In Chapter 1 a list of reasons for considering automation was presented.

In the final analysis, a proposed automation project should be evaluated againsf the same economic criteria as those used to assess any other investment opportunity: Will the investment pay for itself and contribute to the profits of the firm? In the present chapter we consider production economics, a subject closely related to (and based on) engineering economy. For !he reader unfamiliar with engineering economy, we have included some of the introductory principles in the Appendix to this chapter. The Appendix also includes interest tables that will be of use in solving the problems at the end of the chapter. Production economics is concerned with issues and problems in engineering economy and investment analysis that are specifically relevant to the production function. The subject includes methods of evaluating investment proposals for manufacturing, production costs, and break-even analysis. These topics are generally covered in texts on engineering economy [ 1,4]. Production economics also includes certain issues that are not covered in the usual textbooks. These issues are often overlooked in most corporate investment analyses. As a consequence of the omission, many projects in automation are not approved because they fail to meet the company's investment objectives. A good example of these omitted

Production Economics

issues is work-in-process. A reduction in WIP achieved by automating a certain series of production operations will have a beneficial effect on the firm's annual cash flow. In this chapter an attempt is made to address these types of issues so that the full opportunities offered by automation can be considered. We begin with the more traditional topics.

3.1 METHODS OF EVALUATING INVESTMENT ALTERNATIVES

There are several methods of evaluating and comparing investment proposals, including the following:

1. 2. 3. 4.

Payback period method Present worth (PW) method Uniform annual cost (UAC) method Rate-of-return. method

In the discussion of these methods in this section, we adopt the convention that positive cash flows represent money coming in (revenues and/or profits) and negative cash flows represent money expended (costs).

Payback method
The payback method uses the simple concept that the net revenues derived from an investment should pay back the investment in a certain period of time (the payback period). Let us refer to the net revenue in a given year as the net annual cash flow (NACF). If the revenues exceed costs for the year, the NACF is positive. If costs exceed revenues, the NACF is negative. Assuming for the moment that the net annual cash flows are positive and equal from one year to the next, the payback period can be defined as follows:
n =

IC NACF

where 1C is the initial cost of the investment project, and n is the payback period (expressed in years).

EXAMPLE 3.1
A new production machine costs $85,000 installed and is expected to generate revenues of $55,000 per year for 7 years. It will cost $30,000 per year to operate the machine. At the end of 7 years, the machine will be scrapped at zero salvage value. Determine the payback peripd for this investment.

Methods of Evaluating Investment Alternatives

49

Solution:

'
=

The NACF = 55,000 - 30,000 = $25,000 per year for 7 years. The IC payback period is
,,=--85,000 25,000

$85,000, so the

3.4 years

The production machine will pay for itself through the net revenues generated in 3.4 years.

In most real-life situations, the net annual cash flows will not be equal year after year. The concept of payback period is nevertheless applicable. Instead of using Eq. (3. l), a summation procedure is used to determine how many years are required for the initial cost to be recovered by the accumulated net annual cash flows. The procedure is best summarized by the following:

0 = - (IC)

+ 2 (NACFj)
j=,

where NACFj represents the net annual cash flow for year j. The value of n is determined so that the sum of the NACF values equals the IC value.

Present worth method

The P W method uses the equivalent present value of all current and future cash ffows to evaluate the investment proposal. The future cash flows' are converted into their present worths by using the appropriate interest factors. Accordingly, some interest rate must be used in the factors. This interest rate is decided in advance and represents the rate-ofreturn criterion that the company is using to evaluate its investment opportunities. If the aggregate present worth of the project is positive, the return from the project exceeds the rate-of-return criterion. If the present worth of the project is negative, the project does not meet the rate-of-return criterion.

EXAMPLE 3 2 .
The data from Example 3.1 will be used here. Assume that the company considering the investment uses a rate-of-return criterion of 20%. Determine the equivalent present worth of the proposal.

Solution:
Using the interest factors from the tables in the Appendix, all cash flows are converted to their present values. The IC is already a present value.

Production Economics

Since the present worth i s positive, we conclude that. the return from the rnvestment exceeds the rate-of-return criterion of 20%. and the project is therefore meritorious.

Uniform annual cost method

The WAC method converts all current and future cash flows to their equivalent uniform annual costs using the given rate of return. As with the present worth method, a positive aggregate uniform annual cost means that the project exceeds the criterion.

EXAMPLE 3.3
Again, the data from Example 3.1 will be used. The problem is to determine the equivalent uniform annual cost for the project.

Solution:
Using the interest factors from the tables in the Appendix, all cash flows not already expressed as UAC values are converted to their uniform annual cost equivalents. UAC = - 85,000(AIP, 20%, 7 )
= -85,000(0.2774)

+ 55,000

- 30,000

+ 25,000

Since the UAC value is positive, the actual rate of return is greater than 20%, just as we found x i n g t h e r e s e n t worth method.
------------

Rate-of-return method
The rate-of-return method, also called the return-on-investment(ROI) method, goes slightly beyond the PW and UAC methods by actually calculating the rate of return that is provided by the investment. If the calculated rate is greater than the criterion rate of return, the investment is acceptable. T o determine the return on investment, an equation must be set up with the rate of return as the unknown. Either the PW method orthe UAC method can be used to establish the equation. Then the value of the interest rate i that drives the aggregate PW or UAC to zero is determined.

EXAMPLE 3.4
The data from Example 3.1 will be used to demonstrate computation of the rate of return.

