GEN 401

Economics of Metallurgical Industries

4th Year Metallurgical Engineering

Mining, Petroleum, and Metallurgical Engineering Department

Faculty of Engineering – Cairo University

Course Instructor
Dr. Moetaz Nabil
 Topics to be covered

Chapter 4 Equivalence and Interest

Equivalence-Compound Interest --- Single Payment and Uniform Series Formulas
Arithmetic Gradient --- Geometric Gradient

Chapter 5 Present Worth Analysis

Chapter 6 Annual Cash Flow Analysis

Chapter 7 Rate of Return Analysis

Chapter 8 Incremental Analysis

Chapter 10 Depreciation
Straight-Line Depreciation --- Sum-of-Years-Digits Depreciation
Declining Balance Depreciation --- DDB Depreciation with conversion to straight line

Chapter 11 Income Taxes

Slide Set 1
Equivalence
and
Compound Interest
Equivalence
 Equivalence
Application of Equivalence Calculations
 A Simple Question
• If I offer you a gift of $1000 now or $X one
year from now (assuming you don’t need
lunch money right now …)
• Would you choose to accept now or one year
from now if
– X = 1000
– X = 1100
– X = 2000
– X = 10000

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 Which is better?
$3000 $3000 $3000
(+) <= Alternative 
0 1 2 3 4 5 6 7
(-)

$6000 $3000 $3000 $3000

(+)

0 1 2 3 4 5 6 7
(-)

Alternative  =>
$6000

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• Engineering Economics
offers mathematical techniques to compare
engineering projects from an economic point of view.

• Time Value of Money

refers to the change in the amount of money over a
given time period.

• Key Elements - Money, Time & Interest Rate

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Comparing Economic Alternatives

• Issues that need to be addressed when

comparing alternatives
– Periodic costs and revenues (estimates)
– Selection criterion (measure of worth)
– Equal service/benefit
– Tax advantages
– Inflation

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 Engineering Economics –
Goals Restated

• Cash flows, inflows (revenues) and outflows

(costs) of money over time, estimated for each
alternative

• Economic analysis requires defining and

evaluating measures of worth that account for
time value of money to compare alternatives

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 Cash Flow Diagrams

• Net cash flow =

cash inflows – cash outflows

• Net cash flow occurs at the end of the period

(end-of-period convention)

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0 Year 1

Time axis is indexed with the end of each

year from 1,2,…,n (if 0 is now, index 3 is 3
years from now)
Perspective determines the sign on each
cash flow
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 Cash Flow Diagrams
Example 1:

A person borrows $1,000 and pays back the

loan in four periods. The amount at the end
of periods 1, 2, and 3 is equal to $160 (interest)
and the amount at the end of period 4 is $1,160
(principal plus interest.) Draw the cash flow
diagrams for the borrower and the lender.

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Solution: The cash flow diagram for the
borrower is shown below:
$1,000

0 1 2 3 4

$160 $160 $160

$1,160

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Solution: The cash flow diagram for the lender
is shown below:
$1,160

$160 $160 $160

01 2 3 4

$1,000

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 Interest
• Interest is the manifestation of time value of
money.

Interest (paid or earned) = amount owed now

– original amount (principal)

• When one party pays, the other earns – just

different perspectives.

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 Interest Rate
• Interest Rate is interest accrued over a specific
time unit expressed as a percentage of the
principal.

Interest Rate = (interest accrued per time

unit/principal)x100%

• Time unit of the rate is known as the “interest

period”.
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 Simple & Compound Interest
 Interest rate and principal are sufficient to
calculate interest accrued for one interest
period
 For multiple periods, interest could accrue in
two different ways…
 Simple interest calculates the interest for each
interest period as a fraction (i) of the original
principle (P)
 Compound interest calculates the interest for
each interest period as a fraction (i) of the
original principle (P) plus the total interest
accumulated from all previous periods.
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 Simple Interest
• Amount after 1 period is F1= P + P*i = P(1+i)
• Amount after 2 periods is F2= F1 + P*i = P + 2*P*i
• Amount after n periods is Fn = P + n*P*i
• Under a simple interest scheme, P at zero is equivalent to
P(1+ni), after n time periods
• “Future worth” of P after n periods under simple interest
rate i is P(1+ni)

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 Compound Interest

Amount after 1 period is F1= P + P*i = P(1+i)



 Amount after 2 periods is F2= F1 + F1*i = F1*(1 + i) =

P*(1+i)2
 Amount after n periods is Fn = P*(1+i)n

 Under compound interest scheme, P at zero is

equivalent to P(1+i)n, after n time periods

 “Future worth” of P after n periods under

compound interest rate i is P(1+i)n
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period.
***Compound interest scheme is assumed (unless stated otherwise)
 EX 2

YYZ group invested $10,000 and withdrew a

total of $10,500 exactly one year later. Compute
the interest that would have accrued in three
years from investment date, if interest scheme
was (i) simple (ii) compound.

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 Solution
• i = (interest/original amount)*100%
= [($10,500 – $10,000 )/$10,000] * 100% =
5% per year
• Simple Interest = P*n*i = 10000*3*0.05 =
$1500
• Compound Interest = P(1+i)n-P =
10000*1.053-10000 = $1576.25

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 EX 3
• An investment of $40,000 one year ago and
$50,000 now are equivalent at what interest rate ?

• Solution:
• 40K(1 + i) = 50K
• i = (50K-40K)/40K = ¼ = 0.25 or 25%

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 EX 4

• A local bank is offering to pay compound

interest of 7% per year on new savings
accounts. An e-bank is offering 7.5% per year
simple interest on a 5-year certificate of
deposit. Which offer is more attractive to a
company that wants to set aside $1000,000
now for a plant expansion 5 years from now?

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 Solution

• P = 1M
• FCI = 1M(1 + 0.07)5 = $1.40M
• FSI = 1M + 1M*0.075*5 = $1.375M
• Since compound interest account would have
more money, it is preferable
• Is this always the case?

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