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In the last chapter we saw the full range of the engineering decisin-marking process. As
part of that process there was the prediction of outcomes for each alternative. In many
situations the economic consequences of an alternative were immediate, that is, took
place either right away or in a very short period of time. The decisin on the design of a
concrete aggregate mix (example 3-2) or the change of manufacturing method (example
3-3) both represent problems where the economic consequences occur over a short
period of time. Thus we can quickly total the various positive and negative aspcts and
reach a decisin. But can we do the same if the economic consequences occur over a
considerable period of time?
The installation of an expensive piece of machinery in a plant obviously has economic
consequences that occur over a protracted period of time.
If the machinery were bought on credit, then the simple process of paying for it is one that
may take several years. What about the usefulness of the machinery? Certainly it must
have been purchased because it would be a beneficial addition to the plant. These
favorable consequences may last as long as the equipment performs its useful function.
Anyone who has visite an industrial plant probably has seen equipment 10,20,30 years
old or older still in use. There may then be economic consequences that continue over a
substantial time period.
In the previous chapter there were a number of situations where the outcome from
selecting a particular alternative continued over a considerable length of time. In those
situations we created a cash flow table to show the various receipts and disbursements of
money and their timing. In this chapter we will examine the value of money at different
points in time.
We will be able to compare the value of money at different dates. And as we will see, the
ability to compare the value of money at different times is essential to engineering
economic analysis. We must be able to compare, for example, a low cost motor with a
higher cost motor. If there were no other consequences we would obviously prefer the low
cost one. But if the higher cost motor were more efficient and thereby reduced the anual
electric power cost, we are faced with the question of whether to spend more money
future. Through the equivalence relationship we will be able to relate a present sum of
money to future sums. In this chapter we will develop the basic tolos for engineering
economic analysis.
TIME VALUE OF MONEY
We often find that the money consequences of any alternative occcur over a substantial
period of time-say a year or more. When money consequences occur in a short period of
time we simply add up the various sums of money and obtain a net result. But can we treat
money this same way when the time span is greater? Which would you prefer, $100 cash
today or the assurance of receiving $100 a year from now? You might decide you would
prefer the $100 now because that is one way to be certain of receiving it.
But suppose you were convinced that you would receive the $100 one years hence. Now
what would be your answer? A Little thought should convince yuo that is still would be
more desirable to receive the $100 now. If you had the money now, rather tan a year
hence, you would have the use of it for an extra years. And if you had no current use for
$100 you could let someone else use it. The use of money is a valuable asset- so
valuable that people are willing to pay to have money available for their use. Money can
be rented in roughly the same way one rents an apartment only with money the charge for
its use is called interesent instead of rent.
The existence of interest is demonstrated by the continuing offer by Banks and savings
institutions to pay for the use of peoples money, to pay interest. If the current interest rate
is 5% per year, and you put $100 into the bank for one year, how much will you receive
back at the end of the year? Clearly you wiil receive back your original sum of $100
together with $5 interest for a total of $105. This example demosntrates then time
preference for money. We would rather have $100 today tan the assured promise of $100
a year hence. In fact, we probably would need to be assured of at least $105 a year
hence before we would consider taking the deferred payment alternative. This is because
there is a time value of money in the form of the willingness of people to pay interest forr
the use of money.
REPAYING A DEBT
To better understand the mechanics of interest le us consider a situation where we borrow
$5000 and agree to repay it in five years together with 6% anual interest. There are a great
many ways in which the debt might be repaid but for simplicity we have selected four
specific our ways for our example. Table 4-1 tabuates the four plans.
In plan 1 $1000 will be paid at the end of each year plua the interest
EQUIVALENCE
When we are indifferent whether we have a quantity of money now or the assurance of
some other sum of money in the future, or series of future sum-yfs of money or series of
future sums.
If an industrial firm believed 6% was an appropriate interest rate it would have no particular
preference whether it received $5000 now or was repaid by plan 1 of table 4-1. Thus
$5000 today is equivalent to the series of five end-of-year payments.
