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2-Time Value Mechanics.CR

# 2-Time Value Mechanics.CR - Engineering Economics ECO 1192...

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Engineering Economics ECO 1192 Lecture 2: Time-value mechanics Claude Théoret University of Ottawa

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Fall 2009 2. Time-Value Mechanics 2 Reminder: Access to course website http://www.uottawa.ca English/French Quick Picks Virtual Campus Student number & password Select Engineering Economics (ECO 1192A) Lecture Notes Problem Sets (2) Excel functions; applications…. Formulas provided at examinations
Fall 2009 2. Time-Value Mechanics 3 Recommended readings Fraser et al.* chapters 2 and 3 Newnan et al. chapters 3 and 4 Park chapters 2 and 3

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Fall 2009 2. Time-Value Mechanics 4 Lecture objectives 1. Define and calculate different interest rates Simple & compound interest rates nominal, effective and actual rates Discrete & continuous compounding and cash flows 2. Develop different cash flow patterns 3. Understand interest rate factors 4. Combine interest rates and cash flows 5. Apply summary measures
Which project (if any) is best? Project parameters Project A Project B Project C First cost (\$) 3,000 5,000 8,000 Annual cost (\$) 600 900 1300 Annual revenues (\$) 1500 1750 2000 Salvage value (\$) 0 -200 1000 Duration (years) 5 10 20 Interest rate (10%) 10 10 10 ? ? ? ?

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Fall 2009 2. Time-Value Mechanics 6 What constitutes a valid or acceptable project? A project is valid or acceptable if its cash inflows (benefits) exceed its cash outflows (costs) after adjusting for the time at which the cash inflows and outflows occur Remember that an inflow (or outflow) of one dollar at the end of year 1 has a different value than the value of a dollar at the end of year 2.
Fall 2009 2. Time-Value Mechanics 7 Frequently used symbols r ≡ nominal or market interest rate i ≡ effective interest rate n ≡ number of years m ≡ number of within compounding periods if 5% compounded monthly , m = 12 P or PW ≡ Present worth NPW ≡ Net Present Worth AEW ≡ Annual Equivalent Worth F or FW ≡ Future worth NFW Net Future Worth

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Fall 2009 2. Time-Value Mechanics 8 Working assumptions 1. Discrete (not continuous) cash flows and discrete compounding 2. Ownership capital only (no debt capital) 3. No price changes (neither inflation nor deflation during a project’s life) 4. Unlimited funds (no capital budgeting): can select all acceptable independent projects 5. Total certainty (no uncertainty or risk) 6. No government (no taxes; no depreciation of capital assets) 7. No imponderables (all project benefits and costs have been converted to their equivalent monetary value) Value of time and lives saved ……………
Fall 2009 2. Time-Value Mechanics 9 Time value of money: equivalence Time value of money Consumers prefer consuming a good or service NOW rather than later The stronger the preference for consuming NOW over later, the more important is the required compensation We will use interest rates to measure the strength of this time-related preference.

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2-Time Value Mechanics.CR - Engineering Economics ECO 1192...

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