EDA Lec 3
EDA Lec 3
ANALYSIS IN
CONSTRUCTION
Dr Zahoor
Lecture 3
Course topics and schedule
Project
Week Topic Reading (Assignment Journal
)
Introduction, Study Skills , Engineering
1 Chapter 1
Economics, Decision Making Process
2 Cost Concept, Chapter 2
Accounting systems, Balance Sheet, Chapter 18,
3
Income sheet Handouts
4 Time value of Money Chapter 3
5 Interest and Equivalence Chapter 2 Submit Weeks 1-4
7 Rate of Return Chapter 7 Phase 1 Due
8 Deprecation Chapter 11
9 Profit Centre Analysis Hand outs
10 Financial Analysis Chapter 8,9 Submit Weeks 1-9
11 Cash Flow Analysis Chapter 12
12 Benefit Cost Analysis Chapter 9 Phase 2 Due
13 Income Tax Chapter 15
14 Financing Chapter 16
15 Financial Decision Making Chapter 17 Submit Weeks 1-14
16 Project Presentations Phase 3 Due
17 Final Exam
Interest and Equivalence
3
Notation & Cash Flow Diagram &
Tables
Conventions
The horizontal line is a time scale, with
progression of time moving from left to
right
the end of Period 2 is coincident with the
beginning of Period 3.
Arrows signify cash flows and are placed
at the end of the period
If a distinction needs to be made,
downward arrows represent expenses
(negative cash flows or cash outflows)
upward arrows represent receipts
(positive cash flows or cash inflows)
4
Notation & Cash Flow Diagram &
Tables
5
EXAMPLE
6
SOLUTION EXAMPLE
2000
1 2 3 4 5
$10,000
7
Time Value of Money
Question: Would you prefer $100 today or
$100 after 1 year?
There is a time value of money. Money is a
valuable asset, and people would pay to have
money available for use. The charge for its use is
called interest rate.
Question: Why is the interest rate positive?
Argument 1: Money is a valuable resource, which
can be “rented,” similar to an apartment. Interest
is a compensation for using money.
Argument 2: Interest is compensation for
uncertainties related to the future value of the
money.
8
We know that receiving $1 today is worth
more than $1 in the future. This is due
to OPPORTUNITY COSTS.
Opportunity cost is the benefit that is
foregone by engaging a business resource in
a chosen activity…..
The opportunity cost of receiving $1 in
the future is the interest we could have
Today
earned if we had received the $1 Future
sooner.
If we can MEASURE this
opportunity cost, we can:
Today Future
?
If we can MEASURE this
opportunity cost, we can:
Translate $1 in the future into its
equivalent today (DISCOUNTING).
Today Future
?
Simple Interest
Simple interest is interest that is computed on the original
sum.
12
Simple Interest Example
You loan your friend $5000 for five years at a
simple interest rate of 8% per year.
At the end of each year your friend pays you
0.08 5000 = $400 in interest. (this money
is not paid until the end of the fifth year)
At the end of five years your friend also
repays the $5000.
After five years your friend has paid you:
Example:
P = $1,000
i = 8% End of Beginning Interest Ending
N = 3 years Year Balance earned Balance
0 $1,000
14
Compound Interest Formula
n 0 : P
n 1: F1 P(1 i )
2
n 2 : F2 F1 (1 i ) P(1 i )
N
n N : F P (1 i )
15
Compound Interest
Compounded interest is interest that is charged on the
original sum and un-paid interest.
You put $500 in a bank for 3 years at 6% compound
interest per year.
At the end of year 1 you have (1.06) 500 = $530
At the end of year 2 you have (1.06) 530 = $561.80
At the end of year 3 you have (1.06) $561.80 =
$595.51
Note:
$595.51 = (1.06) 561.80 = (1.06) (1.06) 530
= (1.06) (1.06) (1.06) 500 = 500 (1.06)3
16
Single Payment Compound
Formula
If you put P in the bank now at an interest rate of i% for n
years,
the future amount you will have after n years is given by
F = P (1+i)n
The term (1+i)n is called the single payment compound
factor.
The factor is used to compute F, given P, and given i and
n.
Handy Notation.
(F/P,i,n) = (1+i)n
F = P (1+i)n
17
Compound Interest Example
P = Principal amount
i = Interest rate End of Beginning Interest Ending
Year Balance earned Balance
N = Number of
interest periods
0 $1,000
Example:
P = $1,000 1 $1,000 $80 $1,080
i = 8% 2 $1,080 $86.40 $1,166.40
N = 3 years
3 $1,166.40 $93.31 $1,259.71
18
Compound Interest Example
$1,259.71
F = P (1+i)n
0 1 2
19
Compound Interest Example
20
Present Value Example
22
Economic Equivalence
23
Economic Equivalence
•$ 20,000 today
•$ 50,000 ten years from now
•$ 8,000 each year for the next ten years
We need to compare their economic worth!
