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Simple growth.
Compounded growth.
Nominal growth rate.
Effective growth rate.
Factors involved.
Time value of money.
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Unit time is the unit year that occur at each year end.
Basic symbols,
i)
P
Present value / present worth at time 0. It is a single value occuring
only once.
ii)
F
A single value that occur in the future, that is, at any year end
except time/year 0.
iii) A
A uniform annual value that occur in series for more than 1 year,
starting at end of year 1.
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iv) G
G is a set of values that increase uniformly (gradient series) that starts at
year 1 with the value 0.
v)
e
e is a set of values that increase geometrically or exponentially in a series
of years. This series starts with an initial value D and then increases by a
specific percentage of the previous value.
vi) i
A growth rate that occur for each year and is in the form of percentage.
vii) n
It is period of the analyses usually in unit year.
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Example 2.1
Ali planned to borrow RM30,000 now and will payback this loan in a single payment at
the end of the third year. How much will he has to pay at 12% growth rate? Determine
the symbols used in Engineering Economy in this case.
Solution:
P = RM30,000
i = 12%
n = 3 years
F=?
Example 2.2
Refering to example 2.1 how much will the cumulative value of the loan if growth rate is
12% and payment will be made every year for 3 years. Determine the symbols used in
Engineering Economy in this case.
Solution:
P = RM30,000
i = 12%
n = 3 years
A=?
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Principle
The initial or basic value of an investment or loan
Growth
Represents time value of money of the principle
Growth Rate
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x 100%
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Example 2.3
Ahmad made a bank loan of RM20,000 now and is required to
pay back RM21,000 one year from now. What is the growth value
and growth rate of this loan?
Solution:
Growth = RM21,000 RM20,000 = RM1,000
Growth rate = 1,000 x 100%
20,000
= 5%
Exercise:
Borrow RM50,000 now
Pay RM 65,000 one year from now
Growth?
Growth rate?
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Example
Ali deposited RM1,000 in a bank now at the rate of 5% a year. A
year later his savings become RM1,050. Thus a growth of
RM50 occurred over the one year period.
This shows that the value of RM1,000 now is equivalent to
RM1,050 one year from now at growth rate of 5%.
RM1000
Now
Equivalent
i = 5%
RM1050
After 1 year
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Example 2.4
A company provides loan facility for workers with a pay back
scheme based on simple growth. Determine the amount
owed by a worker if he borrowed RM2,000 for 5 years at the
growth rate of 10% per year.
Solution:
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Example 2.5
A client borrowed RM2,000 from a bank with a
compounded growth rate of 10% a year. Determine
the total amount that he owes over a 5 year period.
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Solution:
Growth for year 1 = RM2,000 x 10% = RM200
Total accumulated debt at end of year 1
= RM2,000 + RM200 = RM2,200
Growth for year 2 = RM2,200 x 10% = RM220
Total accumulated debt at end of year 2
= RM2,200 + RM220 = RM2,420
Growth for year 3 = RM2,420 x 10% = RM242
Total accumulated debt at end of year 3
= RM2,420 + RM242 = RM2662
Growth for year 4 = RM2,662 x 10% = RM266.2
Total accumulated debt at end of year 4
= RM2,662 + RM266.2 = RM2,928.2
Growth for year 5 = RM2,928.2 x 10% = RM292.82
Total accumulated debt at end of year 5
= RM2,928.2 + RM292.82 = RM3,221.02
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Conclusion:
With simple growth, the debt became RM3,000 (in 5 years)
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Cash Flow, RM
Time
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Note:
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Example 2.6
A man borrowed RM5,000 now at the growth rate of 12% per
year, how much must he pay at year 5. Construct the cash
flow diagram for this problem.
Solution:
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Example 2.7
Azman invest RM2,000 every year for 6 years. He wants to
know the amount of return in his investment accumulated
after 6 years if growth rate is 10% a year. Construct the cash
flow diagram for this problem.
Solution:
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Single payment
And
Factor
And
F = P (F/P, i, n)
P = F (P/F, i, n)
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known
known
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Example 2.8
Ah Chong saves RM20,000 in a bank that promises a yearly growth
rate of 12%. How much money will be accumulated after 10 years?
