Class Notes (1,100,000)
CA (650,000)
Western (60,000)
1220E (100)
Lecture 5

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

Department
Course Code
Professor
Martin Eidenberg
Lecture
5

This 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—‹
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—‹
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—‹
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—‹
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—‹
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—‹
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€¢