CHE4613 Tutorial 1 - Solution

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Engineering Economics Tutorial Set 1: Time Value of Money

1.

Trucking giant Yellow Corp agreed to purchase rival Roadway from $966million in order to reduce socalled back-office costs by $45 million per year. If the saving were realized as planned, what would be
the rate of return on the investment? [answer = 4.65%]

Solution:
Rate of return = (45/966)(100)
= 4.65% per year
2.

A publicly traded construction company reported that it just paid off a loan that it received 1 year
earlier. If the total amount of money the company paid was $1.6million, and the interest rate on the loan
was 10% per year, how much money did the company borrow 1 year ago? [answer = $1,454,545]

Solution:
P + P(0.10)
1.1P
P
3.

A start-up chemical company has established a goal of making at least a 35% per year rate of return on
its investment. It the company acquired $50 million in venture capital, how much did it have to earn in
the first year? [answer = $17.5million]

Solution:
Earnings

4.

= 1,600,000
= 1,600,000
= $1,454,545

= 50,000,000(0.35)
= $17,500,000

A medium-size consulting engineering firm is trying to decide whether it should replace its office
furniture now or wait and do it 1 year from now. If it waits 1 year, the cost is expected to be $16,000. At
an interest rate of 10% per year, what would be the equivalent cost now? [Answer = $14,545]

Solution:
Equivalent cost now:

5.

P + 0.1P
1.1P
P

= 16,000
= 16,000
= $14,545.45

At what interest rate would $100,000 now be equivalent to $80,000 one year ago? [Answer: i = 25%]

Solution:
80,000 + 80,000(i) = 100,000
i = 25%
6.

A local bank is offering to pay compound interest of 7% per year on new savings accounts. An e-bank if
offering 7.5% per year simple interest on a 5-year certificate of deposit. Which offer is more attractive
to a company that wants to set aside $1,000,000 now for a plant expansion 5 years from now? [Answer
= local bank]

Solution:
Compound amount in 5 years
Simple amount in 5 years

= 1,000,000(1 + 0.07)5
= $1,402,552
= 1,000,000 + 1,000,000(0.075)(5)
= $1,375,000

Local bank offer is better by $27,552

CHE4613 Tutorial 1 - Solution

7.

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Badger pump company invested RM500,000 five years ago in a new product line that is now worth
RM1,000,000. What rate of return did the company earn (a) on a simple interest basis and (b) on a
compound interest basis? [Answer: (a) i=20%/year; (b) i=14.87%/year]

Solution:
Simple:
1,000,000 = 500,000 + 500,000(i)(5)
i = 20% per year
Compound:
1,000,000 = 500,000(1 + i)5
(1 + i)5 = 2.0000
(1 + i) = (2.0000)0.2
i = 14.87% per year
8.

Company frequently borrow money under an arrangement that requires them to make periodic
payments of only interest and then pay the principal of the loan all at once. A company that
manufactures odor control chemicals borrowed $400,000 for 3 years at 10% per year compound interest
under such an arrangement. What is the difference in the total amount paid between this arrangement
(identified as plan 1) and plan 2, in which the company makes no interest payments until the loan is due
and then pays it off in one lump sum? [Answer: Difference paid = $12,400]

Solution:
Plan 1: Interest paid each year = 400,000(0.10)
= $40,000
Total paid
= 40,000(3) + 400,000
= $520,000
Plan 2: Total due after 3 years = 400,000(1 + 0.10)3
= $532,400
Difference paid = $532,400 $520,000
= $12,400
9.

Five separate projects have calculated rate of return of 8, 11, 12.4, 14 and 19%. An engineer wants to
know which project to accept on the basis of rate of return. She learns from the finance department that
company funds, which have a cost of capital of 18% per year, are commonly used to fund 25% of all
capital projects. Later, she was told that borrowed money is currently costing 10% per year. if the
MARR is established at exactly the weighted average cost of capital, which projects should she accept?
[Answer: 12.4%, 14% and 19%]

Solution:
WACC = (0.25)(0.18) + (0.75)(0.10) = 12%
Therefore, MARR = 12%
Select the last three projects: 12.4%, 14%, and 19%

10. Construct a cash flow diagram for the following cash flows: $10,000 outflow at time zero, $3000 per
year outflow in year 1 through 3, and $9000 inflow in years 4-8 at an interest rate of 10% per year, and
an unknown future amount in year 8.
F= ?

Solution:

i = 10% per year

A2 = $9000
0

3
4

A1 = $3000
P = $10,000

CHE4613 Tutorial 1 - Solution

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11. For a company that uses a year as its interest period, determine the net cash flow that will be recorded at
the end of the year from the cash flows shown.
Month
Receipts, RM1000 Disbursements, RM1000
Jan
500
300
Feb
800
500
March
200
400
April
120
400
May
600
500
June
900
600
July
800
300
August
700
300
September
900
500
October
500
400
November
400
400
December
1800
700
Solution:
Month
Jan
Feb
March
April
May
June
July
August
September
October
November
December
Total

Receipts,
RM1000
500
800
200
120
600
900
800
700
900
500
400
1800
8220

Net cash flow for the year

2920

Disbursements,
RM1000
300
500
400
400
500
600
300
300
500
400
400
700
5300

NET CASH FLOW = RM 2,920,000

12. Use the rule of 72 to estimate the time it would take for an initial investment of $10,000 to accumulate
to $20,000 at a compound rate of 8% per year. [Answer: n = 9 years]
Solution:
n = 72/8 = 9 years
13. If you now have $62,500 in your retirement account, and you want to retire when the account is worth
$2million, estimate the rate of return that the account must earn if you want to retire in 20 years without
adding any more money to the account. Use rule 72. [Answer: 18% per year]
Solution:
Account must double in value five times to go from $62,500 to $2,000,000 in 20 years. Therefore, account
must double every 20/5 = 4 years.
Required rate of return = 72/4 = 18% per year