ENGR 3360U

Engineering Economics
Winter 2024-2025
Presented by Dr. Filippo Genco
Lecture 4
Time Cash Flow Modeling,
Compound interest & Series
Sinking Fund & Capital Recovery

Disclaimer: Some material used in this presentation is based on the

book “Engineering Economics” authored by Fraser N. et al.,3rd Edition,
and/or other sources, all subject to copyright as prescribed by the law.
 Subjects to be Covered
◼ Introduction to Eng. ◼ MARR & IRR / ERR &
Economics: Macro & Micro Comparisons
Economics
◼ Uncertainty & Risk
◼ Supply and Demand /
Estimating models ◼ Probability Analysis &
Decision Trees
◼ Role of the BANK of Canada
◼ Depreciation
◼ Balance Sheet Accounting
◼ Taxes & Cash Flow
◼ Financial RATIOs
◼ Replacement Analysis &
◼ Time value of Money Decisions
◼ Interest rates / Cash Flow ◼ Inflation & Price Change
diagrams / C.F. Analysis
◼ Public Decision Making
◼ Compounding & Series
◼ Market Failures &
◼ Benefit Analysis A.W./ Remedies
Payback Period
◼ FINAL Exam 2
 Lecture 4: Outline
❑ What to do in a comparison?
❑ Compound interest definition & Annuities
❑ Present worth factor
❑ Uniform Series
❑ Capital Recovery Factor & Sinking Fund F.
❑ Arithmetic Series
❑ Geometrical Series
• Review & understand the
GOALS concepts of
– Compounding & Annuities
– Capital Recovery & Sinking Fund
– Gradient Series & Applications 3
 Importance of TIME & Interest rate
• Time is a critical factor in engineering
economics.
• There is a preference for consuming goods and
services sooner rather than later.
• The stronger the preference for current
consumption, the greater the importance of time
in investment decisions.
• The amount and timing of a project’s cash
100, 000
PV =
flows (operating expenses; revenues / sales) =
are critical to the value of a project’s(1.08)
13
worth
and its doability. PV = FV N
1+ i 4
 Example of comparison (A vs B)
Project Parameters Project A Project B
Initial investment $10,000 $10,000
Salvage value $0 $0
Life 5 years 5 years
End-of-year cash flows
Year 1 $3,000 $5,000
Year 2 $3,000 $4,000
Year 3 $3,000 $3,000
Year 4 $3,000 $2,000
Year 5 $3,000 $1,000
5
Example of comparison (A vs B) & I. Rate
• Projects A and B have identical initial costs,
duration, and cumulative cash flows over 5 years
($15,000) but different cash flow patterns.
• If the discount rate i = 0%, then A and B are
equivalent.
• If i ≠ 0%, then A and B are not equivalent.
Recall that the rate of interest is:
• the rate of return received by a lender for
lending money (foregoing or trading off
current consumption for future
consumption), or
• the rate of return paid by a borrower for
the use of a lender’s funds. 6
 Simple Interest
• The interest payment each year is found by
multiplying the interest rate times the principal, I
= P*i per each year. After any n time periods, the
accumulated value of money owed under simple
interest, FN, would be:

FN=8 = P(1 + i*n)

• For example, $1000 invested now at 9% simple
interest for 8 years would yield
F8 = $1000[1+0.09(8)] = $1720
• No one uses simple interest.
7
 Compound Interest
• The interest payment each year, or each period, is
found by multiplying the interest rate by the
accumulated value of money, both principal and
interest.
Accumulated EOP
End of Period Value or Amount Interest for Amount Owed or Value Accumulated
(EOP) Owed (1) Period (2) Next Period (3) = (1) + (2)
0 P Pi P + Pi = P ( 1 + i )
1 P ( 1 + i )1 [P ( 1 + i )1]i P ( 1 + i ) + P ( 1 + i )i = P ( 1 + i )2
2 P ( 1 + i )2 [P ( 1 + i )2]i P ( 1 + i )2 + P ( 1 + i )2i = P ( 1 + i )3
3 P ( 1 + i )3 [P ( 1 + i )3]i P ( 1 + i )3 + P ( 1 + i )3i = P ( 1 + i )4
¼ ¼ ¼ ¼

Short or LONG Period?

