Engineering Economy Chapter 2x

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ENGINEERING ECONOMY, Sixth Edition

by Blank and Tarquin
CHAPTER 2
Factors: How Time and

Interest Affect Money
Mc
Graw
Hill Authored by Don Smith, Texas A&M University 2004
1
1. Foundations: Overview
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
2
CHAPTER 2: Section 1
F/P and P/F Factors
3
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
4
2.1 Derivation by Recursion: F/P factor

F1 = P(1+i)
F2 = F1(1+i)…..but:
F2 = P(1+i)(1+i) = P(1+i)2
F3 =F2(1+i) =P(1+i)2 (1+i)
= P(1+i)3
In general:
Fn = P(1+i)n
Fn = P(F/P,i%,n)
5
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
Thus, the two factors are:
1. F = P(1+i)n finds the future worth of P;
2. P = F(1+i)-n finds the present worth from F
6
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.
7
P/A and A/P Factors
8
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
9
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(0.2843) = $28,430 at time t = 0
10
2.2 Uniform Series Present Worth and

Capital Recovery Factors
Annuity Cash Flow

P = ??
…………..
1 2 3 .. .. n-1 n
0
$A per period
11

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
12

Write a Present worth expression
 1 1 1 1  [1]
P  A   ..  n 1
 n
 (1  i ) (1  i ) (1  i ) (1  i) 
1 2
Term inside the brackets is a geometric progression.

Mult. This equation by 1/(1+i) to yield a second equation
13

The second equation

P  1 1 1 1 
 A   ..   n 1  [2]
1 i  (1  i ) (1  i )
2 3
(1  i ) (1  i ) 
n
To isolate an expression for P in terms of A, subtract

Eq [1] from Eq. [2]. Note that numerous terms will
drop out.
14

Setting up the subtraction

P  1 1 1 1 1 
 A   ... n 1 
[2]
(1  i )  (1  i ) (1  i) (1  i)
2 3 4
(1  i) (1  i ) 
n
 1 1 1 1 
- P  A  (1  i)1  (1  i)2  ..  (1  i) n1  (1  i) n  [1]
i  1 1 
= P  A n 1
  [3]
1 i  (1  i ) (1  i ) 
15

Simplifying Eq. [3] further
i  1 1 
P  A n 1
 
1 i  (1  i ) (1  i ) 
A 1   (1  i ) n  1 
P  n 1
 1 P  A n 
for i  0
i  (1  i )   i (1  i ) 
16

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
17
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
18
F/A and A/F Factors
19
2.3 F/A and A/F Derivations $F
Annuity Cash Flow
…………..
N
0
Find $A given the

$A per period Future amt. - $F
20
2.3 Sinking Fund and Series Compound

amount factors (A/F and F/A)
Take advantage of what we already

have
Recall:
Substitute “P” and
 1  simplify!
PF n 
 (1  i ) 
Also:
 i (1  i ) n 
A P 
 (1  i )  1 
n
21
2.3 A/F Factor
By substitution A  F  1   i (1  i ) n

 (1  i ) n   (1  i ) n  1 
we see:   
Simplifying we
have:  i 
Which is the AF 
 (1  i )  1 
n
(A/F,i%,n) factor
22
2.3 F/A factor from the A/F Factor
 i 
Given: A F 
 (1  i )  1 
n
Solve for F in
terms of A  (1  i )  1  n
F=A  
 i 
23
2.3 F/A and A/F Derivations $F
Annuity Cash Flow
…………..
N
0
Find $F given the $A

$A per period amounts
24
2.3 Example 2.5
Formosa Plastics has major

fabrication plants in Texas and Hong
Kong.
It is desired to know the future worth
of $1,000,000 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.
25
2.3 Example 2.5
•A = $1,000,000/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.
27
2.3 Example 2.6
How much money must Carol deposit every

year starting, l year from now at 5.5% per
year in order to accumulate $6000 seven
years from now?
28
2.3 Example 2.6
Solution
The cash How diagram from Carol's
perspective fits the A/F factor.
A= $6000 (A/F,5.5%,7) = 6000(0.12096)
= $725.76 per year
The A/F factor Value 0f 0.12096 was
computed using the A/F factor formula
29
Interpolation in Interest
Tables
30
2.4 Interpolation of Factors