Solution:
A uniform annual cost equation will be set up to illustrate determination of the rate of return.
UAC = -85,000(AIP, i, 7 )

+ 55,000 - 30,000

Methods of Evaluating Investment Alternatives

51

Scanning the AIP values in the interest tables at n = 7 years for different values of i, we find that (AIP, 20%, 7) = 0.2774 and (AIP, 2596, 7) = 0.3163. By interpolation, a value of i = 22.15% corresponding to our.(AIP, i, 7) = 0.2941 is computed.

Comparison of investment alternatives

Any of the four methods can be used to compare investment alternatives. Each method has its relative advantages and disadvantages. The payback method is easy to comprehend but does not incorporate the concept of time value of money into its evaluation. Despite this deficiency, this is a common method used in industry and provides a quick performance measure for the investment proposal. The present worth method is also easy to understand, and it does include interest rates in the evaluation. The UAC method is convenient to use when the service lives of the alternatives are different. Awkward adjustments must be made in the PW method when comparing alternatives with different service lives. The advantage of the rate-of-return method, as we saw in Example 3.4, is that it provides a value for the expected return on the investment. Its disadvantage is that a trial-and-error approach is usually required for problems containing more than one interest factor. One of the most practical uses of the methods described above is to compare investment alternatives. The following example illustrates how the uniform annual cost method can be used to compare two production methods.

EXAMPLE 3.5
Two production methods, one manual and the other automated, are to be compared using the UAC method. The data for the manual method are the same data we have used in Examples 3.1 through 3.4. For the automated method, IC = $150,000, the annual.operating cost = $5000, and the service life is expected to be 5 years. In addition, the equipment associated with this alternative will have a salvage value = $15,000 at the end of the 5 years. Revenues fromeither alternative will be $55,000 per year. A 20% rate of return is to be used as the criterion.

Solution:
The equivalent UAC for the manual method has already been calculated. From Example 3.3, manual UAC = For the automated method,
UAC =

+ $142 1

- 150,000(AIP, 20%, 5)

+ 55,000 - 5000 + 15,000(AIF, 20%, 5)

automated UAC =

+ $ 1856

52

Production Economics
The automated method has the higher positive net uniform annual cash value. Assuming that money is available to make the larger investment, it would be selected.

The situation depicted in this example is typical of automation projects: A larger initial investment must be made for the sake of lower annual operating costs. Less labor is required to run the automated process. In many of the problems in this book, we will make use of annual costs or costs per other time period (e.g., cost per hour) which can be determined from the annual cost. The annual cost given will often be a calculated equivalent UAC. Let us consider next the types of costs in manufacturing and how these costs can be reduced to their equivalent annual or hourly rates.

3.2 COSTS IN MANUFACTURING

Fixed and variable costs

Manufacturing costs can be divided into two major categories, fixed costs and variable costs. The difference between the two is based on whether the expense varies in relation to the level of output. A fixed cost is one that is constant for any level of production output. Examples of fixed costs include cost of the factory building, insurance, property taxes, and the cost of production equipment. All of these fixed costs can be expressed as annual costs. Those items that are capital investments (e.g., factory building and production equipment) can be converted to their equivalent uniform annual costs by the methods of the preceding section. A variable cost is one that increases as the level of production increases. Direct labor costs (plus fringe benefits), raw materials, and electrical power to operate the production machines are examples of variable costs. The ideal concept of variable cost is that it is directly proportional to output level. When fixed and variable costs are combined, we get the total cost of manufacturing as a function of output. A general plot of the relationship is shown in Figure 3.1.

Cost

Output (annual)

FIGURE 3.1 Plot of fixed and variable costs as a function of production output.

Costs in Manufacturing

Overhead costs

Classification of costs as either fixed or variable is not always convenient for accountants and finance people. Fixed costs and variable costs are valid concepts, but the financial specialists of a manufacturing firm usually prefer to think in terms of direct labor cost, material cost, and overhead costs. The direct labor cost is the sum of the wages paid to the people who operate the production machines and perform the processing and assembly operations. The material cost is the cost of all the raw materials that are used to produce the finished product of the firm. In terms of fixed and variable costs, direct labor and material costs must be considered as variable. Overhead costs are all the other costs associated with running a manufacturing firm. Overhead can be divided into two categories: factory overhead (sometimes called factory expense) and corporate overhead. Factory overhead includes the costs of operating the factory other than direct labor and materials. The types of expenses included in this category are listed in Table 3.1. It can be seen that some of these costs are variable whereas others are fixed. The corporate overhead cost is the cost of running the company other than its manufacturing activities. A list of many of the expenses included under corporate overhead is presented in Table 3.2. Many manufacturing firms operate more than one plant, and this is one of the reasons for dividing overhead into factory and corporate categories. FACTORY OVERHEAD. The overhead costs of a firm can amount to several times the cost of direct labor. The overhead can be allocated according to a number of differentbases, including direct labor cost, direct labor hours, spage,matgiaLcost, a n d m on. WeTiIFiusFdiZctlabor cost 5 illustGtehoGfactory overhead rates are determined. Suppose that the total cost of operating a plant amounts to $900,000 per year. Of this total, $400,000 is direct labor cost. This means that $500,000 is indirect or overhead expense: plant supervision, line foremen, annual cost of equipment, energy, maintenance personnel, and so on. The factor overhead rate for this plant would be figured as factory overhead rate =
$500,ooo = 1.25 $400,000

TABLE 3.2 Typical Corporate Overhead

TABLE 3.1 Typical Factory Overhead Expenses Plant supervision Line foremen Maintenance crew Custodial services Security personnel Tool crib attendant Materials handling crew Shipping and receiving Applicable taxes Insurance Heat Light Power for machines Factory cost Equipment cost Fringe benefits Expenses Corporate executives Sales personnel Accounting department Finance department Legal counsel Research and development Design and engineering Other support personnel Applicable taxes Cost of office space Security personnel Heat Light Air conditioning Insurance Fringe benefits

54

Production Economics

Overhead rates are often expressed as percentages, so this equals 125%. This rate could be applied to a particular production job, as illustrated in Example 3.6.

