Professional Documents
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5. List three evaluation criteria besides the economic one for selecting the best
restaurant.
8. Trucking giant Yellow Corp agreed to purchase rival Roadway for $966 million
in order to reduce so-called back-office costs (e.g., payroll and insurance) by $45
million per year. If the savings were realized as planned, what would be the rate
of return on investment?
10. At an interest rate of 8% per year, $10,000 today is equivalent to how much (a) 1
year from now (b) 1 year ago?
12. Certain certificates of deposit accumulate interest at 10% per year simple interest.
If a company invests $240,000 now in these certificates for the purchase of a new
machine 3 years from now, how much will the company have at the end of the 3-
year period?
13. A local bank is offering to pay compound interest of 7% per year on new savings
accounts. An e-bank is offering 7.5% per year simple interest on a 5-year
certificate of deposit. Which offer is more attractive to a company that wants to
set aside $1,000,000 now for a plant expansion 5 years from now?
14. A company that manufactures in-line mixers for bulk manufacturing is company
borrow now or 1 year from now? Assume the total amount due will be
considering borrowing $1.75 million to update a production line. If it borrows the
money now, it can do so at an interest rate of 7.5% per year simple interest for 5
years. If it borrows next year, the interest rate will be 8% per year compound
interest, but it will be for only 4 years. (a) How much interest (total) will be paid
under each scenario, and (b) Should the paid when the loan is due in either case.
1. Define the symbols involved when a construction company wants to know how
much money it can spend 3 years from now in lieu of spending $50,000 now to
purchase a new truck, when the compound interest rate is 15% per year?
2. State the purpose for each of the following built-in Excel functions:
a. FV(i%,n,A,P)
b. IRR(first_cell:last_cell)
c. PMT(i%,n,P,F)
d. PV(i%,n,A,F)
4. Construct a cash flow diagram for the following cash flows: $10,000 outflow at
time zero, $3000 per year outflow in years 1 through 3 and $9000 inflow in years
4 through 8 at an interest rate of 10% per year, and an unknown future amount in
year 8.
5. Use the rule of 72 to estimate the time it would take for an initial investment of
$10,000 to accumulate to 20,000 at a compound rate of 8% per year.
6. If you now have $62,500 in your retirement when the account is worth $2 million,
estimate the rate of return that the account must earn if you want retire in 20 years
without adding any more money to the account.
2. Information gathering.
a. The technology and equipment are expected to last about 10 years.
b. The inflation and income taxes are ignored for simplicity
c. The expected ROI were compound rates of 15%, 5% and 18%. And 5%
rate for enhancing an employee-safety
d. Equity capital financing beyond $5 millions is not possible. The amount of
debt financing and its cost are unknown
e. Annual operating cost 8% of first cost for major equipment
f. Increased annual training cost and salary range from $800,000 to $1.2
million
g. Another economic and non economic factors that may influence to each
alternative.
4. Alternatives Analysis
5.
Nominal and Effective Interest Rates
Nominal interest rate, r, is an interest rate that does not include any
consideration of compounding. By definition:
Effective interest rate is actual rate that applies for a stated period of
time. The compounding of interest during the time period of the
corresponding nominal rate is accounted for by the effective interest
rate. It is commonly expressed on an annual basis as the effective
annual rate ia, but any time basis can be used.
ieff = ( 1 + r/m)m 1
1. An engineer deposit $300 per month into a savings account that pays interest at a
rate of 6% per year, compounded semi-annually. How much will be in the
account at the end of 15 years? Assume no inter-period compounding.
1 900
2-4 700
7 1000 2600
11 - 1000
Continuous Compounding
i% = er 1
5. In N Out Payday Loans advertises that for a fee of only $10, you can
immediately borrow up to $200 for one month. If a person accepts the
offer, what are (a) the nominal interest rate per year and (b) the effective
rate per year?
