ENGINEERING ECONOMICS

LECTURE # 5 Equivalence

Dictionary meaning
‡ ‡ ‡ ‡ ‡ Sameness Likeness Similar Correspondence Equal

‡ But not identical ‡ Two things can be identical but they may not be equivalent

Why Equivalence
‡ Two or more alternatives are required to be judged on an equivalent criteria ‡ If two or more situations are to be compared, their characteristics must be placed on an equivalent basis ‡ Which is more? A pounds of product A or 2.5 Kilograms of product B ± It is necessary to place the two products on an equivalent basis by applying a conversion factor ‡ Only then you can decide which is more!!!

Equivalence
‡ Two things are said to be equivalent if they have the same effect ‡ Three elements are involved in the equivalence of sums of money
± The amounts of the sum ± The time of occurrence of the sum ± The interest rate

‡ Interest formulas consider all the above elements

Example
‡ An engineer sells his product and he is offered a choice of $ 12500 now or $ 2000 per year for the next ten years. years. Engineer is paying 12% interest on his other loans. What 12% loans. should he do? ‡ He needs to create equivalence in the two situations. HOW situations. !!!!! ‡ He should find out the present worth of $ 2000. 2000. ‡ Can we use this formula

Sn = P0(1+i)n

No«.. What should we do

‡ How about factors «. But which factor to be used ‡ In this question u have to find P for an equal annual payment (A) of $ 2000 ««««

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

Example
‡ We need to use P / A = Equal payment series present worth factor

‡ Here A = $2000, i = 12% and n = 10 ‡ Putting the values P = $ 11322.75 which is less then the $12500 therefore 12500, He should go for $ 12500 now

Principles of Equivalence
‡ Equivalent cash flows have the same values ‡ Equivalence can be established at any point of time since it is know that for one cash flow to be equivalent to another, their values must be equal

Sign up to vote on this title
UsefulNot useful