ENGINEERING ECONOMY

Chapter: 2
Lecture: 2

Factors: How Time and

Naif Alhathal

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 Main Topics

2.1 Single-Amount Factors ( F /P and P /F )

2.2 Uniform Series Present Worth Factor and Capital Recovery Factor ( P /A and A /P )

2.3 Sinking Fund Factor and Uniform Series Compound Amount Factor ( A /F and F /A )

2.4 Factor Values for Untabulated i or n Values

2.5 Arithmetic Gradient Factors (P/G and A/G)

2.6 Geometric Gradient Series Factors

2.7 Determining i or n for Known Cash Flow Values

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 2.1 Single-Amount 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). Therefore, 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

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EXAMPLE 2.1
Sandy, a manufacturing engineer, just received a year-end bonus of $10,000 that will be invested
immediately. With the expectation of earning at the rate of 8% per year, Sandy hopes to take the
entire amount out in exactly 20 years to pay for a family vacation when the oldest daughter is due
to graduate from college. Find the amount of funds that will be available in 20 years by using
(a) hand solution by applying the factor formula and tabulated value and (b) a spreadsheet
function.

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2.2 Uniform Series Present Worth Factor and
Capital Recovery Factor ( P /A and A /P )

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EXAMPLE 2.3
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?

EXAMPLE 2.4
the Houston American Cement plant may generate a revenue base of $50 million per year. The president of the Brazilian parent
company Votorantim Cimentos may have reason to be quite pleased with this projection for the simple reason that over the 5-year
planning horizon, the expected revenue would total $250 million, which is $50 million more than the initial investment. With
money worth 10% per year, address the following question from the president: Will the initial investment be recovered over the 5-
year horizon with the time value of money considered? If so, by how much extra in present worth funds? If not, what is the
equivalent annual revenue base required for the recovery plus the 10% return on money? Use both tabulated factor values and
spreadsheet functions.

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2.3 Sinking Fund Factor and Uniform Series
Compound Amount Factor ( A /F and F /A )

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EXAMPLE 2.5
The president of Ford Motor Company wants to know the equivalent future worth of a $1 million capital
investment each year for 8 years, starting 1 year from now. Ford capital earns at a rate of 14% per year.

EXAMPLE 2.6
Once again, consider the HAC case presented at the outset of this chapter, in which a projected $200
million investment can generate $50 million per year in revenue for 5 years starting 1 year after start-
up. A 10% per year time value of money has been used previously to determine P , F , and A values.
Now the president would like the answers to a couple of new questions about the estimated annual
revenues. Use tabulated values, factor formulas, or spreadsheet functions to provide the answers.
( a ) What is the equivalent future worth of the estimated revenues after 5 years at 10% per year?
( b ) Assume that, due to the economic downturn, the president predicts that the corporation will earn
only 4.5% per year on its money, not the previously anticipated 10% per year. What is the required
amount of the annual revenue series over the 5-year period to be economically equivalent to the
amount calculated in ( a )? 10
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 2.4 Factor Values for Untabulated i or n Values

Often it is necessary to know the correct numerical value of a factor with an i or n value that is not listed in
the compound interest tables in the rear of the book. Given specific values of i and n , there are several ways
to obtain any factor value.
• Use the formula listed in this chapter or the front cover of the book,
• Use an Excel function with the corresponding P , F , or A value set to 1.
• Use linear interpolation in the interest tables.

EXAMPLE 2.7
Determine the P/A factor value for i = 7.75% and n = 10 years, using the three methods described previously.

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 2.5 Arithmetic Gradient Factors (P/G and A/G)

An arithmetic gradient series is a cash flow series that either increases or decreases by a constant
amount each period. The amount of change is called the gradient. G= constant arithmetic change
in cash flows from one time period to the next; G may be positive or negative. It is important to realize
that the base amount defines a uniform cash flow series of the size A that occurs each time period.

EXAMPLE 2.8
A local university has initiated a logo-licensing program with the clothier Holister, Inc.
Estimated fees (revenues) are $80,000 for the first year with uniform increases to a total of
$200,000 by the end of year 9. Determine the gradient and construct a cash flow diagram that
identifies the base amount and the gradient series.

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EXAMPLE 2.9
Neighboring parishes in Louisiana have agreed to pool road tax resources already designated for
bridge refurbishment. At a recent meeting, the 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 area. Further, they estimate that the deposits will increase by $100,000 per
year for only 9 years thereafter, then cease. Determine the equivalent (a) present worth and (b)
annual series amounts, if public funds earn at a rate
of 5% per year.
EXAMPLE 2.10
The announcement of the HAC cement factory states that the $200 million (M) investment is
planned for 2012. Most large investment commitments are actually spread out over several years as
the plant is constructed and production is initiated. Further investigation may determine, for
example, that the $200 M is a present worth in the year 2012 of anticipated investments during the
next 4 years (2013 through 2016). Assume the amount planned for 2013 is $100 M with constant
decreases of $25 M each year thereafter. As before, assume the time value of money for investment
capital is 10% per year to answer the following questions using tabulated factors and spreadsheet
functions, as requested below.
(a) In equivalent present worth values, does the planned decreasing investment series equal
the announced $200 M in 2012? Use both tabulated factors and spreadsheet functions.
(b) Given the planned investment series, what is the equivalent annual amount that will be invested
from 2013 to 2016? Use both tabulated factors and spreadsheet functions. 15
 Homework: 2

Q1: Look up the numerical value for the following factors from the interest tables.
1. (P/F, 6%, 8) 2. (A/P, 10%, 10) 3. (A/G, 15%, 20) 4. (A/F, 2%, 30) 5. (P/G, 35%, 15)

Q2: How much can Haydon Rheosystems, Inc., afford to spend now on an energy management system if
the software will save the company $21,300 per year for the next 5 years? Use an interest rate of 10% per
year
Q3: If GHD Plastics purchases a new building now for $1.3 million for its corporate headquarters, what
must the building be worth in 10 years? The company expects all expenditures to earn a rate of return
of at least 18% per year
Q4: Rolled ball screws are suitable for high-precision applications such as water jet cutting. Their total
manufacturing cost is expected to decrease because of increased productivity, as shown in the table.
Determine the equivalent annual cost at an interest rate of 8% per year.
Year 1 2 3 4 5 6 7 8
Cost 200 195 190 185 180 175 170 165

Q5: If the value of Jane’s retirement portfolio increased from $170,000 to $813,000 over a 15-year
period, with no deposits made to the account over that period, what annual rate of return did she
make?

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Q6: The amount of money that Diamond Systems can spend now for improving productivity in lieu of
spending $30,000 three years from now at an interest rate of 12% per year is closest to:
(a) $15,700
(b) $17,800
(c) $19,300
(d) $21,350
Q7: A manufacturing company spent $30,000 on a new conveyor belt. If the conveyor belt resulted in
cost savings of $4200 per year, the length of time it would take for the company to recover its investment
at 8% per year is closest to:
(a) Less than 9 years
(b) 9 to 10 years
(c) 11 to 12 years
(d) Over 12 years

Q8: The cost of lighting and maintaining the tallest smokestack in the United States (at a shuttered
ASARCO refinery) is $90,000 per year. At an interest rate of 10% per year, the present worth of
maintaining the smokestack for 10 years is closest to:
(a) $1,015,000
(b) $894,000
(c) $712,000
(d) $553,000

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