ENG233 Ch2 P
ENG233 Ch2 P
ENG233 Ch2 P
Agenda
Concepts
Time value of money
Single payment
Cash flows
Uniform series payment
Uniform infinite payments
Arithmetic gradients
Uniform payments every t period
Nominal and effective interest
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concepts
Engineering Economy: is a collection of mathematical
techniques to simplify economic comparisons
Time Value of Money: means that money has different
value tomorrow than it has today
Interest: is a measure of the increase between original sum
borrowed or invested and the final sum owed or accrued.
Interest = Total amount accumulated – Original investment
The increase over the original amount is the interest
The original investment or loan: is referred to as Principal
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concepts
Interest calculations
When interest is expressed as a percentage of the original
amount per unit time, it is called interest rate
% interest rate = (Interest per time unit/Original sum)×100%
Example: Suppose you invested LE100,000 on May 1, and
withdraw a total of EL106,000 exactly one year later.
Compute the interest and the interest rate.
Interest = LE106,000 - LE100,000 = LE6,000
Percent interest rate = (LE6,000 per year / LE100,000) ×
100% = 6% per year
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concepts
Equivalence
Equivalence is an essential factor in economic analysis
Different sums of money at different times can be equal in
value
Example: if the interest rate is 6% per year, a LE100 today
(present time) would be equivalent to LE106 one year
from today. Also, LE100 today is equivalent to LE94.34
one year ago. Therefore, LE94.34 last year, LE100 now,
and LE106 one year from now are equivalent when the
interest rate is 6% per year
concepts
Rate of Return
The rate of return is used when determining the
profitability of a proposed investment or past investment
Rate of return (RR) = (Total amount of money received –
Original investment) / Original investment × 100%
= (Profit / Original investment) × 100%
RR is used to compare between alternatives by
determining how much return each alternative could
produce.
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Time Value of Money
The value of money is dependent on the time at which it is
received
The money consequences of any alternative occur over a
long period of time, a year or more
When money consequences occur in a short period of
time, we simply add up the various sums of money But we
cannot treat money this way when the time span is longer
Which would you prefer, LE100 cash today or receiving
LE100 a year from now?
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Time Value of Money
Single Payment
The Future Value of a given present value of money
represents the amount, at some time in the future, that an
investment made today will grow if it is invested at a
specific interest rate
Simple interest: Simple interest is calculated using the
principal only, Thus, if you loan a present sum of money P
at a simple annual interest rate i for a period of n years, the
amount of interest you would receive from the loan:
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Time Value of Money
Single Payment
Compound interest: Compound interest is calculated
using the principal plus the total amount of interest
accumulated in previous periods. Thus, compound interest
means “interest on top of interest”
Example: If you borrow LE1,000 at 6% per year
compound interest, compute the total amount
owed after three year period?
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Time Value of Money
Single Payment: Compound interest
Therefore, if an amount of money P is invested at some
time t = 0, the total amount of money (F) that would be
accumulated after one year : F1 = P + Pi = P(1 + i)
At the end of the second year, the total amount (F2)
F2 = F1 + F1 i = P(1 + i) + P(1 + i)i = P(1 + i) (i +i)
F2 = P(1 + i)2
The total amount accumulated at the end of year 3 (F3)
F3 = F2 + F2 i = P(1 + i)2 + P(1 + i)2 i = P(1+ i)2 (1 + i)
F3 = P(1 + i)3
The total amount of money (F) after (n) number of years,
using compound interest (i); F = P(1 + i)n
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Time Value of Money
Single Payment: Compound interest
P = F / (1 + i)n, this equation is named
“single-payment present worth formula”
The term[1/ (1 + i)n] “single-payment present worth factor”
“وا دة د ا لا ”
This equation could be written in the functional notation as:
P = F (P/F, i, n); reads as: find a present worth sum “P” given
a future sum “F” at an interest rate “i” per period and “n”
interest periods
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Time Value of Money
Single Payment: Use of interest tables
To avoid the trouble of writing out each formula and using
calculators, a standard notation is used: (X/Y, i, n).
