Class Notes (1,100,000)

CA (650,000)

Western (60,000)

Business Administration (400)

1220E (100)

Martin Eidenberg (10)

Lecture 5

# Business Administration 1220E Lecture Notes - Lecture 5: Engineering Economics, Interest, Cash Flow

by OC2377477

School

Western UniversityDepartment

Business AdministrationCourse Code

Business Administration 1220EProfessor

Martin EidenbergLecture

5This

**preview**shows pages 1-2. to view the full**6 pages of the document.**Net Present Value & Interest

Net Present Value compares the value of a dollar today to the value of the same

dollar in the future

Takes the difference between the present value of cash inflows and the

present value of cash outflows

â—‹

â€¢

Future gains of a dollar amount today are based on the interest earned on that

amount

â€¢

2 Types of Interest

Simple Interest

â—‹

Compound Interest

â—‹

â€¢

Simple Interest

Interest is paid on the principal but not on any previously earned interest

â€¢

!"#

$

%&'(

)

â€¢

Compound Interest

Interest is earned on the principal and the interest earned in proceeding periods

â€¢

!"#

$

%&'

)

*

â€¢

Cash Flow Diagrams

Net Present Value (NPV)

#" +

!,

$%&-),

*

,./

â€¢

An investment is:

Good if NPV > 0

â—‹

Bad if NPV < 0

â—‹

â€¢

Internal Rate of Return (IRR)

Discount rate at which the NPV of a series of cash flows equals 0â€¢

Determines the feasibility of an investment

Good: IRR > MARR

â—‹

Bad: IRR < MARR

â—‹

â€¢

External Rate of Return (ERR)

Rate at which the future value of an investment made at t=0 is equal to the

future value of the reinvested cash flows generated by the investment

â€¢

Determines the feasibility of an investment

Good: ERR > MARR

â—‹

Bad: ERR < MARR

â—‹

â€¢

Depreciation & Taxes

Depreciation is not a cash flow and should not be included in a NPV analysisâ€¢

Taxes are real cash flows that need to considered in a NPV analysisâ€¢

Tax shield: depreciation reduces taxesâ€¢

We need to adjust for depreciation to determine after-tax cash flowâ€¢

Public Sector Decisions

The government must evaluate more than just financial considerations

Benefits

Positive factors associated with a project

Â§

â—‹

Disbenefits

Negative factors associated with a project

Â§

â—‹

Revenues

Actual cash income associated with a project

Â§

â—‹

Costs

Actual cash expenses associated with a project

Â§

â—‹

â€¢

The decisions often made are very short-term to be re-electedâ€¢

Voters tend to be short sighted and generally dislike tax increases for any

reason

â€¢

Cost-Benefit Analysis

Quantify all benefits and disbenefits in $ termsâ€¢

Benefit-Cost Ratio: 012"345$67879:7;<=<>797?@AB<C<D@;E797?@AB)

345$FG;A;)

â€¢

Engineering Economics Math

Only pages 1-2 are available for preview. Some parts have been intentionally blurred.

Net Present Value & Interest

Net Present Value compares the value of a dollar today to the value of the same

dollar in the future

Takes the difference between the present value of cash inflows and the

present value of cash outflows

â—‹

â€¢

Future gains of a dollar amount today are based on the interest earned on that

amount

â€¢

2 Types of Interest

Simple Interest

â—‹

Compound Interest

â—‹

â€¢

Simple Interest

Interest is paid on the principal but not on any previously earned interestâ€¢ !"#$%&'()

â€¢

Compound Interest

Interest is earned on the principal and the interest earned in proceeding periodsâ€¢ !"#$%&')*

â€¢

Cash Flow Diagrams

Net Present Value (NPV)

#" +

!,

$%&-),

*

,./

â€¢

An investment is:

Good if NPV > 0

â—‹

Bad if NPV < 0

â—‹

â€¢

Internal Rate of Return (IRR)

Discount rate at which the NPV of a series of cash flows equals 0â€¢

Determines the feasibility of an investment

Good: IRR > MARR

â—‹

Bad: IRR < MARR

â—‹

â€¢

External Rate of Return (ERR)

Rate at which the future value of an investment made at t=0 is equal to the

future value of the reinvested cash flows generated by the investment

â€¢

Determines the feasibility of an investment

Good: ERR > MARR

â—‹

Bad: ERR < MARR

â—‹

â€¢

Depreciation & Taxes

Depreciation is not a cash flow and should not be included in a NPV analysisâ€¢

Taxes are real cash flows that need to considered in a NPV analysisâ€¢

Tax shield: depreciation reduces taxesâ€¢

We need to adjust for depreciation to determine after-tax cash flowâ€¢

Public Sector Decisions

The government must evaluate more than just financial considerations

Benefits

Positive factors associated with a project

Â§

â—‹

Disbenefits

Negative factors associated with a project

Â§

â—‹

Revenues

Actual cash income associated with a project

Â§

â—‹

Costs

Actual cash expenses associated with a project

Â§

â—‹

â€¢

The decisions often made are very short-term to be re-electedâ€¢

Voters tend to be short sighted and generally dislike tax increases for any

reason

â€¢

Cost-Benefit Analysis

Quantify all benefits and disbenefits in $ termsâ€¢

Benefit-Cost Ratio: 012"345$67879:7;<=<>797?@AB<C<D@;E797?@AB)

345$FG;A;)

â€¢

Engineering Economics Math

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