Download Present Value I

Present Worth I
Economic basis to
evaluate engineering
projects
Time Management

The expected time to deliver this
module is 50 minutes. 20 minutes
are reserved for team practices and
exercises and 30 minutes for
lecture.
Learning Objective I
After this class the students
should be able to:

Define present worth, state its
standard assumptions, and use it to
measure the economic
attractiveness of a project or an
alternative.
Situation & Solution

Equivalence can be applied to cash
flows that occur at different times,
but which equivalent measure
should be calculated and how
should it be evaluated? Often the
solution is to calculate a time 0
equivalent value or a present worth.
Warm-up (Reflection)
If the monthly inflation rate expected
for this year is 0.5%. Which will be
annual inflation rate expected?
Each team is invited to answer this question and list
the reasons that justify their respective answers.(5
minutes)
Warm-up (Example 1)
Booker Lee expects a $10,000 bonus when the
product his team is developing is marketed in
4 years. He will invest in a money market
fund that earns 8% per year. He plans to use
the money as a down payment on a house, or
to start a business, or for traveling during
retirement. Assume these occur 10, 20, and
40 years, respectively, after he receives the
bonus. At 8%, what equivalent values can be
calculated? Which one is most meaningful?
Least meaningful?

Each team is invited to reflect about this question, draw cash flow
diagrams, try to speculate some possible answers, and give
explanation about its respective answers.(10 minutes)
Cash Flow Diagram expanded
Solution

P0 = 10,000(P/F, 8%, 4) = 10,000 x .7350 = $7350

F14 = 10,000(F/P, 8%,10) = 10,000 x 2.159 = $21,590

F24 = 10,000(F/P, 8%, 20) = 10,000 x. 4.661 = $46,610

F44 = 10,000 (F/P, 8%, 40) = 10,000 x 21.725 = $217,250
Commentaries
Among them, the time 0 value (PW of $7350) is the most
meaningful. The year 44 value of $217,250 is the least
meaningful, simply because it is the furthest in time from
"now." Because we understand what $7,350 will buy now,
the PW is the one that we should use. Because each of
these values is equivalent to $10,000 at the end of year 4,
they are also equivalent to each other.
Present worth definition
 Present
worth (PW) is the
equivalent value at time 0
of a set of cash flows.
PW of a Project
Revenue
Investment
Costs
PW
What PW means?

After analyze the cash flow diagram
from the slide 15, each team is
invited explain what the PW means?
(5 minutes)
Meanings for PW
PW  0  Pr ofit
PW  0  indifference
PW  0  Loss
Standard assumptions
1.
2.
3.
4.
Cash flows occur at the end of the
period, except for first costs and prepayments like insurance and leases.
Cash flows are known, certain values.
Known, certain values are deterministic
values.
The interest rate, i, is given.
The problem's horizon or study period,
N, is given.
Utilizations of Present Worth



(1) setting a price to buy or sell a
project or an alternative;
(2) evaluating an investment or
project where the price to invest or
the first cost is given; and
(3) calculating an equivalent value
for an irregular series of cash flows.
Homework


George, a graduating civil engineering
student, is offered a job at a remote
construction project overseas. If George
is still with the project when it is
completed at the end of year 5, he will
receive a bonus of $100,000. His discount
rate is 12%. What is the present worth of
the bonus? (Use the Excel software)
Graph the answer for for discount rates
ranging from 0% to 20%. (Simulate in
the Excel software)
Reference

“Engineering Economic: Appling
Theory to Practice”
Ted G. Eschenbach
Oxford University Press
2002
Chapter 5