• 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.
31
2.4 Interpolation of Factors

• Typical Format for Tabulated Interest Tables
32
2.4 Interpolation (Estimation Process)

• At times, a set of interest tables may not have
the exact interest factor needed for an analysis
• One may be forced 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.
33
2.4 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:
34
2.4 Basic Setup for Interpolation
•Work with the following basic relationships
35
2. 4 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
36
2. 4 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
37
2. 4 Estimating for i = 7.3%

• Form the following relationships
38
2.4 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:
39
2.4. The Exact Value for 7.3%

• Using a previously programmed spreadsheet
model the exact value for 7.3% is:
40
CHAPTER 2 Section 5
P/G and A/G Factors
41
2.5 Arithmetic Gradient Factors
• In applications, the annuity cash flow pattern is

not the only type of pattern encountered
•Two other types of end of period patterns are
common
•The Linear or arithmetic gradient
•The geometric (% per period) gradient
•This section presents the Arithmetic Gradient
42

• 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:
43

•The Two Components are:
•The Gradient component
•The base annuity component
•The objective is to find a closed form
expression for the Present Worth of an
arithmetic gradient
44
2.5 Linear Gradient Example

A1+(n-1)G
A1+(n-2)G
Assume the following:
A1+2G
A1+G
0 1 2 3 n-1 N
This represents a positive, increasing arithmetic gradient
45
2.5 Example: Linear Gradient
• Typical Negative, Increasing Gradient:

G=$50
The Base Annuity

= $1500
46
2.5 Example: Linear Gradient
• Desire to find the Present Worth of this cash flow
The Base Annuity

= $1500
47
• 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!
48
2.5 Derivation: Gradient Component Only
Focus Only on the gradient Component

(n-1)G
(n-2)G
“0” G
+2G
Removed Base annuity

0 1 2 3 n-1 N
49
2.5 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!
50
$700
$600
$500
$400
$300
$200
$100
X0 1 2 3 4 5 6 7
The Present Worth Point of the

Gradient
51
2.5 Gradient Component
•The Gradient Component $600

$500
$400
$300
$200
$100
$0
X0 1 2 3 4 5 6 7

Gradient
52
•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

Gradient
53
2.5 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!
54
2.5 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.
55
2.5 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
56
2.5 To Begin- Derivation of P/G,i%,n
P  G ( P / F , i %, 2)  2G ( P / F , i %,3)  ...
[(n-2)G](P/F,i%,n-1) + [(n-1)G](P/F,i%,n)
Next Step:
Factor out G and re-write as …..
57
2.5 Factoring G out…. P/G factor
P=G  (P/F,i%,2)+2(P/F,i%,3) +...(n-1)(P/F,i%,n)
What is inside of the { }’s?
58
2.5 Replace (P/F’s) with closed-form
 1 2 n-2 n-1 
P=G  2
 3
 ...  n-1
 n  [1]
 (1+i) (1+i) (1+i) (1+i) 
Multiply both sides by (1+i)
59
2.5 Mult. Both Sides By (n+1)…..
 1 2 n-2 n-1 
1
P(1+i) =G  1
 2
 ...  n-2
 n-1  [2]
 (1+i) (1+i) (1+i) (1+i) 
•We have 2 equations [1] and [2].

