Beruflich Dokumente
Kultur Dokumente
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The decision of how to invest capital will invariably change the future,
hopefully for the better; that is, it will add value.
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Cost Effectiveness.
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The techniques and computations that you will learn and use
throughout this course utilize the cash flow estimates, time
value of money, and a selected measure of worth.
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ECONOMIC EQUIVALENCE
Economic equivalence is a fundamental concept
upon which engineering economy computations are
based.
ECONOMIC EQUIVALENCE
As an illustration, if the interest rate is 6% per year,
$100 today (present time) is equivalent to $106 one
year from today.
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ECONOMIC EQUIVALENCE
However, the two sums of money are equivalent to each
other only when the interest rate is 6% per year.
ECONOMIC EQUIVALENCE
EXAMPLE 1.
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ECONOMIC EQUIVALENCE
EXAMPLE 1.
ECONOMIC EQUIVALENCE
Solutions
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I = P*n*i Eq. 1
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CASH FLOWS
Engineering economy bases its computations on the timing,
size, and direction of cash flows.
CASH FLOWS
Once all cash inflows and outflows are estimated (or determined for
a completed project), the net cash flow for each time period is
calculated.
The end-of-period convention means that all cash inflows and all
cash outflows are assumed to take place at the end of the interest
period in which they actually occur.
When several inflows and outflows occur within the same period,
the net cash flow is assumed to occur at the end of the period.
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CASH FLOWS
The cash flow diagram is a very important tool in an economic
analysis, especially when the cash flow series is complex.
CASH FLOWS
Cash flow diagram time t = 0 is the present, and t =1 is the end of
time period 1. We assume that the periods are in years for now.
Fig. 2:
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CASH FLOWS
CASH FLOWS
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The cash flows are shown in the Figure 3. The negative cash
outflow P occurs now. The withdrawals (positive cash inflow)
for the A1 series occur at the end of years 1 through 5, and
A2 occurs in years 6 through 8.
Fig. 3:
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Fig. 4:
F1 P Pi P 1 i Eqn. 2
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F2 F1 F1i P 1 i
2
Eqn. 3
F3 F2 F2 i P 1 i
3
Eqn. 3
From the preceding values, it is evident by mathematical
induction that the formula can be generalized for n years.
To find F , given P,
F P 1 i
n
Eqn. 4
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Fig. 5:
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1
P F n
F 1 i n
Eqn. 5
1 i -n
The expression (1 + i ) is known as the single-
payment present worth factor (SPPWF), or the P/F
factor.
Note that the two factors derived here are for single
payments; that is, they are used to find the present or
future amount when only one payment or receipt is
involved.
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Standard notation and tabulated value: Notation for the F/P factor
is (F/P,i%,n).
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1 i n 1
P A n
i0 Eqn. 6
i 1 i
The term in brackets in Equation [6] is the conversion
factor referred to as the uniform series present worth
factor (USPWF).
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i 1 i n Eqn. 7
A P
1 i 1
n
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EXAMPLE
SOLUTION
Using Equation 6
1 0.16 9 1
P 600 9
600 4.6065 $2763 .90
0.161 0.16
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i Eqn. 8
A F
1 i n
1
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1 i n 1
F A Eqn. 9
i
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Example
Solution
The cash flow diagram below shows the annual investments starting
at the end of year 1 and ending in the year the future worth is
desired. For $1000, the F value in year 8 is found by using the F/A
factor.
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Solution
1 0.14 8 1
F 1000 1000 13.2328
0.14
F $13,233
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f f1
x x1 a
f2 f1 f1 c f1 d Eqn. 10
x2 x1 b
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Fig. 9
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Example 6
A local university has initiated a logo-licensing
program with the clothier Hollister, Inc. Estimated
fees (revenues) are $80,000 for the first year with
uniform increases to a total of $200,000 by the end
of year 9. Determine the gradient and construct a
cash flow diagram that identifies the base amount
and the gradient series.
Solution
The year 1 base amount is CF1 = $80,000, and the total increase
over 9 years is
G
CF9 CF1 120,000
$15,000/ yr
n 1 9 1
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Solution
The cash flow diagram shows the base amount of $80,000 in years 1
through 9 and the $15,000 gradient starting in year 2 and continuing
through year 9.
When all the cash flow values are known or have been
estimated, the i value (interest rate or rate of return) or n
value (number of years) is often the unknown.
