19MECH40I Engineering Economy
Chapter 2
TIME VALUE OF
MONEY
Dr. Noha Mostafa
Industrial Engineering department
Zagazig University
19MECH40I Engineering Economy
2
2-1
Introduction
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
3
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
4
DCF
In this chapter, we present the mathematics and basic operations needed to
perform engineering economic analyses incorporating the DCF rules.
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
5
2-2
CASH FLOW
DIAGRAMS (CFD)
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
6
A CFD is constructed using a
segmented horizontal line as a
time scale, with vertical arrows
indicating cash flows.
An upward arrow indicates a
cash inflow or positive-valued
cash flow, and a downward
arrow indicates a cash outflow, or
negative-valued cash flow.
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
7
Example 2.1
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
8
Example 2.1
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
9
Example 2.2
When receiving a given sum of money, we prefer to receive it
sooner rather than later, and when paying a given sum of
money, we prefer to pay it later rather than sooner. Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
10
2-3
Simple interest calculations
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
11
In considering the time value of money, it is convenient to represent
mathematically the relationship between the current or present value of a
single sum of money and its future value.
Fn = P(1+in)
P is the present value of money, Fn is the accumulated value of P over n
years, and i is the interest rate.
This is called the simple interest approach.
The annual interest rate is defined as the change in the
value for $1 over a 1-year period. Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
12
Example 2.5
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
13
Example 2.6
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
14
Example 2.7
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
15
2-4
Compound interest
calculations
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
16
When compound interest is used, the interest rate (i) is interpreted as the
rate of change in the accumulated value of money, and the value of In is
given by:
Where t increments the years from 1 to n and F0 = P and
Fn = Fn-1(1+i)
Video: compound interest explained Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
17
Example 2.8
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
18
2.4.1 Single cash flow
▰ The previous example involved two cash flows: an amount borrowed and an
amount repaid.
▰ We can generalize the loan example and develop an equation to determine the
amount owed after n periods, based on a compound interest rate of i%/period, if
P is borrowed.
F = P (1+i)n
▰ The quantity (1+i)n is tabulated in Appendix A for various values of i and n.
▰ It is denoted (F|P i%, n) and reads ‘‘the F, given P factor at i% for n periods.
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
19
2.4.1 Single cash flow
P = the equivalent value of an amount
of money at time zero, or present
worth.
F = the equivalent value of an amount
of money at time n, or future worth.
i = the interest rate per interest
period.
n = the number of interest periods.
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
20
Team activity#1
Use the tables to calculate the amount at the end of the five years.
F = P (F|P, 10%, 5)
F = 10,000 (1.61051)
F = 16,105.1
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
21
2.4.2 Multiple cash flows
▰ Most engineering economic analyses involve more than a single return occurring
after an investment is made.
▰ In such cases, the present worth equivalent of the future cash flows can be
determined by adding the present worths of the individual cash flows.
▰ To move money forward one time unit, multiply by 1 plus the discount or interest
rate; and to move money backward one time unit, divide by 1 plus the discount or
interest rate.)
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
22
Example 2.12
A $100,000 investment produces returns of $50,000, $40,000, $30,000, $40,000, and
$50,000 at the end of years (EOY) 1 through 5, respectively.
Based on a 10 percent annual compound interest rate, what are the present worth and
future worth equivalents for the multiple cash flows shown?
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
23
Example 2.12
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
24
Example 2.13
Dr. Noha Mostafa
Industrial Engineering Department
19MECH40I Engineering Economy
25
Team activity #2 Use the tables to calculate the future worth of this CF.
Dr. Noha Mostafa
Industrial Engineering Department
INE222 Forecasting
THANKS!
Any questions?
You can find me at
[email protected]
Dr. Noha Mostafa
Industrial Engineering Department