First letter (X) what you “Want to find”, second letter (Y)
what is “Given”. For example, F/P means “find F when given
P”. “i” is the interest rate in percent and “n” represents the
number of periods involved.
Previous Example:
F = P(F/P, 6%, 3) = = 500(1.191) = LE595.5
P = F(P/F, 5%, 4) = 800(0.8227) = LE658.16
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Time Value of Money
Cash Flow/Time Diagrams
A cash flow diagram is simply a graphical representation
of cash flows (in vertical direction) on a time scale (in
horizontal direction). Time zero is considered to be
present, and time 1 is the end of time period 1.
This cash flow diagram is setup for five years.
(LE)
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Time Value of Money
Cash Flow/Time Diagrams
Example: If you borrow LE2,000 now and must repay the
loan plus interest (at rate of 6% per year) after five years.
Draw the cash flow diagram n cash flow diagram.
A = LE1,000
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Time Value of Money
Cash Flow/Time Diagrams
Example: Assume that you want to deposit an amount (P)
into an account two years from now in order to be able to
withdraw LE400 per year for five years starting three
years from now. construct the cash flow diagram cash
flow diagram
A = LE400
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Time Value of Money
Cash Flow/Time Diagrams
Example: Suppose that you want to make a deposit into your
account now such that you can withdraw an equal amount
(A1) of LE200 per year for the first five years starting one
year after your deposit and a different annual amount (A2) of
LE300 per year for the following three years. With an
interest rate (i) of 4.5% per year, construct the cash flow
diagram. A = LE300
A = LE200
n-1 n
A
A(1+i)n-1 A(1+i)2 A(1+i) A
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Time Value of Money
Uniform Series Payment
F = A(1+ i)n-1 + A(1+ i)n-2 + ........ + A(1+ i)2 + A(1+ i) + A
F(1+ i) = A(1+ i)n + A(1+ i)n-1 + ........ + A(1+ i)3 + A(1+ i)2
+ A(1+ i)
Subtracting 1 from 2
F(1+ i) – F = A(1+ i)n – A
iF = A[(1+ i)n – 1]
(1 + i ) n − 1
F = A
i
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Time Value of Money
Uniform Series Payment
By reordering the terms of the previous equaiton
i
A = F
(1 + i ) − 1
n
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Time Value of Money
Uniform Series Payment
the value of a uniform series payment, A, when the present
sum, P, is known could be determined
i (1 + i ) n
A = P
(1 + i ) − 1
n
i (1 + i ) n
A = P
(1 + i ) − 1
n
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Time Value of Money
Uniform Series Payment
Example: A man deposits LE500 in a bank at the end of
each year for five years. The bank pays 5% interest,
compounded annually. At the end of five years,
immediately following his fifth deposit, how much will he
have in his account?
A = LE500; n = 5; i = 5%; F = unknown
(1 + i ) n − 1
F = A
i
F = 500[(1.085 – 1) / 0.05] = LE2763
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Time Value of Money
Uniform Series Payment
Example: How much money would a person have after
eight years if he deposited LE100 per year for eight years at
4% starting one year from now?
A = LE100
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Time Value of Money
Uniform Series Payment
Example: A couple wishing to save money for their child’s
education purchased an insurance policy that will yield
LE10,000 15 years from now. The parent must pay LE500
per year for the 15 years starting one year from now. What
will be the rate of return on their investment?
F = LE10,000
A = LE500
i
A = F
(1 + i ) − 1
n
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Time Value of Money
Uniform Series Payment
Example: How long would it take for LE1,000 to double if
the interest rate is 5%?
F = LE2,000
P = LE1,000
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Time Value of Money
Multiple Factors
Example: A person buys a piece of property for LE5,000
down-payment and deferred annual payments of LE500 a
year for six years starting three years from now. What is
present worth of the investment if the interest rate is 8%?
