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# ENGINEERING ECONOMY

SESSION_II

## Blank & Tarquin: 5-th Edition Ch.

1 Authored by: Dr. Don Smith
11/6/2018 Texas A&M University 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
7. Calculate i
8. Calculate “n”
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 2
ENGINEERING ECONOMY

SESSION II Section 1

## Blank & Tarquin: 5-th Edition Ch.

1 Authored by: Dr. Don Smith
11/6/2018 Texas A&M University 3
2.1 Basic Derivations: F/P factor

## F/P Factor To find F given P

Fn
To Find F given P

………….
N

P0

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 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)
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 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
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 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.
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 7
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
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 8
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(0.1111) = \$11,110 at time t = 0
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 9
ENGINEERING ECONOMY

SESSION Section 2

## Blank & Tarquin: 5-th Edition Ch.

1 Authored by: Dr. Don Smith
11/6/2018 Texas A&M University 10
2.2 Uniform Series Present Worth and
Capital Recovery Factors

P = ??

1 2 3
…………..
.. .. n-1 n
0

\$A per period

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 11
2.2 Uniform Series Present Worth and
Capital Recovery Factors

## 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
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 12
2.2 Uniform Series Present Worth and
Capital Recovery Factors

## 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

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 13
2.2 Uniform Series Present Worth and
Capital Recovery Factors

## 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.

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 14
2.2 Uniform Series Present Worth and
Capital Recovery Factors

## Setting up the subtraction

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

 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) 
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 15
2.2 Uniform Series Present Worth and
Capital Recovery Factors

## 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) 

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 16
2.2 Uniform Series Present Worth and
Capital Recovery Factors

## 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
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 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

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 18
ENGINEERING ECONOMY Fifth Edition

SESSION II Section 3

## Blank & Tarquin: 5-th Edition Ch.

1 Authored by: Dr. Don Smith
11/6/2018 Texas A&M University 19
2.3 F/A and A/F Derivations \$F

…………..
N
0

## Find \$A given the

\$A per period Future amt. - \$F

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 20
2.3 Sinking Fund and Series Compound
amount factors (A/F and F/A)

have
Recall:
Substitute “P” and
 1  simplify!
PF n 
 (1  i) 
Also:
 i(1  i)n 
A P 
 (1  i)  1
n

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 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

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 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 
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 23
2.3 F/A and A/F Derivations \$F

…………..
N
0

## Find \$F given thethe

\$A per period \$A amounts

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 24
2.3 Example 2.5

## Formasa 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.
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 25
2.3 Example 2.5

•F8 = ??

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 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/
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 27
2.3 Example 2.6

## How much money must Carol deposit every

year starting, l year from now at 5% per
year in order to accumulate \$6000 seven
years from now?

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 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

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 29
ENGINEERING ECONOMY

SESSION II Section 4

Interpolation in Interest
Tables

## Blank & Tarquin: 5-th Edition Ch.

1 Authored by: Dr. Don Smith
11/6/2018 Texas A&M University 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.

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 31
2.4 Interpolation of Factors
• Typical Format for Tabulated Interest Tables

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 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 forces 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.

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 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:

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 34
2.4 Basic Setup for Interpolation

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 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

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 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

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 37
2. 4 Estimating for i = 7.3%
• Form the following relationships

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 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:

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 39
2.4. The Exact Value for 7.3%
• Using a previously programmed spreadsheet
model the exact value for 7.3% is:

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 40
ENGINEERING ECONOMY

SESSION II Section 5

## Blank & Tarquin: 5-th Edition Ch.

1 Authored by: Dr. Don Smith
11/6/2018 Texas A&M University 41

## • 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 geometric (% per period) gradient

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 42

## • An arithmetic (linear) Gradient is a cash flow

series that either increases or decreases by a
contestant amount over n time periods.
•A linear gradient is always comprised of TWO
components:
•The base annuity component
•The objective is to find a closed form expression
for the Present Worth of an arithmetic gradient
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 43
A1+n-1G

A1+n-2G
Assume the following:

A1+2G

A1+G

0 1 2 3 n-1 N

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 44

= \$1500

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 45

= \$1500

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 46

## • 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!

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 47

A +n-1G 1

“0” G A1+n-2G

A1+2G

A1+G

## Blank & Tarquin: 5-th Edition Ch. 1

0 1 2
Authored 3 Don Smith Texas A&M
by: Dr. n-1 N
11/6/2018 University 48
2.5 Present Worth Point…

## The Present worth point of a linear

 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!
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 49
2.5 Present Worth Point…

\$700
\$600
\$500
\$400
\$300
\$200
\$100

X0 1 2 3 4 5 6 7

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 50

\$500
\$400
\$300
\$200
\$100

\$0

X0 1 2 3 4 5 6 7

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 51
2.5 Present Worth Point…

## •PW of the Base Annuity is at t = 0

•PWBASE Annuity=\$100(P/A,i%,7)

X0 1 2 3 4 5 6 7

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 52

## 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!

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 53

## The PW of the Base Annuity is simply

the Base Annuity –A{P/A, i%, n} factor
What is needed is a present worth
cash flow.
We need to derive a closed form

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 54

(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

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 55
2.5 To Begin- Derivation of P/G,i%,n

P  G ( P / F , i %, 2)  2G ( P / F , i %, 2)  ...
...+ [(n-2)G](P/F,i,n-1)+[(n-1)G])P/F,i,n)

Next Step:
Factor out G and re-write as …..

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 56
2.5 Factoring G out…. P/G factor

## P  G{( P / F , i%, 2)  2( P / F , i%, 2)  ...

...+ [(n-2)](P/F,i,n-1)+[(n-1)])P/F,i,n)}

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 57
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) 

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 58
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.

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 59
2. 5 Subtracting [1] from [2]…..

 1 2 n-2 n-1 
P(1+i) =G  1
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) 
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 60
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
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 61
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)
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 62
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
There still remains the annuity
component that you must also handle
separately!
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 63
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…………

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 64
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) (1  i)   (1  i)  1 
N N

(A/P,i,n)

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 65
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 

1 n 
A/G,i,n = G  
 i (1  i )  1 
N

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 66

\$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

Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 67

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

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 68
\$400
\$300
\$200
\$100
\$0

0 1 2 3 4 5

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 69
\$400
\$300
\$200
\$100
\$0

0 1 2 3 4 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.
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 70
2.5 PW of the Gradient Component

## P/G,10%,5) Sub. G=\$100;i=0.10;n=5

G  (1  i) N  1 N 
P=    6.8618
i  i(1  i) N (1  i) N 

## Calculating or looking up the P/G,10%,5 factor

yields the following:
Pt=0 = \$100(6.8618) = \$686.18 for the gradient
PW
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 71

•Equals \$1065.26

## •Note: The two sums occur at t =0 and can be

added together – concept of equivalence

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 72
2.5 Example Summarized

\$400
\$300
\$200
\$100

0 1 2 3 4 5

is 10% per year!

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 73
2.5 Shifted Gradient Example: i = 10%

0 1 2 3 4 5 6 7

\$450
\$500
\$550
\$600

## 1. This is a “shifted” negative, decreasing

2. The PW point in time is at t = 3 (not t = o)
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 74

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
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 75

0 1 2 3 4 5 6 7

\$450
\$500
\$550
\$600

periods

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 76
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
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 77

0 1 2 3 4 5 6 7

P0=P3(P/F,10%,3)
P3

P0 0G
1G 2G 3G
4.3781 0.7513

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 78
ENGINEERING ECONOMY Mc
Hill

SESSION II Section 6

## Blank & Tarquin: 5-th Edition Ch.

1 Authored by: Dr. Don Smith
11/6/2018 Texas A&M University 79

## • 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

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 80

## • 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

## Blank & Tarquin: 5-th Edition Ch. 1

A1(1+g)n-1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 81

## • 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 Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 82

## • First Major Point to Remember:

•A1 does NOT define a Base Annuity/
•There is not BASE ANNUITY for a Geometric
•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!
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 83

