Review of Basic Engineering Economy

Reviewof Basic Engineering

Economy

Cash Flows and the Time Value

Cash Flows and the Time Value

of Money

Chapter 2

The Interest Rate

Interest is the cost of money—a cost to the borrower

and an earning to the lender

Interest rate: time rate at which a sum of money earns interest.

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Notation / Terminology

Cash flow: Receipt (inflow) or payment (outflow) of an amount of money.

financial description (visual) of a project

Cash flow Diagram

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End Of Year, EOY

Of

EOY

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Interest period: it determines how frequently interest is calculated.

Money grows (compounds) into larger future sums in the future.

Money is smaller (discounted ) in the past.

Note that even though the length of the interest period can vary,

interest rates are frequently quoted in terms of

an annual percentage rate.

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Example

Example

• Tissue paper company Svenska Cellulosa announced an

paper company Svenska Cellulosa announced an

investment of SEK (Swedish Krona currency ) 490 million

for a new tissue machine at its Valls, Spain plant to expand

capacity by 60,000 tons/year. Most product is for retail

private labels.

• Assume: Investment in 2006 with operations beginning in

2007. The machine has a service life of 10 years and a

salvage value of SEK25M. Fixed O&M costs are SEK10

million in year 1, increase 8% per year. Revenues are

SEK6

SEK6,400/ton against costs of SEK4,600/ton.

against costs of SEK4

• Draw the cash flow diagram.

Source: “SCA Invests Around SEK490M in New Tissue Machine in Spain,” Dow Jones Newswires, December 22, 2005.

Cash Flow Diagram

Cash Flow Diagram

• Net Cash Flow Diagram

Flow Diagram

98.0M 97.2M 96.4M

0

490M

1

2

3

113M

89.5M

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10

This is a “typical” investment.

(Invest at zero, returns later.)

Can also use a spreadsheet!

Return to our Example

Return to our Example

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Example: Tissue...