8
 Compound Interest Example
• Consequently, the value for an amount P invested
for n periods at i rate of interest using compound
interest calculations would be:

F = P (1+ i)
N

• For example, $1000 invested now at 9%

compound interest for 8 years would yield:
F8 = $1000 (1 + 0.09)8 = $1992.6 $1720
• Compound interest is the basis for practically all
monetary transactions. Note that:
HUGE
F4 = $1000 (1 + 0.09)4 = $1411.6 Difference
9
 Present / Future Value
• Discounting is the process of translating a future
value or a set of future cash flows into a present
value. FV
PV = or
(1+ i)
N

Example
P= F and F = P (1+ i)
N

(1+ i)
N

If promised $450,000 in 50 years, assuming 6% interest,

what is the value today? (Discounting)
FVN= PV(1 + i)N
PV = FV/(1 + i)N where 1 / (1+0.06)50 = 0.05428
PV = $450,000 (0.05428)
PV = $24,429.7
10
 Present / Future Value Example
Given the following DATA:
• Amount of deposit today (PV): $60,000
• Interest rate: 12%
• Frequency of compounding: Annual
• Number of periods (5 years): 5 periods
Then we wonder what is the future value (FV or
F) of this single sum?

FVn = PV(1 + i)n means

The reverse
FV = $60,000 x (1.7623) =
is similar
= $105,740.5
11
 Present / Future Value Example
Given the following DATA:
• Amount of deposit at the end (PV): $105,740.5
• Interest rate: 12%
• Frequency of compounding: Annual
• Number of periods (5 years): 5 periods
Then we wonder what is the present value (PV or
P) of this single sum?

FVn = PV(1 + i)n means PV = FVn / (1 + i)n

PV = 105,740.5 / (1.7623) = $60001.1 Recall:

Compound Amount Factor (1+ i)

N
12
 Compound & P. Worth Factors
• Recalling that by definition:

F = P (1+ i)
N

Compound Amount Factor (1+ i)

N

present Worth Factor 1

(1+ i)
N

Please check CHAPT. 4 pag.122 (Newnan)

13
 Present / Future Value Example
• Formula: F = P(1+i)n is the single payment
future value factor.
• Find the value in seven years of $500 today
if the rate of interest is 8½ %. (Ans: $885.07)
• Formula: P = F(1/(1+i)n) = F(1+i)−n is the
single payment present value factor.
• Find the value today of $500 in seven years
if the rate of interest is 8½%. (Ans: $282.46)
• Note: do always the calculation yourself.

14
 Present / Future Value &
Compounding Example
• Interest rate = 8% compounded quarterly
– Nominal rate = 8% (per year) compounded
quarterly, i.e. 4 times per year.
– Effective rate = [1+(8%/4)]4 – 1 = 8.2432%.
– Periodic rate (per quarter) = 8%/4 = 2%.

Investing $1 at 2% per quarter

is equivalent to investing $1 at
8.2432% annually.

15
 Annuities & Annuity Computation
• Definition -- a series of equal dollar payments
coming at the end of a certain time period for a
specified number of time periods.
• Examples -- life insurance benefits, lottery
payments, retirement payments.
• An annuity requires that:
a) the periodic payments or receipts always be of
the same amount,
b) the interval between such payments or receipts
be the same, and
c) the interest be compounded once each interval.
16
 Annuity Example
End of Year
0 1 2 3 4
7%
$1,500 $1,500 $1,500
$1,605
$1,717

If one saves $1,500 a year at the end of every year for

three years in an account earning 7% interest,
Compounded annually how much will one have at the end
of the third year?
FVYear3 = $1,500 (1.07)2 + $1,500(1.07)1 +
$1,500(1.07)0 = $4,822.35
17
 Annuity: Equation Derivation
A A A A A A A A

1 2 3 4 n-2 n-1 n ?
Year Future Value of Annuity
n A
n-1 A(1+i)
n-2 A(1+i)2
. .
. .
1 A(1+i)n-1

Total Future Value (FV) = A + A(1+i) + A(1+i)2

+ ... + A(1+i)n-1 18
 Annuity: Equation Derivation
Now multiplying both sides of the equation by (1+i) to
get:

F(1+i) = A(1+i) + A(1+i)2 + ...+ A(1+i)n

Now subtracting the first equation from the second,
we get:
(1+ i)
N
-1
F=A = (F / A,i, N)
i
This is based on a UNIFORM SERIES of Annuity.

Let’s check an example

19
Annuities Future Value Example 1
Given the following DATA:
• Deposit made at the end of each period: $5,000
• Compounding: Annual
• Number of periods: Five
• Interest rate: 12%
What is future value (FV) of these deposits?

