1) open the xfig program and draw your diagram
2) insert you equation into the diagram using latex command such as $\mathbf{u}$. Remember to use 'special flag' in your text. The special flag option is 'Normal' by default, you need to choose 'Special'. You can check that by looking at the window of the text editor, where you can change the size, colour, justification, choosing the option for Hidden Flag, Rigid Flag, Special Flag and etc, of the text.
3) save the file in fig format.
4) use the the program `figtex2eps' to convert the fig file to eps file by:
./figtex2eps [your diagram].fig
[your diagram].eps will be produced. You can then use epstopdf command to convert the diagram into pdf format if you want.
5) you can also use 'figtex2pdf' to convert the fig file to pdf file by:
./figtex2pdf [your diagram].fig
[your diagram].pdf will be produced.
This method is very user friendly and has no problems compared to the method such as the 'psfrag' method.