CORPORATE OVERHEAD.The corporate overhead rate can be determined in a manner similar to that used for factory overhead. We will use an oversimplified example to illustrate. Suppose that the firm operates two plants with direct labor and factory overhead expenses as follows:
Plant 1
Direct labor Factory expense Total cost

Plant 2
$200,000 $300,000 $500,000

Toral
$600,000 $800,000 $1,400,000

$400,OOO
$500,000 $900,000

In addition, the cost of management, sales staff, engineering, accounting, and so on, amounts to $960,000. The corporate overhead rate would be based on the total direct labor of the two plants:
corporate overhead rate =.

$960,000
$6do.000

(100%) = 160%

Overhead rates, both factory and corporate, are simply a means for allocating expenses that are not directly associated with production. The principal concern in this book will be with determining the appropriate allocation of factory expenses, not corporate overhead.

EXAMPLE 3.6
A batch of 50 parts is to be processed through the factory for a particular customer. Raw materials and tooling are supplied by the customer. The total time for processing the parts (including setup and other direct labor) is 100 h. Direct labor cost is $9.00 per hour. The factory overhead rate is 125% and the corporate overhead rate is 160%. Compute the cost of the job.

Solution:
(1) The direct labor cost for the job is

(2) The allocated factory overhead charge, at 125% of direct labor, would be

(3) The allocated corporate overhead charge, at 160% of direct labor, would be

Costs in Manufacturing

55

Interpretation: (1) The direct labor cost of the job, representing actual cash spent on the customer's order, is $900. (2) The total factory cost of the job, including allocated factory overhead, is $900 + $1 125 = $2025. To evaluate alternative production methods, at least some of the factory overhead, expenses should be included in the cost comparison. (3) The total cost of the job,' including corporate overhead, is $2025 $1440 = $3465. To price the job for the customer, and to earn a profit over the long run on jobs like this, the price would have to be greater than $3465. For example, if the company uses a 10% markup, the price quoted to the customer would be (1.10)($3465) = $381 1 .SO.

Cost of equipment usage

The trouble with overhead rates as we have developed them is that they are based on direct labor cost alone. A machine operator who runs an old, small engine lathe will be costed at the same overhead rate as the operator who runs a modem NC machining center representing a $250,000 investment. Obviously, the time on the automated machine should be valued at a higher rate. If differences between rates of different production machines are not recognized, manufacturing costs will not be accurately measured by the overhead rate structure. To overcome this difficulty, it is appropriate to divide production costs (excluding raw materials) into two components: direct labor and machine cost. Associated with each will be the applicable factory overhead. These cost components will apply not to the aggregate factory operations but to individual production work centers. A work center would typically be one worker-machine system or a small group of machines plus the labor to operate them. The direct labor cost consists of the wages paid to operate the work center. The applicable factory overhead allocated to direct labor might include fringe benefits and line supervision. These are factory expense items which are appropriately charged as direct labor overhead. The machine cost is the capital cost of the machine apportioned over the life of the asset at the appropriate rate of return used by the fir&. This provides an annual cost that may be expressed as an hourly rate (or any other time unit) by dividing the annual cost by the number of hours of use per year. The machine overhead rate is based on those factory expenses which are directly applicable to the machine. These would include power for the machine, floor space, maintenance and repair expenses, and so on. In separating the applicable factory overhead items of Table 3.1 between direct labor and machine, some arbitrary judgment must be used.

EXAMPLE 3.7
The determination of an hourly rate for a given work center can best be illustrated by means of an example. Given the following: direct labor rate = $7.00/h

Production Economics
applicable labor factory overhead rate = 60% capital investment in machine = $100,000 service life = 8 years salvage value = zero applicable machine factory overhead rate = 50% rate of return used 10% The machine is operated one 8-h shift per day, 250 days per year. Determine the appropriate hourly cost for this worker-machine system.

Solution:
The labor cost per hour is $7.00(1

+ 60%) = $1 1.20lh. The machine cost must first be annualized:

=

UAC = IOO,OOO(AIP, 10%,8) 100,000(0.18744) = $18,744/yr

The number of hours per year is 8 x 250 = 2000 hrlyr. Dividing the $18,744 by 2000 gives $9.37/h. Applying the 50% overhead rate, the machine cost per hour is $9.37(1 + 50%) = $14.06/h. So the total work center rate = $1 1.20

+ $14.06

= $25.26/h

In subsequent chapters'there will be problems in which an hourly rate must be applied to a particular automated production system. Example 3.7 illustrates the general method by which this hourly rate is determined.