F = A[(1+i)n - 1] / i means (F = FV and A= Annuity)

FV = $5,000 x (6.35285) = The reverse

= $31,764.25 is similar
for PV
20
 Annuities Present Value Example 1
Given the following DATA:
• Deposit made at the end of each period: $5,000
• Compounding: Annual
• Number of periods: Five
• Interest rate: 12%
What is future value (FV) of these deposits?

FV5 = A[(1+i)n - 1] / i means PV = FVn / (1 + i)n

2 Concepts
PV = $31,764.25 / (1.76234) = here:
= $18,023.87 a) Annuity
b) PV vs FV
21
 Annuities Future Value Example 2
Given the following DATA:
• Deposit made at the BEGINNING of each period:
Value is $8,000
• Compounding: Annual
• Number of periods: N = 8 (at the end)
• Interest rate: 12%
What is future value (FV) of these deposits?

Two STEPS process as I need first to

evaluate the Annuity at end and NOT
Start of the Period.
FVn = PV (1 + i)n 22
Annuities Present Value Example 2
So Ordinary ANNUITY FACTOR (for 8 years) if it
did START at the end of year 1.
[(1+i)n - 1] / i = 12.2996 (i = 12% or 0.12)
Convert the value per a common value of 1.12
Leading to 1.12 x 12.2996 = 13.7756
Correction is needed as we look at the END of
the year and NOT start.

FV = $8000 x (13.7756) = $110,205.2

23
 UNIFORM Series
SERIES SERIES
DISCOUNT COMPOUND
AMOUNT AMOUNT
(PV) (FV)
Transformations

UNIFORM
SERIES

A A A A A
FV = ??
EQUIVALENCE

≡
0 1 2 3 4 5 0 5

Please check CHAPT. 4 pag. 96-107 (Newnan) 24

 UNIFORM Series
• A series is the sum of the terms of a sequence.
• We have already introduced (LECTURE 2 Equal
payments or Uniform Series):
 N 
A1
(1+ i) −1

F=A 
 
 i 
Uniform Series 

We can DEFINE these very important

Factors:
a) Sinking Factor (UNIFORM Series),
b) Capital Recovery Factor
c) Series Present WORTH
25
 Compound AMOUNT FACTOR
(Uniform or equal Payment Series)
• This factor finds the equivalent future value, F,
of the accumulation of a uniform series of equal
annual payments, A, occurring over n periods
at i rate of interest per period.
• Example: What would be the future worth of an
annual year-end cash flow of $800 for 6 years at
12% interest per year? F?

1 2 3 4 5 6 Find F given A
$800 $800 $800 $800 $800 $800

(1+ i)n -1 (1+ 0.12)6 -1

F=A = $800 = $6, 492
i 0.12 26
 SINKING Fund Factor
• This factor determines how much must be
deposited each period in a uniform series, A,
for n periods at i interest per period to yield a
specified future sum.
• Example: If a $1.2 million bond issue is to be
retired at the end of 20 years, how much must be
deposited annually into a sinking fund at 7%
interest per year? F = $1,200,000
A=? 1 2 3 4 20
Find A given F
A A A A A A

i 0.07
A=F = $1, 200, 000 = $29, 272
(1+ i) -1
n
(1+ 0.07) -1
20
27
 Capital RECOVERY Factor
• This factor finds an annuity, or uniform series of
payments, over n periods at i interest per period
that is equivalent to a present value, P.
• Example: What savings in annual manufacturing
costs over an 8 year period would justify the
purchase of a $120,000 machine if the firm’s
minimum attractive rate of return (MARR) were
25%? A A A A A
1 2 3 8

$120,000
Find A given P

i(1+ i)n 0.25(1+ 0.25)8

A=P = $120, 000 = $36, 048
(1+ i) -1
n
(1+ 0.25) -1
8 28
 Present WORTH FACTOR
(Uniform Series)
• This factor finds the equivalent present value, P,
of a series of end-of-period payments, A, for n
periods at i interest per period.
• Example: What lump sum payment would be
required to provide $50,000 per year for 30 years
at an annual interest rate of 9%?
$50,000 $50,000 $50,000 $50,000 $50,000

1 2 3 30 Find P given A

(1+ i)n -1 (1+ 0.09)30 -1

P P=A n
= $50, 000 = $513, 682.7
i(1+ i) 0.09(1+ 0.09) 30

29
Capital Recovery & Sinking F. Factors
• So similarly to what done before and based on
Annuity and Uniform Series:

(1+ i)
N
-1
F=A = (F / A,i, N )
i
(1+ i)
N
-1
Capital Recovery Factor
i
i
Sinking Fund Factor
é(1+ i) N -1ù
ë û
Please check CHAPT. 4 pag. 98 (Newnan) 30
Capital Recovery & Sinking F. Factors
• A Sinking Fund by definition is an interest-bearing
account into which regular (uniform) payments /
deposits are made in order to accumulate some
amount.
• Vice versa the Capital Recovery Factor provides
the value A of equal periodic payments or
receipts that is equivalent to a present amount P
when the interest rate is i and the number of
periods N.
So we have interest in understanding also:
• Arithmetic Gradient Series
• Geometric Gradient Series 31
 Uniform Series Example
PV = ??
$1000 $1000 $1000 $1000 $1000

