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Economic Equivalence [Compatibility Mode]

# Economic Equivalence [Compatibility Mode] - Economic...

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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 2 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 3 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)