B. E.

MECHANICAL ENGINEERING
Choice Based Credit System (CBCS) and
Outcome Based Education (OBE)
SEMESTER - V

MANAGEMENT AND ECONOMICS -18ME51

Module-3

Presented by
Mr.Hemanth kumar C B
Assistant Professor
Department of Mechanical Engineering
BIT, Bengalure-04
 MANAGEMENT AND ECONOMICS -18ME51
SYLLABUS
Module-1 :Management and Planning
Module-2 : Organizing and Staffing
Directing & Controlling
Module-3 : Introduction to Economics
Interest and interest factors
Module-4 : Present, future and annual worth and
rate of returns
Module-5 : Costing and Depreciation
 TEXT BOOKS

1.Principles of Management by Tripathy and Reddy

Tata McGraw Hill , 3rd edition 2006
2. Mechanical estimation and costing, T.R. Banga &
S.C. Sharma, Khanna Publishers ,17th edition 2015
3. Engineering Economy, Riggs J.L. McGraw Hill, 2002
4. Engineering Economy, Thuesen H.G. PHI , 2002

Note: “Interest factor Table” required for Module-3&4

Author: R.Paneerselvam, PHI publication
 REFERENCE BOOKS
1. Management Fundamentals- Concepts, Application, Skill
Development - RobersLusier – Thomson
2. Basics of Engineering Economy, Leland Blank & Anthony
Tarquin, McGraw Hill Publication (India) Private Limited
3. Engineering Economics, R.Paneerselvam, PHI publication
4. Fundamentals of Management: Essential Concepts and
Applications, Pearson Education, Robbins S.P. and Decenzo
David A.
5. Economics: Principles of Economics, N Gregory Mankiw,
Cengage Learning
6. Modern Economic Theory, By Dr. K. K. Dewett & M. H.
Navalur, S. Chand Publications
MODULE-3: INTEREST AND INTEREST FACTORS
• Interest.
• Interest Rate.
• Simple interest [S.I].
• Compound interest [C.I].
• Effective interest rate.
• Nominal interest rate.
• Continuous compounding.
• Cash Flow diagram.
• Time value of Money.
 INTEREST
• Interest is the cost of using capital
• It is the rental amount charged by financial
institution for the use of money
• Interest is an amount of money received as result
of investing funds either by lending it or by using
it in the purchase of materials, labours or
facilities. Interest received in this connection is
“Gain or Profit “
• Interest is an amount of money paid as result of
borrowing funds. Interest paid in this connection
is cost
 INTEREST RATE
• It is the rate of Gain received from an investment

• Usually this rate of gain stated on “per year basis “

• It represents the ‘percentage gain realized’ on the money

committed to the firms.
Example:12%

• It is determined by market forces, demand and supply

• The price determined by mutual agreement between

borrower and the lender and is known as ‘Interest rate’
 Simple interest [S.I]
• Interest earned is directly proportional to the
capital involved in the loan
• The interest earned I,through several time
periods is found by I=P i N
Where P= present amount or principal or
borrowed amount
i=interest rate per period
N=No.of interest period
 Simple interest [S.I]
• If P is a fixed value, the annual interest
charged is constant
• Therefore the total amount a Borrower is
obligated to pay a Lender is
F=P+ I
=P +PiN
F=P(1+iN)
Where F=future sum of money to be paid
Note: When “N” is not a full year, there are two
ways to calculate S.I earned during the period
of the loan.
i)When Ordinary S.I is used, the year is divided
into twelve 30 days periods or year is
considered to have 360 days.
ii)In Exact S.I a year has precisely the calender
no. days and N is a fraction of the no.days the
loan is in effect that year.
 Example
• A rental cost of money is a loan of Rs.1000 for
2 months at 10% .
Ordinary S.I
The amount to be repaid is F=P(1+iN)
Where N is 2 months
N=2/12 years
F=1000(1+0.1x2/12)=Rs.1016.66667
 Example

Exact S.I
The amount to be repaid is F=P(1+iN)
Where N is 2 months
Assume that, Jan(31 days) and Feb (28days)
Then, F=1000[1+0.1x({31+28}/365)]
F=1016.16438
Problem1: A loan at Rs.200 is made for a period of 13 months from january 1
to january 31 the following year at a simple interest rate of 10%.What future
amount is due at the end of the loan period considering Ordinary and Exact S.I

Given: P=Rs.200
i=10%=10/100=0.1
Ordinary S.I
F==P[1+iN]=200[1+0.1(1+1/12))]=Rs221.67
Exact S.I
F=P(1+iN)=200[(1+0.1(1+31/365)]=Rs.221.
 Problem2: What sum must be loaned at 8% simple
interest to earn Rs.350 in 4 years