•Next, subtract [1] from [2] and work
with the resultant equation.
60
2.5 Subtracting [1] from [2]…..
 1 2 n-2 n-1 
1
P(1+i) =G  1
 2
 ...  n-2
 n-1 
 (1+i) (1+i) (1+i) (1+i) 
-  1 2 n-2 n-1 
P=G  2
 3
 ...  n-1
 n 
 (1+i) (1+i) (1+i) (1+i) 
G  (1  i )  1 n  n
P   n 
i  i (1  i ) n
(1  i ) 
61
2.5 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
62
2.5 Further Simplification on P/G
(1  i )  iN  1 N
( P / G, i%, N ) 
i (1  i )
2 N
Remember, the present worth point of any linear

gradient is 2 periods to the left of the 1-G cash
flow or, 1 period to the left of the “0-G” cash flow.
P=G(P/G,i,n)
63
2.5 Extension – The A/G factor
Some authors also include the derivation of the A/G factor.

A/G converts a linear gradient to an equivalent annuity cash flow.
Remember, at this point one is only working with gradient component
There still remains the annuity component that you must also handle separately!
64
2.5 The A/G Factor
Convert G to an equivalent A
A  G ( P / G , i, n)( A / P, i, n)
How to do it…………
65
2.5 A/G factor using A/P with P/G

G (1  i )  1
n
n   i (1  i ) 
n
P   n   
i  i (1  i ) n
(1  i )   (1  i )  1 
n
(A/P,i,n)
The results follow…..
66
2.5 Resultant A/G factor
G  (1  i ) n  1 n   i (1  i ) n 
P   n  
i  i (1  i ) n
(1  i )   (1  i ) n  1 
(A/P,i,n)
1 n 
(A/G,i,n) = AG  
 i (1  i )  1 
n
67
2.5 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
68
2.5 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
69
2.5 Focus on 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 )
70
2.5 The Set Up

$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.
71
2.5 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
72
2.5 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
73
2.5 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!
74
2.5 Shifted Gradient Example: i = 10%
• Consider the following Cash Flow
0 1 2 3 4 5 6 7
$450
$500
$550
$600
1. This is a “shifted” negative, decreasing

gradient.
2. The PW point in time is at t = 3 (not t = o)
75
2.5 Shifted Gradient Example
0 1 2 3 4 5 6 7
$450
$500
$550
$600
•The PW @ t = 0 requires getting the PW @ t =3;

•Then using the P/F factor move PW3 back to t=0
76
2.5 Shifted Gradient Example
0 1 2 3 4 5 6 7
$450
$500
$550
$600
•The base annuity is a $600 cash flow for 3 time

periods
77
2.5 Shifted Gradient Example: Base

Annuity
• PW of the Base Annuity: 2 Steps
0 1 2 3 4 5 6 7
P3=-600(P/A,10%,4)
P0=P3(P/F,10%,3)
P3
P0 A = -$600
3.1699 0.7513
P0= [-600(P/A,10%,4)](P/F,10%,3)
P 0-base annuity = -$1428.93
78
2.5 Shifted Gradient Example: Gradient

• PW of Gradient Component: G = -$50
0 1 2 3 4 5 6 7
P3-Grad = +50(P/G,10%,4)
P0=P3(P/F,10%,3)
P3
P0 0G 3G
1G 2G
4.3781 0.7513
=-$164.46
P0-grad = {+50(P/G,10%,4)}(P/F,10%,3)
79
Geometric Gradient
80
2.6 Geometric Gradients
• An arithmetic (linear) gradient changes by a

fixed dollar amount each time period.
•A GEOMETRIC gradient changes by a fixed
percentage each time period.
•We define a UNIFORM RATE OF CHANGE (%) for
each time period
•Define “g” as the constant rate of change in
decimal form by which amounts increase or
decrease from one period to the next
81
2.6 Geometric Gradients: Increasing
• Typical Geometric Gradient Profile

•Let A1 = the first cash flow in the series
0 1 2 3 4 …….. n-1 n
A1 A1(1+g)
A1(1+g)2
A1(1+g)3
A1(1+g)n-1
82
2.6 Geometric Gradients: Decreasing
• Typical Geometric Gradient Profile

•Let A1 = the first cash flow in the series
0 1 2 3 4 …….. n-1 n
A1(1-g)n-1
A1(1-g)3
A1(1-g)2
A1(1-g)
A1
83
2.6 Geometric Gradients: Derivation
• First Major Point to Remember:
•A1 does NOT define a Base Annuity;

