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Decision Criteria Interest Factor Derivation

Claude Thoret
December 2015

Legend

A = deferred annuity (begins 1 year from now)


C = first term (non-zero) of a geometric series
F = Future worth or value
G = arithmetic gradient
G = rate of growth or decay of a geometric series
i = compound interest rate (=MARR)
n = number of terms (e.g., years)
P = Present worth or value

Decision Criteria Interest Factors


A. Single-Payment Formulas
1. Future Worth or Value
2. Present Worth
B. Uniform Series
1. Compound Amount factor (F/A,i%,n)
2. Uniform Series Sinking Fund Factor ((A/F,i%,N)
3. Uniform Series Discount Factor (P/A,i%,N)
4. Uniform Series Capital Recovery Factor (A/P,i%,N)
C. Arithmetic Gradient Series
1. Present Worth of a arithmetic gradient series
2. Annual equivalent of an arithmetic gradient series
3. Future worth of an arithmetic gradient series
D. Geometric Gradient Series
1. Present Worth of an arithmetic gradient series

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A. Single-Payment Formulas
1.

F = P(F/P,i%,n) = P(1+i)n
2. P = F(P/F,i%,n) = F(1+i)-n

EOY

Investment

0
1
2
3

$P
0
0
0
0
0

Annual Interest
Income

Investment Value (Worth)


EOY

iP
iP(1+i)
iP(1+i)2

iP(1+i)N-1
EOY = End-of-year

P+iP = P(1+i)
P(1+i)+iP(1+i) = P(1+i)2
P(1+i)2+iP(1+i)2 = P(1+i)3

P(1+i)N

B. Uniform Series Formulas


1. Discount Amount Factor (P/A,i%,n) Find P given A, i% and n
P = A(1+i)-1 + A(1+i)-2 + A(1+i)-3 + A(1+i)-n+1 + A(1+i)-n

_____ Equation

1
Multiply Equation 1 by (1+i)
(1+i)P = A(1+i)-1+1 + A(1+i)-1 + A(1+i)-2 + + A(1+i)-n + A(1+i)-n+1 Equation 2
Factor out A and subtract Equation 1 from Equation 2
(1+i)P - P = iP = A-A/(1+i)n-1 = A{1-1/(1+i)n};

P = A{[(1+i)n - 1] / i(1+i)n} ______________________ __ Equation 3


2. Compound Amount Factor (F/A,i%,n) Find F given A, i% and n
From the Single-Payment formulas (Section A above), P=F(1+i)-n
Substitute F(1+i)-n for P in Equation 3 (P = A{[(1+i)n- 1]/[i(1+i)n]}
Therefore, F(1+i)-n= A{[(1+i)n- 1]/[i(1+i)n]} and

F = A{[(1+i)n-1] / i} _____________________________Equation 4
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3. Capital Recovery Factor (A/P,i%,n) Find A given P, i% and n


n

From Equation 3, P = A{[(1+i) - 1] / i(1+i) }

Therefore, A = A{i(1+i)n / [(1+i)n - 1]} ____________ Equation 5

4. Sinking Fund Factor (A/F,i%,n) Find A given F, i% and n


n

From Equation 4, F = A{[(1+i) - 1] / i}

Therefore, A = F{i / [(1+i)n - 1]} ________________ Equation 6


C. Arithmetic Gradient Series Factors
Note: G = constant arithmetic change in the size of the cash inflows or
outflows through consecutive time periods (G can be positive or negative).
1.

Present Worth of an Arithmetic Series (P/G,i%,N)


P = G(P/F,i%,2)+2G(P/F,i%,3)+3G(P/F,i%,4) +(n-2)G(P/F,i%,n-1)
+( n-1)G(P/F,i%,n) OR

P = G[1/(1+i)2 + 2/(1+i)3 + 3/(1+i)4 + ... (n-2)/(1+i)n-1


+ (n-1)/(1+i)n] _______________________________ Equation 7
Multiply both sides of Equation 7 by (1+i)
P(1+i) = G[1/(1+i)1 + 2/(1+i)2 + 3/(1+i)3 + (n-2)/(1+i)n-2
+ (n-1)/(1+i)n-1] ______________________________________ Equation 8
P(1+i)-P = Pi = G[1/(1+i)1 + 1/(1+i)2 + 1/(1+i)3 + 1/(1+i)n-1 + 1/(1+i)n]G[n/(1+i)n] ..
Where G[1/(1+i)1 + 1/(1+i)2 + 1/(1+i)3 + 1/(1+i)n-1 + 1/(1+i)n] = (P/A,i,n)
n

Hence, (P/G,i,n) = (1/i)[{(1+i) -1} / {i(1+i) } - {n/(1+i) }] __ Equation 9

OR
(P/G,i,n) = (1/i)[P/A,i,n) - n/(1+i)n]
OR
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(P/G,i,n) = {(1+i)n- in- 1} / {i2(1+i)n}


2.

