Engineering Economy

Department of Civil Engineering

Parahyangan Catholic University

September 2011

(3 & 4)
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Review..
Simple Interest
I = P.n.i
T=P+I
T = P (1 + n.i)

Compound Interest
T = P (1+i)n

Simple and Compound Exercises (Contd)

1.

In order to build a new warehouse facility, the regional

distributor for Valco Multi-Position Valves borrowed $1.6
million at 10% per year simple interest. If the company
repaid the loan in a lump sum amount after 2 years, what
was (a) the amount of the payment, and (b) the amount of
interest?

2.

Two years ago,ASARCO, Inc. invested $580,000 in a

certicate of deposit that paid simple interest of 9% per
year. Now the company plans to invest the total amount
accrued in another certificate that pays 9% per year
compound interest. How much will the new certicate be
worth 2 years from now?

3.

If $4000 is invested at an annual rate of 6.0% compounded

monthly, what will be the final value of the investment
after 10 years?

Terminology & Symbol

Example:

HP borrowed money to do rapid prototyping for a new

ruggedized computer that targets desert oil eld conditions.
The loan is $1 million for 3 years at 5% per year compount
interest. How much money will HP repay at the end of 3
years?
A new college graduate has a job with Boeing Aerospace. She
plans to borrow $10,000 now to help in buying a car. She has
arranged to repay the entire principal plus 8% per year
interest after 5 years.
ANY SIMILARITY??
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Terminology & Symbol

P = value or amount of money at a time designated as the present or time
(0). Also, P is referred to as present worth (PW), present value (PV), net
present value (NPV), discounted cash flow (DCF), and capitalized cost (CC);
F = value or amount of money at some future time. Also, F is called future
worth (FW) and future value (FV);
A = series of consecutive, equal, end-of-period amounts of money. Also, A
is called the annual worth (AW) and equivalent uniform annual worth
(EUAW); per year, per month;
n = number of interest periods; years, months, days

i = interest rate or rate of return per time period; percent per year,
percent per month, percent per day
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Cash Flow
Cash ows are inows and outows of money.
Cash ows occur during specied periods of time, such as 1 month or 1
year
May be estimates or observed values.
Cash ow estimates are just that estimates about an uncertain future.

( Leland Blank, Anthony Tarquin, 2008)

Cash Flow
Cash ows normally take place at varying times within an interest period,
a simplifying end-of-period assumption is made.
The end-of-period convention means that all cash ows are assumed to
occur at the end of an interest period.
End of the period means end of interest period, not end of calendar year.

So, If the deposit took place on July 1, 2008, and the withdrawals will take
place on July 1 of each succeeding year for 10 years.
( Leland Blank, Anthony Tarquin, 2008)

Cash Flow Diagram (CFD)

It is a graphical representation of cash ows drawn on a time
scale.
Cash ow diagram time t=0 is the present, and t=1 is the end
of time period 1.
Beginning of
Year 1

End of
Year 1

Since the end-of-year convention places cash ows at the

ends of years, the 1 marks the end of year 1.
( Leland Blank, Anthony Tarquin, 2008)

Cash Flow Diagram (CFD)

The direction of the arrows on the cash ow diagram is important.

A vertical arrow pointing up indicates a positive cash ow; an arrow

pointing down indicates a negative cash ow.

It is not necessary to use an exact scale on the cash ow diagram

( Leland Blank, Anthony Tarquin, 2008)

Cash Flow Diagram (CFD)

Example:

A new college graduate has a job with Boeing

Aerospace. She plans to borrow $10,000 now to help
in buying a car. She has arranged to repay the entire
principal plus 8% per year interest after 5 years.

( Leland Blank, Anthony Tarquin, 2008)

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Cash Flow Diagram (CFD)

Exercise:
Each year Exxon-Mobil expends large amounts of funds for mechanical
safety features throughout its worldwide operations. Carla Ramos, a lead
engineer for Mexico and Central American operations , plans
expenditures of $1 million now and each of the next 4 years jus t for the
improvement of eld-bas ed pressure-release valves. Construct the cash
ow diagram to nd the equivalent value of these expenditures at the
end of year 4, us ing a cos t of capital estimate for safety-related funds of
12% per year.

