04.1npw_aw - Economic Decision Making Decisions using Time...

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8/25/04 Valerie Tardiff and Paul Jensen Operations Research Models and Methods Copyright 2004 - All rights reserved Economic Decision Making Decisions using Time Value of Money Models
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2 Engineering Economic Analysis Recall the seven steps of Engineering Economic Analysis
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3 Why Do We Make Investments? Buy stock in return for dividends and a higher stock price in the future. Invest in a machine in return for reduced operating costs or greater sales in the future. Buy a bond in return for interest payments and the return of principal in the future. We give up money now in the hopes of receiving more money in the future. How much return is enough?
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4 Why Do We Borrow Money? We borrow money to buy a $100,000 house in return for paying $300,000 over the next 30 years. We borrow $10,000 to buy a car and pay an extra $2,000 in interest. We buy a new set of clothes and put the bill on our credit card. We spend money now in return for paying more money in the future. How much are we willing to pay?
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5 Example Your brother borrows $200 from you. He will pay back in monthly payments of $14.44 for the next 16 months. Is this an acceptable investment for you, the lender (or investor)? Is this an acceptable loan for your brother, the borrower?
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6 Cash Flow for Lender 0 14.44 0 1 2 3 4 5 6 7 8 16 ÉÉ ÉÉ -200 For the investor
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7 Is this an acceptable investment? What is the total summed over all cash flows? -200 + $14.44 (16) = $31.04 Is this enough? Say the lender requires a minimum return of 1% per month. Does this investment obtain the required return?
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8 Selection Procedure Choose a Minimum Acceptable Rate of Return (MARR) (for the lender) or Evaluate the Equivalent Value of the Cash Flow
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04.1npw_aw - Economic Decision Making Decisions using Time...

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