How Time and Interest Affect

Money
Introduction
The cash flow is fundamental to every economic study. Cash flows
occur in many configurations and amounts—isolated single values,
series that are uniform, and series that increase or decrease by
constant amounts or constant percentages. This chapter develops
derivations for all the commonly used engineering economy factors
that take the time value of money into account.
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
F1 = P + Pi
= P (1 + i)
At the end of the second year, the amount accumulated F2 is the
amount after year 1 plus the interest from the end of year 1 to the end
of year 2 on the entire F1.
F2 = F1 + F1 i
= P (1 + i) + P (1 + i) i (1)

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The amount F2 can be expressed as
F2 = P (1 + i + i + i2)
= P (1 + 2i + i2)
= P (1 + i) 2
Similarly, the amount of money accumulated at the end of year 3,
using Equation (1), will be
F3 = F2 + F2 i

Fig. 1 Cash flow diagrams for single-payment factors: (a) find F,

given P, and (b) find P, given F.
Substituting P (1 + i) 2 for F2 and simplifying, we get
F3 = P (1 + i) 3
From the preceding values, it is evident by mathematical induction
that the formula can be generalized for n years. To find F, given P,
F = P (1 + i) n (2)
The factor (1 + i) n is called the single-payment compound amount
factor (SPCAF), but it is usually referred to as the F∕P factor. The
cash flow diagram is seen in Figure 1a.

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Reverse the situation to determine the P value for a stated amount
F that occurs n periods in the future. Simply solve Equation (2) for
P.
ଵ
ܲ ൌ ‫ܨ‬ቂ ቃൌ ‫ܨ‬ሺͳ ൅ ݅ሻି௡ (3)
ሺଵା௜ሻ೙
−n
The expression (1 + i) 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. The cash flow diagram is shown in Figure 2–1b.
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.
Table 1 summarizes the standard notation and equations for the F∕P
and P∕F factors.
TABLE 2–1 F∕ P and P∕ F Factors: Notation and Equations

This value is determined by using Equation (3).

1
ሺܲ ോ‫ܨ‬ǡͷΨ ǡͳͲሻൌ
(ͳ ൅ ݅)௡
1
=
(1.05)ଵ଴
3
 1
= = 0.6139
16289
For spreadsheets, a future value F is calculated by the FV function
using the format
F = FV (i%, n, P) (4)
A present amount P is determined using the PV function with the
format
P = PV (i%, n, F) (5)
These functions are included in Table 2–1.
Example 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.
Solution
The cash flow diagram is the same as Figure 2–1a. The symbols and
values are P = $10,000 F =? i = 8% per year n = 20 years
(a) Factor formula: Apply Equation (2) to find the future value F.
Rounding to four decimals, we have
F = P (1 + i) n = 10,000(1.08)20 = 10,000(4.6610)
= $46,610

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Standard notation and tabulated value: Notation for the F∕P factor is
(F∕P, i%, n).
F = P (F∕P, 8%, 20) = 10,000(4.6610)
= $46,610
Example 2
An engineer received a bonus of $12,000 that he will invest now. He
wants to calculate the equivalent value after 24 years, when he plans
to use all the resulting money as the down payment on an island
vacation home. Assume a rate of return of 8% per year for each of the
24 years. Find the amount he can pay down, using the tabulated
factor, the factor formula.
Solution
The symbols and their values are
P = $12,000 F =? i = 8% per year n =24 years
The cash flow diagram

Tabulated: Determine F, using the F_P factor for 8% and 24 years.

Table 13 provides the factor value.

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F = P(F/P, i, n) = 12,000(F/P,8%,24)
= 12,000(6.3412)
= $76,094.40
Formula: Apply Equation (1) to calculate the future worth F.
F = P (1 + i) n = 12,000(1 + 0.08)24
= 12,000(6.341181)
= $76,094.17
2 Uniform Series Formulas (P/A, A/P, A/F, F/A)
There are four uniform series formulas that involve A, where A means
that:
1. The cash flow occurs in consecutive interest periods, and
2. The cash flow amount is the same in each period.
The formulas relate a present worth P or a future worth F to a uniform
series amount A. The two equations that relate P and A are as follows.

Fig. 2 Cash flow diagrams used to determine (a) P of a uniform series

and (b) A for a present worth.

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In standard factor notation, the equations are and P = A (P/A, i, n), A
= P (A/P, i, n), respectively. It is important to remember that in these
equations, the P and the first A value are separated by one interest
period. That is, the present worth P is always located one interest
period prior to the first A value. It is also important to remember that
the n is always equal to the number of A values. The factors and their
use to find P and A are summarized in Table2.
TABLE 2 P/A and A/P Factors: Notation, Equation and
Spreadsheet Function

P and A values in lieu of applying the P/A and A/P factors. The PV
function calculates the P value for a given A over n years, and a
separate F value in year n, if present. The format is
= PV (i%, n, A, F)
Similarly, the A value is determined using the PMT function for a
given P value in year 0 and a separate F, if present. The format is
= PMT (i%, n, P, F)

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Example 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?
Solution

(1 + 0.16)ଽ − 1
ܲ ൌ ͸ͲͲቈ ቉= $2763.9
0.16(1 + 0.16)ଽ
The cash flow diagram fits the P/A factor. The present worth is:
P = 600(P/A, 16%, 9) = 600(4.6065) = $2763.90
The PV function = PV (16%, 9, 600) entered into a single spreadsheet
cell will display the answer P = $2763.93.

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The uniform series formulas that relate A and F follow.

Fig. 3 Cash flow diagrams to (a) find A, given F, and (b) find F,
given A.

The number of A values. Standard notation follows the same form as

that of other factors. They are
(F/A, i, n) and (A/F, i, n). Table 3 summarizes the notations and
equations. If P is not present for the PMT function, the comma must
be entered to indicate that the last entry is an F value.
Table 2.3 F/A and A/F Factors: Notation, Equation and
Spreadsheet Function

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Example 4
Formasa Plastics has major fabrication plants in Texas and Hong
Kong. The president wants to know the equivalent future worth of $1
million capital investments each year for 8 years, starting 1 year from
now. Formasa capital earns at a rate of 14% per year.
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

(1 + 0.14)଼ − 1
‫ ܨ‬ൌ ͳͲͲͲቈ ቉= $13232.8
0.14
The actual future worth is $13,232,800.
F = 1000(F/A, 14%, 8) = 1000(13.2328) = $13,232.80

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Example 5
How much money must an electrical contractor deposit every year in
her savings account starting 1 year from now at 5.5% per year in order
to accumulate $6000 seven years from now?
Solution
The cash flow diagram fits the A/F factor. The A/F factor value of
0.12096 was computed using the factor formula.

0.055
‫ ܣ‬ൌ ͸ͲͲͲ൤ ൨= $725.79
(1 + 0.055)଻ − 1
Alternatively, use the spreadsheet function to obtain A = $725.79 per
year.
A =PMT (5.5%, 7, 6000)
A =$6000(A/F, 5.5%, 7) = 600010.120962 _ $725.76 per year

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