( Leland Blank, Anthony Tarquin, 2008)

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Cash Flow Diagram (CFD)

Exercise:
A father wants to deposit an unknown lump-sum amount into an
investment opportunity 2 years from now that is large enough to
withdraw $4000 per year for state university tuition for 5 years starting 3
years from now. If the rate of return is estimated to be 15.5% per year,
construct the cash ow diagram.

( Leland Blank, Anthony Tarquin, 2008)

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Cash Flow Diagram (CFD)

Exercise:
Before evaluating the economic merits of a proposed investment, the XYZ
Corporation insists that its engineers develop a cash flow diagram of the
proposal. An investment of $10,000 can be made that will produce
uniform annual revenue of $5,310 for 5 years and then have a positive
salvage value of $2,000 at the end of year 5. Annual expenses will be
$3,000 at the end of each year for operating and maintenance the project.
DRAW A CASH FLOW DIAGRAM FOR THE 5-YEAR LIFE OF THE PROJECT.

( Leland Blank, Anthony Tarquin, 2008)

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Time & Interest on

Single Cash Flow Problem
Related to P to F or F to P cases
Separate by N periods with interest at i% per period
The Equations:
P to F

F = P(1 + i )

F to P

1 N
P = F(
)
1+ i

(1 + i)

1 N
(
)
1+ i

single-payment
singlecompound amount factor
(SPCAF)

single-payment
singlepresent worth factor
(SPPWF)

(Sullivan et al., 2008)

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Time & Interest on

Single Cash Flow Problem
Related to P to F or F to P cases
Separate by N periods with interest at i% per period
The Diagram:
P to F

F to P

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( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Single Cash Flow Problem
The Notation
Notation::

Example:

A new college graduate has a job with Boeing Aerospace. She

plans to borrow $10,000 now to help in buying a car. She has
arranged to repay the entire principal plus 8% per year interest
after 5 years.
16
( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Single Cash Flow Problem
Interest Factor Table

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( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Single Cash Flow Problem
The Notation
Notation::

Example:

An investor has an option to purchase a tract of land that will be

worth $10,000 in 6 years. If the value of the land increases at 8%
each year, how much should the investor be willing to pay now
for this property?
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( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Single Cash Flow Problem
Example:

Jamie has become more conscientious about paying off his

credit card bill promptly to reduce the amount of interest
paid. He was surprised to learn that he paid $400 in interest
in 2007 and the amounts shown in Figure below over the
previous several years. If he made his payments to avoid
interest charges, he would have these funds plus earned
interest available in the future. What is the equivalent
amount 5 years from now that Jamie could have available had
he not paid the interest penalties? Let i = 5% per year.

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( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Single Cash Flow Problem
Solution

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( Leland Blank, Anthony Tarquin, 2008)

Interest Factor Table

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Time & Interest on

Uniform Series Problem
Example:

1. How much money should you be willing to pay now for a

guaranteed $600 per year for 9 years starting next year, at a
rate of return of 16% per year?
2. Formasa Plastics has major fabrication plants in Texas and
Hong Kong. The president wants to know the equivalent
future worth of $1 million capital investments each year for
8 years, starting 1 year from now. Formasa capital earns at a
rate of 14% per year.

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( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Uniform Series Problem
Diagram

How much money should you be willing to pay now for a

guaranteed $600 per year for 9 years starting next year, at a
rate of return of 16% per year?

23
( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Uniform Series Problem
Diagram

Formasa Plastics has major fabrication plants in Texas and Hong

Kong. The president wants to know the equivalent future
worth of $1 million capital investments each year for 8 years,
starting 1 year from now. Formasa capital earns at a rate of
14% per year.