If you were given your choice between the two alternatves which one would you choose?
Obviously the two alternatives have cash flows that are different. Alternative A requires
that there be larger payments in the first four years, but the toisioztal payments are smaller
tan the sum of the alternative B payments. To make a decisin the cash flows must be
altered so that they can be compared.
DIFFERENCE IN REPAYMENT PLANS
The four plans computed in table 4-1 are different. Table 4-2 repeats the end-or-year
payment Schedule from previous figure. In addition, each plan is graphed to show the debt
still owed at any point in time. Since $5000 was borroawed at the beginning of the first
year all the graphs begin at that point. We see however that the four plans result in quite
different situations on the amount of money owed at any other point in time. In plans 1 and
3 the money owed declines as time passes. In plan 2 the debt remains constant while in
plan 4 the debt increases until the end of the fifth year. These graphs show an important
difference among the repayment plans-the reas under te curves differ greatly. Since the
axes are money owed and time in years, the rea is their product: (money oweed) x (time
in years).
In the discussion of the time value of money, we saw that the use of money over a time
period was valuable and that people are willing to pay interest to have the use of money
for money for periods of time. When people borrow money they are acquiring the use of
money as represented by the rea under the curve on the money owed vs time in years
curve. It follows, therefore, that at a given interest rate the amount of interest to be paid
will be proportional to the rea under the curve. Since in each case the $5000 loan is
repaid, the interest for each plan is the total minus the $5000 principal.
APPLICATION OF EQUIVALENCE CALCULATIONS
To understand the usefulness of equivalence calculation consider the following.
Is the least cost alternative the one that has th lower initial cost and higher operating costs
or the one with higher cost and lower continuing costs? Because of the time value of
money one cannot add up sums of money at different points in time directly. This means
that a comparison between alternatives cannot be made in actual dollars at different points
in time, but must be made in some equivalent comparable sums of money.
Thus far we have discussed computing equivalent present sums for a cash flow. But the
technique of equivalence is not limited to a present computation. Instead, we could
compute the equivalent sum for a cash flow at any point in time. We could compare
alternatives in equivalent year 10 dollars rather tan now (year 0) dollars.
UNIFORM SERIES FORMULAS
Many times we will find situations where there are a uniform series of receipts or
disbursements. Automobile loans, house payments, and many other loans are based on a
uniform payment series. It will often be convenient to use tables based on a uniform
seriers of receipts or disbursements the series A is defined:
A= an end-of-period cash receipt or disbursement in a uniform series continuing for n
periods, the entire series equivalent to P or F at interest rate i.
RELATIONSHIPS BETEEN COMPOUND INTEREST FACTORS
From the derivations we saw there are several simple relationships between the
compound interest factors. They are summarized here.
Single payment
Compound amount factor 1/ present worth factor
Uniform seies
Capital recovery factor= 1/ present worth factor
The uniform series present worth factor is simply the sum of the n terms of the single
payment present worth factor.
SUMMARY
In this chapter, the concepts of time value of money and equivalence are described in
detail. Also the various compound interest formulas are derived. It is essential that these
concepts and the applicability of the interest formulas be understood as the remainder of
the book is based upon them.
Time value of money. The continuing offer of Banks to pay interest for the temporary use
of other peoples money is ample proof that there is a time value of money. Thus we would
always choose to receive $100 today rather tan the promise of $100 t be paid at a future
date.
Equivalence. What sum would a person be willing to accept a year hence instead of $100
today. If a 5% interest rate is considered to be appropriate, a year hence he would require
$105 a year hence were considered equally desirable, we would say the two sums of
money are equivalent. But if on furthey consideration we decided that a 7% interest rate is
applicable, then $105 a year hence would no longer be equivalent to $100 today. This
ilustrates that equivalence is dependen on the interest rate.
quinto ao. Estos grficos muestran una importante diferencia entre los planes de las
reas bajo pago del te curvas difieren en gran medida. Dado que los ejes son dinero que
se adeuda y el tiempo en aos, el rea es su producto: (dinero oweed) x (tiempo en aos).
