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Ibbs_CE167_Lectures 4 to 8

# Ibbs_CE167_Lectures 4 to 8 - Agenda Engineering Economic...

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8/21/2011 1 CE 167 Lectures 4 - 8 Project Investment Analysis Professor William Ibbs Professor William Ibbs 1 Agenda Engineering Economic – Basic Concepts Present vs. Future Valuations Equivalence Interest Investment Analysis Methodologies NPV IRR Payback Benefit / Cost Capital Investment Decisions Bonds, Mortgates Risk & Sensitivity Analysis Why is this important? How does it affect you? Professor William Ibbs 2 CE 167 Engineering and Project Management Engineering Economic Analysis -Basic Concepts- Professor William Ibbs 3 Time Value of Money 4 Professor William Ibbs

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8/21/2011 2 Time Value of Money What is it? Example: You lend someone \$100 today. How much should that person pay you back 3 months from now? \$90 \$100? \$105? \$110? \$120? At some amount you will be indifferent. That amount represents your time value of money. Future Value = Present Value * (1 + interest) periods F = P (1 + i) n Professor William Ibbs 5 Test your Intuition Assume you agree the borrower will pay back \$120. What is the actual interest earned? F = P (1 + i a ) so i a = 20% over these 3 months Is this a good deal? What else could you have done with the \$? What opportunities did you miss out on? Compare alternatives Check if deal is repeatable so you can compare alternatives based on effective interest rate Professor William Ibbs 6 Nominal vs. Effective Interest A nominal interest rate is always specified on an annual basis. For any given interest rate to be meaningful you need to know in addition if there is any compounding…and what the terms are of that compounding. The effective interest rate is the interest you would earn on an annual basis if the compounding period were 1 year. Professor William Ibbs 7 Is \$120 in 3 months from now a good deal? What might a bank offer? Assume deal will be offered again until the end of the year AND you can compound your interest (if nothing to the contrary is stated in a problem, assume compounding). F = \$100 * (1 + 0.2) 4 = \$207.36 Calculate the effective interest rate (1 + i eff ) 1 year = (1 + 0.2) 4 ° i eff = 107.36% Professor William Ibbs 8
8/21/2011 3 Nominal Interest Rate vs. Effective Interest Rate A bank announces a new type of savings account with a nominal interest rate of 7.95% and monthly compounding. It wants to attract customers from a competitor, who is offering 8% with quarterly compounding. Will the new offering be successful? Professor William Ibbs 9 Use of Interest Tables F = P (1 + i) n is defined to be the same as F = P (F/P, i, n) where Professor William Ibbs 10 Cash Flow Diagram Conventions 1 n 0 2 P 1 n 0 2 A 1 n 0 2 G (n-1)G Correction to Shtub p. 50 Professor William Ibbs 11 Compound Interest Formulas 12

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8/21/2011 4 Compound Interest Formulas 13 Equivalence of Cash Flow Diagrams Conventions: P, F, A, G Equivalence: a series of moneys is said to be equivalent if they are equal to each other at a given point in time for a given interest rate.
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Ibbs_CE167_Lectures 4 to 8 - Agenda Engineering Economic...

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