Solution:
F = 20,000 (F/P, 12%, 10)
Refering to the table of
compounded growth rate,
at i = 12% and at 10 year,
F/P = 3.1058
Therefore,
F = 20,000 (3.1058)
= RM62,116
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Annual worth
And
And
And
And
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Example 2.9
How much money should be invested now to gain a return of
RM500 a year for 10 years with growth rate of 12% a year?
Solution:
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Example 2.10
If you invest RM1,000 per year starting at the end of the first
year, how much return will be accumulated at the end of the
8th year if annual growth rate is 10%?
Solution:
F = 1,000 (F/A, 10%, 8)
From the table F/A = 11.4358
Thus,
F = 1,000 (11.4358)
= RM11,435.80
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And
And
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Example 2.11
Rent for a business premise is RM500 for the first year and
increases at a constant rate of RM100 each year for 5 years.
If the annual growth rate is 8%, determine the equivalent
value of;
a) P
b) A
Solution:
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a) P
P = 500 (P/A, 8%, 5) + 100 (P/G, 8%, 5)
From the Table, P/A = 3.9927 dan P/G = 7.3724,
Therefore,
P = 500 (3.9927) + 100 (7.3724) = RM2733.59
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b) A
A = 500 + 100 (A/G, 8%, 5)
From the Table, A/G = 1.8465,
therefore,
A = 500 + 100 (1.8465)= RM684.65
5
0
500
100
684.65
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For i e
And
For i = e
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Example 2.12
Maintenance cost of a machine is RM990 in the first year and
increases at the rate of 10% a year until year 6. Calculate
present value P if the rate of return (growth rate) is;
a) 15% per year
b) 10% per year
Solution:
Where,
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-5400
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What is capitalised
project?
and
When n =
P/A = 1/i
A = Pi
P = A/i
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6,000
n=
P=?
P = A/i = 6000/0.06
= 100,000
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Recurring cost
Eg. Major rework cost of
RM 50,000 every 15
years. Meaning, this cost
recurs every 15 years
until infinity
Consider this recurring
cost in one cycle only for
the whole project life.
Treat this as a single
payment, F
Use A/F factor to find
annual operating cost
IS
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10
20
10,000
500,000
30,000,000
100,000
100,000
Recurring cost
Non-Recurring cost
IS
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Conventional cases
Cash flow (A, F)
starts at first year
and P always at
year 0
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Unconventional cases
Cash flow (A, F, G)
starts at
somewhere in the
middle
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Example 2.14
Abdullah bought a piece of land with a down payment of
RM15,000 and a yearly payment of RM1,000 for 6 years. Due
to financial problems he wishes to delay the yearly payment
and start paying 3 years from now. What is the present value
of the land if growth rate is 10% per year?.
Solution:
0
2
0
3
1
8
6
A
P
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Example 2.15
The transaction for the purchase of a fix asset is shown in the
following table;
Year
1-3
1,000
4-7
3,000
8-10
2,000
Solution:
10
1,000
2,000
3,000
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10
1,000
2,000
3,000
10
PTotal = P1 + P2 + P3
= 2,401.80 + 6,485.85 + 2,172.67
= RM11,060.32
42
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Solution 2.16
Income/return from a machine is shown in the cash flow
diagram below. Calculate P.
Solution:
Thus
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Example 2.17
Based on the following information, calculate;
i. Present worth of project
ii. Projects value at year 7
iii. Balance/remaining value of project at year 7
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Solution :
i.
Present value of project , P
P = - 170,000 8,000 (P/A, 10%, 12) +10,000 (P/G, 10%, 12)
= - 170,000 8,000 (6.8137) + 10,000 (29.9012)
= - 170,000 54,509.60 + 299,012
= RM74,502.40
ii.
iii.
P7
G = 10,000
70,000
7
A = 8,000
12
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Example 2.18
Data on a machine is as follows;
a. Expected market price after 10 years is RM30,000.
b. Revenue from the sales of product is RM12,000 per year.
c. Material and maintenance costs from year 1 to year 5 is RM5,000
per year.
d. Cost for machine overhaul is RM10,000 at year 5.
e. The maintenance cost from year 6 to year 10 is ;
Year
Value (RM)
5,000
6,000
7,000
8,000
10
9,000
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Solution:
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Compute the
Future worth in year
10
Present value
Equivalent annual
amount
Assume i = 12%
3000
700
200
150
10
300
800
1200
1400
1600
IS
1300
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(1 + iyear) = (1 + imonth)n
imonth
iyear = (1 + imonth)n -1
18
month
If imonth = 1%,
iyear
= (1 + 0.01)12 1
= 12.68%
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F=?