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( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Uniform Series Problem
Notation

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( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Uniform Series Problem
Notation

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( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Uniform Series Problem
The Interest Table
(Example)

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( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Uniform Series Problem
Solution
How much money should you be willing to pay now for a guaranteed $600 per year for 9 years
starting next year, at a rate of return of 16% per year?

P = 600(P/A,16%,9) = 600(4.6065) = $2763.90

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( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Uniform Series Problem
Diagram
Formasa Plastics has major fabrication plants in Texas and Hong Kong. The president wants to know the
equivalent future worth of $1 million capital investments each year for 8 years, starting 1 year from now.
Formasa capital earns at a rate of 14% per year.

F = 1000( F/A,14%,82) = 1000(13.2328) = $13,232.80

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( Leland Blank, Anthony Tarquin, 2008)

Summary on Single & Uniform Series Problem

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( Leland Blank, Anthony Tarquin, 2008)

Single and Uniform Cash Flow Problem

Exercises
1. Beckton Steel Products, a company that specializes in crankshaft
hardening, is investigating whether it should update certain
equipment now or wait and do it later. If the cost now is $180,000,
what would the equivalent amount be 3 years from now at an
interest rate of 10% per year?
2. An engineer received a bonus of $12,000 that he will invest now.
He wants to calculate the equivalent value after 24 years, when he
plans to use all the resulting money as the down payment on an
island vacation home. Assume a rate of return of 8% per year for
each of the 24 years. Find the amount he can pay down?!

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( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Single Cash Flow Problem
Exercises
3. Suppose you are offered the alternative of receiving either $3,000
at the end of five years or P dollar today. There is no questions that
the $3,000 will be paid in full (i.e., no risk). Because you have no
current need for the money, you would deposit the P dollars in an
account that pays 8% interest. What value of P would make you
indifferent to your choice between P dollar today and the promise
of $3,000 at the end of five years?
4. You have just purchased 100 shares of GE company stock at $30
per share. You will sell the stock when its market price doubles. If
you expect the stock price to increase 12% per year, how long do
you to wait before selling the stock?
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( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Single Cash Flow Problem
Exercises
5. Suppose you buy a share of stock for $10 and sell it for $20; your
profit it thus $10. If that happen within a year, your rate of return
is an impressive 100%. If it take five years, what would be the rate
of return on your investment?
6. $10 million, You save money in the bank 10 months ago. Today you
received $11,5 million. How much interest you earned?

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( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Single Cash Flow Problem
Exercises

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( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Uniform Series Problem
Exercises
7.

Wilson Technology, a growing machine shop, whishes to set aside money

now to invest over the next four years in automating its customer service
department. The company can earn 10% on a lump sum deposited now,
and its wishes to withdraw the money in the following increments:
Year 1: $25,000 to purchase a computer and database and software
designed for customer service use;
Year 2: $3,000 to purchase additional hardware to accommodate
anticipated growth in use of the systems;
Year 3: No expenses, and
Year 4: $5,000 to purchase software upgrades
How much money must be deposited now in order to cover the
anticipated payment over the next four years?

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( Leland Blank, Anthony Tarquin, 2008)

Time & Interest on

Uniform Series Problem
Exercises
8.

You want to renovate your apartment after 8 years from now. The cost at
least $100,000 will be needed. How much do you need to save each year in
order to have necessary funds if the current rate of interest is 7%? (assume
that end-of-year payments are made)

9.

Your borrowed $21,061.82 to finance the educational expenses for your

senior year of college. The loan will be paid off over five years. The loan
carries an interest rate of 6% per year and is to be repaid in equal annual
installments over the next five years. Assume that the money was borrowed
at the beginning of your senior year and that the first installment will be due
a year later. Compute the amount of the annual installments.

10. Suppose problem in number 9 that you wanted to negotiate with the bank to
defer the first loan installment until the end of year two (but still desire to
make five equal installment at 6% interest). If the bank wished to earn the
same profit as problem number 9, what should the annual installment?
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( Leland Blank, Anthony Tarquin, 2008)

it's a wrap

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