24
Economic Equivalence
a b c d e f
Int. Owed Total Owed
Year Amnt. Princip. Total
Owed int*b b+c Payment Payment
a b c d e f
Int. Owed Total Owed
Year Amnt. Princip. Total
Owed int*b b+c Payment Payment
1 5,000 400 5,400 0 400
2 5,000 400 5,400 0 400
3 5,000 400 5,400 0 400
4 5,000 400 5,400 0 400
5 5,000 400 5,400 5,000 5,400
SUM 2,000 5,000 7,000
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Example (cont'd)
You borrowed $5,000 from a bank at 8% interest rate and you have to pay it back in 5 years.
Plan C: Pay 1,252 in five end-of-year payments.
[Uniform series capital recovery factor (page. 101, example 4.3)]
a b c d e f
Int. Owed Total Owed Total
Year Amnt. Princip. Payment
Owed int*b b+c Payment c+e
a b c d e f
Int. Owed Total Owed
Year Amnt. Princip. Total
Owed int*b b+c Payment Payment
1 5,000 400 5,400 0 0
2 5,400 432 5,832 0 0
3 5,832 467 6,299 0 0
4 6,299 504 6,802 0 0
5 6,802 544 7,347 5,000 7,347
SUM 2,347 5,000 7,347
31 ?
COMPOUND INTEREST
Example (cont'd)
Plan 1: At end of each year pay $1,000 principal plus interest due
$ Owed
EOY
Year Pay. Owed
$6,000
1 $1,400 $5,000
2 $1,320 $4,000 $5,000
3 $1,240 $3,000 $4,000
4 $1,160 $2,000 $3,000 $ Owed
5 $1,080 $1,000 $2,000
$6,200 $15,000 $1,000
$0
1 2 3 4 5
Time (Years)
32
Example (cont'd)
Plan 2: Pay interest due at end of each year and principal at end of five
years.
EOY $ Owed
Year Pay. Owed
1 $400 $5,000 $6,000
2 $400 $5,000
3 $400 $5,000 $5,000
4 $400 $5,000 $4,000
5 $5,400 $5,000
$7,000 $25,000 $3,000 $ Owed
$2,000
$1,000
$0
1 2 3 4 5
Time (Years)
33
Example (cont'd)
Plan 3: Pay in five end-of-year payments
EOY
$ Owed
Year Pay. Owed
1 $1,252 $5,000 $6,000
2 $1,252 $4,148
$5,000
3 $1,252 $3,227
4 $1,252 $2,233 $4,000
$1,000
$0
1 2 3 4 5
Time (Years)
34
Example (cont'd)
Plan 4: Pay principal and interest in one payment at end of 5 years.
EOY
Year Pay. Owed $ Owed
1 $0 $5,000
2 $0 $5,400 $8,000
3 $0 $5,832 $7,000
4 $0 $6,299 $6,000
5 $7,347 $6,802 $5,000
$7,347 $29,333 $4,000 $ Owed
$3,000
$2,000
$1,000
$0
1 2 3 4 5
Time (Years)
35
36
Example (cont'd)
Summary of Payment Plans
(a) (b) (c) (d)
Total
Plan Paid Tot. Int. Area under Ratio:
curve (b)/(c)
1 $6,200 $1,200 $15,000 0.08
2 $7,000 $2,000 $25,000 0.08
3 $6,261 $1,261 $15,767 0.08
4 $7,347 $2,347 $29,333 0.08
or
Since the areas under the curve vary for the 4 plans, but the interest
rate
37 does not, the total interest paid also varies.
Example (cont'd)
38
Rates
Example. You put $500 in a bank for 3 years at
6% compound interest per year. Interest is
compounded quarterly.
39
Rates
Example. You put $500 in a bank for 3 years at 6%
compound interest per year. Interest is compounded
quarterly.
41
Example
Example. In 3 years, you need $400 to pay a debt. In two
more years, you need $600 more to pay a second debt.
How much should you put in the bank today to meet these
two needs if the bank pays 12% per year?
0 1 2 3 4 5
$400
$600
42
Example
Example. In 3 years, you need $400 to pay a debt. In two
more years, you need $600 more to pay a second debt.
How much should you put in the bank today to meet these
two needs if the bank pays 12% per year?
0 1 2 3 4 5
$400
$600
P = 400(P/F,12%,3) + 600(P/F,12%,5)
= 400 (0.7118) + 600 (0.5674)
= 284.72 + 340.44 = $625.16
43
Example
Example. In 3 years, you need $400 to pay a debt. In two
more years, you need $600 more to pay a second debt.
How much should you put in the bank today to meet these
two needs if the bank pays 12% per year?
0 1 2 3 4 5
$400
$600
Interest is compounded
monthly
Interest is compounded yearly
P = 400(P/F, 12%/12,
3*12) + 600(P/F, 12%/12,
P = 400(P/F,12%,3) + 600(P/F,12%,5)
5*12)
= 400 (0.7118) + 600 (0.5674) = 400(P/F, 1%, 36) +
= 284.72 + 340.44 = $625.16 600(P/F, 1%, 60)
44 = 400 (0.6989) + 600
Example: Points of view -
Borrower & Investor
Borrower point of view:You borrow money from
the bank to start a business.
46