1
Economic Equivalence
ME 434W
Han P. Bao
Department of Mechanical Engineering
ME 434
Economic Equivalence
1
Basic Premises of Engineering
Economics
•
Time Value of Money
–
The value of money today is different from its value at
f
i
some future time
–
Money has earning power due to compound interest
–
It is important to differentiate between the time value of
money and the effect of inflation
Notations
i = Interest rate per interest period
ME 434
Economic Equivalence
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n= Number of interest periods
P = Present value of money
F = Future value of money
A = End-of-Period cash receipt in a uniform series

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2
Cash Flow Diagram
The cash flow diagram has the following features:
1- A time line (horizontal line)
2- Up arrows for represent receipt down arrows for disbursements
2
Up arrows for represent receipt, down arrows for disbursements
3- Location of arrows: P at beginning of period, A and F at end of
period
1
2
3
4
5
6
7
F
A
A
A
A
A
A
A
F
the cash
ME 434
Economic Equivalence
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A
A
A
A
A
A
A
0
1
2
3
4
5
6
7
2 ways to draw t
flow diagram
P
P
End-of-Year Convention
Economic Equivalence
•
Economic equivalence (E
2
) to the fact that there is an
indifference with regard to having a quantity of money
now (P) or the assurance of some other sum of money in
the future (F), or series of future sums of money (A).
•
P: Present sum of money
•
F: future sum of money
•
A: End-of-period cash receipt in a uniform series
•
Fundamental relationship of E
2
:
W and G can
want
given
ME 434
Economic Equivalence
4
G
W
G
W
W and G can
be P, F, or A
A more formal notation is
W = G (W/G, i%, n)