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Dr. Karim
C a s h
F l o w
costs
or
revenues
in
projects
financial records.
Engineering projects generally have economic
consequences that occur over an extended
period of time
For example, if an expensive piece of machinery is
installed in a plant were brought on credit, the simple
process of paying for it may take several years
The resulting favorable consequences may last as
long as the equipment performs its useful function
services
Overhaul: major capital expenditure that occurs during the
horizontal
line,
divided
into
Cash-Flow DiagramExample
A grass mower will cost $600. Maintenance costs are
expected to be $180 per year. Income from mowing
grass is expected to be $720 a year. The salvage value
after 3 years is expected to be $175.
OR
+$540 +$540
+$715
+
$175
-$180 -$180 -$180
-$600
-$600
Cash-Flow DiagramPerspective
+$5,300
-$5,300
Borrowers Perspective
-$5,000
Lenders Perspective
Interest
Because of the time value of money, whenever
money is loaned, the lender expects to get back
the money loaned plus interest.
Interest is the price paid for the use of borrowed
money.
As with any financial transaction, interest is either
something you pay (a disbursement) or something
you earn (a receipt) depending on whether you
are doing the borrowing or the lending.
Interest Rate
Interest rate Interest paid over a time
period expressed as a percentage of
principal:
Interest rate
Interest paid
Rate of return
Interest earned
Types of Interest
Simple Interest
Interest paid (earned) on only the
original amount, or principal,
borrowed (lent).
Compound Interest
Interest paid (earned) on any previous
interest earned, as well as on the
principal borrowed (lent).
you
choose.
Therefore,
these
Economic
equivalence
combination of
is
interest rate
and
to determine
amount
is
known
as
SI = P0(i)(n)
Simple Interest
Deposit today (t=0)
= P0(i)(n)
SI
$1,000(.07)(2)
=
= $140
Single-Payment Compound-Amount
Single
Single Deposit
Deposit Future
Future Value
Value
(Compound
(Compound Interest)
Interest)
FV1 = P0(1+i)1
FV2 = P0(1+i)2
etc ..
Accordingly,
FV2
= $1,000 (FVIF7%,2)
= $1,000 (1.145)
= $1,145 [Due to Rounding]
Table I: FVIFi,n
Project Example
We are considering a project that will require a $300,000
investment. A viable alternative that must be considered
is to do nothing and bank the money that would have
been invested in the project. What is the value of
$300,000 after 8 years assuming an interest rate of 6%?
In shorthand notation:
Using the formula derived earlier:
FVn = P0 (1+i)n = $300,000 * (1+.06)8 = $478,154
If our 8 year project is expected to return less
than $478,140 (and there arent any intangibles
Single-Payment Present-Worth
How much do we
need to invest today in
order to have a certain
known sum in the future
, assuming an interest
rate of (i)%?
Uniform Series
Equivalence
The previous formulas dealt with the
time value of one-time payments.
The next formulas deal with the time
value of a series of equal payments
(A n n u i t i e s ).
Examples of Annuities
Equal-Payment-Series CompoundAmount
Va
Vallu
ua
attiio
on
n U
Ussiin
ng
g Ta
Tab
blle
e IIIIII
Solution
We have,
Periodic Payment
Number of Periods
Interest Rate
Future Value
=
R = $700
n = 12
i = 9%/12 = 0.75%
FV = $700 {(1+0.75%)^12-1}/1%
$700 {1.0075^12-1}/0.01
$700 (1.0938069-1)/0.01
$700 0.0938069/0.01
$700 9.38069
$6,566.48
](1+i) = R (FVIFAi
Where:
iis the interest rate per compounding
period;
nare the number of compounding
periods; and
Ris the fixed periodic payment.
Solution
Periodic Payment
R = $1,000
Number of Periods n = 12
Interest Rate
Future Value
(1+1.1%)
i = 1.1%
= $1,000 {(1+1.1%)^12-1}/1.1%
= $1,000 {1.011^12-1}/0.011
(1+0.011)
=
Equal-Payment-Series SinkingFund
How much we need to set
V
Va
a ll u
ua
a tt ii o
on
n U
U ss ii n
ng
g Ta
Ta b
b ll e
e II V
V
Present Value of an Ordinary Annuity =
PVAn
RX
= R (PVIFAi%,n)
PVA3
= $1,000 (PVIFA7%,3)
=
$1,000 (2.624)
= $2,624
Where,
iis the interest rate per compounding period;
nare the number of compounding periods;
and
Ris the fixed periodic payment.
Ta b l e I V: (PVIFAi%,n)
R = $500
n = 12
i = 12%/12 = 1%
PV = $500 (1-(1+1%)^(-12))/1%
= $500 (1-1.01^-12)/1%
$500 (1-0.88745)/1%
$500 0.11255/1%
$500 11.255
$5,627.54
V
Va
a ll u
ua
a tt ii o
on
n U
U ss ii n
ng
g Ta
Ta b
b ll e
e II V
V
Present Value of an Annuity Due =
RX
PVADn = R (PVIFAi%,n)(1+i)
PVAD3 = $1,000 (PVIFA7%,3)(1.07)
= $1,000 (2.624)(1.07)
= $2,808
Where,
iis the interest rate per compounding period;
nare the number of compounding periods;
and
Ris the fixed periodic payment.
Ta b l e I V: (PVIFAi%,n)
Solution
Periodic Payment
R = $1,000
Number of Periods
n = 12
Interest Rate
i = 13.2%/12 = 1.1%
Original Investment
= PV of annuity due on Jan 1, 2010
= $1,000 (1-(1+1.1%)^(-12))/1.1%
(1+1.1%)
= $1,000 (1-1.011^-12)/0.011 1.011
$1,000 (1-0.876973)/0.011 1.011
$1,000 0.123027/0.011 1.011
$1,000 11.184289 1.011
$11,307.32
Example: Equal-Payment-Series
Capital Recovery
= $1000 (A/P,10%,4) =
$315.47