%,n) where
(P/F,i%,n) = (1+i)-n
Single payment present
worth factor (SPPWF), also
called as P/F factor
7
2.1 P/F factor – discounting back in time

• Discounting back from the future

Fn

………….
N
P/F factor brings a single
future sum back to a specific
P
point in time.

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• A standard notation has been adopted for all
factors. The notation includes two cash flow
symbols, the interest rate, and the number of
periods. It is always in the general form (X∕Y,i,n).
The letter X represents what is sought, while the
letter Y represents what is given.
• For example, F∕P means find F when given P. The i
is the interest rate in percent, and n represents the
number of periods involved.

05/29/21 CE 231 Engineering Economy 9

 Factor

Notation Name Find/given Standart Equation with Excel Function

notation factor formula
equation
( F/P, i,n) Single payment F/P F= P(F/P,I,n) F=P(1+i)n = FV(i%,n,,P)
compound
amount
(P/F, i,n) Single payment P/F P= F(P/F, I,n) P=F(1+i)-n =PV(i%,n,,F)
present worth

05/29/21 CE 231 Engineering Economy 10

2.2 Example- F/P Analysis

• Example: P= $1,000; n=3; i=10%

• What is the future value, F?

F = ??

0 1 2 3
P=$1,000
i=10%/year

F3 = $1,000[F/P,10%,3] = $1,000[1.10]3
= $1,000[1.3310] = $1,331.00

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2.2 Example – P/F Analysis

• Assume F = $100,000, 9 years from now. What is the

present worth of this amount now if i =15%?
F9 = $100,000

i = 15%/yr

0 1 2 3
………… 8 9

P= ??
P0 = $100,000(P/F, 15%,9) = $100,000(1/(1.15)9)
= $100,000(0.28426) = $28,426 at time t = 0

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• Hewlett-Packard has completed a study indicating
that $50,000 in reduced maintenance this year (i.e.,
year zero) on one of its processing lines resulted
from improved wireless monitoring technology.
• a. If Hewlett-Packard considers these types of
savings worth 20% per year, find the equivalent
value of this result after 5 years.

05/29/21 CE 231 Engineering Economy 13

P =$50,000 F =? i = 20% per year n 5 years
Use the FP factor to determine F after 5 years.
F =P(F/P,i,n) = $50,000(F/P,20%,5)
=50,000(2.4883)
=$124,415.00

05/29/21 CE 231 Engineering Economy 14

• b. If the $50,000 maintenance savings occurs now,
find its equivalent value 3 years earlier with
interest at 20% per year.

05/29/21 CE 231 Engineering Economy 15

• P = ? F =$50,000 i =20% per year n =3 years
P =F(P/F,i,n) = $50,000 (P/F,20%,3)
=50,000(1 /(1.728)3)
= 50,000 (0,5787)
=$28,935.00

05/29/21 CE 231 Engineering Economy 16

2.2 Uniform Series Formulas
(P/A, A/P, F/A, A/F Factors)

• There are 4 uniform series formulas that involve A.

• A means:
• 1. The cash flow occurs in consecutive interest
periods, and
• 2. The cash flow amount is the same in each period.
• Formulas relate a present word P or a future word F to
a uniform series amount A.

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2.2 Uniform Series

• Desire an expression for the present worth – P of

a stream of equal, end of period cash flows - A

P = ??

0 1 2 3 n-1 n

A = given

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2.2 Uniform Series Present Worth and Capital Recovery
Factors

• This expression will convert an annuity cash flow

to an equivalent present worth amount one
period to the left of the first annuity cash flow.

 (1  i ) n  1 
P  A n 
for i  0
 i (1  i ) 

P / A i %, n factor
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2.2 Capital Recovery Factor
(A/P, i%, n)
The present worth point of
an annuity cash flow is
always one period to the
• Given the P/A factor left of the first A amount

 (1  i ) n  1 
P  A n 
for i  0 Solve for A in terms of P
 i (1  i ) 

Yielding….

 i (1  i )  n
A P  A/P,i%,n factor
 (1  i )  1 
n

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• 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.

05/29/21 CE 231 Engineering Economy 21

2.3 A/F Factor

• Simplifying we have:
 i 
• Which is the (A/F,i%,n) A F 
 (1  i )  1 
factor n

22
 2.3 F/A factor from the A/F Factor

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

• Solve for F in terms of

A  (1  i )  1 
n
F=A  
 i 
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 $F
2.3 F/A and A/F Derivations
• Annuity Cash Flow

…………..
N
0

Find $F given the $A

$A per period amounts

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2.3 Example 2.5

• Formasa Plastics has major fabrication plants in

Texas and Hong Kong.
• It is desired to know the future worth of $1,000
invested at the end of each year for 8 years,
starting one year from now.
• The interest rate is assumed to be 14% per year.