•There is no BASE ANNUITY for a Geometric
Gradient!
•The objective is to determine the Present Worth
one period to the left of the A1 cash flow point in
time
•Remember: The PW point in time is one period to
the left of the first cash flow – A1!
84
2.6 Geometric Gradients: Derivation
• For a Geometric Gradient the following

parameters are required:
•The interest rate per period – i
•The constant rate of change – g
•No. of time periods – n
•The starting cash flow – A1
85
2.6 Geometric Gradients: Starting
• Pg = The Aj’s time the respective (P/F,i,j)

factor
•Write a general present worth
relationship to find Pg….
A1 A1 (1  g ) A1 (1  g ) 2 A1 (1  g ) n 1
Pg     ... 
(1  i )1
(1  i ) 2
(1  i ) 3
(1  i ) n
Now, factor out the A1 value and rewrite as..
86
 1 (1  g )1 (1  g ) 2 (1  g ) n 1 
Pg  A1     ...  n  (1)
 (1  i) (1  i) (1  i) (1  i) 
2 3
(1+g)
Multuply both sides by to create another equation
(1+i)
(1+g) (1+g)  1 (1  g )1 (1  g ) 2 (1  g ) n 1  (2)
Pg  A1     ...  
(1+i) (1+i)  (1  i) (1  i) 2
(1  i) 3
(1  i) n 
Subtract (1) from (2) and the result is…..
87
 1+g   (1  g ) n
1 
Pg   1  A1  n 1
 
 1+i   (1  i) 1 i 
Solve for Pg and simplify to yield….
  1  g n 
1    
  1 i  
Pg  A1 gi
 ig 
 
 
88
2.6 Geometric Gradient P/A factor
  1 g  n

1    
  1 i   gi
Pg  A1
 ig 
 
 
• This is the (P/A,g,i,n) factor and is valid if g is
not equal to i.
89
2.6 Geometric Gradient P/A factor
•Note: If g = i we have a division by “0” –

undefined.
•For g = i we can derive the closed form PW factor
for this special case.
•We substitute i for g into the Pg relationship to

yield:
90
2.6 Geometric Gradient: i = g Case
 1 1 1 1 
Pg =A1     ...  
 (1+i) (1+i) (1+i) (1+i) 
nA1
Pg  For the case i = g
(1  i )
91
2.6 Geometric Gradients: Summary
•Pg = A1(P/A,g,i,n)
  1  g n 
1     nA1
Pg  A1  

1 i  
ig 
gi Pg 



 (1  i )
g not = to i Case: g = i
92
2.6 Geometric Gradient: Notes
•The geometric gradient requires

knowledge of:
•A1, i, n, and g
•There exist an infinite number of
combinations for i, n, and g: Hence one will
not find tabulated tables for the (P/A,
g,i,n) factor.
93
2.6 Geometric Gradient: Notes
•You have to calculated either from the

closed form for each problem or apply a
pre-programmed spreadsheet model to
find the needed factor value
•No spreadsheet built-in function for this
factor!
94
2.6 Geometric Gradient: Example
•Assume maintenance costs for a particular

activity will be $1700 one year from now.
•Assume an annual increase of 11% per
year over a 6-year time period.
95
2.6 Geometric Gradient: Example
•If the interest rate is 8% per year,

determine the present worth of the future
expenses at time t = 0.
•First, draw a cash flow diagram to
represent the model.
96
2.6 Geometric Gradient Example (+g)
•g = +11% per period; A1 = $1700; i =

8%/yr
0 1 2 3 4 5 6
7
$1700
$1700(1.11)1
$1700(1.11)2
$1700(1.11)3
PW(8%) = ??
$1700(1.11)5
97
2.6 Solution
• P = $1700(P/A,11%,8%,7)
•Need to calculate the P/A factor from the
closed-form expression for a geometric
gradient.
•From a spreadsheet we see:
303: Use "g" 667: use f-bar
Geometric Gradients
"E" or g or f-bar = 11%
i= 8%   1  g n 
N= 7 1    
1 i  
7.04732 Pg  A1   gi
P/A,g,i,n factor is……
 ig 
 
