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# Engineering Economy I INDE 3333

UH

GPA 3.62

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This 34 page Class Notes was uploaded by Faustino Borer on Saturday September 19, 2015. The Class Notes belongs to INDE 3333 at University of Houston taught by Lawrence Schulze in Fall. Since its upload, it has received 102 views. For similar materials see /class/208245/inde-3333-university-of-houston in Industrial Engineering at University of Houston.

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Date Created: 09/19/15

nIgtum H mOCZUgtOZm Om mzmme Zm Section 13 Taxes oTaxes represent a significant negative cash flow to the forprofit firm 0A realistic economic analysis must assess the impact of taxes Called and AFTERTAX cash flow analysis oNot considering taxes is called a BEFORE TAX Cash Flow analysis 39Cl L Taxes 0 A BeforeTax cash flow analysis while not as accurate is often performed as a preliminary analysis 0A final more complete analysis should be performed using an AfterTax analysis 0 Both are valuable analysis approached Fact 50 of the US working population does not pay taxes oThe top 5 of wage earners pay 90 of the I taxes 250000 S YOU ARE RICH HOE61101 00 V SV GHSSHHdX3quot39A3NON SES39H HNOHNOS lO ESquot 3H1 HOI CIIVd 33d 39IVLNEH LNnOINV IVNISIHO 39 VON GEIVO 39VLOL LSEIHELLNI NVO39I LNnOV 39IVNISIHO 39 VON Eln39IVA iSEIHELLNI lNEIWlSEIANI 39AEINOW 38 Cl GIVd LNnOINV EHL 39AEINOW IO Eln39IVA EIVL EHL IO NOLVLSEIIINVVI 39 iSHHHiNI 3193 153me Interest Lending Interest can be viewed from two perspectives Lending situation 0 Investing situation 0 You borrow money renting someone else39s money 0 The lender expects a return on the money lent oThe return is measured by application of an interest rate Interest Lending Example 0 You borrow 10000 for one full year 0 Must pay back 10700 at the end of one year 0 Interest Amount I 10700 10000 0 Interest Amount 700 for the year 0 Interest rate i 70010000 7Yr Interest Rate Notation oFor 13 the interest rate is Expressed as a per cent per year oNotation I the interest amount is oi the interest rate Oointerest period N No of interest periods 1 for this problem Interest Borrowing oThe interest rate i is 7 per year c The interest amount is 700 over one year The 700 represents the return to the lender for this use of hisher funds for one year c 7 is the interest rate charged to the borrower 7 is the return earned by the lender Interest Example oBorrow 20000 for 1 year at 9 interest per year oi 009 per year and N 1 Year oPay 20000 00920000 at end of 1 year oInterest I 00920000 1800 oTotaI Amt Paid one year hence 20000 1800 21z800 Interest Example Note the following oTotaI Amount Due one year hence is 20000 00920000 20000109 21800 oThe 109 factor accounts for the repayment of the 20000 and the interest amount oThis will be one of the important interest factors to be seen later 14 Interest Investing Perspective oAssume you invest 20000 for one year in a venture that will return to you 9 per year At the end of one year you will have oOriginal 20000 back oPlus oThe 9 return on 20000 1800 We say that you earned 9year on the investment This is your RATE of RETURN on the investment Inflation Effects 0 A socialeconomic occurrence in which there is more currency competing for constrained goods and services 0 Where a country s currency becomes worth less over time thus requiring more of the currency to purchase the same amount of goods or services in a time period 0 Fact The market sets the price If there is a surplus prices go down if there is a scarcity prices go up Inflation Rates oIanation impacts gtPurchasing Power reduces gtOperating Costs increases gtRate of Returns on Investments reduces gtSpecifically covered in Chapter 14 ECONOMIC EQUIVALENCE oEconomic Equivalence oTwo sums of money at two different points in time can be made economically equivalent if oWe consider an interest rate and 0N0 of Time periods between the two sums l Equality in terms of Economic Value 10193814 J14 Equivalence Illustrated oDiagram the loan Cash Flow Diagram oThe company s perspective is shown 20000 is received here T0 t1Yr 21800 paid back here 20000 now is economically equivalent to 21800 one year from now IF the interest rate is set to equal 9lyear long2514 15 15 Equivalence Illustrated Another wa20000 now is not equal in magnitude to 21800 1 year from now 0 But 20000 now is economically equivalent to 21800 one year from now if the interest rate in 9 per year c If you were told that the interest rate is 9 Which is worth more o20000 now or 21800 one year from now 0 The two sums are economically equivalent but not numerically equal Equivalence To have economic equivalence you must specify 0 Timing of the cash flows oAn interest rate We per interest period c Number of interest periods N Ulla 5314 Simple and Compound Interest 0 Two types of interest