Annual Compounding

Engineering Economics
 • Single Payment, Compound-Amount Factor
• Single Payment, Present-Worth Factor
• Uniform Series, Compound-Amount
Factor
Annual • Uniform Series, Sinking-Fund Factor
Compounding • Uniform Series, Capital-Recovery Factor
• Uniform Series Present-Worth Factor
• Gradient Series Factor
SINGLE-PAYMENT, COMPOUND-
AMOUNT FACTOR
• Suppose that a given sum of money, P, earns
interest at a rate i, compounded annually. We
have already seen compound interest.
• that the total amount of money, F, which will
have accumulated from an investment of P
after n years is given by F = P(1+ i)n.
Example 2.1
• A student deposits P1000 in a savings account that pays interest at
the rate of 6% per year, compounded annually. If all of the money is
allowed to accumulate, how much money will the student have after
12 years?
 SINGLE-
PAYMENT, • The single-payment, present-worth
PRESENT- factor is the reciprocal of the single-
payment, compound-amount factor:
WORTH
FACTOR
Example 2.2
• A certain sum of money will be deposited in a savings account that
pays interest at the rate of 6% per year, compounded annually. If all of
the money is allowed to accumulate, how much must be deposited
initially so that P5000 will have accumulated after 10 years?
UNIFORM-SERIES, COMPOUND-AMOUNT FACTOR

• Let equal amounts of money,

A, be deposited in a savings
account (or placed in some
other interest-bearing
investment) at the end of each
year, as indicated in Fig. 1. If
the money earns interest at a
rate i, compounded annually,
how much money will have
accumulated after n years?
• In this case, we will calculate the future value of each single
investment and then the cumulative future worth of these equal
investments.
• Future value of first investment occurred at time period 1
equals A(1+i)n−1
• Note that first investment occurred in time period 1 (one period after
present time) so it is n-1 periods before the nth period and then the
power is n-1.
• And similarly:
• Future value of second investment occurred at time period
2: A(1+i)n−2
• Future value of third investment occurred at time period 3: A(1+i)n−3
• Future value of last investment occurred at time period n: A(1+i)n−n= A
• So, the summation of all future values is
• F = A(1+i)n−1 + A(1+i)n−2 + A(1+i)n−3 + … + A

• By multiplying both sides by (1+i), we will have

• F(1+i) = A(1+i)n + A(1+i)n−1 + A(1+i)n−2 + … + A(1+i)
• By subtracting first equation from second one, we will have
F(1+i) – F = A(1+i)n + A(1+i)n−1 + A(1+i)n−2 + … + A(1+i) – [A(1+i)n−1 +
A(1+i)n−2 + A(1+i)n−3 + … + A]
F + Fi – F = A(1+i)n + A(1+i)n−1 + A(1+i)n−2 + … + A(1+i) – A(1+i)n−1 -
A(1+i)n−2 - A(1+i)n−3 - … - A
• Which becomes:
Fi = A(1+i)n – A
• Then
• F = A[(1+i)n-1]/i
• The equation is called the uniform-series, compound-amount factor.
Numerical values of this factor can be obtained directly, using this
equation in conjunction with an electronic calculator, or from a set of
compound interest tables such as those given in Appendix A. The
extended notation (F/A, i%, n) is helpful when solving compound
interest problems involving a uniform series.
Example 3
Assume you save 4000 Pesos per year and deposit it at the end of the
year in an imaginary saving account (or some other investment) that
gives you 6% interest rate (per year compounded annually), for 20
years. How much money will you have at the end of the 20th year?
Sinking-Fund Deposit Factor
• This fourth group, is similar to the third group but instead of A as
given and F as unknown parameters, F is given and A needs to be
calculated. This group illustrates the set of problems that ask you to
calculate uniform series of equal payments (or investment), A, to be
invested for n number of time periods at interest rate of i and
accumulated future value of all payments equal to F. Such problems
can be noted as A/Fi,n and are displayed in the following graph. Think
of it as this example: you are planning to have F dollars in n years and
there is a saving account that can give you i percent interest. You
want to know how much you have to deposit every year (at the end
of the year, starting from year 1) to be able to have F dollars
after n years.
• The uniform-series, sinking-fund factor is the reciprocal of the
uniform-series, compound-amount factor:

• A = F{i/[(1+i)n-1]}
• This equation can determine uniform series of equal investments, A,
given the cumulated future value, F, the number of the investment
period, n, and interest rate i. The factor i/[(1+i)n−1] is called the
“sinking-fund deposit factor”, and is designated by A/Fi,n. The factor is
used to calculate a uniform series of equal end-of-period payments, A,
that are equivalent to a future sum F.
Example 4
• Referring to Example 3, assume you plan to have 200,000 dollars after
20 years, and you are offered an investment (imaginary saving
account) that gives you 6% per year compound interest rate. How
much money (equal payments)do you need to save each year and
invest (deposit it to your account) in the end of each year?
Uniform Series Present-Worth Factor
• The fifth group, it covers a set of problems that uniform series of
equal investments, A, occurred at the end of each time period
for n number of periods at the compound interest rate of i. In this
case, the cumulated present value of all investments, P, needs to be
calculated. In summary, P is unknown and A, i, and n are given
parameters. And the problem can be noted as P/Ai,n and displayed as:
• If we replace substitute F in Equation F = A[(1+i)n-1]/i from Equation F =
P(1+i)n, we will have the present value as:

• P(1+i)n =A[(1+i)n-1]/i then

P =A[(1+i)n-1]/[i(1+i)n]
The Equation gives the cumulated present value, P, of all uniform series of
equal investments, A, as P = A[(1+i)n-1]/[i(1+i)n]. And also can be noted as: P
= A * P/Ai,n.The factor [(1+i)n−1]/[i(1+i)n] is called the “uniform series present-
worth factor” and is designated by P/Ai,n. This factor is used to calculate the
present sum, P that is equivalent to a uniform of equal end of period
payments, A. Then P/Ai,n= A[(1+i)n−1]/[i(1+i)n].
Example 5
• Calculate the present value of 10 uniform investments of 2000 dollars
to be invested at the end of each year for interest rate 12% per year
compound annually.

• Note that we use the factor P/Ai,n when we have equal series of
payments. i is the interest rate and n is the number of equal
payments. There is an important assumption here, the first payment
has to start from year 1. In that case P/Ai,n will return the equivalent
present value of the equal payments.
• Now let's consider the case that we have equal series of payments
and the first payment doesn't start from year 1. In that case the
factor P/Ai,n will give us the equivalent single value of equal series of
payments in the year before the first payment. However, we want the
present value of them (at year 0). So, we need to multiply that with
the factor P/Fi,n and discount it to the present time (year 0)
Capital-Recovery Factor

• The sixth group belongs to set of problems that A is unknown and P, i,

and n are given parameters. In this category, uniform series of an
equal sum, A, is invested at the end of each time period for n periods
at the compound interest rate of i. In this case, the cumulated present
value of all investments, P, is given and A needs to be calculated. It
can be noted as A/Pi,n.
• Equation P =A[(1+i)n-1]/[i(1+i)n] can be rewritten for A (as unknown)
to solve these problems:
• A =P[i(1+i)n]/[(1+i)n-1]
• Equation A =P[i(1+i)n]/[(1+i)n-1] determines the uniform series of
equal investments, A, from cumulated present value, P, as A =
P[i(1+i)n]/[(1+i)n-1].The factor [i(1+i)n]/[(1+i)n−1] is called the “capital-
recovery factor” and is designated by A/Pi,n. This factor is used to
calculate a uniform series of end of period payment, A that are
equivalent to present single sum of money P.
Example 6
• Calculate uniform series of equal investment for 5 years from present
at an interest rate of 4% per year compound annually which are
equivalent to 25,000 dollars today. (Assume you want to buy a car
today for 25000 dollars and you can finance the car for 5 years with
4% of interest rate per year compound annually, how much you have
to pay each year?)
Factor Name Formula Requested variable Given variables
Summary
F/Pi,n Single Payment
Compound-Amount Factor
(1+i)
n
F: future value of a single P: present single sum of
sum money
n: number of time periods
i: interest rate
n
P/Fi,n Single Payment Present- 1/(1+i) P: equivalent present value F: single future sum of
Worth Factor of a single sum money
n: number of time periods
i: interest rate
n
F/Ai,n Uniform Series Compound- [(1+i) -1]/i F: Future value of uniform A: uniform series of equal
Amount Factor series of equal investments investments
n: number of time periods
i: interest rate
n
A/Fi,n Sinking-Fund Deposit i/[(1+i) -1] A: Uniform series of equal F: cumulated future value of
Factor end-of-period payments investments
n: number of time periods
i: interest rate
n n
P/Ai,n Uniform Series Present- [(1+i) −1]/[i(1+i) ] P: Present value of uniform A: uniform series of equal
Worth Factor series of equal investments investments
n: number of time periods
i: interest rate
n n
A/Pi,n Capital-Recovery Factor [i(1+i) ]/[(1+i) -1] A: uniform series of equal P: Present value of uniform
investments series of equal investments
n: number of time periods
i: interest rate
Example 7
• Assume a person invests 1000 dollars in the first year, 1500 dollars in
the second year, 1800 dollars in the third year, 1200 dollars in the
fourth year and 2000 dollars in the fifth year. At an interest rate of
8%:
1) Calculate time zero lump sum settlement “P”
2) Calculate end of year five lump sum settlement “F”, that is
equivalent to receiving the end of the period payments
3) Calculate five uniform series of equal payments "A", starting at
year one, that is equivalent to above values.