15-Apr-24

ENGINEERING ECONOMICS 2

-Time Value of Money

-Development of Cash Flow
Diagrams
- Net Present Value Analysis
1 (CE423)
DR. ABDUL QAYOOM
B.E (CIVIL)
M.E (CONSTRUCTION MANAGEMENT)
PhD (CONSTRUCTION ENGINEERING & INFRASTRUCTURE MANAGEMENT)
NEBOSH IGC, IOSH, HABC Lev2 Award Fire Safety © Abdul Qayoom © Abdul Qayoom

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Fundamental Principle of Engineering Economics Fundamental Principle of Engineering Economics

 The relationship between money and time leads to the concept of  Engineering economic investment studies involve huge capital for
time value of money. longer period of time. So, the effect of time value of money should
 A rupee or dollar in hand is worth more than a rupee or dollar be considered in the analysis.
received ‘N’ years from now.  Money can earn an interest for a period of time. Interest represents
 Money has time value because the purchasing power of money as the earning power of money. Therefore, both purchasing power and
well as the earning power of money changes with time. earning power of money should be considered while considering
 During inflation, purchasing power of money decreases over time. the time value of money.

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Simple Interest Simple Interest

When the interest earned or charged is directly proportional to the If 1000 Rs are invested today @ 10% pa simple interest, what is the total
initial investment or principal amount (P), the interest rate (i), and amount accumulated after 1yr, 2yrs, and 5yrs
number of interest period (N), the interest (I) and the interest rate is
said to be simple interest and simple interest rate. Interest = 0.10 × 1000 = 100 pa
Total amount =Principal + Interest
After 1yr = 1000 + 100 = 1100 Rs
After 2 yrs = 1000 + 100 + 100 =1200 Rs
After 5 yrs = 1000 + (100× 5) =1500 Rs

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Compound Interest Compound Interest

When the interest charge for any interest period (a year) is based on If 1000 Rs are invested today @ 10% pa compound interest, what is the
the remaining principal amount plus any accumulated interest total amount accumulated after 1yr, 2yrs, and 5yrs
charges up the beginning of that period, the interest is said to the Interest = 0.10 × 1000 = 100 pa
compound. Total amount =Principal + Interest
After 1yr = 1000 + 100 = 1100 Rs
After 2 yrs = 1100 + 10 %(1100) =1210 Rs
After 3 yrs = 1210 + 10 %(1210) =1331 Rs
After 4 yrs = 1331 + 10 %(1331) =1464 Rs

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After 5 yrs = 1464 + 10 %(1464) =1610 Rs © Abdul Qayoom

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CASH FLOW: The actual rupees or dollar coming into or out of the CASH OUTFLOW OR NEGATIVE CASH FLOW: Actual rupee or dollar paid
treasure of a firm. A cash flow occurs when money is transferred from out by a firm. i.e. expenditures or payment.
one organization or individual to other. Thus, cash flow represents the
economic effects of an alternative in terms of money spend or NET CASH FLOW: Difference between total cash inflows (receipts) and
received. the total cash outflows for a specified period of time. e.g. one year.

CASH INFLOW OR POSITIVE CASH FLOW: Actual rupee or dollar coming

into firm. i.e. receipts or incomes.

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 Horizontal line in a cash flow diagram is a time scale with

progression of time moving from left to right.
 The period (or year) labels are applied to the intervals of time rather
than points on the tie scale. The end of the period 2 is coincident
with beginning of period 3.
 The arrows signify cash flows. Cash outflows are represented by
downward arrows and Cash inflows are represented by upward
arrows.

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Single Cash Flows
Future Worth
 Cash flow diagram is dependent on point of view. If a lender lends
A present sum P invested now for N interest periods at interest rate i%
Rs. 25,000. (it is cash outflows for him) and at the end of 4 years,
per period. Its future worth F would be
receives compound interest plus his principal Rs. 11,713 at 10%
interest rate per annum (it is cash inflow for him).
 If the directions of arrows are reversed, diagram would be from F = P * (1 + i)N
borrower's point of view.

The factor (1 + i)N is termed as Single Payment Compound Amount

Factor.
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Single Cash Flows Single Cash Flows
Future Worth Future Worth
We may also express that factor in functional notation as EXAMPLE: If you invest Rs.10,000 now for 10 years at 10% per annum,
how much would it be worth at the end of 10 years?
(F/P, i, N), which is read as "Find F, given P, i, and N."

F = P * (1 + i)N = 10,000 * (1 + 0.1)10 = Rs.25,937

It is expressed as

Alternately, F = P * (F/P, i, N) = 10,000 * (P/F, 10, 10) = 10,000 * (2.5937)

F = P * (1 + i)N = P * (F/P, i, N) = Rs.25,937

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Single Cash Flows Single Cash Flows
Present Worth Present Worth

Finding the present worth of a future sum is simply the reverse of EXAMPLE: An investor wants to purchase a land that will worth Rs.
compounding and is known as the discounting process. 100,000,000 in 6 years. If the land value increases 8% each year, how
much should invest now?

P = F / (1 + i)N = F * (P/F, i, N) P = F * (1 + i)-N = Rs. 100,000,000 * (1 + 0.0.8)-10

= Rs. 60,000,302
Alternately,
The factor (1 + i)-N is known as the single payment present worth factor
P = P * (P/F, i, N) = 100,000,000 *(P/F, 8%, 6) = 100,000,000 * (0.6302) =
and is designate as (P/F, i, N). The interest rate i is also known as
Rs.60,000,302
discount rate and the P/F, i, N factor is termed as discounting factor.
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Uneven Payment Series Uneven Payment Series

Future worth of any uneven series of payments can be calculated by

the future worth of each individual payment and summing the results.
i=10%

EXAMPLE: Find FW & PW of the following cashflow:

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Uneven Payment Series Uniform Series @ Regular Intervals

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Uniform Series @ Regular Intervals Uniform Series @ Regular Intervals

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Practice Problems Practice Problems

1. While in college Ellen received $10,000 in student 2. Suppose you wanted to buy a $100,000 house. You have

loans at 5% interest. She will graduate in June and is $20,000 cash to use as the down payment. The bank offers
to loan you the remainder at 6% nominal interest. The term
expected to begin repaying the loans in either 5 or
of the loan is 20 years. Compute your monthly loan
10 equal annual payments. Compute her yearly
payment assuming the payment is the same for all months.
payments for both repayment plans.

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Practice Problems Practice Problems

3. Lester Peabody decides to install a fuel storage system for his farm 4. The local loan shark has loaned you $1000. The interest rate you
that will save him an estimated 6.5 cents/gallon on his fuel cost. He must pay is 20%, compounded monthly. The loan will be repaid by
uses an estimated 20,000 gallons/year on his farm. Initial cost of the making 24 equal monthly payments. What is the amount of each
system is $10,000 and the annual maintenance is a uniform gradient monthly payment?
amount of $25. After a period of 10 years the estimated salvage is
$3,000. If money is worth 12%, is it a wise investment?

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29 QUESTIONS

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