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Example
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Solution
Solution
0 .2
1
i 1 0 .10760 or 10 .76 %
0 .6
Alternatively, the interest rate can be found by setting up the standard
P/F relation, solving for the factor value, and interpolating in the tables.
P F P F , i , n
30 , 000 50 , 000 P F , i , 5
P F , i , 5 0 . 60
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Solution
Example
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Solution
The cash flow diagram is shown below . Either the A/F or F/A
factor can be used.
Solution
Using A/F.
A F A F , i, n
5000 100 , 000 A F , i ,15
A F , i ,15 0 . 050
From the A/F interest tables for 15 years, the value 0.0500 lies
between 3% and 4%. By interpolation, i 3.98%.
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Example
Solution
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Solution
PA is the present worth of a uniform annual series A , and
P'A is the present worth at a time other than period 0.
Solution
PA PA' P F ,8%, 2
The total present worth is determined by adding PA and the
initial payment P0 in year 0.
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i a 1 i 1
m
Eqn. 13
i 1 i a
1 m
1 Eqn. 14
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Where
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in Equation [15].
EXAMPLE
Tesla Motors manufactures high-performance battery electric
vehicles. An engineer is on a Tesla committee to evaluate bids for
new-generation coordinate-measuring machinery to be directly
linked to the automated manufacturing of high-precision vehicle
components. Three bids include the interest rates that vendors will
charge on unpaid balances. To get a clear understanding of finance
costs, Tesla management asked the engineer to determine the
effective semiannual and annual interest rates for each bid. The bids
are as follows:
Bid 1: 9% per year, compounded quarterly
Bid 2: 3% per quarter, compounded quarterly
Bid 3: 8.8% per year, compounded monthly
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EXAMPLE
(a) Determine the effective rate for each bid on the basis
of semiannual periods.
SOLUTION
(a) Convert the nominal rates to a semiannual basis,
determine m, then use Equation [15] to calculate the
effective semiannual interest rate i. For BID 1,
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SOLUTION
For BID 2,
SOLUTION
For BID 3,
2
0.044
i% / 6 months 1 1 1.0445 1 4.45%
2
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SOLUTION
4
0.09
i%/ year 1 1 1.09311 9.31%
4
SOLUTION
For BID 2,
4
0.12
i% / year 1 1 1.1255 1 12.55%
4
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SOLUTION
For BID 3,
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Fig. 10
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If the cash flows are combined in such a manner that the
income and disbursements can be represented by a
single factor such as P/F or P/A , it is possible to look up
the interest rate (in the tables) corresponding to the
value of that factor for n years.
EXAMPLE
Applications of green, lean manufacturing techniques coupled with
value stream mapping can make large financial differences over
future years while placing greater emphasis on environmental
factors. Engineers with Monarch Paints have recommended to
management an investment of $200,000 now in novel methods that
will reduce the amount of wastewater, packaging materials, and
other solid waste in their consumer paint manufacturing facility.
Estimated savings are $15,000 per year for each of the next 10 years
and an additional savings of $300,000 at the end of 10 years in facility
and equipment upgrade costs. Determine the rate of return.
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SOLUTION
Use the trial-and-error procedure based on a PW equation.
1. The cash flow diagram is show below
SOLUTION
2. Use Equation [16] format for the ROR equation.
0 200 ,000 15 ,000 P A , i ,10 300 ,000 P F , i ,10
3. Use the estimation procedure to determine i for the first trial. All
income will be regarded as a single F in year 10 so that the P/F
factor can be used. The P/F factor is selected because most of
the cash flow ($300,000) already fits this factor and errors created
by neglecting the time value of the remaining money will be
minimized. Only for the first estimate of i , define P = $200,000, n =
10, and F = 10(15,000) + 300,000 = $450,000. Now we can state
that
200 ,000 450 ,000 P F , i ,10
P F , i ,10 0.444
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SOLUTION
The roughly estimated i is between 8% and 9%. Use 9% as the first trial
because this approximate rate for the P/F factor will be lower than
the true value when the time value of money is considered.
SOLUTION
Since the interest rate of 11% is too high, linearly interpolate between
9% and 11%.
22 ,986 0
i * 9 .00 2 .0
22 ,986 6002
i * 9 .00 1 .58 10 .58 %
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