Given:
P=?, i=8%, I=350,N=4years
Wkt. I=PiN
P=I/iN=1093.75
Problem3: How long will it take Rs.800 to yield
Rs.72 in simple interest at 4%.
Problem4: At what rate will Rs.65.07 yield
Rs.8.75 in simple interest in 3 years 6 months
Solution 3: P=Rs.800 , I=72, i=4% N=?
I=PiN,
N=21/4years

Solution 4: P=65.07, I=8.75,

N=3 years 6 months= 3x12+6=42 months
N=42/12years.
Wkt, I=PiN
i=I/(PxN)= 3.8%
Problem5: Find the Ordinary and Exact simple
interest on Rs.5000 at 5% for 56 days
Solution:
Given: P=Rs.5000, i=5%=5/100=0.05, N=56days
Ordinary simple interest
I=PiN=5000x(5/100)x (56/360)=Rs 38.89
Exact simple interest
I=PiN=5000x(5/100)x (56/365)=Rs 38.36
 Compound Interest [C.I]

• This is the method of charging interest on the

interest earned.
• If the borrower does not pay the interest earned at
the end of each period and is charged interest on
the total amount owed.(principal plus interest)the
interest is said to be compounded.
• The interest owned in the previous year becomes
part of the total amount owned for this year.
Example: A loan of Rs1000 at 16% interest compouded
annually for 4 year period will produce results as shown
in table

Table: Calculation of compound interest when interest is paid Annually

Year Amount Owned at the Interest to be Amount Amount to be

beginning of year paid at the Owned at the paid by
end of year end of year borrower at
the end of
year
1 Rs1,000 Rs160 Rs.1,160 Rs.160
2 1,000 160 1,160 160
3 1,000 160 1,160 160
4 1,000 160 1,160 1,160
Table: Calculation of compound interest when interest is permitted to compound

Year Amount Owned Interest to be added Amount Owned Amount to be

at beginning of to loan at the end of at the end of year paid by
year year (B) (A+B) borrower at the
(A) end of year

1 1000.00 1000.00x0.16=160.00 1000(1.16)= 00.00

1160.00
2 1160.00 1160.00x0.16=185.60 1000(1.16)2= 00.00
1345.60
3 1345.60 1345.60x0.16=215.30 1000(1.16)3= 00.00
1560.90

4 1560.90 1560.900x0.16= 1000(1.16)4 1,810.64

249.75 =1810.64
 Compound Interest [C.I]
F=?
Let P=Principal amount
i% i=Rate of interest
p N=No.of years
F1=Compound amount in I yr
F2=Compound amount in I yr
FN=Compound amount in Nth yr
0 1 2 3 N-1 N
Compound amount=principal + principal x Rate of interest
F1= P + P i =P(1+i)
F2= F1+ F1 x i
2
F2= F1(1+i)= P(1+i)(1+i)=P(1+i)
N
Similarly FN= P(1+i)
N
Where (1+i) is known as ‘compound amount factor’
 Nominal Interest Rates
• Interest rates are normally stated on an annual
basis. However agreements may specify that
interest will be compounded several times per
year : monthly, quarterly, semiannually, etc.
• For example , 1 year divided into four quarters
with interest at 2 percent per quarter is
typically quoted as 8 percent compounded
quarterly. Stated in this fashion , the 8 percent
rate is called “nominal annual interest rate”
 Nominal Interest Rates
• The nominal rate of interest (r) is expressed on
an annual basis and is detemined by
multiplying the actual or effective interest rate
per interest period by the number of
compounding periods per year
i. e r= i x m
or i= r/m
 Effective interest rate
Let r=nominal interest rate
i= effective interest rate in the time interval
l= length of the time interval (years)
m=reciprocal of the length of the compounding
period (in years)
The effective interest rate for any time interval is
given by i=(1+r/m)i.m-1
If the interest is compounded only once in the year
then l.m=1 and
i=r/m
• To find the applicable effective interest rate for
any time interval ,the following relationship
may be used:
i=(1+ r/m)C-1, C≥1
where C is the number of compounding periods
in the time interval , C=l.m
i)When C=1 then i=r/m
ii) When C>1, the effective interest rate for any
time interval, i=(1+ r/m)C-1
Problem1 :Find the compound amount of Rs100 for 4 years at 6%
compounded annually

Problem 2: What is the compound amount of Rs750 for 5 years at 6%

compounded quarterly

Problem 3: Accumulate a principal of Rs.1000 for 5 years 9 months at a nominal

rate of 12% compounded monthly. How much interest is earned

Problem 4: Find the difference between the amount of Rs.100 at simple interest
and at compound interest for 5 years at 5%