3.3 BREAK-EVEN ANALYSIS

Break-even analysis is a method of assessing the effect of changes in production output on costs, revenues, and profits. It is most commonly conceptualized in the form of a break-even chart. To construct the break-even chart, the manufacturing costs are divided into fixed costs and variable costs. The sum of these costs is plotted as a function of production output. To plot the total cost, the variable cost per unit change in output must be determined. Revenues can also be plotted on a break-even chart as a function of production output. Break-even analysis can be used for either of two main purposes:
1. Projit analysis. In this case the break-even chart shows the effect of changes in output on costs and revenues. This gives a picture of how profits (or losses) will vary for different output levels. The break-even point is the output level at which total costs

Break-Even Analysis

57

equal revenues and the profit is zero. An example of a break-even chart used for profit analysis is shown in Figure 3.2. 2. Production rnethod cost comparison. In this case the break-even chart shows the effect of changes in output level on the costs of two (or more) different methods of production. The break-even point for this chart is the output level at which the costs for the two production methods are equal. (When more than two production methods are plotted on the same chart, there will be a break-even point for each pair of production methods.) Figure 3.3 shows a break-even chart used for production method cost comparison. We will illustrate the two types of break-even analysis by means of two examples.

EXAMPLE 3.8
This example illustrates the use of a break-even chart for profit analysis. A manually operated production machine costs $66,063. It will have a service life of 7 years with an anticipated salvage value of $5000 at the end of its life. The machine will be used to produce one 'type of part at a rate of 20 unitslh. The annual cost to maintain the machine is $2000. A machine overhead rate of 15% is applicable to capital cost and maintenance. Labor to run the machine costs $10.00/h and the applicable overhead rate is 30%. Determine the profit break-even point if the value added is $l.OO/unit and the rate-of-return criterion is 20%.

Cost/ revenue

Profit

20,000

40,000

60,000

80,000 ~ n n & l
output

FIGURE 3.2 Profit break-even chart (see Example 3.8).

Production Economics
Costs A
-

Cost function for automated method

for
I

I
Annual output FIGURE 3.3 Production method cost break-even chart (see Example 3.9).
20,000 40,000 60,000 80,000

LI

1 I

Solution:
Let Q be the annual level. Variable cost is labor cost, including applicable overhead, divided by ptoduction rate. $lO.OO/h(l 30%) = $0.65/unit 20 pieceslh The variable cost as a function of Q is 0.65Q. The annual fixed cost is figured on the machine investment plus the maintenance. First, ignoring overhead, we have UAC = 66,063(AIP, 20%, 7)
= $19,939

+ 2000. - 5000(AIF, 20%, 7)

Adding the 15% overhead, the fixed cost = $22,930. The sum of the fixed and variable costs provides the total cost equation as a function of Q: total cost = $22,930

+ 0.65Q

Revenues as a function of Q are the product of value added per unit multiplied by Q. Revenues = $1.00Q. This is plotted in Figure 3.2. The break-even point occurs where the revenue line intersects the total cost line. To calculate the break-even point, the following equation can be set up: profit = 1.00Q - 22,930 - 0.65Q = 0

Break-Even Analysis

Q = 65,514 unitslyr At a production rate of 20 unitslh this would require 65,514120 = 3276 hlyr.

EXAMPLE 3.9
This example illustrates the cost break-even analysis. Suppose that an alternative to the manually operated production machine of Example 3.8 is available. The alternative is an automated machine, costing $125,000, but capable of a production rate of 50 unitslh. Its service life is 5 years with no salvage value at the end of that time. Annual maintenance will cost $5000. One-third of one operator costing $12.00/h will be required to run the machine. The overhead rates and rate of return used in Example 3.8 are applicable. Determine the break-even point for the automated and manual methods of production.

Solution:
C

Variable cost for the automated machine is ($12.00/h)(1/3)(1 + 30%) = 50 pieceslh

104,unit

Fixed cost is the capital cost plus maintenance, with machine overhead added.

Total cost is variable cost plus fixed cost: total cost = 53,820

+ 0.104Q

The total cost functions for the two production methods are plotted in Figure 3.3. The break-even point is represented by the intersection point for the two methods. Setting the two total cost equations equal yields 53,820

+ 0.104Q

= 22,930

+ 0.65Q

53,820 - 22,930 = 0.65Q - 0.104Q 30,890 = 0.546Q Q = 56,575 unitslyr For the manual method, this corresponds to 2829 h of production per year, and for the automated method this quantity would require 1131.5 h of operation per year. Just to complete the example, let us compute the profit break-even point for the automated method given that the value added per unit is $1.00. profit = 1.00Q - 53,820

- 0.104Q

= 0

Production Economics

This would require 1201.3 h of operation per year.

3.4 UNIT COST OF PRODUCTION

In Examples 3.8 and 3.9, one of the complications in the problems was the difference in production rates for the two alternatives. The automated method outproduced the manual method, which is often the case in comparing automation against manual production. To help decide between the alternatives, it is often useful to determine the unit cost of production for the two (or more) methods under consideration. The unit cost for a certain operation is the total cost of production divided by the number of units produced. The total cost of production includes both fixed and variable costs. Accordingly, because of the fixed portion of the cost of production, the unit cost will vary as a function of annual output' Q. As the annual output increases, the unit cost decreases. Using the manual production method from Example 3.8 to illustrate, dividing the total cost equation by the quantity Q, we get the unit cost equation, which we will symbolize by C,, (cost per piece):

Similarly, the unit production cost for the automated method of Example 3.9 is given by

