Module03 - Principles of Engineering Economy Time Value of...

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Principles of Engineering Economy Time Value of Money, Interest and Interest Rates Part I
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Key Concepts Last Module: Cash Flow Diagram This Module: Time Value of Money: the value of money changes with time Money provides utility (value) when spent Value of money grows if invested Value of money decreases due to inflation Interest: used to move money through time for comparisons
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Cash Flow Analysis Given that any investment opportunity can be drawn by a cash flow diagram, how can we select the best? Transform all cash flow diagrams into something similar for comparison. Use a Common Interest Rate Use Time Value of Money Calculations
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Time Value of Money Money has value because it gives us utility. Generally, money is preferred now, as opposed to later (same amount) One can spend it now and get utility One can invest it and watch it grow with interest for greater future utility One can put it under the mattress and watch it lose purchasing power
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Time Value of Money To describe the same amount of money at different periods of time requires the use of an interest rate. With a positive rate: Money grows (compounds) into larger sums in the future. Money is smaller (discounted ) in the past.
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Interest Cost of Money Rental amount charged by lender for use of money In any transaction, someone “earns” and someone pays interest Savings Account: bank pays you; 1.5% fee to depositor Home/Auto Loan: borrower pays bank; 7.5% fee to bank
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Interest Interest Rate comprised of many factors Example: Home Mortgage: 7.5% Prime Rate : ( Banks borrow money at this rate from the Federal Reserve banks when needed) 5% Risk Factor : 1% Administration Fees : 0.5% Profit : 1% May inflate more for higher risk client.
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Definitions Principal (capital): P Amount invested or loaned Interest Rate: i Rental charge for money defined as a percentage of principal per time period Compounding Period Defines how often interest is calculated (may not be paid, however) Length of loan/investment: N periods
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Simple Interest Interest earned/paid is directly proportional to capital involved.
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Simple Interest Interest earned/paid is directly proportional to capital involved. =(Principal) (Interest Rate) (Periods)
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Simple Interest Interest earned/paid is directly proportional to capital involved. =(Principal) (Interest Rate) (Periods) I = P iN
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Example Taiwan High Speed Rail Corp. was looking to refinance its loan of NT$382 billion for owning and operating the high- speed rail link between Taipei and Kaohsiung, Taiwan.
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