≡
0 1 2 3 4 5 0

• Find the balance in ten years of annual deposits of

$1500 into a fund that pays interest of 8%
compounded annually.

 (1 + 0.08)10 − 1
F = $1500  = $21,729.84
 0.08 

32
 Uniform Series Example
Comparing alternatives
Interest rate: 8.00%
Annual Value at Interest Interest/
Year deposit EOY Income FV
0
1 $1,500 $1,500.00 $0.00 0.00% EOY
2 $1,500 $3,120.00 $120.00 3.85% Or
3 $1,500 $4,869.60 $369.60 7.59%
End
4 $1,500 $6,759.17 $759.17 11.23%
5 $1,500 $8,799.90 $1,299.90 14.77%
of
6 $1,500 $11,003.89 $2,003.89 18.21% The
7 $1,500 $13,384.21 $2,884.21 21.55% Year
8 $1,500 $15,954.94 $3,954.94 24.79%
9 $1,500 $18,731.34 $5,231.34 27.93%
10 $1,500 $21,729.84 $6,729.84 30.97%
33
 Uniform Series Example

PV = ??
$1000 $1000 $1000 $1000 $1000

≡
0 1 2 3 4 5 0

• What is the value today of five end-of-year

deposits of $1500 beginning one year from today if
interest is 8% compounded annually?
é1- (1+ i)-n ù é1- (1+ 0.08)-5 ù
P = Aê ú = $1500 ê ú = $5989.06
ë i û ë 0.08 û

34
 Strict Arithmetic Series
• Let’s then introduce STRICT Arithmetic
GRADIENT series of N receipts or
disbursements that increase by a constant
amount from period to period. Often this series
is associated with Annuity that though will be
considered later.
• Cash flows: 0G, 1G, 2G, ..., (N–1)G at the end of
periods 1, 2, ..., N…
Find P given G

 (1 + i) − iN − 1
N
P = G 
 i (1 + i)
2 N

35
 Arithmetic Uniform Series
More often though the ARITMETIC UNIFORM
SERIES is used where there is the combinations of
two parts: a) Strict linear and b) Uniform Series

n
 (1 + i) − iN − 1
N
i(1+ i)
P = G  A=P
 i (1 + i)
2 N
 (1+ i) -1
n

36
 Arithmetic Uniform Series
Combining the 2 together we get (A is Aequivalent):

Similarly we can get:

Example
Please check CHAPT. 4 pag. 108-115 (Newnan) 37
 Arithmetic Uniform Series Example
• A company has maintenance costs that will be
$1500 six months from today and will grow by $175
every six months after that.
• Find the value today of the maintenance costs
over a ten-year period if the rate of interest is 8¼%
compounded semiannually.
• So we can write: G = $175; i = 0.00825/2 = 0.04125
= i ; n = 102per year = 20.
é 1 20 ù
Aeq = $175ê - ú = $175 x 8.17 =1428.82$
ë 0.04125 (1+ 0.04125) -1û
20

é1-1.04125-20 ù
P = ($1500 + $1428.82)ê ú = $2928.82 x 13.44 = 39366.65$
ë 0.04125 û
38
 Arithmetic Uniform Series Example 2
• We will save for buying a used car by depositing
$200 in one month then $5 less each month for
two years.
• Determine the amount you will have saved after two
years (and so the type of used car) if the interest
rate is 6½% compounded monthly. G = −$5; i =
0.065/12 = 0.005416= i; n = 212 = 24.

é 1 24 ù
Aeq = -$5ê - ú = -$5[184.638 - $173.396] = -$56.21
ë 0.005416 (1+ 0.005416) -1û
24

é1.005416 24 -1ù
F = ($200 - $56.21)ê ú = $3674.68.10
ë 0.005416 û
39
 Arithmetic Series: Example A
• A lottery prize pays $1000 at the end of the first year,
$2000 the second, $3000 the third, etc., for 20
years.
• If there is only one prize in the lottery, 10 000 tickets
are sold, and you can invest your money elsewhere
at 15% interest, how much is each ticket worth, on
average?

