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ECH 3603: Pembangunan Dan Pengurusan Proje: Terminology

The document defines key terms related to capital, interest, and cash flows. It discusses: 1) Types of capital including equity and debt capital. Interest is the amount paid to use money, while interest rate is the interest per time unit. 2) Simple and compound interest are two types of interest calculations. Compound interest, where interest earns interest, is more common. 3) Cash flows include estimates of revenues, expenses, salvage values, and costs. These are presented graphically in a cash flow diagram using conventions like end-of-period assumptions. 4) Economic equivalence means two sums of money at different times can be equal if the interest rate and time periods between them are

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49 views21 pages

ECH 3603: Pembangunan Dan Pengurusan Proje: Terminology

The document defines key terms related to capital, interest, and cash flows. It discusses: 1) Types of capital including equity and debt capital. Interest is the amount paid to use money, while interest rate is the interest per time unit. 2) Simple and compound interest are two types of interest calculations. Compound interest, where interest earns interest, is more common. 3) Cash flows include estimates of revenues, expenses, salvage values, and costs. These are presented graphically in a cash flow diagram using conventions like end-of-period assumptions. 4) Economic equivalence means two sums of money at different times can be equal if the interest rate and time periods between them are

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nanabobomomo
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© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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ECH 3603 : Pembangunan dan Pengurusan Proje

TERMINOLOGY

objective
Definition Capital Interest rate

Capital refers to wealth in the form of money or property that can be used to produce more wealth Types of Capital Equity capital is that owned by individuals who have invested their money or property in a business project or venture in the hope of receiving a profit. Debt capital often called borrowed capital, is obtained from lenders (e.g., through the sale of bonds) for investment.

INTEREST the amount of money paid to use money INTEREST RATE Interest per time unit
INTEREST RATE INTEREST PER TIME UNIT ORIGINAL AMOUNT

Determination of Interest Rate

Determination of Interest Rate


Interest Rate Money Supply MS1

ie Money Demand Quantity of Money

Simple and Compound Interest


Two types of interest calculations Simple Interest Compound Interest Compound Interest is more common worldwide and applies to most analysis situations

Simple Interest
Simple Interest is calculated on the principal amount only
Easy (simple) to calculate Simple Interest is:

(principal)(interest rate)(time); RM I = (P)(i)(n)


Borrow RM 100 for 3 years at 5% per year Let P = the principal sum i = the interest rate (5%/year) Let N = number of years (3)
Total Interest over 3 Years...?

Compound Interest
In this application, compounding means to compute the interest owed at the end of the period and then add it to the unpaid balance of the loan Interest then earns interest

Compound Interest An Example


Investing $1000 for 3 year at 5% per year P0 = $1000, I1 = $1,000(0.05) = $50.00 P1 = $1,000 + 50 = $1,050 New Principal sum at end of t = 1: = $1,050.00 I2 = $1,050(0.05) = $52.50 P2=1050 + 52.50 = $1102.50 I3 = $1102.50(0.05) = $55.125 = $55.13 At end of year 3 =1102.50 + 55.13 = $1157.63

Parameters and Cash Flows


Parameters
First cost (investment amounts) Estimates of useful or project life Estimated future cash flows (revenues and expenses and salvage values) Interest rate

Cash Flows
Estimate flows of money coming into the firm revenues salvage values, etc. (magnitude and timing) positive cash flows--cash inflows Estimates of investment costs, operating costs, taxes paid negative cash flows -- cash outflows

Cash Flow Diagramming


Engineering Economy has developed a graphical technique for presenting a problem dealing with cash flows and their timing. Called a CASH FLOW DIAGRAM

Terminology and Symbols


P = value or amount of money at a time designated as the present or time 0. F = value or amount of money at some future time. A = series of consecutive, equal, end-of-period amounts of money. n = number of interest periods; years i = interest rate or rate of return per time period; percent per year, percent per month t = time, stated in periods; years, months, days, etc

The Cash Flow Diagram: CFD


Extremely valuable analysis tool Graphical Representation on a time scale Does not have to be drawn to exact scale But, should be neat and properly labeled Assume a 5-year problem

END OF PERIOD Convention


A NET CASH FLOW is Cash Inflows Cash Outflows (for a given time period) We normally assume that all cash flows occur: At the END of a given time period End-of-Period Assumption

ECONOMIC EQUIVALENCE
Economic Equivalence Two sums of money at two different points in time can be made economically equivalent if: We consider an interest rate and, No. of Time periods between the two sums

Equality in terms of Economic Value

More on Economic Equivalence Concept


Five plans are shown that will pay off a loan of RM 5,000 over 5 years with interest at 8% per year.

Plan1. Simple Interest, pay all at the end Plan 2. Compound Interest, pay all at the end Plan 3. Simple interest, pay interest at end of each year. Pay the principal at the end of N = 5 Plan 4. Compound Interest and part of the principal each year (pay 20% of the Prin. Amt.) Plan 5. Equal Payments of the compound interest and principal reduction over 5 years with end of year payments

Plan 1 @ 8% Simple Interest


Simple Interest: Pay all at end on RM5,000 Loan

Plan 2 Compound Interest 8%/yr


Pay all at the End of 5 Years

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