Engineering Economic Analysis Methods

Single-payment Factors (F/P and P/ F)

The most fundamental factor in engineering economy is
the one that determines the future 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).
Note that compound interest refers to interest paid on top
of interest. Therefore, if an amount P is invested at time t =
0, the amount F1 accumulated 1 year hence at
interest rate of i percent per year will be
From the preceding values, it is evident by mathematical
induction that the formula can be generalized for n years to

The factor (l + 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.
The expression is brackets is known as the single-payment
present worth factor (SPPWF), or the P / F factor. This
expression determines the present worth P of a given future
amount F after n years at interest rate i.
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. 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. Thus, (F/P,6%,20) represents the factor that is used
to calculate the future amount F accumulated in 20 periods if the
interest rate is 6% per period and for the given P. The standard
notation, simpler to use than formulas and factor names, will be used
hereafter.
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 in the figure . 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, and summing the
results
 . The equation is

To simplify 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). Then subtract the two equations, [1] from [2]and simplify to
obtain the expression for P when. This progression follows.
The term in brackets in the last Equation 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 for a
uniform end-of-period series of A values beginning at the end of period
1 and extending for n periods.
To reverse the situation, the present worth P is known and the equivalent
uniform-series amount A is sought. The first A value occurs at the end of
period 1, that is, one period after P occurs. Solve for A to obtain

The term in brackets is called the capital recovery factor (CRF), or A\ P

factor: It calculates the equivalent uniform annual worth A over n years
for a given P in year 0, when the interest rate is i.
These formulas 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.
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. From the previous two equation we get

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 uniform
series A begins at the end of period 1 and continues through
the period of the given F.
The term in brackets is called the uniform-series compound amount
factor (USCAF), or F \ A factor. When multiplied by the given uniform
annual amount A, it yields the future worth of the uniform series. It is
important to remember that the future amount F occurs in the same
period as the last A.
The uniform-series factors can be symbolically determined by using an
abbreviated factor form. For example, F \ A = (F \ P)(P \ A), where
cancellation of the P is correct. Using the factor formulas, we have

Also the A\F factor in Equation may be derived from the A\P factor
by subtracting i.
Arithmetic Gradient Factors (P\G and A\G)
An arithmetic gradient is a cash flow series that either increases or
decreases by a constant amount. The cash flow, whether income or
disbursement, changes by the same arithmetic amount each period.
The amount of the increase or decrease is the gradient.
In this section three factors are derived for arithmetic
gradients: the P\G factor for present worth, the A\ G factor
for annual series and the F\G factor for future worth.
There are several ways to derive them. We use the single-
payment present worth factor (P\ F,i,n), but the same
result can be obtained using the F \ P, F \ A, or P\A factor.
In gradient figure, the present worth at year 0 of only the
gradient is equal to the sum of the present worth of the
individual values, where each value is considered a future
amount.
Multiplying both sides of Equation by

Subtract first Equation from the second Equation and simplify.

The arithmetic-gradient present worth factor, or P\G factor, may
be expressed in two forms:

Conversion diagram from an arithmetic ingredient to a present worth

The equivalent uniform annual series (A value) for an arithmetic
gradient G is found by multiplying the present worth in Equation by
the (A\ P,i,n) factor expression. In standard notation form, the
equivalent of algebraic cancellation of P can be used to obtain the
(A\G,i,n) factor.
Conversion diagram of an arithmetic gradient series
to an equivalent uniform annual series.
The total present worth PT for a gradient series must consider the base
and the gradient separately. Thus, for cash flow series involving
conventional gradients:
• The base amount is the uniform-series amount A that begins in year 1
and extends through year n. Its present worth is represented by PA .
• For an increasing gradient, the gradient amount must be added to the
uniform series amount. The present worth is PG.
• For a decreasing gradient, the gradient amount must be subtracted
from the uniform-series amount. The present worth is - PG
The general equations for calculating total present worth PT of
conventional arithmetic gradients are

where AA is the annual base amount and AG is the equivalent

annual amount of the gradient series.
Geometric Gradient Series Factors
It is common for cash flow series, such as operating costs,
construction costs, and revenues, to increase or decrease from
period to period by a constant percentage, for example, 5% per
year. This uniform rate of change defines a geometric gradient
series of cash flows. In addition to the symbols i and n we need
the term g.