C,,. = 0.104

53,820 +-

The two relationships are plotted as a function of Q in Figure 3.4. Note that the unit costs are equal at the previously determined break-even point of Example 3.9 (56,575 units per year). In subsequent chapters we will sometimes use the unit cost as a measure of performance for a production system. The reader should recall that these unit costs are calculated under assumed conditions of annual cost and production rate. As indicated in Figure 3.4, the actual cost per unit of production is strongly dependent on the level of annual output. One other observation about Examples 3.8 and 3.9 is that the total cost equations for the two alternatives ignore certain practical realities that might influence how the production methods are implemented. For both methods, the number of hours of operation were calculated at the various break-even points. In the case of the manual method, the number of annual hours of operation at the profit break-even point = 3276 h. This is

Unit Cost of Production

Unit

4.00

Unit cost function for automated

for manual method

20,000

40,000

60,000

80,000 Annual
output

FIGURE 3.4 Unit cost as a function of annual output Q for the two production
methods of Examples 3.8and 3.9.

greater than the number of hours normally worked by one person per year (40lweek X 50 weekslyr = 2000 hlyr). Will the extra hours be achieved by using two machines, or by using two shifts on one machine, or by working overtime by one production worker? In each instance, there are additional costs which are not included in the total cost equation. If two machines are used, the capital cost (fixed cost) is doubled. If two shifts are used, the worker on the second shift will probably be paid at a higher rate, and there will be other additional costs if the plant does not normally operate a second shift. If overtime is used to achieve the 3276 annual hours of operation, the cost will increase, as the overtime rate is higher (typically time-and-a-half) than the regular shift rate. Problem 3.12 requires the reader to determine the total cost equation and unit cost equation for the three alternatives described here. In the case of the automated production machine, the number of hours of annual operation to reach the profit break-even point is 1201.3 h, well under 2000 hlyr. If the company operates the machine at that point or only slightly above, it will be running below capacity and the utilization will be low. In this case, the company might want to consider ways of increasing demand for the product in order to raise the machine utilization.

Production Economics

(a) Manufacturing lead time for the batch of castings. (b) Total cost to the shop of each casting when it is completed, including the holding cost. (c) Total holding cost of the batch for the time it spends in the machine shop as work-inprocess.

APPENDIX: INTEREST AND INTEREST TABLES

Basic concepts
Money is considered to possess a time value because when money is borrowed for a period of time, it is expected that the amount paid back will be greater than that which was borrowed. The difference is referred to as interest. The amount of interest is determined hy three factors: the length of time the money was borrowed, the interest rate, and whether simple interest or compound interest was used to compute the amount. To explain these factors, let us concern ourselves with the difference between simple and compound interest.

SIMPLE INTEREST. The interest rate is generally expressed in terms of an annual rate. To compute the interest for a certain amount of money borrowed for exactly 1 year, the amount is multipled by the interest rate. We can reduce this to the following formula:

where i = annual interest rate

P = principal (the starting amount)

I = interest With simple interest, when an amount of money is borrowed for a period greater than 1 year, the interest charge is determined by multiplying the yearly interest charge by the number of years: I = Pni
.

where n represents the number of years. The amount of money paid back at the end of n years can be determined from the formula

F=P

+ I = P ( l + ni)

(A3.1)

where F represents the future amount to be paid, in this case under simple interest.

COMPOUND INTEREST. With simple interest, the amount I is directly proportional to the length of time n. If interest is compounded during the length of time, the final amount F (principal plus interest) grows at a faster rate. To illustrate compound interest, consider the manner in which a savings account might grow if the interest were com-

Appendix: Interest and Interest Tables

71

pounded annually. Using an initial deposit of $1000 and an interest rate of 5%, the savings account at the end of the first year would be worth

F, = $1000(1

+ 0.05) = $1050

This amount is used to compute the interest for the second year. Thus, the savings wauld have grown by the end of the second year to

The general equation for calculating the future equivalent of some present value P can be determined by the equation

F = P(l

+ i)"

(A3.2)

In engineering economy ca?culations, compound interest is almost always used, because it reflects more accurately the time value of money.

lnterest factors
Equation (A3.2) represents one of six common interest-rate problems: the problem of computing the future worth of some present value, given the rate of return i and the number of years n. There are a total of six of these problems. They occur frequently enough that an interest factor has been defined to cover each problem. In the paragraphs below the six interest factors are described.
1 . Single-payment compound amount factor (SPCAF). This is the case we have previously considered: finding the future value F of a present sum P As the reader can deduce from Eq. (A3.2), the formula used to calculate the single-payment compound amount factor is

SPCAF = ( 1

+ i)"

(A3.3)

We shall adopt the following notation for the SPCAF, which will be easier to remember and use than the name of the factor: SPCAF = (FIP, i%, n ) (A3.4)

The terms in parentheses' can be read: Find F , given P, i, and n. This general form will be used for the interest factors that follow. 2. Single-payment present worth factor (SPPWF). This is the inverse of the previous interest problem. The SPPWF is used to compute the present worth of some future value.

72

Production Economics

SPPWF = (PIF, i%, n ) =

1 (1

+ i)"

3. Capital recovery factor (CRF). Instead of paying off a borrowed sum with a single future payment, another common method is to make uniform annual payments at the end of each of n years. The amount of each payment is figured to yield the required interest rate i. The capital recovery factor is designed specifically for this case.

CRF = (AIP, i%, n ) =

i(l
(1

+ i)"

+ i)"
- 1

where A represents the amount of the annual payment.

4 . Uniform series present worth factor (USPWF).This solves the preceding problem in reverse: finding the present value of a series of n future end-of-year equal payments.

