IE 347 FALL 2023 / 2024

OCTOBER 10, 12 2023

WEEK 2
 IE347 Week Topics

Basics
Engineering Economy
Interest and Interest Rates
Cash Flows
Minimum Attractive Rate of Return

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 Time Value of Money

Two Alternatives
Alternative 1.$100 cash today

Alternative 2.Assurance of receiving $100 a year from now

Question: Which one would you prefer?

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 Time Value of Money

Two Alternatives
Alternative 1.$100 cash today

Alternative 2.Assurance of receiving $110 a year from now

Question: Which one would you prefer?

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 Time Value of Money

In Financial World money itself is a commodity

Like any other commodity that are bought and sold

money costs and earns money

The charge of using the money is called interest

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 Economic Equivalence

Economic equivalence exists between cash flows that

have the same economic effect

That equivalence depends on the interest rate

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 Economic Equivalence

$100 in October 2023

10% annual rate

October 2024

October 2022

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 Economic Equivalence

$100 October 2023

$200 October 2024

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 Time Value of Money

$100 in 2023

$50/year for 4 years (from 2024 to 2027)

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 Interest

Interest Amount

Two perspectives to an amount of interest

Interest Paid
Interest Earned

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 Interest

Interest Rate (%) and Rate of Return

Interest Period

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 Interest – Example
A person borrows $200 today and must repay a total
of $220 exactly one year later, on October 10, 2024.

Interest period

Interest amount

Interest rate / Rate of return

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 Interest –Example

A person invests $200 today and will receive a total of

$240 exactly 6 months later, on April 10, 2024.

Interest period

Interest amount

Interest rate / Rate of return

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 Compound and Simple Interest

An engineer borrowed $1,000 from his company for one

year at 5% per year.

Find the interest amount and the total amount due after 1
year.

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 Compound and Simple Interest

An engineer borrowed $1,000 from his company for 3 years

at 5% per year.

How much money will the engineer repay at the end of 3

years?

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 Compound and Simple Interest

For more than one interest period, the interest type

should be defined
Simple interest
Compound interest

Simple interest is calculated using the principal only,

ignoring any interest accrued in preceding periods.

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 Compound and Simple Interest

An engineer borrowed $1,000 from his company for 3

years at 5% per year simple interest.

How much money will the engineer repay at the end of 3

years?

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 Compound and Simple Interest

Compound interest is accrued on the principal plus the total

amount of interest accumulated in all previous periods.

Interest = (principal+ accumulated interest)(interest rate)

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 Compound and Simple Interest

An engineer borrowed $1,000 from his company for 3

years at 5% per year compound interest.

How much money will the engineer repay at the end of 3

years?

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 Terminology and Symbols

P: value or amount of money at present or time 0.

Present Worth (PW)
Present Value (PV)
Net Present Value (NPV)

F: value or amount of money at some future time.

Future Worth (FW)
Future Value (FV)

A: series of consecutive, equal, end-of-period amounts

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 Terminology and Symbols

i: interest rate (or rate of return) per interest period

compound unless otherwise stated
expressed as percent per interest period

n: number of interest periods

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 Terminology and Symbols -- Example

A Credit Union loaned money to an engineer.

The loan is $1,000 for 3 years at 5% per year.

The amount of money that the engineer will repay at the

end of 3 years.

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 Cash Flows

Cash Flows: The estimated inflows and outflows of money

+ : cash inflows
− : cash outflows

Net Cash flow = Cash Inflows - Cash Outflows

End-of-period convention: All cash flows occur at the end of

the interest period.

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 Cash Flow Diagram

Graphical representation of cash flows drawn on a time scale

includes what is known, what is estimated, what is needed
t = 0: the present,
t = 1 is the end of time 1

Cash inflow

Cash outflow

Perspective should be defined

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 Cash Flows

1. Draw a time line

2. Show the cash flows

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 Cash Flows -- Example

A Credit Union loaned money to an engineer.

The loan is for $1,000 for 3 years at 20% per year.
How much money will the engineer repay at the end of 3 years?

From Engineer’s Perspective

From Credit Union’s Perspective

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 Cash Flows

A businessman started to invest by depositing $1M on

January 1, 2023 to a national bank.

He plans to deposit $2M on July 1, 2025 and $3M on

July 1, 2028.

He wants to withdraw $3M on January 1, 2031.

If he manages to invest according to that plan, how

much money will he have on January 1, 2033. if the
interest is taken as 10 % per each year?

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 Cash Flows

A businessman started to invest by depositing $1M on

January 1, 2023 to a national bank.

He plans to deposit $2M on July 1, 2025 and $3M on

July 1, 2028.

He wants to withdraw $3M on January 1, 2031.

If he manages to invest according to that plan, how

much money will he have on January 1, 2033. if the
interest is taken as 4 % per each semi year?

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 Cash Flows

Interest period = year

n = 10 years
i = 10% per annual
Concern : how to deal with $2M on July 1, 2025 and
$3M on July 1, 2028

Interest period = 6 months (semi annual)

n = 20 semi annuals
I = 6% per semi annual
Concern : how to deal with big n

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 Cash Flows

A businessman started to invest by depositing $1M on January 1,

2023 (year 0) to a national bank.

He plans to deposit $2M on July 1, 2025 (January 1, 2026, year 3)

and $3M on July 1, 2028 (January 1, 2029, year 6).

He wants to withdraw $3M on January 1, 2031 (year 8).

If he manages to invest according to that plan, how much money

will he have on January 1, 2033 (year 10) if the interest is taken as
10% per each year?

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 Cash Flows

A businessman started to invest by depositing $1M on January 1,

2023 (semi year 0) to a national bank.

He plans to deposit $2M on July 1, 2025 (semi year 5) and $3M on

July 1, 2028 (January 1, 2029, semi year 11).

He wants to withdraw $3M on January 1, 2031 (semi year 16).

If he manages to invest according to that plan, how much money

will he have on January 1, 2033 (semi year 20) if the interest is
taken as 4% per each semi year?

9.10.2023
 IE347 Week Topics

Basics
Engineering Economy
Interest and Interest Rates
Cash Flows
Minimum Attractive Rate of Return

9.10.2023
 Minimum Attractive Rate of Return

Rate of Return = amount earned / amount invested

For any investment to be profitable positive return on

investment must be realized

An acceptable rate of return is called Minimum Attractive

Rate of Return (MARR)

MARR is not a rate calculated, decided by managers

For an Accepted Investment:

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 Minimum Attractive Rate of Return

Cost of Capital: the interest paid to raise capital

Equity Financing
Debt Financing
Weighted Average of Equity and Debt Financing

For an Accepted Investment:

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 Minimum Attractive Rate of Return

Opportunity Cost:

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