g = constant rate of change, in decimal form, by which amounts

increase or decrease from one period to the next
As shown cash flow diagrams in the figure for geometric gradient
series with increasing and decreasing uniform rates. The series starts
in year 1 at an initial amount A 1' which is not considered a base
amount as in the arithmetic gradient.
The relation to determine the total present worth ~ for the entire cash
flow series may be derived by multiplying each cash flow by the P /
F factor .

Cash now diagram of (a) increasing and (b) decreasing geometric gradient series and
present worth Pg.
subtract the above Equation from the result,
factor out Pg, and obtain
The term in brackets in Equation is the geometric-gradient-series
present worth factor for values of g not equal to the interest rate i. The
standard notation used is (P / A,g,i ,n). When g = i, substitute i for g in
Equation and we obtain

In summary, the engineering economy relation and factor formulas to

calculate Pg in period t = 0 for a geometric gradient series starting in
period 1 in the amount A1 and increasing by a constant rate of g each
period are
It is possible to derive factors for the equivalent A and F values;
however, it is easier to determine the Pg amount and then multiply by
the A\P or F \P factor.
EXAMPLES
1.A person wishes to have a future sum of birr 50,000 for his son’s
education after 10 years from now. What is the single-payment that
he should deposit now so that he gets the desired amount after 10
years? The bank gives 8% interest rate compounded annually.

2. A person who is now 30 years old is planning for his retired life.
He plans to invest an equal sum of birr 10,000 at the end of every
year for the next 25 years starting from the end of the next year. The
bank gives 8% interest rate, compounded annually. Find the
maturity value of his account when he is 55 years old.

3. A company has to replace a present facility after 20 years at an

outlay of birr 500,000. It plans to deposit an equal amount at the
end of every year for the next 20 years at an interest rate of 8%
compounded annually. Find the equivalent amount that must be
deposited at the end of every year for the next 20 years.
4. A bank gives a loan to a company to purchase an equipment worth
birr 1,000,000 at an interest rate of 8% compounded annually. This
amount should be repaid in 20 yearly equal installments. Find the
installment amount that the company has to pay to the bank.

5.ABC Plastics company has major fabrication plants in two

countries. The president of the company wants to know the
equivalent future worth of a $1 million capital investment each year
for 8 years, starting 1 year from now. ABC company capital earns at
a rate of 8% per year.

6. A sports apparel company has initiated a logo-licensing program.

It expects to realize a revenue of $80,000 in fees next year from the
sale of its logo. Fees are expected to increase uniformly to a level of
$200,000 in 9 years. Determine the arithmetic gradient and construct
the cash flow diagram.
7. Three contiguous countries have agreed to pool tax resources
already designated for country-maintained bridge refurbishment(repair).
At a recent meeting, the country engineers estimated that a total of
$500,000 will be deposited at the end of next year into an account for
the repair of old and safety-questionable bridges throughout the three-
country area. Further, they estimate that the deposits will increase by
$100,000 per year for only 9 years thereafter. Determine the equivalent
(a) present worth and (b) annual series amounts if country funds earn
interest at a rate of 8% per year.