USPWF = (PIA, i%, n ) =

I

(1

i(l

+ iln - 1 + i)"

5 . Sinkingfund factor (SFF). "Sinking fund" refers to the situation in which we want to put aside a certain sum of money at the end of each year so that after n years, the accumulated fund, with interest compounded, will be worth F . The sinking fund factor allows us to determine the amount A to be put aside each year.
a

SFF = (AIF, i%, n ) =

(1

+ i)n -

6 . Uniform series compound amountfactor (USCAF). The reverse of the preceding problem arises when it is desired to know how much money has accumulated after n years of uniform annual payments at interest rate i .
USCAF = (FIA, i%, n ) =
(1

+ i)" i

(A3.9)

TABLES INTEREST OF FACTORS. Instead of calculating the value of the interest factor needed in a given problem, values are tabulated for a wide variety of interest rates and years. In this appendix, the interest factors are given for interest rates equal to 1096, 12%, 15%, 20%, 25%, 3096, 4096, and 50%. Although this list is not nearly complete, these values cover the range of annual rates of return that seem to prevail during the period in which this book is being written.

TABLE A3.1 10% Interest Factors for Annual Compounding* Equal Payment Series Single Payment PresentCompound- Present- Compound- Sinkingfund worth worth amount amount factor factor factor factor factor T o find F To find P T o find F To find A To find P Given A Given F Given A Given P Given F P/A,i,n F/A,i,n A!F,i,n P/F,i,n F/P,i,n 1.oooo 0.9091 0.9091 1.000 1.100
1.210 1.331 1.464 1.611 1.772 1.949 2.1 44 2.358 2.594 2.853 3.138 3.452 3.798 4.177 4.595 5.054 5.560 6.1 16 6.728 7.400 8.140 8.954 9.850 10.835 11.918 13.110 14.421 15.863 17.449 19.194 21.114 23.225 25.548 28.102 45.259 72.890 117.391 189.059 304.482 490.371 789.747 12718 9 5 2048.400 3298.969 5313.023 8556.676 13780.612 0.8265 0.751 3 0.6830 0.6209 0.5645 0.5132 0.4665 0.4241 0.3856 0.3505 0.3186 6.2897 0.2633 ' 0.2394 0.21 76 0.1979 0.1799 0.1635 0.1487 0.1 351 0.1 229 0.1117 0.1015 0.0923 0.0839 0.0763 0.0694 0.0630 0.0573 0.0521 0.0474 0.0431 0.0392 0.0356 0.0221 0.0137 0.0085 0.0053 0.0033 0.0020 0.0013 0.0008 0.0005 0.0003 0.0002 0.0001 0.0001 2.100 3.310 4.641 6.105 7.71 6 9.487 11.436 13.579 15.927 18.531 21.384 24.523 27.975 31.772 35.950 40.545 45.599 51.1 59 57.275 64.003 71.403 79.543 88.497 98.347 109.182 121.100 134.210 148.631 164.494 181.943 201.1 38 222.252 245.477 271.024 4421593 718.905 1163.909 1880.591 3034.81 6 4893.707 7887.470 12708.954 20474.002 32979.690 53120.226 85556.760 137796.1 23
.

1.1 000 0.5762 0.4021 0.3155 0.2638 0.2296 0.2054 0.1875 0.1 737 0.1628 0.1 540 0.1468 0.1408 0.1 358 0.1 31 5 0.1 278 0.1247 0.121 9 0.1 196 0.1 175 0.1 156 0.1 140 0.1 126 0.1113 0.1 102 0.1 092 0.1083 0.1075 0.1067 0.1061 0.1055 0.1050 0.1045 0.1041 0.1037 03023 0.1014 0.1009 0.1005 0.1003 0.1 002 0.1001 0.1001 0.1001 0.1 000 0.1000 0.1 000 0.1000

Capitalrecovery factor T o find A Given P A/P,i,n

Uniform gradientseries factor T o find A Given G A/G,i,n

0.0000 0.4762 0.9366 1.3812 1.8101 2.2236 2.621 6 3.0045 3.3724 3.7255 4.0641 4.3884 4.6988 4.9955 5.2789 5.5493 5.8071 6.0526 6.2861 6.5081 6.7189 6.9189 7.1 085 7.2881 7.4580 7.61 87 7.7704 7.91 37 8.0489 8.1762 8.2962 8.4091 8.51 52 8.6149 8.7086 9.0962 9.3741 9.5704 9.7075 9.8023 9.8672 9.91 13 9.9410 9.9609 9.9742 9.9631 9.9889 9.9928

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 40 45 50 55 60 65 70 75 80 85 90 95 100

0.4762 0.3021 0.21 55 0.1 638 0.1 296 0.1054 0.0875 0.0737 0.0628 0.0540 0.0468 0.0408 0.0358 0.031 5 0.0278 0.0247 0.021 9 0.01 96 0.0175 0.01 56 0.0140 0.0126 0.01 13 0.0102 0.0092 . 0.0083 0.0075 0.0067 0.0061 0.0055 0.0050 0.0045 0.0041 0.0037 0.0023 0.0014 0.0009 0.0005 0.0003 0.0002 0.0001 0.0001 0,0001 0.0000 0.0000 0.0000 0.0000

1.7355 2.4869 3.1699 3.7908 4.3553 4.8684 5.3349 5.7590 6.1446 6.4951 6.8137 7.1 034 7.3667 7.6061

. 7.8237
8.021 6 8.2014 8.3649 8.51 36 8.6487 8.771 6 8.8832 8.9848 9.0771 9.1610 9.2372 9.3066 9.3696 9.4269 9.4790 9.5264 9.5694 9.6086 9.6442 9.7791 9.8628 9.9148 9.9471 9.9672 9.9796 9.9873 9.9921 9.9951 9.9970 9.9981 9.9988 9.9993 .

