Engineering Economic Analysis

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144 PRESENTWORTH ANALYSIS

In Chapters 3 and 4 we accomplished two important tasks. First, we presented the concept

of equivalence. We are powerless to compare series of cash flows unless we can resolve

them into some equivalent arrangement. Second, equivalence, with alteration of cash flows

from one series to an equivalent sum or series of cash flows, created the need for compound

interest factors. So, we derived a whole series of compound interest factors-some for

periodic compounding and some for continuous compounding. This background sets the

stage for the chapters that follow.

ASSUMPTIONSIN SOLVING ECONOMIC ANALYSISPROBLEMS

One of the difficulties of problem solving is that most problems tend to be very compli-

cated. It becomes apparent thatsomesimplifying assumptions are needed to make such

problems mana,geable. The trick, of course, is to solve the simplified problem and still be

satisfied that the solution is applicable to the realproblem! In the subsections that fol-

low, we will consider six different items and explain the customary assumptions that are

made. These assumptions apply to all problems and examples, unless other assumptions are

given.

End-of-Year Convention

As we indicated in Chapter 4, economic analysis textbooks and practice follow the end-

of-period convention. This makes"A" a seriesof end-of-period receipts or disbursements.

(We generally assumein problems that all seriesof receipts or disbursementsoccur at the

endof the interest period. This allows us to use valuesfrom our compoundinteresttables

without any adjustments.)

A cash flow diagram ofP, A,andFfor the end-of-period convention is as follows:

Year0

Jan 1

End of Year 1

Dee 31 Jan 1

.End of Year 2

Dee 31

A

,A

t

p F

If one were to adopt a middle-of-period convention, the diagram would be:

Year0

Jan 1

Middle of

Year 1

Jun 30 Dee 31 Jan 1

Middle of

Year 2

Jun 30

End of Year 2

Dee 31

A A

p F

As the diagrams illustrate, onlyAshifts;Premains at the beginning-of-period andFat the

end-of-period, regardless of the convention.The compound interest tables in the Appendix

are based on the end-of-period convention.

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