En la discusin sobre el valor temporal del dinero, vimos que el uso de dinero durante un
perodo de tiempo era valioso y que la gente est dispuesta a pagar un inters de tener el
uso de dinero por dinero por periodos de tiempo. Cuando la gente pide prestado el dinero
que estn adquiriendo el uso del dinero, representado por el rea bajo la curva en el
dinero que se adeuda vs vez en aos curva. Se deduce, por tanto, que a una tasa de
inters dada la cantidad de intereses a pagar ser proporcional al rea bajo la curva.
Dado que en cada caso el prstamo de 5000 est pagado, el inters para cada plan es el
total menos el 5,000 dlares director.
SOLICITUD DE CLCULOS DE EQUIVALENCIA
Para entender la utilidad del clculo de equivalencia en cuenta lo siguiente.
Es la alternativa de menor costo el que tiene un menor costo inicial y mayores costos de
operacin o el que tiene mayores costos y menores costos continuos? Debido al valor
temporal del dinero no se puede aadir hasta sumas de dinero en diferentes puntos en el
tiempo directamente. Esto significa que una comparacin entre las alternativas no se
pueden hacer en dlares reales en diferentes puntos en el tiempo, pero se debe hacer en
algunos equivalentes sumas comparables de dinero.
Hasta ahora hemos hablado de la computacin equivalentes presentes sumas para un
flujo de caja. Pero la tcnica de la equivalencia no se limita a un presente de clculo. En
su lugar, podramos calcular la suma equivalente a un flujo de efectivo en cualquier punto
en el tiempo. Podramos comparar alternativas en el ao equivalente a 10 dlares en
lugar tan ahora (ao 0) de dlares.
FRMULAS DE LA SERIE DE UNIFORMES
Muchas veces nos encontraremos con situaciones en las que hay una serie uniforme de
los ingresos o egresos. Prstamos para automviles, pagos de la casa, y muchos otros
prstamos se basan en una serie de pagos uniforme. A menudo ser conveniente utilizar
tablas basado en un Seriers uniformes de los ingresos o egresos de la serie A se define:
A = un recibo al final de su perodo de desembolso de efectivo o de una serie uniforme
continua de n periodos, toda la serie equivalente a P o F en la tasa de inters i.
seies uniformes
Factor de recuperacin de capital = 1 / factor de valor
La serie uniforme factor de valor presente no es ms que la suma de los n trminos del
pago nico factor de valor presente.
RESUMEN
En este captulo, los conceptos de valor temporal del dinero y la equivalencia se describen
con detalle. Tambin las diversas frmulas de inters compuesto se derivan. Es esencial
que estos conceptos y la aplicacin de las frmulas de inters entenderse como el resto
del libro se basa en ellos.
Valor temporal del dinero. La oferta continua de Bancos de pagar intereses por el uso
temporal de otros Popular dinero es prueba suficiente de que no es un valor temporal del
dinero. Por lo tanto nosotros siempre optar por recibir $ 100 hoy y no broncearse la
promesa de US $ 100 t ser pagado en una fecha futura.
Equivalencia. Qu suma sera una persona estar dispuesto a aceptar un ao de ah en
vez de $ 100 en la actualidad. Si se considera una tasa de inters del 5% para ser
apropiado, un ao de ah que se requieren $ 105 por ao, por lo tanto se consideraron
igualmente deseables, diramos las dos sumas de dinero son equivalentes. Pero si en la
consideracin furthey decidimos que una tasa de inters del 7% es aplicable, entonces $
105 por ao, por lo tanto ya no sera equivalente a 100 dlares en la actualidad. Esta
ilustrates que la equivalencia se dependen del tipo de inters.
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