'Tah1r.s are reprinted by permission from G.J . Thuesen and W. Fabrycky, Engineering Economy. 6th ed. (Englewood Cliffs, NJ: Prenricr-Hall Inc.. 1984). pp. 574-588.

74
TABLE A3.2 12% Interest Factors for Annual Compounding
r

Production Economics

Single Payment

Compoundamount factor T o find F To find P To find F Given P Given A Given F FIA, i, n P/F, n i, FIP, i, n
1.120 1.254 1.405 1.574 1.762 1.974 2.211 2.476 2.773 3.106 3.479 3.896 4.364 4.887 5.474 6.130 6.866 7.690 8.613 9.646 10.804 12.100 13.552 15.179 17.000 19.040 21.325 23.884 26.750 29.960 33.555 37.582 42.092 47.143 52.800 93.051 163.988 289.002 0.8929 0.7972 0.71 18 0.6355 0.5674 1.000 2.120 3.374 4.779 6.353 8.1 15 10.089 12.300 14.776 17.549 20.655 24.133 28.029 32.393 37.280 42.753 48.884 55.750 63.440 72.052 81.699 92.503 104.603 118.1 55 133.334 150.334 169.374 190.699 214.583 241.333 271.293 304.848 342.429 384.521 431.664

Equal Payment Series SinkingPresentfund worth factor factor To find A To find P Given F Given A AIF, i, n P / A , i, n
1.OOOO 0.4717 0.2964 0.2092 0.1 574 0.1 232 0.0991 0.0813 0.0677 0.0570 0.0484 0.0414 0.0357 0.0309 0.0268 0.0234 0.0205 0.0179 0.01 58 0.0139 0.0123 0.0108 0.0096 0.0085 0.0075 0.0067 0.0059 0.0053 0.0047 0.0042 0.0037 0.0033 0.0029 0.0026 0.0023 0.0013 0.0007 0.0004 0.8929 1.6901 2.4018 3.0374 3.6048 4.1114 4.5638 4.9676 5.3283 '5.6502 5.9377 6.1944 6.4236 6.6282 6.8109 6.9740 7.1196 7.2497 7.3658 7.4695 7.5620 7.6447 7.7184 7.7843 7.8431 7.8957 7.9426 7.9844 8.0218 8.0551 8.0850 &I116 8.1 354 8.1 566 8.1755 8.2438 8.2825 8.3045
.

Capitalrecovery factor T o find A Given P AIP, i, n

1. I 200 0.5917 0.41 64 0.3292 0.2774 0.2432 0.2191 0.201 3 0.1877 0.1 770 0.1 684 0.1 61 4 0.1 557 0.1509 0.1468 0.1434 0.1405 0.1379 0.1358 0.1339 0.1323 0.1308 0.1296 0.1 285 0.1 275 0.1 267 0.1 259 0.1 253 0.1 247 0.1242 0 1237 0.1233 0.1 229 0.1 226 0.1 223 0.1 21 3 0.1 207 0.1 204

Uniform gradientseries factor To find A Given G AIG, i, n

0.0000 0.471 7 0.9246 1.3589 1.7746 2.1721 2.551 5 2.9132 3.2574 3.5847 3.8953 4.1897 4.4683 4.7317 4.9803 ,5.2147 5.4353 5.6427 5.8375 6.0202 6.1913 6.3514 6.501 0 6.6407 6.7708 6.8921 7.0049 7.1098 7.2071 7.2974 7.381 1 7.4586 7.5303 7.5965 7.6577 7.8988 8.0572 8.1 597

1 2 3 4 5 6

7
8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 40 45 50

0.5066 0.4524 0.4039 0.3606 0.3220 0.2875 0.2567 0.2292 0.2046 0.1 827 0.1 631 0.1 457 0.1 300 0.1 161 0.1037 0.0926 0.0827 0.0738 0.0659 0.0588 0.0525 0.0469 0.041 9 0.0374 0.0334 0.0298 0.0266 0.0238 0.0212 0.0189 0.0108 0.0061 0.0035

767.091 1358.230 2400.01 8

Appendix: Interest and Interest Tables

75

TABLE A3.3 15% Interest Factors for Annual Compounding

Equal Payment Series Single Payment I~ompound-1 SinkingPresentomp pound-1 Presentamount fund worth worth amount factor factor factor factor factor T o find F To find P To find F T o find A To find P Given F Given A Given F Given A Given P F/P, i, n P/A, i, n P/F,i,n F/A,i,n AIF, i, n

Capital-

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 40 45

1.150 1.323 1.521 1.749 2.01 1 2.31 3 2.660 3.059 3.518 4.046 4.652 5.350 6.1 53 7.076 8.1 37 9.358 10.761 12.375 14.232 16.367 18.822 21.645 24.891 28.625 32.91 9 37.857 43.535 50.066 57.575 66.21 2 76.144 87.565 100.700 11 5.805 133.1 76 267.864 538.769 1083.657

