ES 25

ENGINEERING ECONOMY

CASH FLOW
LECTURE 3

Dyanne Brendalyn Mirasol – Cavero, MEng

Cash Flow
 The sums of money recorded as receipts or
disbursements in a project’s financial records
 Can be drawn to help visualize and simplify
problems that have diverse receipts and
disbursements
 Examples: deposits to a bank, dividend interest
payments, loan payments, operating and
maintenance costs, and trade-in salvage on
equipment.
Cash Flow
Purpose :
 To provide information about the cash inflows and

outflows of an entity during a period.

 To summarize the operating, investing, and financing

activities of the business.

 Helps users to assess a company’s liquidity, financial

flexibility, operating capabilities, and risk.

Cash Flow
Provides answers to the following important
questions:
- Where did cash come from?
- What was cash used for?
- What was the change in the cash balance?
Cash Flow Standards
 The horizontal (time) axis is marked off in equal
increments, one per period, up to the duration of
the project.
 Receipts are represented by arrows directed
upward. Disbursements are represented by arrows
directed downward. The arrow length is
approximately proportional to the magnitude of the
cash flow.
Cash Flow Standards
 Two or more transfers are in the same period are
placed end to end, and these may be combined.
 Expenses incurred before t=0 are called sunk costs
which are not relevant to the problem unless they
have tax consequences in an after-tax analysis.
Cash Flow
Example :
Consider a mechanical device that will cost
P20,000 when purchased. Maintenance will cost
P1,000 each year. The device will generate
revenues of P5,000 each year for five years, after
which the salvage value is expected to be P7,000.
Present the project’s cash flows in terms of standard.
Cash Flow
Cash Flow
Net cash flow = receipts – disbursements
=cash inflows –cash outflows
Cash Flow
End of period – all cash flows are assumed to occur at
the end of an interest period (not end of calendar
year)
Cash Flow Analysis
 Single payment cash flow
- can occur at the beginning of the time line
(designated as t=0), at the end of the time line
(designated as t=n), or any time in between.
Cash Flow Analysis
 Uniform series cash flow
- consists of a series of equal transactions starting at
t=1 and ending at t=n. The symbol A (representing
an annual amount) is typically given to the
magnitude of each individual cash flow
Cash Flow Analysis

Uniform series cash flow

Cash Flow Analysis
 Gradient series cash flow
- starts with a cash flow (typically with the symbol G)
at t=2 and increases by G each year until t=n, at
which the time the final cash flow is (n-1)G. The
value of the gradient at t=1 is zero.
Cash Flow Analysis

Gradient series cash flow

Time Value of Money
 The funds placed in a secure investment will
increase in value in a way that depends on the
elapsed time and interest rate.
 The interest rate that is used in calculations is known
as the effective interest rate. If compounding once a
year, it is known as the effective annual interest rate.
However, effective quarterly, monthly, or daily
interest rates are also used.
Cash Flow Formulas
 Single Payment

FV  PV (1  i) n

 1 
PV  FV  n
 (1  i) 
Cash Flow Formulas
 Single Payment Example
An engineer received a bonus of $12,000 that he
will invest now. He wants to calculate the equivalent
value after 24 years, when he plans to use all the
resulting money as the down payment on an island
vacation home. Assume a rate of return of 8% per
year for each of the 24 years. Find the amount he
can pay down.
Cash Flow Formulas
 Uniform series cash flow
 Note :
The four uniform series formulas that involve A, where A
means :
 The cash flow occurs on consecutive interest periods
 The cash flow amount is the same in each period
Cash flow formulas
 Uniform series cash flow (present worth)

 (1  i)  1
n
PV  A  n 
 i(1  i) 

 i(1  i)n 
A  PV  
 (1  i)  1
n
Cash flow formulas
 Uniform series cash flow (future worth)

 i 
A  FV  
 (1  i )  1 
n

 (1  i)n  1
FV  A  
 i 
Cash flow formulas
 Uniform series cash flow example
How much money should you be willing to pay now
for a guaranteed $600 per year for 9 years next
year, at a rate of return of 16% per year?
Cash flow formulas
 Gradient series cash flow
 Arithmetic gradient

 (1  i ) n  1  G  (1  i ) n  1 n 
PV  A  n 
   n 
 i (1  i )  i  i (1  i ) (1  i ) 
n

 Conventional gradient

 (1  i ) n  1  G  (1  i ) n  1 n 
PV  A  n 
   n 
 i (1  i )  i  i (1  i ) (1  i ) 
n
Cash flow formulas
 Gradient series cash flow (example)
The highway department expects the cost of
maintenance for a piece of heavy construction
equipment to be $5,000 in year 1, to be $5,500 in
year 2, and to increase annually by $500 through
year 10. At an interest rate of 10% per year,
determine the present worth of 10 years of
maintenance costs.
Cash flow formulas
 Gradient series cash flow
 Geometric gradient (cash flows that change by a
constant percentage)
 A1 = total cash flow in period 1

 g = rate of change per period (decimal form)

 i = interest rate per period

Cash flow formulas
  1 g  n

1    
  1 i  
PV  A1
 ig 
 
 
g i

1 n 
AG  
 i (1  i)  1 
n
Cash flow formulas

 n 
P  A1  
 (1  i ) 
g i
Cash flow formulas
 Gradient series cash flow (example)
A mechanical contractor has four employees whose
combined salaries through the end of the year are
$250,000. if he expects to give an average raise
of 5% each year, calculate the present worth of the
employee’s salaries over the next 5years. Let
i=12% per year.