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2.3 Example 2.5

•A = $1,000/yr; n = 8 yrs, i = 14%/yr

•F8 = ??

26
2.3 Example 2.5

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. Cash flows are indicated
in $1000 units. The F value in 8 years is

F = l000(F/A,14%,8) = 1000( 13.23218) =

$13,232.80 = 13.232 million 8 years from
now/

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2.3 Example 2.6

• How much money must Carol deposit every year

starting, 1 year from now at 5.5% per year in order to
accumulate $6000 seven years from now?

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2.3 Example 2.6

• Solution
• The cash How diagram from Carol's perspective fits
the A/F factor.
• A = F(i/(1+i)n – 1)
• A = 6000(0.055/(1+0.055)7-1) =6000(0.12096)
• or
• A= $6000 (A/F, 5.5%,7) = 6000(0.12096) = $725.76
per year
• The A/F factor Value of 0.12096 was computed using
the A/F factor formula
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Interpolation of Factors in Interest Tables

• All texts on Engineering economy will provide

tabulated values of the various interest factors
usually at the end of the text in an appendix
• Refer to the back of your text for those tables.

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 Interpolation of Factors
• Typical Format for Tabulated Interest Tables

31
Interpolation (Estimation Process)
• At times, a set of interest tables may not have
the exact interest factor needed for an analysis
• One may be forces to interpolate between two
tabulated values
• Linear Interpolation is not exact because:
• The functional relationships of the interest
factors are non-linear functions
• Hence from 2-5% error may be present with
interpolation.

32
An Example
• Assume you need the value of the A/P factor
for i = 7.3% and n = 10 years.
• 7.3% is most likely not a tabulated value in
most interest tables
• So, one must work with i = 7% and i = 8% for
n fixed at 10
• Proceed as follows:

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Basic Setup for Interpolation
•Work with the following basic relationships
 i = 7.3% using the A/P factor
• For 7% we would observe:

COMPOUND PRESENT SINKING COMPOUND CAPITAL

N AMT. FACTOR WORTH FUND AMOUNT RECOVERY
F/P P/F A/F F/A A/P
10 1.9672 0.5083 0.0724 13.8164 0.14238

(A/P,7%,10) = 0.14238
 i = 7.3% using the A/P factor
• For i = 8% we observe:

COMPOUND PRESENT SINKING COMPOUND CAPITAL

N AMT. FACTOR WORTH FUND AMOUNT RECOVERY
F/P P/F A/F F/A A/P
10 2.1589 0.4632 0.0690 14.4866 0.14903

(A/P,8%,10) = 0.14903

36
Estimating for i = 7.3%
• Form the following relationships

37
Final Estimated Factor Value
• Observe for i increasing from 7% to 8% the
A/P factors also increases.
• One then adds the estimated increment to the
7% known value to yield:

38
The Exact Value for 7.3%
• Using a previously programmed spreadsheet
model the exact value for 7.3% is:

39
2.3 Gradient Formulas
(P/G and A/G Factors)
• Sometimes the cash flows that occur in consecutive
interest periods are not the same amount (not an A
value), but they do change in a predictable way
• Two other types of end of period patterns are common
•The Linear or arithmetic gradient
•The geometric (% per period) gradient

40
2.3 Arithmetic Gradient Factors
• An arithmetic (linear) Gradient is a cash flow series that
either increases or decreases by a constant amount
over n time periods.
•A linear gradient is always comprised of TWO
components:
•The Gradient component
•The base annuity component
•The objective is to find a closed form expression for the
Present Worth of an arithmetic gradient

41
2.3 Linear Gradient Example
A1+n-1G

A1+n-2G
• Assume the following:

A1+2G

A1+G

0 1 2 3 n-1 N

This represents a positive, increasing arithmetic gradient

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2.3 Example: Linear Gradient
• Typical Negative, Increasing Gradient: G=$50

The Base Annuity

= $1500

43
2.3 Example: Linear Gradient
• Desire to find the Present Worth of this cash flow

The Base Annuity

= $1500

44
2.3 Arithmetic Gradient Factors
• The “G” amount is the constant arithmetic change from
one time period to the next.
•The “G” amount may be positive or negative!
•The present worth point is always one time period to the
left of the first cash flow in the series or,
•Two periods to the left of the first gradient cash flow!

