Engineering Economy

Reviewer

Find P or F from Single Amounts

How to do it: The simplest problems to solve in engineering economic analysis are those which involve finding the value of a single amount of money at an earlier or later date than that which is given. Such problems involve finding the future worth (F) of a specified present amount (P), or vice versa. These problems involve using the equations:

F = P(1 + i)n or P = F[1/ (1 + i)n]In terms of standard factor notation, the equation on the left is represented as F=P(F/P,i,n) and the equation on the right is represented as P = F(P/F,i,n).

Find Present Worth (P)

Example: #1: A person deposits P5,000 into a money market account which pays interest at a rate of 8% per year. The amount that would be in the account at the end of ten years is most nearly: a. P2,792 b. P9,000 c. P10,795 d. P12,165

Solution: Answer: C. The P5,000 represents a present amount, P. The future amount, F, is F = P5,000 ( F/P, 8%, 10) = P5,000 [1 / ((1 + 0.08)^-10)] = P10,794.625

Find Future Worth (F)

Example #2: A small company wants to deposit a single amount of money now so that it will have enough to purchase a new truck costing P50,000 five years from now. If the money can be deposited into an account which earns interest at 10% per year, the amount that must be deposited is most nearly a. P10,000 b. P31,050 c. 33,250 d. 319,160

Solution: Answer: C. The P50,000 represents a present amount, P. The future amount, F, is P = P50,000 ( P/F, 10%, 5) = P50,000 [1 / ((1 + 0.10)^ 5)]

= P31,046.066

Find P from a Uniform Series (A) and Vice Versa

How to do it: Uniform series cash flows are represented by the symbol A. A uniform series refers to cash flows which: (1) occur in consecutive interest periods, and (2) are the same amount each time. To solve for P for these types of problems, the following equation is used: P = A In standard factor notation, the equation is P = A(P/A,i,n). It is important to note in using this equation that the present worth, P, is located one interest period ahead of the first A. It is also important to remember that n must be equal to the number of A values and the interest rate, i, must be expressed in the same time units as n. For example, if n is in months, i must be an effective interest rate per month. This standard equation can be used in reverse to convert a present worth into a uniform series amount using the form A = P(A/P,i,n). This, for example, is used to determine the monthly payment associated with a car purchase or house loan for a compound interest rate of i%.

Find P from a Uniform Series (A)

Example #3: A company expects the material cost of a certain manufacturing operation to be $20,000 per year. At an interest rate of 8% per year, the present worth of this cost over a five year project period is closest to:

a. P29,386

b. P56,220

c. P79,854

d. P117,332

Solution: Answer: C. P = A(P/A,i,n) = P20,000 [(1+0.08)^5 1 ) / ((0.08)(1 + 0.08)^ 5)] = P79,854.201

Find A from a Uniform Series (A) Given P

Example #4: A piece of machinery has a first cost of $31,000 with a monthly operating cost of $10,000. If the company wants to recover its investment in five years at an interest rate of 1% per month, the monthly income must be closest to: a. P5,498 b. P6,386 c. 8,295 d. 10,688

Solution: The A value is per month. Answer: D. A = 31,000 ( A/P, 1%, 60) + 10,000 = 31,000 [ (1+0.01)^60 0.01) / (1+0.01)^60 1 )] + 10,000 = P10,689.578

Find F from a Uniform Series (A) and Vice Versa

How to do it:

In the previous problem type, the procedure for converting a uniform series into an equivalent present amount was discussed. Here a uniform series is converted into a future amount instead of a present one. The equation for doing so is:
F = A The standard notation form is F= A(F/A,i,n). It is important to remember that the F occurs in the same period as the last A. As before, the n is equal to the number of A values and the i used in the calculation must be expressed over the same time units as n. The standard equation can be set up and solved in reverse to find an A value from a given future worth, F, using A = F(A/F,i,n).

Find F from a Uniform Series (A) and Vice Versa

Example #5: If a person deposits P100 per month into an account which pays interest at a rate of 6% per year compounded monthly, the amount in the account at the end of five years would be nearest to: a. P564 b. P369 c. P6,977 d. P7,992

Solution: Since the cash flow (i.e., A values) occurs over monthly interest periods, the n and i must have monthly time units. Answer: C. F = 100 ( F/A, 0.5%, 60)

= 100 [ ((1+0.005)^60 1) / (0.005)]

= 6,977.003

Find A from a Uniform Series (A) Given F

Example #6: A small company wants to have enough money saved to purchase a new P200,000 warehouse in five years. If the company can invest money at 18% per year, the amount that must be invested each year is closest to: a. P27,960 b. P36,920 c. P49,650 d. P63,960

Solution: Answer: A. A = P200,000 (A/F, 18%, 5) = P200,000 [(0.18) / ((1+0.18)^5 1)] = P27,955.568

Identify Nominal and Effective Interest Rates

How to do it:
Nominal and effective interest rates are similar to simple and compound interest rates, with a nominal rate being equivalent to a simple interest rate. All of the equations expressing time value of money are based on compound (i.e., effective) rates, so if the interest rate that is provided is a nominal interest rate, it must be converted into an effective rate before it can be used in any of the formulas. The first step in the process of insuring that only effective interest rates are used is to recognize whether an interest rate is nominal or effective. Effective Rate - When no compounding period is given, interest rate is an effective rate, with compounding period assumed to be equal to stated time period while

Nominal Rate - When compounding period is given without stating whether the interest rate is nominal or effective, it is assumed to be nominal. Compounding period is as stated.

Nominal or Effective
Interest Statement 5% per year compounded monthly 10% per year Effective 15% per year compounded monthly 20% per year compounded quarterly Nominal or Effective Nominal Effective Effective Nominal Compounding Period Monthly Yearly Monthly Quarterly