CASE 1
1 year
12 months
P=1000
F = P(1 + i)n
= 1000 (1 + 0.12)1
= 1120
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CASE 2
F=?
1 year
0
0
12
P=1000
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CASE 3
1 year
0
0
F=?
12
P=1000
2nd
time charging:
F6mth = 1030 (1 + 0.03) = 1060.9
3rd time
= {(
1000)/1000}x100
= _____%
4th time
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0
months
3
months
6
months
9
months
12
months
Nominal
3%
6%
9%
12%
Effective
3%
6.09%
9.27%
12.55%
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1.
ieff/period = (1 + iN/period/m)m 1
2.
3.
eff/year
= (1 + 0.12/1)1 -1 = 0.12
eff/year
= (1 + 0.12/2)2 -1 = 0.1236
eff/year
= (1 + 0.12/4)4 -1 = 0.1255
IS
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PP = CP
PP > CP
1 yr
1 yr
PP < CP
Eg. CP = 3
months,
Payment in
6 months
1 yr
Eg. Payment at 6
months, CP = 6
months
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Case 1, PP>CP
Method 1: Use iN for a period that follow
compounding period. Eg. Compounded
semiannually (twice a year), i nominal must be
per 6 months. No of periods = 2xn where 2 is no
of compounding per year and n is no of years
Or Method 2: use ieff for 1 year period. Calculate
ieff with formula ieff/period = (1 + iN/period/m)m 1
where m is no of compounding periods within a
year
IS
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Case 2, PP=CP
ieff per compounding period is equal to iN for the
payment. Eg. 12% per year compounded
semiannually and payment also at 6 months. In
this case ieff/6mth = iN/6mth = 6%.
Follow calculation using 1st method in case 1
IS
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Case 3, PP<CP
IS
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IS
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Example 2.19
For a growth rate of 12% a year compounded every 3 months,
determine;
a. Nominal and effective growth rate for 3 months.
b. Nominal and effective growth rate for 6 months.
c. Nominal and effective growth rate for 1 year.
d. Nominal and effective growth rate for 1 month.
Solution:
In (a) growth is compounded every 3 months, that is, 4 times a
year (4 period) that growth is calculated.
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Example 2.20
An individual saves RM1,000 now, RM3,000 four years from
now and RM1,500 six years from now. At a growth rate of
12% a year compounded twice a year, how much money is
accumulated in his account at year 10.
Solution:
iN = 12% compounded twice yearly
(year)
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Note:
Single Payment
Case: PP > CP
3000
1500
10 year
PP = 1 year,
CP = 6 months
1000
iN / yr
1
m
- 1 = (1 + 0.12/2)2 - 1= 12.36%
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A = 500
0
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Interest rate
What to find,
what is given
Standard notation
$500 semiannually
for 5 years
Find P, given A
P= 500(P/A,8%,10)
Find F, given A
F= 75(F/A,2%,36)
5% per quarter
Find F, given A
F= 180(F/A,5%,60)
1% per month
Find P, given G
P= 25(P/G,1%,48)
1% per month
Find A, given P
A= 5000(A/P,3.03%,24)
iS
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In single payment, if
PP > CP use iN and mn or ieff
PP = CP use iN & mn
In series A, G or e
PP > CP use ieff
PP = CP use iN & mn
iS
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Example 2.21
Calculate the nominal and effective growth if growth is
compounded every month.
Solution :
iNyear = ?
iEyear= ?
Thus,
(1 + iEmonth) = (1 + imonth)12
(1 + imonth) = (1 + 0.0364)12
(1 + imonth) = 1.5362
imonth = 0.5362 (53.62%)
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10,000
25,000
20,000
30,000
1/2
iS
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A = $500
Effective i% per 6 months
= (1 + 0.10/2)2 1 = 10.25%
F = 500(F/A, 10.25%, 14)
= 14,244.50
What is the minimum revenue
per year should the company
generate in order to recover
the maintenance cost?
IS
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