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Lecture 14
Engineering Economics
Be reading Chapter 5
•
Homework 6 is due Oct 22. It is 4.9, 5.2, 5.4, 5.6, 5.11
•
Wind Farm field trip will be on Nov 5 from about 8am to 4pm – turn in forms to sign up.
•
Campus Wind Turbine Project: Let your voice be heard! If you would like to email your student senators
• with your wind turbine views some folks to talk with are Bradley Tran (president-iss@illinois.edu), Bobby
Gregg (bobby.gregg@gmail.com), Melanie Cornell (cornell4@illinois.edu)
Energy Economic Concepts
(From Prof. Gross)
• The economic evaluation of a renewable energy resource
requires a meaningful quantification of cost elements
– fixed costs
– variable costs
• We use engineering economics notions for this purpose
since they provide the means to compare on a consistent
basis
– two different projects; or,
– the costs with and without a given project
Time Value of Money
M M
n-1 P(1+i ) n-1 P(1+i ) n-1 i P(1+i ) n-1 + P(1+i ) n-1 i = P(1+i ) n
n P(1+i ) n
The value in the last column for the e.o.p. (k-1) provides the value in
the first column for the e.o.p. k (e.o.p. is end of period)
Terminology/Overview
0 1 2 3 4
Outward cash flows
Present
• Each cash flow has (1) amount, (2) time, and (3) sign
Cash Flows
∑ A ( 1 + i)
n− t
Fn = t
t =0
A0 A1 A2 At A n-2 A n-1 An
... ...
0 1 2 t n–2 n–2 n
Cash Flows
= 10,000 ( 1 + d )
−5
P = F5 β 5
Discount Rate
F5=?
0 1 2 3 4 5
year
$ 2,000 $ 2,000
∑A β ∑ A ( 1 + i)
−t
P = t
t
= t
t =0 t =0
• Note that n
∑ A ( 1 + i)
−t
P = t
t =0
142 4 3 t =0
1 4 42 4 43
β n
F n
= β n Fn
or equivalently
Fn = ( 1 + i ) P
n
• Given that
P = $1,000 and i = .12
P ( 1 + i) = $1,000( 1 + .12)
5 5
= $1,762.34 = F
Example 3
142 43 142 43
β β 2
NPV=$ 161.98 { 0 1 2
Uniform Cash Flow Set
At = A t = 1, 2,..., n
• Such a set is called an equal payment cash flow set
• Each payment can be thought of as a future value and
the results will be the same
• We compute the present worth
n n
P = ∑ At β
t =1
t
= A ∑ β t = Aβ 1 + β + β 2 + ... + β n− 1
t =1
Uniform Cash Flow Set, cont.
j =0
1− β n
=
1− β
Uniform Cash Flow Set, cont.
• Therefore 1 − β n
P = A β
1− β
β = (1 + d)
−1
• But and so
1 d
1−β = 1− = = βd
1+ d 1+d
• We write P = A 1 − β n
d
1− βn
• We call the equal payment series present
d value function
Uniform Cash Flows, PVF
1−β n
1 − (1 + d ) −n
(1 + d ) − 1
n
= =
d d d (1 + d )n
this is also written as (P|A,d%,n)
In the News: States Not Meeting
Renewable Energy Goals
• USA Today had an article last week that discussed progress states
were making on meeting their renewable portfolio standards; 35
states have such goals
• There is no central clearing house on compliance, so the article
just discussed several examples
– NJ would like to have 1000MW of offshore wind by 2012, but will miss
that by about a year
– CA has a 20% goal by 2010, but won’t achieve that until 2013 or 2014
– AZ planned to get 0.3% from solar by 2009, but probably won’t achieve
that until 2011
www.usatoday.com/money/industries/energy/2009-10-08-altenergy_N.htm
California and Solar
0 1 2 3 4 5 6 7 0 1 2
a b
Equivalence, cont.
7
• We compute P a = 2000 ⋅ ∑ β t
= 7162.33
t =3
3
0 1 2 4 5 6 7 8
d = 6%
$ 300
Example, cont.
• We compute F 8 at t = 8 for d = 6%
F8 = 300 ( 1 + .06) − 300( 1 + .06)
7 5
+
200 ( 1 + .06) + 400( 1 + .06)
4 2
+ 200
= $ 951.56
• We next compute P
P = 300 ( 1 + .06) − 300( 1 + .06)
−1 −3
= $ 597.04
• We check that for d = 6%
F8 = 597.04 ( 1 + .06) = $ 951.56
8
Motor Purchase Example
a 2,400 79.0
b 2,900 77.5
0 1 2 t 19 20
... ... ...
Aa Aa Aa Aa Aa
$2400
20
∑ ( 1.1of) motor
−t
• We a
= 2, 400
P evaluate the+present
10,112worth = $a88, 489
t =1
Motor Purchase Example, motor b
$2900
20
• ∑ ( 1.1) of
−t
WePnext
b
= evaluate
2, 900 + the present
9, 920 worth = motor b
$ 87, 354
t =1
Motor Purchase Example, cont.
{ At = A : t = 0, 1, 2, ... }
• Then,
P = A
( 1 − β n
) A
1
d n →∞ d
For an infinite horizon uniform cash-flow set
A
= d
P
Infinite Horizon Cash-Flow Sets, cont.
dP = A
is the annual amount recovered in terms of
returns on investment
Internal Rate of Return
1 2 3 4 8
$30,000
Internal Rate of Return
1− β 8
P = − 30,000 + 6,000 =0
d
has the (non-obvious) solution of d equal to about 12%.
• The interpretation is that under a 12% discount rate, the present
value of the cash flow set is 0 and so 12% is the IRR for the given
cash- flow set
– The investment makes sense as long as other investments yield less than
12%.
Internal Rate of Return
1 − β 15
= 5.00
d d = 18.4%
Source: http://en.wikipedia.org/wiki/File:US_Historical_Inflation.svg