Lecture No4c3.ppt

# Lecture No4c3.ppt - Contemporary Engineering Economics 4 th...

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Contemporary Engineering Economics, 4 th edition ©2007 Time Value of Money Lecture No.4 Chapter 3 Contemporary Engineering Economics Copyright © 2006

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Contemporary Engineering Economics, 4 th edition © 2007 Chapter Opening Story —Take a Lump Sum or Annual Installments Mrs. Louise Outing won a lottery worth \$5.6 million. Before playing the lottery, she was offered to choose between a single lump sum \$2.912 million , or \$5.6 million paid out over 20 years (or \$280,000 per year). She ended up taking the annual installment option, as she forgot to mark the “Cash Value box”, by default. What basis do we compare these two options?
Contemporary Engineering Economics, 4 th edition © 2007 Year Option A (Lump Sum) Option B (Installment Plan) 0 1 2 3 19 \$2.912M \$283,770 \$280,000 \$280,000 \$280,000 \$280,000

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Contemporary Engineering Economics, 4 th edition © 2007 What Do We Need to Know? To make such comparisons (the lottery decision problem), we must be able to compare the value of money at different point in time . To do this, we need to develop a method for reducing a sequence of benefits and costs to a single point in time . Then, we will make our comparisons on that basis.
Contemporary Engineering Economics, 4 th edition © 2007 Time Value of Money Money has a time value because it can earn more money over time ( earning power ). Money has a time value because its purchasing power changes over time ( inflation ). Time value of money is measured in terms of interest rate . Interest is the cost of money —a cost to the borrower and an earning to the lender This a two-edged sword whereby earning grows, but purchasing power decreases (due to inflation), as time goes by.

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Contemporary Engineering Economics, 4 th edition © 2007 The Interest Rate
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