45
2.3 Derivation: Gradient Component Only
• Focus Only on the gradient Component

A1+n-1G

“0” G A1+n-2G

A1+2G

A1+G

0 1 2 3 n-1 N
46
2.3 Present Worth Point…

• The Present worth point of a linear gradient is

always:
• 2 periods to the left of the “1G”
point or,
• 1 period to the left of the very first
cash flow in the gradient series.

DO NOT FORGET THIS!

47
2.3 Present Worth Point…

$700
$600
$500
$400
$300
$200
$100

X0 1 2 3 4 5 6 7

The Present Worth Point of the

Gradient

48
2.3 Gradient Component

•The Gradient Component $600

$500
$400
$300
$200
$100

$0

X0 1 2 3 4 5 6 7

The Present Worth Point of the

Gradient

49
2.3 Present Worth Point…

•PW of the Base Annuity is at t = 0

•PWBASE Annuity=$100(P/A,i%,7)

Base Annuity – A = $100

X0 1 2 3 4 5 6 7

The Present Worth Point of the

Gradient

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2.3 Present Worth: Linear Gradient

• The present worth of a linear gradient is the

present worth of the two components:
• 1. The Present Worth of the Gradient
Component and,
• 2. The Present Worth of the Base Annuity flow
• Requires 2 separate calculations!

51
2.3 Present Worth: Gradient Component

• The PW of the Base Annuity is simply the Base

Annuity –A{P/A, i%, n} factor
• What is needed is a present worth expression for
the gradient component cash flow.
• We need to derive a closed form expression for
the gradient component.

52
2.3 Present Worth: Gradient Component

• General CF Diagram – Gradient Part Only

(n-1)G
(n-2)G
3G
2G
1G

0G

We want the PW at time t = 0 (2 periods to the left of 1G)

0 1 2 3 4 ……….. n-1 n

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2.3 The P/G factor for i and N

G  (1  i )  1 N 
N
P=   N 
i  i (1  i ) N
(1  i ) 

( P / G, i %, N ) factor
54
 2.3 Resultant A/G factor

1 n 
A/G,i,n = G  
 i (1  i )  1 
N

55
2.3 Gradient Example
• Consider the following cash flow
$500
$400
$300
$200
$100

0 1 2 3 4 5

Present Worth Point is here!

And the G amt. = $100/period

Find the present worth if i = 10%/yr; n = 5 yrs

56
2.3 Gradient Example- Base Annuity

• First, The Base Annuity of $100/period

A = +$100

0 1 2 3 4 5

•PW(10%) of the base annuity = $100(P/A,10%,5)

•PWBase = $100(3.7908)= $379.08
•Not Finished: We need the PW of the gradient component
and then add that value to the $379.08 amount

57
 2.3 The Gradient Component
$400
$300
$200
$100
$0

0 1 2 3 4 5

We desire the PW of the Gradient Component at t = 0

PG@t=0 = G(P/G,10%,5) = $100(P/G,10%,5)

58
2.3 The Gradient Component
$400
$300
$200
$100
$0

0 1 2 3 4 5

PG@t=0 = G(P/G,10%,5) = $100(P/G,10%,5)

Could substitute n=5, i=10%
G  (1  i )  1
N
N  and G = $100 into the P/G
P=    closed form to get the value
i  i (1  i ) N
(1  i ) N  of the factor.

59
2.3 PW of the Gradient
Component
PG@t=0 = G(P/G,10%,5) = $100(P/G,10%,5)

P/G,10%,5) Sub. G=$100;i=0.10;n=5

G  (1  i ) N  1 N 
P= 
i  i (1  i ) N
 
(1  i ) N 
6.8618

Calculating or looking up the P/G,10%,5 factor

yields the following:
Pt=0 = $100(6.8618) = $686.18 for the gradient
PW

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2.3 Gradient Example: Final
Result
• PW(10%)Base Annuity = $379.08

•PW(10%)Gradient Component= $686.18

•Total PW(10%) = $379.08 + $686.18

•Equals $1065.26

•Note: The two sums occur at t =0 and can be

added together – concept of equivalence

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2.3 Example Summarized
This Cash Flow… $500
$400
$300
$200
$100

0 1 2 3 4 5

Is equivalent to $1065.26 at time 0 if the interest rate is

10% per year!

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