1. How much money could the maker of fluidized bed scrubbers afford to spend
now instead of spending $150,000 in year 5 if the interest rate is 10% per year in
years 1 through 4 and 1% per month in years 5 through 8?
2. For the cash flows shown below, determine (a) the future worth in year 5 and (b)
the equivalent A value for years 0 through 5.
0 5000 12
14 6000 12
5 9000 20
PRESENT WORTH ANALYSIS (PW ANALYSIS)
Mutually exclusive project: only one of the viable projects can be selected
Independent project: more than one viable project may be selected
Example.
Perform a PWA of equal-service machines, if MARR is 10%/year
Revenues for all three alternatives are expected to be the same
Answer:
Example.
A project engineer with EnvironCare is assigned to start up a new office in a city where a
6-year contract has been finalized to take and analyze ozone-level readings. There are
two options:
Location A Location B
First Cost, $ -15,000 -18,000
Annual Cost, $ -3,500 -3,100
Deposit Return, $ 1000 2000
Lease Time, years 6 9
(a) Determine which lease option should be selected on the basis of PW, if MARR is
15%/year
(b) If a study period of 5 years is used, which location should be selected ?
(c) If a study period of 6 years is used, and the deposit return of alternative B is
estimated to be $ 6000 after 6 years, which location should be selected?
Answer.
Since the lease have different term, the LCM(6,9) is 18
Location B is selected, because the PWB value is numerically larger than PWA
Step 1. Draw cash flow diagram showing all non-recurring (one-time) cash-flows
and at least two cycles of all recurring cash-flows.
Step 2. Find the PW of all non-recurring amounts . This is their CC value
Step 3. Find the equivalent uniform AW (annual worth/value) through one life
cycle of all recurring amounts.
Step 4. Divide the AW in step 3 by i to obtain a CC value.
Step 5. Add CC values obtained in step 2 and 4.
The payback period np is the estimated time (in years), it will take for the estimated
revenues and other economic benefits to recover the initial investment and a stated rate of
return.
np
If the stated rate i>0%, then 0 = -P + NCFt (P/F, i, t)
t=1
Where: P : is the initial investment (first cost)
NCFt : Net Cash Flow for each year t = receipt disbursement
If NCF values are expected to be equal each year: 0 = - P + NCF (P/F, i, np)
If the NCF series are uniform: np = P/NCF
Generally, LCC estimates may be categorized into simplified format for the major phases
of acquisition and operation as following:
A. Acquisition Phase
Requirement definition Stage:
(a) Determination of user need
(b) Anticipated system
(c) Preparation and documentation
Preliminary design
(a) Feasibility Study
(b) Conceptual
(c) Early Stage Plans
Detail Design. Detail Plan & Resources
(a) Capital, human, facilities, information system, marketing
(b) Some acquisition of assets
B. Operation Phase
All activities are functioning, products & services are available
Construction & implementation, testing and preparation
Usage Stage: to generate products and services
Phase Out & Disposal Stage
Equity Financing: The corporation uses its own funds from cash on hand, stock sales,
or retained earning. The individuals can use their own cash, savings or investment.
Debt Financing: The corporation borrows from outside sources and repays the
principal and interest. Sources of dept capital may be bonds, loans, mortgages, venture
capita pools. Individuals can utilize debt sources, such as credit card or from a credit
union.
A time-tested method of raising capital is through the issuance of IOU (I owe you), which
is financing through debt. One form of IOU is bond.
Bonds are usually issued in face value amounts of $100, $1000, $5000 or $10,000.
Bond Interest I (also called bond dividend) is paid periodically
The bond interest is paid c times per year.
The stated interest rate is called the bond coupon rate b
Example.
Determine the purchase price you should be willing to pay now for a 4.5% $5000 10-year
bond with interest paid semiannually. Assume your MARR is 8% per year compounded
quarterly.
Solution..
Problems
5.9, 5.11, 5.14, 5.16, 5.26, 5.28, 5.38, 5.39, 5.42, 5.49, 5.50