## • 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

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 84

## •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

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 85

 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 

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 86

 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 
 
 
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 87

  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 not
equal to i.
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 88

## •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:

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 89
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)
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 90

•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

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 91

## •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.
•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!
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 92

## •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.
•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.

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 93

## •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

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 94
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.
303: Use "g" 667: use f-bar
"E" or g or f-bar = 11%
i= 8%   1  g n 
1    
N= 7 1 i  
7.04732 Pg  A1   gi
P/A,g,i,n factor is……
 ig 
 
First Amt= \$ 1,700.00  
Blank & Tarquin: 5-th Edition Ch. 1
P. Value = \$Authored
11,980.44
by: Dr. Don Smith Texas A&M
11/6/2018 University 95
2.6 Geometric Gradient ( -g )

## • Consider the following problem with a negative

growth rate – g. g = -10%/yr; i = 8%; n = 4
A1 = \$1000
\$900
\$810
\$729

0 1 2 3 4
P0=??

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 96

• 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
"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. Blank
Value & Tarquin:
= 5-th Edition
\$ Ch. 12,876.37
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 97
ENGINEERING ECONOMY

SESSION II Section 7

Determination of an Unknown
Interest Rate

## Blank & Tarquin: 5-th Edition Ch.

1 Authored by: Dr. Don Smith
11/6/2018 Texas A&M University 98
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
•Termed, “rate of return analysis”
•In some cases:
•i can easily be determined
•In others, trial and error must be used

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 99
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?
\$5,000

0 1 2 3 4 5

•F = P(1+i)n

\$3,000
•5,000 = 3,000(1+i)5
•(1+i)5 = 5,000/3000 = 1.6667
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 100
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?
\$5,000

0 1 2 3 4 5

## •(1+i)5 = 5,000/3000 = 1.6667

\$3,000
•(1+i) = 1.66670.20
•i = 1.1076 – 1 = 0.1076 = 10.76%
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 101
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.

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 102
2.7 Example of the IRR function

=IRR(\$D7:\$D12)
Blank & Tarquin: 5-th Edition Ch. 1
Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 103
ENGINEERING ECONOMY

SESSION II Section 8

Determination of Unknown
Number of Years

## Blank & Tarquin: 5-th Edition Ch.

1 Authored by: Dr. Don Smith
11/6/2018 Texas A&M University 104
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?
Fn = \$2000
•Draw the cash flow diagram as….
i = 5%/year; n is unknown!

0 1 2 ... . . . ……. n

## P = \$1,000 Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 105
2.8 Unknown Number of Years

## • 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……

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 106
2.8 Unknown Number of Years

• 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)

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 107
2.8 No. of Years – NPER function

## • From Excel one can formulate as:

=NPER(C23,C22,C20,C21)

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 108
ENGINEERING ECONOMY

SESSION II Section 9

Basic Sensitivity Analysis

## Blank & Tarquin: 5-th Edition Ch.

1 Authored by: Dr. Don Smith
11/6/2018 Texas A&M University 109
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
•The procedure is to vary the input parameters
within certain ranges and observe the change on
the output variable.

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 110
2.9 Basic Sensitivity Analysis

## • 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

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 111
2.9 Basic Sensitivity Analysis

## • 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”

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 112
2.9 Basic Sensitivity Analysis

## • 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.

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 113
2.9 Basic Sensitivity Analysis

## • 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”

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 114
ENGINEERING ECONOMY Mc
Graw
Hill

SESSION II Summary

## Blank & Tarquin: 5-th Edition Ch.

1 Authored by: Dr. Don Smith
11/6/2018 Texas A&M University 115
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

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 116
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!!!

## Blank & Tarquin: 5-th Edition Ch. 1

Authored by: Dr. Don Smith Texas A&M
11/6/2018 University 117
ENGINEERING ECONOMY

## Blank & Tarquin: 5-th Edition Ch.

1 Authored by: Dr. Don Smith
11/6/2018 Texas A&M University 118

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