Engineering Economics & Management

(MS490)
Time Value of Money

Dr. Muhammad Ullah

Assistant Professor
GIKI School of Management Sciences
Single-Payment Compound Amount Factor
If an amount is invested at time the amount accumulated after a year is
given as;

At the end of 2nd year, the accumulated amount is given by;

Similarly;
Single Payment Compound
Amount Factor (SPCAF), also
factor
Generalized formula for calculating future values is given by;
Single Payment Present
Worth Factor, factor
Example
• After graduation, Mr. Saad Hassan, an Electrical Engineer is
planning to go on vacation to London in five years time.
This trip will cost him Rs. 500,000. How much, does he
need to deposit today at the rate of 10% in a saving
account to have Rs. 500,000 at the end of five years?
Cash Flow Diagram
Solution Using Formula 500,000

𝑃 = 𝐹 ( 1+𝑖 )−𝑛 𝒊=𝟏𝟎 %

−5
¿ 500,000 ( 1+ 0.10 ) 0 1 2 3 4 5

= 310,450

P= ?
Factor Notation
• This notations includes two cash flows symbols, interest rate and
number of periods
• General form is: (X/Y, i, n) which means calculating “X” from “Y”. i.e. X
is required and Y is given, “i” is interest rate and “n” is number of
periods.
A Typical Uniform Series and its Present
Worth
Present Worth of Uniform Series
 Example: P/A Factor

An engineer believes that by modifying the structure of a certain water

treatment plant, his company would save Rs. 50,000 per year. At an
interest rate of 10% per year, how much could the company afford to
spend now to just break even over a 6 year project period?

P = A(P/A, i, n)
P = Rs. 50,000(P/A,10%,6)
P = Rs. 50,000 (4.3553)
P = Rs. 217,765
Example: Calculating A from P
Q: You borrow $15,000 from a bank to purchase a used car. The interest
rate on your loan is 0.25% per month and you will make a total of 36
monthly payments. What is your monthly payment?
Sinking Fund Factor
factor relationship is given by;

Since

Sinking Fund Factor

Uniform Series Compound Amount Factor

Example: Sinking Fund Factor
An engineering firm has to pay Rs. 1,000,000 for the replacement of
production plant by the end of fifth year from now. The market rate of
interest is 10% per year. How much the company should deposit annually
in a saving account to have exactly Rs. 1,000,000 by the end of fifth
year?
Solution:
Arithmetic Gradient
• An arithmetic gradient series is a cash flow series that either increase
or decrease by a constant amount each period.
• The amount of change (increase or decrease) is called the gradient.
• Gradient series can be both: cash inflows or cash outflows.
• Let suppose that an engineer predicts that the cost of operating the
plant will increase by Rs. 50,000 each year until the plant become
obsolete. The cash flow series of operating the plant involves a
constant gradient, which is Rs. 50,000 per year.
Example: Arithmetic Gradient
• Let suppose, You bought a used bike with one year warranty.
• The cost of using bike during first year is only the petrol expense that is
estimated to be $2,500.
• From second year, you have to pay $200 per year for repair and
maintenance. This cost will increase by $200 each year.
• What will be the amount in 2nd year?
Arithmetic Gradient
Typical Arithmetic Gradient Cash Flow
PT = ?

i = 10%
0 1 2 3 4 5

400
450
Amount in year 1 500
is base amount 550
600

This diagram = this base amount plus this gradient

PA = ? PG = ?
i = 10% i = 10%

+
0 1 2 3 4 5 0 1 2 3 4 5

Amount 400 400 400 400 400

50
in year 1 100
PA = 400(P/A,10%,5) PG = 50(P/G,10%,5) 150
is base 200
amount 𝑷 𝑻 =𝑷𝑨+ 𝑷𝑮=𝟒𝟎𝟎( 𝑷 / 𝑨,𝟏𝟎% , 𝟓)+𝟓𝟎(𝑷 /𝑮 , 𝟏𝟎% ,𝟓)
Converting Arithmetic Gradient to A
Arithmetic gradient can be converted into equivalent A value using
i = 10% i = 10%
0 1 2 3 4 5 0 1 2 3 4 5

G
2G A=?
3G
4G

General equation when base amount is involved is

A = base amount + G(A/G,i,n)

For decreasing gradients,

0 1 2 3 4 5
change plus sign to minus
4G
3G
2G A = base amount -
G
Summation of Arithmetic Gradient

can be easily calculated from factor. is something that we should take

care of. [Next slide]

Alternatively;
Conversion of in
Future Value of Arithmetic Gradient
• Multiply by factor;
 Example: Arithmetic Gradient
The present worth of $400 in year 1 and amounts
increasing by $30 per year through year 5 at an
interest rate of 12% per year is closest to:
(A) $1532 (B) $1,634 (C) $1,744 (D) $1,829

Solution:
PT = ? PT = 400(P/A,12%,5) + 30(P/G,12%,5)
i = 12% = 400(3.6048) + 30(6.3970)
0 1 2 3 4 5 Year = $1,633.83
Answer is (B)
40
0 430 The cash flow could also be converted into an A
460
490 (uniform series) value as follows:
G = $30 520
A = 400 + 30(A/G,12%,5)
= 400 + 30(1.7746)
= $453.24
 Solution:
(a)

In present worth terms, the planned series will exceed the equivalent of $200 M in
2012 by approximately $7.5 M.
Solution:
(b)
 Geometric Gradients
Geometric gradients change by the same percentage each period
Cash flow diagram for present worth
of geometric gradient There are no tables for geometric factors

Use following equation for

( )
𝒏
𝟏+ 𝒈
𝟏−
𝟏+𝒊
𝑷 𝒈= 𝑨 𝟏
𝒊−𝒈
where: A1 = cash flow in period 1
g = rate of increase

If ,

Note: If g is negative, change signs in front of both g values

Geometric Gradient
If , Eq. 2.31 implies;
Example: Geometric Gradient

Find the present worth of $1,000 in year 1 and

amounts increasing by 7% per year through year
10. Use an interest rate of 12% per year.
(a) $5,670 (b) $7,333 (c) $12,670 (d)
$13,550

Pg = ? Solution:
i = 12%
1 2 3 4 10 𝑃 𝑔=1000[1 −(1+0.07 /1+0.12)10 ]/(0.12− 0.07)
= $7,333
0
1000
1070 Answer is (b)
1145
g = 7%

1838 To find A, multiply Pg by (A/P,12%,10)

Example 2.11
Calculating and for know Cash Flows

 Calculator

 Excel

 Linear Interpolation
Problem # 2.45
Acme Bricks, a masonry products company, wants to have $600,000 on
hand before it invests in new conveyors, trucks, and other equipment. If
the company sets aside $80,000 per year in an account that increases in
value at a rate of 15% per year, how many years will it be before Acme can
purchase the equipment?

Solution
600,000 = 80,000(F/A,15%,n) ¿ [ ( 1 +𝑖 )𝑛 − 1
𝑖 ]
(F/A,15%,n) = 7.50

Interpolate in the 15% interest table or use a spreadsheet function. By spreadsheet, n = 5.4
years.
30
 Interpolation

5 6.7424
x 0.757
1 n 7.500 6 2.0113
years
6 8.7537

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References
• Engineering Economy 7th Edition by Leland Blank, Anthony Tarquin
[ISBN-10: 0073376302]

• Course Material Link:

https://pern-my.sharepoint.com/:f:/g/personal/muhammad_ullah_giki_ed
u_pk/EnRMK3GdevxHnfQ7-19oJ9MBAgDPRhmfD7vsTV_GZw4-lA?e=34q
BJv

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