Engineering Economic Analysis

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Computing Cash Flows 63

The cash flowsfor both the alternativesin this problem are very simple. The cash flow table,

with disbursements given negative signs, is as follows:

Endof Year

o (now)

1

2

3

4

5

Pay in FuUNow-

-$29,100

o

o

o

o

o

Pay Over 5 Years

---$5000

-8000

-6000

-6000

-6000

-6000

.- =

~..~. _..~. .~.

A man borrowed $1000 from a bank at 8% interest. He agreed to repay the loan in two end-of-year
payments. At the end of the first year, he will repay half of the $1000 principal amount plus the
interest that is due. At the end of the second year,he will repay the remaining half of the principal
amount plus the interest for the second year. Compute the borrower's cash flow.

.SOL '.TI()N

In engineering economic analysis, we normally refer to the beginning of the first year as "time 0."

At this point the man receives $1000 from the bank. (A positivesign represents a receipt of money
and a negative sign, a disbursement.) Thus, at time 0, the cash flow is +$1000.
At the end of the first year, the man pays 8% interest for the use of $1000 for one year. The

interest is 0.08 x $1000 =$80. In addition, he repays half the $1000 loan, or $500. Therefore,

the end-of-year-I cash flow is -$580.

At the end of the second year, the payment is 8% for the use of the balance of the principal
($500) for the one-year period, or 0.08 x 500 = $40. The $500 principal is also repaid for a total

end-of.;.year-2cash flow at -$540. The cash flow is:

Endof Year

o (now)

1

2

Cash Flow

+$1000

-580

-540

l

In this chapter, we will demonstrate techniques for comparing the value of money at

different dates, an ability that is essential to engineeringeconomicanalysis. We must be able

to compare, for example, a low-cost motor with a higher-cost motor. If there were no other

consequences, we would obviously prefer the low-cost one. But if the higher-cost motor

were more efficient and thereby reduced the annual electric power cost, we would want

to consider whether to spend more money now on the motor to reduce power costs in the