Future Worth of an Arithmetic Series (F/G,i%,N)


Multiply Equation 9 by (1+i)n to obtain

(F/G,i,n) = (1/i)[{(1+i)n-1} / i} - n] _______________ Equation 10


OR
(F/G,i,n) = (1/i)[F/A,i,n) - n]

3.
Equivalent uniform series of an arithmetic gradient series
(A/G,i,n)
If the Present Worth or Value of an arithmetic series is (P/G,i,N), its
equivalent uniform series (A) is given by the product

(A/G,i,n) = (P/G,i,n)(A/P,i,n) __________________ Equation 11


OR
If the Future Worth or Value of an arithmetic series is (F/G,i,N), its equivalent
uniform series (A) is given by the product

(A/G,i,n) = (F/G,i,n)(A/F,i,n) __________________ Equation 12

D. Geometric Gradient Series Factors (P/C,i%,g%,N)


Note: The period-by-period change is a uniform rate = g (g can be positive or
negative). C is the first term (must be non-zero) of a geometric series.
1.

Present Worth of a Geometric

Two cases: g=i or gi


Note that the first term of the geometric series is C; the second term is C(1+g);
the third term is C(1+g)2 and last term is C(1+g)n-1

Case 1: g i
The present worth or value of a geometric series where g i
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P = C/(1+i) + C(1+g)/(1+i)2 +C(1+g)2/(1+i)3 + +C(1+g)n-1/(1+i)n


P = C(1+i)-1 + C(1+i)-1[(1+g)/(1+i)] + C(1+i)-1[(1+g)2/(1+i)2] +
+ C(1+i)-1[(1+g)n-1/(1+i)n-1] ____________________________ Equation 13
Let x = C(1+i)-1 and y = [(1+g)/(1+i)]
Therefore, P = x + xy + xy2 ..+xyn-1 _____________________ Equation 13a
Multiply Equation 13a by y:
yP = yx + xy2 + xy3 ..+xyn ______________________________ Equation 14
Subtract Equation 14 from Equation 13a:
P-yP = (P(1-y) = x xyn = x(1-yn) and P = x(1-yn)/(1-y) _______ Equation 15
Substitute the original values for x and y in Equation 15,
P = C(1+i)-1{1-[(1+g)/(1+i)]n} / [1-(1+g)/(1+i)]
P = {C/(i-g)}{1-[(1+g)/(1+i)]n [if gi] _______________________ Equation 15

Case 2: g = i
The present worth or value of a geometric series where g = i
P = C/(1+i) + C(1+g)/(1+i)2 + C(1+g)2/(1+i)3 + + C(1+g)n-1/(1+i)n
P = C/(1+i) + C(1+i)/(1+i)2 + C(1+i)2/(1+i)3 + + C(1+i)n-1/(1+i)n
P = C/(1+i) + C/(1+i) + C/(1+i) + + C/(1+i)
Therefore P = nC\(1+i) = nC/(1+g)

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Summary of Formulas
A. Single-Sum Factors

= (/, , ) = ( + ) = (%, , , )

= (/, , ) = ( + ) = (%, , , )

B. Uniform-Series Factors [i 0% and n is finite)

1. Present Worth of a Uniform Series: (P/A,i,n); Excel Function: PV(i%,n,A)

( + )
=
( + )

2. Capital Recovery: (A/P,i,n); Excel Function: PMT(i%,n,P)

( + )
=
( + )

3. Future Worth of a Uniform Series: (F/A,i,n); Excel Function: FV(i%,n,A)

( + )
=

4. Sinking Fund: (A/F,i,n); Excel Function: PMT(i%,n,,F)

( + )

C. Arithmetic Gradient Series [i 0% and n is finite)


1. Present Worth of an Arithmetic Gradient Series

( + )
(/, , ) =

( + )
( + )

OR

( + )
(/, , ) =

( + )
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2. Future Worth of an Arithmetic Gradient Series

( + )
(/, , ) =

3. Conversion of an arithmetic gradient series to a uniform series (annuity)

(/, , ) =

( + )

D. Geometric Gradient Series [i 0% and n is finite)


1. Present Worth of a Geometric Gradient Series (g = rate of growth (> 0%) or
decay (< 0%).

If i g

If i = g

(/, , , ) =

=
+
+

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References
Blank, Tarquin and Iverson, Engineering Economics, Canadian Edition, McGraw-Hill
Ryerson, 2008
Fraser and Jewkes, Engineering Economics - Financial Decision Making for Engineers,
5th Canadian Edition, Pearson Publishing, 2013.
Larsen, R.W., Engineering With Excel, 4th Edition, Pearson, 2013.
Newnan, Whittaker, Eschenbach and Lavelle, Engineering Economic Analysis, 3rd
Canadian Edition, 2012.
White, Case and Pratt, Principles of Engineering Economic Analysis, 5th Edition, John
Wiley & Sons, 2010.

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