Problem 5: Find the compound amount of Rs.5000 at 6% for 4,8 and 12 years
and compare the results. Does doubling the time double the amount of
interest earned

Problem 6: Determine the effective interest rate for a nominal annual rate of 6 %
that is compounded.
(a)Semiannully (b) quarterly (c) monthly (D)Daily
 Solution 1: F=?, P=100, N=4 years, i=6%
FN= P(1+i)N =Rs.126.24
Solution 2: F=?, P=750, N=5years=5 x 4 =20, i=6%/4=1.5%.
FN= P(1+i)N =1010.14

Solution 3: P=1000, r=12%, m=12

N=5years 9 month=5 x 12+9 =69, i=12%/12=1.0%.
FN= P(1+i)N =1986.89.
I=F-P=1986.89=1000=986.86

Solution 4: P=100, N=5 years i=5%

S.I, I=PiN=25, F=P+I=100+25=125
C.I FN= P(1+i)N =100(1+0.05)5=127.628
Difference b/w amount =127.628-125=2.63
 Solution 5: F=? P=5000 i=6%
F4=P[1+i]N=5000[1+0.06]4=6312.40 I=F-P=1312.4
F8=P[1+i]N=5000[1+0.06]8=7969.25 I=F-P=2969.25
F12=P[1+i]N=5000[1+0.06]12=10061 I=F-P=5061
• Solution 6: r=6%
Semi-annually, m=2 i=(1+r/m)l.m-1
=0.0609=6.09%
Quarterly, m=4 i=(1+r/m)l.m-1
=0.0613=6.13%
Monthly, m=12 i=(1+r/m)l.m-1
=0.0616=6.16%
Daily, m=365 i=(1+r/m)l.m-1
=0.0618=6.18%
 Example: Find the effective interest rate for the
following cases
1.Nominal rate of 12% compounded monthly with time
interval of one year.
Given: r=12%, l=1
compounded monthly=m=12, C=1 x12=12
i=(1+r/m)l.m-1 =(1+0.12/12)12-1= 0.1268 or12.68%

2.Nominal rate of 18% compounded weekly with time

interval of one year.
Given: r=18%, l=1
compounded weekly=m=52, C=1 x52=52
i=(1+r/m)l.m-1= (1+0.18/52)52-1= 0.1968 or 19.68%
3.Nominal rate of 14% compounded monthly
with a time interval of six months
Given: r=14%, l=1
compounded monthly=m=6, C= 1x6=6
i=(1+r/m)l.m-1 =(1+0.14/6)6-1= 0.1484 or14.84%
4.Nominal rate of 10% compounded weekly with a
time interval of six months
Given: r=10%, l=1
compounded weekly=m=24, C= 1x24=24
i=(1+r/m)l.m-1 =(1+0.10/24)24-1= 0.1049 or 10.49%
 5.Nominal rate of 13% compounded monthly
with a time interval of two years

Given: r=13%, l=2

compounded monthly=m=12, C=2 x12=24
i=(1+r/m)l.m-1 =(1+0.13/12)24-1= 0.2951or29.51%
6.Nominal rate of 9% compounded semiannully
with a time interval of two years
Given: r=9%, l=2
compounded monthly=m=2, C=2 x2=4
i=(1+r/m)l.m-1 =(1+0.09/2)4-1= 0.1925or19.25%
Problem: A credit plan charges interest at the rate of
18% compounded monthly. what is the effective interest
rate.
Given: r=18%, l=1
compounded monthly=m=12, C=1x12=124
i=(1+r/m)l.m-1 =(1+0.18/12)12-1= 0.1956 or
19.56%
Problem: What nominal annual interest rate compounded
monthly yields an effective annual rate of 19.56%
r=? , i=19.56% , m=12, l=1, C=1x12=12
i=(1+ r/m)C-1
 THE TIME VALUE OF MONEY