First Amt= $ 1,700.00  
P. Value = $ 11,980.44
98
2.6 Geometric Gradient ( -g )
• Consider the following problem with a

negative growth rate – g.
A1 = $1000
$900
$810
$729
0 1 2 3 4
P0=??
g = -10%/yr; i = 8%; n = 4
We simply apply a “g” value = -0.10
99
2.6 Geometric Gradient (-g value)
• Evaluate:   1  g n 
1    
For a negative g 1 i  
value = -0.10 Pg  A1   gi
 ig 
 
 
303: Use "g" 667: use f-bar
Geometric Gradients
"E" or g or f-bar = -10%
i= 8%
N= 4
P/A,g,i,n factor is…… 2.87637
First Amt= $ 1,000.00

P. Value = $ 2,876.37
100
Determination of an Unknown
Interest Rate
101
2.7 When the i – rate is unknown
• A class of problems may deal with all of

the parameters know except the interest
rate.
•For many application-type problems, this
can become a difficult task
•Termed, “rate of return analysis”
•In some cases:
•i can easily be determined
•In others, trial and error must be used
102
2.7 Example: i unknown
• Assume on can invest $3000 now in a

venture in anticipation of gaining $5,000 in
five (5) years.
•If these amounts are accurate, what
interest rate equates these two cash
flows?
103
• The Cash Flow Diagram is…

$5,000
0 1 2 3 4 5
$3,000 •F = P(1+i)n
•5,000 = 3,000(1+i)5
•(1+i)5 = 5,000/3000 =
1.6667
104
• Solution: $5,000
0 1 2 3 4 5
•(1+i)5 = 5,000/3000 =
$3,000 1.6667
•(1+i) = 1.66670.20
•i = 1.1076 – 1 = 0.1076 =
10.76%
105
2.7 For “i” unknown
• In general, solving for “i” in a time value

formulation is not straight forward.
•More often, one will have to resort to
some form of trial and error approach as
will be shown in future sections.
•A sample spreadsheet model for this
problem follows.
106
2.7 Example of the IRR function
=IRR($D7:$D12)
107
Determination of Unknown
Number of Years
108
2.8 Unknown Number of Years
• Some problems require knowing the

number of time periods required given the
other parameters
•Example:
•How long will it take for $1,000 to double
in value if the discount rate is 5% per
year?
•Draw the cash flow diagram as….
109
Fn = $2000
0 1 2 ... . . . ……. n
P = $1,000
i = 5%/year; n is unknown!
110
• Solving we have….. Fn =
$2000
0 1 2 ... . . . ……. n
P = $1,000
•Fn=? = 1000(F/P,5%,x): 2000 =

1000(1.05)x
•Solve for “x” in closed form……
111
• Solving we have…..
•(1.05)x = 2000/1000
•Xln(1.05) =ln(2.000)
•X = ln(1.05)/ln(2.000)
•X = 0.6931/0.0488 = 14.2057 yrs
•With discrete compounding it will take
15 years to amass $2,000 (have a little
more that $2,000)
112
2.8 No. of Years – NPER function
• From Excel one can formulate as:
=NPER(C23,C22,C20,C21)
113
Spreadsheet Application –
Basic Sensitivity Analysis
114
2.9 Basic Sensitivity Analysis
• Sensitivity analysis is a procedure applied

to a formulated problem whereby one can
assess the impact of each input parameter
relating to the output variable.
•Sensitivity analysis is best performed
using a spreadsheet model.
•The procedure is to vary the input
parameters within certain ranges and
observe the change on the output variable.
115
• By proper modeling, one can perform

