ENGINEERING AND PROJECT
MANAGEMENT
MMB 533
LECTURER:
DR L. SEBONI
OFFICE: 247/475
[email protected]
Introduction to Engineering
Economics – Time Value of Money
OBJECTIVE
To explain the time value of money calculations
Introduction to Engineering
Economics – Time Value of Money
MONEY HAS A TIME VALUE
• Capital - wealth in the form of money or property that can be used to
produce more wealth.
•Engineering economics studies involve the commitment of capital for
extended periods of time.
•A dollar today is worth more than a dollar one or more years from now
Introduction to Engineering
Economics – Time Value of Money
Return to capital in the form of interest and profit is an essential ingredient of
engineering economics studies.
Introduction to Engineering
Economics – Time Value of Money
SIMPLE INTEREST - COMPUTATION
P= principal amount lent or borrowed
N= number of interest periods (e.g., years)
i= interest rate per interest period
Introduction to Engineering
Economics – Time Value of Money
EXAMPLE:
If $5,000 were loaned for five years at a simple interest rate of
7% per year, the interest earned would be:
Introduction to Engineering
Economics – Time Value of Money
Compound interest --- reflects both the remaining principal and any
accumulated interest.
For $1,000 at 10%…
Introduction to Engineering
Economics – Time Value of Money
Economic Equivalence -
Allows comparing alternatives on a common basis.
Each alternative can be reduced to an equivalent basis
dependent on a number of things. What are they?
- interest rate,
– amount of money involved, and
– timing of monetary receipts or expenses.
Introduction to Engineering
Economics – Time Value of Money
Tools to determine Economic Equivalence
Notation used in formulas for compound interest calculations.
i = effective interest rate per interest period
N = number of compounding (interest) periods
P = present sum of money; equivalent value of one or more cash
flows at a reference point in time; the present
F = future sum of money; equivalent value of one or more cash
flows at a reference point in time; the future
A = end-of-period cash flows in a uniform series
Introduction to Engineering
Economics – Time Value of Money
Cash flow diagram
Introduction to Engineering
Economics – Time Value of Money
Cash
flow table
Introduction to Engineering
Economics – Time Value of Money
Applying Compound Interest Formula
We can apply compound interest formulas to “move” cash flows
along the cash flow diagram.
Using the standard notation, we find that a present amount, P,
can grow into a future amount, F, in N time periods at interest
rate I according to the formula:
Introduction to Engineering
Economics – Time Value of Money
Applying Compound Interest Formula
It is common to use standard notation for interest factors
This is also known as the single payment compound amount
factor.
single payment present worth factor
Introduction to Engineering
Economics – Time Value of Money
NOMINAL AND EFFECTIVE INTERET RATES
More often than not, the time between successive
compounding, or the interest period, is less than one year (e.g.,
daily, monthly, quarterly).
The more frequent the compounding the greater the effective
interest.
Introduction to Engineering
Economics – Time Value of Money
CONTINUOS COMPOUNDING OF INTEREST
Interest can be compounded continuously.
Interest is typically compounded at the end of discrete periods.