8. Engineers at Sea World, a division of Busch Gardens, Inc., have

completed an innovation on an existing water sports ride to make it
more exciting. The modification costs only $8000 and is expected to
last 6 years with a $1300 salvage value for the solenoid mechanisms.
The maintenance cost is expected to be high at $1700 the first year,
increasing by 11 % per year thereafter. Determine the equivalent present
worth of the modification and maintenance cost. The interest rate is 8%
per year.
 Exercise
1.A company is planning to expand its business after 5 years from
now. The money required for the expansion programme is birr
40,000,000. What annual equivalent amount should the company
deposit at the end of every year at an interest rate of 8%
compounded annually to get birr 40,000,000 after 5 years from
now?
2. A company is planning to expand its business after 5 years from
now. The expected money required for the expansion programme is
birr 50,000,000. The company can invest birr 5,000,000 at the end
of every year for the next five years. If the assured rate of return of
investment is 8% for the company, check whether the accumulated
sum in the account would be sufficient to meet the fund for the
expansion programme. If not, find the difference in amounts for
which the company should make some other arrangement after 5
years.
3.A company takes a loan of birr 2,000,000 to modernize its boiler
section. The loan is to be repaid in 20 equal installments at 8%
interest rate, compounded annually. Find the equal installment
amount that should be paid for the next 20 years.
4. A bank gives loan to a company to purchase an equipment which
is worth of birr 500,000, at an interest rate of 8% compounded
annually. This amount should be repaid in 25 yearly equal
installments. Find the installment amount that the company has to
pay to the bank.
5. A working woman is planning for her retired life. She has 20 more
years of service. She would like to deposit 10% of her salary which
is birr 5,000 at the end of the first year and thereafter she wishes to
deposit the same amount (birr 5,000) with an annual increase of birr
1,000 for the next 14 years with an interest rate of 8%. Find the total
amount at the end of the 15th year of the above series.
6.GE Marine Systems is planning to supply a Japanese shipbuilder
with aero-derivative gas turbines to power 11 DD-class destroyers
for the Japanese Self-Defense Force. The buyer can pay the total
contract price of $1,700,000 now or an equivalent amount 1 year from
now (when the turbines will be needed). At an interest rate of
8% per year, what is the equivalent future amount?

7. Thompson Mechanical Products is planning to set aside $ 150,000

now for possibly replacing its large synchronous refiner motors
·whenever it becomes necessary. If the replacement isn't needed for 7
years, how much will the company have in its investment set-aside
account if it achieves a rate of return of 8% per year?
8. V-Tek Systems is a manufacturer of vertical compactors, and it is
examining its cash flow requirements for the next 5 years. The
company expects to replace office machines and computer equipment
at various times over the 5-year planning period. Specifically, the
company expects to spend $9000 two years from now, $8000 three
years from now, and $5000 five years from now. What is the present
8.Income from cardboard recycling at Fort Bliss has been increasing
at a constant rate of $1000 in each of the last 3 years. If this year's
income (i.e., end of year 1) is expected to be $4000 and the increased
income trend continues through year 5, (a) what will the income be 3
years from now (i.e ., end of year 3) and (b) what is the present worth
of the income over that 5-year period at an interest rate of 8% per
year?
9. Ford Motor Company was able to reduce by 80% the cost required
for installing data acquisition instrumentation on test vehicles by
using MTS-developed spinning wheel force transducers. (a) If this
year's cost (i.e., end of year 1) is expected to be $2000, what was the
cost the year before installation of the transducers? (b) If the costs are
expected to increase by $250 each year for the next 4 years (i .e.,
through year 5), what is the equivalent annual worth of the costs
(years 1 through 5) at an interest rate of 8% per year?
10. A proximity sensor attached to the tip of an endoscope could reduce
risks during eye surgery by alerting surgeons to the location of critical
retinal tissue. If a certain eye surgeon expects that by using this
technology, he will avoid lawsuits of $1.25 and $0.5 million 2 and 5
years from now, respectively, how much could he afford to spend now
if his out-of-pocket costs for the lawsuits would be only 10% of the
total amount of each suit? Use an interest rate of 8% per year.
11. Under an agreement with the Internet Service Providers (ISPs)
Association, SBC Communications reduced the price it charges ISPs to
resell its high-speed digital subscriber line (DSL) service from $458 to
$360 per year per customer line. A particular ISP, which has 20,000
customers, plans to pass 90% of the savings along to its customers.
What is the total future worth of these savings over as-year horizon at
an interest rate of 8% per year?
12. Amazon is considering purchasing a sophisticated computer
system to "cube" a book's dimensions-measure its height, length,
and width so that the proper box size will be used for shipment.
This will save packing material , cardboard, and labor. If the
savings will be $150,000 the first year, $160,000 the second year,
and amounts increasing by $10,000 each year for 8 years, what is
the present worth of the system at an interest rate of 8% per year?