0.8696 0.7562 0.6575 0.5718 0.4972 0.4323 0.3759 0.3269 0.2843 0.2472 0.21 50 0.1 869 0.1 625 0.1 41 3 0.1 229 0.1 069 0.0929 0.0808 0.0703 0.061 1 0.0531 0.0462 0.0402 0.0349 0.0304 0.0264 0.0230 0.0200 0.01 74 0.01 51 0.01 31 0.01 14 0.0099 0.0086 0.0075 0.0037 0.001 9 0.0009

1.000 2.1 50 3.473 4.993 6.742 8.754 11.067 13.727 16.786 20.304 24.349 29.002 34.352 40.505 47.580 55.71 7 65.075 75.836 88.212 102.444 118.810 137.632 159.276 184.1 68 21 2.793 245.71 2 283.569 327.1 04 377.1 70 434.745 500.957 577.1 00 664.666 765.365 881.1 70 1779.090 3585.1 28 721 7.716

1.OOOO 0.4651 0.2880 '0.2003 0.1 483 0.1 142 0.0904 0.0729 0.0596 0.0493 0.041 1 0.0345 0.0291 0.0247 0.021 0 0.018 0 0.0154 0.01 32 0.01 13 0.0098 0.0084 0.0073 0.0063 0.0054 0.0047 0.0041 0.0035 0.0031 0.0027 0.0023 0.0020 0.0017 0.001 5 0.0013 0.001 1 0.0006 0.0003 0.0002

0.8696 1.6257 2.2832 2.8550 3.3522 3.7845 4.1 604 4.4873 4.7716 5.0188 5.2337 5.4206 5.5832 5.7245 5.8474 5.9542 6.0472 6.1280 6.1 982 6.2593 6.31 25 6.3587 6.3988 6.4338 6.4642 6.4906 6.5135 6.5335 6.5509 6.5660 6.5791 6.5905 6.6005 6.6091 6.61 66 6.6418 6.6543 6.6605

60

Production Economics
TABLE A3.4 20% Interest Factors for Annual Compounding

Appendix: Interest and Interest Tables

TABLE A3.5 25% Interest Factors for Annual Compounding

Production Economics
TABLE A3.6 30% Interest Factors for Annual Compounding

Appendix: Interest and Interest Tables

TABLE A3.7 40% Interest Factors for Annual Compounding

80
TABLE A3.8 50% Interest Factors for Annual Compounding

Production Economics

Single Payment Compoundamount factor To find F Given P F/P, n i,

1 2 3 4 5 6 7 8 9 10 11 12. 13 14 15 16 17 18 19 20 21 22 23 24 25 7.500 2.250 3.375 5.063 7.594 11.391 17.086 25.629 38.443 57.665 86.498 129.746 194.620 291.929 437.894 656.841 985.261 1477.891 2216.837 3325.256 4987.882 7481.824 !1222.730 16834.1 00 25251.160

Equal Payment Series Compoundamount factor To find F Given A F/A, n i,

1.000 2.500 4.750 8.125 13.188 20.781 32.172 49.258 74.887 113.330 170.995 257.493 387.239 581.858 873.788 1311.681 1968.522 2953.783 4431.671 6648.51 1 9973.765 14961.640 22443.470 33666.21 0 50500.330

Presentworth factor To find P Given F

Sinkingfund factor To find A Given F AIF,i, n

1.0000 0.4000 0.2106 0.1231 0.0759

Presentworth factor To find P Given A P/A,i, n

0.6667 1.1112 1.4075 1.6050 1.7367 1.8245 1.8830 1.9220 1.9480 1.9654 1.9769 1.9846 1.9898 1.9932 1.9955 1.9970 1.9980 1.9987 1.9991 1.9994 1.9996 1.9998 1.9999 1.9999 2.0000

Capitalrecovery factor To find A Given P A/P,i, n

1.5000 0.9001 0.7106 0.6231 0.5759 0.5482 0.531 1 0.5204 0.51 34 0.5089 0.5059 0.5039 0.5026 0.501 8 0.5012
i

Uniform gradientseries factor To find ;4 Given G AIG,i, n

0.0001 0.4001 0.7369 1.01 54 1.2418 1.4226 1.5649 1.6752 1.7597 1.8236 1.8714 1.go68 1.9329 1.951 9 1.9657 1.9757 1.9828 1.9879 1.991 5 1.9940 1.9958 1.9971 1.9980 1.9986 1.9991

P/F, n i,
0.6667 0.4445 0.2963 0.1976 0.1317 0.0878 0.0586 0.0391 0.0261 0.01 74 0.01 16 0.0078 0.0052 0.0035 0.0023 0.0016 0.001 1 0.0007 0.0005 0.0004 0.0003 0.0002 0.0001 0.0001 0.0001

0.0482 0.0311 0.0204 0.01 34 0.0089 0.0059 0.0039 0.0026 0.001 8 0.0014 0.0008 0.0006 0.0004 0.0003 0.0002 0.0002 0.0001 0.0001 0.0001 0.0001

0.5008 0.5006 0.5004 0.5003 0.5002 0.5002 0.5001 0.5001 0.5001 0.5001

,.

COMMENTS THE USEOF THE INTEREST FACTORS. In using the interest factors, ON we must be clear as to when the various cash flow transactions represented by P, F, and A .occur during the year. The present worth.transaction, P, occurs at the beginning of the year. F and A transactions are assumed to be end-of-year cash flows. Our definitions of the six interest factors were based on 1-year intervals or periods. Actually, interest can be compounded more frequently than annually. Savings accounts are often compounded quarterly. The foregoing interest factors can be adapted to periods other than annual periods. However, for our purposes it will be sufficient and convenient to maintain the annual compounding convention.