• First find annuity value of prize and then find

present value of annuity.
A = 1000, G = 1000, i = 0.15, N = 20
Atotal = A + G* Factor = 1000 + 1000 * (A/G, 15%, 20)
= 1000 + 1000(5.3651) = 6365.10$
40
 Arithmetic Series: Example A
• Now find present value of annuity, recalling the
significance of PRESENT Worth FACTOR:

(1+ i) -1
N
P = Atotal N
i(1+ i)
P = Atotal (P/A, i, N) where Atotal = 6365.10$
i = 15%, N = 20
P = 6365.10 * (P/A, 15, 20)
= 6365.10 * (6.2593) = 39,841.07 $

• Since 10 000 tickets are to be sold, on average

each ticket is worth (39 841.07)/10,000 = $3.98.
41
 Linear vs Geometric Gradient
Cash flows on a linear gradient
increase by a constant amount
each interest period:

Cash flows on a geometric

gradient increase by a constant
percentage each interest period.
The percentage is called
GROWTH RATE g

42
 Geometric Gradient Series
• Payment grows by a constant rate, g:
Find P given A1 and g

A1 A1(1+g) A1(1+g)2 A1(1+g)3 A1(1+g)4

0 1 2 3 4 5
• General formulas (i ≠ g):
1 − (1 + g )n (1 + i ) −n 
P = A1  
 i −g 
 (1 + i )n − (1 + g )n 
F = A1   Note : i  g.
 i −g 
43
 Geometric Series Example B
• A company has maintenance costs that will
be $1500 six months from today and will
grow by 4% every six months after that.
• Find the value today of the maintenance
costs over a ten-year period if the rate of
interest is 9% compounded semiannually.
g = 0.04; i = 0.09/2 = 0.045; n = 102 = 20.
é1- (1.04)20 (1.045)-20 ù
P = $1500 ê ú
ë 0.045 - 0.04 û
= $27, 439.93
44
 Geometric Gradient Series
• Payment grows by a constant rate, g:
Find P given A1

A1 A1(1+g) A1(1+g)2 A1(1+g)3 A1(1+g)4

0 1 2 3 4 5
• General formulas (i = g):

é ù
P = A1 ën(1+ i) û -1

Please check CHAPT. 4 pag. 115-118 (Newnan) 45

 Geometric vs Arithmetic Series
• Typically for volatile numbers, the geometric
average provides a far more accurate
measurement of the true return by taking into
account year-over-year compounding.
• The geometric mean differs from the arithmetic
average, or arithmetic mean, in how it is calculated
because it takes into account the compounding
that occurs from period to period. Because of this,
investors usually consider the geometric mean a
more accurate measure of returns than the
arithmetic mean.
• This is especially true for investment portfolios.
46
 Non-standard series: Payments at the
beginning of the period
• For some series, the payments occur at the
beginning of each payment period.
• These are also called annuities due. The formulas
are: 1 − (1 + i ) −n 
P = A (1 + i ).
 i 
 (1 + i )n − 1
F = A (1 + i ).
 i 
–These formulas are the essentially those for
ordinary annuities, multiplied by the factor (1+ i).
Please check CHAPT. 4 pag. 118-121 (Newnan) 47
Non-standard series: Payment period
 Compounding period
• These are called general annuities.
• Convert the nominal interest rate to the
equivalent rate for the payment period.
• p = number of payment periods per year,
and c = number of compounding periods
per year. (1+ i ) p = (1+ i)c ; i = (1+ i)c p -1.
eq eq

1 − (1 + i eq )−n   (1 + i eq )n − 1
P = A . F = A .
 i eq   i eq 
48
 Another Example
• We arrange a mortgage loan for $295,000 that
requires monthly payments for 25 years at an
interest rate of 5.35% compounded
semiannually.
• Find the amount of the monthly payment (i.e. A).
ieq +1= (1+ i)c p where c = number of compounding periods per year.
p = number of payment periods per year
(1+ imo ) = (1+ )
2
0.0535
2
12
=1.004409439
é1-1.04409439-300 ù
$295000 = A ê ú
ë 0.04409439 û
A = $1774.98 49
SUMMARY

50
 Homework for Next Class
❑ Please, read and study CHAPT. 3 & CHAPT. 4 (from
Fraser / Annual Worth Comparison) or CHAPT. 4 Newnan
(Gradients), CHAPT. 5 (PW. Analysis) and CHAPT. 6
(Annual Cash Flow Analysis) from Newnan.

QUESTIONS ?

51