A = LE500
P1 = LE5,000
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Time Value of Money
Multiple Factors
Example: Calculate the present worth (P) ?
LE10,000 LE15,000
A = LE20,000
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Time Value of Money
Uniform Infinite Series
Civil engineering projects (roads, bridges, dams, etc.) are
generally design and constructed to last for a long periods that
may exceed 100 years
These projects are naked as long aged projects
In the uniform infinite series payments, uniform payments are
invested at the end of each period for a very long time that
may be considered as infinite times
A’ i
1 2 3 4 ∞
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Time Value of Money
Uniform Infinite Series
Example: The construction of a bridge costs LE10,000,000,
the annual maintenance cost LE40,000 at the first 10 years.
Then, the maintenance cost increases to LE50,000 after that. It
is required to calculate the present worth of the costs and the
equivalent annual cost if the interest rate is 8%?
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 ∞
A = LE40,000 A’ = LE50,000
P = LE10,000,000
A = LE40,000
P = LE10,000,000
P1 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 ∞
A’ = LE50,000
P2
P’
PT = P + P1 + P2
P1 = 40,000(P/A, 8% , 10) = LE268404
P’ = A’ / i = 50,000/0.08 = LE625,000
P2 = 625,000(P/F, 8% ,10) = 625,000 (0.4632) = LE289,500
PT = 10,000,000 + 268,404 + 289,500 = LE10,557,904
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Time Value of Money
Arithmetic Gradient Uniform Series
In case of the cash flow or payments is not of constant amount
A, there is a uniformly increasing series. The uniformly
increased payments may be resolved into two components
A + (n-1)G
(n-1)G
A + 3G
A + 2G 3G
2G
A+G
A A G
0
= +
P’ P’’
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Time Value of Money
Arithmetic Gradient Uniform Series
G (1 + i ) n − 1
F= − n
i i
the present worth of F could be determined
(1 + i ) n − in − 1
P = G
i (1 + i )
2 n
The term within the brackets is called the arithmetic gradient
present worth factor
“رة د ت ظ ” لا ما
When using the interest tables, it could be represented as
P = G(P/G, i% , n)
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Time Value of Money
Arithmetic Gradient Uniform Series
Example: A man purchased a new automobile. He wishes to
set aside enough money in a bank account to pay the car
maintenance for the first five years. It has been estimated that
the maintenance cost of an automobile is s follows:
Year 1 2 3 4 5
Cost (LE) 120 150 180 210 240
P P’ P’’
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Time Value of Money
Arithmetic Gradient Uniform Series
Example: Calculate the equivalent uniform annual cost (A) of
the following schedule of payments
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Time Value of Money
Arithmetic Gradient Uniform Series
13,370.80
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Time Value of Money
Uniform Series Infinite Payments Every t Periods
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Time Value of Money
Nominal and Effective Interest
Nominal interest rate /year, r, is the annual interest rate
without considering the effect of compounding. Effective
interest rate per year, ia, is the annual interest rate taking
into account the effect of compounding during the year
r = Nominal interest year per period (usually one year)
i = Effective interest rate per period
ia = Effective interest rate per year
m = Number of compounding sub-periods per time period
Then, i = r/m
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Time Value of Money
Nominal and Effective Interest
Example: Consider r = 13% compounded monthly. Find
effective interest rate per year
r = 13; then, i = r/m = 13/12 = 1.08333% = 0.018333
ia = (1 + i)m –1 = (1 + 0.0108333)12 – 1= 13.80% per year
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Time Value of Money
Nominal and Effective Interest
60 = 50 (1 + r)
(1 + r) = 1.2; then r = 0.2 = 20% per week
Then, nominal interest rate per year = 52 weeks × 0.2 = 10.4 =
1040%
Effective interest rate per year, ia = (1 + r/m)m – 1 = (1 + 0.2)52
-1= 13104 = 1310400%
F = P(1 + i)n = 50(1 + 0.2)52 = LE655,200
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