“what-if” analysis on one or more of the
input parameters and observe any changes
in a targeted output (response) variable
•Commercial add-in packages are available
that can be linked to Excel to perform such
an analysis
•Specifically: Palisade Corporation’s
TopRank Excel add-in is most appropriate.
116
• When you build your own models, devise

an approach to permit varying at least one
of the input parameters and store the
results of each change in the output
variable…then plot the results.
•If a small change in one of the input
parameters represents a significant change
in the output variable then…
•That input variable is “sensitive”
117
• If an input parameter is deemed

“sensitive” then some effort should go into
the estimation of that parameter
•Because it does influence the response
(output) variable.
•Less sensitive input parameters may not
have as much effort required to estimate
as those input parameters do not have that
much impact on the targeted response
variable.
118
• When you build your own models, devise

an approach to permit varying at least one
of the input parameters and store the
results of each change in the output
variable…then plot the results.
•If a small change in one of the input
parameters represents a significant change
in the output variable then…
•That input variable is “sensitive”
119
Mc
Graw
Hill
CHAPTER 2:
Summary of Important Points
120
Chapter Summary
• This chapter presents the fundamental

time value of money relationships
common to most engineering economic
analysis calculations
•Derivations have been presented for:
•Present and Future Worth- P/F and F/P
•Annuity Cash flows – P/A, A/P, F/A and
A/F
•Gradients – P/G, A,G and P/A,g,i,n
121
Chapter Summary
• One must master these basic time value

of money relationships in order to proceed
with more meaningful analysis that can
impact decision making.
•These relationships are important to you
professionally and in your personal lives.
•Master these concepts!!!
122
ENGINEERING ECONOMY, Sixth Edition
Blank and Tarquin
End of Slide Set
Mc
Graw
Hill
123

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ENGINEERING ECONOMY, Sixth Edition

Factors: How Time and

F/P and P/F Factors

2.1 Basic Derivations: F/P factor

F/P Factor To find F given P

Compound forward in time

2.1 Derivation by Recursion: F/P factor

2.1 Present Worth Factor from F/P

2.1 P/F factor – discounting back in time

Discounting back from the future

P/A and A/P Factors

2.2 Example- F/P Analysis

2.2 Example – P/F Analysis

Assume F = $100,000, 9 years from now.

2.2 Uniform Series Present Worth and

Annuity Cash Flow

2.2 Uniform Series Present Worth and

Desire an expression for the

2.2 Uniform Series Present Worth and

Write a Present worth expression

Term inside the brackets is a geometric progression.

2.2 Uniform Series Present Worth and

The second equation

To isolate an expression for P in terms of A, subtract

2.2 Uniform Series Present Worth and

Setting up the subtraction

2.2 Uniform Series Present Worth and

Simplifying Eq. [3] further

2.2 Uniform Series Present Worth and

This expression will convert an annuity

2.2 Capital Recovery Factor

F/A and A/F Factors

2.3 F/A and A/F Derivations $F

Annuity Cash Flow

Find $A given the

2.3 Sinking Fund and Series Compound

Take advantage of what we already

2.3 A/F Factor

2.3 F/A factor from the A/F Factor

2.3 F/A and A/F Derivations $F

Annuity Cash Flow

Find $F given the $A

2.3 Example 2.5

Formosa Plastics has major

2.3 Example 2.5

•A = $1,000,000/yr; n = 8 yrs, i = 14%/yr

2.3 Example 2.5

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

2.3 Example 2.6

How much money must Carol deposit every

2.3 Example 2.6

2.4 Interpolation of Factors

2.4 Interpolation of Factors

2.4 Interpolation (Estimation Process)

2.4 Basic Setup for Interpolation

•Work with the following basic relationships

2. 4 i = 7.3% using the A/P factor

COMPOUND PRESENT SINKING COMPOUND CAPITAL

2. 4 i = 7.3% using the A/P factor

COMPOUND PRESENT SINKING COMPOUND CAPITAL

2. 4 Estimating for i = 7.3%

2.4 Final Estimated Factor Value