Lecture # 6 TUTORIAL on numerical questions

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Equivalence
Year 0 1 2 3 4 5 Total Plan 1 $1,000 $1,000 $1,000 $1,000 $1,000 $5,000 Plan 2 $5,000

Interest rate = 10%

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‡ Present value of Plan 1
± P = $1,000(3.791) = $3,791

‡ Present value of Plan 2
± P = $5,000

‡ Alternative 2 is better than alternative 1 since alternative 2 has a greater present value

Factors
‡ F / P = Single payment future worth factor ‡ P / F = Single payment present worth factor ‡ F / A = Equal payment series future worth factor ‡ A / F = Equal payment series sinking fund factor ‡ P / A = Equal payment series present worth factor ‡ A / P = Equal payment series capital recovery factor ‡ A / G = Arithmetic gradient series factor ‡ F / G = Arithmetic gradient future worth factor ‡ P / G = Arithmetic gradient present worth factor ‡ Geometric Gradient factor

Factors - Formulae
‡ ‡ ‡ ‡ ‡ ‡ i = annual interest rate n = interest period P = present principle amount A = Equal annual payments F = Future amount G = Annual change or gradient

F / P = Single payment future worth factor F = P (1 + i)n F / P = (1 + i)n
P / F = Single payment present worth factor

1 / (1 + i)n = P/F

F / A = Equal payment series future worth factor
What will be the future worth of an amount of $ 100 deposited at the end of each next five years and earning 12 % per annum? Answer = $ 635

A / F = Equal payment series sinking fund factor
It is desired to accumulate $ 635 by making a series of five equal annual payments at 12 % interest annually, what will be the required amount of each payment? Answer = $ 100

P / A = Equal payment series present worth factor

i = 12%, n = 5, A = $1000 Answer = $ 3604.579

A / P = Equal payment series capital recovery factor
A car has useful life of 5 years. The maintenance cost occurs at the end of each year. The owner wants to set up an account which earns 12 % annually on an amount of $ 3604 to cater for this maintenance cost. What is the maintenance cost per annum?

P = $ 3604 i = 12% n=5 Answer = $ 1000

A = ? , i = 10 %, n = 6 A = A1 + A2 A = $897.067 We have to apply A/P and A/G Factors

Sarah and her husband decide they will buy $1,000 worth of utility stocks beginning one year from now. Since they expect their salaries to increase, they will increase their purchases by $200 per year for the next nine years. What would the present worth of all the stocks be if they yield a uniform dividend rate of 10% throughout the investment period and the price/share remains constant? Solution ‡ How should we go about this questions ‡ Question involves P/A Factor and P/G Factor ‡ A = $ 1000, i = 10%, n = 9, G = $200 ‡ PW of the base amount ($1,000) is: = $5767.72 ‡ PW of the gradient is: = $3053.50 ‡ Total PW = 5767.72 + 3053.50 = $8821.22

Quiz - 1
‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ The essential pre-requisite of successful engineering application is Economic Feasibility. In evaluation of most ventures, Economic Efficiency must take precedence over physical efficiency. Engineers are confronted with two interconnected environments the Physical and Economical. Value is an appraisal of utility in terms of medium of exchange. Exchange is possible when the object is not valued equally by parties. Marginal Cost is an increment of output whose cost is barely covered by the monetary return derived from it. Interest is the rent for loaned money. The costs and benefits of engineering projects over time are summarized on a Cash Flow Diagram. Generally, money grows (compounds) into larger future sums and is Smaller / Discounted in the past. Sink cost is generally disregarded in economics. Life Cycle Cost considers all types of costs over the life of a product. Net efficiency is Physical Efficiency times economical efficiency.

Question # 2: What are the principles of Engineering Economy? ‡ Analyze the idea ‡ Develop the alternatives ‡ Focus on differences in the alternatives ‡ Use a consistent view point ‡ Use a common unit of measurement ‡ Consider all relevant criteria ‡ Make uncertain explicit ‡ Revisit your decision

Question # 3: What will be the future worth of an amount of $ 100 deposited at the end of each next five years and earning 12 % per annum? 

FV = PMT[(1+i)n - 1]/i  PMT or A = $ 100 n=5  i = 12%  Answer = $ 635

Geometric Gradient

Example
‡ Airplane ticket price will increase 8% in each of the next four years. The cost at the end of the first year will be $180. How much should be put away now to cover a students travel home at the end of each year for the next four years? interest rate as 5%. Assume

¨ 1  (1  g ) n (1  i )  n ¸ ¹ P ! A© © ¹ ig ª º ¨ 1  (1 . 08 ) 4 (1 . 05 )  4 ¸ ¨  0 . 11928 ¸ ¹ ! 180 © ! 180 © ¹ ! $ 715 . 67 © ¹ . 05  . 08 ª  0 . 03 º ª º

Example
‡ A graduating TE is going to make $35,000/yr with Granite Communications. A total of 10% of the TE salary will be placed in the mutual fund of their choice. The TE can count on a 3% salary increase with the standard of living increases for the next 30 years of employment. If the TE is aggressive and places their retirement in a stock index fund that will average 12% over the course of their career, what can the TE expect at retirement?

A = 35,000 x 0.1 = 3,500 i = 12% g = 3% n = 30

F !

« (1  i ) n  (1  g ) n » ¬ ¼ i g ­ ½

« (1 . 12 ) 30  (1 . 03 ) 30 » ! 3500 ¬ ¼ ! 3500 v 305 . 92 ! $ 1, 070 , 714 0 . 09 ­ ½

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