calculations 0 Simple Interest Car Loans Loan Sharks Compound Interest Mortgage Compound Interest is more common worldwide and applies to most analysis situations Simple Interest 0 Simple Interest Calculated on the principal amount only oEasy simple to calculate oSimple Interest is principalinterest ratetime 1 Pi1 Simple and Compound Interest Borrow 1000 for 3 years at 5 per year 0 Let P the principal sum oi the interest rate 5year Let n number of years 3 I 10000053 5m 0 Total Interest over 3 Years Accrued Simple Interest 3 Years 150 of interest has accrued P1000 1 21 31 115ooo 125ooo I35000 Pay back 1000 150 of interest The unpaid interest did not earn interest over the 3year pe od Simple Interest Summary In a multiperiod situation with simple interest oThe accrued interest does not earn interest during the succeeding time period Normally the total sum borrowed lent is paid back at the end of the agreed time period PLUS the accrued owed but not paid interest Compound Interest Compounding means to compute the interest owed at the end of the period and then add it to the unpaid balance of the loan 0 Interest then earns interestquot 0 To COMPOUND stop and compute the associated interest and add it to the unpaid balance 0 When interest is compounded the interest that is accrued at the end of a given time period is added in to form a NEW principal balance 0 That new balance then earns or is charged interest in the succeeding time period g3 Compound Interest Example 0 Assume P 1000 0 i 5 per year compounded annually CA 0N 3 years c For compound interest 3 years we have P1000 w 11 2 3 years 1 1000 5000 115ooo 5250 5513 I251 5250 115763 I35513 34 Example Determining best Loan Payoff Five plans are shown that will pay off a loan of 5000 over 5 years with interest at 8 per year Plan1 Simple Interest pay all at the end Plan 2 Compound Interest pay all at the end Plan 3 Simple interest pay interest only at the end of each year Pay the principal at the end of N 5 Plan 4 Compound Interest and part of the principal each year pay 20 of the Principal Amount each year Plan 5 Equal Payments of the compound interest and principal reduction over 5 years with end of year Ioigayments Plan 1 Simple Interest Pay all at end on 5000 Loan l1 2 all 39l lill l5 End of Interest Owed Tatal awed at EndwafYear Tatal Dwed Year far Year End Of Year 7 fayment aftef ngment Plan 139 Simple InterEM Pay All at End U 5500 l 40000 5430 5440000 2 5300013 53009U 3 40030 SEQUDU 10013 4 440000 550000 v 650000 5 40000 700000 ST D nals 700000 10192014 Plan 2 Compound Interest Pay all at the End of 5 Years ll 2 l3 l4 l5 Eml all lnterest Dwed Tutal United at EndinfTear Tutu Dwed quotrear fer Year End uf fear Payment alter Payment El 55mm l 5mm 54 54mm 2 43101 EESEHZI d 5332M 3 46551 19355 a 619535 14 33333 6130244 a ERMA4 5 5442 T34615 534 l Tetals 53 6gt6alv 10192014 Plan 3 Simple Interest Interest Paid Annually Principal Paid at the End Balloon Note ill 2 W W l5l Endl of interest Dwecl Total Wed at EndnufTear Tutal Dwedl V lealquot far quotfear End pl Year Payment after Payment ll 39 500001 l 5413000 55mm 54mm 50mm 2 54mm 4mm 5mm 3 mm 540000 4mm Emilia at 54mm 4mm 5mm 5 4mm Totals Sliml ll 10192014 Authored by Don Smith TX mm University 28 Plan 4 Compound Interest Interest and 20 of Principal Paid back annually l 2 3139 4 51 Encli Elf lnterest Owed Tatal Unwed at Endanfm fear Tntal awed fear A far lr39aar End atquot Year Payment after Payment 55mm l W ll39 Sl i 2 32mm 43mm lBlEl 30mm 3 EMHG 3241300 1241360 2mm 4 team 2 l 6013 l 6006 l 39lil 5 S l ll 39 l 1030200 Tum 620000 10192014 Plan 5 Equal Repayment Plan Annual Payments Part Principal and Part Interest l ll l2 l3 4 El End nf lnterest Dwed Tmal Due2d at EndniYear Total Dwed Year fur Year End of Year Payment after Payment l mmm l 55mm 155400130 125223 4172 2 343 LEE 447954 125128 322125 3 153 IS 343543 l 25223 2231l 5 4 17365 1 L30 125123 l 5952 5 9 2th lESZEE 1 Tums 5626 4l 10192014 Comparisons 5 Plans Plan 1 Simple interest original principal008 Plan 2 Compound interest total owed previous year008 Plan 3 Simple interest original principal008 Plan 4 Compound interest total owed previous year008 Plan 5 Compound interest total owed previous year008 Analysis Note that the amounts of the annual payments are different for each repayment schedule and that the total amounts repaid for most plans are different even though each repayment plan requires exactly 5 years c The difference in the total amounts repaid can be explained 1 by the time value of money 2 by simple or compound interest and 3 by the partial repayment of principal prior to year 5 Terminology and Symbols P value or amount of money at a time designated as the present or time 0 0 Also P is referred to as Present Worth PW Present Value PV Net Present Value NPV Discounted Cash ow DCF and capitalized cost CC dollars

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