Rs.1 Rs.1+ Interest

1 2 3
……
. n-1 n
Now

Fig: Illustration of the time value of Money

The change in the amount of money over a given time period is
called the “time value of money”
 THE TIME VALUE OF MONEY
• Because Money can earn at a certain interest rate
through its investments for a period of time.
• A Rs. Received at some future date is not worth
as much as Rs. in hand at present.
• A Rs. in hand now is worth more than a Rs.
Received ‘n’ years from now.
• Because having the Rs. now provides the
opportunity for investing that Rs. for n years more
than the Rs. to be received n years.
• Since money has earning power, this opportunity
will earn a return ,so that after ‘n’ years the
original Rs. plus its interest will be a larger
amount than Rs.1 received at that time
• Thus the fact that “money has a time value means
that equal Rs. amounts at different points in time
have different value as long as the interest rate
that can be earned exceed zero”.
• This relationship between money and time is
illustrated in fig.
• It is also true that money has time value because
the purchasing power of a Rs. changes through
time.
• During periods of inflation the amount of goods
that can be bought for a particular amount of
money decreases as the time of purchase occurs
further out in the future.
• Therefore, when considering the time value of
money it is important to recognize both the
earning power of money and purchasing power of
money.
• Money has a time value because it can earn
more money over time(earning power).
• Money has a time value because its purchasing
power changes over time (inflation).
• Time value of money is measured in terms of
interest rate.
• Interest is the cost of money—a cost to the
borrower and an earning to the lender
 In economic environment, capital is the basic
resource .It can be converted to production of
goods ,consumer goods or services. It has the
power to earn and satisfy wants
From Lenders point of view
• Capital is a fluid resource .
• Capital can be spent on goods expected to
produce a profit or on a personal satisfaction.
• It can be hoarded or given away
 From Lender’s point of view
• It can also be loaned. If it is loaned the Lender
will normally expect some type of
compensation. The common compensation is
interest.
• Interest compensates for the administrative
expenses of making the loan, for the risk that
the loan will not be repaid and for the loss of
earnings that have been obtained, if the money
had been invested for the money
 From Borrower’s point of view
• A loan is both an obligation and an
opportunity.
• A borrower must expect to repay the loan
• Failure to repay leads to a damaged
reputation, loss of possessions and other
consequences.
• The loan offers an opportunity to do
something immediately that would
otherwise have to be delayed.
 From Borrower’s point of view
• In some cases the objective would no longer
exist after a delay.
• To take the advantages of an existing course
of action or to fulfill a current need.
• The borrower agrees to pay a certain amount
in addition to the sum immediately received.
this premium is the interest paid to avoid
waiting for the money
 Cash Flow Diagram [CFD]
• The cash flow is the actual inflow(receipts)
and outflow (disbursements) at different points
in time that occur over the life of an
investment.
• CFD is a pictorial representation of all the
quantities used in computations of compound
interest such as presentamount(p),future
amount (F), rate of interest(i), no. of interest
periods(N) and so on.
 Cash Flow Diagram [CFD]
• A CFD represents receipts received durng a
period of time by an Upward arrow(an increase in
cash) located at periods end.
• The arrows height must be proportional to the
magnitude at the receipts during that period
• Similarly , Disbursements during a period are
represents by a Downward arrow(decrease in
cash).there arrows are then placed on a time scale
that spans all time periods covered by the
proposed investment.
 A TYPICAL CASH FLOW DIAGRAM

Future some F
End of year 1
Starting of the year 1

.-
+0
1 2 3 4
N
Interest i%

Present amount/worth
Principal (P)
 Following are some of the conventions used
while drawing CFD
• The horizontal line is a time scale with time.
The periods are marked to intervals of time 0,
1, 2, 3,……N. These periods can be years,
months, weeks, days etc.
• The arrows signify cash flows and are replaced
at the end of the period. Down ward arrows
represents cash outflows (disbursements),
where as Upward arrows represents cash
inflows (receipts) etc.
 CFD dependent on point of view
Borrower Point of View Fig: (a)
(Loan in Rs)
Rs.1000

1 2 i% 3 4
+ 0
-
…………………………………...
Rs.160
Payments (expenditures)
Rs.1160
 CFD dependent on point of view
CFD: Lender’s Point of View Rs.1160

Fig:(b) Payments (receipts)

Rs.160
………………………………………..
.

+ 0 1 2 3 4
-

Rs.1000
Loan, Rs
 CFD dependent on point of view
• Fig.(a) and (b) represents the same transaction:
a loan paid off in four installments.
• From the borrower’s view point in Fig(a), the
receipt of loan is a positive inflow of Cash,
where subsequent installment payments
represent negative outflow.
• Flows are reversed when viewed from the
lender’s perspective in Fig(b)
Example: I borrow Rs.10000 at 8% per year for 5 years. How
much do I pay back at the end of 5 years? Construct the cash flow
diagram .
Example: Assume you borrow JD8500 from a bank today to purchase an JD8000 used
car for cash next week, and you plan to spend the remaining JD500 on a new paint job
for the car two weeks from now.
Problem: An electrical engineer wants to deposit an amount P now such that she can
withdraw an equal annual amount of A1 $2000 per year for the first 5 years, starting 1
year after the deposit, and a different annual withdrawal of A2 $3000 per year for the
following 3 years. How would the cash flow diagram appear if i 8.5% per year?