M2 - (Notes) - Time Value of Money.pdf - MINE 396 \u2013 ENGINEERING ECONOMICS Part 2 The Time Value of Money Learning Outcomes \u2022 \u2022 \u2022 \u2022 \u2022 \u2022

M2 - (Notes) - Time Value of Money.pdf - MINE 396 –...

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MINE 396 – ENGINEERING ECONOMICS Part 2 The Time Value of Money A quantity of money held at present (time = 0) has a different buying power than the same quantity held in the future. Inflation is one reason for this, where the supply of money increases so that its unit value decreases and its buying power decreases. The opportunity to earn interest by lending money increases the value of the loaned amount which directly increases its buying power in the future. The difference between the value of money in the present (its present value ) and its value in the future (its future value ) is fundamental to the concept of valuation where, typically, future quantities of cash resulting from the operation of the project will be predicted and their total value in the present will be desired. Inflation will be discussed in a later section. For now, it can be said that inflation and interest essentially compete against each other in their effects on buying power of money. In the following it will be assumed that there is no inflation. Interest rates Interest is what a lender charges for the use of his/her money. The idea and terminology are illustrated in Figure 1 for a typical consumer loan where a bank lends money (the principal) for a specified time (the term) to an individual who uses the money to buy things. During the term the bank charges interest on the outstanding principal at a specified percentage rate. At the end of Learning Outcomes Define interest and economic equivalence Demonstrate how interest affects the value of money depending on how the interest is applied and on when the money is received or spent. Use the interest rate to compute an economically equivalent future value of a quantity of money. How interest can be compounded several times within a time interval to increase the future value of money. The differences between return on investment and interest How to discount a discrete or continuous cash flow to obtain an economically equivalent present value of a quantity of money to be received in the future.
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MINE 396 Engineering Economics 2 MINE 396 – ENGINEERING ECONOMICS Part 2 The Time Value of Money the term all the principal is returned to the bank. The principles 1 are the same for a commercial loan to a company, but there are differences between consumer and commercial loan contracts. 2 Figure 1: A consumer loan and its terminology. The principles are the same in the case of investment. When an individual or a company invests money, they are effectively lending the money to the owner of the investment and a return is expected for the use of the money. The return is entirely analogous to an interest rate and is also expressed as a percentage per unit time. For reasons to be discussed later, the return expected on an investment is typically greater that the interest rate required on a loan. 3 Simple Interest This is the simplest form of interest and is still used in some circumstances. Let V ( t ) be the value of a quantity of money at time t
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