Value of Money
The lesson describes how compounding, time
and interest rate are used to express an amount
of money at one point in time as an equivalent
amount at another. These ideas are central to
the procedures use to economically evaluate and
compare project solutions.
The subjects of Engineering Economics
traditionally use equivalence
to express a complicated cash flow
as a single equivalent number. This lesson
introduces these factors and shows how they can
be used to answer a variety of interesting business
and personal finance questions.
For investment analysis, common economic
measures are the net present worth
of a cash flow. This lesson
shows how these measures are computed using the
To accept or not accept is the question
posed for project selection. This lesson shows
that the answer depends on the investor's minimum
acceptable rate of return (MARR).
provides a simple rule to make the decision.
This lesson uses the present and annual worth criteria for selection between
mutually exclusive alternatives. Both methods yield the same selection, but we
will see that there are important differences in application and interpretation.
The rate of return
in this lesson gives the same answers as the
net worth methods, but it is more
familiar to most decision makers. The lesson shows
how to calculate the internal
rate of return
(IRR) for a cash flow and how
it is used to make selection decisions.
of Return Comparisons
This lesson explores the rate of return method for comparing alternatives. We
learn the important lesson that the rate of return method must be applied to
increments of investment rather than directly to the individual alternatives.
Inflation of costs and revenues is inevitable
in modern economies and it complicates economic decision
making. Although the present worth, annual worth, and
rate of return methods can be used when the effects of
inflation are included, this lesson shows how the methods
must be adjusted.
With uncertainty, the chance of making
the wrong decision is inescapable. The decision
maker who simply neglects risk in his or her decisions
is neglecting reality. This lesson provides
tools to explicitly recognize uncertainty or risk.
Non-probabilistic indicators of risk are described.
Probability theory and simulation provide numerical
This lesson extends the results of this
section to the explicit consideration of risk. No deterministic
analysis should be acceptable to the decision maker when
there is significant uncertainty in the parameters of
the analysis. The decision problem is made more difficult
by risk, but the lesson shows how risk can be expressly
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by Paul A. Jensen
Copyright 2005 - All rights reserved